As private equity (PE) continues to grow and thrive in Canada, there are a number of tax considerations investors and investment firms must take note of.
In a think piece on Mondaq, Norton Rose Fulbright associate Andrew Lim said forms of partnerships, particularly limited partnerships, continue to be a preferred private equity vehicle. However, there are tax concerns needed to be understood if partnerships involve non-resident investors.
Lim noted two issues concerning withholding tax and disposition strategies.
With regards to withholding tax, Lim explained that Part XIII of the Income Tax Act requires non-resident persons to pay an income tax of 25% on every amount a resident pays or credits to non-residents.
"For this purpose under paragraph 212(13.1)(b), a payee partnership, other than a "Canadian partnership", is deemed to be a non-resident person. Looking at the definition of 'Canadian partnership' in section 102, this requires all the members of the partnership to be resident in Canada. As confirmed by the Canada Revenue Agency, Part XIII may apply to the entirety of an amount paid to the partnership even where there is a single non-resident member," he said.
As such, Lim stressed that PE funds with several layers of ownership should pay close attention to the residency status of both direct and indirect members. Lim said the partnership still doesn't qualify as a "Canadian partnership" even if the fund is controlled by a resident general partner.
Lim added: "Where a PE fund has partnerships, trusts or other opaque entities as its members, it is not uncommon to seek further representation and warranties from that member as to the residency status of its ultimate beneficial owner(s) to ensure proper characterization."
On the other hand, under Section 116 of the Tax Act, every non-resident that disposes of taxable Canadian property (TCP) is required by the regulator to acquire a certificate of compliance. Without such certificate, the purchaser may be held responsible to collect and remit 25% of the purchase price to the CRA.
"In the context of partnerships, the definition of TCP also includes an interest in a partnership where at any time during a 60-month period that ends at that time, more than 50% of the fair market value of that partnership interest was derived directly or indirectly from one or any combination of real or immovable property situated in Canada, resource property, timber resource property, and options in respect of, or interests in, or for civil rights in, property described in any of subparagraphs (i) to (iii) whether or not the property exists," Lim expounded.
With this rule, the dispositions of the interest in the PE fund partnership could be subjected to Section 116 and Canadian Tax.
Lim furthered that choices for managing the characterization of PE partnership interests as TCP and section 116 requirements include combining TCP and non-TCP assets and maintaining the proportionate value of TCP assets within the fund to keep TCP below 50%.
For CRA, this will need an indication of total gross assets that account for real or immovable property without considering account debts or other liabilities.
Lastly, when looking at disposition and exit strategies, treaty benefits should be considered given that particular non-resident investors may be exempt from Canadian tax, especially when partnership interest form treaty-protected property.
"However, considerable care should be taken before relying on this characterization, as not all tax treaties provide for the exemption of gains derived principally from immovable property. Entitlement to treaty benefits may also require satisfying a comprehensive ‘limitation on benefit’ provision or ‘principal purpose test’ and the consideration of treaty shopping issues," Lim explained.