23 May 2013 Roundtable, 2013-0483751C6 - Foreign Affiliate Dumping

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Questions on the following issues were asked:
(a) Transitional 212.3(10)(f);
(b) Share redemptions and 212.3(9) PUC reinstatement;
(c) 15(2.11) and 212.3(11) PLOI elections - case by case or global;
(d) 212.3(16) – more closely connected
(i) bright line test or question of fact, and
(ii) which entities must be considered;
(e) Cash damming and "indirectly funded" in 17.1(1)(b);
(f) Short-term loans and cash pooling as 212.3(10)(c) investments;
(i) FIFO for tracking repayments,
(ii) what constitutes a series of loans, and
(iii) all loans in the series being repaid;
(g) Internal dispositions and 212.3(9) PUC reinstatement; and
(h) 212.3(3) dividend substitution election when no Qualified Substitute Corporations.

IFA Roundtable, May 2013 Question 6

Question 6: Foreign Affiliate Dumping and PLOI Rules

Question 6(a)

For transactions or events before August 14, 2012, a taxpayer can elect to apply a transitional version of the foreign affiliate dumping rules. Does the CRA consider that the original version of paragraph 212.3(10)(f) that would apply during the transition period captures the indirect acquisition of foreign affiliates (i.e. the acquisition of Canadian companies owning foreign affiliates)?

Response:

Transitional paragraph 212.3(10)(a) reads like current paragraph 212.3(10)(a) and describes a direct acquisition of the capital stock of a subject corporation by a CRIC. Transitional paragraph 212.3(10)(f) provides that an investment in a subject corporation by a CRIC includes any transaction or event that is similar in effect to any of the transactions described in transitional paragraphs 212.3(10)(a) to (e).

The determination of whether a CRIC's particular acquisition of the shares of a Canadian company owning foreign affiliates would be similar in effect to its acquisition of shares of the capital stock of subject corporations as described in transitional paragraph 212.3(10)(a), such that the transitional paragraph 212.3(10)(f) would apply to the CRIC's acquisition of the shares of the Canadian company, is a question of fact that could only be determined after reviewing all of the facts and relevant information regarding the particular acquisition.

However, in general, we would view a CRIC's acquisition of the shares of a Canadian company owning foreign affiliates to be similar in effect to the CRIC's acquisition of shares of the capital stock of a subject corporation if the total fair market value of all the foreign affiliate shares that are held directly or indirectly by the Canadian company comprises all or substantially all of the total fair market value of all of the properties owned by the Canadian company.

Question 6(b)

Does the PUC reinstatement rule in subsection 212.3(9) apply where the PUC of the CRIC that was previously suppressed is subsequently reduced as part of the redemption of shares owned by the non-resident corporate parent as well as on a return of PUC on the shares?

Response:

New subsection 212.3(9) allows for a reinstatement of PUC in respect of a class of shares of a CRIC or a qualifying substitute corporation immediately before a distribution/reduction of capital in certain circumstances where the PUC was initially reduced by the operation of paragraph 212.3(2)(b) or (7)(b).

In our view the words "reduces…the paid-up capital in respect of the class…" as they appear in subsection 212.3(9) are broad enough to encompass a reduction in PUC of shares of a class that arises as a consequence of a redemption of shares of that class. We find contextual support for this interpretation in the wording of subsection 84(4).

Question 6(c)

Can a PLOI election under either of subsection 15(2.11) or 212.3(11) be considered to be made in respect of a particular debt if the election specifies that it is being made in respect of each indebtedness owing by the particular debtor to the particular CRIC? In other words, can it be expressed and made in a way that covers all indebtedness owing by the particular debtor to the particular CRIC, or will a separate election be required for each indebtedness?

