Whether s. 212(3.6) applies prospectively (p. 6)
[I]f the particular debt or other obligation is issued in Year 1, but the dividend obligation only arises in Year 3, does subsection 212(3.7) apply for all periods of time before the dividend obligation arises? This concern is perhaps more acute in the context of the B2B loan arrangement rules, as the consequences of a B2B arrangement under subsection 212 (3.2) are more mechanical - if subsection 212(3.7) applies, the shares are deemed to be debt and are included in the formula in subsection 212(3.2)….
Despite the less than clear statutory language, a more reasonable interpretation is to apply the rule in subsection 212(3.6) on a prospective basis only. Although references to the "particular time" were removed in subsection 212(3.6), subsection 212(3.7) still refers to the concept of "the particular time" in the formula variables. — One possibility is that these are orphaned references from the prior version of these provisions, as there is no longer a reference to "particular time" in subsection 212(3.6). On the other hand, the references to "particular time" in subsection 212(3.7) could be interpreted as referring to the "particular time" in the formula in subsection 212(3.2), such that the relevant amounts determined under subsection 212(3.7) are to be determined separately for all particular times during the "relevant period" referred to in subsection 212(3.2). But that alone could still allow for the retroactive application of the rule. Another possibility is that the references to "particular time" in subsection 212(3.7) could also refer to the "time" at which a dividend obligation arises under subsection 212(3.6), although this is somewhat inconsistent with the normal drafting style used in the Act….
Whether dividend can be declared and paid simultaneously (p. 7)
[T]he Department of Finance expressly stated that dividends paid on common shares could be subject to the character substitution rules, provided the connection test is met….
[P]erhaps it is possible to structure a dividend without there being any time between declaration and payment. Furthermore, it seems surprising that the Department of Finance would craft a rule that is dependent on the vagaries of corporate law and the existence of an "obligation" for any brief moment in time if they truly intended to capture "plain vanilla” common shares.
Whether a common share can be a specified share (p. 8)
[I]t seems reasonable to question whether a common share can, in certain circumstances, qualify as a “specified share”….
[T]he definition also uses of the words “or any…arrangement relating to the share”, which could import factual circumstances that go beyond traditional legal rights and obligations…. [A] controlling shareholder can, at any time, “require” the issuing subsidiary corporation to acquire its shares, without the need to resort to any legal rights beyond the control it has over the subsidiary…. [W]ould its control position with respect to the subsidiary be sufficient to constitute an "arrangement" that could result in common shares being "specified shares"? On the one hand, such an interpretation would seem well beyond the intended scope of the rules, as that would presumably capture all equity funding arrangements in a controlled group. On the other hand, some meaning must be attributed to the use of the term "arrangement”…
Cannot benefit from ultimate funder withholding rate if immediate funder rate is higher (p. 11)
Consider … where NR1 (treaty country [with 10% withholding rate]) has funded CA through NR2 (non-treaty country) and NR3 ([held by NR2 and in a] treaty country [with 0% withholding rate]). In this case, the B2B loan arrangement rules will apply and deem NR1 to receive a notional interest payment on which 10% withholding tax will apply. The interposition of non-treaty NR2 in the funding chain will not affect this result as NR2 will not qualify as an "ultimate funder”….
[C]onsider…where NR1 (treaty country) funds CA through NR2 (non-treaty country). In this case the 25% withholding tax rate on the payments to NR2 will simply apply as the B2B rules cannot be used to reduce the withholding tax rate that applies to the immediate funder…
Upper-tier common equity can create benefit of ultimate funder status to access lower withholding rate (p. 12)
NR1 provides some level of common equity funding to NR2 as part of the overall funding arrangement. As we have seen above, this could result in the common shares being deemed to be a relevant funding arrangement, and for NR1 to be owed a debt obligation that is equal to the full amount of the particular debt or other obligation owed by CA. If that is the case, then this structure would ensure "ultimate funder" status for NR1, which would preserve the 10% withholding tax rate on payments from CA to NR3.
Loss of specified right exclusions where a NR bank lends to Canco through a non-resident affiliate (pp. 12-13)
NR1 borrows from a third-party bank and on-lends the funds to CA…CA and NR2, another company in the group, provide security (in the form of pledged assets) in support of NR1's borrowing. In this situation, NR1 is the "immediate funder" and a "relevant funder" [fn 68: Paragraph (a) of the definition of “relevant funder” in subsection 212(3.8).] and the bank is also a "relevant funder" [fn :69: The bank would be a "relevant funder" under paragraph (a) of that definition in subsection 212(3.8) as the creditor in respect of the debt or other obligation referred to in paragraph (b) of the definition of "relevant funding arrangement" in subsection 212(3.8).] and may be an "ultimate funder". This in and of itself would not be problematic as the interest withholding tax applicable on a direct payment from CA to the bank would presumably be nil [fn 70: Paragraph 212(1)(b).], such that the B2B rules would not apply. However, if the bank has a "specified right" granted by NR2 which secures repayment of NR1's borrowing, then the bank would not be an "ultimate funder". As the grantor of a specified right, NR2 would become a "relevant funder" [fn 71: Paragraph(b) of the definition of “relevant funder” in subsection 212(3.8).] and an "ultimate funder". Therefore, if the B2B rules applied, the withholding tax would be determined from NR2's perspective (and a 10% rate would apply). The issue is whether the carve-out in the definition of "specified right" can apply, in these circumstances.
[T]he bank only has the right to enforce its security and sell the pledged assets on default, such that the second part of the definition is relevant…
[T]he NR2 pledge supports NR1’s borrowing, and not CA’s borrowing (as the latter is an internal borrowing). The question therefore is whether NR1’s borrowing from the bank is an amount described in subparagraph (6)(d)(i) or (ii). The amount referred to in subparagraph 18(6)(d)(i) is the "particular amount", which in the context of subsection 18(6), is presumably the amount owing by CA. The amounts referred to in subparagraph 18(6)(d)(ii) are amounts (other than the particular amount) that the taxpayer, or a non-arm's length person, owes to the "intermediary". The bank is not the "intermediary" in the context of subsection 18(6), and therefore the arrangement appears to be outside of the scope of the carve-out in the "specified right" definition. Had the bank loaned the funds directly to CA and had NR2 provided security in support of that borrowing, the carve-out would have presumably applied.
Interest deductibility where co-borrower arrangements (p. 20)
U.S.-styled credit agreements involving both U.S. and Canadian borrowers within the same corporate group are sometimes drafted in a manner such that U.S. and Canadian borrowers are "co-borrowers" with each borrower being jointly and severally liable for the obligations of all the other borrowers…a separate co-borrower agreement is often entered into among the borrower. Such an agreement will specify which portion of the indebtedness is owing by each borrower and provides that each borrower will be obligated to pay and will pay such portion of the indebtedness and interest thereon as though it is the sole borrower for that portion, without affecting the remedies that the lenders have against the borrower under the credit agreement through the joint and several liability of the borrowers….In Nelson…a husband and his wife had a joint line of credit and an oral agreement that each is responsible for 50% of the amounts drawn on the line of credit. The Tax Court of Canada found that the 50-50 allocation should be respected. The commercial case law also supports the position that a co-debtor, while having joint and several liability for the full amount of the indebtedness vis-à-vis the lender, is only liable as amongst the co-debtors for its share. [fn 84: See, for example, Lafrentz v. M & L Leasing, 2000 ABQB 714]
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