Example of application of s. 212.3(1)(a)(ii) to loan made by resident individual’s company to a CFC held by his U.S. brother through a US company and Canadian subs thereof (p. 5)
[T]he CRIC is controlled by a Canadian resident individual. However, the loan from the CRIC to the subject corporation owned indirectly by the individual’s brother, a non-resident of Canada, [through NR Parent and its subsidiary, Canco1] will be caught by the FAD rules as (a) the subject corporation will be a foreign affiliate of Canco1, which is a corporation that does not deal at arm’s length with the CRIC, and (b) Canco1 will be controlled by a non-resident corporation. As a consequence, the loan from the CRIC to the subject corporation will result in a deemed dividend to the NR Parent. Moreover, as the NR Parent will not own any shares of the CRIC, the CRIC will not be entitled to reduce its paid-up capital under subsection (7) in respect of the investment as it will not have a “cross-border class”… .
Example of application of s. 212.3(1)(a)(ii) to loan made by 9% shareholder of (factually NAL) Canco (held by NR Parent) to a CFC held by Canco (p. 6)
[T]he CRIC and NR Parent [holding 9% and 91% of the shares of Canco1, which holds the subject corporation] deal at arm’s length, but … the CRIC does not deal at arm’s length with Canco1 due to factual circumstances…. [A]s Canco1 will be legally controlled by the NR Parent, a loan from the CRIC to the subject corporation will be caught by the FAD rules as (a) the subject corporation will be a foreign affiliate of Canco1, which is a corporation that does not deal at arm’s length with the CRIC, and (b) Canco1 will be controlled by a non-resident corporation. Consequently, the loan from the CRIC to the subject corporation will result in a deemed dividend to the NR Parent, subject to a PLOI election being made.
Interestingly, the FAD rules would not apply if the CRIC owned10% of Canco1, such that the subject corporation was also a foreign affiliate of the CRIC….
General statement of where a deemed dividend may arise as a result of s. 212.3(1)(a)(ii) (p. 6)
[A]s a general statement, these situations appear to arise where (a) the CRIC is not itself controlled by a non-resident corporation but the other Canadian corporation (i.e., a non-arm’s length Canadian resident corporation) is; (b) the other Canadian corporation owns the shares of the subject corporation; (c) the subject corporation is not a foreign affiliate of the CRIC but is a foreign affiliate of the other Canadian corporation; and (d) the CRIC makes an investment in the subject corporation….
Relevance of partnership agreement to control of corporations held by a limited partnership (p. 10)
[T]he “very capacity to act” [fn 50: Duha at para.50.] in respect of the voting entitlement is dictated by the applicable partnership law and the terms of the partnership agreement itself. As such, when seeking to ascertain who has “effective control” over the shares, in our view, a partnership agreement is more than merely an external document (which is to be ignored under the Duha analysis) but rather it is a document which goes to the root of ownership itself. Accordingly, it is likely that a Court would find that, for purposes of determining de jure control under the Act, it is the general partner who has effective control over a company whose shares are partnership property.
S. 212.3(25) deeming rule likely supplements rather than replaces the regular de jure control test (pp. 11-12)
[T]he legal fiction created by paragraph 251(5)(b) of the Act does not result in the real owners of the shares no longer owning those shares, or no longer controlling…. [fn: 58: See … Viking Food … and Ekamant Canada] … .
[Finance’s] commentary associated with the application of the strategic business expansion exception in subsection (16) … would imply that the deeming rule under 212.3(25) is not intended to supplant any party who would otherwise be considered to have control in the absence of such deeming rule….
[T]he most appropriate … approach to determine whether a non-resident corporation controls a CRIC in the context of a partnership is to apply a two-part test (the “Two-Part Test”): one examining control under the current state of affairs and the second under the legal fiction created by the deemed ownership rule.
Avoidance of FAD rules for inbound private equity LP through use of Canadian GP (p. 13)
[U]nlike the typical PE Partnership Structure, a Canadian corporation will be the general partner. The shares of this Canadian general partner, in turn, will be owned by one or more individuals - likely principals of the private equity firm. … This first alternative private equity structure works well in a situation where the fund is at the beginning stages of its life cycle….
Avoidance of FAD rules for inbound private equity LP through use of subsidiary buyco LP with Canadian GP (p. 14)
[T]he private equity fund maintains its existing structure whereby a limited partnership is the collective investment vehicle, the general partner is a non-Canadian corporation, and the fund sponsor is compensated in whatever manner it prefers. However, instead of the top limited partnership acquiring the shares of the CRIC, this limited partnership will form a subsidiary limited partnership of which it will be the sole limited partner. The general partner of this bottom limited partnership will be a Canadian corporation and this limited partnership, in turn, will acquire the shares of the CRIC. The sole shareholder of the Canadian general partner will be one or more individuals - again, likely principals of the private equity fund. …
[S]imilar to the conclusion under the first alternative structure, provided there is a wide dispersal of investors with no one investor owning more than 50% of the voting shares of the CRIC, no one investor will have de jure control of the CRIC under this legal fiction.
