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David Rotfleisch on Form T1134 For Foreign Affiliates: How the T1134 Canadian Income Tax Form Is Used in Reporting Foreign Affiliates to CRA

posted 1 year ago

What is Form T1134? – Introduction by a Toronto Tax Lawyer

Residents of Canada are subject to income tax under the Canadian Income Tax Act on their worldwide earnings. Multinational business structures are effective from a financial and operational perspective, and they are frequently required in order to transact with certain entities located outside of Canada. The Canada Revenue Agency, however, is troubled by the practical challenges involved in observing foreign investment and commercial activity. The Income Tax Act mandates that Canadian taxpayers disclose any income originating from or assets located in a foreign jurisdiction in order to help address this problem. The focus of this article will be on Canadian taxpayers’ obligations to file form T1134 with the CRA with regard to their active foreign affiliates, the penalties for doing so, and the exemptions from what are becoming increasingly onerous reporting requirements.

T1134 Reporting Requirement

Each “reporting entity” is required to submit a prescribed form under subsection 233.4(4) of the Income Tax Act “in respect of each foreign affiliate of the entity”.  According to paragraph 233.3(1)(a), “reporting entity” is defined to include a resident taxpayer “of which a non-resident corporation is a foreign affiliate at any time in the year”. A corporation based outside of Canada is considered a foreign associate of a resident taxpayer under subsection 95(1) of the Tax Act if:

  • 1% or more of the taxpayer’s shares in the corporation are held in equity; and,
  • The combined equity percentages of the taxpayer and each “person” related to the taxpayer are at least 10%.

The definition is intended to cover situations when a single taxpayer owns 10% or more of a foreign corporation, or where a taxpayer owns 10% or more of a foreign corporation together with related parties (described below). A corporation is considered a “person” under subsection 248(1) of the Tax Act, and the definition of “related persons” under subsection 251(2) of the Income Tax Act encompasses not only relationships based on blood, marriage, common-law partnerships, or adoption but also instances in which corporations are controlled by individuals who are related to one another. For the purposes of this article, it is sufficient to say that related individuals cannot simply avoid the regulations of the Income Tax Act by utilizing the corporate form because the laws relating to foreign affiliates and related persons under the Income Tax Act are extensive.

The Revenue Canada T1134 “Information Return Relating to Controlled and Not-Controlled Foreign Affiliates” is the form that each reporting entity is required to complete and submit. The reporting entity is required to provide the CRA with information about the foreign affiliate on Form T1134, including but not limited to: the book value of the shares in the foreign affiliate that it owns, any sums owed to the foreign affiliate by the reporting entity and vice versa, consolidated financial statements of the foreign affiliate (if available), the foreign affiliate’s total assets, its net income, and any taxes paid or owed by the reporting entity, and if there is any foreign accrual property income (FAPI) earned during the reporting period from the foreign affiliate. A thorough examination of a foreign affiliate’s financial position and business activities is required to complete the T1134, which is a difficult undertaking that almost probably necessitates the help of one of our knowledgeable Toronto tax lawyers.

The 2021 T1123 updates may be accessed here.

Form T1134-Related Penalties

Failure to file form T1134 on time entails hefty penalties that increase in severity. According to subsection 162(7) of the Income Tax Act, the simple failure to file form T1134, regardless of intention or knowledge, results in a $2,500 penalty for each year the form is not filed. For tax years beginning after 2021, the T1134 form must be submitted 10 months after the reporting entity’s tax year ends. These penalties will be subject to interest.

The new T1134 form, which is effective for the tax year beginning in 2021, states that penalties will be imposed if the taxpayer provides erroneous or missing information on the T1134.

Every person or partnership who “knowingly or under circumstances amounting to gross negligence” fails to file a T1134 as and when required is subject to a penalty of $500 per month up to a maximum of 24 months, or $12,000, for each failure to file form T1134. This is stated in subsection 162(10) of the Income Tax Act. Additionally, under subsection 162(10.1) of the Income Tax Act, if the requirements of subsection 162(10) have been met and more than 24 months have passed since form T1134 was required to be filed with CRA, the penalty is equal to 5% of the “greatest of all amounts each of which is the total of the cost amounts to the person or partnership at any time in the year or period of a property of the person or partnership that is a share of the capital stock or indebtedness of the affiliate”. These penalties will be subject to interest.

As a result, it is clear that neglecting to file form T1134 carries serious consequences that could severely impact a taxpayer’s operation, particularly if multiple years’ worth of penalties are assessed after a CRA tax audit.