Response:

In order for a particular amount owing to be a PLOI, pursuant to either subsection 15(2.11) or 212.3(11), an election in respect of the amount owing must be filed with the Minister of Revenue on or before the filing-due date of the CRIC for the year in which the amount became owing (or, for the purposes of subparagraph15(2.11)(d)(ii), on or before the filing-due date of the CRIC for its taxation year in which ends the fiscal period of the qualifying Canadian partnership in which the amount became owing).

If the filing due date is the same for electing PLOI treatment for more than one amount owing (i.e., more than one amount owing became owing in a given taxation year of the CRIC or, for the purposes of subparagraph 15(2.1)(d)(ii), of the qualifying Canadian partnership), a single written communication may be prepared and filed with the Minister which contains an election for each particular amount owing. However, in order for a PLOI election to be valid, in our view, it must refer to a specific amount owing.

Question 6(d)

In the context of paragraph 212.3(16)(a) [exception – more closely connected business activities], if a subject corporation carries on an active business related to the CRIC's Canadian business (e.g. local distributor of goods manufactured by the CRIC) and also carries on similar activities in respect of operations of non-resident members of the non-resident corporate parent's group, is there a threshold that would be relevant in determining whether the subject corporation's business is more closely connected to the CRIC's (e.g., subject corporation's revenues are derived 51% from distributing CRIC's products, and 49% from distributing products of other group members)?

Will the CRA require data concerning all other group members in order to compare the relative degree of connectedness?

Response:

The determination of whether a particular CRIC's investment in a particular subject corporation meets the more closely connected test in subsection 212.3(16) can only be made following a review of all of the circumstances of a particular situation. We have, as yet, no firm guidelines. However, in making a determination of whether the business activities test contained in paragraph 212.3(16)(a) is met, we would consider the Department of Finance's comments in their Explanatory Notes that:

"…This requirement reflects the intention that the exception from subsection 212.3(2) apply only where the relationship between the CRIC's and the subject corporation's businesses clearly justify the investment in the subject corporation being made by the CRIC rather than by another member of the multinational group."

In order to determine whether a particular CRIC's investment in a particular subject corporation meets the business activities test contained in paragraph 212.3(16)(a) we would need to consider the business activities of:

* the CRIC;
* all corporations resident in Canada with which the CRIC does not, at the investment time, deal at arm's length;
* the subject corporation;
* all subject subsidiary corporations, as that term is described in paragraph 212.3(16)(a); and
* all non-resident corporations with which the CRIC, at the investment time, does not deal at arm's length, other than any corporation that is, immediately before the investment time, a controlled foreign affiliate of the CRIC for the purposes of section 17 of the Act.

Question 6(e)

In the computation of the amount to be included in income under paragraph 17.1(1)(b) in respect of a PLOI, element A of the formula is the greater of two amounts. One of those amounts is the amount of interest payable in respect of a debt obligation – entered into as part of a series of transactions or events that includes the transaction by which the PLOI arose – to the extent that the proceeds of the debt can reasonably be considered to have directly or indirectly funded, in whole or in part, the PLOI.

Could the indirectly funded rule in paragraph 17.1(1)(b) be avoided through the use of cash damming techniques? For example, what if a CRIC sets up two bank accounts and uses account A to receive borrowings and fund business expenses and account B to receive business revenues and fund a PLOI, or alternatively, CRIC 1 uses its business revenues to fund a PLOI while CRIC 2 (a sister corporation where there are no cross-shareholdings, or inter-company debts, with CRIC 1), uses borrowings to fund its business expenses?

Response:

For the purposes of interest deductibility, it is noted in paragraph 16 of IT-533, Interest Deductibility and Related Issues, that cash damming readily allows taxpayers to trace borrowed money to specific uses for purposes of paragraph 20(1)(c). However, we infer from the language

"a debt obligation - entered into as part of a series of transactions or events that includes the transaction by which the amount owing arose"

and

"the proceeds of the debt obligation can reasonably be considered to have directly or indirectly funded, in whole or in part the amount owing"

which appear in subparagraph (ii) of the description of A in paragraph 17.1(1)(b) and not in paragraph 20(1)(c), that it was intended that the application of paragraph 17.1(1)(b) would not be limited by the principle of "tracing" as it has related to paragraph 20(1)(c). Accordingly, we are not prepared to concede that the proceeds of a debt obligation cannot reasonably be considered to fund a PLOI simply because those proceeds were deposited into one account while the funds used to directly make the PLOI were withdrawn from another.