Avoidance of FAD rules for inbound private equity LP through having CRIC issue special voting shares to individual principals (p. 15)
[T]he CRIC will undergo a reorganization of capital pursuant to which two new classes of shares will be created: non-voting fully participating shares (the “Participating Shares”) and fully voting non-participating shares (the “Voting Shares”). The limited partnership will acquire (and own) all of the Participating Shares and all the Voting Shares will be acquired (and owned) by one or more individuals- again likely principals of the private equity fund.
Non-application of GAAR re above planning (pp. 15-16)
Canadian case law suggests that the selection of a general partner should not be considered a “transaction” for purposes of the GAAR…. [fn 69: Spruce Credit Union … 2012 TCC 357, confirmed by 2014 FCA 143.]…
[I]t can be inferred that Finance determined that foreign corporate control is the flex point at which the policy considerations of facilitating international competitiveness and neutrality are abandoned in favour of the policy of protecting the domestic tax base. It is noteworthy that economic ownership, whether majority non-resident individual or corporate, was not chosen as the applicable threshold provided that de jure control does not rest with a non-resident corporation. It is speculated that non-resident corporate control may have been chosen as the “tipping point” as it was primarily foreign multinationals who were engaging in the behavior which Finance sought to prevent.
In terms of the alternative structures discussed above, each has the common element that non- resident corporate control is relinquished in favour of Canadian corporate control. As such, it appears to be consistent with the object and spirit of the FAD rules…
Failure of drop-down by Amalco (resulting from Buyco and Canadian target) to subsidiary of target to satisfy s. 212.3(18)(a)(i) (pp. 18-19)
[A] foreign corporation (“FP”) forms a Canadian acquisition corporation (“Canco”) in order to acquire all of the shares of a Canadian target corporation (“Canadian Target”)….that…owns shares or debt obligations of underlying foreign affiliates and…also has a wholly-owned Canadian subsidiary (“Canadian Subsidiary”). Following the acquisition by Canco of all of the shares of Canadian Target, Canco and Canadian Target amalgamate to form an amalgamated corporation (“Amalco”). [fn 88: [I]f a parent corporation in the context of a vertical amalgamation has ever reduced its paid-up capital as a result of the application of the FAD rules, it is important that the stated capital of Amalco be expressed as something along the lines of “equal to the stated capital of the parent [on] the amalgamation” rather than the more typical “equal to the paid-up capital of the parent immediately prior to the amalgamation”] …it is [then] desired that Amalco transfer the shares or debt obligations of the underlying foreign affiliates (owned by Canadian Target prior to the amalgamation) to the Canadian Subsidiary. …
[T]he question arises…whether such an “investment” by the Canadian Subsidiary will qualify for the related party reorganization exception in subparagraph 212.3(18)(a)(i). In this scenario, the contemplated transfer will not satisfy all of the required conditions for 212.3(18)(a)(i). While Amalco and the Canadian Subsidiary will be related immediately before the investment time, neither of the additional alternative conditions for the application of that exception will apply. With respect to the shareholder level condition, the shareholder (FP) of the disposing corporation (i.e. Amalco) is not the CRIC making the investment nor is it a Canadian-resident corporation that is related to the CRIC. With respect to the alternative condition in subparagraph 212.3(18)(a)(i) that is applied at the level of the disposing corporation (again, Amalco), that condition is also not satisfied…since Canadian Target dealt at arm’s length with FP during the Reference period,…
Drop-down “works” if Canadian target and Buyco not amalgamated first, or if 2-tier acquisition structure (pp. 19-20)
Oddly, if Canco and Canadian Target were not amalgamated as part of the acquisition and restructuring, then the transfer of the foreign affiliate shares or debt from Canadian Target to the Canadian Subsidiary would appear to qualify for the exception in 212.3(18)(a)(i) because the shareholder (“Canco”) of the disposing corporation (i.e. “Canadian Target”) should never have dealt at arm’s length with FP during the Reference Period, assuming Canco was formed by FP and the shares of Canco were always owned by FP. …
[T]he related party exception should also be available if FP had simply employed a two-tier Canadian-company acquisition structure to acquire and amalgamate with Canadian Target instead of a single tier acquisition structure…. [under which] FP forms Canco1 which, in turn, forms Canco2 and Canco2 then acquires all of the shares of, and then amalgamates with, Canadian Target … because the shareholder (Canco1) of the disposing corporation never dealt at arm’s length with FP during the Reference Period… .