Exemption from the Due Diligence Rule for Incomplete Information

The entity submitting the T1134 must have specific information, which might not be available by the form’s filing deadline. As a result, the Canada Revenue Agency offers a due diligence exception for reporting entities to submit incomplete T1134 forms in the following circumstances:

  • The individual or partnership filing the T1134 does not have access to the information on the date the form is submitted.
  • When submitting the T1134, the individual or partnership makes an honest disclosure that the information is unavailable.
  • The individual or partnership made a sincere effort to obtain the information.
  • At the time of the transaction, it was reasonable to anticipate that the person or partnership would be provided with enough information for all transactions that had an impact on information on the T1134 that had taken place after the T1134’s inception in March 1996.
  • Within 90 days of it becoming accessible, the individual or partnership supplies the missing information.

Exemption from the Reporting Obligation for the First Year

The requirement to submit form T1134 to the Canada Revenue Agency is exempt from certain circumstances. . Individuals, as defined in paragraph 248(1) of the Income Tax Act to exclude corporations, are exempt from filing a T1134 for the year in which they first became Canadian residents. This excludes circumstances in which a former resident returns to Canada after having lived abroad for some time.

Reporting Requirements for Foreign Affiliates That Are Dormant

For the purposes of the T1134, dormant foreign affiliates fall under a specific corporate classification that is exempt from some T1134 reporting requirements. In 2021, these exclusions as well as the definition of “dormant foreign affiliates” changed. For the tax years beginning in 2021 and thereafter, the revised definition and filing exemption will be in effect.

Keep in mind that the dormancy issue is inapplicable if the taxpayer’s holdings in foreign affiliates cost $100,000 or more in total.

Gross receipts and fair market value amounts are the two requirements that must be met for a foreign affiliate to be considered dormant. According to the information section of form T1134, “gross receipts” refers to “any receipt received in the year” and “includes all non-revenue receipts, such as loans, etc.” According to what the term implies, a foreign affiliate’s degree of activity rather than its revenue or profitability determines whether or not it is “dormant.”

Form T1134 leaves room for uncertainty by stating that the fair market value of the foreign affiliate’s assets, and not their cost, is the relevant factor when determining whether or not a specific foreign affiliate is “dormant”. While it is reasonable to expect taxpayers to maintain track of the cost value of a foreign affiliate’s assets, it is frequently difficult to determine fair market value until the assets are sold to third parties at arm’s length on the open market.

This uncertainty aided a taxpayer, as in the case of Desmarais v The Queen, 2013 TCC 356, who neglected to file T1134-A (the forerunner to the contemporary form T1134) in relation of a foreign affiliate of the taxpayer. In the case of Desmarais, the CRA reassessed the taxpayer (an individual) in 2010 for the taxation years 2003 and 2004 in order to impose penalties against the taxpayer under subsection 162(7) of the Income Tax Act due to the taxpayer’s alleged failure to file form T1134-A with the Minister in relation to a foreign affiliate of the taxpayer. The Minister was required by subparagraph 152(4)(a)(i) of the Tax Act to demonstrate that the taxpayer had made a representation “attributable to neglect, carelessness, or wilful default” when he failed to file form T1134-A for the 2003 and 2004 taxation years because the reassessment was far outside the typical three-year reassessment period, or statute barred.

The following describes the corporate structure:

  • A non-resident corporation named “OREX” had 29% of its shares owned by the taxpayer;
  • AIMO, a different corporation, had about 49% of its shares owned by OREX; and,
  • 20% of the stock in the Russian company “Okhotsk” was owned by AIMO.

Based on the fact that AIMO sold its 429 shares of Okhotsk for $7,500,000 (USD) on June 30, 2006, CRA argued that OREX was not a “dormant” foreign affiliate as defined by form T1134-A because the fair market value of OREX’s investment in AIMO during the 2003 and 2004 tax years was greater than $1,000,000 (CAD). Contrarily, the taxpayer maintained that OREX was in fact “dormant” and offered the following proof:

  • The book value of investment in Aimo at one Swiss Franc listed in the financial statements of OREX as of December 31, 2002; and
  • The 429 Okhotsk shares that AIMO had, valued at $3,689 based on its financial statements for the tax years 2003 and 2004.

