Care should be taken in structuring an inbound PE investment or in implementing post-acquisition restructuring so as to avoid FAD-rule application
As a result of an amendment enacted on December 2017, the foreign affiliate dumping (FAD) rules have been expanded to apply where the Canadian corporation (CRIC) making the investment in the non-resident subject corporation is not itself controlled by a non-resident corporation but a non-arm’s length Canadian resident corporation is, and the subject corporation is a foreign affiliate of that other Canadian corporation but not of the CRIC. This expanded rule might apply, for example, where the CRIC is a 9% shareholder of Canco with the other 91% held by Canco’s non-resident parent and the CRIC lends to a non-resident subsidiary of Canco – provided that the CRIC does not deal at arm’s length with Canco as a factual matter.
It is suggested that the s. 212.3(25) deeming rule likely supplements rather than supplants the regular de jure control test, so that if there is an acquisition by a limited partnership, a determination as to whether the FAD rules apply should take into account both the residence of the general partner and also, having regard to the s. 212.3(25) look-through rule, whether there is any control of the CRIC by a limited partner.
Application of the FAD rules where there is an inbound investment through a private equity LP with a non-resident general partner could be avoided, for example, through the use of subsidiary buyco LP having a Canadian-resident general partner. Given that the drafting of those rules chose foreign corporate control rather than foreign economic ownership as the tripping point for their engagement, such avoidance “appears to be consistent with the object and spirit of the FAD rules.”
The supposed safe harbour in s. 212.3(18)(a)(i) for transfers of shares or debts of subject corporations between Canadian-resident corporations operates in a capricious manner having regard to any reasonable policy rationale for the scope of this exception. To mention only one example, if an acquisition of control of a foreign parent (“FP”) holding Canco1 (which, in turn, holds Canco2) is followed as part of the series of transactions by a transfer of a foreign affiliate between the two Cancos, the safe harbour is unavailable – unless, following such acquisition of FP, FP first transfers the Canco1 shares it owns to a new Canadian corporation and a new Canadian company is also inserted between Canco1 and Canco2.
Neal Armstrong. Summaries of Dean Kraus and John O’Connor, “Foreign Affiliate Dumping: Selected Issues,” 2017 Annual CTF Conference draft paper under s. 212.3(1)(a)(ii), s. 212.3(1)(b) and s. 212.3(18)(a)(i).