TAX STRUCTURING FOR CANADIAN INVESTMENT IN LATIN AMERICAN MINING PROJECTS
| Jurisdiction | Derecho Internacional |
(Apr 2013)
TAX STRUCTURING FOR CANADIAN INVESTMENT IN LATIN AMERICAN MINING PROJECTS
Partner, Thorsteinssons
Toronto
Steve Suarez
Partner, Borden Ladner Gervais LLP
Toronto
MICHAEL COLBORNE, Partner, Thorsteinssons, Toronto
STEVE SUAREZ is a partner in the Toronto office of the law firm of Borden Ladner Gervais LLP where his practice is focused on mergers & acquisitions, inbound investment, corporate restructurings and audit management, and tax dispute resolution, with particular focus on the natural resources sector. Steve created and maintains www.miningtaxcanada.com, a website devoted to taxation issues of relevance to the mining community. He is a member of several professional organizations including as a Councillor of the Canadian Branch of the International Fiscal Association and the Co-Chair of Toronto Centre Canada Revenue Agency & Tax Professionals Consultation Group. Steve is a former Chair of the Tax Section of the Canadian Bar Association (Ontario), and a former member of the CBA-CICA Joint Committee on Taxation. He is also a member of the Executive of the Management & Economics Society of the Canadian Institute of Mining, Metallurgy and Petroleum. Steve graduated from University of Toronto in Toronto in 1988. In 1994, he received his M.B. A. from the Ivey School of Business, University of Western Ontario, where he was the Gold Medalist. He was called to the Ontario Bar in 1990, the New York Bar in 1993, and added to the roll of Solicitors (England & Wales) in 1994. Steve has been acknowledged as a leading Canadian tax lawyer by a number of international publications such as Chambers Global: The World's Leading Lawyers for Business 2012 (Tax), International Tax Review: World Tax 2012, The International Who's Who of Corporate Tax Lawyers 2012, and Who's Who Legal: Canada 2012 (Corporate Tax).
Canada is home to more mining companies than any other country, with the Toronto Stock Exchange (TSX) and the TSX Venture Exchange (TSX-V) representing 70% of the equity capital raised globally for mining companies in 2012.1 In many of these cases Canadian mining companies have no actual mining projects in Canada, and the exploration and development is conducted entirely outside Canada. This is because the presence of the TSX and TSX-V and the infrastructure of mining bankers, financiers, lawyers, accountants and geologists in Canada make it desirable to use a Canadian corporation as the investment vehicle, even where the underlying mining project is elsewhere. The result is that many, many mining exploration and development projects are owned directly or indirectly by Canadian corporations.
Latin America is the most common area of the world for a Canadian corporation to hold a foreign mining project. The economies of mining are such that taxes constitute a major expense that can severely affect the viability of a project, especially in a cross-border scenario where the tax system of more than one country is involved. Failing to plan at the outset of the project can be extremely costly.
Obviously different countries within Latin America have different taxation systems, and so it is impossible to produce tax strategies that will work in all circumstances. However, what is possible is to create a high-level conceptual framework for identifying and addressing a number of taxation issues that are generally relevant in different mining projects, no matter what foreign country they are located in. This is the objective of this paper, in the context of a Canadian public company ("Canco") considering investing in a mining project in Latin America.
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Direct versus Indirect Investment
A threshold-level decision that drives many of the tax (and non-tax) issues is whether Canco will own the foreign mining project directly (i.e., through a branch in the source country), or whether the project will be owned by a foreign entity the equity interests in which are owned (directly or indirectly) by Canco. The decision to carry on business outside of Canada directly or through a foreign subsidiary is very important, and the Canadian tax consequences of these two alternatives are very different.
