Dealership investments in captive insurers and Form T1134: Filing requirements

Recently, the Canada Revenue Agency (CRA) has increased audit activity relating to Canadian  investments in captive insurers and the related information return filings.

Some Canadian dealerships have historically held interests in non-resident insurance and reinsurance corporations (i.e., Captive Insurers). In a typical arrangement, a dealer would hold all shares of a specific class in the Captive Insurer, which would entitle the dealer to earnings generated by the assets invested by that particular dealer (and not the earnings of the Captive Insurer as a whole). While this seems like a relatively simple premise, these investments in Captive Insurers are being subject to increasingly complex tax reporting requirements where an error can result in extensive penalties.

Prior to the 2018 Federal Budget, Canadian dealers were required to file Form T1134 Information Return Relating to Controlled and Non-Controlled Foreign Affiliates if they held an interest in a non-resident Captive Insurer and that Captive Insurer was a “foreign affiliate” of the dealer. To determine if the Captive Insurer is a foreign affiliate, one would look to the percentage of shares owned by the dealer and any person related to the dealer.

If the Captive Insurer was a “controlled foreign affiliate” (CFA) of the dealer, meaning the dealer held more than 50 percent of the voting shares — either alone, with related parties, or in conjunction with the four largest other Canadian shareholders — then the dealer may also have had a requirement to report passive income earned by the Captive Insurer, known as foreign accrual property income (FAPI). Prior to the 2018 Federal Budget, FAPI reporting was less of a concern because it was uncommon for Canadian dealerships to have enough ownership in a Captive Insurer for the Captive Insurer to be considered a CFA. This changed with the introduction of the Tracking Interest Rules in the 2018 Federal Budget.

The Tracking Interest Rules were specifically designed to capture arrangements where a Canadian shareholder holds their interest in a non-resident through a share class or series that “tracks” its earning to the individual earnings of the shareholder and the assets contributed by that shareholder. Following the introduction of the Tracking Interest Rules, the assets, liabilities, and earnings of a specific tracking share class will be deemed to be a separate business carried on by the non-resident — but which the Canadian shareholder will generally be considered to wholly own and control. The business is effectively treated as a CFA for reporting purposes. As a result, many of the Canadian dealers with investments in Captive Insurers fell within these rules and were required to file T1134s and start reporting FAPI for taxation years beginning after February 26, 2018.

For taxation years beginning after December 31, 2020, Form T1134 was significantly revised; the new form includes questions specifically addressing tracking interests as well as requiring other additional disclosures. The filing due date for Form T1134 has also been pushed up to 10 months after the dealer’s year-end (previously 12 months). Due to the increased reporting complexity and reduced time to prepare the forms, the potential for T1134 penalties has also increased. There is a basic penalty of $25 per day up to 100 days, with a maximum of $2,500 for each T1134 not filed. The penalties can increase to $1,000 per month to a maximum of $24,000 for each T1134 not filed if CRA issues a demand to file and the taxpayer fails to comply.

The CRA has increased their compliance activity in the captive insurance investment area as they look for arrangements caught by the Tracking Interest Rules or where T1134s were not historically filed. If taxpayers are found to be non-compliant with their filing obligations, penalties can quickly add up, especially in respect of taxation years impacted by the new Tracking Interest Rules. 

Key Takeaways:

• The changes to Form T1134 and to the taxation of FAPI related to captive insurance arrangements add complexity to the reporting process. Assistance from a tax advisor who is well versed in these areas will be important. Reporting errors or failure to file these forms can result in costly penalties as well as increased scrutiny from CRA.
• If you are selected for a tax audit as part of the increased CRA focus in this area, contact your tax advisor immediately for assistance. MNP has a team of dedicated professionals that can help guide you through the audit process.

Contact us

For more information about the Tracking Interest Rules, how it impacts your business, and the related information reporting requirements, contact Tim Bloos, CPA, CA, LL.B., B.C.L., Partner, International Tax, at 416.515.3888 or [email protected]