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: US Sub was originally acquired by a sister company of the CRIC (Canco) that is engaged in a completely separate and distinct business from Canco's. 1. Is the first condition in paragraph 212.3(16)(a) met on the basis that the business of US Sub is more closely connected to Canco, both of which are in Business Segment 1, despite the fact that US Sub was originally acquired by USCo which is in Business Segment 2? 2. What is the meaning of "reasonably expected" in the preamble in paragraph 212.3(16)(c) and "to a greater extent" and "any" in subparagraph 212.3(16)(c)(iii) of the Act? 3. How is the determination in subparagraph 212.3(16)(c)(iii) made where some of the officers of Canco are also officers of a non-resident corporation that does not deal at arm's length with Canco? 4. For the purpose of subparagraph 212.3(16)(c)(iii) of the Act, is it sufficient that the performance evaluation and compensation are based on the results of a business segment of the subject corporation?
Position: 1. Yes, based on the facts provided. 2. and 3. Whether the requirement in subparagraph 212.3(16)(c)(iii) is satisfied is a case-by-case determination to be made in light of all of the pertinent facts. 4. One must generally demonstrate that the performance evaluation and compensation of the officers are based on the operating results of the subject corporation to some extent.
Reasons: 1. Consistent with the Explanatory Notes to the provision and facts. 2. and 3. Based on the text of the provision, case law, and consistent with the Explanatory Notes applied to the provision. 4. Consistent with the Explanatory Notes to the provision.
XXXXXXXXXX 2021-091790
Catherine Zhang
April 2, 2026
Dear XXXXXXXXXX:
Re: Application of subsection 212.3(16)
This is in response to your letter in which you requested the CRA’s view of the application of paragraph 212.3(16)(a) and subparagraph 212.3(16)(c)(iii) of the Income Tax Act (the “Act”) in the context of the facts described below.
Facts
Corporate Structure
1. US Pubco is a public company and resident of the United States (“US”) for treaty purposes (US Pubco and its subsidiaries are referred to as the “Group”).
2. US Pubco owns all the shares of US Holdco, a US corporation.
3. US Holdco owns all the shares of the capital stock issued by Canco. US Holdco also owns all the shares of the capital stock issued by USCo, a US corporation.
4. Canco is a Canadian corporation. Canco wholly-owns foreign corporations that are “connected affiliates” within the meaning of that term in subparagraph 212.3(16)(b)(ii) (the “Canco Foreign Subsidiaries”).
5. In 2017, USCo purchased the common shares of US Sub from a third party. US Sub is a US corporation. USCo borrowed funds from a third party to fund the acquisition since it was easier to obtain third party secured acquisition financing due to the physical assets that USCo had available to be pledged as collateral.
6. In 2021, Canco acquired the shares of US Sub from USCo for fair market value consideration (the moment of that acquisition is referred to as the “Investment Time)”.
Business Activities of the Group
7. “Business Segment 1” and “Business Segment 2” are the two business segments of the Group. The activities within Business Segment 1 are similar and expected to remain so and the activities within Business Segment 2 are similar and expected to remain so. Business Segment 1 and Business Segment 2 are different.
8. Business Segment 1 is carried on by Canco, the Canco Foreign Subsidiaries and US Sub.
9. Business Segment 2 is carried on by USCo.
10. The objective of the acquisition of US Sub by Canco at the Investment Time was to integrate the legal and operational structures of the entire Business Segment 1 in Canco’s group.
Officers of the Relevant Entities
11. The directors and officers of the relevant entities are:
a. US Pubco: its Chief Executive Officer (“CEO1”) and its Chief Financial Officer (“CFO1”). They are both residents of Canada where they work principally.
b. US Holdco: CEO1 and CFO1.
c. Canco: CEO1, CFO1 and a third Canadian resident, EVP1, all of whom work principally in Canada.
d. USCo: CEO1, CFO1 and another individual, EVP2, who is a resident of the US.
e. US Sub: CEO1, CFO1 and EVP1.
