Joint Committee comments on the draft hybrid mismatch arrangements proposals

Comments of the Joint Committee on the draft hybrid mismatch arrangements proposals include:

• Where a dividend is subject to the denial of the s. 113 deduction, by s. 113(5), for a dividend received from a foreign affiliate, no deduction is available under s. 113(1) for foreign withholding tax paid on the dividend, and the dividend remains “income from a share of the capital stock of a foreign affiliate of the taxpayer”, such that no foreign tax credit under s. 126(1) nor deduction under s. 20(12) is available for the foreign withholding tax paid on the dividend. It is recommended that relief be provided for foreign withholding tax paid on dividends that are subject to s. 113(5) by modifying it to allow grossed-up deductions for such withholding tax.
• Where, for example, a FAPI-earning controlled foreign affiliate has issued a financial instrument that is treated as debt from a Canadian perspective and as equity from a foreign tax perspective, it seems inappropriate to deny a deduction in computing such FAPI through an extension to such context of the proposed hybrid mismatch rules, given that if this instrument had instead been treated as equity from a Canadian perspective, such that there would not have been any deduction in computing FAPI for the “interest” payments, the existence of the instrument would have in any event resulted in a reduction of the Canadian taxpayer’s participating percentage in respect of the affiliate, and thus a corresponding reduction of attributed FAPI. It is recommended that s. 95(2)(f.11)(ii)(A) be expanded to exclude the application of ss. 12.7 and 18.4 in computing a foreign affiliate’s income from property, income from a business other than an active business and income from a non qualifying business.
• It should be clarified that there would not be considered to be a hybrid mismatch if, for example, a taxpayer borrows money at interest from a third party for the purpose of making an interest-bearing loan to a foreign subsidiary, i.e., the fact that the interest on this borrowing “shelters” the Canadian interest income should not be considered to give rise to a non-inclusion situation.
• There is potential double taxation under the draft rules through considering there to be a mismatch where the amount is deductible (but not actually deducted) in the foreign jurisdiction, e.g., under draft s. 18.4(9).
• S. 20(1)(yy) only relieves where the application of the hybrid mismatch rules results in the denial of a deduction under s. 18.4(4), and not where there is an income inclusion under s. 12.7(3), i.e., if a payment under a hybrid mismatch arrangement produces a foreign tax deduction in a particular foreign taxation year, and Canadian ordinary income in a taxation year beginning more than 12 months after the end of the particular year, the recipient of the payment is required to include an amount in its income under s. 12.7(3), notwithstanding that an amount is also included in Canadian ordinary income under the general Canadian income tax rules.
• Where s. 18.4(4) denies a deduction for an amount paid as interest, s. 214(18) deems such amount to have been paid as a dividend for Part XIII purposes. Where a deduction is subsequently provided under s. 20(1)(yy) (i.e., because such amount is demonstrated to be foreign ordinary income that has not previously been taken into account), the draft rules do not currently provide for any refund or reduction of the withholding tax that would result from such deemed dividend treatment.

Neal Armstrong. Summaries of Joint Committee, “Hybrid Mismatch Arrangements Proposals,” 30 June 2022 Submission of the Joint Committee under s. 113(5), s. 18.4(1) – Canadian ordinary income – (a)(iii), specified entity, s. 18.4(3), s. 18.4(9), s. 12.7(3) and s. 227(6.1).