Purposes of the s. 18(6)(d) de minimis rule (p. 26:5)
[There] is a de minimis requirement that ensures that the back-to-back rule applies only if the particular non-resident funds, through an intermediary, a significant portion of the particular debt and connected debts. The total principal amount of the intermediary debt and/or fair market value (FMV) of the property subject to the specified right must be at least 25 percent of the total principal amount of the particular debt and connected debts. In other words, if the intermediary funds the particular debt primarily from its own sources (that is, from sources other than a particular non-resident), the back-to-back loan rules should not apply.
Scope of “specified right” (pp. 26:6)
...[O]ne of the main reasons for the introduction of a more robust back-to-back rule in the thin capitalization context was to address situations in which a particular non-resident indirectly funds a particular debt by granting certain security interests or property rights to the intermediary (instead of loaning money to the intermediary). ...
...The definition of specified right now appears to target security interests and property rights that the intermediary can monetize and use to fund the particular debt to the taxpayer. …
...[I]f a foreign parent corporation has a Canadian subsidiary and a foreign subsidiary, and the group enters into a multi-party credit agreement in which all parties guarantee the facility, pledge their assets, and borrow, except that the subsidiaries do not guarantee the foreign parent's borrowings for foreign tax reasons, the requirements for the exception to the definition of "specified right" may not be satisfied. [fn 31: [J]oint Committee…July 25, 2016…at page 12.] …
...[T]he formulas in the back-to-back rules in subsection 18(6) make use of the precise FMV of the specified right property, which could require such property to be valued on a regular basis. This may be difficult if the property is illiquid… .
Meaning of “because of” in s. 18(6)(c)(i) (p. 26:8)
While the Supreme Court's comments in Copthorne appear to soften the "strong causal connection" language from Krull [a.k.a. Hoefele] both cases suggest that there needs to be some level of connection. ...
Observations on scope of “relevant funder” (pp. 26:9-10)
...First, the use of the broadly-defined terms "relevant funder" and "relevant funding arrangement" allow the back-to-back rule to apply to multiple-intermediary structures. Second, the definitions of "relevant funder" and "relevant funding arrangement" are somewhat circular (note part 2 of both definitions). Finally, although the previous back-to-back rule that applied in the interest withholding tax context did not apply to a loan to the immediate funder that was made by a partnership, the revised rule applies in this situation. Widely held flowthrough entities typically used intermediary corporations to make loans into Canada in order to obtain withholding tax certainty without the need to track in detail the residence of their members. ...
General effect of definition (p. 26:10)
...An ultimate funder effectively is a relevant funder (other than the immediate funder) that has funded a relevant funding arrangement, but only to the extent it is the ultimate source of funding. [fn 50: That is, it has not used funding it received as a debtor or holder of a specified right. ...]
Potential usefulness of election (p. 26:12)
...This election may prove useful because most Canadian tax treaties limit withholding tax on interest to 10 percent, but it will be important to carefully check the applicable rates in each case.
Overview of s. 212(3.5) (pp. 26:13)
When a relevant funder receives funding (either by way of debt or specified right) which it uses (together with other funds) to fund several particular debts, additional rules are necessary to prevent the deemed interest payments under subsection 212(3.2) from exceeding the portion of the actual interest payments that relate to the back-to-back arrangement. ...
In these circumstances, subsection 212(3.5) provides that the amount owing by the relevant funder (or the FMV of the property in respect of which the relevant funder has been granted a specified right), in respect of each particular debt is reduced proportionately based on the total of all particular debts.
No requirement for specified share to pay dividends( p. 26:14-15)
...For a share to be a specified share, there is no requirement that a payment be made on the share. For example, if a Luxembourg entity issues redeemable preferred shares, those shares likely would be deemed to be a debt obligation for purposes of subsections 212(3.1) to (3.8). If the share issuance directly or indirectly funds an interest-bearing loan to a Canadian taxpayer, the connectivity tests likely would be met, resulting in a back-to-back arrangement. As a result, the holder of the preferred shares would be deemed to receive an interest payment, subject to Canadian withholding tax, even if the holder receives no payment at all on those shares in respect of the loan.
Application of connectivity test to SPVs (p. 26:16)
...In practice, when an equity subscription is used to fund a special purpose vehicle (SPV) that uses the proceeds to fund a loan, the connectivity tests likely will be met. ...
...[I]f an SPV was funded initially with equity in order to invest in a non-Canadian asset, but the SPV later sells the asset and reinvests the funds in a loan to a Canadian taxpayer, the arrangement could be subject to these rules.
2nd leg might arise years later (p. 26:25-26)
...[T]he connectivity tests do not require that the two legs of a back-to-back arrangement be put in place at or around the same time. Therefore, each time a Canadian entity receives funding of any sort, it will have to trace the historical origin of that funding, even if one leg of the back-to-back arrangement was put in place a long time before, and the funds in the intermediary have been reinvested a number of times. For example, consider a situation in which a share investment is made in an intermediary jurisdiction for purposes of investing in a non-Canadian entity. A number of years later, the non-Canadian investment is sold and a new investment is made into Canada (which respects the applicable Canadian thin capitalization ratios). This arrangement could be subject to the back-to-back rules (including the character substitution rules), and therefore the arrangement must be reviewed and monitored for compliance on an ongoing basis. Is it feasible to require such historical tracing and ongoing monitoring? Will this significantly increase compliance costs for multinational groups who do business in Canada?
Second, foreign jurisdictions most likely will not provide foreign tax credits to compensate for the Canadian withholding tax paid under the back-to-back rules. This is because it is likely the intermediary jurisdiction will provide a credit only for the rate on payments actually made to its jurisdiction, not for any additional or notional amount. The ultimate funder's jurisdiction is unlikely to provide a foreign tax credit at all because it will not recognize a Canadian source of income.
Reasonably allocable requirement (pp. 26:20-21)
It is not clear what is required to prove to the satisfaction of the minister that a portion of the particular amount is reasonably allocable to an ultimate licensor, but the technical notes suggest looking at the relevant amounts actually paid to each ultimate licensor.
FIFO treatment of repayments (p. 26:25)
Finance has indicated that repayments are considered to occur on a first-in-first-out basis, in accordance with the CRA's general policy on shareholder loan repayments. However, in order to qualify for the exception in subsection 15(2.6) to the general shareholder loan rule, the deemed repayment must not be part of a series of loans or other transactions and repayments. Further, in a cross-border context in which withholding tax will be an issue, taxpayers must diligently review their loans and repayments because a refund application under subsection 227(6.1) must be made within two years of repayment and cannot be late-filed.
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