CRA rules that a 2-step distribution (PUC increase and distribution) by a ULC sub of U.S. parent avoids the anti-hybrid rule even though the distribution is funded by a hybrid dividend

A Canadian holding company (‘Holdco") is wholly-owned by the unlimited liability company subsidiary ("ULC") of the U.S. parent, with the exception of exchangeable preferred shares held by Canadian taxable investors. ULC (which is fiscally transparent for U.S. purposes) will increase the stated capital of its shares held by U.S. parent, and then use a dividend received from Holdco to fund a distribution to U.S. parent of the resulting paid-up capital.

The fact that this PUC distribution will be funded out of a hybrid dividend (i.e., a dividend which for Code purposes will be treated as being paid directly to U.S. parent) is irrelevant for purposes of the anti-hybrid rule in Art. IV, para. 7(b) of the Canada-U.S. Treaty. CRA gave its standard ruling that the s. 84(1) deemed dividend arising on the stated capital increase by ULC will be subject to a Treaty-reduced (5%) rate of Part XIII tax.

Neal Armstrong. Summary of 2014 Ruling 2014-0534751R3 under Treaties, Art. 4.