In Canada Limited v. The Queen, Canadian Tax Court, following a policy of avoiding double taxation, just approved the use of certain tax avoidance arrangements between Canadian and U.S. businesses. The technique involved claiming Foreign Tax Credits (FTC’s) from the U.S. by creating partnerships between U.S. and Canadian citizens.
As tax law expert Jerald David August of Fox Rothschild LLP explains:
“The FTC provisions in the Code allow a U.S. taxpayer to claim a credit against its U.S. income tax liability for foreign taxes paid or accrued, directly or indirectly, with respect to its foreign source income. FTC generators are complex transactions that are designed to: (i) recover the foreign tax paid claimed as an FTC to avoid any foreign tax cost; or (ii) to eliminate the income that resulted in the FTC; or (iii) transactions which have elements of both (i) and (ii). [IRS] in its 2008 directive noted that the FTC generator is causing a “significant drain” on the Treasury and also has resulted in the Treasury allocation substantial resources to combating transactions that are abusive.”
In 2008 the U.S. Treasury issued regulations attempting to crack down on the use of FTC generators. The Canadian Treasury followed suit and introduced similar regulations. The issue in Canada Limited v. The Queen was to decide the legality of an FTC generator partnership within the framework of the Canadian Treasury regulations. The Court held that the FTC generators in this circumstance were within the law, a holding that August noted that the Court viewed as “consistent with a strong policy in avoiding double taxation.”
Double taxation exists in many ways throughout the tax system, the best example being how corporate income is taxed, and then the earnings paid to individuals in either wages or dividends is taxed again. Double taxation only adds more burdens to economic recovery, increasing transaction costs from tax filing and often transferring resources to the least productive uses. The Treasury claims that using FTC generators are often abusive and reduce tax revenue. However, FTC partnerships are just a rational response to preserving assets for productive uses.
While this case would be viewed at best as merely persuasive authority in U.S. courts, policymakers and judges here would do well to follow the policy of avoiding double taxation from Canada Limited.