The determination of whether it can reasonably be considered that the proceeds from any particular debt obligation of the CRIC (or a qualifying Canadian partnership, a person resident in Canada with which the CRIC did not, at the time the PLOI arose, deal at arm's length or a partnership of which the CRIC or the person is a member) had directly or indirectly funded, in whole or in part, a particular PLOI can only be determined after reviewing all of the facts and relevant information regarding the entering into of the debt obligation and the making of the PLOI. However, it is our general view that it would be reasonable to expect that the proceeds from a borrowing had directly or indirectly funded, in whole or in part, a PLOI when a CRIC borrows money and, while the borrowing is outstanding, it makes a PLOI. Whereas, it is difficult to imagine circumstances in which it would be reasonable to consider that the borrowings of a sister Canco, where there are no cross shareholdings or inter-corporate debts, had directly or indirectly funded the PLOI of a CRIC.

Question 6(f)

Subsection 212.3(10) defines "investment" in a subject corporation made by a CRIC and subparagraph 212.3(10)(c)(i) excludes an amount that becomes owing by the subject corporation to the CRIC that arises in the ordinary course of business of the CRIC and that is repaid, other than as part of a series of loans or other transactions and repayments, within 180 days after the day on which the amount becomes owing.

(i) Would CRA accept FIFO as the method to track the origination and settlement of multiple debts that may arise from inter-company dealings or cash pooling?

(ii) Would CRA consider a "series of loans" to arise where there are inter-company dealings or cash-pooling but each item arises for its own reasons and not in contemplation of recycling an existing item?

(iii) Would CRA accept that each loan in a "series" will be repaid once all loans in the series have been repaid?

Response:

It is our understanding that the reference to "inter-company dealings" in the question is a reference to the transaction of a CRIC selling property or services to a subject corporation on credit in the ordinary course of the CRIC's business. An amount owing to the CRIC as the result of such an inter-company dealing would, in our view, meet the ordinary course of business exception in subparagraph 212.3(10)(c)(i) if the resulting debt is repaid within the time limit required by that exception.

"Cash pooling" arrangements take many forms and the determination of whether a particular "cash pooling" arrangement results in an amount that becomes owing to a CRIC that arises in the ordinary course of the business of the CRIC is a question of fact that could only be determined after reviewing all of the facts and relevant information regarding the particular cash pooling arrangement and the business of the particular CRIC. However, we would note that the ordinary course of business exception in subparagraph 212.3(10)(c)(i) could, in our view, apply when a CRIC temporarily advances funds at risk in its business (i.e., the permanent removal of such funds would have a destabilizing effect on the business of the CRIC) to a subject corporation if the resulting debt is repaid in the manner required by that exemption.

In our view, the repayment rule in subparagraph 212.3(10)(c)(i) is similar to the rule in subsection 15(2.6) that applies in the shareholder debt context.

(i) If a particular amount owing is made up of several amounts owing of the same nature (for example as the result of numerous individual acquisitions of product or services on credit), we would accept FIFO as the method to track the origination and settlement of multiple amounts owing. Whereas, if a particular amount owing is made up of several amounts owing of different natures (for example one amount owing may be secured and payable at maturity whereas another amount owing may be unsecured and payable in installments and/or the amounts owing may have different interest rates), we would expect the debtor to specify which amount owing is intended to be repaid by a particular payment.