12. The involvement of the officers listed above in the business and their compensation can be summarized as follows:
a. CEO1 and CFO1’s compensation is based on the consolidated results of the Group.
b. EVP1 and other officers of Canco (CEO1 and CFO1) had the principal decision-making authority with respect to the acquisition of US Sub by Canco in 2021.
c. EVP1 manages the day-to-day operations of Business Segment 1. EVP1’s performance evaluation and compensation is based solely on the results of Business Segment 1, which includes US Sub’s results.
d. EVP2 manages the day-to-day operations of Business Segment 2. EVP2’s performance evaluation and compensation is based solely on the results of Business Segment 2.
Questions
Subsection 212.3(16) provides the exception to the foreign affiliate dumping rules in section 212.3 and it has five conditions. In general, the first condition assesses whether the business activities carried on by the subject corporation is more closely connected to the business activities carried on by the CRIC (or a Canadian-resident corporation that does not deal at arm’s length with the CRIC). The second condition requires officers of the CRIC to have the principal decision-making authorization in respect of the making of the investment and the majority of them to be resident of Canada (or the residence country of a “connected affiliate”, as defined in paragraph 212.3(16)(b) to mean a corporation that is a controlled foreign affiliate of the CRIC for purposes of section 17). The third and the fourth conditions require the officers of the CRIC to have ongoing principal decision-making authority in respect of the investment and a majority of those officers to be resident in Canada (or the residence country of a connected affiliate). The fifth condition requires the performance evaluation and compensation of the officers of the CRIC (or a Canadian-resident corporation that does not deal at arm’s length with the CRIC) will be based on the results of operations of the subject corporation to a greater extent than will be the performance evaluation and compensation of any officer of a non-resident corporation (other than certain non-resident corporations).
Your questions relate to the application of the exception in subsection 212.3(16) to the application of subsection 212.3(2) of the Act (commonly referred to as the “foreign affiliate dumping” rules). More specifically on the first and fifth conditions listed above:
1. Is the “more closely connected business activities” test in paragraph 212.3(16)(a) of the Act met on the basis that the business of US Sub is more closely connected to Canco, both of which are in Business Segment 1, despite the fact that US Sub was originally acquired by USCo which is in Business Segment 2?
2. Please clarify the meaning of “reasonably expected” in the preamble in paragraph 212.3(16)(c) and “to a greater extent” and “any”, in subparagraph 212.3(16)(c)(iii) of the Act.
3. How is the determination in subparagraph 212.3(16)(c)(iii) made where some of the officers of Canco are also officers of a non-resident corporation that does not deal at arm’s length with Canco (US Pubco, US Holdco and USCo)?
4. For the purpose of subparagraph 212.3(16)(c)(iii) of the Act, is it sufficient that the performance evaluation and compensation are based on the results of the business segment of US Sub (the subject corporation) or does the performance evaluation and the compensation need to tie specifically to the results of US Sub?
Comments
This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.
Question 1 - Application of paragraph 212.3(16)(a)
Subject to paragraph 212.3(16)(a), subsection 212.3(2) could otherwise apply to deem Canco to pay a dividend to its parent, US Holdco. The exception in that paragraph applies if:
“the business activities carried on by the subject corporation [US Sub] and […] [the subject subsidiary corporations] […] are […] more closely connected to the business activities carried on in Canada by the CRIC [Canco], or by any corporation resident in Canada with which the CRIC does not, at the investment time, deal at arm’s length, than to the business activities carried on by any non-resident person with which the CRIC [Canco], at the investment time, does not deal at arm’s length, other than
(i) the subject corporation,
(ii) the subject subsidiary corporations, and
(iii) any corporation that is, immediately before the investment time, a controlled foreign affiliate of the CRIC [Canco] for the purposes of section 17”.
The paragraph indicates that such determination is made “on a collective basis”, that the condition needs to be met at the Investment Time and that is expected that it will continue to be met.
The Explanatory Notes to subsection 212.3(16) state that for purposes of paragraph 212.3(16)(a), the reference to business activities is “intended to refer to active business operations rather than simply investing in shares in other companies and the management and governance activities that may relate thereto.” In addition, the Explanatory Notes indicate that the business activities of two corporations can be considered “connected” when the activities are similar in nature or integrated.