In light of the fact that “the market value of AIMO’s investment in Okhotsk was only really determined at the time of the redemption, in August 2006, of the 429 shares for US$7,500,000, and it was not until then that it became possible to establish with some degree of certainty the fair market value of OREX’s investment in AIMO,” the Tax Court of Canada accepted the taxpayer’s appeal and overruled the tax assessments. Essentially, the taxpayer did not make any misrepresentation “attributable to neglect or wilful default” by failing to file form T1134-A because there was uncertainty regarding the value of OREX’s investment in AIMO during 2003 and 2004, and as a result,  the Canada Revenue Agency did not meet the evidentiary burden necessary to permit the CRA to reassess the taxpayer in Desmarais outside of the customary three-year period.

The Desmarais case serves as an illustration of potential problems that can occur when a reporting requirement is based on the fair market value, rather than the cost, of an asset held by a foreign affiliate. This is because fair market value frequently becomes apparent only after the asset is sold, whether by the specific taxpayer or by another holder of the asset. Revenue Canada appears to have been trying to either make a show of the taxpayer in Desmarais or set a precedent for levying type penalties under section 162(7) of the Tax Act. After all, reassessing statute-barred taxation years and going to court for $5,000 in penalties is illogical on its own.

2021 and beyond

The T1134 Summary and the “T1134 Supplement” are the two sections of the T1134 form. The supplement gives more details on the taxpayer’s foreign affiliates than the T1134 Summary does. Except for dormant foreign affiliates, each foreign affiliate of the taxpayer shall file a separate T1134 Supplement. Foreign affiliates that are dormant need only be noted on the T1134 Summary.

If a foreign affiliate is “dormant” throughout the reporting period and the total cost to the taxpayer of its stake in all of the foreign affiliates of the taxpayer is less than $100,000, no “T1134 Supplement” is required for that dormant foreign affiliate. A foreign affiliate that is dormant meets the following criteria:

  • Had annual gross receipts (including the proceeds from selling property) of less than $100,000; and
  • Had no assets with a total fair market value of more than $1,000,000 at any point in the year.

2020 and earlier

When a foreign affiliate is “dormant” throughout the reporting period and the total cost of the taxpayer’s interest in all of the foreign affiliates is less than $100,000, the taxpayer was not required to file form T1134 in 2020 or earlier. The following foreign affiliates were listed as dormant foreign affiliates:

  • Had annual gross receipts of less than $25,000 (including the proceeds from the sale of property); and,
  • Had no assets with a total fair market value of more than $1,000,000 at any point in the year.

Canadian Tax Lawyers’ Voluntary Disclosure for Failing to File Form T1134

The requirement for taxpayers to submit Form T1134 is a complex reporting requirement that frequently necessitates a thorough review of the provisions of the Canadian Income Tax Act with the help of one of our top Canadian tax lawyers. CRA’s Voluntary Disclosures Program may be available to a taxpayer who has not submitted Form T1134 as required if:

  • You have not heard from CRA regarding the failure to submit form T1134;
  • You’ve had at least a year since you had to submit the form T1134;
  • A penalty is imposed for failure to submit form T1134; and
  • The voluntary disclosure details every instance of the taxpayer’s failure to comply with the Income Tax Act.

A taxpayer has a solid chance of successfully making a voluntary disclosure to CRA for failing to file form T1134 as and when necessary if the aforementioned conditions are satisfied. A successful voluntary disclosure totally waives all fines, eliminates the threat of criminal prosecution, and frequently provides some interest relief on any potential tax liabilities. The voluntary disclosures program is perfectly suited for failed reporting duties under the Income Tax Act because the penalties are harsh and the taxes owed are frequently very little or nonexistent.

T1134 Requirements – The Conclusion

The historically common practice of moving assets and operations outside of Canada now comes with the more onerous reporting requirements imposed by subsection 233.4(4) of the Income Tax Act and, by extension, form T1134. This is frequently done in an effort to reduce domestic income taxes owing by taking advantage of lower income tax rates in offshore jurisdictions. Taxpayers who fail to fulfill their duty to file form T1134 with the Canada Revenue Agency when necessary could incur severe penalties.

There are exceptions to the T1134 reporting requirement, but even those exceptions frequently require taxpayers to keep meticulous records and accurately assess their foreign affiliates—tasks that may be too much for one person or a small, privately held corporation to handle. Our leading Toronto tax lawyers have in-depth knowledge of the CRA’s Voluntary Disclosures Program and are very experienced in determining whether you must submit a T1134 with regard to your foreign affiliates.

Disclaimer:

“This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the articles. If you have specific legal questions, you should seek the advice of a lawyer.”

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