(ii) Our views on whether the repayment of a particular amount owing is part of a series of loans or other transactions and repayments are set out in Interpretation Bulletin IT-119R4, Debts of Shareholders and Certain Persons Connected With Shareholders. In general terms, it is a question of fact whether or not a repayment of an amount owing is part of a series of loans or other transactions and repayments. Specifically, however, repayments of a temporary nature (for example, certain cash pooling arrangements) may be evidence of a series of loans and repayments.

(iii) In our view, a final, bona fide, repayment would not be considered part of a series for the purpose of subparagraph 212.3(10)(c)(i). Therefore, we would consider that a particular amount owing by a subject corporation to a CRIC which arose in the ordinary course of the business of the CRIC would meet the exception in subparagraph 212.3(10)(c)(i) if its final, bona fide, repayment was made within 180 days after the day on which the particular amount became owing, even if, arguably, that bona fide repayment is the last transaction in a series of loans or other transactions and repayments.

Question 6(g)

Do internal dispositions give rise to "proceeds" for the purposes of clause 212.3(9)(c)(ii)(A), and does it matter whether the CRIC retains a complete or partial indirect interest in the subject shares? For example, what if the CRIC sells shares of one foreign affiliate ("FA1") to another foreign affiliate ("FA2") for cash?

Response:

As noted in the closing words of clause 212.3(9)(c)(ii)(A), a PUC reinstatement is not available to a CRIC when its disposition of shares of a subject corporation results in an acquisition of those shares to which subsection 212.3(18) applies. In our view, this exclusion will result in many internal dispositions not resulting in the availability of a PUC reinstatement. However, if the PUC in respect of a class of shares of the capital stock of a CRIC (the "Class") had previously been suppressed as a result of its investment in FA1 and then the CRIC sells FA1 to FA2 for cash such that the CRIC's cross border investment is reduced and then, within 180 days, reduces the PUC in respect of the Class, in our view, the PUC reinstatement provided for in subsection 212.3(9) will apply.

Question 6(h)

Can a subsection 212.3(3) dividend substitution election be made even if there is no qualified substitute corporation in the group?

Response:

Pursuant to the subsection 212.3(3) dividend substitution election, all or a portion of a dividend that would otherwise be deemed to be paid by the CRIC to the parent and received by the parent from the CRIC, pursuant to paragraph 212.3(2)(a), may instead be deemed firstly, to be paid by one or more qualified substitute corporations and/or secondly, to be paid to and received by another non-resident corporation that is controlled by the parent.

The phrase "…in respect of classes of shares of the capital stock of any of the CRIC and one or more of the qualifying substitute corporations…" as it appears in the preamble to subsection 212.3(3) allows, in our view, an election to be made, pursuant to subsection 212.3(3), in respect of shares of the CRIC when there are either no qualified substitute corporations in the group or if there is simply no desire to have any other corporation be viewed as the payer of the dividend. Furthermore, the phrase "is, as reduced by the application of subparagraph (i), deemed…" as it appears in subparagraph 212.3(3)(a)(ii) does not, in our view, require that an amount be agreed on in respect of a class of shares of the capital stock of a qualifying substitute corporation, only that any such amounts be considered in the application of subparagraph 212.3(3)(a)(ii). As a result, the entirety of a dividend that would otherwise be deemed to be paid by the CRIC to the non-resident corporate parent and received by the parent from the CRIC, pursuant to paragraph 212.3(2)(a), may instead, pursuant to subparagraph 212.3(3)(a)(ii), be deemed to be paid by the CRIC to another non-resident corporation in the group and received by that other non-resident corporation from the CRIC.

Finally, the CRIC and the parent may choose to elect under subsection 212.3(3) simply to trigger paragraph 212.3(6)(a) and thereby subsection 212.3(7). In such case, there need not be a qualified substitute corporation or a non-resident corporation other than the parent taking part in the election but to achieve its goal, the election must satisfy subparagraph 212.3(6)(a)(ii).

Lori Carruthers
2013-048375