Section 212.3

Table of Contents

Subsection 212.3(1) - Foreign affiliate dumping — conditions for application

Commentary

References, in the discussion below of the foreign affiliate dumping rules in s. 212.3, to draft provisions refer to draft legislation released by the Department of Finance on August 16, 2013 or on August 29, 2014. (The Commentary is in the course of being revised to reflect the more recent draft amendments, and until this is finished there will be inconsistencies.) As these draft provisions are generally proposed to have retroactive effect, the discussion focuses on such draft amendments, in those instances where they differ from the current provisions of the Act.

Subsection 212.3(1) provides seven conditions for the application of subsection 212.3(2), which generally provides for a deemed dividend subject to a paid-up capital grind instead occurring under s. 212.3(7).

Preliminary conditions

The first three conditions are that:

(i) a corporation resident in Canada (referred to in s. 212.3 as a "CRIC")

(ii) must make an "investment" (principally defined in s. 212.3(10))

(iii) in a non-resident corporation (referred to in that capacity in s. 212.3 as the "subject corporation").

Example 1-A (acquisition by other than a CRIC)

A non-resident corporation acquires shares of a CRIC, whose principal assets are non-resident subsidiaries, from the shareholders of the CRIC. As this does not entail an investment by the CRIC in subject corporations, the s. 212.3 rules do not apply. See Nord Gold offering for High River.

If the non-resident corporation instead utilized a Canadian acquisition company to acquire such shares, the s. 212.3 rules instead generally would be applicable on the basis of the rule in s. 212.3(10)(f), which would treat such transaction as an indirect acquisition by the acquisition company of the shares of the non-resident corporations.

As the s. 212.3 rules do not apply to transactions between foreign affiliates, it may be desirable for a CRIC to hold foreign affiliates through a foreign affiliate holding company, so that funds can be redeployed within the non-resident group without engaging s. 212.3. The holding company also could transfer shares of subsidiaries to other foreign affiliates in consideration for debt without the debt restrictions in s. 212.3(18) applying.

Timing of FA status

The fourth condition, in paragraph 212.3(1)(a), is that the subject corporation, in addition to being a non-resident, must be a foreign affiliate of the CRIC immediately after the investment is made (or must become a foreign affiliate of the CRIC as part of a series of transactions or events that includes the making of the investment). References to a "series of transactions" are deemed by s. 248(10) to include related transactions or events completed in contemplation of the series. This rule has been judicially interpreted as assimilating to a series of transactions a prior transaction where the subsequent series occurs "because of" or "in relation to" the previous transaction: Canada Trustco and Copthorne. By virtue of the "series of transactions" reference, subsection 212.3(2) can also apply where a portfolio (non-foreign affiliate) interest in a non-resident corporation is acquired by a CRIC, and because of that investment the CRIC subsequently engages in a transaction that results in the non-resident corporation becoming its foreign affiliate -even if that subsequent transaction was not contemplated at the time of the original investment.

Example 1-B (assimilation of previous loan to series)

A CRIC (which is a subsidiary of a non-resident parent) makes a $10 million loan to a non-resident corporation with which it deals at arm's length. The borrower subsequently loses the ability to service the loan, and the CRIC agrees to the repayment of the loan by the issuance of common shares with a fair market value of $2 million, representing more than 10% of the equity of the borrower (which thereby has become a foreign affiliate).

This subsequent conversion transaction presupposes the previous loan and, in that sense, is "in contemplation" of the previous investment of $10 million. Accordingly, the s. 212.3 rules potentially may apply to the CRIC on the basis that it has made a $10 million investment in a subject corporation.

The subsequent conversion transaction itself will be exempt from the s. 212.3 rules under s. 212.3(18)(d).

Timing of control of CRIC

The fifth condition is that the CRIC must either be controlled by a non-resident corporation (the "parent") immediately after the time the investment is made (the "investment time") or becomes so controlled after the investment time and as part of a series of transactions or events that includes the making of the investment): draft s. 212.3(1)(b). The italicized references to the CRIC being controlled by the parent immediately after the investment time or to the acquisition of control occurring only after the investment time are alleviatory additions contained in the draft amendments. Respecting the second change, under current law, there would be a concern that the s. 212.3 rules could apply where the CRIC becomes so controlled, but then ceases to be controlled by the parent before the investment time. In other words, under current law, there was no provision for excluding the application of the s. 212.3 rules where an investment is made by a CRIC in a foreign affiliate and, as part of the same series of transactions, the CRIC ceases to be controlled by its non-resident parent and by any other non-resident persons. This point is illustrated by an example in the August 29, 2014 Explanatory Notes of the Department of Finance (essentially identical in this regard to its August 16, 2013 Explanatory Notes):

[Explanatory Notes] Example 1 (s. 212.3(1)(b))

Facts

  • NR Co, a non-resident corporation, owns all of the shares of Canco 1, a corporation resident in Canada.
  • As part of a series of transactions and events, the following events occur in sequence:
    • Canco 1 acquires all of the shares of Canco 2, a corporation resident in Canada, from vendors with which NR Co and Canco 1 deal at arm's length. As a result, Canco 2 becomes controlled by NR Co.
    • New shares of Canco 1 are sold through a public offering. As a result of the public offering, NR Co ceases to control Canco 1 and Canco 2.
    • Canco 2 acquires all of the shares of Forco, a non-resident corporation.

Analysis

The investment by Canco 2 in the shares of Forco did not occur while Canco 2 was controlled by a non-resident corporation, nor did Canco 2 become controlled by a non-resident corporation after the investment time as part of a series of transactions. Rather, Canco 2 became controlled by NR Co only prior to the investment time and as part of the series. As such, the conditions in paragraph 212.3(1)(b) are not satisfied, and subsection 212.3(2) will not apply, in respect of the investment by Canco 2 in the shares of Forco.

In contrast to the August 16, 2013 draft amendment to s. 212.3(1)(b), the October 20, 2014 draft amendment is engaged if the CRIC is controlled immediately after the time the investment is made, rather than at the time of the investment. The August 29, 2014 Explanatory Notes state:

This amendment ensures that the condition in paragraph 212.3(1)(b) is not satisfied when the investment is made by the CRIC at the same time as an event that causes a non-resident corporation to cease to control the CRIC. This situation could arise, for example, where a non-resident corporation controls the CRIC immediately before the CRIC acquires all the shares of another non-resident corporation from a Canadian-resident vendor and, as a result of the share consideration issued by the CRIC to the vendor, the CRIC ceases to be controlled by the non-resident corporation.

No relief is provided where the CRIC is controlled by the parent immediately after the investment time but ceases to be so controlled by the parent as part of the same series of transactions – even where this is pre-ordained.

Example 1-C (parent ceases to control as part of series)

Essentially the same transactions occur as in the Explanatory Note Example 1 (immediately above) except that the closing of the public offering by Canco 1 closes shortly after (but not immediately after) the closing of the acquisition of Forco by Canco 2. As the CRIC (Canco 2) is controlled by parent (NR Co) immediately after the investment time (the closing of the Forco acquisition), s. 212.3(2) will apply to that acquisition.

As discussed above, based on Canada Trustco and Copthorne, a subsequent acquisition of control of the CRIC can be considered to be part of the series of transactions that included the making of investments if the subsequent acquisition was made on the basis of the investments having been made. The likely absurdity of this result suggests that this expanded sense of a "series of transactions" was not intended in the context of the s. 212.3 rules or (given that similar difficulties arise under other provisions of the Act - see Groupe Honco) that these two decisions incorrectly interpreted the intended meaning of a series of transactions.

Example 1-D (non-resident acquisition of CRIC in contemplation of previous investments in CFAs by CRIC)

A CRIC incorporates a non-resident subsidiary in Year 1 to develop a mineral resource, which is wholly-owned by the CRIC with the exception of the acquisition of 10% of the common shares by a company resident in the local jurisdiction. The CRIC subscribes for preferred share of the subsidiary over the course of Years 1 to 5. In Year 5, a non-resident corporation acquires the CRIC in order to indirectly acquire what now is a valuable mine of the non-resident subsidiary.

The safe harbour rule discussed immediately below would not be available because the investments of the CRIC in the subsidiary were for preferred shares and there was a third-party investor.

As discussed above, if the non-resident purchaser is considered to have purchased the CRIC because of such previous investments of the CRIC, such purchase may be considered to be part of the same series of transactions as the investments by the CRIC under the Copthorne test. In such case, the CRIC could be deemed under s. 212.3(2) to have paid dividends to the non-resident purchaser at the dividend times defined in draft s. 212.3(1.1) (i.e., 180 days after the making of the various investments in Years 1 to 5) and, therefore, be liable for failure to withhold Part XIII tax, even though at those times it likely would have had no inkling of the subsequent purchase. (A "grind" of the paid-up capital of the CRIC in lieu of such dividends under draft s. 212.3(7) would not be available as at the dividend times the shares of CRIC would not yet be owned by a non-resident parent.)

Avoidance of control/reverse takeovers

A non-resident corporation will be considered to control a CRIC even if that corporation is merely a device for pooling the investment funds of unrelated non-resident investors, such as private equity funds. Conversely, the control test in s. 212.3(1) will not be satisfied if such investors invest in the CRIC directly.

If, rather than a direct acquisition of the CRIC by a non-resident corporation (Forco), there is a reverse takeover of the CRIC, so that the CRIC acquires Forco, and Forco's shareholder or shareholders acquire control of the CRIC, the acquisition by the CRIC of Forco will be an investment to which s. 212.3(2) applies if on the exchange a non-resident corporate former shareholder of Forco (Parent) acquire a majority of the voting shares of the CRIC. However, this result potentially may not obtain if it might be considered that the share attributes of Parent's shares' of the CRIC do not give it the right to elect a majority of the CRIC board.

Example 1-E (reverse takeover and effect of board nomination restrictions)

Non-resident Parent owns 100% of Forco. Parent transfers its shares of Forco to CRIC, a Canadian widely-held public corporation whose assets are non-resident subsidiaries, in consideration for the issuance to it of voting common shares of CRIC (so that it now holds 70% of all such shares) and for the issuance to it of a special voting share – with there being a simultaneous issuance of a second special voting share to another non-resident person ("Associate") with whom Parent is on friendly terms. By virtue of the Special Share terms, Parent and Associate have the right to nominate only 1/3 of the CRIC board members, but with the balance to be nominated by the board itself, and with Parent's Special Share entitling it to a veto power respecting all major decisions. Parent then immediately subscribes cash for further voting common shares (so that its equity interest in CRIC increases to 85%), with the subscription proceeds applied by CRIC to invest in a non-resident subsidiary.

Consequences.

It is unclear as to whether Parent acquires de jure control of CRIC on the reverse takeover. Although it can be said that it does not thereby acquire "ownership of such number of shares as carries with it the right to a majority of the votes in the election of the Board of Directors" (Buckerfield's, see also Bagtech), it might also be considered that it nonetheless can "exercise effective control over the affairs and fortunes of the corporation" (CRIC) through its shareholdings (Duha).

Change in sequencing.

If the cash subscription instead occurred immediately before the share exchange and the creation and issuance of the special shares, so that Parent acquires de jure control of CRIC before CRIC's acquisition of Forco, s. 212.3(2) would apply to such acquisition – whereas the same uncertainty would apply as to whether the investment of such cash proceeds in non-resident subsidiaries occurring after the issuance of the special shares would be subject to s. 212.3(2).

See reverse takeover of Mercator by Intergeo.

Safe harbour rule

The sixth condition is satisfied if any of the following tests (contained in draft ss. 212.3(1)(b)(i) to (iii)) is satisfied:

  • At the investment time, the parent, either alone or together with persons with whom the parent does not deal at arm's length and any partnerships described below, owns shares of the CRIC that either give the holders thereof 25% or more of the votes that could be cast at any annual meeting of the shareholders of the CRIC, or have a fair market value of 25% or more of the fair market value of all the shares of the CRIC. For these purposes, ownership of the CRIC's shares by the parent and each person who does not deal at arm's length with the parent or by any such partnership is to be determined as if all rights referred to in paragraph 251(5)(b) were immediate and absolute and the parent and each of those other persons had exercised those rights. A partnership referred to under these tests is any partnership of which the parent or a person with whom it does not deal at arm's length is a member other than as a limited partner (as defined in s. 96(2.4).) Thus, such partnerships are regarded entities for purposes of applying these tests rather than being looked through under s. 212.3(25(b) (s. 212.3(1)(b)(i)).
  • The investment is a portfolio acquisition of preferred shares of a subject corporation as determined in accordance with the rules in s. 212.3(19), i.e., (as paraphrased in the Explanatory Notes) "the shares are in substance preferred shares and the subject corporation is not a subsidiary wholly-owned corporation" (s. 212.3(1)(b)(ii)).
  • Under an arrangement entered into in connection with the investment, a person or partnership, other than the CRIC or a person related to the CRIC, has in any material respect the risk of loss or opportunity for gain or profit with respect to a property that can reasonably be considered to relate to the investment s. 212.3(1)(b)(i)). The Explanatory Notes state that this third test would be satisfied, "for example, where the CRIC's investment is funded by limited-recourse debt from a non-resident corporation that subsequently becomes its parent as part of the series of transactions or events that includes the making of the investment or where the CRIC has a right to sell the investment (i.e., a put right) to the parent, or a person that is not related to the CRIC, at some later time for a predetermined amount."

The August 29, 2014 Explanatory Notes refer to the sixth condition, viewed as something which will prevent the application of s. 212.3(2) unless one of the three tests is satisfied, as "a ‘safe harbour' from the application of subsection 212.3(2), subject to certain restrictions where the CRIC does not fully participate in (i.e., acquires preferred shares), or has its risk limited in respect of, the investment in the subject corporation," and go on to state:

The purpose of the safe harbour rules is to reduce impediments to corporate takeovers. The rules recognize that, if a non-resident corporation does not own, at the investment time, an equity interest in the CRIC that allows the non-resident corporation to materially influence the CRIC's investment decisions (i.e., 25% or more of the CRIC's equity as measured by votes or value), then the non-resident cannot generally be considered to have caused the CRIC to make an investment in anticipation of the non-resident acquiring control of the CRIC. However, the rules also recognize that if a CRIC has limited risk associated with the making of an investment – by virtue of either the nature or terms of the investment, or risk-mitigating arrangements related to the investment – the CRIC may be prepared to accommodate "dumping" transactions prior to an acquisition of control by a non-resident corporation.

The Explanatory Notes provide two examples to illustrate the point that the safe harbour rule in s. 212.3(1)(b) permits a non-resident corporation to establish a toehold (under 25%) position in a CRIC in order to fund an investment by the CRIC (Example 2 below) - but that the safe harbour will not be available if that toehold investment effectively is limited in recourse only to the investment (Example 3):

[Explanatory Notes] Example 2 (Paragraph 212.3(1)(b))

Facts

  • Canco 1 is a Canadian resident public company. Forco, a wholly owned foreign affiliate of Canco 1, owns an interest in a mining project located outside of Canada. Canco 1 requires funding in order to finance continued exploration and development of the project.
  • NR Co, a non-resident corporation, in order to partially fund the required investment in the project, acquires shares of Canco 1 that comprise 20% of the votes and value of all the shares of Canco 1. NR Co also advances a loan to Canco 1 with market terms, in order for Canco 1 to make an investment in Forco.
  • The project turns out to be sufficiently promising such that NR Co (as part of the series of transaction that includes the initial share acquisition and loan) subsequently makes an offer, which is accepted by the shareholders of Canco 1, to acquire a controlling interest in Canco 1.

Analysis

The investment by Canco 1 in Forco is an investment to which subsection 212.3(2) would apply if the requirements in paragraph 212.3(1)(b) were satisfied. With respect to the safe harbour in paragraph 212.3(1)(b), it will apply if none of the conditions in subparagraphs 212.3(1)(b)(i) to (iii) are satisfied. The condition outlined in paragraph 212.3(1)(b)(i) is not satisfied because at the investment time NR Co, together with persons with which NR Co does not deal at arm's length, did not own at least 25% of the shares of Canco 1 (as measured by votes or value). As well, the investment in Forco is not an investment described in subparagraph 212.3(1)(b)(ii), nor did the CRIC enter into an arrangement in connection with the investment in Forco that limits its risk of loss or opportunity for gain or profit. Therefore, the investment by Canco 1 in Forco is not an investment that satisfies the requirements of paragraph 212.3(1)(b) and section 212.3(2) will not apply.

[Explanatory Notes] Example 3 (Paragraph 212.3(1)(b))

Facts

  • NR Co, a non-resident corporation, is in advanced discussions with the shareholders of Canco 1, a corporation resident in Canada, to acquire all the shares of Canco 1. Canco 1 is not controlled by a non-resident corporation.
  • Prior to the acquisition of the shares of Canco 1, NR Co agrees to extend a loan to Canco 1 so that Canco 1 can acquire all the shares of Forco, a non-resident corporation, from NR Co. The loan may be settled at any time, at the option of either Canco 1 or NR Co, by Canco 1 transferring the Forco shares back to NR Co.
  • The shareholders of Canco 1 approve the takeover bid and NR Co acquires all the shares of Canco 1.

Analysis

Canco 1 becomes controlled by NR Co as part of the series of transactions or events that includes the making of the investment by Canco 1 in Forco. Paragraph 212.3(1)(b) will apply if any of the conditions in subparagraphs 212.3(1)(b)(i) to (iii) are satisfied. The limited-risk repayment terms of the loan are an arrangement entered into in connection with the investment by Canco 1 in Forco under which a person other than Canco 1 (i.e., NR Co) has in a material respect the risk of loss or opportunity for gain or profit with respect to the property (i.e., the shares of Forco) acquired by Canco 1 on the investment. Therefore, the investment by Canco 1 in Forco is an investment that satisfies the requirements of paragraph 212.3(1)(b) and section 212.3(2) will apply.

On a literal reading, the safe harbour might not be available even in Example 2. If Forco were the principal asset of Canco 1, then the risk of loss or opportunity for gain of NR Co on its investment in Canco 1 would be highly correlated with the performance of the underlying investment. However, Example 2 may imply that the exclusion in s. 212.3(1)(b)(iii) from safe-harbour treatment nonetheless will not apply if the terms of the investment in CRIC are not referenced to the underlying investment.

The wording of the exclusion in s. 212.3(1)(b)(iii) also is broad enough to apply where there is a third party investor participating in the investment.

Example 1-F(3rd party with profit participation in investment during toehold period)

A non-resident corporation (NR Co), has agreed to acquire all the shares of Canco, a public company, subject to approval of a plan of arrangement by the Canco shareholders In the meantime, it makes a loan on market terms to Canco, which uses the proceeds to fund an investment in a non-resident subsidiary (Forco), namely, a contribution of capital. Canco holds 70% of the common shares of Forco, and a company resident in the local jurisdiction (Stateco) holds 30% of the common shares, which were issued to it for a relatively modest amount. On the occurrence of various events of default under the shareholders' agreement for Forco, Stateco would have the right to acquire the 70% bloc of Canco on favourable terms.

After shareholder approval, NR Co acquires all the shares of Canco.

On a literal reading, the exclusion in s. 212.3(1)(b)(iii) from safe harbour treatment might apply as Stateco has a material opportunity for profit with respect to a property (its investment in Forco) that may reasonably be considered to relate to the investment (i.e., the contribution of capital by Canco benefits it pro tanto). Furthermore, it has a contingent right to acquire Canco's shares of Forco.

Such application of the exclusion may not be a significant concern provided that NR Co takes up the Canco shares within 180 days of the making of the investment by Canco. In these circumstances, draft s. 212.3(2) would not apply until the time that NR Co so acquired the shares of Canco, so that the paid-up capital suppression rule in draft s. 212.3(7) typically would be available to avoid a deemed dividend.

Further exclusions

The seventh condition, in s. 212.3(1)(c), is that neither s. 212.3(16) nor s. 212.3(18) applies in respect of the investment. The Explanatory Notes of the Department of Finance state that s. 212.3(16) provides an exception "in circumstances where the investment is made by the CRIC in the context of a strategic business expansion," although in practice this exception often will be unavailable. Subsection 212.3(18) provides exceptions for various qualifying types of reorganization transactions that do not involve a new investment by the CRIC in the subject corporation.

Articles

Peter Lee, Paul Stepak, "PE Investments in Canadian Companies", draft 2017 CTF Annual Conference paper

Quaere whether FAD rules apply to a non-s. 87(11) amalgamation (pp. 15-16)

[T]here is no explicit relief for an amalgamation is not described in subsection 87(11) in the context of an acquisition, even in circumstances where it is difficult to see where there would be a policy abuse. …

[I]f a. non-87(11) amalgamation is necessary, what is the FAD consequence? The charging provision in subsection 212.3(2)(a) treats as a deemed dividend the "fair market value ... of any property transferred, any obligation assumed or incurred, or any benefit otherwise conferred, by the CRIC ... that can reasonably relate to the investment". On a textual, contextual and purposive reading of the rule, in the context of an amalgamation of a parent and one or more direct or indirect wholly-owned subsidiaries, one could argue that this FMV is nil.

Avoidance of FAD rules where loan made directly by NR parent to CFA (p. 24)

[W]here an FA of Target has existing debt that needs to be funded with buyer cash. [fn 125: Note also the potential application of the upstream loan rules (i.e., subsection 90(6)) if the reverse is true and FA cash is to be used to repay Target debt.] Absent planning, either Target or Acquireco could fund the debt payoff and in doing so inadvertently make an investment in the FA. This can be addressed a number of ways, including by either having Acquireco's non-resident parent loan the funds directly to the FA at closing, or by having Acquireco loan the funds to Target, Target loan the funds to the FA, with Target making a PLOI election.

Sabrina Wong, "Summary of International Amendments in Bill C-63, Budget Implementation Act, 2017, No. 2", International Tax (Wolters Kluwer CCH), No. 97, December 2017, p. 6

Uncertainty in September 16, 2016 amendments respecting “other Canadian corporation” (p. 8)

[W]ith respect to the September 16, 2016 proposed amendment… [i]t was not clear whether the reference to "other Canadian corporation" in proposed paragraph 212.3(1)(b) (i.e., the corporation that must be controlled by the parent) is meant to refer to every corporation that does not deal at arm's length with the CRIC or only to a non-arm's length corporation of which the subject corporation (in which the CRIC made an investment) is an FA.

Clarification in revised s. 2121.3(1) that the subject corporation is an FA of the other corporation (p. 8)

The revised proposed amendment to subsection 212.3(1) contained in Bill C-63 did not provide further clarification that the "other Canadian corporation" must be a Canadian resident corporation (although the explanatory notes continue to be clear on this point), nor does it change the non-arm's length standard or provide a carve-out for paragraph 251(5)(b) rights. However, the revised proposed amendment to subsection 212.3(1) is reorganized so as to clarify that the "other Canadian corporation" referred to in paragraph 212.3(1)(b) (i.e., the corporation that must be controlled by the non-resident parent), is the non-arm's length corporation of which the subject corporation is an FA. The revised proposed amendment also clarifies that the reference to the "other Canadian corporation" is only relevant where the CRIC made an investment in a subject corporation which is not its FA (or becomes its FA as part of the series of transactions) but is an FA of the non-arm's length corporation (or become the non-arm's length corporation's FA as part of the series of transactions). This clarification appears to largely address the Joint Committee's concerns of the potential overly broad application of the FAD rules.

Philip Halvorson, Dalia Hamdy, "An Overview of the Foreign Affiliate Dumping Rules", (OBA article), 23 February 2016

Purpose of s. 212.3(1)(b)(i) safe harbour (p. 3 at f.n. 7)

The purpose of the safe harbor rule is to reduce impediments to corporate takeovers. The rules recognize that, if a non-resident corporation does not own, at the investment time, an equity interest in the CRIC that allows the non-resident corporation to materially influence the CRIC's investment decisions (i.e., 25% or more of the CRIC's equity as measured by votes or value), then the non-resident cannot generally be considered to have caused the CRIC to make an investment in anticipation of the non-resident acquiring control of the CRIC.

Exclusion from s. 212.3(1)(b)(ii) safe harbour for preferred shares (p. 3 at f.n. 8)

[I]n essence, the "safe harbour" provision in subparagraph 212.3(l)(b)(ii) does not apply to investments in preferred shares. The FAD Rules generally do not look favourably on investments in preferred shares, as is also evidenced by subsection 212.3(19) which overrides certain rollover exceptions in subsection 212.3(18) or the "bona fide business" exception in subsection 212.3(16) in respect of investments in preferred shares.

Brett Anderson, Daryl Maduke, "Practical Implementation Issues Arising from the Foreign Affiliate Dumping Rules", 2014 Conference Report, (Canadian Tax Foundation), 19:1-49

FAD rules apply only to 1st tier FA investments (p. 34)

[A]s a result, certain transactions with similar economic results Can give rise to an investment for the purposes of the FAD Rules when the transaction is between a CRIC and a Subject Corporation but not when the transaction is between a Subject Corporation and a lower tier affiliate.

…[A]ssume a CRIC owns 80% of the common shares of a Subject corp. and an arm's length third party owns the remaining 20%. If the CRIC were to exchange its common shares for preferred shares of the Subject Corp., subsection 212.3 (19) would prevent subsection 212.3(18) from applying to protect the resulting new investment from subsection 212.3(2). As discussed above with respect to debt repayments, whether the disposition of one investment and the making of a new investment give rise to adverse consequences depends on whether the original investment caused a PUC reduction.

A different result arises if the assumptions are changed slightly. Assume the CRIC owns all of the common shares of the Subject Corp. and the Subject Corp. owns 80% of the common shares of a second tier foreign affiliate. The other 20% of the second tier foreign affiliate's shares are owned by an arm's length third party. In this case the Subject Corp. exchanges its common shares of the second tier foreign affiliate for preferred shares….[T]his second scenario should not give rise to a new investment for purposes of the FAD Rules….

Ian Bradley, "Living with the Foreign Affiliate Dumping Rules", Canadian Tax Journal (2013) 61:4, 1147-66.

Engagement of rules where investors pool through holding company (p. 1152)

Investments in Canadian corporations are often made by groups of unrelated non-resident investors, such as private equity funds. Before the introduction of the FA dumping rules, these groups often invested through foreign holding companies. Centralizing ownership in a single foreign entity simplified Canadian tax-compliance obligations. However, these holding structures may produce unfavourable results under the new rules.

Consider a situation in which five unrelated non-resident corporations invest in a CRIC through a foreign holding company. Each investor owns 20 percent of the shares of the holding company, which owns all of the CRIC's shares. Since the holding company controls the CRIC, the control test in subsection 212.3(1) is satisfied, even though none of the investors is in a position to control the CRIC.

The control test should produce different results if each non-resident investor holds its CRIC shares directly… .

Non-application to off-shore transactions (pp. 1160-1)

The FA dumping rules generally apply to transactions between a CRIC and a foreign affiliate, rather than transactions between foreign affiliates. Accordingly, there may be opportunities to refinance or redeploy invested funds at the affiliate level without altering the CRIC'S investment in the subject corporation….

Paragraph 212.3(1)(a)

Subparagraph 212.3(1)(a)(ii)

Articles

Dean Kraus, John O’Connor, "Foreign Affiliate Dumping: Selected Issues", 2017 Annual CTF Conference draft paper

Example of application of s. 212.3(1)(a)(ii) to loan made by resident individual’s company to a CFC held by his U.S. brother through a US company and Canadian subs thereof (p. 5)

[T]he CRIC is controlled by a Canadian resident individual. However, the loan from the CRIC to the subject corporation owned indirectly by the individual’s brother, a non-resident of Canada, [through NR Parent and its subsidiary, Canco1] will be caught by the FAD rules as (a) the subject corporation will be a foreign affiliate of Canco1, which is a corporation that does not deal at arm’s length with the CRIC, and (b) Canco1 will be controlled by a non-resident corporation. As a consequence, the loan from the CRIC to the subject corporation will result in a deemed dividend to the NR Parent. Moreover, as the NR Parent will not own any shares of the CRIC, the CRIC will not be entitled to reduce its paid-up capital under subsection (7) in respect of the investment as it will not have a “cross-border class”… .

Example of application of s. 212.3(1)(a)(ii) to loan made by 9% shareholder of (factually NAL) Canco (held by NR Parent) to a CFC held by Canco (p. 6)

[T]he CRIC and NR Parent [holding 9% and 91% of the shares of Canco1, which holds the subject corporation] deal at arm’s length, but … the CRIC does not deal at arm’s length with Canco1 due to factual circumstances…. [A]s Canco1 will be legally controlled by the NR Parent, a loan from the CRIC to the subject corporation will be caught by the FAD rules as (a) the subject corporation will be a foreign affiliate of Canco1, which is a corporation that does not deal at arm’s length with the CRIC, and (b) Canco1 will be controlled by a non-resident corporation. Consequently, the loan from the CRIC to the subject corporation will result in a deemed dividend to the NR Parent, subject to a PLOI election being made.

Interestingly, the FAD rules would not apply if the CRIC owned10% of Canco1, such that the subject corporation was also a foreign affiliate of the CRIC….

General statement of where a deemed dividend may arise as a result of s. 212.3(1)(a)(ii) (p. 6)

[A]s a general statement, these situations appear to arise where (a) the CRIC is not itself controlled by a non-resident corporation but the other Canadian corporation (i.e., a non-arm’s length Canadian resident corporation) is; (b) the other Canadian corporation owns the shares of the subject corporation; (c) the subject corporation is not a foreign affiliate of the CRIC but is a foreign affiliate of the other Canadian corporation; and (d) the CRIC makes an investment in the subject corporation….

Paragraph 212.3(1)(b)

Articles

Dean Kraus, John O’Connor, "Foreign Affiliate Dumping: Selected Issues", 2017 Annual CTF Conference draft paper

Relevance of partnership agreement to control of corporations held by a limited partnership (p. 10)

[T]he “very capacity to act” [fn 50: Duha at para.50.] in respect of the voting entitlement is dictated by the applicable partnership law and the terms of the partnership agreement itself. As such, when seeking to ascertain who has “effective control” over the shares, in our view, a partnership agreement is more than merely an external document (which is to be ignored under the Duha analysis) but rather it is a document which goes to the root of ownership itself. Accordingly, it is likely that a Court would find that, for purposes of determining de jure control under the Act, it is the general partner who has effective control over a company whose shares are partnership property.

S. 212.3(25) deeming rule likely supplements rather than replaces the regular de jure control test (pp. 11-12)

[T]he legal fiction created by paragraph 251(5)(b) of the Act does not result in the real owners of the shares no longer owning those shares, or no longer controlling…. [fn: 58: See … Viking Food … and Ekamant Canada] … .

[Finance’s] commentary associated with the application of the strategic business expansion exception in subsection (16) … would imply that the deeming rule under 212.3(25) is not intended to supplant any party who would otherwise be considered to have control in the absence of such deeming rule….

[T]he most appropriate … approach to determine whether a non-resident corporation controls a CRIC in the context of a partnership is to apply a two-part test (the “Two-Part Test”): one examining control under the current state of affairs and the second under the legal fiction created by the deemed ownership rule.

Avoidance of FAD rules for inbound private equity LP through use of Canadian GP (p. 13)

[U]nlike the typical PE Partnership Structure, a Canadian corporation will be the general partner. The shares of this Canadian general partner, in turn, will be owned by one or more individuals - likely principals of the private equity firm. … This first alternative private equity structure works well in a situation where the fund is at the beginning stages of its life cycle….

Avoidance of FAD rules for inbound private equity LP through use of subsidiary buyco LP with Canadian GP (p. 14)

[T]he private equity fund maintains its existing structure whereby a limited partnership is the collective investment vehicle, the general partner is a non-Canadian corporation, and the fund sponsor is compensated in whatever manner it prefers. However, instead of the top limited partnership acquiring the shares of the CRIC, this limited partnership will form a subsidiary limited partnership of which it will be the sole limited partner. The general partner of this bottom limited partnership will be a Canadian corporation and this limited partnership, in turn, will acquire the shares of the CRIC. The sole shareholder of the Canadian general partner will be one or more individuals - again, likely principals of the private equity fund. …

[S]imilar to the conclusion under the first alternative structure, provided there is a wide dispersal of investors with no one investor owning more than 50% of the voting shares of the CRIC, no one investor will have de jure control of the CRIC under this legal fiction.

Avoidance of FAD rules for inbound private equity LP through having CRIC issue special voting shares to individual principals (p. 15)

[T]he CRIC will undergo a reorganization of capital pursuant to which two new classes of shares will be created: non-voting fully participating shares (the “Participating Shares”) and fully voting non-participating shares (the “Voting Shares”). The limited partnership will acquire (and own) all of the Participating Shares and all the Voting Shares will be acquired (and owned) by one or more individuals- again likely principals of the private equity fund.

Non-application of GAAR re above planning (pp. 15-16)

Canadian case law suggests that the selection of a general partner should not be considered a “transaction” for purposes of the GAAR…. [fn 69: Spruce Credit Union … 2012 TCC 357, confirmed by 2014 FCA 143.]…

[I]t can be inferred that Finance determined that foreign corporate control is the flex point at which the policy considerations of facilitating international competitiveness and neutrality are abandoned in favour of the policy of protecting the domestic tax base. It is noteworthy that economic ownership, whether majority non-resident individual or corporate, was not chosen as the applicable threshold provided that de jure control does not rest with a non-resident corporation. It is speculated that non-resident corporate control may have been chosen as the “tipping point” as it was primarily foreign multinationals who were engaging in the behavior which Finance sought to prevent.

In terms of the alternative structures discussed above, each has the common element that non- resident corporate control is relinquished in favour of Canadian corporate control. As such, it appears to be consistent with the object and spirit of the FAD rules…

Peter Lee, Paul Stepak, "PE Investments in Canadian Companies", draft 2017 CTF Annual Conference paper

No s. 245(4) abuse where use of a Canadian GP to avoid FAD rules (pp. 15, 16)

[T]he purpose of the FAD rules is to deter foreign multi-nationals from … benefiting economically by stuffing non-Canadian operating companies under Canada in circumstances where it otherwise would make little or no sense to do so. That harm is quite distant from a PE fund looking to buy a Canadian-owned or public Canadian multinational and then continue to run the business. …

[T]here are [thus] good policy reasons why the FAD rules should not apply to PE funds that are direct owners of Canadian portfolio companies. That same reasoning would support the argument that structuring the Fund to avoid the rules if possible does not violate the object, spirit or purpose of the FAD rules. That result is achieved if there is no non-resident corporation that controls the CRIC. This can be done if, for example the general partner of the Fund is a Canadian corporation… . However, this only works where the general partner can be owned directly by the individual partners/members of the sponsor. If the sponsor happens to be corporate or bank-owned, as some are, then the solution noted above is unlikely to be commercially viable.

