Numerous difficulties remain in applying the FA system to partnerships

Observations on the application (or non-application) of the foreign affiliate (FA) system to partnerships include:

• The s. 93 regime (for converting capital gains into dividends) does not apply to any gain realized by a corporation resident in Canada (CRIC), or an FA of a CRIC, respecting a disposition of a partnership interest in a partnership that holds FA shares. If an actual dividend must be paid in order for a CRIC to benefit from any underlying FA surplus, this might have foreign withholding tax consequences. However, the loss denial rules in s. 93 do apply where a partnership interest is sold. The reason for this apparently inequitable treatment is not clear.
• The “partnership postamble” to the s. 95(1) definition of “excluded property” (EP) attempts to provide for a CRIC’s investment in assets “through” a partnership producing an equivalent excluded property result as if there had been a direct investment. However, in circumstances where the postamble wording is too narrow to accomplish this, there are good arguments that para. (a) of the EP definition (which refers to property of the FA that is “used or held by the [FA] principally for the purpose of gaining or producing income from an active business carried on by it”) can apply to an FA’s partnership interest. Under partnership law in common-law provinces (and somewhat similarly in Quebec), all members of a partnership are considered to be carrying on any activity carried on by the partnership.
• Para. (c) of the EP definition refers to property of the FA “all or substantially all of the income from which is … income from an active business.” Respecting an earlier version of para. (c), concerns were expressed that where a partnership of which a foreign affiliate is a member disposes of capital property used principally for the purpose of gaining or producing income from an active business, the property does not qualify as excluded property, given the requirement that the EP must be property “of” the FA. However, it is now accepted that this likely is not a concern, given inter alia that pursuant to Canadian common-law partnership principles, each member is considered to have an undivided interest in the property of the partnership.
• Where FA2 borrows from a sister FA Finco to fund FA Opco “through” a subsidiary Holdco partnership of FA2, s. 95(2)(y) may be broad enough to render s. 95(2)(a)(ii)(D) applicable so as to deem the interest on the loan to be active business income to FA Finco.

The sticking point in the analysis may be whether paragraph 95(2)(y) is broad enough to deem FA 2 to own its proportionate share of the FA Opco shares for the purpose of satisfying the requirement, set out in subclause 95(2)(a)(ii)(D)(III), that the FA Opco shares be “excluded property of” FA 2. In the context of the recent amendments that are clearly aimed at ensuring that the FA regime in general, and paragraph 95(2)(a) in particular, applies appropriately to FA structures involving partnerships, there are excellent arguments that paragraph 95(2)(y) is broad enough to accommodate this structure, on the appropriate facts.

Neal Armstrong. Summaries of Tina Korovilas and Drew Morier, “Non-Corporate Vehicles in the Foreign Affiliate Context,” Canadian Tax Foundation, 2018 Conference Report, 20:1 – 114 under s. 96, s. 104(1), Reg. 5907(11.2)(b), s. 90(1), s. 93.1(2)(a), s. 93.1(2)(d)(i), Reg. 5901(2)(b)(ii), s. 93(1.3), s. 95(1) – excluded property – para. (e), para. (a), para. (c), s. 95(2)(y), s. 95(2)(z), s. 95(2)(a)(ii)(B)(II), s. 95(2)(a)(ii)(D) and s. 94(1) – exempt foreign trust – (h)(ii)(C)(I).