Determining whether the business activities of US Sub are more closely connected to the business activities of Canco at the Investment Time than to the business activities carried on by other non-resident corporations with which Canco does not deal at arm’s length (excluding the entities that are specifically excluded from the test in this provision), and were expected to remain so, first requires the identification of such persons.
The Canco Foreign Subsidiaries are excluded from that test. Therefore, the fact that the Canco Foreign Subsidiaries also operate in Business Segment 1 would not be relevant to that determination, provided that the terms of the exception in subparagraph 212.3(16)(a)(iii) are met.
The second part of that test is the determination of the degree of connection between the business activities of US Sub and the business activities of Canco; that requires an examination of all the relevant facts.
The facts point out that at the Investment Time, the business activities of US Sub were in Business Segment 1, and were similar to the business activities carried on in Canada by Canco in that same business segment. On that basis, the business activities of US Sub would appear to be closely connected to the business activities of Canco.
The first condition of the exception to the foreign affiliate dumping rules in paragraph 212.3(16)(a) of the Act would appear to be met.
Questions 2, 3 and 4 - Application of subparagraph 212.3(16)(c)(iii)
Question 2 is about the meaning of the words “reasonably expected” in the preamble in paragraph 212.3(16) and “to a greater extent” and “any” in subparagraph 212.3(16)(c)(iii).
It might be helpful to outline how the conditions in that provision relate to the relevant entities involved in this scenario. The provision applies if, at the time Canco acquires the shares of US Sub, it was “reasonably expected” that:
“the performance evaluation and compensation of the officers of the CRIC [Canco], […] who are resident, and work principally, in Canada, or in a country in which a connected affiliate is resident, will be based on the results of operations of the subject corporation [US Sub] to a greater extent than will be the performance evaluation and compensation of any officer of a non-resident corporation (other than the subject corporation [US Sub], a corporation controlled by the subject corporation or a connected affiliate [as defined in subparagraph 212.3(16)(b)(ii)]) that does not deal at arm’s length with the CRIC)” [i.e., any officer of US Pubco, US Holdco and USCo]. [Emphasis added]
The Explanatory Notes provide guidance on the meaning of the words “reasonably expected” in the preamble in paragraph 212.3(16)(c) and “to a greater extent” and “any” in subparagraph 212.3(16)(c)(iii) by saying that the extent “would generally be expected to be determined based on a proportion of the officer's overall performance or compensation” (“the proportion test”). The relevant excerpt of the Explanatory Notes reads as follows:
“The fifth condition, in subparagraph 212.3(16)(c)(iii), is that it must reasonably be expected, at the time of the investment, that the performance evaluation and compensation of officers of the CRIC (who are resident, and work principally, in Canada or in the residence country of a connected affiliate) will be based on the operating results of the subject corporation to a greater extent than will be the performance evaluation and compensation of any officer of another non-resident group member (other than the subject corporation, a corporation controlled by the subject corporation or a connected affiliate). The extent to which an officer's performance evaluation or compensation is based on operating results would generally be expected to be determined based on a proportion of the officer's overall performance or compensation [“the proportion test”]. Thus, where, for example, officers of the CRIC and officers of the non-resident parent corporation both receive comparable bonus amounts that are linked (e.g., by a compensation formula) to the performance of the subject corporation, the compensation of the CRIC's officers may nevertheless be considered to be connected to the subject corporation's results to a greater extent than that of the parent's officers if such bonuses constitute a greater proportion of the overall compensation of the former than of the latter.” [Emphasis added]
The Explanatory Notes to subsection 212.3(16) above points out that the proportion test “would generally be expected” to be an approach that would be considered; however, the other pertinent facts in a given situation would also need to be considered.
For instance, the example that is provided in the Explanatory Notes appears to assume that the officers in both groups of officers described in subparagraph 212.3(16)(c)(iii) are different. It also appears to assume that the performance evaluation and compensation of all the officers in each relevant group is determined in the same way. It does not explain how the test is to be applied when the circumstances are different from these.