Subsection 212.3(1.1)

Articles

Brett Anderson, Daryl Maduke, "Practical Implementation Issues Arising from the Foreign Affiliate Dumping Rules", 2014 Conference Report, (Canadian Tax Foundation), 19:1-49

PUC offset filing deadline could arise before acquisition of control (p. 19:31)

The policy reasons for implementing a one-year time frame within which acquisitions must be completed are not readily apparent….

…[O]ne can imagine situations…where the PUC offset rules would apply to reduce, at least partially, the deemed dividend with respect to the investment. In such cases, it is conceivable that the deadline for filing the form requiredunder paragraph 212.3(7)(d) could be prior to Parentco's acquiring control of CRIC.

Subsection 212.3(2) - Foreign affiliate dumping — consequences

Commentary

Where the conditions set out in s. 212.3(1) are satisfied, s. 212.3(2) can then apply to deem dividends by the CRIC to its (non-resident) parent or can cause the paid-up capital ("PUC") of its shares to be reduced.

Subject to the PUC "grind" rule in s. 212.3(7), s. 212.3(2)(a) deems a dividend to be paid by the CRIC to the parent (or under s. 212.3(3) to a qualifying substitute corporation) in an amount equal to the fair market value of any property transferred (other than shares of the CRIC), and other amounts described below, that can reasonably be considered to relate to the investment in the subject corporation. The dividend is deemed to be paid at the "dividend time" (as defined in s. 212.3(4)), namely, the investment time, where the CRIC is controlled by the parent at the investment time, and the first to occur of the CRIC becoming controlled by the parent and one year after the investment time, if the CRIC instead becomes controlled by the parent after the investment time but part as of the same series of transactions.

More completely, s. 212.3(2)(a) provides that the amount of such deemed dividend is equal to

the total of all amounts each of which is the portion of the fair market value at the investment time of any property (not including shares of the capital stock of the CRIC) transferred, any obligation assumed or incurred, or any benefit otherwise conferred, by the CRIC, or of any property transferred to the CRIC which results in the reduction of an amount owing to the CRIC, that can reasonably be considered to relate to the investment [in the subject corporation].

The result of a deemed dividend under paragraph 212.3(2)(a) is that the parent is subject to Part XIII dividend withholding tax under subsection 212(2).

Respecting the above "benefit" language, the October 15, 2012 Explanatory Notes of the Department of Finance state:

The reference in paragraph 212.3(2)(a) to "benefit otherwise conferred" is intended to capture any other means by which the CRIC transfers value to the subject corporation (for example, a forgiveness of debt) and is meant to be interpreted and applied in a fashion similar to that of the shareholder benefit conferral rule in subsection 15(1). (The contribution of capital rule in paragraph 212.3(10)(b) has corresponding language.) However, under the new "secondary adjustment" rules in section 247 of the Act, subsection 212.3(2) will not apply to a benefit conferral to the extent that new subsection 247(12) applies in respect of the benefit conferral, as provided under new subsection 247(15).

Paragraph 212.3(2)(b) provides that the PUC of the CRIC is reduced by the amount of any increase in the PUC of its shares "that can reasonably be considered to relate to the investment." As an example, the Explanatory Notes indicate that "where a subject corporation is transferred by the parent to the CRIC in exchange for shares of the CRIC, any PUC increase resulting from that transfer would be negated" under this rule.

Example 2-A (basic FA dumping transaction)

A Canadian subsidiary (a CRIC) of a non-resident corporation (the parent) purchases the shares of a non-resident subsidiary of the parent, having a fair market value ("FMV") of $100 in consideration for issuing interest-bearing debt to the parent of $60 and shares having a PUC and FMV of $40 (i.e., consideration that complies with the thin capitalization rules in s. 18(4)). The shares of the CRIC had nominal PUC prior to this transasction, so that prior to considering the s. 212.3 rules, the total PUC of the shares of the CRIC would now be $40.

The CRIC is deemed under s. 212.3(2)(a) to have paid a dividend to the parent of $60, being the value of the non-share consideration paid by it for its investment (viz., the property, other than shares, "transferred...that can reasonably be considered to relate to the investment"), and the PUC increase of $40 is denied under s. 212.3(2)(b).

If the starting PUC of the CRIC had been positive, the amount of the $60 deemed dividend would have been automatically reduced under the s. 212.3(7) rule.

If the non-resident subsidiary in the above example were engaged in an active business in a qualifying jurisidiction (i.e., most jurisdictions other than certain tax havens), and was expected to be held by the CRIC for the indefinite future then, in the absence of the CRIC rules, the CRIC would be able to use the interest accruing on the debt arising on this transaction to partially or fully shelter its Canadian business profits without any requirement to include dividends paid to it by its non-resident subsidiary out of exempt surplus in its taxable income. Furthermore, the non-resident parent at a time of its choosing could now use the $10M of basis it had created for its investment in the CRIC to distribute cash generated by the Canadian business as returns of PUC or repayments of principal.

Subsection 212.3(2) reverses both consequences. First, as s. 212.3(b) deems the PUC of the shares of the CRIC to be nil, its interest-deductibility limit under the thin capitalization rules in s. 18(4) is reduced to nil, so that it is not entitled to an interest deduction on its acquisition debt. Second, the ability to make withholding-tax-free distributions of Canadian profits also is reversed, and perhaps on a punitve basis as any deemed dividend is deemed to arise immediately rather than only to the extent there are PUC or principal distributions to the non-resident parent.

The Explanatory Notes express the provisons' policy as follows:

...these rules are designed to deter Canadian subsidiaries of foreign-based multinational groups from making investments in non-resident corporations that are, or become as a result of the investment..., foreign affiliates of the Canadian subsidiary in situations where these investments can result in the inappropriate erosion of the Canadian tax base. The erosion can arise because of the exempt treatment of most dividends from these foreign affiliates in combination with the interest deductions on debt incurred to make such investments (Part I tax base) or the ability to extract corporate surplus from Canada free of dividend withholding tax (affecting directly the Part XIII tax base and, indirectly through the diminution of income-earning capacity in Canada, the Part I tax base). In the case of Canadian subsidiaries of foreign-based multinational groups, the result of planning that exploits Canada's system of foreign affiliate taxation is inappropriate, particularly when undertaken without providing any significant economic benefits to Canada.

S. 212.3(2)(b), rather than (a), generally will apply where the CRIC acquires shares of a subject corporation (either directly or “through” a Canadian target as described in s. 212.3(10)(f)) Canadian target (viewed as an indirect

Example 1-B (application of s. 212.3(2)(b) on triangular exchange)

Buyco (a CRIC), which is wholly-owned by a non-resident public company (Parent) agrees to acquire all the shares of a Canadian public company (Target – which is mostly invested in a non-resident subsidiary) under a Plan of Arrangement, pursuant to which:

  • the shares of Target will be transferred to Buyco
  • Parent provides the specified consideration for 1 (e.g., shares in its capital or cash) directly to the Target shareholders
  • simultaneously with 1 and 2, Buyco issues common shares to Parent having a stated capital equal to the value of the consideration provided in 2

By virtue of s. 212.3(10)(f), the investment of Buyco (the CRIC) in the shares of Target is viewed as an indirect investment in a subject corporation. The only “property…transferred…by the CRIC” is the shares issued by it to Parent, and this transfer is specifically exempted from the application of s. 212.3(2)(a) by the exclusion therein for “shares of the capital stock of the CRIC.” Instead, s. 212.3(2)(b) applies to reduce the paid-up capital of the shares in the capital of the CRIC the amount of the increase the shares’ PUC “that can reasonably be considered to relate to the investment” in Target. Thus the full increase in PUC that occurred on the shares’ issuance as part of the triangular exchange would be reversed.

The literal wording of s. 212.3(2) which. for example, refers both to obligations assumed by the CRIC and property transferred to the CRIC, create the possibility of there being a double inclusion in the computation of a deemed dividend under s. 212.3(2)(a).

Example 2-C (potential double deemed dividend)

A CRIC whose shares have nominal PUC acquires the shares of a non-resident subsidiary having a fair market value of $100 from its non-resident parent in consideration for a non-interest-bearing demand promissory note of $100.

On a literal reading, this results in a deemed dividend of $200 arising to the non-resident parent under s. 212.3(2)(a), i.e., the sum of "any obligation assumed or incurred...by the CRIC...that can reasonably be considered to relate to the investment" (the $100 note incurred by it), plus "any property transferred...by the CRIC...that can reasonably be considered to relate to the investment" (the $100 value of the note issued to the parent viewed as property transferred by the CRIC to the parent relating to the investment). (Note that s. 212.3(2)(a) specifically excludes shares issued by the CRIC from the category of property transferred by it, which may imply that the issuance of a note is regarded as a transfer of property.)

The Explanatory Notes of the Department of Finance indicate that s. 212.3(2) should not be interpreted so as to give rise to double taxation in an analogous context where the parent first contributes cash to the CRIC as share subscription proceeds and those cash proceeds are then used by the CRIC to acquire the subject corporation - so that the first transfer of property by the CRIC is not considered to "relate to" the second-stage investment:

Paragraph 212.3(b) causes the PUC of the CRIC to be reduced where the creation of the PUC is related to an investment in a subject corporation. Thus, where a subject corporation is transferred by the parent to the CRIC in exchange for shares of the CRIC, any PUC increase resulting from that transfer would be negated.

Where, for example, a parent first contributes cash to the CRIC in exchange for shares of the CRIC with PUC equal to the amount of the cash and the CRIC subsequently uses that cash to make an investment in a subject corporation, it is intended that only the deemed dividend rule apply – the PUC creation would not be considered to relate to the investment, as it is one step removed. It is similarly intended that only the deemed dividend rule would apply where a contribution of capital is made (rather than a contribution in exchange for shares), and that none of paragraphs 84(1)(c.1) to (c.3) would apply to prevent such contributed surplus from subsequently being converted into PUC. Similar reasoning applies in situations where a CRIC borrows money and uses the proceeds to purchase shares or debt of a foreign affiliate – the incurring of the debt itself is not intended to give rise to a deemed dividend: only the cash payment is intended to give rise to a deemed dividend.

Accordingly:

  • where shares of a CRIC are issued in exchange for the acquisition by it of an investment in a subject corporation, the PUC arising on such issuance is reduced under s. 212.3(2)(b) and there is no deemed dividend under s. 212.3(2)(a) arising because of the issuance; and any deemed dividend is computed only by reference to the making of the investment;
  • where the CRC instead borrows money to acquire such investment, it is only the direct acquisition of this investment that results in a potential deemed dividend under s. 212.3(2)(b): the borrowing (which "is one step removed") is not considered to "relate to the investment" and does not give rise to a further deemed dividend; and
  • where there is a contribution of capital to the CRIC to fund its acquisition of the investment, the resulting contributed surplus also is considered not to relate to the investment – and there is no prohibition under proposed versions of ss. 84(1)(c.1), (c.2) and (c.3) against such contributed surplus being converted into PUC.

The Explanatory Notes also state that the "reasonably considered to relate" language in s. 212.3(2):

is mainly intended to deal with situations in which the "indirect acquisition" rule in paragraph 212.3(10)(f) is applicable, i.e., where the CRIC acquires foreign affiliate shares indirectly by acquiring shares of a Canadian corporation, in certain circumstances. In these situations, it would often be the case that the acquired Canadian corporation would also own assets other than foreign affiliate shares and thus, it is necessary to reasonably allocate the consideration paid by the CRIC to the foreign affiliate assets. In the absence of specific factors that indicate otherwise, it would be expected that the most reasonable way to allocate the consideration would be on a pro-rata basis based on the fair market value of the underlying assets acquired.

Under current law, s. 212.3(2) deems the CRIC to have paid a dividend at the investment time rather than (as discussed above) at the dividend time, as is proposed under the draft amendments. The related August 29, 2014 Explanatory Notes indicate that this change was made in order to permit the accessing of Treaty-reduced withholding tax rates which depend on the parent (or other relevant dividend recipient) owning a specified portion of the CRIC's equity and/or voting shares (e.g., 25% ):

The dividend withholding tax rate to be applied may be reduced under an applicable tax treaty. By providing that the deemed dividend occurs at the dividend time – generally defined by subsection 212.3(1.1) as the time when the parent acquires control of the CRIC (as long as control is acquired within one year after the investment time) – rather than at the investment time, the amendment generally ensures that the parent may benefit from the most favourable withholding rate reduction under the applicable treaty. If the parent does not acquire control within one year of the investment time, subsection 212.3(1.1) provides that the dividend time occurs one year after the investment time, which may result in a higher withholding tax rate (depending on the terms of the applicable tax treaty).

Administrative Policy

2015 Ruling 2015-0604051R3 - Internal Reorganization

extensive reps required re series of transactions

In connection with a s. 55(3)(a) distribution of a Canadian subsidiary (Canco3) to a sister chain of companies held by U.S. parents, s. 212.3(2) rulings were granted based on very extensive representations about arm’s transactions not occurring as part of or before the series.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(3) - Paragraph 55(3)(a) - Subparagraph 55(3)(a)(iii) note resulting from share redemption required to be vapourized on amalgamation/GAAR assessment required to reduce outside Canadian basis that US parents “paid for” by paying 5% Canadian withholding tax/rep re pubco share value being unaffected 815
Tax Topics - Income Tax Act - Section 152 - Subsection 152(1.11) s. 55(3)(a) rulings conditional on U.S. parents accepting GAAR assessments to reduce their outside basis 224
Tax Topics - Income Tax Act - Section 15 - Subsection 15(1.1) pro-rata highly dilutive stock dividend 115

28 May 2015 IFA Roundtable Q. 10, 2015-0581641C6 - IFA 2015 Q.10: 111(4)(e) election and 212.3

no transfer of property on deemed s. 111(4)(e) acquisition

The taxpayer was a foreign-controlled CRIC. Following the acquisition of control of its non-resident parent, it made a s. 111(4)(e) designation respecting its 100% shareholding of its FA. Would the resulting deemed reacquisition of those shares engage the foreign affiliate dumping rules? CRA responded:

[T]he subparagraph 111(4)(e)(ii) deemed reacquisition of the FA shares by the… CRIC would constitute an "investment in a subject corporation made by a CRIC" as described in paragraph 212.3(10)(a) and would not be an investment described in paragraph 212.3(18)(a) given that the CRIC would not be related to itself. … However…the amount of the deemed dividend would be equal to nil.

…The deemed disposition and reacquisition of shares pursuant to paragraph 111(4)(e) would neither constitute a transfer of any property by the CRIC for purposes of paragraph 212.3(2)(a) nor would it constitute any of the other amounts referred to in subsection 212.3(2)(a).

2012 Ruling 2012-0452291R3 - XXXXXXXXXX - ATR

Existing structure

A Canadian public company (Pubco) has x% (apparently, over 50%) of its common shares held by a non-resident public company (Norco1). Pubco holds a y% indirect equity interest in a non-resident corporation (Opco), which holds the "Project" in Country 3 (perhaps, a development stage mining project), and is also resident in Country 3. A local government-owned corporation (Stateco), which has an entitlement to elect certain of the Opco directors, holds the balance of the shares of Opco. The indirect equity stake of Pubco in Opco is held partly through Forco2 (resident in Country 2), which is a subsidiary of Forco1 (also resident in Country 2), which is held by Pubco and a Canadian subsidiary of Pubco ("Cansub"). The balance of the equity stake is held through a chain of non-resident holding companies (Holdco1, holding Holdco2, holding Holdco3) resident in three different non-Canadian jurisdictions.

Proposed transactions

Additional internal debt and equity financing will be provided to Opco in accordance with the thin capitalization rules of the local country (Country 3), in accordance with two sets of transactions.

  • Pubco (acting through a branch in Country 1 – assumed here to be Luxembourg) will subscribe with cash for common shares and/or mandatorily redeemable preferred shares ("MRPS") of Finco. Finco is a Luxembourg company (likely, a S.à r.l.). The MRPS are voting, do not bear dividends, are convertible at any time into a fixed value of Finco common shares or another class of MRPS at the holder's option, are redeemable before the maturity date at the holder's option and are required to be redeemed by Finco on the specified maturity date. They are debt for Luxembourg tax purposes, but shares for Luxembourg corporate purposes.
  • Finco will lend the net proceeds (as the Finco Loan) to Forco2 which, in turn, will use the proceeds to make the Forco2 Loan (bearing interest at a positive spread) to "XXXX" which, in turn, will acquire common shares of Opco, to be used by Opco for its operational and capital requirements.
  • Forco2 will transfer a portion of its shares of Opco to XXXX in exchange for an interest-bearing limited recourse obligation (Note A)
  • Finco, upon a further subscription by the Luxembourg branch of Pubco for common shares or MRPS, will lend the net proceeds (as Loan X, bearing interest at a positive spread) to Forco2 which, in turn, will use the proceeds to make Loan Y to Opco for its operational and capital requirements.
  • Pubco (and/or Cansub) will subscribe cash for Equity Investment A in Forco1, which will use such proceeds to make Equity Investment B in Forco2, which will use such proceeds to make Equity Investment C in Opco
Rulings
  • Application of s. 95(2)(a)(i) to income on Forco2 Loan and Note A, and s. 95(2)(a)(ii)(B) to Finco Loan
  • Non-application of ss. 17(1) and (2) to Pubco
  • Non-application of ss. 95(6)(b) and 17(4)(b) to Pubco's direct acquisition of shares in Finco or its indirect acquisition of shares of Forco2
  • Non-application of s. 258(3)
  • Opinion that s. 212.3(2) may apply as "the exception provided for in subsection 212.3(16) may not be met here"
  • Finco is a corporation, ownership interests in Finco are shares, and distributions of its profits are dividends (and similarly re Forco2 and Opco)

Articles

Joint Committee, "Technical Amendments Package of September 16, 2016", Submission letter of 15 November 2016

Expansion of s. 212.3(2)(a) to “other Canadian corporations”

S. 212.3(2)(a) is being expanded to investments other than by a CRIC in its own FA – for example, where a US-resident individual owns USCo which owns CaSub, the FAD rules will apply where a CCPC owned by his Canadian brother invests in an FA of the CCPC.

Ian Crosbie, "Recent Transactions of Interest, Part I", 2015 CTF Annual Conference paper

Summary description for acquisition of Yukon target with mostly U.S. assets (“Kodiak”) by U.S. public corp (“Whiting”) (pp. 15:5-6)

[W]hiting established a taxable Canadian corporation as a subsidiary to effect the transaction ("Whiting Bidco"). …

2) [A]t the same time,

a) In consideration for shares in the capital of Whiting (the "consideration") delivered to the Kodiak shareholders by Whiting on behalf of Whiting Bidco, Whiting Bidco issued shares to Whiting with a fair market value equal to the value of the consideration; and

b) Whiting Bidco purchased the outstanding Kodiak shares in exchange for the consideration, to be issued directly by Whiting to Kodiak shareholders on behalf of Whiting Bidco….

5) Whiting Bidco and Kodiak amalgamated (to form "Kodiak Amalco") "with the same effect as if they were amalgamated under...the BCBCA", "except that the separate legal existence of [Kodiak] will not cease and [Kodiak] will survive the Amalgamation".

Need to avoid Whiting shares being issued to Whiting Bidco (p. 15:8)

The transaction also presented a potential pitfall under the FAD rules. Had Whiting issued its shares to Whiting Bidco for delivery by Whiting Bidco to the Kodiak shareholders, there could have been two investments in FAs by a CRIC. Had Whiting issued shares to Whiting Bidco, immediately afterwards Whiting would have been an FA of Whiting Bidco, because the shares would have represented more than 10 percent of Whiting's total issued common share capital. In evaluating whether the FAD rules apply, it is necessary to evaluate whether a corporation in which a CRIC makes an investment is an FA of the CRIC immediately after the investment. There is no "at the end of the series of transactions" requirement or purpose test, suggesting that even momentary FA status could be sufficient to trigger the application of the FAD rules.

As discussed above, the acquisition of shares of Kodiak by Whiting Bidco was a deemed investment in an FA by a CRIC. Accordingly, had the transaction proceeded with Whiting issuing its shares to Whiting Bidco, the FAD rules could have applied in respect of two FA investments and would have had the potential to create a deemed dividend under subsection 212.3(2) in respect of each such investment. The PUC created by the issuance of Whiting Bidco shares to Whiting would have been sufficient to offset one of the FA investments (as it did), but there would have been no further PUC available to offset the other FA investment, meaning that a dividend equal to the value of the transaction could have been deemed to have been paid by Whiting Bidco to Whiting, and could have been subject to withholding tax at a 5 percent rate (under the Canada-U.S. tax convention.). Having Whiting deliver the shares directly to the Kodiak shareholders on behalf of Whiting Bidco, but without Whiting Bidco acquiring the Whiting shares, was intended to avoid this possible pitfall. [fn 18: This approach also is taken to avoid so-called "corporate incest"…]

Potential advantages of a direct acquisition not available where no significant Canadian operations (p. 15:8-9)

Had Whiting purchased the shares of Kodiak directly, paragraph 212.3(10)(f) would not have applied. In order for the acquisition of shares of a Canadian corporation to trigger the FAD rules, the shares must be acquired by another Canadian corporation (the CRIC). This would not have been the case. In this context, Whiting would have acquired the Kodiak shares with their historical PUC, but that PUC would not have been suppressed under the FAD rules, and would have been available for a broader range of purposes -- supporting thin capital computations for shareholder debt, making other distributions from Canada, avoiding FAD rule consequences in respect of future investments in FAs, etc. While it is easy to conceive of situations where this might be valuable to a purchaser, it is unlikely that the Whiting-Kodiak transaction would have benefitted meaningfully from such an approach. The fact that Kodiak's assets were all foreign meant that there would be little direct benefit from introducing debt into Canada, and that there was little likelihood that the suppressed PUC would not be available for any distribution that Kodiak Amalco might wish to make….

Brett Anderson, Daryl Maduke, "Practical Implementation Issues Arising from the Foreign Affiliate Dumping Rules", 2014 Conference Report, (Canadian Tax Foundation), 19:1-49

Two interpretations of subject corporation acquired under earnout agreement: PV all investment obligations at investment time; or succession of property transfers? (p. 24)

One interpretation is that an earnout involves multiple transfers of property by a CRIC for the purposes of paragraph 212.3(2)(a). Under this interpretation, each subsequent payment under the earnout would be a transfer of property that would increase the deemed dividend. Determining the amount of the increase to the deemed dividend would require determining the FMV of the transferred property at the Investment Time, not at the time the property actually was transferred to the Subject Corp….[I]t is possible that a CRlC could make future earnout payments by "transferring property that did not exist at the investment time (such as shares of a corporation that was incorporated after the investment time); it is unclear how such transfers of property would be valued in applying paragraph 212.3(2)(a).

An alternative interpretation is that under an earnout a CRIC agrees to make an initial transfer of property at the Investment Time, and, also at the investment time, incurs a contingent obligation to make future earnout payments. This interpretation would require the contingent obligation to be valued at the investment time and necessitate an analysis of the likelihood of the CRIC being required to make future earnout payments as well as the quantum of such payments….[W]hile both interpretations create potential valuation concerns, the former interpretation should be preferred because in many circumstances, where the subsequent payments are made in cash, the valuation issues should be manageable. If the acquisition was structured as an installment sale with a definite amount payable in future years the CRIC could be viewed as incurring an obligation for the future payments. These amounts are more certain then in a transaction structured with future earnout payments.

Ian Bradley, "Living with the Foreign Affiliate Dumping Rules", Canadian Tax Journal (2013) 61:4, 1147-66.

Irreversibility of deemed dividend (p. 1155)

Unlike a PUC reduction, a deemed dividend cannot be reversed at a later date. In fact, withholding tax may be imposed again when the proceeds of the investment are repatriated from Canada, resulting in double taxation. For this reason, taxpayers making investments that are subject to the FA dumping rules will generally want to ensure that sufficient cross-border PUC is available to prevent a deemed dividend from arising.

PUC grind for unrelated shareholders (p. 1157)

The PUC reduction in paragraph 212.3(2)(b) applies where the PUC of CRIC shares is increased in relation to an investment. This PUC reduction can also apply to shares held by unrelated parties… . Consider the situation where a foreign controlled CRIC acquires the shares of a foreign corporation ("Forco") from unrelated vendors. The consideration paid to the vendors includes CRIC shares, under an earnout arrangement. The acquisition of the Forco shares is an investment by the CRIC. However, the value of the newly issued CRIC shares is not included in computing the deemed dividend under paragraph 212.3(2)(a). Instead, the PUC of these shares is reduced under paragraph 212.3(2)(b). Thus, the share consideration effectively transfers some of the tax burden from the non-resident parent to the vendors.

Subsection 212.3(3) - Dividend substitution election

Commentary

Draft s. 212.3(3) provides for a joint election to be made to allow for all or a portion of a dividend that would otherwise be deemed, under s. 212.3(2)(a), to be paid by a corporation resident in Canada (the CRIC) to its non-resident parent to instead be deemed to be paid by either the CRIC or another Canadian-resident corporation in the corporate group (a "qualifying substitute corporation," or "QSC") to either the parent or another non-resident corporation that at the relevant time (the "dividend time") does not deal at arm's length with the parent. Accordingly, instead of the dividend being deemed to be paid by the CRIC to the parent, there can be an election for the payor and recipient to be:

  • the CRIC and such non-arm's length non-resident corporation
  • a qualifying substitute corporation and the parent, or
  • a QSC and such non-arm's length non-resident corporation

As noted in the Explanatory Notes accompanying the August 16, 2013 draft amendments:

By allowing taxpayers to elect as payee any non-resident corporation that does not deal at arm's length with the parent, the amendment provides greater flexibility than the current rules, which allow only non-resident corporations controlled by the parent to be payees.

Under the draft version of s. 212.3(3), the relationships are tested at the "dividend time" (as defined in draft s. 212.1(1.1)), namely, the investment time, where the CRIC is controlled by the parent at the investment time, and the first to occur of the CRIC becoming controlled by the parent and 180 days after the investment time, if the CRIC instead becomes controlled by the parent after the investment time but as part of the same series of transactions.

At a minimum, the joint election under s. 212.3(3) must be made jointly by the CRIC and the parent. In addition, any QSC which is to pay the deemed dividend must be a party; as must the non-arm's length non-resident corporation if it is to be the receipient of the deemed dividend. The election must be filed with the Minister on or before the filing-due date of the CRIC for its taxation year that includes the dividend time.

Example 3-A (s. 212.3(3) election for dividend to be paid by 1st tier Canadian subsidiary)

The US Parent wholly-owns QSC, a Canadian resident corporation whose shares have nominal PUC. QSC wholly-owns CRIC whose shares also have nominal PUC. CRIC makes a $100 investment in FA.

In the absence of an election under s. 212.3(a), CRIC will be deemed to have paid a dividend of $100 to parent, which would be subject to Part XIII withholding tax of $15, as Parent does not hold any of the voting stock of CRIC.

If a joint election is made for the dividend to be deemed to be paid by QSC, the rate of withholding will be reduced to 5%.

An election made under draft s. 212.3(3) is subject to the further application of draft s. 212.3(7), which potentially allow dividends that are otherwise deemed to arise under s. 212.3(3) to be offset against the paid-up capital of the "cross-border" shares of the QSC or CRIC in respect of which those dividends are deemed to be paid. Such PUC can also be reinstated, in certain circumstances, under s. 212.3(9).

CRA indicated (23 May 2013 IFA Round Table, Q. 6(h)) that a s. 212.3(3) dividend substitution election could be made even if there was no QSC in the group. This meant that even in these circumstances, the election could be used to determine which non-resident corporation received the s. 212.3(2) dividend from the CRIC. This point is now clear under the wording of draft s. 212.3(3): the election can be made for the dividend to be deemed to be paid by the CRIC to any non-resident corporation with which the parent does not deal at arm's length at the dividend time.

Example 3-B (election where no QSC)

Parent and its wholly-owned non-resident subsidiary (NR Subco) respectively own common shares of CRIC with a PUC of $100, 9% of the relative fair market value of the CRIC equity and a majority of the voting rights, and non-voting preference shares of CRIC (representing the balance of the equity) with a PUC of $400 and less than half the voting rights. CRIC uses borrowed money to acquire a non-resident corporation (FA) for $1,000.

Consequences:

In the absence of a draft s. 212.3(3) dividend substitution election, and before considering the application of draft s. 212.3(7), CRIC would be deemed under s. 212.3(2) to pay a $1,000 dividend to Parent. This dividend would be reduced to $500 under draft s. 212.3(7) by the $500 amount of the cross-border PUC. However, that residual dividend of $500 would be considered to be paid to Parent and, depending on the terms of the applicable treaty (if any), that dividend might not be eligible for a Treaty-reduced rate of 5%.

If a s. 212.3(3) joint election is made to deem there to be a $500 dividend paid by the CRIC to NR Subco, this may produce a better result under the applicable treaty betweeen Canada and the country of residence of NR Holdco.

Administrative Policy

2015 Ruling 2014-0541951R3 - Foreign Affiliate Debt Dumping

two Canadian corporate partners immediately beneath the U.S. border are QSCs respecting investments made by lower-tier CRICs in a U.S. LLP

A U.S. corporation will indirectly subscribe for units in a (presumably U.S.) limited liability partnership (FA1) by subscribing for preferred shares in its two immediate Canadian subsidiaries (Canco1, the general partner of a Canadian LP (“LP1”), and Canco2, the limited partner), with those funds going down through a long stack of Canadian subsidiary LPs (starting with LP1) and corporations as preferred unit and preferred share subscription proceeds, so as to land in FA1. A number of months later, FA1 will pay a distribution proportionately to its partners, who directly comprise (i) a limited partner corporation (Canco9), and (ii) a general partner which is a general partnership (“GP”) - whose partners on a s. 212.3(25) look-through basis are two other indirect Canadian corporate subs in the group (Canco7 and Canco8). The ruling letter described FA1 as a (non-resident) subject corporation rather than as a Canadian partnership, and described the distribution as being deemed by s. 90(2) to be a dividend.

CRA ruled that Canco1 and Canco2 (at the top of the Canadian stack) will each be considered to be a QSC. The letter does not specify how the s. 212.3 effect of the investments made by the three CRICs (namely, the three direct or indirect partners of FA1 – or one CRIC if the partnership interests of Canco7 and Canco8 are nominal) is effectively allocated to the one or both of the QSCs.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(9) - Paragraph 212.3(9)(b) - Subparagraph 212.3(9)(b)(ii) s. 212.3(9)(b)(ii) PUC restoration for upper-tier QSCs on the payment by a U.S. LLP of a proportionate “dividend” to lower tier CRIC partners 306
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Corporation proportionate distribution by LLP treated as dividend 126
Tax Topics - Income Tax Act - Section 90 - Subsection 90(2) proportionate LLP distribution to three direct or indirect general or limited partners treated as dividend on single class of shares 108

23 May 2013 IFA Round Table, Q. 6(h)

In response to a query as to whether a s. 212.3(3) dividend substitution election can be made even if there is no qualified substitute corporation in the group, CRA indicated that this election can be used even where there is only one Canadian corporation in the group. This permits the election to be used to determine which non-resident corporation received the s. 212.3(2) dividend, or which class of shares it was paid on - or the dividends to which the PUC suppression under s 212.3(7) would apply.

Articles

Philip Halvorson, Dalia Hamdy, "An Overview of the Foreign Affiliate Dumping Rules", (OBA article), 23 February 2016

Background to introduction of Foreign-Affiliate Dumping rules (p.2)

[P]art of the Advisory Panel’s mandate was to provide recommendations to improve Canada's international tax policy respecting investment into Canada by foreign businesses and foreign investment by Canadian businesses….[fn 5: The Advisory Panel on Canada's System of International Taxation, "Enhancing Canada's International Tax Advantage", 2008]… .

The Department of Finance adhered to the principles embraced in the Advisory Panel report by repealing the broader rules in section 18.2 and introducing the FAD Rules….

[W]hereas the initial flurry of amendments included substantive changes in direction and tax policy to the FAD Rules themselves, more recent changes could be described as substantive tweaks designed to allow the rules to work better within a certain policy framework. As such, it is more likely that future amendments will be designed as either tightening or relieving measures to fit within a now (generally) established framework.

Subsection 212.3(4) - Qualifying substitute corporation

Cross-Border Class

Commentary

In order for a class of shares of a CRIC or qualifying substitute corporation (QSC) to qualify as a "cross-border class" under the current draft amendments, (i) the parent (or a non-resident corporation not dealing at arm's length with it) must own at least one share of the class, and (ii) no more than 30% of the issued and outstanding shares of the class may be owned by Canadian-resident person(s) not dealing at arm's length with the parent. The (previous) August 16, 2013 definition of "cross-border class" contained in draft s. 212.3(7)(a) (now moved to draft s. 212.3(4)) contained only the first condition. The addition of the second condition likely is intended to stop potential transactions for largely absorbing a deemed dividend under s. 212.3(2)(a) by grinding the PUC of shares of a CRIC or QSC held by a non-arm's length Canadian resident.

Example 7-C (effect of 30% test)

Parent incorporates a Canadian-resident holding company (CanHoldco) with 1 common share having a PUC of $1 and with $99 of debt. CanHoldco subscribes $100 for 100 common shares of CRIC, and Parent subscribes $1 for an additional common share of CRIC. CRIC acquires all the shares of FA for $100.

Consequences:

Draft s. 212.3(7)(c) requires that the amount of the $100 deemed dividend that would otherwise arise to Parent under draft s. 212.3(3)(b) be applied first to reduce the PUC of the 1 common share of CanHoldco by $1. Second, the common shares of CRIC (which also would represent a cross-border class in the absence of the draft second condition in the definition of "cross-border class") would have their PUC reduced from $101 to $2. Accordingly, the $100 deemed dividend would be eliminated at the cost of reducing cross-border PUC by approximately $2 in the absence of the second condition.

