23 May 2013 Roundtable Q. , 2013-0485311C6
Principal Issues: Will s. 94.1 apply to an investment in an offshore mutual fund?
Position: Possibly
Reasons: All of the conditions in s. 94.1 must be met, including the "one of the main reasons" test.
2013 International Fiscal Association Annual Conference May 23/24, 2013
Question # 1: Offshore Investment Funds
A taxpayer resident in Canada invests in an offshore mutual fund because it wishes to take advantage of the investment expertise of the fund managers. The fund is resident in a country that does not levy an income or profits tax on the income earned by the fund; nor is there a withholding tax on payments made by the fund to the Canadian resident. The mutual fund is widely held, and is not a foreign affiliate of the Canadian taxpayer. Will section 94.1 of the Income Tax Act (the "Act") apply to the Canadian taxpayer with respect to the interest in the fund?
Response
One of the conditions for the application of section 94.1 is that one of the main reasons for the taxpayer acquiring, holding or having the interest in the offshore investment fund property was to derive a benefit from portfolio investments in certain assets in such a manner that the taxes on the income, profits and gains from the assets for any particular year are significantly less than the tax that would have been applicable under Part I of the Act if the income, profits and gains had been earned directly by the taxpayer.
Based on case law on the "one of the main reasons" test in other provisions of the Act, it is our view that tax reduction or deferral does not have to be the only reason, or even the main reason for the investment; it merely has to be one of the main reasons. A particular fund manager's expertise may be another of the main reasons for the investment. The onus is on the taxpayer to prove that none of the main reasons for the investment is tax reduction or deferral. In John S. Walton v The Queen, 98 DTC 1780, the court, quoting the Supreme Court of Canada, said that it will "look for objective manifestations of purpose, and purpose is ultimately a question of fact to be decided with due regard for all of the circumstances". We generally would expect that a Canadian taxpayer investing in a mutual fund resident in a tax haven country would be subject to section 94.1 of the Act.
Bill C-48, currently before Parliament, contains enhancements to section 94.1 of the Act that were announced in the Federal Budget on March 4, 2010. The "one of the main reasons" test remains the same under Bill C-48.
Sherry Thomson
2013-048531