Background to introduction of Foreign-Affiliate Dumping rules (p.2)
[P]art of the Advisory Panel’s mandate was to provide recommendations to improve Canada's international tax policy respecting investment into Canada by foreign businesses and foreign investment by Canadian businesses….[fn 5: The Advisory Panel on Canada's System of International Taxation, "Enhancing Canada's International Tax Advantage", 2008]… .
The Department of Finance adhered to the principles embraced in the Advisory Panel report by repealing the broader rules in section 18.2 and introducing the FAD Rules….
[W]hereas the initial flurry of amendments included substantive changes in direction and tax policy to the FAD Rules themselves, more recent changes could be described as substantive tweaks designed to allow the rules to work better within a certain policy framework. As such, it is more likely that future amendments will be designed as either tightening or relieving measures to fit within a now (generally) established framework.
Purpose of s. 212.3(1)(b)(i) safe harbour (p. 3 at f.n. 7)
The purpose of the safe harbor rule is to reduce impediments to corporate takeovers. The rules recognize that, if a non-resident corporation does not own, at the investment time, an equity interest in the CRIC that allows the non-resident corporation to materially influence the CRIC's investment decisions (i.e., 25% or more of the CRIC's equity as measured by votes or value), then the non-resident cannot generally be considered to have caused the CRIC to make an investment in anticipation of the non-resident acquiring control of the CRIC.
Exclusion from s. 212.3(1)(b)(ii) safe harbour for preferred shares (p. 3 at f.n. 8)
[I]n essence, the "safe harbour" provision in subparagraph 212.3(l)(b)(ii) does not apply to investments in preferred shares. The FAD Rules generally do not look favourably on investments in preferred shares, as is also evidenced by subsection 212.3(19) which overrides certain rollover exceptions in subsection 212.3(18) or the "bona fide business" exception in subsection 212.3(16) in respect of investments in preferred shares.
Prevention of structured access to 30% intra-Canadian exception (p.5)
[G]iven that the CRIC must be controlled by a non-resident person in the first instance, there is presumably at least one class of share that would qualify as a cross-border class. However, the rules do permit some level of intra-Canadian holdings so long as no more than 30% of the shares of any class are held by related Canadian corporations. Presumably this condition is a concession, acknowledging that Canadian groups, particularly those with minority shareholders, may not always be in a position to restructure their affairs in the case of legacy holdings. As such, on the surface, groups could conceivably arrange so that 30% of the shares of a Cross-border class are held by related Canadian corporations, and as such, every dollar of PUC grind to that class will result in no more than $0.70 of grind to shares actually held by the non-resident group. However, the FAD Rules also contain a specific anti-avoidance rule (subsection 212.3(6)) which may apply generally where a group deliberately structures their holdings to purposely reduce any sting from the PUC grind mechanisms.
Activation of dead asset under PLOI rules (p. 7)
[T]he FAD Rules are based on the presumption that an investment by a foreign-controlled CRIC in a subject corporation, and that does not meet other exceptions such as the bona fide business exception in subsection 212.3(16), produces no economic benefit to Canada. However, electing into the PLOI regime results in a prescribed base-level income inclusion in respect of the loan or indebtedness. As such, this will necessarily result in income at a floor rate, and should [not?] be considered a "dead asset" as a matter of policy. Consequently, investments in a PLOI are not subject to the FAD Rules.
PUC reinstatment rule avoids a double PUC grind or recognizes deployment of proceeds in Canada (p.8)
[A] investment by a foreign-controlled CRIC in a foreign affiliate, that does not satisfy the bona fide business exception, should be considered a "dead asset". The PUC grind essentially puts the CRlC in "the same position as if it had distributed the amount of the investment as a return of capital on its shares rather than made the investment. However, if that property that was subject to the investment (e.g., shares of a foreign affiliate of the CRIC) is subsequently actually distributed as a return of capital, this would otherwise require a reduction to PUC under rules elsewhere in the Act, and without a reinstatement mechanism, a double PUC grind would result. Further, if the CRIC receives proceeds as a return from that property, and reinvests those proceeds within Canada, the amount should no longer be considered invested in a dead asset. Thus a PUC reinstatement mechanism puts the CRIC in the same position as if it had not made an investment in respect of the dead asset in the first instance.
More closely-connected test for investments that otherwise would have been made (p. 8)
This first exception is intended to allow a Canadian corporation to invest in FA in circumstances where the Canadian corporation would have made the investment even if it had not been foreign-controlled….
Purpose of s. 212.3(18) exceptions (p. 9)
[T]hese exceptions are generally intended to prevent the application of the FAD rules when there is no new investment in a foreign affiliate. In other words, if a particular corporation has already run the gauntlet by making an investment in a subject corporation that might otherwise trigger the FAD Rules, reorganizing the affairs of the particular corporation, or a related Canadian group, ought not, in policy terms, trigger the FAD rules again.
Supplemented by anti-stuffing rules (p. 9)
Paragraph 212.3(18)(a) applies if the investment is an acquisition of shares or a debt obligation of a subject corporation, and is either (i) acquired from an non-arm's length corporation resident in Canada or (ii) on an amalgamation described in subsection 87(1) of two or more corporations to form the CRIC if all of the predecessor corporations to the amalgamations are related. These rules are also subject to certain "anti-stuffing" provisions requiring additional rules around timing and "relatedness" of the CRIC, the disposing corporation/predecessor corporations and the non-resident parent which are generally designed against backing into these exceptions via what is in essence a new investment from third party vendors, which must be carefully considered.
Supplemented by anti-stuffing meansures (p. 10)
[S]imilar to the rules in paragraph 212.3(18)(a), paragraph 212.3(18)(c) also contains various "anti-stuffing" measures that test the relatedness of the various of the relevant parties designed to prevent taxpayers from inappropriately relying on these corporate reorganization exceptions for what is in essence an acquisition of a new property into the Canadian group….
Avoidance of misuse of PLOI exception (p. 10)
Subsection 212.3(18.1)…would prevent a CRIC from first acquiring a debt that was a PLOI (which would not be subject to the FAD Rules), and then converting that PLOI into a new debt, or into shares, in a manner that relies on an exception in subsection 212.3(18), thereby making an investment in a subject affiliate without the FAD Rules ever applying.
Preferred share exception (p. 10)
Subsection 212.3(19) overrides the bona fide business exception or the internal reorganization exception on an acquisition of shares of a subject corporation by a CRIC, to the extent that the shares do not fully participate in the profits and appreciation in value of the subject affiliate (i.e., preferred shares) unless the subject affiliate would be a subsidiary wholly-owned corporation of the CRIC (taking into account shares owned by a parent or subsidiary of the CRIC, in the case of a wholly-owned group).
Prevention of stuffing by accommodating vendor within 1 year before CRIC acquisition (p. 6)
In the geneal case, one would expect that the investment time is the dividend time. The FAD Rules also factor situations where an investment is made in respect of a subsidiary corporation at a time that is prior to the non-resident actually controlling the CRIC, but where the CRIC becomes controlled by the non-resident parent as part of the same series as the investment. Presumably this is meant to address situations where prior to an acquisition of control of a CRIC an accommodating vendor might "stuff" foreign affiliate investments under the CRIC in a manner that might avoid the FAD Rules because the CRIC was not technically controlled by the non-resident parent at that investment time.
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