However, under draft s. 212.3(4), the common shares of CRIC no longer would qualify as a cross-border class, so that no offset against the PUC of that class would occur under s. 212.3(7) - i.e., Parent would be deemed to receive a dividend of $99 (since now the only cross-border class of shares would be the common shares of CanHoldoc, having a PUC of only $1) .

Dividend Time

Commentary

The "dividend time" is defined as the investment time, where the CRIC is controlled by the parent at the investment time, and the first to occur of the CRIC becoming controlled by the parent and one year after the investment time, if the CRIC instead becomes controlled by the parent after the investment time but as part of the same series of transactions. The "dividend time" determines the time at which a deemed dividend arises under s. 212.3(2) or any PUC grind occurs under s. 212.3(7) in lieu thereof. The delay of up to one year takes into account that this deemed dividend might otherwise arise prior to the time that the parent has acquired cross-border shares with a PUC which may be ground under s. 212.3(7) so as to eliminate that deemed dividend.

This one-year period represents a change from the (previous) August 16, 2013 definition of "dividend time" contained in draft s. 212.3(1.1) (now moved to draft s. 212.3(4)), which provided for a 180-day period instead. This change likely was made in response to an October 15, 2013 CBA/CICA Joint Committee submission that 180 days was too short having regard, for example, to "a merger transaction which is subject to significant regulatory and stakeholder approvals."

Articles

Philip Halvorson, Dalia Hamdy, "An Overview of the Foreign Affiliate Dumping Rules", (OBA article), 23 February 2016

Prevention of stuffing by accommodating vendor within 1 year before CRIC acquisition (p. 6)

In the geneal case, one would expect that the investment time is the dividend time. The FAD Rules also factor situations where an investment is made in respect of a subsidiary corporation at a time that is prior to the non-resident actually controlling the CRIC, but where the CRIC becomes controlled by the non-resident parent as part of the same series as the investment. Presumably this is meant to address situations where prior to an acquisition of control of a CRIC an accommodating vendor might "stuff" foreign affiliate investments under the CRIC in a manner that might avoid the FAD Rules because the CRIC was not technically controlled by the non-resident parent at that investment time.

Qualifying Substitute Corporation

Commentary

A qualifying substitute corporation (QSC) is defined in draft s. 212.3(4) as a Canadian-resident corporation that is controlled by the parent corporation of the CRIC or by a non-resident corporation with which the parent does not deal at arm's length and that has an equity percentage (as defined in s. 95(4)) in the CRIC, where "shares" of the capital stock of the corporation are owned by the parent or a non-resident corporation with which the parent does not deal at arm's length. The Department of Finance Explanatory Notes interpret this share ownership requirement as requiring that "at least one share" of the corporation be so owned.

By virtue of s. 212.3(15), where a chain of non-resident corporations control the Canadian-resident corporation, only the 1st tier non-resident corporation is considered to be the parent for these purposes. The current version of s. 212.3(4) did not permit the QSC to be controlled by a non-arm's length non-resident corporation rather than by the parent. The Explanatory Notes state:

This amendment addresses, in particular, the situation where a qualifying substitute corporation is not controlled by the parent because the actual parent corporation that controls the related group is deemed by paragraph 212.3(15)(a) to not control the CRIC and thus is not the parent for purposes of section 212.3.

This definition is relevant for the purposes of the election in s. 212.3(3) and the potential suppression of PUC in s. 212.3(7) in lieu of a dividend.

The requirement that, to be a QSC, shares of the corporation must be owned by the parent or another non-resident corporation with which it does not deal at arm's length dovetails with the stipulation in draft s. 212.3(7) that it is only "cross-border classes" of shares (i.e., classes or series of shares any shares of which at the dividend time are owned by the parent or a non-resident corporation with which it does not deal at arm's length) which are subject to a potential grind of paid-up capital under draft s. 212.3(7).

Equity-percentage rule

The effect of the equity-percentage branch of the QSC definition is to preclude the operation of the PUC suppression rule on a subsidiary of the CRIC even where an investment in shares of the subsidiary by the parent funded the relevant investment in a foreign affiliate by the CRIC.

Example 4-A (need for equity percentage of QSC in CRIC)

Parent holds all the shares of CRIC having a PUC of $1 and all of the Class B non-voting shares of CanSubco having a PUC of $100 (representing a previous share subscription for that amount). CRIC holds all the Class A voting shares of CanSubco.

CRIC acquires all the shares of FA for $100. This purchase is funded by CanSubco selling an investment which it had acquired with the $100 share subscription proceeds previously received from Parent, and lending or dividending such $100 proceeds to CRIC.

Consequences:

Because CanSubco does not have an equity percentage in CRIC, it does not qualify as a QSC - even though the PUC of its shares represents funds received from Parent which indirectly funded the purchase of FA. Accordingly, the $100 PUC of the Class B shares is not available to reduce a deemed dividend to Parent under s. 212.3(7).

Partnership as potential blocker

A partnership which is interposed between a CRIC and indirect Canadian-resident corporate shareholders may act as a "blocker" so as to prevent such shareholders from qualifying as QSCs. The equity percentage definition in s. 95(4) takes into account shares which are indirectly held through other corporations, but does not address shares held through partnerships. S. 93.1 provides a look-through rule for purposes inter alia of s. 212.3 in determining whether a non-resident corporation is a foreign affiliate of a corporation resident in Canada, but not for purposes of determining whether the corporation resident in Canada has an equity percentage in a CRIC.

While s. 212.3(25)(b) deems there to be proportionate ownership by partners of partnership property, this rule applies only for the purposes of s. 212.3. The equity percentage determination which is referenced in the QSC definition is applied for such purposes. Accordingly, it would appear that a partnership is a look-through for purposes of the QSC definition.

If this interpretation were not correct, a CRIC whose shares were held by a Canadian partnership would have no QSCs, even if the partnership interests were owned by related Canadian corporations.

Example 4-B (partnership as potential blocker)

Non-resident parent has two Canadian-resident subsidiaries, Canco 1 and 2, which hold all the shares of CRIC through a partnership. CRIC invests in a non-resident subsidiary (FA).

If the concerns discussed above materialized, a deemed dividend arising from an investment by CRIC in FA would not be reduced under s. 212.3(7) by the cross-border PUC of the shares of Canco 1 and 2 held by Parent, and the dividend might not benefit from reduced treaty rates.

Subsection 212.3(5) - Modification of terms — paragraph (10)(e)

Commentary

S. 212.3(5) affects the application of s. 212.3(10)(e), which deems there to be an investment by a corporation resident in Canada (a CRIC) in a non-resident corporation (the subject corporation) where there is an extension of the maturity date of a debt obligation owing by the subject corporation to the CRIC or an extension of the redemption date of shares of the subject corporation owned by the CRIC. S. 212.3(5) deems the CRIC to have transferred to the subject corporation property with a fair market value equal to the amount owing, in the case of a debt obligation, and equal to the fair market value of the share, in the case of redeemable shares.

Subsection 212.3(6)

Articles

Philip Halvorson, Dalia Hamdy, "An Overview of the Foreign Affiliate Dumping Rules", (OBA article), 23 February 2016

Prevention of structured access to 30% intra-Canadian exception (p.5)

[G]iven that the CRIC must be controlled by a non-resident person in the first instance, there is presumably at least one class of share that would qualify as a cross-border class. However, the rules do permit some level of intra-Canadian holdings so long as no more than 30% of the shares of any class are held by related Canadian corporations. Presumably this condition is a concession, acknowledging that Canadian groups, particularly those with minority shareholders, may not always be in a position to restructure their affairs in the case of legacy holdings. As such, on the surface, groups could conceivably arrange so that 30% of the shares of a Cross-border class are held by related Canadian corporations, and as such, every dollar of PUC grind to that class will result in no more than $0.70 of grind to shares actually held by the non-resident group. However, the FAD Rules also contain a specific anti-avoidance rule (subsection 212.3(6)) which may apply generally where a group deliberately structures their holdings to purposely reduce any sting from the PUC grind mechanisms.

Subsection 212.3(7) - Reduction of deemed dividend

Commentary

S. 212.3(7) potentially provides that a dividend which otherwise would be deemed to be paid by a corporation resident in Canada (a CRIC) under s. 212.3(2)(a) (or by a qualifying substitute corporation (QSC) under s. 212.3(3)(b)) in respect of an investment of the CRIC is to be reduced through application of paid-up capital (PUC) of the shares of the CRIC (or qualifying substitute corporations in respect of the CRIC.) Any such reduction occurs under draft s. 212.3(7)(a) (b) or (c), depending on whether direct tracing is established as described in s. 212.3(7)(a) and on the amount of qualifying cross-border PUC.

PUC suppression under s. 212.3(7)(a)

The reduction under draft s. 212.3(7)(a) applies to the shares of the CRIC or of a QSC that are owned immediately after the dividend time (as defined in s. 212.3(4))only by persons that deal at arm's length with the CRIC. (A class of shares includes a series thereof: s. 248(6).) For draft s. 212.3(7)(a) to apply in these circumstances the amount of PUC in respect of the class must have arisen as a consequence of one or more transfers of property, directly or indirectly, to the CRIC, and all of the property transferred must have been used by the CRIC to make, in whole or in part, the investment (or, where applicable, an indirect investment through the making of a direct investment in the shares of a "10(f)" corporation described in 212.3(10)(f)). In its 20 October 2014 Explanatory Notes, the Department of Finance paraphrases these requirements as follows:

In other words, where the creation of an amount of PUC in respect of the relevant classes of shares of the CRIC or qualifying substitute corporations can be traced to a direct or indirect (through related corporations) transfer of property to the CRIC and the property is subsequently used by the CRIC to make an investment in a subject corporation, then that amount of PUC can be reduced as an offset against the deemed dividend under paragraph 212.3(2)(a).

From the standpoint of the parent, it often will be desirable for s. 212.3(7)(a) to apply before any application of s. 212.3(7)(b) or (c). First, ss. 212.3(7)(b) or (c) apply only to cross-border classes, whereas s. 212.3(7)(a) potentially can apply to a class of shares which is held only by a resident arm's length investor. Such application may reduce a deemed dividend which otherwise would arise under s. 212.3(2)(a) (in the scenario where the PUC of cross-border classes is fully eliminated under s. 212.3(7)(b)) or reduce the grind to cross-border classes otherwise occurring under s. 212.3(7)(c).

Second, where the arm's length third party is a non-resident which holds its shares in a separate class, the application of s. 212.3(7)(a) to its shares will reduce the grind to the cross-border classes held at least in part by the parent or affiliated non-resident. See Example 7-B below.

Third, the non-application of draft s. 212.3(7)(a) to an investment by a CRIC in a subject corporation which is fully funded by PUC subscribed by the non-resident parent and third parties, may result in a deemed dividend to the parent even after application of the PUC grind under s. 212.3(7)(b). See Example 7-1A below.

Draft 212.3(7)(a) requires the taxpayer to "demonstrate" compliance with these requirements. It is not clear what this adds to the general principle that the onus is on the taxpayer to establish a prima facie case that the Minister's assumptions in assessing it were wrong (Newmont).

PUC suppression under s. 212.3(7)(b)

Draft s. 212.3(7)(b) addresses the situation where the amount of the dividend that otherwise would be deemed to be paid is equal to or greater than the total of all amounts comprising the PUC in respect of a "cross-border class" of shares immediately before the dividend time. Where this is the case

  • the amount of the deemed dividend is reduced by the total PUC of the cross-border classes immediately before the dividend time (s. 212.3(7)(a)(i)), and
  • the PUC of each of the cross-border classes is reduced to nil (s. 212.3(7)(a)(ii)).

For purposes of draft s. 212.3(7), a "cross-border class" is any class of shares (or, in light of s. 248(6), any series of shares) of the capital stock of the CRIC, or a QSC, where any shares of that class or series are owned at the dividend time by the parent or a non-resident corporation with which it does not deal at arm's length at the dividend time. The "dividend time," as defined in draft s. 212.1(4), refers to the investment time, where the CRIC is controlled by the parent at the investment time, and to the first to occur of the CRIC becoming controlled by the parent and one year after the investment time, if the CRIC instead becomes controlled by the parent after the investment time but as part of the same series of transactions.

The combined effect of the definition of "cross border class" and the strictness of the requirements for a PUC grind to apply to the shares of third parties under s. 212.3(7)(a) is that an investment by a CRIC in a subject corporation which is fully funded by PUC subscribed by the non-resident parent and third parties is that a deemed dividend to the parent can arise even after application of the PUC grind under s. 212.3(7)(b).

Example 7-1A(deemed dividend resulting from ouster of s. 212.3(7) and lower tier funding)

Parent capitalizes a newly-incorporated Canadian corporation (QSC) with $60 for Class A shares and Partnership 1, of which a non-resident trust with whom Parent does not deal at arm's length is a 1% partner and the other 99% are arm's length non-residents, subscribes $40 for Class B shares of QSC. QSC subscribes $100 for Class X shares of CRIC and Partnership 2, of which a resident individual with whom Parent does not deal at arm's length is a 1% partner and the other 99% are arm's length residents, subscribes $80 for Class Y shares of CRIC. CRIC purchases FA from an arm's length vendor for $180.

Consequences

In the absence of a QSC election under s. 212.3(3) and a PUC grind under s. 212.3(7), CRIC would be deemed to pay a $180 dividend to Parent. The Class Y and Class B shares are not cross-border classes as neither Parent nor a non-resident corporation with whom Parent does not deal at arm's length owns any of its shares, and the Class A shares are the only such class. Accordingly, it is assumed that CRIC, QSC (which is a "qualifying substitute corporation" as defined in s. 212.3(4)) and Parent would elect under s. 212.3(3) for this $180 dividend to be deemed to be paid instead by QSC to Parent.

Applying s. 212.3(25)(b), each 1% partner is deemed to own shares of QSC or CRIC, as the case may be. Accordingly, neither the Class B shares nor Class Y shares are eligible to absorb under s. 212.3(7)(a) a portion of the deemed dividend as they are not completely owned by persons dealing at arm's length with Parent (and, therefore, CRIC). Accordingly, the deemed dividend paid by QSC to Parent is reduced under draft s. 212.3(7)(b) from $180 to $120, thereby reducing the PUC of the Class A shares to nil.

PUC suppression under s. 212.3(7)(c)

Draft s. 212.3(7)(c) addresses the situation where the amount of the deemed dividend, otherwise determined is less than the PUC of all cross-border classes immediately before the dividend time. Where this is the case

  • the amount of the deemed dividend is reduced to nil (draft s. 212.3(7)(c)(i))
  • in computing, at or at any time after the dividend time, the PUC of the cross-border classes of shares of the CRIC or of a QSC, there is to be deducted, in total, the amount of the dividend (draft s. 212.3(7)(c)(iv)), and
  • in determining the amount to be deducted in respect of any particular cross-border class, there is to be allocated such amount as results in the greatest total reduction of the PUC immediately after the dividend time in respect of shares of cross-border classes owned by the parent or another non-resident corporation with which it does not deal at arm' length at the dividend time (draft s. 212.3(7)(c)(ii)).

The Explanatory Notes to the current version of s. 212.3(7)(c) state:

the deemed dividend must be allocated first to the class of shares of the CRIC or QSC of which the parent or non-arm's length non-resident owns the greatest proportionate share at the dividend time; then, any remainder, to the class of which the parent or non-arm's length non-resident owns the second greatest proportionate share; and so on.

This ordering proposition also appears to be a mathematically correct inference from draft ss. 212.3(7)(c)(ii). In the situation where there is more than one cross-border class of shares with the same proportionate ownership by the non-resident parent (and non-resident corporations which do not deal with it at arm's length), the PUC grind is required under draft s. 212.3(7)(c)(iii) to also occur on a proportionate basis, rather than the CRIC being able to choose the class to which the grind occurs in the reporting form which it is required to file with the CRA under s. 212.3(7)(d)(i). For example, if the parent owned all of a CRIC's common and preferred shares, under the previous August 16, 2013 draft rule the PUC reduction might have been expected to apply only to the common shares. If in the interim the CRIC had, say, redeemed the preferred shares, a deemed dividend could be triggered as a result of this retroactive change.

Grinding of PUC attributable to arm's length shareholders

Where draft s. 212.3(7)(b) applies, the PUC of each class of cross-border shares is obliterated, even where an arm's length shareholder holds some of the shares of such a class.

Example 7-A (3rd party PUC reduction under s. 212.3(7)(b))

Parent holds 51% of the common shares of CRIC having a PUC of $51, and an arm's length third party (TP) holds 49% of the common shares of CRIC with a PUC of $49 at the time that CRIC acquires a foreign corporation for $100.

Draft s. 212.3(7)(b) will apply to reduce the PUC of the common shares from $100 to nil. Draft s. 212.3(7)(a) cannot apply to TP as its shares are not held in a separate class or series.

A similar issue arises under draft s. 212.3(7)(c): although draft s. 212.3(7)(c)(ii) requires that an amount equal to what otherwise would be the deemed dividend under draft s. 212.3(2) be applied first to those cross-border classes which will maximize the reduction in the PUC attributable to shares of the parent or a non-resident corporation which does not deal at arm's length with it, this approach nonetheless can result in the reduction of the PUC of shares held by arm's length persons (and reduce the reduction that otherwise might have occurred to the PUC attributable to cross-border shares held by the parent or its non-resident affiliates).

Example 7-B (3rd-party PUC reduction under s. 212.3(7)(c))

CRIC which is a wholly-owned subsidiary of CanHoldco, makes an $80 investment in FA. The 120 common shares of Canholdco, which have a PUC of $120, are hold as to 70 shares by Parent, and 50 shares by NR, which deals at arm's length with Parent. Parent and NR also hold Class A and Class B preference shares, respectively, of Canholdco with a PUC for each such class of $20. The share subscription proceeds of the Class B preference shares were not used to help pay for the investment (i.e., draft s. 212.3(7)(a) is assumed not to apply).

Consequences:

Before considering s. 212.3(7), CRIC (or CanHoldco, if a related election is made under s. 212.3(3)) will be deemed to have paid a dividend of $80 to Parent. This deemed dividend is eliminated under s. 212.3(7)(c). The associated reduction of $80 in PUC will be applied first to the Class A preference shares (which are 100% owned by Parent), as to $20, and second, as to $60, to the common shares. Accordingly, there will be a pro rata reduction in the PUC of the common shares attributable to NR from $50 to $25.

The PUC of NR's shares would not be ground if it instead had held a separate class of "Class B" common shares and the subscription proceeds thereof were not all traceable to the investment (so that s. 212.3(7)(a) did not apply), and there instead would have been a larger grind to the PUC attributable to the Class A common shares of CanHoldco held by Parent. If (contrary to the initial assumptions) the subscription proceeds of the Class B preference shares were all used in making the investment (i.e., draft s. 212.3(7)(a) would apply first to eliminate the PUC of those shares. This would reduce the grind to the common shares pro tanto.

PUC suppression as at the dividend time

Draft ss. 212.3(7)(b)(ii) and 212.3(7)(c)(ii) provide for the reduction of the PUC of a cross-border class of shares of the CRIC or QSC as at the time which is "immediately after the dividend time." (Somewhat similarly, draft s. 212.3(7)(a) provides for a grind of the PUC of a class of shares of a CRIC or QSC held by an arm's length person "immediately after the dividend time.") Accordingly, subsequent events which cause a class of shares to cease to be held by the parent or a non-resident corporation with which the parent does not deal at arm's length, should not cause any retroactive change to the application of the PUC suppression under draft s. 212.3(7).

Example 7-D (PUC suppression immediately after dividend time)

Parent and an arm's length Canadian-resident third party investor (Cdn TP) hold 60 and 40 common shares of a newly-incorporated Canadian-resident corporation (CanHoldco) with a PUC of $100. CanHoldco, along with other assets, holds 1 common share of CRIC, a wholly-owned subsidiary, which has assets of $1. Parent subscribes $100 for 100 common shares of CRIC, which purchases a non-resident corporation (FA) for $100. Parent then transfers its common shares of CRIC to CanHoldco in consideration for common shares of CanHoldco having a stated capital of $100.

Consequences:

CanHoldco is a QSC so that both its shares and those of CRIC qualify as cross-border classes, assuming in the case of CRIC that CanHoldco is not considered to have acquired its shares of CRIC immediately after the investment time. (Such an immediate acquisition would result in a Canadian resident which did not deal at arm's length with Parent, namely, CanHoldco, holding more than 30% of the common shares of CRCI immediately after the investment time, so that the common shares of CRIC would not qualify as a "cross-border class." ) As the total PUC of these two classes was $201 immediately before the dividend time, the $100 deemed dividend otherwise arising under s. 212.3(2)(a) is eliminated under draft s. 212.3(7)(c)(ii). All of the $100 PUC grind under draft ss. 212.3(7)(c)(ii) is applied to the common shares of CRIC, as their percentage ownership by Parent is higher than for the common shares of CanHoldco.

This grind should not change as a result of the transfer of the common shares of CRIC by Parent to CanHoldco. Note that due to the operation of s. 212.1, the common shares issued by CanHoldco to Parent have a nil PUC, so that the cross-border PUC attributable to the shares of Parent in effect still reflects the grind to the PUC of the common shares of CRIC.

Need for timely cross-border PUC

The PUC suppression under s. 212.3(7) only operates to reduce or offset a deemed dividend under s. 212.3(2)(a) based on the quantum of the PUC of cross-border classes of shares immediately after the dividend time" (as defined in draft s. 212.3(4)), namely, the investment time, where the CRIC is controlled by the parent at the investment time, and the first to occur of the CRIC becoming controlled by the parent and 180 days after the investment time, if the CRIC instead becomes controlled by the parent after the investment time but part of the same series of transactions. Accordingly, there is the potential for a suboptimal sequencing of an investment and related transactions to result in the inability to offset the deemed dividend. For example, such inability will arise when the PUC of shares relating to an investment does not arise until subsequently to the investment, unless such PUC arose immediately thereafter.

Example 7-E (triangular share-exchange acquisition)

Parent wishes to indirectly acquire all the shares of Canco, a public corporation whose only asset is shares of a non-resident subsidiary having a fair market value of $100. To accomplish this, it first incorporates CRIC. Then, under a plan of arrangement, the shareholders of Canco transfer their shares to CRIC in consideration for CRIC agreeing to cause the issuance to them of Parent shares having a FMV of $100. Parent issue such shares to them, and CRIC then issues shares to Parent with a stated capital of $100.

Consequences:

As Parent controlled CRIC at the investment time, the dividend time coincides with the investment time.

In the absence of the PUC suppression rule in s. 212.3(7) applying, CRIC could be considered to have incurred, at the investment time, a $100 obligation to cause the issuance of the Parent shares, in which event s. 212.3(2)(a) (when read in conjunction with s. 212.3(10)(f)) would deem CRIC to pay a $100 dividend to Parent.

The PUC for the shares of CRIC does not arise until after the investment time. No PUC suppression is available under draft s. 212.3(7) unless such PUC is considered to arise "immediately after" the investment time, which may be unclear.

The same issue does not arise where such shares are issued simultaneously with the making of the investment in the subject corporation. (This contrasts with the result under the 16 August 2013 version of the draft amendments which generally provided for the absorption of such a deemed dividend by the paid-up capital of a cross border class of shares only "immediately before" the "dividend time" - typically, the investment time.)

Example 7-F (simultaneous cash and share exchange acquisition)

Parent wishes to indirectly acquire all the shares of Canco, a public corporation whose only asset is shares of a non-resident subsidiary having a fair market value of $100. To accomplish this, it first incorporates CRIC and subscribes $1 for one common share. Under a Plan of Arrangement, Parent subscribes $100 for common shares of CRIC, but with the CRIC shares not to be issued, and the subscription price not to be paid, until the steps described immediately below. Next, under the Plan of Arrangement: (a) the shareholders of Canco transfer their shares to CRIC in consideration for $100 of cash which Parent is directed to deliver on CRIC's behalf; (b) Parent delivers $100 of cash to the shareholders of Canco in satisfaction of its subscription price for CRIC's shares; and (c) CRIC issue common shares to Parent (having a stated capital of $100) in consideration for such payment of the $100 subscription price.

Consequences:

Parent is deemed under s. 212.3(10)(f) to have made a $100 investment in FA. As Parent controlled CRIC before the investment time, the investment time is also the dividend time.

In the absence of the PUC suppression rule in s. 212.3(7) applying, CRIC would be deemed by s. 212.3(2)(a) to have paid a $100 dividend to Parent. Under the current version of draft s. 212.3(7)(c), this deemed dividend is eliminated by $100 of the $101 PUC of the cross-border classes of shares of CRIC immediately after the dividend time. On the other hand, under the 16 August 2013 version of draft s. 212.3(7), this deemed dividend would have been reduced by $1 to $99 under draft s. 212.3(7)(a) and would not have been reduced by the $100 of PUC that arose at the same time as the investment time.

Similar relief respecting the timing of the grind under s. 212.3(7) can occur under the October 20, 2014 version of the draft amendments on an amalgamation. A horizontal amalgamation of unrelated Canadian holding companies holding subject corporations will result in investments in such subject corporations. S. 212.3(2) would have applied without the benefit of a grind under the August 16, 2013 version of s. 212.3(7), as the amalgamated corporation did not exist and, therefore, did not have outstanding shares with a cross-border PUC, immediately before the time of the amalgamation. The particular issue is resolved under the "immediately after" language of the draft October 20, 2014 amendments. The same timing point arises on an amalgamation of Canadian holding corporations giving rise to indirect investments under s. 212.3(10)(f).

Example 7-G (horizontal amalgamation)

Non-resident Parent holds all the shares of CRIC1, having a PUC of $100. CRIC1's only asset is all the shares of FA1 having a fair market value of $100. CRIC2's only asset is all the shares of FA2 having a fair market value of $50. Its outstanding shares have a PUC of $20.

CRIC1 and CRIC2 amalgamate, and immediately thereafter the former shareholders of CRIC2 transfer their shares of Amalco to Parent for cash or shares of Parent.

S. 212.3(18)(a)(ii) does not apply to the amalgamation because CRIC1 and CRIC2 were unrelated, s. 212.3(22)(a) does not apply because the amalgamation was a horizontal amalgamation and the continuity rule in draft s. 212.3(9.2) does not apply for purposes of s. 212.3(7). Amalco (which for these purpose is a new CRIC) is treated under s. 212.3(10)(a) as having made an investment in the two subject corporations, with such investment effectively being deemed by s. 212.3(2) to be equal to the fair market value of the shares of FA1 and 2 of $150 . If this investment is considered to be made at the very time that Amalco came into existence, then the cross-border PUC of its shares immediately after that time will be $120. Accordingly, the deemed dividend of $150 otherwise arising under s. 212.3(2) would be reduced to $120 under s. 212.3(7)(b).

Cross-border PUC also may be reduced at the investment time where a CRIC purchases a non-resident corporation and payment of all or a portion of the purchase price is deferred, for example, as a result of an earn-out clause. If the funds for the purchase are only invested in shares of the CRIC as payments under the purchase agreement come due, there may be insufficient cross-border PUC at the investment time to completely eliminate a deemed dividend under s. 212.3(7).

Example 7-H (deferred purchase price)

Non-resident Parent subscribes for shares of newly-incorporated CRIC for $70, and CRIC acquires a non-resident corporation (FA) from an arm's length vendor for a purchase price of $100. At the time of acquisition, $70 is paid by CRIC to the vendor, and Parent places $30 into an escrow account. When the escrow conditions are satisfied, the $30 is paid to the vendor on behalf of CRIC, with CRIC issuing additional shares to Parent in recognition of the $30 benefit received by it at that time.

The $100 investment reduces the PUC of CRIC's shares from $70 to nil under s. 212.3(7)(a), and Parent receives a deemed dividend of $30 under s. 212.3(2)(a).

If Parent had instead subscribed $100 for CRIC's shares, with CRIC itself establishing the $30 escrow account, no deemed dividend would arise.

Effect on interest deductions

Unlike the current legislation, PUC suppression under draft s. 212.3(7) occurs automatically, so that the CRIC and non-resident parent do not have the right to elect for there instead to be a deemed dividend. In some circumstances they might have had a preference for deemed divdiend treatment instead.

Example 7-I (effect of PUC grind on operation of thin capitalization rule)

The non-resident parent (Parent) of CRIC holds all the shares of CRIC, having a PUC of $400, as well as a CRIC note bearing interest at 10%. CRIC then makes a $400 investment in a non-resident subsidiary (FA).

This investment automatically reduces the cross-border PUC from $400 to nil under draft s. 212.3(7)(a). In general terms, this would have the effect of denying interest deductions to CRIC under s. 18(4) of $60 per year, which might result in additional income tax liabilities to CRIC of $15 per year. If there had been no such PUC suppression, and Parent instead received a deemed dividend of $400, the one-time withholding tax cost of this (ignoring any future distribution of the investment in FA or proceeds thereof) might be $20, if an applicable treaty reduced the Part XIII tax rate to 5%.

Contributions of capital

S. 84(1)(c.3) provides that a corporation resident in Canada can convert contributed surplus that arose in specified circumstances, including a contribution of capital from a shareholder, into paid-up capital without a deemed dividend arising. There is an exclusion for contributed surplus which arose "in connection with" an investment to which s. 212.3(2) applied. However, the Explanatory Notes of the Department of Finance state:

Where, for example, a parent first contributes cash to the CRIC in exchange for shares of the CRIC with PUC equal to the amount of the cash and the CRIC subsequently uses that cash to make an investment in a subject corporation, it is intended that only the deemed dividend rule apply – the PUC creation would not be considered to relate to the investment, as it is one step removed. It is similarly intended that only the deemed dividend rule would apply where a contribution of capital is made (rather than a contribution in exchange for shares), and that none of paragraphs 84(1)(c.1) to (c.3) would apply to prevent such contributed surplus from subsequently being converted into PUC

The general effect is that contributed surplus arising from a contribution of cash by a non-resident parent to a CRIC to fund an investment in a subject corporation (or used for other purposes) can subsequently be converted into cross-border PUC - but not so as to eliminate any deemed dividend otherwise arising under s. 212.3(2)(a) at the dividend time.

Example 7-J (initial loss of PUC-suppression room where contributions of capital)

Parent, which holds common shares of CRIC with a PUC of $40, makes a contribution of capital of $100 to CRIC (giving rise to contributed surplus of that amount), which CRIC uses to purchase FA from a 3rd party.

At the investment time, the $100 dividend otherwise deemed to arise to Parent is reduced under s. 212.3(7)(a) to $60, and the PUC of Parent's shares is reduced to nil. If CRIC later converts its $100 contributed surplus into stated captial, no $100 deemed dividend under s. 84(1) arises and the cross-border PUC increases to $140. As the PUC suppression rule in s. 212.3(7)(a) operates on the amount of cross-border PUC "immediately prior" to the dividend time (here, the investment time) there is no retroactive reduction in the deemed dividend of $60 arising at the investment time.

If Parent instead had transferred the $100 to CRIC as share subscription proceeds, the PUC of CRIC's shares would be reduced under s. 212.3(7)(b) from $200 to $100, and there would be no deemed dividend.

Filing requirement

Where the amount of the deemed dividend otherwise arising under paragraph 212.3(2)(a) is reduced as described above under draft s. 212.3(7)(a), (b) or (c), the CRIC is required by s. 212.3(7)(d) to file with the Minister of National Revenue, on or before the 15th day of the month following the month that includes the dividend time, a prescribed form setting out

  • the amounts, immediately after the dividend time, of the paid-up capital of each cross-border class (or a class to which s. 212.3(7)(a) applied);
  • the paid-up capital of the shares of each of those classes that are owned by the parent or another non-resident corporation with which the parent does not, at the dividend time, deal at arm's length; and
  • the reduction under draft s. 212.3(7)(a)(ii), (b)(ii) or (c)(ii) in respect of each cross-border class

Administrative Policy

12 June 2015 External T.I. 2015-0583821E5 - 212.3(7)(d) - Prescribed information

particulars of filing letter

The filing requirements of s. 212.3(7)(d)(i) will be met where a letter (containing the information listed below) is filed by the CRIC with its T2 return (or, where the CRIC files electronically, mailed to its Tax Centre), on or before the s. 212.3(7)(d)(ii) filing-due:

(i) the amounts of the paid-up capital, determined immediately after the dividend time and without reference to s. 212.3(7), of each class of shares described in s. 212.3(7)(a) or that is a cross-border class in respect of the investment;

(ii) the paid-up capital of the shares of each of the classes in (i) that are owned by the parent or another non-resident corporation that does not, at the dividend time, deal at arm's length with the parent;

(iii) the reduction under any of ss. 212.3(7)(a)(ii), (b)(ii) and (c)(ii) for each such class;

(iv) details of the investment including the investment time, the s. 212.3(10) type of investment and its fair market value; and

(v) details of the deemed dividend under s. 212.3(2)(a) including the dividend time and the quantum.

To the extent the filing requirements of s. 212.3(7)(d)(i) have not been met by the relevant filing-due date, s. 227(6.2) would allow a CRIC to request a refund of the withholding taxes paid in respect of the deemed dividend under s. by way of a written application made no more than two years after the filing requirements of subparagraph 212.3(7)(d)(i) are met.

Articles

Joint Committee, "Technical Amendments Package of September 16, 2016", Submission letter of 15 November 2016

Penal consequences of not filing

A late-filing dividend under s. 212.3(7)(d) is not eligible for the dividend substitution election under s. 212.3(3)

Brett Anderson, Daryl Maduke, "Practical Implementation Issues Arising from the Foreign Affiliate Dumping Rules", 2014 Conference Report, (Canadian Tax Foundation), 19:1-49

Potential conflict between NR parent and 3rd party Cdn. investor re application of s. 212.3(7)(a) (p.29)

Figure 16 illustrates an example where paragraph 212.3(7)(a) potentially could apply. Only Canco (assumed to be a person which deals at arm's length with Parent) owns the class B shares. Further assume that all of the PUC of the class B shares arose on the transfer of property to the CRIC….

