Anomalous results may arise under the revised hybrid mismatch rules

Some of the concerns expressed regarding the hybrid mismatch rules contained in Bill C-59, are summarized below:

The inclusion in foreign accrual property income (FAPI) of a foreign affiliate (FA) by virtue of A(b) of the FAPI definition of a dividend paid to it by another FA that is deductible under foreign tax laws tends to produce double taxation given that the there is no deduction in the FAPI of the payer FA for the amount of the dividend included in the recipient’s FAPI.

Where the hybrid mismatch rules include a payment in an FA’s FAPI or taxable surplus, the foreign tax credit generator rules (in ss. 91(4.1) to (4.7) and Regs. 5907(1.03) to (1.07)) will often deny relief for foreign tax on that payment. This is so even where relief would be provided in a comparable scenario involving a Canadian recipient (for instance, that of a Canadian corporation which is denied an s. 113 deduction under s. 113(5) for a dividend from an FA because the dividend was deductible under foreign tax law except that it receives a deduction under s. 113(6) for a (relevant tax factor) multiple of any foreign withholding tax on the dividend.)

Where a payment is included in the Canadian taxpayer’s income under the hybrid mismatch rule, but this mismatch is later resolved, the Explanatory Notes suggest that ss. 12(3) and 248(28) should generally prevent a timing mismatch from producing a double income inclusion. However, these provisions may not be effective in some situations, for instance, where the future income inclusion arises to a different Canadian taxpayer, or under foreign tax laws.

Neal Armstrong. Summaries of Ian Bradley and Seth Lim, “The Updated Hybrid Mismatch Rules,” International Tax Highlights (Canadian Tax Foundation and IFA Canada), Vol. 3, No. 1, February 2024. p. 2 under s. 95(1) – FAPI - A(b) and s. 227(6.3).