Reg. 5907(2.02) may be limited to transactions for excluded property dispositions whose purpose is converting low-taxed taxable surplus into accessible exempt surplus

Reg. 5907(2.02) can reclassify additions of exempt earnings (or deductions from exempt loss) as additions to taxable earnings. Although this anti-avoidance rule clearly can apply to some intercompany excluded-property transfers that are “avoidance transactions,” on a literal reading its application could be much broader. However, it is suggested that:

On the basis of the legislative history leading up to Bill C-48, it is clear that regulation 5907(2.02) is one of several rules designed to target a specific form of tax avoidance, namely, foreign affiliate surplus-stripping transactions, which involve a disposition of excluded property by a foreign affiliate for the purpose of converting, on a tax-free basis, low-taxed taxable surplus into exempt surplus that can then be repatriated, or otherwise relied on, to minimize Canadian income taxes. A textual, contextual, and purposive interpretation of regu­lation 5907(2.02) supports the view that the rule should apply only in these limited circumstances.

Neal Armstrong. Summary of Gwendolyn Watson, "The Foreign Affiliate Surplus Reclassification Rule", Canadian Tax Journal (Canadian Tax Foundation) (2019) 67:4, 1233-66 under Reg. 5907(2.02).