…[D]oes the fact that the CRIC did not use $10 of the aggregate amount it received for issuing its shares to make the investment in the Subject Corp. prevent the PUC of the class B shares from being reduced under paragraph 212.3(7)(a). This is a critical point for both the Parent and Canco. From Parent's perspective, the investment was $90 and if the PUC of the class B shares is not available, the Parent should be deemed to receive a dividend of $30. From Canco's perspective, if the PUC of the class B shares is reduced future distributions that otherwise should be returns of capital may give rise to deemed dividends.

If the $10 retained by the CRIC was funded proportionately by the funds received from Parent and Canco, on the precise wording of paragraph 212.3(7)(a), it appears that since less than all of the property received from Canco was transferred to Subject Corp., the PUC of the class B shares will not be reduced….

[C]an the CRIC choose not to "demonstrate" the requirements are satisfied, and essentially choose to maintain PUC in the class of shares owned by the arm's length investors or is a CRIC required to demonstrate once the CRA asks for the relevant information. Could a CRIC contractually agree that it would not demonstrate that the requirements of paragraph 212(7)(a) are satisfied?...

Paul Barnicke, Nelson Ong, "FA Dumping: PUC Offset", Canadian Tax Highlights, Volume 22, Number 10, October 2014, p. 5.

Retroactive requirement in October 2014 proposals to file form for PUC offset (pp. 5-6)

Under the August 2013 proposals, [the] PUC offset was automatic… . Taxpayers may have undertaken transactions in respect of which the PUC offset rules applied, but they may not have filed a form because, for example, they have not yet determined the PUC of each cross-border class. To avoid a deemed dividend and the resulting deemed withholding tax, a form should be filed. The form is due on or before the CRIC's filing-due date for its taxation year that includes the dividend time (generally, the time of the investment), but a transitional rule deems the form to have been timely filed if it is filed on or before the later of the CRIC's filing-due date for its taxation year that includes the day on which the proposals receive royal assent and one year after the proposals receive royal assent.

Retroactive requirement to proportionately reduce PUC of cross-border classes with equal percentage ownership by non-resident parent group (p. 6)

If the relevant non-resident corporations own equal proportions in more than one cross-border class, currently the PUC reduction can be allocated to any such class or classes and still meet the requirement to maximize the impact of the PUC reduction on shares owned by the relevant non-resident corporations. In these circumstances, however, new subparagraph 212.3(7)(c)(iii) in the October 2014 proposals requires a PUC reduction for each cross-border class that is proportionate to that class's PUC. Because the proposal is retroactive, the impact of the PUC offset rules may be different from what a CRIC expected when it made the relevant FA investment. For example, the result may differ if a non-resident corporation owns all of a CRIC's common and preferred shares and the PUC reduction was expected to apply only to the common shares. This situation could be especially problematic if in the interim the CRIC undertook a transaction (such as a preferred share redemption) that relied on the shares' PUC being a certain amount: if the October 2014 proposal is retroactive, the redemption could inadvertently trigger a deemed dividend.

Ian Bradley, "Living with the Foreign Affiliate Dumping Rules", Canadian Tax Journal (2013) 61:4, 1147-66.

Insufficient PUC where deferred purchase price (p. 1156)

Timing issues can also occur if a CRIC purchases foreign affiliate shares and payment of all or a portion of the purchase price is deferred until after the acquisition owing to earnouts or price adjustment clauses. If the funds for the purchase are invested in the CRIC only as they are needed, there may be insufficient cross-border PUC at the investment time (the time the shares of the foreign affiliate are acquired by the CRIC).

PUC grind for unrelated shareholders (p. 1156)

The subsection 212.3(7) PUC reduction can effectively transfer part of the tax burden of the FA dumping rules from the parent to unrelated shareholders, even if those shareholders have no influence on the investment decision….

Charles Taylor, "Foreign Affiliate Dumping Developments", International Tax, No. 72, October 2013, p. 9

Adverse thin cap impact of automatic grind under s. 212.3(7) (p. 10)

While PUC reduction is generally preferable to a withholding tax cost, there are circumstances in which taxpayers may prefer to pay the withholding tax. PUC, after all, goes into the equity base for determining whether subsection 18(4) limits the deductibility of related-party interest expense. If a joint Committee recommendation that taxpayers should be permitted to elect to be subject to withholding tax is accepted, the election will, presumably, be available to deal with those situations in which taxpayers would have chosen to pay withholding tax rather than realize a PUC reduction. As currently drafted, however, taxpayers may find unanticipated PUC reductions imposed upon them because this change is to be effective from the 2012 Budget date. Presumably Finance views it as a relieving measure, but there may be situations in which it is not.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(9) 143

Subsection 212.3(8) - Paid-up capital adjustment

Commentary

S. 212.3(8) provides for a potential upward adjustment to the paid-up capital of shares where such PUC has been reduced under s. 212.3(2)(b) or s. 212.3(7)(b) and there has been a subsequent realization of a deemed dividend under s. 84(3), (4) or (4.1) in respect of those shares because of a share redemption, acquisition, or cancellation or a distribution of paid-up capital. The upward adjustment per s. 212.3(8)(a) generally is equal to the amount by which such deemed dividends is higher as a result of the PUC reduction rule in s. 212.3(2)(b) or s. 212.3(7)(b). As indicated in the Finance Explanatory Notes, similar rules exist in various other provisions of the Act that adjust paid-up capital – for example ss. 85(2.1)(b), 212.1(2), and 128.1(3).

The limitation in s. 212.3(8)(b) takes into account any increase in PUC under the PUC reinstatement rule in s. 212.3(9), so that, for example, if the PUC is fully reinstated, there will be no upward adjustment under s. 212.3(8)(b).

Example 8-A

Parent, which owns all the shares of CRIC having a PUC and stated capital of $2,000, subscribes for further shares of CRIC for $1,000, with CRIC using such proceeds to acquire all the shares of FA. Years later, CRIC purchases ½ of its shares for cancellation for $2,000.

Although on a literal reading, the PUC of $1,000 otherwise arising on the subscription is eliminated under s. 212.3(2)(b), in fact (as discussed in the commentary on s. 212.3(2)) the PUC of the shares increases, through the subscription, to $3,000. The deemed dividend of $1,000 which otherwise would arise under s. 212.3(2)(a) on making the investment in FA is eliminated under s. 212.3(8)(a), with the PUC of CRIC's shares being reduced from $3,000 to $2,000 under s. 212.3(8)(b).

The purchase for cancellation of ½ the shares (having a PUC of $1,000) gives rise to a deemed dividend of $1,000 under s. 84(3). The PUC of the remaining shares otherwise would be $500 (i.e., their stated capital of $1,500 minus the reductions under s. 212.3(7)(b) of $1,000). This PUC is increased by $500 (to a total of $1,000) under s. 212.3(8)(a), i.e., by the difference between the actual deemed dividend of $1,000, and the deemed dividend of $500 that would have arisen if there had been no PUC reductions under s. 212.3(7) (or s. 212.3(2)(b)). The PUC reinstatement rule referenced by s. 212.3(8)(b) does not apply.

Subsection 212.3(9) - Paid-up capital reinstatement

Commentary

Where the PUC of a class or series of shares of a CRIC (or, as discussed further below, qualifying substitute corporation) was reduced under s. 212.3(2)(b) or s. 212.3(7), s. 212.3(9) allows for a reinstatement of that PUC immediately before its distribution (or other reduction), on the satisfaction of stipulated conditions.

Relation to previous investment

The deduction under s. 212.1(2)(b) or 212.3(7) is required under the preamble to draft s. 212.3(9) to be in respect of an investment in a subject corporation described in ss. 212.3(10)(a) to (f). This is a complete listing of all types of investments in a subject corporation other than an acquisition of an option described in s. 212.3(10)(g). This is more generous than the current version of s. 212.3(9), which does not include amounts becoming owing by the subject corporation to the CRIC (s. 212.3(10)(c)), acquisitions of debt obligations of the subject corporation by the CRIC (s. 212.3(10)(d)) and the extension of the maturity date of debt obligations of subject corporation owing to the CRIC (s. 212.3(10)(e)(i)). The August 16, 2013 Explanatory Notes (relating to the first introduction of this expansion of s. 212.3(9)) state::

This permits the PUC reduced under paragraph 212.3(2)(b) or subsection 212.3(7) to be reinstated when the particular corporation has received a repayment of, or proceeds from the disposition of, the debt of the subject corporation that arose from the investment, or has received interest on the debt.

General PUC limitations

The amount of the PUC reinstatement is the lesser of the two amounts described in ss. 212.3(9)(a) and (b). The first is the amount by which the PUC was reduced under s. 212.3(2)(b) or s. 212.3 (7), before the subsequent time of the PUC distribution (or other PUC reduction) in respect of the investment in the foreign affiliate (as reduced by the amount of any prior PUC reinstatements for the relevant class or series of shares in respect of that investment): s. 212.3(9)(a). For simplicity of exposition, this discussion initially assumes that it is the CRIC that is the "particular corporation" which invested in the subject corporation which experienced the PUC grind under s. 212.3(2)(b) or s. 212.3 (7)(b) to its share capital.

The reduction under draft s. 212.3(9)(a)(ii) to the amount of the s. 212.3(9)((a) adjustment is for previous s. 212.3(9) reinstatements added "before the time that is immediately before the subsequent time " of the PUC distribution (or reduction) in question. This wording avoids a circularity problem which otherwise would arise if the draft s. 212.3(9)(a)(ii) reduction instead occurred at the same time as the reinstatement (which occurs immediately before the subsequent time.) This circularity issue, which arose under the current version of s. 212.3(9) as well as the August 16, 2013 version of draft s. 212.3(9), was pointed out in the 15 October submission to the Department of Finance of the Joint Committee on Taxation of the CBA and CICA. The amount of the PUC reinstatement is the least of the three amounts described in ss. 212.3(9)(a) to (c). The first is the amount of the distribution (or reduction) of paid-up capital: s. 212.3(9)(a).

Limitation re FMV of distributed subject shares

The second amount is determined under s. 212.3(9)(b). The October 20, 2014 Finance Explanatory Notes indicate that in concept this amount "is based on the extent to which the distribution is traceable to property acquired as an investment." Two situations are contemplated.

S. 212.3(9)(b)(i) references the situation where shares of the subject corporation, or shares substituted for those shares (in either case, defined as the "distributed shares"), are distributed subsequently to an investment in the subject corporation which had occurred in one of three specified manners: an acquisition of its shares (s. 212.3(10)(a), a contribution of capital to it (s. 212.3(10)(b)) or an indirect acquisition of its shares through the direct acquisition of shares of a Canadian-resident corporation described in s. 212.3(10)(f). In this situation (unlike the second situation described in draft s. 212.3(9)(b)(ii), where it is generally sufficient for proceeds to be received in Canada by the CRIC or a non-arm's length Canadian corporation) the distribution must be made as a PUC distribution on a cross-border class.

Where the investment had been made through a contribution of capital, the amount under s. 212.3(9)(b) is equal to the portion of the fair market value of the distributed shares immediately before the distribution by the CRIC that can reasonably be considered to relate to the contribution of capital, subject to the QSC gross-up described below.

Where the investment had been made through a share acquisition described in s. 212.3(10)(a) or (f), the amount under s. 212.3(9)(b) is equal to the lesser of the amounts determined in draft s. 212.3(9)(b)(i) – A (B)(I) and (II).

The (I) amount refers to the portion of the fair market value ("FMV") immediately before the subsequent (distribution) time of the distributed shares that can reasonably be considered to relate to the shares (labeled as the "acquired shares") of the subject corporation that were acquired on the previous investment. Where the distributed shares are the acquired shares themselves, this related value test clearly will be met. Where the distributed shares are substituted property (for example, shares of a holding company), a factual application of this test will be required if the company whose shares are distributed holds or has held other assets.

The (II) amount is determined by applying a proportion to the previous PUC grind referenced in draft s. 212.3(9)(a)(i). That proportion is the ratio of the FMV amount determined as the (I) amount is of the FMV, immediately before the subsequent time, of the acquired shares (or the portion of the FMV of acquired shares that were substituted for the acquired shares that can reasonably be considered to relate to the acquired shares).

Accordingly, in the straightforward scenario of a PUC distribution of shares of the subject corporation where they had appreciated in value subsequent to the investment time, the reinstatement amount, before gross-up, will be the proportion of previous grind under s. 212.3(7) or s. 212.3(2)(b) based on the relative fair market value of the distributed shares immediately before the distribution by the CRIC to the fair market value of all the all the acquired shares (not to be confused with all the issued and outstanding shares of the subject corporation where less than 100% of its shares were acquired).

The gross-up is accomplished by dividing this amount by the equity percentage (as defined in s. 95(4)) of the QSC whose cross-border class is in issue. If the particular corporation is the CRIC itself, no gross-up occurs.

In order to void duplication of the adjustment under s. 212.3(9)(b)(i) for the value of distributed shares reasonably relating to contributed capital (as determined under s. 212.3(9)(b)(i) - A(A)), the amount determined under s. 212.3(9)(b)(i) - A(B) (for other recognized investments in the shares of the subject corporation) does not include the portion of the FMV of the distributed shares which can reasonably be considered to relate to an investment in the subject corporation by way of contribution of capital. Accordingly, there conceptually may be an apportionment of the value of the distributed shares between the value derived from a previous contribution of capital and value derived from previous share subscriptions or purchases, although in most instances the relative apportionment will have no effect on the level of PUC reinstatement under s. 212.3(9).

In contrast with the treatment under draft s. 212.3(9)(b)(ii) of distributions of proceeds of investments, which includes distributions of debt proceeds, draft s. 212.3(9)(b)(i) does not accommodate the in specie distribution of debt investments and only covers in specie share distributions.

Example 9-1A (PUC reinstatement on partial FA share distribution out of partially-owned lower-tier sub)

Non-resident Parent holds common shares of Canco having a PUC of 50 and subscribes $100 for further common shares. Canco subscribes $100 for common shares of Cansub, and investors dealing at arm's length with Parent subscribe $50 for common shares of Cansub. Cansub purchase FA from an arm's length vendor for $150.

After the FA common shares have appreciated by 20% to $180, Cansub distributes ½ of those shares pro-rata to its shareholders as a return of capital, with the shares so received by Canco (having a FMV of $60) being distributed in turn by Canco to Parent as a return of capital.

Consequences

The shares of Cansub do not qualify as a cross-border class. The PUC of the common shares of Canco is ground under draft s. 212.3(7)(b) from $150 to nil. As the distributed shares are the shares of FA itself (rather than a holding company), all of their FMV of relates to the shares of FA acquired on the previous investment. Before considering the QSC gross-up, the PUC reinstatement under draft s. 212.3(9)(b)(i) – A is the lesser of the shares' FMV of $60 and the proportion of the previous PUC grind of $150 determined by applying the relative FMV of the distributed shares to that figure. According the pre-gross-up reinstatement is: $60/$180*$150, or $50.

This figure then is grossed up through dividing by the equity percentage of Canco in FA of 66 2/3%, so that the PUC reinstatement under draft s. 212.3(7)(b)(i) is $75. Accordingly, on the distribution of ½ of the FA shares, there is a ½ restoration of the PUC of the Canco shares.

This example is a somewhat modified version of the example in the October 30, 2014 Finance Explanatory Notes on draft s. 212.3(9).

Limitation re distribution of subject share or debt proceeds, or dividends or interest

Draft s. 212.3(9)(b)(ii) references the second situation where there is a receipt by the "particular corporation" making a PUC distribution on a cross-border class (i.e., the CRIC or a QSC) or by a corporation resident in Canada with which the particular corporation was not dealing at arm's length (in either case, referred to as the "recipient corporation"), of what the particular corporation demonstrates to be

  1. proceeds from a disposition of the "acquired shares" of the subject corporation (or from the disposition of other shares to the extent the proceeds thereof "can reasonably be considered to relate to the subject shares" - or to shares of a subject corporation to which the CRIC made a contribution of capital, i.e., an investment described in paragraph 212.3(10)(b)),
  2. dividends or reductions of PUC in respect of the class or series of shares of the subject corporation (or the portion of a reduction of PUC or a dividend in respect of substituted shares that "can reasonably be considered to relate to the subject shares"), or
  3. repayments of or proceeds from the disposition of debt obligations, or other amounts owing by the subject corporation, in connection with an investment described in ss. 212.3(10)(c), (d) or (e)(i).

There are specified exclusions from the eligible proceeds or repayments described in 1 and 3 above. The proceeds in 1 do not include the fair market value of shares of another foreign affiliate of the taxpayer that were acquired by the recipient corporation as consideration for the disposition and as an exempted investment under s. 212.3(16) or (18) applies, or proceeds from a disposition of shares to a corporation resident in Canada where such acquisition of the shares is an investment exempted by s. 212.3(16) or (18).

There is a similar exclusion from the proceeds (including repayment proceeds) of a debt or other obligation in 3 above. A qualifying receipt by the recipient corporation for these purposes does not include proceeds of an obligation acquired by another foreign affiliate where such proceeds are received by the particular corporation as a result of an investment (described in any of s. 212.3(10)(a) to (f)) exempted by s. 212.3(16) or (18), or as proceeds from a disposition to an affiliated corporation resident in Canada where s. 212.3(16) or (18) applies to the other corporation in respect of its acquisition. Also excluded is interest on such debt obligations or other amounts owing.

As noted in the October 20, 2014 Explanatory Notes, draft 212.3(9)(b)(ii) in contrast to previous versions of the provision "no longer require[s] a return of, or reduction to, the PUC of a class of shares of the particular corporation to which subsection 212.3(9) applies in order to obtain the PUC reinstatement."

The reinstatement under s. 212.3(9) is of the PUC of a particular class of shares of the particular corporation. The previous grinds to the PUC of a cross-border class occur under s. 212.3(7) or (2)(b), and are cumulatively observed under draft s. 212.3(9)(a), on a class-by-class basis. However, the relevant proceeds received by the recipient corporation under s. 212.3(9)(b)(ii) are recognized on an aggregate basis. Accordingly, the formula in draft s. 212.3(9)(b)(ii) requires a proration of such proceeds based on the amount determined under draft s. 212.3(9)(a) "in respect of" each class expressed as a fraction of all amounts determined under draft s. 212.3(9)(a) in respect of all classes of the particular corporation and of corporations that do not deal with it at arm's length. Thus the proration reflects the history of which cross-border classes had their PUC previously ground. The October 20, 2014 Explanatory Notes state that these formula adjustments "effectively take into account the possibility that a particular investment may result in PUC reductions in respect of more than one class of shares or in respect of one or more Canadian corporations, and are intended to prorate any PUC reinstatement across all the classes that were impacted by the investment."

Under the draft s. 212.3(9)(b)(i) branch of the PUC reinstatement rule, the reinstatement is not triggered until there is a qualifying distribution of shares as a reduction of the PUC of a class of shares of the particular corporation. Under the draft s. 212.3(9)(b)(ii) branch, the reinstatement is triggered by the receipt by a recipient corporation of qualifying proceeds irrespective of whether such proceeds are distributed. In contrast to the current version of s. 212.3(9), there is no requirement to establish that the proceeds, dividends, distributions of paid-up capital, debt repayments or interest referred to above were received no more than 180 days before a the distribution of paid-up capital by the particular corporation.

The reinstatement of a cross-border class's PUC is tied (where draft s. 212.3(9)(b)(i) does not apply) to proceeds being demonstrated to relate in a specified manner to the investment which gave rise to a previous grind in such PUC. Accordingly, there effectively is a requirement to demonstrate that proceeds which might otherwise give rise to a reinstatement do not relate to an investment which was exempted under s. 212.3(16) or (18). Conversely, where such an investment ceases to be exempted, so that a grind to the PUC of a cross-border class occurs under draft s. 212.3(7), the potential then arises for such grind to be reinstated under draft s. 212.3(9)(b).

Example 9-A (exempted investment followed by non-exempted reorganization, and distribution years later of PUC not traceable to receipt of proceeds of non-exempted investment)

Parent subscribes for common shares of CRIC (which has a Canadian business), so that the PUC of those shares increases from $100 to $200. CRIC then acquires FA from a 3rd party. S. 212.3(2) does not apply to this investment as it satisfies the tests in s. 212.3(16). Subsequently, CRIC transfers all its shares of FA (which at that time have a fair market value of $120) to another wholly-owned foreign affiliate ("Luxco") in exchange for preferred shares of Luxco ("MRPS") with a redemption amount of $120 and for ordinary shares with a nominal value. This investment in Luxco is not exempted by s. 212.3(16) or (18) (see s. 212.3(19)).

Luxco sells FA for $150, and uses such proceeds to redeem the MRPS held by CRIC. CRIC does not distribute the $150 to Parent but instead reinvests it in its Canadian business. Several years later, the Canadian business is sold, and CRIC distributes the proceeds thereof to Parent, including $200 by way of a PUC distribution.

Consequences

The investment of CRIC does not give rise to a deemed dividend under s. 212.3(2)(a) – whereas its subsequent investment in Luxco is not so exempted, so that the PUC of CRIC's shares held by Parent is reduced by $120 to $80 under draft s. 212.3(7)(c).

The $150 redemption proceeds received by CRIC are equal to and traceable to the proceeds of disposition of its shares of Luxco (or a dividend to the extent that s. 93 deemed these proceeds to be a dividend). As the PUC reinstatement is limited (by draft s. 212.3(9)(a)) to the $120 amount of the previous PUC suppression, the PUC of the CRIC shares is restored by $120 to $200 immediately before the receipt of the $150 proceeds of the investment in the subject corporation. This PUC is available for use at a subsequent juncture without any tracing requirement

Requirement for PUC distribution

Under current law, there is a requirement for there to be a PUC reduction of the PUC of the cross-border class of shares in order for the grind under s. 212.3(7) to be restored. This means that if the proceeds of subsequent sales of the investments giving rise to such grind are directly reinvested in other subject corporations rather than being first distributed to the non-resident parent, there will potentially be multiple applications of s. 212.3(2) notwithstanding that there is no net increase in the investment of the CRIC in subject corporations.

This problem is resolved under draft s. 212.3(9)(b).

Example 9-B (reinvestment of sales proceeds)

CRIC acquires the shares of FA1 for $100, thereby reducing the PUC of its shares (held by non-resident Parent) from $150 to $50. CRIC subsequently sells FA1 for $150 and uses such proceeds to acquire another non-resident corporation (FA2) from a third party.

Under current law, the purchase of FA2 is an investment which first grinds the cross-border PUC of the shares of CRIC under s. 212.3(7)(b), and next results in a dividend of $100 being deemed by s. 212.3(2) to be paid to Parent.

Under draft s. 212.3(9)(b)(ii), the PUC of the cross-border class is reinstated to $150 immediately before the receipt of the $150 sale proceeds. Accordingly, there is $150 of PUC on the cross-border class to avoid a deemed dividend on the reinvestment of those proceeds.

Share redemption as PUC distribution [revisions up to this point]

CRA indicated (23 May 2013 IFA Round Table, Q. 6(b)) that a share redemption by the CRIC will be considered to be a distribution or reduction of paid-up capital by the CRIC for purposes of s. 212.3(9)(c), and draft amendments to this provision confirmed this interpretation (with the related Explanatory Notes stating that these amendments were made "in order to clarify that the PUC reinstatement can apply not only where the particular corporation reduces PUC as part of a return of capital, but also where the PUC is reduced as a result of a redemption, acquisition or cancellation of shares by the particular corporation.") However, as illustrated in Example 9-A below, it often will be preferable for the CRIC to effect a distribution of the subject shares or proceeds, rather than using such property to redeem its shares, given that only part of a PUC increase under s. 212.3(9) may reduce the deemed dividend arising on the share redemption.

If the above requirements are not satisfied, the PUC reinstatement rule will not apply.

Example 9-C (defective buy, bump and sell transaction)

Parent subscribes $1,000 for common shares of a newly-incorporated Canadian holding company (Buyco) which, in turn, purchases the shares of a Canadian holding company (Target) whose assets comprise investments in all the shares of two non-resident subsidiaries (FA1 and FA2) with a fair market value of $300 and $700, respectively.

Buyco winds-up Target (perhaps bumping the cost of the shares of FA1 to $300 under s. 88(1)(d)), and distributes the shares of FA1 to Parent by purchasing for cancellation 30% of its shares, with Parent selling FA1 to an arm's length purchaser.

Consequences:

Under the indirect investment rule in s. 212.3(10)(f), Buyco is considered to have invested in FA1 and FA2 (the subject corporations), so that the paid-up capital of its shares is ground to nil under s. 212.3(7)(b)(ii).

Immediately before the distribution of the subject shares (of FA1), the PUC of Parent's shares of Buyco is increased under s. 212.3(9)(c)(i) by their fair market value (presumably still $300). Accordingly, the purchase for cancellation of CRIC shares for $300 gives rise to a deemed dividend of $210 (as the redeemed shares have a PUC of $90).

If Buyco distributed the FA1 shares on a stated capital reduction rather than transferring such shares to Parent as redemption proceeds, there would be no deemed dividend, as the rule in s. 84(4) would permit the utilization of all the $300 PUC of the common shares.

PUC distributions by CRIC of dividends respecting subject corporation

As discussed above, the operation of s. 212.3(9)(c)(ii) is not restricted to PUC distributions by the CRIC of proceeds of sale of the shares of the subject corporation, but also extends to PUC distributions by the CRIC which it can demonstrate were received directly or indirectly (within the 180 preceding days) as a dividend (or qualifying return of capital, or QROC) "in respect of" a class of shares of the subject corporation (or substituted shares). This wording seems to imply that ordinary-course dividends paid by a subject corporation to a CRIC can result in a reinstatement of the PUC of a cross-border class of shares of the CRIC to the estent distributed on those shares.

This proposition is consistent with May 2014 IFA Roundtable, Q. 1, 2014-0526691C6, which deals with the situation where CRIC is considered to have made an investment in a subject corporation (Forco) by virtue of not charging fees on its guarantee of Forco debt, and the question then arises as to the extent to which the resulting grind to the PUC of cross-border shares in its capital can be reversed under s. 212.3(9)(c)(ii). CRA appears to suggest that the annual PUC grind associated with the no-fee guarantee can be reversed if the CRIC makes subsequent distributions of cross-border PUC that it demonstrates are funded out of dividends (or QROC distributions) that are "in respect of" to its Forco shares (and CRA does not state that such dividend (or QROC) distributions must be specifically traceable to the additional earnings which arise from Forco not bearing a guarantee fee.)

Example 9-D (reinstatement of PUC grind from imputed guarantee benefit)

CRIC has 80 outstanding Class A common shares owned by non-resident Parent having a PUC and stated capital of $800 and 20 Class B common shares owned by a person with whom it and Parent deals at arm's length having a PUC and stated capital of $200. CRIC guarantees a $1000 borrowing by Forco (its wholly-owned subsidiary) at no charge. This results in a conferral of a benefit of $10 per annum by it on Forco (being the amount of what would be an arm's length guarantee fee in the circumstances.) The resulting "investment" by it of $10 per annum in Forco under s. 212.3(10)(b) results in an annual reduction of the PUC of the Class A common shares of $10 per annum. However, not paying any guarantee fees means that the annual earnings of Forco are $110 rather than $100.

Immediately after the end of each year, Forco pays a dividend of $110 to CRIC which, in turn, immediately distributes $110 of stated capital in cash to Parent.

This likely means that there is an annual restoration under s. 212.3(9)(c)(ii) of the PUC of the Class A common shares of $10 per annum, so that the $110 PUC distribution only reduces the PUC of the Class by a net $100. Note that draft s. 212.3(9)(c)(ii)(A)(II) only requires that the Forco dividends received by CRIC and distributed as PUC are "in respect of" to its Forco shares (which on these facts should be quite obvious) and that CRA, in the IFA Roundtable statement referenced above, does not state that such dividend (or QROC) distributions must be specifically traceable to the additional earnings which arise from Forco not bearing a guarantee fee.

If the above tidy facts were altered so that, for example, there were no dividends from Forco other than a $300 special dividend at the end of every five years, with corresponding PUC distributions being made by CRIC immediately thereafter, the resulting greater difficulty in tracing such PUC distributions to the annual savings of Forco from paying no guarantee fees likely would not be problematic.

Reinstatement of PUC of QSC

The above discussion has focused on the scenario where there is a reinstatement of the PUC of the CRIC which invested in the subject shares (or was deemed to so invest under the indirect investment rule in s. under s. 212.3(10)(f)). However, the effect of the second limitation (under s. 212.3(9)(c)(ii)) discussed above is that it is the corporation whose shares' PUC has suffered a grind under s. 212.3(7) (or s. 212.3(2)) which is also potentially eligible to have that PUC reinstated under s. 212.3(9). Accordingly, where such grind has occurred to the PUC of the shares of a QSC rather than of the CRIC which invested in the subject shares, it is only the QSC's shares whose PUC may potentially be restored.

Example 9-E (reinstatement of QSC PUC)

Parent subscribes $1,000 for shares of a newly-incorporated wholly-owned subsidiary (QSC), which subscribes the same amount for all the shares of CRIC. CRIC acquires all the shares of a non-resident corporation (FA) for $1,000.

Years later, CRIC sells the shares of FA in an arm's length sale for $2,000 cash proceeds, of which $800 are required to be used to pay down a secured loan owing by it. In due course, CRIC makes a s. 93(1) election, so that $1,000 of the proceeds are deemed to be received by it as a dividend.

Within 180 days of the closing of the FA sale, CRIC pays a dividend of $1,000 to QSC, which immediately makes a stated capital distribution of $1,000 to Parent.

Consequences:

In order to avoid a dividend of $1,000 being deemed by s. 212.3(2) to be paid by CRIC to Parent at the time of acquisition of FA, CRIC, QSC and Parent elect under s. 212.3(3) for there to be a $1,000 dividend paid by QSC to Parent at that time. This $1,000 deemed dividend then is eliminated under s. 212.3(7), so that the PUC of the shares of QSC held by Parent is reduced by that amount to nil.

The $1,000 received by QSC from CRIC appears to be an indirect receipt of a portion of the $1,000 proceeds of disposition of the FA shares, or the $1,000 deemed dividend, received directly by CRIC. Accordingly, the PUC of the shares of QSC held by Parent is reinstated to $1,000 immediately before the $1,000 stated capital distribution by QSC, so that such distribution does not give rise to a deemed dividend under s. 84(1).

PLOI election as an alternative for potential PUC reinstatement for debt investments

As noted above, a PUC reinstatement potentially is available where the CRIC (or QSC) distributes debt, or the proceeds of debt, an investment in which resulted in a PUC suppression under s. 212.3(7). However, if the CRIC and the parent elected under s. 212.3(11) for such debt to be a pertinent loan or indebtedness (where the debt qualifies for this election), such debt is excluded (under ss. 212.3(10)(c) and (d) from being considered to be an investment in the subject corporation. Since there is then no resulting suppression of the PUC of shares in the CRIC or QSC, any proceeds of such debt can then generally be distributed by the CRIC or QSC as a PUC distribution.

Accordingly, it will not always be obvious whether a "PLOI" election should be made.

CRIC/QSC share reorganizations

The reinstatement rule only applies to the same class of CRIC or QSC shares to which there was a suppression of PUC under s. 212.3(7). Accordingly, access to reinstatement will be lost if such shares are exchanged for shares of another class (including on an amalgamation) or for shares of a related corporation. See Chong.

Example 9-F (loss of reinstatement due to s. 86 reorganization)

A CRIC which was capitalized with nominal common share capital and $100 of preference shares by Parent, makes a $100 investment in the shares of a non-resident subsidiary, thereby resulting in the reduction under s. 212.3(7) of the PUC of the preference shares from $100 to nil. If those preference shares are subsequently changed on a s. 86 reorganization into shares of a different class, the potential entitlement for that $100 PUC to be reinstated under s. 212.3(9) on a qualifying distribution by the CRIC will be lost.

Maintenance of stated capital/PUC discrepancy

The wording of draft s. 212.3(9) is somewhat circular. Draft s. 212.3(9)(a) provides that the PUC reinstatement cannot exceed the amount of the PUC distribution or other reduction at the subsequent time. However, the existence of distributable PUC at the subsequent time often will depend on draft s. 212.3(9) having operated to reinstate PUC immediately before the subsequent time. It would appear that this circularity does not prevent the operation of draft s. 212.3(9) provided that there is corporate capital (e.g., stated capital) at the subsequent time to reduce. This point is illustrated in Example 9-E below.

Because of the need to be able to distribute (or otherwise reduce) stated capital (or other corporate capital) at the subsequent time, it generally will be preferable for the CRIC or its successors to maintain their stated capital notwithstanding that their PUC may have been ground under draft s. 212.3(7). This point also is illustrated in Example 9-E.

Example 9-G (need for stated capital distribution at the subsequent time)

Parent subscribes $100 for common shares of CRIC, which uses those funds to acquire all the shares of Canco, a Canadian public company holding mining assets in a foreign subsidiary (FA), under a plan of arrangement. CRIC then amalgamates with Canco under the CBCA and the plan of arrangement, with the stated capital of Amalco being stated in the plan of arrangement to be equal to the paid-up capital for purposes of the Act of the shares of CRIC and the issued share capital of Amalco being identical to that of CRIC.

Amalco (which under s. 212.3(22)(a) is a continuation of CRIC and whose shares are a continuation of those of CRIC if it makes a s. 87(3.1) election) subsequently sells its shares of FA for $150, makes ss. 87(3.1) and 93(1) elections, and then (at the "subsequent time") distributes $100 of the proceeds to Parent.

Consequences:

The purchase of the shares of Canco is treated under s. 212.3(10)(f) as an investment of $100 by Parent in FA. The PUC of the shares of CRIC is reduced by $100 to nil under draft s. 212.3(7)(a).

A PUC reinstatement under draft s. 212.3(9) cannot exceed the amount of the PUC reduction at the subsequent time. If the stated capital of Amalco had been initially set at $100, then it would have been able to make a stated capital distribution of $100 at the subsequent time. This would then likely cause s. 212.3(9) to deem the PUC of its shares to be reinstated to $100 immediately before the subsequent time. However, as its starting stated capital instead is nil, it cannot engage the reinstatement rule by making a stated capital distribution. (It cannot purport to follow the corporate procedures for distributing capital if it has none for corporate purposes.) Accordingly, none of the $100 proceeds can be distributed by Amalco as a PUC distribution.

