Taking Advantage of the Double Tax Treaty with Barbados
Andrew Rogerson LLB (Hons) TEP
Barbados, in common with most offshore finance centres, provides a favourable tax regime for International Business Corporations ("IBC"s). IBC status is given to companies that are carrying on the business of international manufacturing or international trade or commerce. Broadly speaking, these activities have to be carried out in Barbados, with exports or the provision of services being to countries outside the Caricom area. Currently Barbados' taxation of IBC's is at the rate of 2.5% for the first US$10m of their profits and gains, reducing to 1% on such over $30m. Pursuant to s13.1 International Business Companies Act (1991) dividends paid by an IBC to a non-resident are free from withholding tax.
Barbados has a Double Tax Treaty with Canada, which was signed in 1980.
Pursuant to s113(1)(a) ITA dividends from active business income earned by foreign affiliates based in treaty partner countries (such as Barbados) are effectively exempt from Canadian tax when distributed to Canadian resident shareholders (individual or corporate).
The definition of "active business income" is to be found in Foreign Accrual Property Income ("FAPI") rules. The FAPI deeming provision found in s91(1) ITA, requires a Canadian resident to include in his income his appropriate share of the income of a controlled foreign affiliate. I will now attempt to provide a very basic explanation of FAPI to put the Barbados advantage into context.
FAPI is essentially passive income that has been diverted through inter-corporate charges from the income tax base of related Canadian resident taxpayers to a controlled overseas affiliate. The Rules are designed to prevent the erosion of the Canadian tax base. They apply to various kinds of Canadian source income , including income from selling property, interest and leasing income and income from providing certain services (see s95(2) ITA).
Active business income is everything that is not FAPI. It typically includes income from manufacturing processing, transportation, services and other activities that require a high level of involvement of people. However pursuant to an elaborate set of rules under s95(2)(a), some income that is prima facie FAPI, in the nature of interest, rents and royalties, is deemed to be active business income with all the benefits that flow from this, provided it receives such income from another member of a "corporate group". Thus, although the main activity of a corporate group is the production of active business income, it may transfer income that would be characterised, in isolation, as FAPI within the group and it retains its nature as active business income.
Pursuant to s95(1) ITA a non-resident corporation such as a Barbadian IBC is deemed to be a "foreign affiliate" of a Canadian resident shareholder (individual or corporation), if the Canadian resident, who alone or together with other persons, owns at least 10% of the of the shares of a class or series of the IBC and the Canadian resident holds a minimum of one per cent thereof.
Paragraph 113(1)(a) ITA allows a full deduction for dividends paid out of "exempt surplus". Exempt surplus of a foreign affiliate is active buses income earned by a foreign affiliate of the taxpayer resident in a designated treaty country.
The net result of the above is as follows. A Canadian resident corporation establishes a foreign affiliate in Barbados in the form of an IBC. The IBC makes $100 profit. Barbadian tax on the profit is levied at 2.5% leaving $97.50 to be remitted by the Barbadian foreign affiliate to its parent company in Canada. The parent company receives the dividend completely free of Canadian taxation.
Foreign affiliates engaged in the following areas: captive insurance, third party licensing and financing and bond trading, must employ more than 5 employees in Barbados in the active conduct of their business.
On a related issue, capital gains of a Barbados trust realised in Canada are taxable under the treaty in Barbados only. Thus, a Barbados trust may often be effectively utilised to hold shares in a Canadian company or in real estate transactions.
Andrew Rogerson is an Ontario Barrister, Solicitor & Notary Public with substantial experience in offshore tax havens. He is a Fellow of the Society of Trust and Estate Practitioners (STEP) whose practice encompasses Estate Planning and Asset Protection. Contact Andrew Rogerson
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