CRA applies the tax avoidance test in the non-portfolio property rule to the hypothetical Canadian tax treatment of dividend distributions rather than of underlying earnings

CRA considered whether s. 94.1 would impute  foreign accrual property income to an LLC  subsidiary (BCo) of Canco on its investment in another LLC (CCo) which had an indirect investment in a non-resident corporation (Opco) with an active business.  CRA discussed the tax avoidance test in s. 94.1(1), which refers to the income from non-portfolio invetments being subject to income tax that is significantly less than the income tax that would be applicable if earned directly by the taxpayer.  CRA stated that this test would not be satisfied (so that s. 94.1 would not apply) because the earnings of Opco could be distributed up the chain out of exempt surplus.  Thus, CRA interpreted this test as referring to the Canadian tax treatment of such distributions rather than the Canadian tax treatment of the business earnings if they had been earned directly by Canco in a branch business.

CRA also noted that if (contrary to the facts before it) "Canco's economic investment in Opco were substantially less than 10%, then we suggest that the CRA might consider the application of [s. 95(6) or GAAR] to say that the Class B shares [of CCo] were issued only to take advantage of the foreign affiliate status."

Neal Armstrong.  Summary of 10 January 2011 Memorandum 2009-0342861I7 under s. 94.1(1).