However, it might be possible to cause draft s. 212.3(9) to apply if Amalco instead redeemed it shares or purchaased them for cancellation (procedures which as a corporate matter do not depend on the presence of stated capital) - although, as noted in Example 9-B, this generally is a less advantageous procedure.

Distribution of sales proceeds by an indirect CRIC

The potential reinstatement of the PUC of shares in the capital of a CRIC (or qualifying substitute corporation) in the scenario where there has been a distribution of proceeds of disposition only applies by virtue of draft s. 212.3(9)(c)(ii) to the extent of the fair market value of property received by the CRIC (or QSC) "directly or indirectly" as proceeds of disposition of the subject shares (of the subject corporation) or substituted shares (of another foreign affiliate).

This test may not be satisfied where a CRIC, whose shares are held directly by the parent, previously made an indirect investment in the subject shares through another Canadian-resident corporation (as described in s. 212.3(10)(f)) - with that Canadian subsidiary then distributing the sales proceeds of the subject shares to the CRIC (e.g., as a dividend, PUC distribution, share redemption proceeds or inter-company debt repayment). Under the scheme of the Act, proceeds of disposition are received only by the taxpayer disposing of the property giving rise to such receipt. This then raises the question as to whether the receipt of any such distribution by the CRIC from its Canadian subsidiary can represent an "indirect" receipt by it of proceeds of disposition where in fact the amount was received only by that Canadian subsidiary as proceeds.

Some support for a broader interpretation of "indirectly" may be found in the Explanatory Notes, which indicate that the current version of s. 212.3(9)(c)(ii) reflects a concept of "traceability" (although there is no indication as to why a broader concept such as "derived from" was not utilized as was done in s. 84(4.1)) and to the fact that s. 212.3(9)(c)(ii) refers to proceeds of disposition of subject shares received directly or indirectly by the "particular corporation," which effectively is defined to include a QSC. By definition, a QSC has an equity percentage in the CRIC so that, except under an incestuous corporate structure, it could never receive proceeds of disposition of the subject shares directly.

Example 9-H (distribution of proceeds of subject shares received by CRIC as a dividend)

Parent forms CRIC with $101 cash share subscription proceeds, and CRIC uses $100 of those proceeds to acquire all the shares of Canco, whose only asset is FA. Canco subsequently sells half of the shares of FA for $100, and immediately pays a $100 dividend to CRIC, which immediately distributes $100 of stated capital to Parent.

Consequences:

The PUC of the shares of CRIC held by Parent was reduced from $101 to $1 under draft s. 212.3(7)(b) at the investment time.

The $100 sales proceeds were received by CRIC as a dividend rather than as proceeds of disposition of the shares of FA, so that the test in draft s. 212.3(9)(c)(ii) is not satisfied unless this dividend can be regarded as representing the indirect receipt by CRIC of sales proceeds of the subject shares which, in fact, were only received by Canco. If this concern is valid, the $100 PUC of the cross-border class held by Parent is not restored immediately before the stated capital distribution, and such distribution gives rise to a deemed dividend of $99 under s. 84(4).

The application of draft s. 212.3(9)(c)(ii)(II) to the direct or indirect receipt of a dividend or qualifying return of capital on subject shares potentially accommodates a sale of a subsidiary of the subject corporation, with the subject corporation then distributing such proceeds as a dividend or other distribution on its shares. However, essentially the same issue as discussed above arises as to whether a distribution, in turn, by a Canadian subsidiary of a CRIC of a dividend or qualifying return of capital received on subject shares can represent the "indirect" receipt by the CRIC of such amounts.

The reinstatement rule also will not operate where the CRIC distributes shares of a Canadian holding company for a subject corporation to the parent rather than the subject shares themselves.

Sandwich structures

The mechanics of the reinstatement rule are not necessarily inconsistent with eliminating a "sandwich" structure to which s. 212.3 has applied.

Example 9-I (eliminating sandwich structure - discussed by Angelo Nikolakakis at 2013 IFA Conference)

Parent forms CRIC with $100 of share capital, and CRIC uses those proceeds to purchase a non-resident corporation (FA1) whose two assets are the shares of FA2 with a fair market value of $80, and the shares of Canco, with an FMV of $20.

FA1 sells its shares of Canco to CRIC in consideration for a $20 note. CRIC then transfers its shares of FA1 to Parent as a PUC distribution. If so desired, FA1 converts its note of CRIC into equity.

Consequences:

On the $100 investment by CRIC in FA1, the $100 PUC of the shares of Parent in CRIC is ground to nil under s. 212.3(7). By virtue of s. 212.1(4), s. 212.1 does not apply to the sale by FA1 of Canco to CRIC. The $100 PUC of the shares in CRIC is reinstated to $100 on CRIC's distribution of FA1, so that such PUC distribution occurs free of withholding tax.

If the note owing by CRIC to FA1 is converted into equity, the "outside" PUC of CRIC will now be $20 - whereas if no sale of Canco had occurred, such outside PUC would be nil.

Options

As noted above, the reinstatement rule in s. 212.3(9) is not available in respect of an option or other investment in the subject corporation described in 212.3(10)(g). It is not clear why there is no recognition for the cost of a warrant as being part of the cost of shares or debt which were acquired on exercise of the option.

Example 9-J (no reinstatement re cost of options)

Parent holds all the shares of CRIC having a PUC of $300. In connection with a public offering by a listed non-resident company (FA), CRIC subscribes $100 for 100 units of FA, with each unit consisting of one common share and a warrant to acquire a further common share at a subscription price of $1 – with CRIC thereby acquiring 15% of the common shares of FA. $80 of this amount is reasonably allocated to the common shares, and $20 to the warrants.

CRIC subsequently exercises its warrants, and acquires 100 further shares of FA with a fair market value of $150 upon paying the $100 aggregate exercise price. CRIC then sells its shares of FA for $300, and immediately distributes such proceeds to Parent as a stated capital distribution.

Consequences:

The full amount of the $100 unit subscription by CRIC is an investment for purposes of s. 212.3(2), with the result that the PUC of CRIC held by Parent is ground by $100 under s. 212.3(7) to $200. The exercise of the warrants results in a further investment of $100 in FA (i.e., under s. 212.3(2)(a) the fair market value of the property transferred by CRIC to FA rather than the cost under s. 49(3) of the FA shares to CRIC), thereby resulting in a further grind of such PUC by $100, to $100.

Immediately before the distribution of the proceeds of $300, the PUC of CRIC is reinstated in the amount of $180, i.e., by the amount of the two investments in the subject shares and not the investment in the warrants – so that the PUC is increased to $280. Accordingly, a deemed dividend of $20 is received by Parent on th estated capital distribution.

Administrative Policy

22 May 2014 IFA Roundtable Q. 1, 2014-0526691C6 - IFA 2014 - CRIC Guarantees of debt for no fee

reinstatement under s. 212.3(9)(c)(ii)(A)(II) through PUC distributions of dividends

Forco, a controlled foreign affiliate Canco (which in turn is controlled by non-resident Parent, but with a minority of its shares held by arm's-length persons), borrows funds from a related non-resident entity for use in its active business. Although Canco does not charge a fee for its guarantee of the Forco debt, s. 247(7.1) applies, so that there is no adjustment to the nil fee under s. 247(2). CRA first noted that such no-fee guarantees generally give rise to an imputed investment by CRIC in Forco under 212.3(10)(b), before turning to the question below.

Q. 1(d)

If the resulting deemed dividend is reduced to nil by virtue of a full PUC grind under s. 212.3(7), it appears there could be multiple PUC grinds arising as a consequence of future Forco loans guaranteed by Canco without a fee. Comments? CRA stated:

[T]he mere repayment of the underlying debt (which would relieve the foreign controlled CRIC of its guarantee obligations) would not satisfy the requirements of subsection 212.3(9) in order to reinstate the PUC. …That being said…to the extent the CRIC demonstrates that… no more than 180 days before it [subsequently] reduces the PUC in respect of the class…[for which] an amount is required by paragraph 212.3(7)(b) to be deducted in computing the PUC, it has received dividends or a qualifying return of capital in respect of shares of the capital stock of the subject corporation, there would be an amount for the purposes of subparagraph 212.3(9)(c)(ii).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(10) - Paragraph 212.3(10)(b) imputed benefit from no-fee guarantee 307

23 May 2013 IFA Round Table, Q. 6(b)

reinstatement on redemption

The PUC reinstatement rule in s. 212.3(9) applies where the PUC of a CRIC that was previously suppressed is reduced as part of the redemption of shares owned by the foreign parent as well as on a return of paid-up capital on the shares.

23 May 2013 IFA Round Table Q. 6(g)

internal dispositions potentially reinstate

Do internal dispositions give rise to "proceeds" for the purposes of s. 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?

As a result of the exclusion for acquisitions to which s. 212.3(18) applies, many internal dispositions will not result in a PUC reinstatement. However, if the PUC of a class of shares of a CRIC was suppressed as a result of its investment in FA1 and the CRIC then sells FA1 to FA2 for cash such that the CRIC's cross border investment is reduced and, within 180 days, it reduces the PUC in respect of the suppressed class, the PUC reinstatement will apply.

Articles

Philip Halvorson, Dalia Hamdy, "An Overview of the Foreign Affiliate Dumping Rules", (OBA article), 23 February 2016

PUC reinstatment rule avoids a double PUC grind or recognizes deployment of proceeds in Canada (p.8)

[A] investment by a foreign-controlled CRIC in a foreign affiliate, that does not satisfy the bona fide business exception, should be considered a "dead asset". The PUC grind essentially puts the CRlC in "the same position as if it had distributed the amount of the investment as a return of capital on its shares rather than made the investment. However, if that property that was subject to the investment (e.g., shares of a foreign affiliate of the CRIC) is subsequently actually distributed as a return of capital, this would otherwise require a reduction to PUC under rules elsewhere in the Act, and without a reinstatement mechanism, a double PUC grind would result. Further, if the CRIC receives proceeds as a return from that property, and reinvests those proceeds within Canada, the amount should no longer be considered invested in a dead asset. Thus a PUC reinstatement mechanism puts the CRIC in the same position as if it had not made an investment in respect of the dead asset in the first instance.

Angelo Nikolakakis, "Foreign Affiliate Dumping – The New Paid-Up Capital Offset and Reinstatement Rules", International Tax (Wolters Kluwer CCH), October 2014 Number 78, p.1.

No requirement to distribute proceeds of investment (p. 4)

As noted above, the new rules would no longer require any distribution of capital in order to result in a PUC reinstatement. Rather, it would be sufficient for an offending investment to be disposed of. This is an important change to the application of the PUC reinstatement rule for two main reasons. First, it would facilitate the reinvestment in Canada of the proceeds from the disposition of an offending investment. Second, it would prevent many instances of duplicative applications of the FAD Rules where such proceeds are reinvested in a sequential offending investment that is not covered by a reorganization exception such as those contemplated by subsection 212.3(18) of the Act. That is, since the PUC would be reinstated "immediately before" the receipt of such proceeds, it should once again be available to support the application of the offset in the event that the form of such proceeds results in an offending investment.

Reinstatement exclusion where reinvestment is in a closely-connected corp. (pp. 4-5)

Three types of events would result in this category of reinstatement [under draft s. 212.3(9)(b)(ii)]. The first would be the receipt of proceeds from the disposition of the acquired shares, other than where the disposition results in an acquisition to which a reorganization exception applies under subsection 212.3(18) of the Act or the application of the "more closely connected" exception under subsection 212.3(16) of the Act. While it seems sensible to exclude situations where a reorganization exception applies under subsection 212.3(18) of the Act, it is more difficult to understand why there I should be an exclusion for situations in which the "more closely connected" exception under subsection 212.3(16) of the Act is satisfied. Where that test is satisfied, that investment should be viewed as a "good" investment, so arguably the PUC should be reinstated, since it would not have been constrained in the first place had that investment been made initially.

Steve Suarez, "An Analysis of Canada's Latest International Tax Proposals", Tax Notes International, September 29, 2014, p. 1131.

Example of operation of PUC reinstatement rule (p. 1142)

[A] Canadian corporation (Cansub)...originally purchased all of the shares of Foreignco for $100 million. This investment resulted in the PUC of the shares of Canco (a QSC regarding Cansub) automatically being reduced by $100 million under the PUC offset rule. When Cansub later distributes 60 percent of the Foreignco shares to its shareholders and Canco in turn distributes the Foreignco shares it received (48 percent) to Nonresidentco as a return of capital, the value of the shares distributed by Canco is $57.6 million,32 100 percent of which relates to the original $100 million investment. Because Canco is distributing 48 percent of the originally acquired Foreignco shares, $48 million of the originally reduced PUC is available to be reinstated, grossed up to $60 million33 in this case to reflect that Canco bore the entire $100 million PUC reduction even though it only owns 80 percent of Cansub.

Paul Stepak, Eric C. Xiao, "The 88(1)(d) Bump – An Update", 2013 Conference Report (Canadian Tax Foundation), pp.13:1-60

Difficulty in distributing out of a s. 212.3(10)(f) target as a loan repayment rather than PUC distribution (pp. 13:44-45)

Assume that the final home of FA1 is under Foreign Sub. Rather than have Amalco distribute the shares of FA1 to Foreign Parent as a post-bump return of capital, it may be more efficient to have Amalco distribute the FA1 shares directly to Foreign Sub. …

A direct distribution can often be easily achieved by having Foreign Sub make a pre-closing loan to Bidco, with a principal amount equal to the fair market value of FA1. Then after closing and following the bump, Amalco can repay the loan by delivering the FA1 shares to Foreign Sub.

However, the direct loan approach does not work where Target is a 10(f) corporation. The acquisition of a 10(f) corporation by a foreign corporate-controlled CRIC is treated as an investment for the purposes of the FAD rules. The amount of the investment (roughly, the portion of the purchase price allocable to the shares of Target's foreign affiliates) will grind cross-border PUC under subsection 212.3(7). I f there is insufficient PUC, the investment will result in a deemed dividend under paragraph 212.3(2)(a). There will be insufficient cross-border PUC if the loan approach described above is used, such that a deemed dividend will be triggered on the acquisition of Target.

Share subscriptions by Foreign Parent giving rise to PUC are a better choice for funding Bidco if Target is a 10(f) corporation. However, in order to distribute the shares of FA1 out of Canada after amalgamation, the buyer will need to be comfortable that the ground PUC will be reinstated, as provided for in subsection 212.3(9)….

Steve Suarez, "Canada's 88(1)(d) Tax Cost Bump: A Guide for Foreign Purchasers", Tax Notes International, December 9, 2013, p. 935

Use of s. 88(1)(d) in buy, bump and sell transactions (p. 937)

The introduction of the foreign affiliate dumping (FAD) rules in 2012 makes the 88(1)(d) bump more important than ever to foreign purchasers. The FAD rules create significant adverse (and ongoing) Canadian tax consequences for foreign-controlled Canadian corporations with foreign subsidiaries, and they effectively encourage Canadian group members to dispose of existing foreign affiliates whenever possible. Amendments made to the version of the FAD rules enacted in late 2012 facilitate the use of the 88(1)(d) bump in these circumstances, and when the 88(1)(d) bump is available to reduce or eliminate Canadian CGT [capital gains tax] on shares of foreign affiliates (and there are no tax impediments in the foreign affiliate's home country), it will generally be the primary tool used by foreign purchasers of a Canadian corporation that owns foreign subsidiaries to avoid having to contend with the FAD rules on an ongoing basis.

Charles Taylor, "Foreign Affiliate Dumping Developments", International Tax, No. 72, October 2013, p. 9

Potential desirability of triggering withholding tax under s. 84(1) (p. 10)

Taxpayers should be sensitive to the potential for double taxation resulting from a withholding tax liability arising as a consequence of the application of the FAD rules. If there is insufficient PUC to shelter the CRIC (and its shareholders) from a withholding tax liability, it may be logical to increase stated capital (and PUC) immediately before the investment time. The same withholding tax liability would presumably arise as a result of the PUC increase, but the result is that the CRIC would potentially have access to a future PUC reinstatement under subsection 212.3(9), should the conditions of that provision be met. Perhaps Finance could amend subsection 212.3(9) to provide for such a result and eliminate the need for self-help. Such a change would be consistent with the general liberalization of the PUC reduction and reinstatement regime.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(7) 142

Henry Chong, "Section 212.3: Missing PUC Adjustments", Canadian Tax Highlights, Vol. 21, No. 5, May 2013, p. 12.

One problem with the PUC reinstatement rules is that a reinstatement applies only to the same class of CRIC or QSC shares that was originally reduced; it does not apply if those shares were exchanged for another share class of the same or a different corporation in a tax-free corporate reorganization or within the same related corporate group. New shares received on the exchange or transfer inherit the reduced PUC but not the PUC reinstatement entitlement of the old shares.

He goes on to note that the s. 212.3(18) rules provide no relief in this regard and that although "Finance was aware of this problem," s. 212.3 as enacted provided no relief.

Paragraph 212.3(9)(b)

Articles

Subparagraph 212.3(9)(b)(ii)

Administrative Policy

2015 Ruling 2014-0541951R3 - Foreign Affiliate Debt Dumping

s. 212.3(9)(b)(ii) PUC restoration for upper-tier QSCs on the payment by a U.S. LLP of a proportionate “dividend” to lower tier CRIC partners

Current structure

Canco1 and Canco2 are wholly-owned subsidiaries of USco5 (a qualifying person under the Canada-U.S. Treaty and an indirect subsidiary of U.S. public company) who are the general and limited partners, respectively of LP1, which is atop five stacked Canadian subsidiaries (Canco 3 down to Canco7. Canco5 has public exchangeable shareholders. Canco7 is the sole limited partner of LP2, whose general partner (Canco8) is wholly-owned by Canco7. Canco7, Canco8 and LP2 are all the general partners of GP. GP is the sole general partner of FA1, which is a limited liability partnership and a non-resident corporation under the ITA, and FA1’s limited partner is a wholly-owned Canadian subsidiary of GP (Canco9). FA1 wholly owns FA2, which wholly owns FA3, which wholly owns FA4.

Proposed transactions
  1. USco5 will finance a subscription by GP and Canco9 for units of FA1, by subscribing for preferred shares of Canco1 and 2, with those proceeds cascading down the stack of intervening partnerships and Canadian corporations through successive preferred unit and preferred share subscriptions.
  2. FA1 will use such funds to either subscribe for ordinary shares of FA2 or lend the funds to FA2.
  3. FA2 will lend the funds in the same amount to FA4.
  4. FA1 will make a distribution (the “Distribution”) (deemed to be a dividend by s. 90(2)) proportionately to Canco9 and GP, within X months of FA4 receiving the loan from FA2.
Purpose

To ensure adequate funds are made available to FA4 to fund its pension plan and to repatriate excess cash from FA1.

Rulings
  • Canco1 and Canco2 will each be considered to be a qualifying substitute corporation as defined in s. 212.3(4).
  • The Distribution will be considered to be received as a dividend in respect of a class of shares of capital stock of FA1 by the Taxpayers (Canco7, 8 and 9) for the purposes of s. 212.3(9)(b)(ii) – A(B).
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Corporation proportionate distribution by LLP treated as dividend 126
Tax Topics - Income Tax Act - Section 90 - Subsection 90(2) proportionate LLP distribution to three direct or indirect general or limited partners treated as dividend on single class of shares 108
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(3) two Canadian corporate partners immediately beneath the U.S. border are QSCs respecting investments made by lower-tier CRICs in a U.S. LLP 230

Variable A

Clause (b)

Administrative Policy

2016 Ruling 2016-0629011R3 - PUC reinstatement under 212.3(9)

PUC restoration where borrowed money dividended up only to the level of a lower-tier CRIC, with cross-border PUC of both lower- and upper-tier CRICs computed both in Cdn$ and U.S.$ where lower-tier CRIC had U.S.$ EFC

Background

Foreign Parent holds a majority position in Pubco through foreign subsidiaries (Foreign Holdco 2 and Foreign Holdco 1) which, in turn, hold shares of Pubco (being common shares)

  • through Foreign Holdco 2, which holds common shares of Pubco, viewed as the “Cross-Border Class 3” or “CBC-3” of Pubco;
  • through Canholdco 1, all of whose shares, being common shares, or the “CBC-1,” are held by Foreign Holdco 1,
  • through Canholdco 2, whose common shares, held by Foreign Holdco 2, are the “CBC-2” and whose preferred shares are held by Canholdco 1, and
  • through Canholdco 3, whose preferred shares are held by Canholdco 1,and whose common shares are held by Canholdco 2.

Pubco is a public corporation that previously elected under s. 261(3) for the U.S. dollar to be its elected functional currency, and that is described in s. 212.3(10)(f). “Opco” is a non-resident subsidiary of Pubco (held through Forco 2 which, in turn was held by a foreign subsidiary (Forco 1) jointly held by Pubco and a Canadian subsidiary of Pubco). Pubco has been funding a major project of Opco mostly through a non-resident subsidiary (Finco) of Pubco that was capitalized by Pubco mostly with mandatorily redeemable preferred shares (MRPS).

Foreign Holdco 2 holds Foreign Holdco 3 and Foreign Holdco 4. Foreign Holdco 3 holds Canco 1 and Canco 2, except that non-voting cumulative redeemable shares of Canco 2 are held by Canco 1.

Recently completed transactions

Opco borrowed U.S. dollars in order to inter alia fund the repayment of loans owing to Finco (directly and by way of repaying loans from Forco 2). Finco, in turn, paid dividends on its common shares and distributions on its MRPS to Pubco, both in U.S. dollars (the “Finco Distributions”). Pubco, in turn, inter alia lent those funds to Canco 1, which subscribed for preferred shares of Canco 2, which effected a return of capital to Foreign Holdco 3 (which repaid indebtedness owing to Foreign Holdco 4).

Rulings

A. The cash from the Finco Distributions constitute receipts of property described in s. (B) of variable A of the s. 212.3(9)(b)(ii) formula.

B. This ruling references the concepts of: “Net PUC Reduction,” respecting a particular CBC, being the sum of amounts determined for such class under s. 212.3(9)(a) regarding an investment for which Finco is the subject corporation, as of the time that is immediately before the time that is immediately before the first Finco Distribution, plus a further specified reduction under s. 212.3(7); “Net US$ PUC Reduction” being the Net PUC Reduction for CBC-1, CBC-2 and CBC-3 determined in U.S. dollars for the sole purpose of determining Pubco’s Canadian tax results (“CTRs”) within the meaning of s. 261(1); and “Net C$ PUC Reduction” CBC -1”,being the Net PUC Reduction for CBC-1, CBC-2 and CBC-3 determined in Canadian dollars for the purpose of determining their respective PUC balances. The Ruling:

Provided that (i) the total amount of the Finco Distributions as determined in US$ is no less than the total of each “Net US$ PUC Reduction in respect of CBC-1, CBC-2 and CBC-3, and that (ii) the C$ equivalent of such amounts of Finco Distributions is no less than the total of each Net C$ PUC Reduction in respect of CBC-1, CBC-2 and CBC-3, the application of subsection 212.3(9) to the Finco Distributions will have resulted, at the time the last Finco Distribution is completed, in the PUC of each of the Relevant CBCs being increased under that subsection by an amount equal to the total of all amounts previously deducted (less amounts previously reinstated) in respect of Investments in Finco, as the Subject Corporation, for the purpose of the maintenance of the relevant PUC accounts of Pubco, CanHoldco 1 and CanHoldco 2, in C$ and in US$.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(18) - Paragraph 212.3(18)(c) - Subparagraph 212.3(18)(c)(v) exclusion where (10)(f) corp on-subscribes proceeds in FA investments 168
Tax Topics - Income Tax Act - Section 261 - Subsection 261(5) - Paragraph 261(5)(a) cross-border PUC of both lower- and upper-tier CRICs computed both in Cdn$ and U.S.$ where lower-tier CRIC had U.S.$ EFC 332

Subsection 212.3(10) - Investment in subject corporation

Paragraph 212.3(10)(a)

Commentary

S. 212.3(10)(a) provides that an investment in a subject corporation for purposes of the s. 212.3 rules includes an acquisition of shares of the subject corporation by the CRIC. Accordingly, an investment includes both a subscription by the CRIC for treasury shares of the subject corporation, and a purchase or other acquisition of shares from another person, including the CRIC's non-resident parent corporation or an affiliated corporation (subject to exceptions in s. 212.3(18) – as well as arm's length persons (or a partnership). In the usual case, the amount of the investment effectively is determined under s. 212.3(2)(a), which does not have a general rule deeming the amount of the investment to be at least equal to the fair market value of the acquired shares.

Administrative Policy

28 May 2015 IFA Roundtable Q. 10, 2015-0581641C6 - IFA 2015 Q.10: 111(4)(e) election and 212.3

deemed investment under s. 111(4)(e)

Following the acquisition of control of the non-resident parent of a CRIC, the CRIC made a s. 111(4)(e) designation respecting its 100% shareholding of its FA. Before going on to find that the resulting deemed dividend under 212.3(2)(a) would be nil, CRA stated:

[T]he subparagraph 111(4)(e)(ii) deemed reacquisition of the FA shares by the… CRIC would constitute an "investment in a subject corporation made by a CRIC" as described in paragraph 212.3(10)(a) and would not be an investment described in paragraph 212.3(18)(a) given that the CRIC would not be related to itself. …

See summary under s. 212.3(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(18) - Paragraph 212.3(18)(a) deemed investment under s. 111(4)(e) 97
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(2) no transfer of property on deemed s. 111(4)(e) acquisition 147

Paragraph 212.3(10)(b)

Commentary

S. 212.3(10)(b) provides that an investment in a subject corporation for purposes of the s. 212.3 rules includes a contribution of capital to the subject corporation by the CRIC. Thus, a transfer of property by the CRIC to the subject corporation is an investment for such purposes even if the CRIC does not receive any consideration, such as the issuance of shares or debt, of the subject corporation. Furthermore, a contribution of capital for these purposes is deemed to include any transaction or event under which a benefit is conferred on the subject corporation by the CRIC. The Explanatory Notes of the Department of Finance state that:

This benefit conferral rule is similar to the rule in s. 15(1) that applies in the shareholder benefit context.

Example 10b-A (conferral of benefit)

CRIC transfers intellectual property to a non-resident subsidiary in consideration for an obligation to pay a royalty. If the terms of the royalty and the other circumstances are such that CRIC is considered to have conferred a benefit on the subsidiary, the value of that benefit will be considered to be an investment made by it in that subsidiary, thereby potentially giving rise to a deemed dividend to its non-resident parent.

Transactions entailing the conferral of a benefit by a CRIC on its non-resident subsidiary may be exempted under s. 212.3(18). For example, the transfer by a CRIC of shares of one non-resident subsidiary to a second non-resident subsidiary for nominal share consideration would generally qualify for rollover treatment under s. 85.1(3), so that s. 212.3(18)(b)(ii) would deem there to be no resulting investment by the CRIC in the second non-resident subsidiary notwithstanding that it likely would be considered to have conferred a benefit on it.

Administrative Policy

22 May 2014 IFA Roundtable Q. 1, 2014-0526691C6 - IFA 2014 - CRIC Guarantees of debt for no fee

imputed benefit from no-fee guarantee

Forco, a controlled foreign affiliate Canco (which in turn is controlled by non-resident Parent, but with a minority of its shares held by arm's-length persons), borrows funds from a related non-resident entity for use in its active business. Although Canco does not charge a fee for its guarantee of the Forco debt, s. 247(7.1) applies, so that there is no adjustment to the nil fee under s. 247(2).

Q. 1(a)

Does the no-fee guarantee constitute a conferral of a benefit so that there is an "investment" under s. 212.3(10)? CRA stated:

[J]ust as it has been CRA's longstanding position that a corporation guaranteeing the debt of a shareholder for no fee can be viewed as the conferral of a benefit for the purposes of subsection 15(1), in the inverse situation where a CRIC guarantees the debt of a subject corporation for no fee, CRA is of the view that there can be a benefit conferred for the purposes of paragraph 212.3(10)(b).

Q. 1(b)

Canco arguably is not conferring a benefit on Forco, since Canco benefits from Forco's access to debt capital. In what circumstances would CRA consider the provision of the guarantee by Canco for no fee not to be a conferral of a benefit for purposes of s. 212.3(10)(b)? CRA stated:

…CRA would generally not view the provision of such a guarantee as the conferral of a benefit if fair market value consideration were otherwise given in exchange for the guarantee and it would be reasonable in the circumstances to conclude that a party dealing at arm's length would provide the guarantee on the same terms.

Q.1(c)

What is the resulting investment's quantum? CRA stated:

[T]he quantum of the benefit… is the fair market value of the benefit at the time the investment is made (i.e., when the benefit is conferred)…[which] is a factual determination… .

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(9) reinstatement under s. 212.3(9)(c)(ii)(A)(II) through PUC distributions of dividends 244

Paragraph 212.3(10)(c)

Commentary

S. 212.3(10)(c) provides that an investment in a subject corporation for purposes of the s. 212.3 rules includes a transaction as part of which an amount becomes owing by the subject corporation to the CRIC, unless the amount owing satisfies the exception in s. 212.3(10)(c)(i) to (iii).

Multinational groups often have cash pooling arrangements under which a bank account (or other cash) of a treasury company is utilized by other group members, so that they have fluctuating credit or debit balances with the treasury company. Where a CRIC participates in a cash pooling arrangement, the utilization by group members of cash which otherwise would have been cash of the CRIC generally will be an investment under s. 212.3(10)(c) unless the "ordinary course" exception in s. 212.3(10)(c)(i) described below is available, or PLOI elections (also discussed below) are made.

Centralized procurement or other arrangements under which trade debts of non-resident affiliates become owing to a CRIC also could be investments under s. 212.3(10)(c).

The first exception, in s. 212.3(10)(c)(i), is for an amount owing that becomes owing to the CRIC in the ordinary course of the CRIC's business and is repaid, other than as part of a series of loans or other transactions and repayments, within 180 days of the day it becomes owing. The Explanatory Notes of the Department of Finance state that:

The "ordinary course of business" exception could apply, for example, where the CRIC supplies property to the subject corporation on credit in the ordinary course of the CRIC's business operations (and the resulting debt is repaid in the manner required by that exception).

As summarized in greater detail below, CRA accepts that its policies in IT-119R4 on the meaning of the concept of "series of loans or other transactions and repayments" generally are applicable in this context as well.

The second exception, in s. 212.3(10)(c)(ii), is for an amount owing that the CRIC and the parent have jointly elected under s. 212.3(11)(c) to have treated as a "pertinent loan or indebtedness", as discussed below under s. 212.3(11).

The Explanatory Notes of the Department of Finance state that, subject to these two exceptions:

paragraph s. 212.3(10)(c) is generally intended to include, as investments for purposes of section 212.3: loans made by the CRIC to the subject corporation; transactions resulting in trade debts or other unpaid purchase price owing by the subject corporation to the CRIC; and any other transaction as part of which an amount becomes owing by the subject corporation to the CRIC.

The third exception, in s. 212.3(10)(c)(iii), is for an amount owing to the CRIC by the subject corportion that became owing because a dividnd was declared (but has not yet been paid) by the subject corporation.

Administrative Policy

23 May 2013 IFA Round Table Q. 6(f)

  • Would the 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?
  • Would the CRA consider a "series or 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?
  • Would the CRA accept that each loan in a "series" will be repaid once all loans in the series have been repaid?
Response

An amount owing to the CRIC as the result of selling property or services to a subject corporation on credit in the ordinary course of the CRIC's business would meet the ordinary course of business exception in s. 212.3(10)(c)(i) if the resulting debt is repaid within the time limit required by that exception.

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. However, the ordinary course of business exception could 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.

The repayment rule in s. 212.3(10)(c)(i) is similar to that in s. 15(2.6).

(i) If a particular amount owing comprises several amounts owing of the same nature (e.g., various product acquisitions on credit), FIFO would be an acceptable method to track the origination and settlement the amounts. However, if a particular amount owing is made up of several amounts owing of different natures (e.g., secured v. unsecured, or different interest rates), CRA would expect the debtor to specify the application of payments.

(ii) The "series of loans or other transactions and repayments" issue is discussed in IT-119R4. However, repayments of a temporary nature (for example, certain cash pooling arrangements) may be evidence a series of loans and repayments.

(iii) A final bona fide repayment would not be considered part of a series for the purpose of s. 212.3(10)(c)(i), so that a particular amount owing by a subject corporation to a CRIC which arose in the ordinary course of its business of the CRIC would meet the exception if its final bona fide repayment was made within 180 days after the day on which it became owing.

Articles

John Lorito, Trevor O'Brien, "International Finance – Cash Pooling Arrangements", 2014 Conference Report, (Canadian Tax Foundation), 20:1-33

Cash pooling advances in the ordinary course (pp. 19-20)

[I]n…2013-0483751C6, the CRA commented that…the ordinary course of business exception could 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 [FA Corporation] if the resulting debt is repaid in the manner required by that exemption." Therefore, provided amounts advanced under a cash pooling arrangement are repaid within 180 days and the cash put on deposit with the cash pool is needed in the CRIC'S on-going operations, it may be possible for a CRIC to avoid the application of the Foreign Affiliate Dumping rules that would otherwise be applicable on advances made to its foreign affiliates under a cash pooling arrangement. The position suggested by the CRA with respect to operating cash placed on deposit in a cash pooling arrangement appears reasonable in that one would generally expect that, under a physical cash pooling arrangement, the head account holder should generally assume the role of banker and that the taxpayer should be treated on an equivalent basis as having placed funds on deposit with an unrelated bank, as it would have otherwise in the ordinary course of its business. It is understandable that the position suggested by the CRA specifically focused on "funds at risk in its business" as anything broader would have been inconsistent with the provisions of the Foreign Affiliate Dumping rules [fn 66: To discourage CRIC's controlled by NR Parents from making investments in FA Corporations.].

See description of cash pooling under s. 15(2.3).

Ian Bradley, "Living with the Foreign Affiliate Dumping Rules", Canadian Tax Journal (2013) 61:4, 1147-66.

Group working capital management is problematic (p. 1164)

Multinational groups often optimize their cash management by pooling the excess cash balances of group members in a central treasury company, then redistributing this cash to group members as needed. Cash transfers are generally made by way of frequent short-term loans between the group members and the treasury centre. If a CRIC participates in cash-pooling arrangements with its foreign affiliates, any cash-pooling loans to these affiliates could be considered investments subject to the FA dumping rules.

