Canada continues to be an attractive market for private equity (“PE“) investors with recent transactions highlighting significant investments into Canadian real estate and energy infrastructure assets.
Partnerships (particularly, limited partnerships) continue to be a popular PE vehicle, providing a means of pooling and aggregating investment funds and allowing for income or losses to be “flowed-through” to its members for Canadian tax purposes, subject to certain exceptions.
However, the use of partnerships with non-resident investors in PE investments raises two particular issues.
Withholding Tax
Part XIII of the Income Tax Act (Canada) (the “Tax Act“), requires that every non-resident person pay an income tax of 25% on every amount that a person resident in Canada pays or credits to a non-resident person. 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[1]. As confirmed by the Canada Revenue Agency (the “CRA“), Part XIII may apply to the entirety of an amount paid to the partnership even where there is a single non-resident member[2].
PE funds involving multiple layers of ownership should therefore pay considerable attention to the residency status of both direct and indirect members. Even where the fund is controlled by a Canadian resident general partner, it will still not qualify the partnership as a “Canadian partnership.”
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.
Section 116
Disposition strategies should also consider the application of section 116 of the Tax Act.
Pursuant to that section, every non-resident person that disposes of “taxable Canadian property”[3] (“TCP“) is required to notify the CRA and obtain a “certificate of compliance”, in the absence of which a purchaser will be liable 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;
- Canadian resource property;
- timber resource property;
- 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.
As a result of this rule, dispositions of the interest in the PE fund partnership could themselves be subject to s. 116 and Canadian tax.
Options for managing the characterization of PE partnership interests as TCP and section 116 requirements include grouping TCP and non-TCP assets together and keeping track of the proportionate value of TCP assets within the fund to keep TCP below 50%. Administratively, the CRA takes the view that this will require a determination of total gross assets that comprises real or immovable property without taking into account debts or other liabilities[4].
Finally, in considering disposition or exit strategies, treaty benefits should also be considered as certain non-resident investors may be exempt from Canadian tax where their partnership interest constitutes “treaty-protected property”[5]. 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[6]. 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.
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[1] s.102(2) also provides a “look-through” rule where a partnership is a partner of another partnership.
[2] See: CRA View, 9716735 “Taxation of Non-Resident Partners.”
[3] See: s. 248 on “taxable Canadian property.”
[4] See: CRA View, 2012-0444091C6 “17 May 2012 IFA Conference Roundtable – Definition of taxable Canadian property.”
[5] Sections 116(5.01), (6) and (6.1).
[6] See: Canada-Luxembourg Tax Treaty and Canada-Netherlands Tax Treaty.
