Various pitfalls can attend inbound and outbound acquisitions
The foreign affiliate dumping (FAD) rules were intended to target two types of transactions:
- debt dumping (for example, Canadian Opco borrows to acquire preferred shares of a non-resident Opco subsidiary of its non-resident parent and receives (s. 113(1)(a)) exempt dividends on those shares)
- surplus stripping (for example, Canadian Opco, with distributable cash but whose shares have low paid-up capital (PUC), purchases (or subscribes for) such preferred shares)
However, their scope is wider. For example, they apply where the Canadian subsidiary (CRIC) uses cash on hand to invest in common shares of a wholly owned non-resident Opco for use in its foreign active business – even though there is no debt dumping or surplus stripping involved.
Similarly, it is unclear why it is necessary to meet all of the requirements of the s. 212.3(16) “closely connected business exception” where there is no debt dumping or surplus stripping. For example, where a Canadian public corporation with no operations in Canada becomes a CRIC on being acquired for cash by a foreign multinational, it cannot satisfy that exception because it does not carry on business itself - even if its executives have sole decision-making authority respecting the foreign Opcos. If a “bump and run” transaction could not be structured, this has caused potential foreign acquirors to abandon Canadian acquisitions.
The structure resulting where a Canadian public corporation, that has no operations in Canada, is acquired by a Canadian Acquisitionco as described in s. 212.3(10)(f), is undesirable since the PUC of the shares of Canadian Acquisitionco is reduced to nil pursuant to ss. 212.3(2) and (7), so that any investment (other than by way of PLOI) made in a foreign Opco by the Canadian public corporation or Canadian Acquisitionco would result in a cross-border deemed dividend. Accordingly, the FAD rules encourage a bump-and-run transaction, which provides no benefit to Canada.
Where a non-resident acquisition target is a holding company that has numerous operating subsidiaries that have made substantial upstream loans to it, an element of circularity can arise in determining whether the shares of such operating subsidiaries and, thus, the shares of the holding company, are excluded property.
Due to an upward cascading effect in a multi-tier structure of FAs, a non-resident target with non-excluded property of only 3% on a consolidated basis nonetheless might not have its shares qualify as excluded property. It may be possible to engage in purification transactions to achieve excluded property status.
In this regard, it would be more appropriate for the drafting of s. 17(8) to not require excluded property status “always and forever” and to instead provide for its application during the period in which the shares being financed are excluded property.
Reg. 5907(2.01) to some extent accommodates “pack and sale” transactions (respecting a drop down of a business unit to a foreign Newco followed by an arm’s length sale of the Newco) by rendering Reg. 5907(5.1) inoperative to transactions occurring on a rollover basis under the foreign tax law (so that exempt surplus may be generated) if certain conditions are met, one of which is that the only consideration received in respect of the particular drop-down disposition is shares of the capital stock of another FA of the taxpayer. Thus, the assumption of liabilities on the drop-down transaction would exclude access to Reg. 5907(2.01). See 2014-0550451E5.
Neal Armstrong. Summaries of Raj Juneja and Pierre Bourgeois, “International Tax Issues that Get in the Way of Doing Business", 2019 Conference Report (Canadian Tax Foundation), 36:1 – 42 under s. 212.3(1), s. 212.3(16), s. 212.3(10)(f), s. 251(5)(b), s. 18(5) – specified right, Reg. 105(1), s. 95(2)(a)(ii), s. 95(1) – excluded property – (b) and Reg. 5907(2.01).