Trade debts can also be problematic…[as well as] factoring arrangements.

Paragraph 212.3(10)(d)

Commentary

S. 212.3(10)(d) provides that an investment in a subject corporation for purposes of the s. 212.3 rules includes an acquisition of a debt obligation of the subject corporation by the CRIC from another person, subject to the two exceptions provided for in ss. 212.3(10)(d)(i) and (ii) (essentially identical to those in ss. 212.3(10)(c)(i) and (ii).

The first exception, in s. 212.3(10)(d)(i), is for an acquisition made in the "ordinary course of the business" of the CRIC from a person with which the CRIC deals, at the time of the acquisition, at arm's length – for example, the purchase of a trade receivable by the CRIC in the ordinary course of its factoring business. As such debts must be acquired from arm's length persons, factoring arrangements for the transfer of intragroup receivables do not qualify for this exception.

The second exception, in s. 212.3(10)(d)(ii), is for an amount owing that the CRIC and the parent have jointly elected under s. 212.3(11)(c) to have treated as a "pertinent loan or indebtedness", as discussed below under s. 212.3(11).

The Explanatory Notes of the Department of Finance state that:

Paragraph 212.3(10)(d) is intended to include acquisitions of outstanding debts of a subject corporation from any person (or, by virtue of the look-through rules in subsection 212.3(25), any partnership), whether dealing at arm's length or non-arm's length with the CRIC.

Paragraph 212.3(10)(e)

Commentary

Overview

S. 212.3(10)(e) provides that an investment in a subject corporation for purposes of the s. 212.3 rules includes an extension of either the maturity date of a debt obligation owing by the subject corporation to the CRIC (other than a debt obligation that is a pertinent loan or indebtedness immediately after the extension – see s. 212.3(11)) or of the redemption, acquisition or cancellation date of shares of the subject corporation held by the CRIC (paraphrased in the Explanatory Notes of the Department of Finance as the extension of "the date on which shares of the subject corporation held by the CRIC are to be redeemed, acquired or cancelled by the subject corporation."

Loss of grandfathering

The Explanatory Notes state:

For example, where the subject corporation issued a debt obligation or preferred shares to the CRIC before March 29, 2012 (i.e., the effective date of the foreign affiliate dumping rules) that would have been an investment under paragraph 212.3(10)(c) or 212.3(10)(a), respectively, had they instead been issued after March 28, 2012, an extension of the maturity date of the debt or the redemption date of the preferred shares would constitute an investment. Where, instead, the debt obligation or the shares are issued by the subject corporation to the CRIC after March 28, 2012, and subsection 212.3(2) applies to such investment, a subsequent extension of the maturity or redemption date, as the case may be, would result in a second investment to which subsection 212.3(2) would apply.

Accordingly, one of the effects of s. 212.3(10)(e) is to ensure a loss of grandfathering where the CRIC holds loans of a subject corporation with a maturity date, or preferred shares that provide that redemption (or liquidation) must occur on or before a stipulated date.

Slippery concept of maturity extension

Demand notes (as discussed below), or preferred shares that are redeemable by the holder or the corporation or both at any time in its discretion, do not appear to come within this provision.

It may have been contemplated that a waiver of a right to repayment, or redemption, on a particular date (but without any agreement on a "new" maturity date) is to be regarded as an extension of the maturity date, although this is not clear on the wording. Promissory notes which are payable on demand by the holder do not have a maturity date; nor should the passing of a prescription period be equated with their maturity.

Although loans made to the subject corporation in the ordinary course of business of the CRIC, or acquisitions in the ordinary course of such business of loans owing by the subject corporation, are usually are exempted under s. 212.3(10)(c) or (d), there is no similar exception for the extension of the due date for a loan made (or a receivable purchased) by the CRIC in the ordinary course of business. This generally will not be a practical concern if a temporary indulgence respecting payment on the due date is not considered to be an "extension" of the debts' maturity date. However, as noted in the paragraph above, it may have been contemplated that payment date indulgences were to be regarded as maturity date extensions, at least if they crossed some amorphous threshold of materiality.

There is no provision deeming interest accruing on a debt obligation (an undefined term) to be a separate debt obligation - so that presumably extensions of the due dates for the interest accruing on a debt would not trigger a deemed investment under s. 212.3(10)(e), assuming such extension did not cross the maturity date for the principal.

PLOI election

In the case of most loans owing by a subject corporation to a CRIC, a dilemma will arise prior to the maturity date: if a new loan is made following maturity, that new loan will be an investment under the s. 212.3 rules unless an election is made for that loan to be a pertinent loan or indebtedness (PLOI), where this election is available or the exception in s. 212.3(16) is available; and if the maturity date instead is extended without there being a new loan, s. 212.3(10)(e) generally will apply to deem there to be an investment unless any available PLOI election is made (or the exception in s. 212.3(16) is available).

Before taking into account the draft August 16, 2013 draft amendments, in many instances the effect of this dilemma would have been to force the making of a PLOI election if available. Given that the potential for reinstatement of PUC under s. 212.3(9) has been extended under those draft amendments to debt investments, there often will be uncertainty as to whether or not it is desirable for the PLOI election to be made.

Share reorganization exceptions

There are exemptions in ss. 212.3(18)(b)(i) and (iii) for conversions of shares under s. 51 or share capital reorganizations under s. 86. Accordingly, a conversion of preferred shares with a maturity date into common shares generally would not be deemed to give rise to an investment, so that such a conversion prior to any such maturity date may be desirable.

By virtue of s. 212.3(19), the exception for such reorganizations typically would not apply to a conversion into another class of preferred shares, so that utilizing s. 51 conversions or 86 reorganizations to replace preferred shares with a maturity date by those without one generally would trigger a deemed investment under s. 212.3(1)(e) – provided that such transaction were properly regarded as giving rise to an acquisition by the CRIC of a "new" class of shares.

Amount of deemed investment (s. 212.3(5))

Where s. 212.3(10)(e) applies to deem the CRIC to have made an investment, s. 212.3(5) deems the CRIC for purposes of the deemed dividend rule in s. 212.3(2)(a) to have transferred property to the subject corporation (that relates to the investment) with a fair market value equal to the amount owing on the debt obligation (i.e., including accrued interest), or the fair market value of the shares, as the case may be, immediately after the deemed investment. The Explanatory Notes of the Department of Finance state that this rule is

intended to give results similar to those that would occur had the debt been repaid and re-loaned, or had the shares been redeemed and re-issued, as the case may be, instead of being extended.

Articles

Ian Bradley, "Living with the Foreign Affiliate Dumping Rules", Canadian Tax Journal (2013) 61:4, 1147-66.

Maturity date extension (p. 1159)

Finance has stated that the policy objective of this rule is to treat a term extension as a repayment and reinvestment of the original investment. However, if the original investment is actually repaid, a PUC reinstatement may be obtained by repatriating the investment proceeds to the parent. If paragraph 212.3(10)(e) applies, the same invested funds can trigger two PUC reductions. However, only one PUC reinstatement is available when these funds are ultimately repatriated to the parent. This rule can therefore result in double taxation.

Paragraph 212.3(10)(f)

Commentary

Overview

In the absence of s. 212.3(10)(f), investments engaging the s. 212.3 rules would be restricted to direct investments (as broadly defined in s. 212.3(10)) by a CRIC in a subject corporation. However, s. 212.3(10)(f) provides that where a CRIC (directly) acquires shares of another Canadian-resident corporation (the immediate target) – which itself holds, directly or indirectly, shares of one or more foreign affiliates – the indirect acquisition of each such foreign affiliate by the CRIC will be considered a separate investment in a subject corporation if the total fair market value of all the foreign affiliate shares held, directly or indirectly, by the Canadian target corporation (the numerator test) comprises more than 75% of the total fair market value of all the properties owned by the Canadian target (the denominator test).

Application of 75% test

Parenthetical language in s. 212.3(10)(f) requires that, for purposes of the denominator test, the total fair market value of all the properties owned by the immediate target is to be determined without taking into account any debts of any Canadian corporation in which the immediate target has a direct or indirect interest (so that, in the case of share investments in a corporation, the fair market value of the shares is to be grossed-up for debt owing by the corporation). The Explanatory Notes of the Department of Finance state:

As a result, where the Canadian target owns shares of another Canadian corporation, the fair market value of those shares is to be determined for these purposes without taking into account any debts of that other corporation. The debts of the Canadian target are also not taken into account because the 75% test is applied based on the "properties" of the Canadian target.

Respecting the denominator test, the Explanatory Notes state:

This computation includes only the value of the Canadian target's proportionate equity interest in its foreign affiliates, rather than the total value of each foreign affiliate. In addition, since the parenthetical language in paragraph 212.3(10)(f) excludes only debts of Canadian corporations, any debts of foreign affiliates will be reflected in their share values for these purposes. Finally, where a foreign affiliate itself owns shares of another foreign affiliate of the Canadian target, such that the value of the upper-tier foreign affiliate's shares reflects that of the lower-tier affiliate, the rule against "double counting", in paragraph 212.3(14)(b), precludes taking the value of the lower-tier foreign affiliate into account more than once.

If the condition in s. 212.3(10)(f) is satisfied, then for the purposes of s. 212.3(2), the CRIC will be considered to have made a separate investment in a subject corporation, namely, each foreign affiliate of the immediate target. The Explanatory Notes state that "the CRIC must reasonably allocate the consideration paid for the Canadian target corporation to the foreign affiliate shares in order to determine the appropriate consequences under subsection 212.3(2)."

Double-counting

S. 212.3(10)(14)(b) provides that for purposes of s. 212.3(10)(f), the fair market value of properties held directly or indirectly by the immediate target is not to be taken into account more than once in determining whether the condition in s. 212.3(10)(f) is satisfied. S. 212.3(10)(14)(b) is supplemented by the more specific rule in s. 212.3(18)(c)(v), which avoids multiple investments where there is a downward cascading of funds through upper-tier CRICs.

Subsequent dispositions of Canadian assets

Even if the conditions in s. 212.3(10)(f) are not met at the time of the CRIC's investment in the Canadian target, s. 212.3(14)(a) potentially will deem s. 212.3(10)(f) to apply if property of the immediate target is subsequently disposed of as part of the same series of transactions as the investment.

Explanatory Notes example

The Explanatory Notes of the Department of Finance provide the following exhaustive example (diagram added):

Example (212.3(10)(f))

Assumptions

  • NR Co, a non-resident corporation, owns all the shares of Canco 1, a corporation resident in Canada. Canco 1 has excess cash that it uses to acquire all the shares of Canco 2, a Canadian-resident corporation that deals at arm's length with Canco 1 at all times prior to the acquisition, for $18 million.
  • Canco 2's assets consist of business assets, with an aggregate fair market value of $3 million, and all of the shares of Canco 3, another corporation resident in Canada whose shares have an aggregate fair market value of $15 million.
  • Canco 3's assets consist of:
    • Canadian business assets, with an aggregate fair market value of $2 million;
    • all of the shares of FA 1, a foreign affiliate of Canco 3; and
    • 50% of the shares of FA 2, another foreign affiliate of Canco 3.
  • Canco 3 has debt obligations payable in an aggregate amount of $2 million.
  • The fair market value of all the shares of FA 1 is $8 million. FA 1's assets consist of business assets with an aggregate fair market value of $7 million, and all of the shares of FA 3, which have a fair market value of $1 million. FA 3 itself has business assets with a fair market value of $1 million and no liabilities.
  • The fair market value of all the shares of FA 2 is $14 million. FA 2 has business assets with an aggregate fair market value of $18 million, and debts in an aggregate amount of $4 million. The other 50% of FA 2's shares is held by an arm's length person.
  • None of FA 1, FA 2 or FA 3 satisfies the conditions for the exception in s. 212.3(16).

Analysis

Part A

  • In this example, Canco 1 has, by acquiring the shares of Canco 2, indirectly acquired the shares of FA 1, FA 2 and FA 3. In order to determine whether s. 212.3(2) applies to these acquisitions, it is necessary to test whether the acquisition by Canco 1 of the shares of Canco 2 satisfies the condition in s. 212.3(10)(f).
  • S. 212.3(10)(f) requires a comparison between, on the one hand, the total fair market value of all the foreign affiliate shares owned, directly or indirectly, by Canco 2 and, on the other hand, the total fair market value (determined without reference to debt obligations of any Canadian corporation in which Canco 2 has a direct or indirect interest) of all the properties owned by Canco 2. It is necessary to first determine the aggregate fair market value of all the shares Canco 2 owns, directly or indirectly, in its foreign affiliates. In this case, Canco 2 owns, indirectly through Canco 3, 50% of the shares of FA 2, with a fair market value of $7 million (i.e., 50% of the $14 million total fair market value of all the shares of FA 2). Canco 2 also owns indirectly all of the shares of FA 1, with a fair market value of $8 million. Although Canco 2 also owns indirectly all of the shares of FA 3, because the value of such shares is reflected in the value of the shares of FA 1, and is thus already taken into account once, the rule against "double counting", in s. 212.3(14)(b) (discussed below), ensures that the value of the shares of FA 3 is not taken into account separately. Thus, the total fair market value of all the foreign affiliate shares that are owned, directly or indirectly, by Canco 2 is $15 million.
  • It is then necessary to determine the aggregate fair market value of all the properties owned (i.e., directly) by Canco 2. In this case, Canco 2 owns business assets worth $3 million. In addition, Canco 2 owns all the shares of Canco 3, which have a fair market value of $15 million. However, for the purposes of the test in s. 212.3(10)(f), the value of the Canco 3 shares is to be determined without taking into account Canco 3's debts of $2 million, by virtue of the parenthetical language in that s.. Accordingly, the value of the Canco 3 shares for these purposes is $17 million. Therefore, the total fair market value of all of Canco 2's properties for these purposes is $20 million.
  • Based on the foregoing, the condition in s. 212.3(10)(f) will not be met in the case of Canco 1's acquisition of the shares of Canco 2 because the total fair market value of all of the foreign affiliate shares owned, directly or indirectly, by Canco 2 ($15 million) does not exceed 75% of the total fair market value of all of the properties owned by Canco 2 ($20 million). As a result, Canco 1's indirect acquisitions of the foreign affiliates of Canco 2 will not constitute "an investment in a subject corporation made by a CRIC" under s. 212.3(10) and s. 212.3(2) will not apply.

Part B

  • If, on the other hand, it were assumed that the foreign affiliates in this case were worth $1 more, the 75% threshold in s. 212.3(10)(f) would be exceeded and Canco 1's indirect acquisitions of each of FA 1, FA 2 and FA 3 would constitute separate investments in a subject corporation by a CRIC to which s. 212.3(2) would apply.
  • In that case, for the purposes of s. 212.3(2), and assuming that the debt obligations of Canco 3 are not specifically attributable to any particular assets of Canco 3, the portion of the $18 million purchase price paid by Canco 1 for the acquisition of Canco 2 that could reasonably be considered to relate to Canco 1's investment in FA 1 would be approximately $6.18 million ($7.0 million less $0.82 million, the pro-rata portion of Canco 3's debt attributable to FA 1); to Canco 1's investment in FA 2 would be approximately $6.18 million ($7.0 million less $0.82 million, the pro-rata portion of Canco 3's debt attributable to FA 2); to Canco 1's investment in FA 3 would be approximately $0.88 million ($1.0 million less $0.12 million, the pro-rata portion of Canco 3's debt attributable to FA 3); and to Canco 3's Canadian business assets would be approximately $1.76 million ($2.0 million less $0.24 million, their pro-rata portion of Canco 3's debt).
  • Thus, approximately $13.24 million of the $18 million total purchase price paid would be attributable to the foreign affiliates, and the other $4.76 million would be attributable to the business assets of Canco 2 ($3 million) and Canco 3 ($1.76 million). (Note that the result would generally be no different if the purchase price allocation to the foreign affiliate shares were instead made on the basis that FA 3's value was included in the value of the FA 1 shares, rather than ascribing separate values to FA 1 and FA 3.) Thus, under s. 212.3(2)(a), Canco 1 would be deemed to pay a dividend to NR Co in the amount of approximately $13.24 million.

Administrative Policy

23 May 2013 IFA Round Table Q. 6(a)

Does CRA consider that the original version of s. 212.3(10)(f) (for transactions before August 14, 2012) capture the indirect acquisition of foreign affiliates (i.e. the acquisition of Canadian companies owning foreign affiliates)?

Response

: Transitional s. 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 ss. 212.3(10)(a) to (e). In general, CRA 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.

Articles

Brett Anderson, Daryl Maduke, "Practical Implementation Issues Arising from the Foreign Affiliate Dumping Rules", draft 2014 Annual CTF Coference Report paper.

Exclusion from bad assets of debt receivable from subject corporation (p.8)

[P]arent owns all of the issued and outstanding shares of the CRIC and the CRIC acquires all of the shares of Canco from an arm's length persons for a total purchase price of $100. At the acquisition time Canco owns shares of its foreign affiliate (Subject Corp.), debt of Subject Corp., and other assets which have an aggregate FMV of $30, $50, and $20 respectively. Canco owns no other assets at the acquisition time.

Under this scenario, the CRIC has not made an investment in Subject Corp. at the acquisition time given that the FMV of Canco's shares of Subject Corp. represent only 30% (75% or less) of Canco's Total Assets at that time. It is important to note that only shares of Canco's foreign affiliates (and not the debt receivable from the Subject Corp.) are included in Canco's Bad Assets. However, for purposes of computing the Total Assets of Canco, the debt receivable from the Subject Corp is taken into consideration.

Paragraph 212.3(10)(g)

Commentary

S. 212.3(10)(g) provides that an investment for purposes of s. 212.3 includes an acquisition by a CRIC of an option or interest in (or, under civil law, a right in), respect of shares or debt of a subject corporation – except that there is an exclusion for the types of (ordinary course) debt excepted from the definition of investment under ss. 212.3(10)(c)(i), (c)(ii), (d)(i) and (d)(ii)). The Explanatory Notes of the Department of Finance state:

The reference to an "interest" in this subsection is not intended to include, in and of itself, an acquisition by a CRIC of shares of another Canadian corporation that itself holds shares or debt of a subject corporation.

The amount of an investment under s. 212.3(10)(g) is determined under ordinary principles as the cost of acquisition of the option or interest.

S. 212.3(10)(g) deems the acquisition of an option to be an investment but does not deem it to be an acquisition of shares, so that it would appear that s. 212.3(10)(f) will not apply to the acquisition of options on shares of a Canadian corporation holding a foreign affiliate.

As discussed above under s. 212.3(9), no reinstatement is available under s. 212.3(9) for the paid-up capital grind occurring under s. 212.3(7) as a result of an investment described in s. 212.3(10)(g).

Subsection 212.3(11) - Pertinent loan or indebtedness

Commentary

Ss. 212.3(10)(c)(ii), 212.3(10)(d)(ii) and 212.3(10)(e)(i) indicate that an investment in a subject corporation by a CRIC does not include: a loan to the subject corporation by the CRIC which is a "pertinent loan or indebtedness" (a "PLOI") immediately after the lending; the acquistion by the CRIC of a debt obligation of the subject corporation which is a PLOI immediately after the acquisition; or the extension of the maturity date of a debt obligation owing by the subject corporation to the CRIC where that debt is a PLOI immediately after such extension. The intent is that PLOIs are subject to the interest imputation rule in s. 17.1(1) rather than being subject to the s. 212.3 rules.

The effect of s. 212.3(11)(a) is that indebtedness (or another amount owing) will not qualify to be a PLOI if it became owing before March 28, 2012, and its maturity date was not extended after that date.

A second condition set out in s. 212.3(11)(b) is that the indebtedness (or other amount owing) not be described in either s. 212.3(10)(c)(i) or (d)(i), which provide separate exceptions, from what otherwise would be an investment in a subject corporation, for certain types of indebtedness arising or acquired in the ordinary course of business of the CRIC.

A third condition, contained in s. 17.1(3), is that the interest on the mooted PLOI which otherwise would be imputed under s. 17.1 is not reduced under an applicable tax treaty. This condition may have little practical significance if the CRIC does not seek to challenge the level of imputed interest on treaty grounds.

Where the debt obligation (or other amount owing) became owing after March 28, 2012, it becomes a PLOI by the CRIC and the parent filing a joint election in respect of the amount owing by the filing-due date of the CRIC for the taxation year in which the amount became owing. In the case of a debt obligations that became owing before March 29, 2012 and whose maturity date was thereafter extended, it becomes a PLOI if the CRIC and the parent elect in respect of that amount owing before the filing-due date of the CRIC for the taxation year in which the maturity date for the debt obligation was extended.

Cash pooling arrangement and similar cash management systems typically involve daily or weekly advances and repayments of funds, and with net outstanding balances being accounted for rather than there being any tracking that would make it possible to specify when any particular daily advance has been repaid. A requirement by CRA that a PLOI election must specify each specific debt (see 23 May 2013 IFA Round Table Q. 6(c) below) likely will not be practicable in the context of such arrangements.

Administrative Policy

23 May 2013 IFA Round Table Q. 6(c)

Will CRA permit a blanket PLOI election (specifying that it is being made for each debt owing from the particular debtor to the particular CRIC)?

Response

: If the filing due date is the same for electing PLOI treatment for more than one amount owing:

[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.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 15 - Subsection 15(2.11) blanket PLOI election 86

Articles

Philip Halvorson, Dalia Hamdy, "An Overview of the Foreign Affiliate Dumping Rules", (OBA article), 23 February 2016

Activation of dead asset under PLOI rules (p. 7)

[T]he FAD Rules are based on the presumption that an investment by a foreign-controlled CRIC in a subject corporation, and that does not meet other exceptions such as the bona fide business exception in subsection 212.3(16), produces no economic benefit to Canada. However, electing into the PLOI regime results in a prescribed base-level income inclusion in respect of the loan or indebtedness. As such, this will necessarily result in income at a floor rate, and should [not?] be considered a "dead asset" as a matter of policy. Consequently, investments in a PLOI are not subject to the FAD Rules.

Ian Bradley, "Living with the Foreign Affiliate Dumping Rules", Canadian Tax Journal (2013) 61:4, 1147-66.

PLOI elections impracticable where cash pooling (p. 1166)

The PLOI filing obligations may cause practical difficulties in the context of the ordinary-course financial arrangements described above. Making a separate election for each debt could be cumbersome, especially if balances fluctuate frequently and accounting systems do not link particular advances to particular repayments….

Subsection 212.3(13)

Administrative Policy

26 May 2016 IFA Roundtable Q. 11, 2016-0642031C6 - PLOI late-filed penalties

aggregating A/R debits for penalty purposes under review

Where a corporation resident in Canada wishes to make PLOI elections respecting intercompany balances resulting from hundreds of intercompany sales, CRA considers that “each intercompany transaction resulting in a receivable… should be treated as a unique amount of indebtedness,” so that the $100 per month late filing penalty must be calculated separately with respect to each such receivable. However, “the possibility of providing administrative relief in this regard is currently under review,” e.g., “aggregat[ing] certain amounts receivable… on an annual, quarterly, or monthly basis.”

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 15 - Subsection 15(2.13) potential administrative relief on computing late-filed PLOI election penalties on a debit-by-debit basis 232

Subsection 212.3(14) - Rules for paragraph (10)(f)

Paragraph 212.3(14)(a)

Articles

Brett Anderson, Daryl Maduke, "Practical Implementation Issues Arising from the Foreign Affiliate Dumping Rules", 2014 Conference Report, (Canadian Tax Foundation), 19:1-49

Example of "hollowing out" transaction: subsequent sale of good assets by subject corp. (p. 10)

The explanatory notes issued by Finance with respect to paragraph 212.3(14)(a) specifically indicate that paragraph 212.3(14)(a) is intended to prevent both pre-acquisition "stuffing" of a Canco and post-acquisition "hollowing-out" of a Canco….

[T]he CRIC acquires all of the shares of Canco for a total purchase price of $100. At the acquisition time, Canco owns shares of its wholly-owned foreign affiliate (Subject Corp.) which have a FMV of $50 as well as the IP associated with Canco's operating business ("Canco's IP") which, also has a FMV of $50….[A] series of transactions is carried out to move Canco's IP offshore following which Canco's only assets are shares of Subject Corp….

[C]anco's Bad Assets to Total Assets ratio at the acquisition time is 50% (less than 75%). However, Canco's Bad Assets to Total Assets ratio after the transfer of Canco's IP to IPCo is 100% (greater than 75%). Therefore, if the transfer of Canco's IP is part of the series, paragraph 212.3(14)(a) should apply to deem Canco's Bad Assets to Total Assets ratio at the acquisition time to be greater than 75% and, as a result, CRIC has made an investment in Subject Corp. at the acquisition time for the purposes of the FAD rules.

Second example: collection by 10(f) corp of trade receivable (p. 11)

[T]he CRIC acquires all of the shares of Canco from arm's length parties for a total purchase price of $100. At the acquisition time Canco owns shares of its foreign affiliate (Subject Corp.), business assets, and trade receivables which have an aggregate FMV of $80, $20, and $10 respectively. … Canco has a $10 trade payable to Subject Corp. at the acquisition time for goods previously purchased from Subject Corp. and used in Canco's active business. Shortly after the acquisition Canco collects its accounts receivable from its third party customers and uses the funds to repay its accounts payable to Subject Corp.

In this situation, Canco's Bad Assets to Total Assets ratio at the acquisition time is 72.7% (less than 75%). However, Canco's Bad Assets to Total Assets ratio after Canco repays its indebtedness to Subject Corp. is 80% [fn 33: Bad Assets = ($80 Investment in Subject Corp.) over Total Assets = $100 ($20 in business assets + $80 investment in Subject Corp.) = $80] (greater than 75%). Whether paragraph 212.3(14)(a) applies to deem Canco's Bad Assets to Total Assets ratio at the acquisition time to be greater than 75% (and, as a result, deems CRIC to have made an investment in Subject Corp. at the acquisition time for the purposes of the FAD rules) may rest on whether the repayment by Canco of its indebtedness to Subject Corp. is considered to occur as part of the series of or events that includes the acquisition and a disposition of property described in subparagraph 212.3(14)(a)(i).

Subsection 212.3(15) - Control

Commentary

S. 212.3(15) alters the usual rules for determining control, for the purposes of s. 212.3 and for purposes of the corporate immigration rule in s. 128(1)(c.3).

S. 212.3(15)(a)(i)

The normal rule is that "control" (as judicially interpreted) includes indirect control so that, for example, a "grandparent" corporation controls a "child" corporation. Conversely, under s. 256(6.1)(a), a corporation is considered to be controlled by its parent notwithstanding that ultimate control rests with the grandparent. Draft s. 212.3(15)(a)(i) departs from these (multiple control) rules by providing that a CRIC that is controlled by more than one non-resident corporation is deemed not to be controlled by any such corporation that controls another non-resident corporation that controls the CRIC – unless the application of this deeming rule would result in the CRIC not being controlled by any non-resident corporation. In other words, the CRIC generally is deemed to be controlled only by the immediately-controlling non-resident corporation.

The Department of Finance Explanatory Notes respecting the current version of draft s. 212.3(15)(a)(i) state that it is a relieving provision:

It is intended to prevent multiple dividends from being deemed under subsection 212.3(2) or paragraph 128(1)(c.3). Multiple dividends could otherwise arise under subsection 212.3(2) due to the fact that paragraph 212.3(2)(a) deems the CRIC to have paid a dividend to the "parent", which is defined in paragraph 212.3(1)(b) to mean any non-resident corporation that controls the CRIC at the time of the investment. Consequently, in the absence of paragraph 212.3(15)(a), where more than one non-resident corporation controls the CRIC (for example where a non-resident public company owns another non-resident corporation that, in turn, owns the CRIC), paragraph 212.3(2)(a) could deem a separate dividend to have been paid to each such non-resident.

As noted, draft s. 212.3(15)(a)(i) applies unless its application would result in the CRIC not being controlled by at least one non-resident corporation. The Department of Finance Explanatory Notes state that:

This exclusion addresses situations where corporate groups organize themselves so that all non-resident "controllers" control each other.

In most jurisdictions, this exclusion would be fanciful in light of prohibitions against corporate incest.

Example 15-A (corporate incest)

NR2 (a non-resident corporation) holds all the voting common shares of NR1, another non-resident corporation which, in turn, holds all the shares of CRIC. However, NR1, in turn, controls NR2 by virtue of holding special voting shares with more votes than the common shares in the capital of NR2.

In the absence of the noted exclusion, s. 212.3(15)(a)(i) would deem both NR1 and NR2 to not control CRIC because each of them controls another non-resident corporation (being the other NR corporation) which controls CRIC. Accordingly, both NR1 and NR2 continue to be "parents" of CRIC, so that both would potentially be deemed by s. 212.3(2) to receive a dividend from CRIC based on an investment made by it.

The draft s. 212.3(15)(a)(i) rule, that control of a CRIC does not include control by an upper-tier parent, means that a transfer of the CRIC to that indirect parent can result in a second application of the foreign affiliate dumping rules.

Example 15-B (Transfer of CRIC to indirect parent as part of series)

Parent 1 (a non-resident) controls Parent 2 (also non-resident), which subscribes for shares of newly-incorporated CRIC for $100, which acquires shares of FA for $100. As part of the same series of transactions, Parent 2 distributes its shares of CRIC to Parent 1 as a dividend.

S. 212.3(2) deems the $100 investment to give rise to the deemed payment of a $100 dividend by CRIC to its parent (subject to s. 212.3(7) instead applying to reduce the paid-up capital of its shares). Parent 2 clearly is a "parent" for these purposes. Parent 1 is deemed by draft s. 212.3(15)(a)(i) not to control CRIC at the time of the investment. However, Parent 1 also qualifies as a "parent" under the definition of that term in s. 212.3(1) as it acquires control of CRIC as part of the same series of transactions and ("through" Parent 2) had a greater than 25% interest in CRIC at the investment time. Accordingly, it could be considered that s. 212.3(2) also applies in relation to Parent 1, so that it deems CRIC to pay a $100 dividend to Parent 1 at the investment time.

S. 212.3(15)(a)(ii)

S. 212.3(15)(a)(ii) applies where a CRIC is controlled by a non-resident corporation, and the non-resident corporation is ultimately controlled by a Canadian-resident corporation i.e., it is indirectly controlled by that Canadian-resident corporation, which is not, in turn, controlled by any non-resident person. In these circumstances, the CRIC is deemed not to be controlled by a non-resident. Accordingly, the preconditions in s. 212.3(1) for the application of the foreign affiliate dumping rules will not apply to an investment by the CRIC.

The s. 212.3(15)(a)(ii) rule likely only applies where there is ultimate control by a single Canadian-resident corporation (and, conversely, it would appear that a Canadian corporation can qualify as the ultimate controller for purposes of s. 212.3(15)(a)(ii) even if it, in turn, is controlled by a group of non-resident corporations or other non-resident persons). Furthermore, as s. 212.3(1)(a)(ii) provides that the s. 212.3 rules can be engaged where a CRIC becomes controlled by a non-resident corporation as part of the same series of transactions, it may not be sufficient to satisfy the test in s. 212.3(15)(a)(ii) at the time of investment by the CRIC.

Example 15-C (dilution of control of ultimate Canadian controller)

The shareholders of a non-resident corporation (Parent) consist of two Canadian-resident corporations owned by two brothers (CanHoldco1 and CanHoldco2) holding 51% and 10% of its shares, respectively, and various members of the (mostly non-resident) public. Parent incorporates a Canadian-resident corporation (Buyco), which acquires all the shares of Canco (whose only asset is a non-resident subsidiary) in consideration for an obligation of Buyco to cause the issuance of shares of Parent to the public shareholders of Canco. Such issuance of Parent shares reduces the aggregate shareholding of CanHoldco1 and 2 in Parent to 51%.

As Parent will cease to be controlled by CanHoldco1 as part of the same series of transactions (and the control thereafter of Parent by two Canadian-resident corporations (CanHoldco1 and2), which may constitute a group of persons, is not relevant for purposes of s. 212.3(15)(a)(ii), Buyco will be deemed by s. 212.3(10)(f) to have made an investment in Canco's non-resident subsidiary for purposes of the s. 212.3 rules.

S. 212.3(15)(b)

Draft s. 212.3(15)(b) applies for purposes of s. 212.3 (and s. 128.1(1))(c.3)) where at any time a corporation is not, in the absence of s. 212.3(15), controlled by any non-resident corporation, and a related group (as defined in s. 251(4)), each member of which is a non-resident corporation, "is in a position" to control the corporation. Where draft s. 212.3(15)(b) applies, it deems the corporation to be controlled at that time by the member of the group that has the greatest direct equity percentage (within the meaning of s. 95(4)) in the corporation at that time, or if no member of the group has a direct equity percentage in the corporation that is greater than that of every other member, the member determined by the corporation or, if the corporation does not make a determination, by the Minister of National Revenue.

The related Explanatory Notes of the Department of Finance state that draft s. 212.3(15)(b):

ensures that subsection 212.3(2) cannot be avoided where a corporation is held through a related group of non-resident holding companies, no one member of which owns shares having more than 50% of the votes in respect of the corporation.

Although the Explanatory Notes do not discuss this point, draft s. 212.3(15)(b) presumably refers to the related group being "in a position" to control the corporation, rather than simply controlling it, having regard to the possibility that there might be contingent acquisition rights referred to in s. 251(5)(b).

Articles

Ian Bradley, "Living with the Foreign Affiliate Dumping Rules", Canadian Tax Journal (2013) 61:4, 1147-66.

Deemed control acquisition on acquisition by indirect controller (p. 1154)

…For Example, one non-resident corporation ("NR 1") owns another non-resident corporation ("NR 2"), which owns a CRIC….

The CRIC makes an investment in a foreign affiliate. As part of the same series of transactions, the CRIC's shares are transferred up the ownership chain, from NR 2 to NR 1. When NR 1 acquires the CRIC shares, it becomes the CRIC's direct parent company, and paragraph 212.3(15)(a) no longer applies. The CRIC is controlled by NR 2 at the investment time, and becomes controlled by NR 1 as part of the series that includes the investment. The FA dumping rules could therefore apply twice to the same investment, once from the perspective of NR 1 and once from the perspective of NR 2.