2-tier structure also protects where upstream transfer of the CFA (pp, 20-21)
[F]P forms a two-tier acquisition structure to acquire a Canadian Target and, following the acquisition of Canadian Target by Canco2 [which is held in turn by Canco1] the two corporations are amalgamated to form Amalco…. [W]hat is desired is to transfer the foreign affiliate shares or debt held by the Canadian Target (and, following the amalgamation, by Amalco) upstream in the corporate group to Canco1.
[A]malco and Canco1 are related immediately prior to the time that Canco1 acquires the foreign affiliate shares or debt. In addition, the shareholder condition should also be satisfied because the shareholder of Amalco (i.e. Canco1) never dealt at arm's length with FP during the Reference Period…
Unavailability of relief where sub of Cdn Target transfers FA up to Buyco parent (pp. 21-22)
Now…the foreign affiliate shares or debt that are … to be transferred up to Canco1 are…owned by a wholly-owned Canadian subsidiary of Canadian Target… [F]or commercial or regulatory reasons, the Canadian Subsidiary cannot be amalgamated with Canco2 and Canadian Target….
[T]he requirements of subparagraph 212.3(18)(a)(i) will not be satisfied…because the disposing corporation (Canadian Subsidiary) dealt at arm's length with FP during the Reference Period and also because a predecessor to Amalco (i.e. Canadian Target), which is the shareholder of the disposing corporation (i.e. Canadian Subsidiary) dealt at arm's length with FP during the Reference Period….
Acquisition of foreign parent (“FP”) followed by transfer of FA between FP child and grandchild (p. 22)
[C]anco1 owns all of the shares of Canco2 and … Canco1 has always been owned and controlled by a … FP … . [A]n arm's length foreign corporate acquirer will acquire all of the shares of FP… [I]t is desired,…to move foreign affiliate shares or debt historically held by Canco1 to Canco2 or vice-a-versa. …
[N]either Canco1 nor Canco2 could transfer foreign affiliate shares or debt from one to the other and rely on the subparagraph 2l2.3(l8)(a)(i) exception. This is because both Canco1 and Canco2, and their corresponding shareholders (i.e. Canco1 and FP), did deal at arm's length…with the foreign acquirer of FP at some point during the Reference Period, and the foreign acquirer…is a non-resident corporation that participated in the series and was related to FP at some point in time during the Reference Period….
Better result if insertion of new Holdcos in chain (pp. 22-23)
If, following the acquisition of FP by the foreign acquirer, FP first transferred the Canco1 shares it owns to a new Canadian corporation, then Canco1 may then be able to transfer the foreign affiliate shares and debt in reliance on subparagraph 212.3(18)(a)(i) on the basis that this new Corporation is the shareholder of Canco1 immediately before the time at which the foreign affiliate shares or debt will be transferred and this new corporation never dealt at arm's length with either FP or the foreign acquirer during the Reference Period. Such an insertion of a new Canadian holding company will not result in Canco2 meeting the exception, however, unless of course a new Canadian company was also inserted between Canco1 and Canco2….
Intractability of amalgamation squeeze-outs (pp. 23-24)
One example where it is simply not possible to restructure so that a contemplated amalgamation will qualify as a subsection 87(11) amalgamation is a typical amalgamation squeeze-out transaction… [for instance where] Canco2 [held by FP through Canco 1] will amalgamate with Canadian Target to form Amalco and, on such amalgamation, the common shares of Canadian Target held by the 30% minority public shareholders will be converted into redeemable preferred shares of Amalco which will be immediately redeemed for cash….
[T]he FAD rules were drafted on the basis that an amalgamation may result in the amalgamated corporation having "acquired" any shares or debt of an underlying foreign affiliate from a predecessor corporation and a prudent tax advisor can be expected to proceed on that basis from a planning perspective….
[S]ubparagraph 212.3(18)(a)(ii) will not be applicable…While Canadian Target and Canco2 will be related to each other immediately prior to the squeeze-out amalgamation, Canadian Target will have dealt at arm’s length…with FP during the Reference Period. Further, each of the shareholders of Canadian Target will not satisfy the shareholder level conditions immediately prior to the amalgamation because the 30% public shareholders of Target will have dealt at arm's length with FP during the Reference Period. …
[A] cogent argument can be made in these circumstances that, even if Amalco has made an "investment" in foreign affiliate shares or debt for FAD purposes, Amalco itself has not transferred any property or assumed any obligation that relate to such investment and therefore no FAD consequences should arise.
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