Bermuda announces Tax Information Exchange Agreement with Canada

On 7 May 2009, the Bermuda Ministry of Finance announced a tax information exchange agreement with Canada (“TIEA”). Bermuda government sources indicate that Canada has committed to sign and bring the agreement into force before September 2009.

While the terms of the TIEA have not been made publicly available, the TIEA will provide for the exchange of informationrelating to criminal and civil tax matters. TIEAs are not new for Bermuda – the Bermuda/USA TIEA has been in force for over 20 years. Bermuda currently has 11 TIEAs in force and completed negotiations for 4 further TIEAs.

“Designate Treaty Country” = Tax Savings

As a consequence of the 2007 Canadian Budget, once the Canada/Bermuda TIEA comes into force Bermuda will become a “designated treaty country”1. As a result certain income earned by a Bermudian subsidiary and remitted to its Canadian parent corporation will be eligible for favorable Canadian tax treatment. The same treatment was previously only available to foreign affiliates resident in countries that have entered into a double taxation treaty with Canada (e.g. Barbados, Ireland, Cyprus). Unlike Canada’s double taxation treaty partners, Bermuda does not levy any corporate income tax, capital gains tax or withholding tax, accordingly Canadian corporations may realise tax savings by using a Bermuda subsidiary as part of their overseas structure.

Background

Canada has a partial exemption and partial credit regime for dividends paid by a foreign subsidiary to its Canadian parent, dependent on whether or not the dividends are derived from active business income earned by a foreign affiliate resident in a designated treaty country or a country which has a TIEA with Canada. Active business income earned by a foreign subsidiary will only be subject to Canadian tax when it is repatriated to Canada by way of a dividend to its Canadian parent. If the dividend is paid out of the subsidiary’s “exempt” earnings it can generally be received by the Canadian parent without any Canadian tax. If paid from the subsidiary’s “taxable” earnings the Canadian parent is required to include the dividend in income but is entitled to a deduction based on a gross-up of the foreign tax paid by the subsidiary. This deduction will not fully off set the income inclusion to the Canadian parent, where the foreign income is earned in a low or no tax jurisdiction. Accordingly a Canadian parent will seek to structure its international operations, intra-group financing and licensing so that the subsidiaries generate exempt income.

A further consequence of the 2007 Canadian Budget is that Canadian parents of subsidiaries based in countries which fail to enter into a TIEA with Canada within 60 months of a ‘written invitation to enter into negotiations’ will become subject immediate attribution of active business income – a form of punitive taxation. Accordingly a Canadian multinational which uses Bermuda in its overseas structure will take comfort it will not need to alter the structure in the future to avoid this punitive tax.

Conclusion

Once the Canada Bermuda TIEA is in force, it will become possible to earn active business income through a Bermudian subsidiary and repatriate that income to Canada without any Bermudian or Canadian tax (since Bermuda does not impose any corporate income or withholding tax on dividends). Accordingly, Bermuda will become an even more attractive jurisdiction for Canadian corporations looking to set up certain types of off shore operations.