In our experience, it is rare for Canco to own the foreign mining project directly. A separate corporation usually offers limited liability commercially, and in some cases local law may require the use of a separate local entity. A Canadian taxpayer might elect to carry on a foreign venture directly where, for example, losses for tax purposes are expected and these losses could be used by the Canadian taxpayer against income from activities in Canada. However, should it subsequently be desirable to carry on the foreign project through a foreign corporation, the transfer of the venture's assets to the foreign corporation (even if wholly-owned by the Canadian taxpayer) will cause any accrued gains on those assets to be realized for Canadian (and often foreign) tax purposes.
A Canadian mining corporation may choose to conduct foreign mining operations through a separate foreign entity (typically a corporation) for a number of reasons:
• a separate entity resident in the source country may obtain more favourable tax treatment under the laws of that country;
• if the source country tax rate on income from the project is less than the Canadian tax rate that would otherwise apply if the Canadian resident earned such income directly, there may be either an absolute savings of tax or a deferral of Canadian tax created by carrying on the project through a separate foreign entity. In fact, from a Canadian tax perspective, where the foreign venture is carried on through a foreign entity that is a "foreign affiliate" of a Canadian mining company, Canada may effectively forego taxation of income earned in the foreign mining venture, via the exempt surplus system described below;
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• a separate local entity allows greater flexibility in terms of repatriation of funds from the foreign project and the timing of how they are taxed; and
• carrying on the foreign venture through a separate entity offers the possibility of selling the foreign venture (or an interest in the foreign venture) either at the project level itself (i.e., the assets located in the foreign country) or at the entity level (interests in the foreign entity).
Most of the tax advantages of using a separate foreign entity depend on that entity not being a resident of Canada for tax purposes, and instead being a resident of another country. In general, for a corporation this requires that the entity be created under the laws of that foreign country (not Canada or a province thereof)) and that the "central management and control" of the corporation be located in that foreign country. Typically "central management and control" of a corporation is considered to reside with the board of directors of the corporation, although if the directors have no real authority (or habitually do not exercise such authority), it may be determined to lie elsewhere. Where the foreign country has a tax treaty with Canada, that treaty may also include provisions relevant to establishing the residency of an entity for tax purposes.
As noted, foreign mining projects are rarely held directly by Cancos, and the balance of the paper proceeds on the basis that Canco creates the shares of a foreign subsidiary corporation ("Mineco") that is the direct owner of the relevant interest in the mining project.2
Identifying Relevant Tax Objectives
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There are a number of tax objectives that should be considered at the outset of the investment, some of which are longer-term in focus than others. As the initial structure put in place is often difficult and costly to amend later on, it is advantageous to consider both immediate and future tax issues when planning the investment. In this regard, it is essential to keep in mind both tax issues in the particular Latin American country where the mining project exists (the "source country") and Canadian tax issues. Depending on the facts, tax issues in third countries (e.g., any country in which a significant Canco shareholder is resident, or any country in which a holding company used in the structure is resident) may also become relevant.
In general terms, the following tax objectives are ones that should be considered before the investment is made:
• Minimize source-country taxes from operations: it is important to make sure that any expenditures made retain the greatest possible potential for reducing source-country taxes on income from the project. As generally there is little or no taxable income produced in the early years of most projects, this may often require planning to defer expenses, use any available loss carryforward regimes, or otherwise ensure that deductibility is not lost due to timing limitations.
• Minimize Canadian accrual-basis taxation of source country income: it is generally desirable to defer Canadian taxation of income from source-country taxation as long as possible. The extent to which this can be achieved depends on whether the income earned by Mineco is, for Canadian tax purposes, treated as "foreign accrual property income" (FAPI) and imputed to Canco under Canadian anti-deferral rules.
• Minimize source-country taxation of amounts repatriated: to the extent that Mineco makes payments out of the source country to Canco or other members of the Canco group (e.g., interest, dividends, royalties, etc.), it is desirable to minimize the extent to which the source country levies withholding taxes on such payments.
• Minimize Canadian taxation of amounts repatriated: minimizing or preventing Canadian taxation of amounts received from Mineco is also an important tax objective. In the case of dividends paid by Mineco, Canada may exempt the dividend entirely or tax it with a credit...
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