Subsection 212.3(16) - Exception — more closely connected business activities

Paragraph 212.3(16)(a)

Commentary

S. 212.3(16) provides an exception from the application of the foreign affiliate dumping rules to an investment by a CRIC in a subject corporation where that investment is closely connected to the business of the CRIC, as that concept is narrowly defined in ss. 212.3(16)(a) to (c). The Explanatory Notes of the Department of Finance state:

This exception generally recognizes that certain foreign affiliate investments made by foreign-controlled CRICs may have been made by the CRIC even if the CRIC had not been foreign-controlled. The exception is intended to allow a Canadian subsidiary of a foreign multinational corporation to invest in foreign affiliates in certain circumstances where the Canadian subsidiary is making a strategic acquisition of a business that is more closely connected to its business than to that of any non-resident member of the multinational group.

In order for the exception to be available, the CRIC must demonstrate the satisfaction of five conditions – three of them in s. 212.3(16)(c), and a further two in s. 212.3(16)(a) and (b). (A sixth condition, if you will, contained in the preamble to 212.3(16), is that the investment must not be in shares, other than fully participating shares as described in s. 212.3(19), of a subject corporation which is not wholly owned.

The first condition stipulated by s. 212.3(16)(a) is that the business activities carried on by the subject corporation, and any corporation (a "subject subsidiary corporation") in which the subject corporation has an "equity percentage" (defined in s. 95(4)), must collectively be 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 at the investment time) in Canada than to those of any other non-resident corporation that does not deal at arm's length with the CRIC (other than the subject corporation, a subject subsidiary corporation and any corporation that is a controlled foreign affiliate of the CRIC for the purposes of s. 17).

The Explanatory Notes comment on this concept of a more closely connected business activity:

For these purposes, "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.

The concept of "connectedness" is not defined, but for the purposes of these rules it is intended that the business activities of two corporations be considered "connected" in either of two circumstances. First, business activities can be considered connected where they are similar in nature or "parallel". For example, two businesses could be closely connected where they both involve the manufacture and distribution of similar types of products, or the provision of similar services. Second, business activities can be considered connected where they are integrated, in the sense of one corporation's business being "upstream" or "downstream" to the business of the other corporation, or in the sense of one business using technology of the other in its operations. Thus, for example, two corporations could be considered to have connected business activities if the primary activity of one corporation consists of selling the output of, or providing inputs to, the manufacturing process of the other corporation. In each case, the question is whether the businesses are connected in a manner indicative of the investment in the subject corporation being a logical expansion of the CRIC's business.

In order for the condition in paragraph 212.3(16)(a) to be satisfied, it is not sufficient that the CRIC's and the subject corporation's businesses be connected or even closely connected – the businesses must be more closely connected to one another than the subject corporation's business is to the business of any other non-resident corporate group member (other than the subject corporation, a subject subsidiary corporation or a CFA). Thus, this condition would not be met where, for example, the subject corporation's business is equally closely connected to that of the CRIC as it is to that of another non-resident group member (other than a subject subsidiary corporation or a CFA). 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.

The closely-connected-business-activity test described above must be satisfied at the investment time. In addition, the business activities of the subject corporation and subject subsidiary corporations also must be "expected to remain, on a collective basis" more closely connected to the business activities of the CRIC and Canadian-resident corporations with which it does not deal at arm's length than to the business activities of the specified non-resident corporations. The Explanatory Notes express this as a requirement "that the parties have an expectation, at the time of the investment, that the closer business connection… will continue for the foreseeable future," and state that "this requirement acts as a check to ensure that the connection to Canada is not temporary or contrived."

The Explanatory Notes provide the following example:

Example 1 – foreign-controlled Canadian manufacturer

If commercial aircraft are manufactured by the CRIC and its non-resident parent company, the closer business connection condition in paragraph 212.3(16)(a) would not likely be met if the CRIC were to purchase a non-resident corporation that is a competing commercial aircraft manufacturer. In that case, the business activities of the acquired company would likely be no more closely connected to those of the CRIC than to those of the non-resident parent.

If, however, the CRIC were the only company in the multinational group that manufactures military aircraft, then the closer business connection condition in paragraph 212.3(16)(a) may well be satisfied were the CRIC to purchase a non-resident corporation that was a competing military aircraft manufacturer.

Administrative Policy

6 September 2013 External T.I. 2013-0474671E5 - "more closely connected business activities"

Canco, which carries on a Canadian active business and is a wholy-owned subsidiary of NR Parent, subscribes for shares of US Holdco (a wholly-owned US subsidiary) which, in turn, has as its only asset US Opco, which is a US corporation carrying on similar business activities to those of Canco since at least March 30, 2012. For the purposes of the "more closely connected business activities" test in s. 212.3(16)(a), must the subject corporation (US Holdco) itself also carry on active business activities similar to those of Canco?

In finding that this was not necessary, as s. 212.3(16)(a) established a collective test, CRA stated:

[T]he simple holding of shares by a holding company such as ... of US Opco by US Holdco…is not a business activity and would therefore be ignored for the purposes of this test. Accordingly, the collective business activities of US Holdco and US Opco would be comprised only of those carried on by US Opco. Since those business activities ... were at the investment time and were expected to remain, more closely connected to the business activities carried on in Canada by the CRIC than to any business activities carried on by any non-resident corporation with which the CRIC does not deal at arm's length, the first condition in paragraph 212.3(16)(a) ... would be met.

23 May 2013 IFA Round Table Q. 6(d)

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 Parent's group, is there a threshold that would be relevant in determining whether the its business is more closely connected to the CRIC's (e.g., its revenues are derived 51% from distributing CRIC's products - and is data required re all other group members?

Response

CRA has no firm guidelines, but would consider the Explanatory Notes statement of intention that the exception 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...." CRA also 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 s. 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 s. 17.

Articles

Paragraph 212.3(16)(b)

Commentary

Ss. 212.3(16)(a) to (c) specify conditions which must all be satisfied in order for s. 212.3(16) to provide an exception from the application of the foreign affiliate dumping rules to an investment by a CRIC in a subject corporation.

The condition specified in s. 212.3(16)(b) is that officers of the CRIC (or, under draft amendments, of a corporation resident in Canada with which it did not deal at arm's length) must have had and exercised the principal decision-making authority in respect of the making of the investment and a majority of those officers must be persons that are resident, and work principally, in Canada or the residence country of a "connected affiliate" at the time the investment is made. A "connected affiliate" is defined in s. 212.3(16)(b) to mean a corporation that is a controlled foreign affiliate (as defined for purposes of s. 17) whose business activities are, and are expected to remain, at least as closely connected to those of the subject corporation and subject subsidiary corporations as are the Canadian business activities of the CRIC or any Canadian-resident corporation that does not deal at arm's length with the CRIC.

For these purposes, s. 212.3(17) provides that any person that is an officer of the CRIC and of a non-resident corporation that does not deal at arm's length with the CRIC (other than the subject corporation, a subject subsidiary corporation or a connected affiliate) is deemed to not be resident, and to not work principally, in a country in which a connected affiliate is resident.

The Explanatory Notes state that where the condition in s. 212.3(16)(b) – that the relevant officers have the principal decision-making authority and actually exercise such authority - is satisfied:

[T]he CRIC would be, in this respect, acting in a manner similar to a Canadian (non-foreign controlled) multinational corporation undertaking a strategic foreign expansion of its business.

Respecting the exercise of principal decision-making, the Explanatory Notes state:

The reference in paragraph 212.3(16)(b) to "principal" decision-making authority is intended to ensure that this condition will be met only where substantive responsibility for the decision to make the investment, and with respect to the terms of the investment, rests with and is exercised by relevant officers of the CRIC. Where the CRIC's officers have and exercise only formal authority to approve the investment, but the real decision-making authority with respect to the making of the investment resides with officers of a non-resident corporation, then this condition will not be met. Similarly, where the formal decision-making authority with respect to an investment in a foreign affiliate made by a CRIC is exercised by officers or directors of the non-resident parent of the CRIC, the condition could still be met if, for example, the substantive business decisions with respect to the investment are made by the relevant officers of the CRIC, based on their execution of the business plan of the CRIC and having undertaken or managed all of the commercial and investment due diligence relating to the acquisition or investment in the subject corporation.

The definition of "officer" in s. 248(1) includes a corporate director. Responsibility for the central management and control of a corporation rests with its board of directors except where its responsibilities have been delegated under a unanimous shareholders' agreement. The fact that a board will most often accept the recommendations of senior management does not detract from its authority and responsibility for major corporate decisions. Although boards of wholly-owned Canadian subsidiaries may in fact "rubber stamp" decisions that have been made elsewhere (i.e., not truly exercise the authority which in theory they have), on closer analysis it often will emerge that the decision which is being rubber stamped is one for which a non-resident board took responsibility. On the other hand, the boards of foreign controlled Canadian corporations with minority public shareholders generally will exercise their fiduciary responsibilities with significant care. It may follow from this that, at least where there is a working board, the officers referred to s. s. 212.3(16)(b) are directors rather than officers in the ordinary sense of the word. If this is correct, it may ease the task of demonstrating compliance with s. 212.3(16)(b), as directors' meetings generally are better documented than the deliberations of management.

Where there is a delegation of authority under a unanimous shareholders' agreement to a shareholder, the ultimate decision-making authority for that shareholder should also reside in its board.

The Explanatory Notes further state that officers will be considered to work principally in Canada, or in the residence country of a connected affiliate:

if they spend the majority of their working time in Canada or the connected affiliate's country, and also carry out a majority of their important functions, and make most of their important decisions, with respect to the CRIC in that country.

Articles

Peter Lee, Paul Stepak, "PE Investments in Canadian Companies", draft 2017 CTF Annual Conference paper

Scope of requirement for exercise of principal decision-making authority under more closely connected business (MCCB) activities exception (p.19)

[T]here is nothing in the overall scheme of the FAD rules to support the view that the MCCB exception should be read so narrowly as to be virtually meaningless in all but the most extreme, and commercially impractical, of factual circumstances….

[N]o one would be surprised to find that day-to-day operational decisions, including investments for FAD purposes, are made by company management. However, in this context transactions such as add-on acquisitions or refinancings, are a bit different. The key skills and value-add that a PE sponsor brings to the table are transactional: such as negotiating a purchase agreement or a credit facility, or understanding the broader market, and so it is in the best interest of the Canadian company's business that the sponsor be involved in those types of transactions. But that may blur the principal decision-making line. It is unfortunate that utilizing those resources might increase the risk of an adverse FAD result.

Paragraph 212.3(16)(c)

Commentary

Ss. 212.3(16)(a), 212.3(16) (b), 212.3(16) (c)(i), 212.3(16) (c)(ii) and 212.3(16)(c)(iii) specify five conditions which must all be satisfied in order for s. 212.3(16) to provide an exception from the application of the foreign affiliate dumping rules to an investment by a CRIC in a subject corporation.

The conditions in ss. 212.3(16)(c)(i) and (ii) are similar to those in s. 212.3(16)(b), except that they have a prospective orientation (expressed in the Explanatory Notes of the Department of Finance as including "all times following the time of the investment." At the time the investment is made, it must be reasonably expected that officers of the CRIC (or, under draft amendments, of a corporation resident in Canada with which it does not deal at arm's length) will have and exercise the ongoing principal decision-making authority in respect of the investment and that a majority of those officers will be persons that are residents of, and work principally in, Canada or the residence country of a connected affiliate. The Explanatory Notes state:

The particular matters over which [the relevant officers] would be expected to hold and exercise such authority would generally depend on the relative size and nature of the CRIC's investment in the subject corporation. For example, where the CRIC owns a controlling interest in the subject corporation, the range of matters in respect of the subject corporation over which the CRIC's officers can be expected to exercise principal decision-making authority will be greater than where the CRIC does not own a controlling interest in the subject corporation.

As essentially discussed above in relation to s. 212.3(16)(b), s. 212.3(16)(c)(i) would appear to be satisfied if it is reasonably expected that the board of directors of the CRIC will be a working board which will exercise its responsibility to make major decisions respecting the investment in the subject corporation.

S. 212.3(16)(c)(iii) requires that, at the investment time, it is reasonably expected that the performance evaluation and compensation of the relevant officers of) 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 relevant officers for these purposes are officers of the CRIC (who are resident, and work principally, in Canada or in the residence country of a connected affiliate, or ( under draft amendments) of a corporation resident in Canada with which the CRIC does not deal at arm's length. The Explanatory Notes state:

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. 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. …

The extent to which the operating results of the subject corporation affect the performance evaluation and compensation of an officer would depend on the relative size and complexity of the subject corporation's operations and the level of responsibility the officer has over those operations. Where the CRIC acquires control of the subject corporation in circumstances where the investment in the subject corporation constitutes a strategic expansion of the CRIC's business, it is expected that the relevant officers of the CRIC 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. The same expectation exists where the CRIC does not have or acquire control of the subject corporation but the subject corporation is controlled by the multinational group of which the CRIC is a member.

The Explanatory Notes also provide the following example:

Example 2 – foreign-based private equity fund

If a foreign-based private equity ("PE") fund acquired a Canadian operating company (the "CRIC"), the PE fund is managed by its foreign-based general partner ("GP"), the CRIC is controlled by the GP, the CRIC is a portfolio company of the PE fund (i.e., the CRIC is the parent of a group of companies all of which carry on a particular type of business and is the entity that would be sold or taken public), and the CRIC either owns foreign affiliates that require funding or expands internationally through the acquisition of foreign affiliates, the exception may be available with respect to investments in foreign affiliates made by the CRIC. In these circumstances, it may be reasonable to expect that the business of any foreign affiliate in which the CRIC makes an investment would be more closely connected to the CRIC than to any business carried on by the GP or any other portfolio company in the group. In addition, provided the CRIC had stand-alone executive management whose performance and compensation was determined exclusively by reference to the performance of the multinational group of which the CRIC was the parent, then it would also be reasonable to expect that the decision making elements of the exception would be satisfied. In particular, the nature of the oversight exercised by the GP would not normally be considered to displace the decision making authority of the officers of the CRIC for purposes of this exception. This reflects the normal role of a GP as an owner (and manager of portfolio companies), separate and distinct from the governance and management of the CRIC.

If, however, the PE fund also owned, for example, a non-resident corporation in a business similar to the CRIC and if the CRIC was operationally a part of a group that included such non-resident corporation (whether or not the CRIC was a subsidiary of the non-resident corporation), in applying this exception, regard must be given to whether the business activities of any foreign affiliates of the CRIC, in which the CRIC makes an investment, are more closely connected to the CRIC than to the non-resident corporation and to whether any officers of such non-resident corporation exercised decision making control over the CRIC. If the business activities of the foreign affiliates in which the CRIC made investments were as or more closely connected with the non-resident corporation, or officers of the non-resident corporation in effect controlled the decision making of the CRIC, this exception would not apply.

The above example refers to the management of the CRIC being evaluated and compensated based on the "performance" of the multinational group controlled by the CRIC, without indicating that such evaluation and compensation is a "numbers driven" exercise. This may indicate that this test could be satisfied where performance is evaluated on a qualitative basis – and that it may be satisfied where the subject corporation looms larger in a qualitative assessment of the relevant officers of the CRIC (or of a corporation resident in Canada with which it did not deal at arm's length) than in a qualitative assessment of officers of the relevant non-resident corporations.

Subsection 212.3(17) - Dual officers

Commentary

S. 212.3(17) is ancillary to the tests in ss. 212.3(16)(b) and (c), which require a majority of the officers of a CRIC - or (under draft amendments) of a corporation resident in Canada with which it did not deal at arm's length - who had and exercised principal-decision-making authority respecting the investment in a subject corporation, to be resident and working principally either in Canada or in the country of residence of a connected affiliate (as defined in s. 212.3(16)(b)(ii)). In particular, s. 212.3(17) excludes for such purposes any officer of a non-resident corporation with which the CRIC, at the investment time, does not deal at arm's length (other than the subject corporation, a subject subsidiary corporation or a connected affiliate). Accordingly, such a dual-office person does not count towards satisfying the majority test in s. 212.3(16)(b) or (c)(ii).

The fact that an affiliated non-resident corporation does not qualify as a subject subsidiary corporation or as a connected affiliate does not establish that it has any influence over decisions made by the CRIC. Nonetheless, an officer of the CRIC who serves as a director or other officer of such a non-resident corporation will not be counted towards satisfaction of the majority test.

Subsection 212.3(18) - Exception — corporate reorganizations

Articles

Joint Committee, "Technical Amendments Package of September 16, 2016", Submission letter of 15 November 2016

Effect on look-through rule interpretation

The addition of s. 212.3(18)(b)(viii) may imply that a broader range of transfers are not capable of coming within the s. 212.3(25) partnership look-through rules. The requirement that s. 97(2) apply should be removed.

Paragraph 212.3(18)(a)

Commentary

S. 212.3(18) of the Act provides exceptions from the application of the foreign affiliate dumping rules in s. 212.3 for various forms of corporate reorganization transactions. The Explanatory Notes of the Department of Finance state:

The underlying premise for these exceptions is that if no incremental value is being transferred from a CRIC to a subject corporation, subsection 212.3(2) should not apply.

S. 212.3(18)(a)(i)

S. 212.3(18)(a)(i) provides that s. 212.3(2) (including, by implication, the paid-up capital grind rule in s. 212.3(7)) does not apply to an acquisition of shares of a subject corporation by a CRIC from another corporation resident in Canada to which the CRIC was related (otherwise than by virtue of an option right or other right described in s. 251(5)(b)) immediately before such acquisition provided that the two companies did not deal at arm's length at any time during the series of transactions or

events which included the making of the investment, other than the portion of that period which was on or after the investment time. The Explanatory Notes of the Department of Finance state that this provision

is intended to cover, among other things, situations where foreign affiliate shares are transferred by a Canadian corporation on a winding up into its Canadian-resident parent (subject to the arm's length/series test).

As noted above, the exemption in s. 212.3(18)(a)(i) for transfers of subject corporation shares between related Canadian corporations does not apply where the transferor dealt at arm's length with the transferee at any time during the series of transactions that included the investment in the subject corporation. It is not clear whether this exclusion operates where a "Buyco" subsidiary of the CRIC acquires an arm's length target and amalgamates with it, and the amalgamated corporation then distributes shares of a foreign affiliate (formerly held by the target) to the CRIC. Given that the amalgamated corporation is deemed by s. 212.3(22)(a) to be a continuation of the target, this could be viewed as the equivalent of a transfer of such shares to the CRIC by the target - which dealt at arm's length with CRIC at a time which quite arguably was part of the series of transactions which included such distribution (viewed as an investment by CRIC in the subject corporation) – so that this exclusion from the exemption in s. 212.3(18)(a)(i) would apply.

This issue is proposed in the comfort letter summarized below to be addressed by draft amendments, whose scope is not specified.

A point also to be addressed by that comfort letter is that s. 212.3(18) does not exempt transfers of FA debt between related Canadian corporations

The exemption in s. 212.3(18)(a)(i) will be available even if the transferor and transferee Canadian corporation will commence to deal with each other at arm's length as part of the same series of transactions.

Example 18a-A (related corporations becoming arm's length on butterfly)

As part of a butterfly split-up of the Canadian subsidiary (DC) of a non-resident parent (Forco2), DC transfers shares of non-resident subsidiaries to a Canadian subsidiary (TC) of the non-resident parent of Forco2 (Forco1). Given that DC and TC were related corporations at all times up to the time of this transfer, the exemption in s. 212.3(18)(a)(i) is available, notwithstanding that as part of the same series of transactions, Forco2 will be spun out to the public shareholders of Forco1, so that DC and TC will commence to deal with each other at arm's length.

See summary of 2012 Ruling 2011-0431101R3 under s. 55(1) - distribution.

S. 212.3(18)(a)(ii)

S. 212.3(18)(a)(ii) provides that s. 212.3 does not apply to an acquisition of shares of a subject corporation by a CRIC on an amalgamation described in s. 87(1) of two or more corporations to form the CRIC, if

(i) the amalgamating corporations were related (otherwise than by virtue of an option right or other right described in s. 251(5)(b)) immediately before such acquisition (s. 212.3(18)(a)(ii)(A)), and

(ii) none of the amalgamating corporations dealt at arm's length (determined without reference to s. 251(5)(b)) with any other amalgamating corporation at any time during the series of transactions or events which included the making of the investment, other than the portion of that period which was on or after the investment time (s. 212.3(18)(a)(ii)(B)).

Therefore, a qualifying amalgamation of subsidiaries of a non-resident parent does not trigger an application of a s. 212.3(2) dividend, or a PUC suppression under s. 212.3(7), even where one (or more) of the amalgamating corporations is substantially invested in non-resident subsidiaries, and the shares of another of the amalgamating corporations has substantial paid-up capital (subject to the discussion further below of the indirect investment rule).

Example 18a-B (amalgamation squeeze-out - discussed by Angelo Nikolakakis at 2013 IFA Conference)

Parent incorporates a Canadian subsidiary (Buyco) to make a bid for all the shares of Canco (a Canadian public company), whose only asset is shares of FA with a fair market value of $100. 70% of the Canco shareholders tender, and Parent subscribes $70 for shares of Buyco in order that Buyco can take up the tendered shares.

In order to acquire the remaining 30% of the Canco shares, Buyco incorporates Subco and capitalizes it with $30 of share capital, which is funded in turn by a share subscription by Parent for Buyco shares. Canco and Subco amalgamate, and the preference shares of Amalco received by the minority shareholders on the amalgamation are redeemed for $30.

Consequences:

The purchase of 70% of the shares of Canco by Buyco is treated under s. 212.3(10)(f) as a $70 investment by Buyco (viewed as a CRIC) in the shares of FA. Accordingly, the PUC of the share investment of Parent in Buyco is ground under s. 212.3(7) to nil.

The $30 share investment in Buyco by Parent (and in Subco by Buyco) has a PUC of $30. In the absence of s. 212.3(18)(a)(ii), the amalgamation of Subco and Canco would be considered to entail an acquisition of all the shares of FA by Amalco, which is deemed by s. 87(2)(a) to be a new corporation for purposes of the Act (including likely the s. 212.3 rules). However, s. 212.3(18)(a)(ii) deems there to be no investment. (Similarly, s. 212.3(18)(c)(i) clarifies that Buyco is not considered to have made an indirect $30 investment in FA.)

Accordingly, the $30 PUC of Parent's share investment in Buyco is not suppressed under s. 212.3(7).

A similar rule for s. 87(1) amalgamations otherwise resulting in an indirect acquisition under the s. 212.3(10)(f) rule is contained in s. 212.3(18)(c)(i); and a comparable rule for foreign mergers under s. 87(1) is contained in s. 212.3(22)(a).

As with other rules in s. 212.3(18), the rule in s. 212.3(18)(a)(ii) only provides some relief with respect to a share investment of an amalgamating corporation. Accordingly, where an amalgamating corporation holds debt of a subject corporation, the effect may be to force the amalgamated corporation to elect under s. 212.3(11) for that debt to be a pertinent loan or indebtedness (where that election is available).

Administrative Policy

28 May 2015 IFA Roundtable Q. 10, 2015-0581641C6 - IFA 2015 Q.10: 111(4)(e) election and 212.3

deemed investment under s. 111(4)(e)

Following the acquisition of control of the non-resident parent of a CRIC, the CRIC made a s. 111(4)(e) designation respecting its 100% shareholding of its FA. Before going on to find that the resulting deemed dividend under 212.3(2)(a) would be nil, CRA stated:

[T]he subparagraph 111(4)(e)(ii) deemed reacquisition of the FA shares by the… CRIC would constitute an "investment in a subject corporation made by a CRIC" as described in paragraph 212.3(10)(a) and would not be an investment described in paragraph 212.3(18)(a) given that the CRIC would not be related to itself. …

See summary under s. 212.3(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(10) - Paragraph 212.3(10)(a) deemed investment under s. 111(4)(e) 97
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(2) no transfer of property on deemed s. 111(4)(e) acquisition 147

Articles

Philip Halvorson, Dalia Hamdy, "An Overview of the Foreign Affiliate Dumping Rules", (OBA article), 23 February 2016

Purpose of s. 212.3(18) exceptions (p. 9)

[T]hese exceptions are generally intended to prevent the application of the FAD rules when there is no new investment in a foreign affiliate. In other words, if a particular corporation has already run the gauntlet by making an investment in a subject corporation that might otherwise trigger the FAD Rules, reorganizing the affairs of the particular corporation, or a related Canadian group, ought not, in policy terms, trigger the FAD rules again.

Supplemented by anti-stuffing rules (p. 9)

Paragraph 212.3(18)(a) applies if the investment is an acquisition of shares or a debt obligation of a subject corporation, and is either (i) acquired from an non-arm's length corporation resident in Canada or (ii) on an amalgamation described in subsection 87(1) of two or more corporations to form the CRIC if all of the predecessor corporations to the amalgamations are related. These rules are also subject to certain "anti-stuffing" provisions requiring additional rules around timing and "relatedness" of the CRIC, the disposing corporation/predecessor corporations and the non-resident parent which are generally designed against backing into these exceptions via what is in essence a new investment from third party vendors, which must be carefully considered.

Finance

9 July 2013 Comfort Letter addressed to Brian Bloom of Davies Ward Philips & Vineberg LLP:

  • A non-resident corporation ("Foreign Parent"), which was controlled by a non-resident limited partnership (the "Fund") controlled in turn a corporation resident in Canada ("CRIC"), which in turn held all the shares of the capital stock of a subsidiary corporation resident in Canada ("Acquire Co"). CRIC capitalized Acquire Co with a combination of interest-bearing debt and equity, in order for Acquire Co to acquire all of the shares of a Canadian-resident publicly traded corporation ("Target") from arm's length vendors.
  • At the time of acquisition, the assets of Target consisted of Canadian business assets, other than shares and debt (the "FA Shares" and "FA Debt") of a wholly-owned US-resident foreign affiliate ("FA"); (ii) a debt obligation owed to it by FA the "FA Debt"); the fair market value of each of the FA Shares and FA Debt was less that 10% of the value of all Target property, so that s. 212.3(10)(f) did not apply to Acquire Co's acquisition of the Target shares.
  • Acquire Co and Target amalgamated (as per s. 87(11)) to form "Amalco".
  • Amalco subsequently transferred (1) the FA Shares to CRIC in consideration for the repurchase by Amalco of shares of its capital stock held by CRIC, and (2) the FA Debt to CRIC as a repayment of a portion of amounts owed by Amalco to CRIC.

Respecting both issues raised below, Finance indicated that it would recommend that the legislation be amended so that s. 212.3(2) would not apply in the specific context of these transactions.

Respecting the concern that the acquisition by CRIC of the FA Shares from Amalco (viewed under s. 212.3(22) as a continuation of Target) may not satisfy the 212.3(18)(a) exception given (having regard to the condition in s. 212.3(18)(a)(i)(B)) that Target previously dealt at arm's length with CRIC, Finance stated that the s. 212.3(18)(a)(i)(B) condition:

…prevents the application of the exception in paragraph 212.3(18)(a) to a transfer of shares of a foreign affiliate between two related Canadian resident corporations, where one of the corporations was acquired by the corporate group prior to, and as part of a series that includes, the transfer. While the condition in clause 212.3(18)(a)(i)(B) may not be met in the scenario you have described in your letter, we agree that it would be an inappropriate result for subsection 212.3(2) to apply to the acquisition by CRIC of the FA Shares….

Respecting a submission that the acquisition by CRIC of the FA Debt as a partial repayment of debt should be excluded from the application of s. 212.3(2), Finance stated:

[W]e agree that the internal transfer of the FA Debt between Amalco and CRIC, which are both members of a related Canadian corporate group, does not, in and of itself result in a "new" investment in a subject corporation by the Canadian corporate group. We are prepared to recommend… that the legislation be amended in a manner such that proposed subsection 212.3(2) would not apply in the specific context of these transactions.

Subparagraph 212.3(18)(a)(i)

Articles

Dean Kraus, John O’Connor, "Foreign Affiliate Dumping: Selected Issues", 2017 Annual CTF Conference draft paper

Failure of drop-down by Amalco (resulting from Buyco and Canadian target) to subsidiary of target to satisfy s. 212.3(18)(a)(i) (pp. 18-19)

[A] foreign corporation (“FP”) forms a Canadian acquisition corporation (“Canco”) in order to acquire all of the shares of a Canadian target corporation (“Canadian Target”)….that…owns shares or debt obligations of underlying foreign affiliates and…also has a wholly-owned Canadian subsidiary (“Canadian Subsidiary”). Following the acquisition by Canco of all of the shares of Canadian Target, Canco and Canadian Target amalgamate to form an amalgamated corporation (“Amalco”). [fn 88: [I]f a parent corporation in the context of a vertical amalgamation has ever reduced its paid-up capital as a result of the application of the FAD rules, it is important that the stated capital of Amalco be expressed as something along the lines of “equal to the stated capital of the parent [on] the amalgamation” rather than the more typical “equal to the paid-up capital of the parent immediately prior to the amalgamation”] …it is [then] desired that Amalco transfer the shares or debt obligations of the underlying foreign affiliates (owned by Canadian Target prior to the amalgamation) to the Canadian Subsidiary. …

[T]he question arises…whether such an “investment” by the Canadian Subsidiary will qualify for the related party reorganization exception in subparagraph 212.3(18)(a)(i). In this scenario, the contemplated transfer will not satisfy all of the required conditions for 212.3(18)(a)(i). While Amalco and the Canadian Subsidiary will be related immediately before the investment time, neither of the additional alternative conditions for the application of that exception will apply. With respect to the shareholder level condition, the shareholder (FP) of the disposing corporation (i.e. Amalco) is not the CRIC making the investment nor is it a Canadian-resident corporation that is related to the CRIC. With respect to the alternative condition in subparagraph 212.3(18)(a)(i) that is applied at the level of the disposing corporation (again, Amalco), that condition is also not satisfied…since Canadian Target dealt at arm’s length with FP during the Reference period,…

Drop-down “works” if Canadian target and Buyco not amalgamated first, or if 2-tier acquisition structure (pp. 19-20)

Oddly, if Canco and Canadian Target were not amalgamated as part of the acquisition and restructuring, then the transfer of the foreign affiliate shares or debt from Canadian Target to the Canadian Subsidiary would appear to qualify for the exception in 212.3(18)(a)(i) because the shareholder (“Canco”) of the disposing corporation (i.e. “Canadian Target”) should never have dealt at arm’s length with FP during the Reference Period, assuming Canco was formed by FP and the shares of Canco were always owned by FP. …

[T]he related party exception should also be available if FP had simply employed a two-tier Canadian-company acquisition structure to acquire and amalgamate with Canadian Target instead of a single tier acquisition structure…. [under which] FP forms Canco1 which, in turn, forms Canco2 and Canco2 then acquires all of the shares of, and then amalgamates with, Canadian Target … because the shareholder (Canco1) of the disposing corporation never dealt at arm’s length with FP during the Reference Period… .

2-tier structure also protects where upstream transfer of the CFA (pp, 20-21)

[F]P forms a two-tier acquisition structure to acquire a Canadian Target and, following the acquisition of Canadian Target by Canco2 [which is held in turn by Canco1] the two corporations are amalgamated to form Amalco…. [W]hat is desired is to transfer the foreign affiliate shares or debt held by the Canadian Target (and, following the amalgamation, by Amalco) upstream in the corporate group to Canco1.

[A]malco and Canco1 are related immediately prior to the time that Canco1 acquires the foreign affiliate shares or debt. In addition, the shareholder condition should also be satisfied because the shareholder of Amalco (i.e. Canco1) never dealt at arm's length with FP during the Reference Period…

Unavailability of relief where sub of Cdn Target transfers FA up to Buyco parent (pp. 21-22)

Now…the foreign affiliate shares or debt that are … to be transferred up to Canco1 are…owned by a wholly-owned Canadian subsidiary of Canadian Target… [F]or commercial or regulatory reasons, the Canadian Subsidiary cannot be amalgamated with Canco2 and Canadian Target….

[T]he requirements of subparagraph 212.3(18)(a)(i) will not be satisfied…because the disposing corporation (Canadian Subsidiary) dealt at arm's length with FP during the Reference Period and also because a predecessor to Amalco (i.e. Canadian Target), which is the shareholder of the disposing corporation (i.e. Canadian Subsidiary) dealt at arm's length with FP during the Reference Period….

Acquisition of foreign parent (“FP”) followed by transfer of FA between FP child and grandchild (p. 22)

[C]anco1 owns all of the shares of Canco2 and … Canco1 has always been owned and controlled by a … FP … . [A]n arm's length foreign corporate acquirer will acquire all of the shares of FP… [I]t is desired,…to move foreign affiliate shares or debt historically held by Canco1 to Canco2 or vice-a-versa. …

[N]either Canco1 nor Canco2 could transfer foreign affiliate shares or debt from one to the other and rely on the subparagraph 2l2.3(l8)(a)(i) exception. This is because both Canco1 and Canco2, and their corresponding shareholders (i.e. Canco1 and FP), did deal at arm's length…with the foreign acquirer of FP at some point during the Reference Period, and the foreign acquirer…is a non-resident corporation that participated in the series and was related to FP at some point in time during the Reference Period….

Better result if insertion of new Holdcos in chain (pp. 22-23)

If, following the acquisition of FP by the foreign acquirer, FP first transferred the Canco1 shares it owns to a new Canadian corporation, then Canco1 may then be able to transfer the foreign affiliate shares and debt in reliance on subparagraph 212.3(18)(a)(i) on the basis that this new Corporation is the shareholder of Canco1 immediately before the time at which the foreign affiliate shares or debt will be transferred and this new corporation never dealt at arm's length with either FP or the foreign acquirer during the Reference Period. Such an insertion of a new Canadian holding company will not result in Canco2 meeting the exception, however, unless of course a new Canadian company was also inserted between Canco1 and Canco2….

Intractability of amalgamation squeeze-outs (pp. 23-24)

One example where it is simply not possible to restructure so that a contemplated amalgamation will qualify as a subsection 87(11) amalgamation is a typical amalgamation squeeze-out transaction… [for instance where] Canco2 [held by FP through Canco 1] will amalgamate with Canadian Target to form Amalco and, on such amalgamation, the common shares of Canadian Target held by the 30% minority public shareholders will be converted into redeemable preferred shares of Amalco which will be immediately redeemed for cash….

