Taxpayers that have implemented cross-border tower financing structures and that have claimed a Canadian tax deduction for any U.S. taxes paid should revisit their structures carefully in light of the Tax Court of Canada’s recent decision in FLSMIDTH Ltd. v. The Queen (2012 TCC 3), which is the Court’s first decision concerning tower structures.
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The primary tax benefit of the typical tower structure is an interest deduction in both Canada and U.S. in respect of the same borrowing. However, in certain tower structures, a spread is earned by a U.S. entity based on the amount of interest that is received by that entity from lower-tier entities in the structure and the amount of interest that is paid by the entity on external bank financing. This spread is typically subject to U.S. federal income tax.
In FLSMIDTH Ltd. v. The Queen, the viability of the double interest deductions was not at issue; rather, the issue was whether an additional deduction under subsection 20(12) of the Income Tax Act (Canada) (the “Act”) was available under the Act with respect to the U.S. income tax that was paid on the spread.
Generally, the taxpayer would be entitled to the deduction under subsection 20(12) of the Act for the U.S. tax paid if two conditions were met:
1. the tax must have been paid in respect of a source of income under the Act; and
2. the U.S. tax must not reasonably be regarded as having been paid in respect of income from the share of a capital stock of a foreign affiliate of the taxpayer.
The Tax Court agreed that the U.S. tax was paid in respect of a source of income for purposes of the Act, even though that specific source of income (i.e., income that was characterized as interest for U.S. tax purposes) was not itself subject to tax under the Act; however, the Tax Court denied the deduction on the basis that the tax was in respect of income from the share of a foreign affiliate of the taxpayer. Central to the Court’s decision was the broad interpretation that is to be given to the term “in respect of” for purposes of the Act.
Taxpayers that have implemented tower structures and that have claimed a subsection 20(12) deduction on any U.S. tax paid should reconsider their structures and contact a tax advisor to discuss the potential implications of this case in their particular circumstances.
At this time it is unclear whether the taxpayer will appeal this decision to the Federal Court of Appeal.