Restrictions on s. 115.2 safe harbour (p. 86)
The safe harbour contains a number of restrictions. For example, a share in the capital stock of a private portfolio company, or an interest in an unlisted partnership or trust, will not be a "qualified investment" for purposes of the safe harbour where more than half the value of the share or interest is derived from Canadian real estate or resource property. Similar restrictions apply to publicly traded entities where more than 25% of the issued shares of any class of capital stock of the corporation or of the total value of interests in the partnership or trust are owned by the fund. The safe harbour also prohibits certain entities affiliated with a "Canadian service provider" from investing in the non-Canadian fund. Further, the safe harbour will not apply to a fund structured as a corporation or trust if it is promoted principally to Canadian resident investors, or at any time when investments in the fund have been sold to Canadian investors and remain outstanding. Accordingly, reliance on the safe harbour requires a detailed analysis of the non-Canadian fund, its investors, fund sponsor, service providers, and proposed investments.
Goodwill fluctuations relative to real estate may potentially taint private equity investments (p. 86)
Private equity funds currently invest predominantly in Canadian bio-tech, clean-tech, and high-tech companies, the shares of which are unlikely to constitute TCP. However, the value of a company's technology or goodwill may fluctuate, and if the company is operating a plant or has acquired office space, the relative value of such assets may at some point during the prior 60 months cause its shares to be TCP. Accordingly, there is a risk that a non-Canadian private equity fund (or, where the fund is structured as a partnership, its members) [fn 1: Currently, such a fund may file one notification on behalf of all non-Canadian partners on the condition that sufficient information about each individual partner is provided. However, the fund will not be able to file a single tax return on behalf of all of the, partners….] may be subject to the foregoing regime with respect to the disposition of shares of a portfolio company….
Advantages of separate fund for Canadian investors (p. 87)
A non-Canadian private equity fund that expects to have significant investor capital sourced in Canada and to invest in Canadian portfolio companies should consider forming a separate fund restricted to Canadian investors that would invest in parallel with the main fund….In addition to permitting certain tax-deferred entry and exit transactions for Canadian investors, a parallel fund avoids two significant indirect tax inefficiencies associated with investing in a partnership that has one or more non-Canadian members (a "Non-Canadian Fund"):…
Avoidance of s. 116 withholding (p. 88)
[I]f the Non-Canadian Fund Sells property (e.g. shares in the capital stock of a Canadian portfolio company) that are TCP, this can result in the TCP rules being indirectly visited upon Canadian investors.
Avoidance of s. 212(13.1)(b) withholding (p. 88)
[T]he ITA provides that if a payment subject to Canadian withholding tax (e.g., interest, dividends, royalties, etc.) is made by a Canadian portfolio company to a Non-Canadian Fund, the entire payment is treated as paid to a non-resident of Canada…Recently, the CRA has adopted an alleviating administrative policy whereby no amount in respect of the portion of such payments allocable to a Canadian resident partner of a Non-Canadian Fund would be required to be withheld by a Canadian portfolio company. However, this policy, for which there is no legislative basis, does not expressly supersede past contrasting published positions. Some Canadian investors have expressed uneasiness with this uncertainty and are not receptive to investing jointly with non-Canadians in a fund that is subject to Canadian withholding tax. While a concern over withholding taxes is often downplayed where portfolio companies are not expected to pay material amounts of dividends, it should be noted that common exit transactions can nonetheless result in withholding tax arising on net proceeds distributed to a Non-Canadian Fund by way of a dividend or share redemption proceeds.
As a result of these concerns, many Canadian investors insist on the use of a parallel fund. This is typically easier for Canadian private equity fund sponsors to accommodate than for non-Canadian sponsors, who would otherwise not consider forming a Canadian partnership having a Canadian resident general partner.
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