According to case law (see Canadian Propane Gas & Oil v. MNR 73 DTC 5019 (Federal Court Trial Division) at 5028 and Sun Life Assurance Company of Canada v. The Queen, 2015 TCC 37, at paragraphs 37 to 39), the term “reasonably expected” in the preamble in paragraph 212.3(16)(c) is a test that needs to be judged by an objective observer with knowledge of all of the pertinent facts.
Question 3 is a request for comments on the application of the test in subparagraph 212.3(16)(c)(iii) in such circumstances where an officer or more is in both groups (i.e., dual officers).
Subsection 212.3(17) deals with dual officers. However, it only applies to deem a dual officer to not be resident, and to not work principally, in a country in which a “connected affiliate” is resident. Looking at the facts at hand, subsection 212.3(17) does not apply given that Canco’s officers all reside and work principally in Canada, not in a country where a “connected affiliate” is resident.
Given that subsection 212.3(17) does not apply to dual officers who reside and work principally in Canada, it is necessary to assess whether the exception in subparagraph 212.3(16)(c)(iii) applies to the current facts. As mentioned above, the extent to which the performance evaluation and compensation of an officer is based on the results of operations of the subject corporation for purposes of subparagraph 212.3(16)(c)(iii) is a case-by-case determination to be made by an objective observer in light of all of the pertinent facts (which includes but is not limited to the proportion test described above).
Applying the test in subparagraph 212.3(16)(c)(iii) to the facts at hand, the first step is establishing the groups to be compared.
CEO1, CFO1 and EVP1 are the officers of Canco, they reside and work principally in Canada.
The other group of officers that needs to be considered is CEO1, CFO1 and EVP2. EVP2 is an officer of USCo. CEO1 and CFO1 are the officers of US Pubco, US Holdco and USCo. These corporation are relevant since they are non-resident corporations that do not deal at arm's length with the CRIC (Canco) and are not the subject corporation, corporations controlled by the subject corporation, or “connected affiliates” within the meaning of subparagraph 212.3(16)(b)(ii).
CEO1, CFO1 and EVP1 are in the first group relevant to that comparison. The facts provided indicate that “CEO1 and CFO1’s compensation is based on the consolidated results of the Group”, suggesting that the extent to which their compensation is based on the results of US Sub is based on the proportion by which US Sub contributes to the overall results of the Group. EVP1’s performance evaluation and compensation is based solely on the results of Business Segment 1, which includes US Sub’s results.
In light of the limited information provided with the question, the proportion test for the compensation of CEO1 and CFO1 would result in a tie for the test in subparagraph 212.3(16)(b)(iii). Being in both groups, their compensation would be equal. In a real life situation, other relevant information (i.e., in addition to the proportion test) would be considered in determining if “the performance evaluation and compensation of the officers of the CRIC [Canco], […] who are resident, and work principally, in Canada, or in a country in which a connected affiliate is resident, will be based on the results of operations of the subject corporation [US Sub] to a greater extent” than the second group described in the provision.
Question 4 requests comments on whether the performance evaluation and compensation for purposes of subparagraph 212.3(16)(c)(iii) is based on the results of a Business Segment 1 or on the specific results of US Sub (the foreign corporation for which the individual acts as officer).
The text of subparagraph 212.3(16)(c)(iii) specifically mentions “the results of the operations of the subject corporation”. The excerpt of the Explanatory Notes to subsection 212.3(16) below emphasizes that for purposes of subparagraph 212.3(16)(c)(iii):
“where the investment in the subject corporation [US Sub] constitutes a strategic expansion of the CRIC's [Canco’s] business, it is expected that the relevant officers of the CRIC [which include three individuals who are also officers of US Sub] would have a high level of responsibility over the subject corporation's operations and that a greater proportion of their compensation would be based on the operations of the subject corporation than any other officer's compensation in the multinational group.” [Emphasis Added]
Moreover, the Explanatory Notes note that “it is expected that an officer's performance evaluation and compensation will reflect, to some extent, the operating results of the subject corporation.” [Emphasis Added]
Thus, for purpose of subparagraph 212.3(16)(c)(iii), one must generally demonstrate that some proportion of the performance evaluation and compensation of the officers are based to some extent on the operating results of the subject corporation.
We trust that these comments will be of assistance to you.
Yours truly,
Yves Grondin
Section Chief
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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