[T]he FAD rules were drafted on the basis that an amalgamation may result in the amalgamated corporation having "acquired" any shares or debt of an underlying foreign affiliate from a predecessor corporation and a prudent tax advisor can be expected to proceed on that basis from a planning perspective….

[S]ubparagraph 212.3(18)(a)(ii) will not be applicable…While Canadian Target and Canco2 will be related to each other immediately prior to the squeeze-out amalgamation, Canadian Target will have dealt at arm’s length…with FP during the Reference Period. Further, each of the shareholders of Canadian Target will not satisfy the shareholder level conditions immediately prior to the amalgamation because the 30% public shareholders of Target will have dealt at arm's length with FP during the Reference Period. …

[A] cogent argument can be made in these circumstances that, even if Amalco has made an "investment" in foreign affiliate shares or debt for FAD purposes, Amalco itself has not transferred any property or assumed any obligation that relate to such investment and therefore no FAD consequences should arise.

Subparagraph 212.3(18)(a)(ii)

Clause 212.3(18)(a)(ii)(B)

Articles

Peter Lee, Paul Stepak, "PE Investments in Canadian Companies", draft 2017 CTF Annual Conference paper

No relief for a non-s. 87(11) amalgamation of Acquireco, Target and Target subs (p. 15)

[T]here is no explicit relief for an amalgamation is not described in subsection 87(11) in the context of an acquisition, even in circumstances where it is difficult to see where there would be a policy abuse. Many people surprised by the fact that the reorganization rule in subsection 212.3(18) may be of no help. [fn 34: Clause 212.3(18)(a)(ii)(B) of the relieving rule requires that one of two conditions be met, the first of which in subclause (I) - will never be possible where there is an amalgamation of Acquireco, Target and one or more of Target's subsidiaries, since Target and its subsidiaries presumably will be dealing at arm's length with the parent at some point in the series. The second prong of the second condition in subclause (II) contains a requirement that will disqualify the same illustrative amalgamation from the relieving rule since the shareholder of Target's subsidiaries Target will have been dealing at arm's length with the parent.]

Paragraph 212.3(18)(b)

Commentary

Listed exceptions

S. 212.3(18)(b) provides in a listed set of circumstances (relating to share-for-share transactions at the foreign affiliate level and certain distributions made by a foreign affiliate) that an acquisition of shares of a subject corporation by the CRIC will not be subject to the application of s. 212.3(2). As noted in the Department of Finance Explanatory Notes:

the exceptions will only apply to foreign affiliate shares that are received – subsection 212.3(2) is intended to apply to the extent that debt or other forms of non-share consideration are also received as a result of the share-for-share or distribution transaction.

The exceptions are for the following acquisitions of shares of the subject corporation by the CRIC:

  • On an exchange to which s. 51(1) applies (s. 212.3(18)(b)(i)), i.e., the shares of the subject corporation are acquired solely in exchange for (a) other shares of the subject corporation which were held by the CRIC as capital property, or (b) convertible bonds, debentures or notes of the subject corporation.
  • As consideration for a disposition of shares to which s. 85.1(3) applies (or would apply but for the exclusion in s. 85.1(4)) (s. 212.3(18)(b)(ii)), i.e., a transfer of shares of a foreign affiliate of the CRIC to the subject corporation for shares of the subject corporation.
  • In the course of a reorganization of the capital of the subject corporation to which s. 86(1) applies (s. 212.3(18)(b)(iii)), e.g., an exchange by the CRIC of all the shares of a particular class of shares of the subject corporation for shares of another class pursuant to a change in the articles (or local law equivalent thereof) of the subject corporation.
  • As a result of a foreign merger (as defined in s. 87(8.1)) under which the subject corporation was formed (s. 212.3(18)(b)(iv)), e.g., generally an amalgamation or merger of a wholly-owned foreign affiliate of the CRIC with a "grandchild" non-resident subsidiary which otherwise would be considered to result in the acquisition by the CRIC of shares of a "new" merged entity.
  • On a liquidation and dissolution to which s. 88(3) applies (s. 212.3(18)(b)(v)), e.g., the distribution of the shares of a "grandchild" foreign affiliate of the CRIC (viewed as the subject corporation) to the CRIC on the winding-up of an immediate non-resident subsidiary of the CRIC.
  • On a redemption of shares of a foreign affiliate of the CRIC (s. 212.3(18)(b)(vi)), e.g., the distribution of shares of a "grandchild" foreign affiliate of the CRIC through a redemption of shares of the "child" foreign affiliate held directly by the CRIC.
  • As a dividend (or as a qualifying return of capital as defined in s. 90(3)) in respect of the shares of a foreign affiliate of the CRIC (s. 212.3(18)(b)(vii)), e.g., a distribution to the CRIC of the shares of a "grandchild" foreign affiliate of the CRIC by a "child" foreign affiliate held directly by the CRIC (assuming, as appears likely, that such distribution would be deemed to be a dividend by s. 90(2) or a valid election was made for it to be a qualifying return of capital).

The above exceptions do not apply to "preferred share" acquisitions, as set out in s. 212.3(19). Also, the last three exceptions (in ss. 212.3(18)(b)(v) to (vii)) do not apply to the extent of debt assumed by the CRIC on the relevant distribution, as specified in s. 212.3(20).

Debt transfers

The lack of exclusions in s. 212.3(18)(c) for most transactions in intercompany debt can render such transactions potentially hazardous.

Example 18b-A(potential double deemed dividend/PUC suppression on receipt and re-contribution of debt)

CRIC, whose shares have a PUC of $200 and are owned by Parent, is the sole shareholder of two foreign affiliates: FA Opco and FA Finco. FA Finco holds a €100 loan owing by FA Opco.

FA Finco is wound-up and CRIC transfers the €100 loan (which it acquired under s. 88(3)(c) at a cost equal to the loan's fair market value of, say $150, assuming that it did not elect under s. 88(3.1) for the winding-up to be a "QLAD") to a newly-incorporated foreign affiliate (FA Newco) as a contribution of capital (a non-rollover transaction).

As s. 212.3(18)(b)(v) only exempts investments in a subject corporation which are shares rather than debt of the subject corporation, the acquisition of the loan represents an investment by CRIC in FA Opco of $150 - unless a valid election is made under s. 212.3(11) for that loan to be a pertinent loan or indebtedness - thereby resulting (in the absence of such a PLOI election) in the PUC of CRIC's shares being suppressed under s. 212.3(7)(b) to $50.

The contribution of the loan by CRIC to FA Newco is deemed to be an investment in FA Newco under s. 212.3(10)(b). This investment potentially gives rise to a deemed dividend of $100 paid by CRIC to Parent after taking into account a further $50 suppression of the PUC of the shares in the capital of CRIC under s. 212.3(7)(a).

Survivor-style foreign mergers

The exemption in s. 212.1(3)(18)(b)(iv) requires that the shares of a subject corporation resulting from a foreign merger qualify as shares which were acquired by the CRIC on a foreign merger under which the subject corporation "was formed." In a foreign merger of a subject corporation with a subsidiary under which the subject corporation is the survivor, such survivor, in fact, would not be considered to be newly-formed under the applicable foreign corporate law. It likely was intended that, in this situation, the newly-formed requirement would be satisfied by s. 87(8.2)(b), which deems the subject corporation to be a newly-formed corporation for purposes of the foreign merger definition in s. 87(8.1).

Example 18b-B (application of foreign merger exemption to survivor-style merger)

An immediate wholly-owned subsidiary of CRIC (FA1) merges (as described in ss. 87(8.1) and 8.2)) with its wholly-owned subsidiary (FA2). Under the applicable foreign corporate law, FA1 is considered to be the surviving corporation, and the existence of FA2 is considered to have ended on the merger. The share capital of FA1 is not affected by the merger.

By virtue of s. 87(8), s. 87(4)(b) deems CRIC to have acquired its post-merger shares of FA1 for an amount equal to their adjusted cost base. Accordingly, in the absence of s. 212.1(3)(18)(b)(iv), CRIC is effectively deemed to have made an investment (as described in s. 212.3(10)(a)) of that amount in FA1, thereby coming within s. 212.3(2) subject to any relief under draft s. 212.3(7).

S. 87(8.2)(b) deems FA1 to be a newly-formed corporation for purposes of the foreign merger definition in s. 87(8.1). It likely could be considered that among the purposes of that definition is to engage the application of the exemption in s. 212.1(3)(18)(b)(iv), which requires that the shares of FA1, which CRIC is deemed to have acquired on the merger, qualify as shares acquired by it on a foreign merger under which FA1 "was formed." (For an analogous approach to interpreting a deeming provision which applies to a narrower set of provisions which are then cross-refenerenced by other provisions, see Olsen.) This result would be clearer if s. 87(8.2 ) referenced s. 212.1(3)(18)(b)(iv) directly.

Paragraph 212.3(18)(c)

Commentary

Exclusion for related party acquisitions of shares of other corporation

S. 212.3(18)(c)(i) provides that s. 212.3(2) (including, by implication, the paid-up capital grind rule in s. 212.3(7)) does not apply to an indirect acquisition of shares of a subject corporation by the CRIC resulting from the direct acquisition of shares of another corporation resident in Canada (as described in s. s. 212.3(10)(f)), where the direct acquisition was from another corporation resident in Canada to which the CRIC was related (otherwise than by virtue of an option right or other right described in s. 251(5)(b)) immediately before such acquisition provided that the two companies did not deal at arm's length at any time before the acquisition and within the series of transactions that includes the acquisition. This exception from the application of s. 212.3(2) is similar to that in s. 212.3(18)(a)(i) for a related-party acquisition of shares of the subject corporation itself by the CRIC.

Amalco as CRIC making indirect investment

S. 212.3(18)(c)(ii) deems there not to be an investment (so that 212.3(2)(a) does not apply) where there is an amalgamation described in s. 87(1) of two or more predecessor corporations to form a CRIC, and one of the predecessors held the shares of a subject corporation "through" another Canadian-resident corporation. In the absence of s. 212.3(18)(c)(ii), such an amalgamation would result in the CRIC making an (indirect) investment described in paragraph 212.3(10)(f) where, as a result of the amalgamation, the CRIC indirectly acquires shares of a subject corporation by directly acquiring, from one of the predecessor corporations, shares of the intermediate Canadian-resident corporation holding the subject corporation.

Similarly to s. 212.3(18)(a)(ii), there are requirements, in order for the exclusion in s. 212.3(18)(c)(ii) to apply, that:

(i) the amalgamating corporations were related (otherwise than by virtue of an option right or other right described in s. 251(5)(b)) immediately before the amalgamation (s. 212.3(18)(c)(ii)(A)); and

(ii) none of the amalgamating corporations dealt at arm's length (determined without reference to s. 251(5)(b)) with any other amalgamating corporation at any time during the series of transactions or events which included the making of such (indirect) investment otherwise arising from the amalgamation, other than the portion of that period which was on or after the investment time (s. 212.3(18)(c)(ii)(B)).

Shareholder of Amalco as CRIC making indirect investment

On an amalgamation governed by s. 87(1), the shareholder of an amalgamating corporation who holds its shares of the amalgamating corporation as capital property generally is deemed by s. 87(4) to have disposed of those shares for their adjusted cost base and to have acquired its shares of the amalgamated corporation at the same amount. If such shareholder is controlled by a non-resident parent and most of the assets of the amalgamated corporation (viewed as a CRIC) are shares of a subject corporation, then such deemed acquisition will be an indirect investment in the subject corporation as described in s. 212.3(1)(f).

Accordingly, draft s. 212.3(18)(c)(ii) provides that s. 212.3(2) does not apply to an indirect investment (described in s. 212.3(10)(f)) in a subject corporation resulting from a direct acquisition by a shareholder CRIC of shares of another corporation resident in Canada on an amalgamation described in . 87(1). This avoids multiple deemed dividends under s. 212.3(2) (or PUC suppressions under s. 212.3(7)) that otherwise would arise if there were a succession of s. 87 amalgamations of Canadian subsidiaries of CRICs.

Exclusion where arm's length relationship during pre-investment series

S. 212.3(18)(c)(ii) does not apply to deem an investment not to occur if any of the predecessor corporations to the amalgamation was not related to the other predecessors (with related status for these purposes being determined without reference to s. 251(5)(b) rights) or if any of the predecessors dealt at arm's length (also determined without reference to s. 251(5)(b) rights) with an predecessor at any time that (i) is in the period during which the series of transactions or events that included the making of the investment, and (ii) is before the investment time.

Example 18c-A (avoiding deemed indirect investment by amalgamating corporation's shareholder)

All the shares of Canco whose only asset, other than a minor investment in Cansub, is shares of FA are acquired by CRIC1, whose immediate and "grandparent" shareholders are CRIC2 and (non-resident) Parent, respectively. Canco then is amalgamated with Cansub to form Amalco1 and Amalco1 is amalgamated with CRIC1 to form Amalco2.

The two predecessors of Amalco1 were related to each other at all relevant times up to their amalgamation. Accordingly, on the 1st amalgamation, Amalco1 will be deemed by draft s. 212.3(18)(a)(ii) not to have made an investment in FA, and CRIC1 will be deemed by draft s. 212.3(18)(c)(ii) not to have made an indirect investment in FA by virtue of what, in the absence of draft s. 212.3(18)(c)(ii), would have been deemed by s. 87(4) to have been a direct investment in Amalco1 on that amalgamation.

The 2nd amalgamation would not be not eligible for exemption under draft s. 212.3(18)(c)(ii) if it were relevant that one of the amalgamating corporations (CRIC2) dealt at arm's length with the two predecessors (Canco and Cansub) of the other amalgamating corporation (Amalco1) during that portion of the series of transactions occurring before the acquisition of Cansub by CRIC1. However, Amalco1 came into existence at a time when it did not deal at arm's length with CRIC1, and there does not appear to be a provision deeming it for these purposes to be a continuation of Canco and Cansub (cf. 87(1.2) and ss. 251(3.1) and 3.2)).

If this is correct, on the 2nd amalgamation, CRIC2 will be deemed by draft s. 212.3(18)(c)(ii) not to have made an investment in FA by virtue of having acquired the shares of Amalco2 on the amalgamation (and similarly Amalco2 itself will be deemed by s. 212.3(18)(a)(ii) not to have made a direct investment in FA.)

As the two amalgamations also are described in s. 87(11), draft s. 212.3(22)(a)(iii) also would apply to avoid an indirect investment by the Canadian shareholder in FA by virtue of its deemed (direct) acquisition under s. 87(4) of shares of the amalgamated corporation (i.e., CRIC1 respecting the formation of Amalco 1, and CRIC2 respecting the formation of Amalco 2) without any requirement to satisfy the arm's length test in s. 212.3(18)(c)(ii)(B).

The somewhat similar fact in 2012 Ruling 2012-0451421R3 resulted in deemed dividends under s. 212.3(2) in the absence of the relieving rule in draft s. 212.3(18)(c)(ii).

Excluded exchanges

S. 212.3(18)(c)(iii) and (iv) provide that an indirect acquisition of shares of a subject corporation by the CRIC resulting from the direct acquisition of shares of another corporation resident in Canada (as described in s. s. 212.3(10)(f)) will not be subject to the application of s. 212.3(2) in the following circumstances::

  • On an exchange to which s. 51(1) applies (s. 212.3(18)(c)(iiii)), i.e., the shares of the other (Canadian) corporation (which in turn directly or indirectly holds the subject corporation) are acquired solely in exchange for (a) other shares of that other corporation which were held by the CRIC as capital property, or (b) convertible bonds, debentures or notes of the other corporation.
  • In the course of a reorganization of the capital of the other corporation to which s. 86(1) applies (s. 212.3(18)(b)(iv)), e.g., an exchange by the CRIC of all the shares of a particular class of shares of the other corporation for shares of another class in connection with a change in the articles or other corporate charter of the other corporation.

S. 212.3(18)(c)(v)

S. 212.3(18)(c)(v) provides that s. 212.3(2) does not apply to an investment that is an indirect acquisition of shares of a subject corporation by a CRIC (referred to in s. 212.3(10)(f)), resulting from a direct acquisition by the CRIC of shares of another Canadian-resident corporation, if:

  • the other Canadian-resident corporation (or a particular Canadian-resident corporation related to the CRIC and the other corporation at the time of such indirect investment) in turn uses the property transferred by the CRIC to make a direct investment in a subject corporation (i.e., not one to which s. 212.3(10)(f) applies), and
  • such investment in the subject corporation occurs within 30 days (either before or after) the making of the indirect investment and as part of the same series of transactions or events.

The Explanatory Notes of the Department of Finance state:

Subparagraph 212.3(18)(c)(v) provides an exception that it is intended to prevent subsection 212.3(2) from applying more than once, in certain circumstances, where funds are transferred through tiers of Canadian corporations and invested in a foreign affiliate.

Example 18c-B (application of s. 212.3(18)(c)(v) to cascading investment)

(Non-resident) Parent, CRIC2, CRIC1, Canco and FA constitute a chain of wholly-owning corporations with no other relevant assets (other than the operating assets of FA with a value of $400). Parent subscribes $100 for shares of CRIC2, and so on down the chain to FA.

In the absence of s. 212.3(18)(c)(v) (and ignoring potential relief from double taxation in s. 212.3(10)(14)(b)), s. 212.3(10)(f) would deem each of CRIC2 and CRIC1 to make a $100 investment in FA, with the result that a $100 investment in FA would give rise to $200 of deemed dividends to Parent subject to any available PUC suppression under s. 212.3(7). Furthermore, a further $100 dividend would arise under the general rule (in s. 212.3(2)(a) ) respecting the $100 investment by Canco in FA.

S. 212.3(18)(c)(v) deems CRIC2 not to have made an indirect investment in FA, on the basis that, as part of the same series of transactions and within 30 days, a corporation resident in Canada to which CRIC2 and CRIC1 are related at the investment time, namely, Canco, makes an investment in the subject corporation (FA) using property transferred indirectly by CRIC2 to Canco.

Similarly, s. 212.3(18)(c)(v) deems CRIC1 not to have made an indirect investment in FA, on the basis that, as part of the same series of transactions and within 30 days, the corporation in which it invested in directly (Canco) makes an investment in the subject corporation (FA) using property transferred to Canco by CRIC1.

Administrative Policy

2012 Ruling 2012-0451421R3 - Purchase of Target and bump

deemed investment on amalgamation of subsidiary

After giving effect to preliminary transactions relating to the Bidco structure:

  • a non-resident public company (Parent) is the sole shareholder of another non-resident corporation (Parent Subco), which is the principal shareholder of New Holdco (a taxable Canadian corporation and not a public corporation), which holds all the shares of Bid Holdco (a taxable Canadian corporation), which holds Bidco, a taxable Canadian corporation
  • the only significant investor in the shares of Target (a taxable Canadian corporation and a listed public corporation) is Investor, which in a Lock-Up Agreement has agreed for itself and all related persons not to acquire any shares of Target, certain Buyers referred to below or Parent, or to acquire "Restricted Assets," within the following X years; Target assets following the acquisitions below will form only a small part of Parent's business or that of the 1st and 3rd Buyer described below
  • three "Buyers" (the first and third of which is partly owned by Investor) have agreed to buy certain Target assets under a Plan of Arrangement and have represented to Bidco that they do not hold (or, in the case of the second Buyco, hold no more than X% thereof) and will not acquire any Target common shares as part of the series of transactions, and will not within X years allow a "Restricted Person" to acquire directly or indirectly any transferred asset or any property substituted (for purposes of s. 88(1)(c)(vi)) for a transferee asset, other than securities listed on a stock exchange, as to which it will instruct each underwriter engaged by it not to accept orders from Restricted Persons

Under the proposed transactions:

  • Target common shares of dissenters will be transferred to Bidco for their fair value
  • notes of Target will be amended, with Parent paying consent fees and with the agreement of Target to reimburse it therefor; Parent and Parent Subco will guarantee payment of the amended notes
  • Target and a wholly-owned Canadian subsidiary thereof (Subco 1) will amalgamate to form Target Amalco (the Target Amalgamation)
  • Target Amalco will implement various "packaging transactions" under which it will transfer assets on a rollover basis to newly-formed Canadian subsidiaries (New Subcos), including New Target
  • Bidco will use share subscription proceeds indirectly derived from money borrowed by Parent Subco from third party lenders (who are believed to not be persons described in s. 88(1)(c)(vi)(B)) to make a loan to Target Amalco to repay credit facilities
  • at the "Transfer Effective time" under the Plan of Arrangement, Bidco will acquire all the Target common shares for cash; and outstanding Target management stock options, restricted share units and deferred units will be disposed of to Target for cash payments
  • Target Amalco will elect to cease to be a public corporation
  • the stated capital of the shares of Subco 2 (a taxable Canadian subsidiary of Target Amalco) and New Target will be reduced
  • Target Amalco, Subco 2 and New Target will amalgamate to form Target Amalco 2 (the Target Amalco Amalgamation)
  • following a reduction of the stated capital of Target Amalco 2's shares, Bidco and Target Amalco 2 will amalgamate to form Amalco (the Amalgamation)
  • various debts of Subco 3 (a subsidiary of Amalco) will be redonominated into Canadian dollars
  • various transactions respecting distributions of stated capital by Amalco up the chain and loan transfers are not described here; such stated capital distributions will include the distribution of proceeds derived from the disposition by Subco 15 (a subsidiary of Subco 3) and Subco 16 (a subsidiary of Subco 15) of properties to a member of the Parent group
  • the Buyers will exercise their purchase rights by acquiring subsidiaries of Amalco including New Subcos
  • Target Amalco and its subsidiaries will elect not to have s. 256(9) apply with respect to the acquisition of control by Bidco
  • Amalco will make a s. 88(1)(d) designation in respect of each non-depreciable capital property acquired by it on the amalgamation of Bidco and Target Amalco 2

Rulings:

  • s. 212.3 will not apply to the acquisition of the shares of Target Amalco by Bidco provided the acquisition occurs before 2013 and is completed in accordance with the terms of the Arrangement Agreement.
  • s. 212.3(2) will not apply to an investment made in a subject corporation by Target Amalco, Target Amalco 2 or Amalco as a result of the Target Amalgamation, the Target Amalco Amalgamation and the Amalgamation
  • s. 212.3(2) will apply to Bidco and to Bid Holdco to the extent that their acquisition of Target Amalco 2 shares and Amalco shares, respectively, resulting from the application of s. 87(4) to the Target Amalco Amalgamation and the Amalgamation, respectively, fall within the meaning of "investment" as described in s. 212.3(10)(f)
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 88 - Subsection 88(1) - Paragraph 88(1)(c.3) - Subparagraph 88(1)(c.3)(i) guarantee 26
Tax Topics - Income Tax Act - Section 88 - Subsection 88(4) - Paragraph 88(4)(b) Target Amalco 2 formed post-AOC and pre-bump (occurring on amalgamation of Target Amalco 2 with Bidco) is a continuation its predecessors for s. 88(1)(c) midamble purposes/prepackaging transactions before formation of Target Amalco 2/Target asset buyers agree not to purchase Target shares 911

Articles

Philip Halvorson, Dalia Hamdy, "An Overview of the Foreign Affiliate Dumping Rules", (OBA article), 23 February 2016

Supplemented by anti-stuffing meansures (p. 10)

[S]imilar to the rules in paragraph 212.3(18)(a), paragraph 212.3(18)(c) also contains various "anti-stuffing" measures that test the relatedness of the various of the relevant parties designed to prevent taxpayers from inappropriately relying on these corporate reorganization exceptions for what is in essence an acquisition of a new property into the Canadian group….

Subparagraph 212.3(18)(c)(v)

Administrative Policy

2016 Ruling 2016-0629011R3 - PUC reinstatement under 212.3(9)

exclusion where (10)(f) corp on-subscribes proceeds in FA investments

Foreign Parent holds a majority position in Pubco indirectly including through Canholdco 2 and Canholdco 1. Pubco is a public corporation that previously elected under s. 261 for the U.S. dollar to be its elected functional currency and that it is described in s. 212.3(10)(f). A non-resident subsidiary (Finco) of Pubco has been funding a major project of “Opco,” that was capitalized mostly with mandatorily redeemable preferred shares (MRPS).

CanHoldco 2 subscribed for Pubco common Shares from treasury in U.S. dollars, which constituted an indirect acquisition by a CRIC (CanHoldco 2) under s. 212.3(10)(f). Pubco used those U.S. dollars to make investments in its FAs within 90 days and as part of the same series of transactions. CRA stated that such on-investment:

was not subject to subsection 212.3(2) based on the application of subparagraph 212.3(18)(c)(v), as this amount represented direct Investments made by a CRIC (Pubco) in its FAs (including Finco) under subsection 212.3(10) (other than one described in paragraph 212.3(10)(f)) and those direct Investments by Pubco were themselves subject to subsection 212.3(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212.3 - Subsection 212.3(9) - Paragraph 212.3(9)(b) - Subparagraph 212.3(9)(b)(ii) - Variable A - Clause (b) PUC restoration where borrowed money dividended up only to the level of a lower-tier CRIC, with cross-border PUC of both lower- and upper-tier CRICs computed both in Cdn$ and U.S.$ where lower-tier CRIC had U.S.$ EFC 599
Tax Topics - Income Tax Act - Section 261 - Subsection 261(5) - Paragraph 261(5)(a) cross-border PUC of both lower- and upper-tier CRICs computed both in Cdn$ and U.S.$ where lower-tier CRIC had U.S.$ EFC 332

Paragraph 212.3(18)(d)

Commentary

S. 212.3(18)(d) provides that s. 212.3(2) (including, by implication, the paid-up capital grind rule in s. 212.3(7)) does not apply to a direct acquisition by a CRIC of shares of a subject corporation (described in s. 212.3(10)(a)) or an indirect acquisition of shares of a subject corporation by the CRIC resulting from the direct acquisition of shares of another corporation resident in Canada (as described in s. s. 212.3(10)(f)), where such acquisition of shares was received by the CRIC as the sole consideration for an exchange of a debt obligation owing to the CRIC, other than an exchange to which s. 51(1) applies.

The Explanatory Notes of the Department of Finance state that s. 212.3(18)(d)

prevents subsection 212.3(2) from applying where debt is exchanged for equity and is intended to supplement the rules in subparagraphs 212.3(18)(b)(i) and (c)(iii) that deal with subsection 51(1) conversions of debt into equity. In contrast to subsection 51(1), paragraph 212.3(18)(d) does not require that a conversion feature exist in the terms of the debt instrument.

Subsection 212.3(18.1)

Commentary

Draft s. 212.3(18.1) provides that the exceptions in s. 212.3(18), which otherwise can apply to stop s. 212.3(2) from applying to various forms of corporate reorganizations and distributions, do not apply to an investment that is an acquisition of property, if the property can reasonably be considered to have been received by the CRIC as repayment in whole or in part, or in settlement, of a pertinent loan or indebtedness (PLOI) (as defined in s. 212.3(11)). Accordingly, where the exclusion in s. 212.3(18.1) so applies, s. 212.3(2) generally will apply to such an investment subject to any operation of the PUC-suppression rule in draft s. 212.3(7).

Before giving effect to draft s. 212.3(18.1), when a valid election had been made for a loan made by a CRIC to a subject corporation to qualify as a PLOI, s. 212.3(2) did not apply in respect of the PLOI. After the enactment of the original s. 212.3 rules, the Department of Finance then realized that this meant (subject to any application of the general anti-avoidance rule) that the application of the s. 212.3 rules could be avoided in a wide range of circumstances through the CRIC first investing in debt of the subject corporation, electing for that debt to be a PLOI, and then converting such debt into equity using one of the permitted reorganization transactions described in s. 212.3(18) (thereby eliminating the imputation of interest income under the rules respecting PLOI). This is illustrated in the example in the Explanatory Notes reproduced further below.

Accordingly, the Explanatory Notes state that s. 212.3(18.1) "clarifies" that a CRIC cannot replace a PLOI with a second investment in a subject corporation described in s. 212.3(18.1) without s. 212.3(2) applying to the second investment.

[Explanatory Notes] Example

Facts

  • A CRIC makes a loan to its foreign affiliate and an election is made under paragraph 212.3(11)(c) to have the loan treated as a PLOI.
  • One year later, the loan is exchanged for shares issued by the foreign affiliate to the CRIC in an exchange to which subsection 51(1) applies.

Analysis

As a result of the PLOI election, the CRIC is required, under paragraph 17.1(1)(b), to include in its income interest at the prescribed rate for the year during which the PLOI remains outstanding. Subsection 212.3(2) does not apply to this investment because of the PLOI election.

The subsequent acquisition by the CRIC of shares is an investment described in paragraph 212.3(10)(a). Subject to the exceptions in paragraphs 212.3(16) or (18), subsection 212.3(2) would apply to this investment. The investment is described in subparagraph 212.3(18)(b)(i); but pursuant to subsection 212.3(18.1), the exception in subparagraph 212.3(18)(b)(i) does not apply in this case because the investment is an acquisition by the CRIC of shares of the subject corporation that are received by the CRIC in settlement of a PLOI. Therefore, subsection 212.3(2) applies to the investment.

Articles

Philip Halvorson, Dalia Hamdy, "An Overview of the Foreign Affiliate Dumping Rules", (OBA article), 23 February 2016

Avoidance of misuse of PLOI exception (p. 10)

Subsection 212.3(18.1)…would prevent a CRIC from first acquiring a debt that was a PLOI (which would not be subject to the FAD Rules), and then converting that PLOI into a new debt, or into shares, in a manner that relies on an exception in subsection 212.3(18), thereby making an investment in a subject affiliate without the FAD Rules ever applying.

Subsection 212.3(19) - Preferred shares

Commentary

S. 212.3(19) provides that the exceptions in ss. 212.3(16) and 212.3(18)(b) and (d) to the application of s. 212.3(2) do not apply to a CRIC's acquisition of shares of a subject corporation if the shares may not be reasonably considered to fully participate in the profits of the subject corporation and any appreciation in its value. Furthermore, as described in draft s. 212.3(1)(b)(ii), under draft s. 212.3(19), an acquisition of such non-participating shares by a CRIC generally will be subject to the application of s. 212.3(2) even if the parent at that investment time does not yet have a 25% interest in the CRIC if it subsequently acquires control of the CRIC as part of the same series of transactions. Although the Explanatory Notes of the Department of Finance paraphrase the rule in s. 212.3(19) as one providing that "the exceptions are not available where the CRIC acquires what are commonly referred to as ‘preferred shares'," this definition of a non-qualifying share is broader than the concept of a preferred share. For example, an "alphabet share" which participated only in the profits of a business division of the subject corporation likely would be subject to the exclusion in s. 212.3(19).

The determination as to whether shares acquired by the CRIC fully participate in the profits of the subject corporation and any appreciation in the value of the subject corporation is to be made having regard to all the terms and conditions of the shares themselves and any agreement in respect of the shares.

Even if the shares of the subject corporation acquired by the CRIC are less than fully participating, this is stated not to preclude the availability of the exceptions in ss. 212.3(16) and 212.3(18)(b) and (d) if the subject corporation is a "subsidiary wholly-owned corporation" of the CRIC throughout the period during which the series of transactions or events that includes the acquisition of the subject corporation occurs and after taking into account a deemed ownership rule. Under the deemed ownership rule, the CRIC is deemed to also own any shares of the subject corporation which are owned by a Canadian-resident subsidiary wholly-owned corporation of the CRIC or by a Canadian-resident corporation resident of which the CRIC is a subsidiary wholly-owned corporation. The definition of this phrase in s. 248(1) excludes directors' qualifying shares. Accordingly, if the subsidiary wholly-owned corporation exception is satisfied, the CRIC would be considered to have a fully participating interest in any preferred shares of the subject corporation that the CRIC acquires.

Common share provisions (where there is more than one class of shares in the authorized capital) generally provide for the declaration and payment of dividends thereon in the discretion of the board, subject to priority for accrued but unpaid dividends on any issued and outstanding preferred shares; and for an entitlement to receive the remaining assets of the corporation or the sales proceeds thereof on liquidation or dissolution proceedings after the payment of the corporation's debts and satisfaction of the prior claims of any issued and outstanding preferred shares. It is commonplace for many years to pass before any such distribution in fact is made on common shares. In this light, it presumably is intended that shares can be considered to be fully participating in the profits of a subject corporation and appreciations in its value even if the current policy of the subject corporation is to not pay dividends and there are no asset sales resulting in the current receipt of the shareholders of appreciation in the subject corporation's assets.

It is not clear whether the reference to full participation in any appreciation in the value of the subject corporation refers to the right to participate fully in any gain on a sale of the subject corporation's assets, or to fully participate in the realization of gains on a sale of its shares; or to a valuation proposition that the fair market value of the shares would appreciate in some sort of pro tanto, or fully or partially correlated, manner with increases in the intrinsic value of the subject corporation. This distinction might matter, for example, where common shares of a subject corporation were underwater in the sense that any increases in realizable value would go first to the account of preferred shareholders who are third parties or affiliate non-residents; yet any such increase would result in an immediate increment in the valuation of those common shares.

Example 19-A(under-water common shares of FA)

The assets of CRIC, whose non-resident shareholder is Parent, consist ofall the common shares of FA1 which, in turn, holds all the shares of FA2, whose only asset is a development mineral property with a fair market value of $70. Parent directly holds preferred shares of FA1 with a redemption amount of $100. As they economically represent a call option on the future of the project of FA2 and represent voting control, the common shares of FA1 have a fair market value of $20 and, conversely, the fair market value of the preferred shares is lower than $70.

FA1 and FA2 merge in a foreign merger as described in s. 87(8.1). FA1 is the survivor entity with the same share capital as before. However, s. 87(8.2) effectively deems it to be a new corporation for purposes of s. 87(8.1), and perhaps also for purposes of s. 212.1(3)(18)(b)(iv) (see Example 18b-B).

Consequences

In the absence of the exemption in s. 212.1(3)(18)(b)(iv) applying, CRIC would be deemed by ss. 87(8) and 87(4)(b) to have acquired its common shares of FA1 for their adjusted cost base on the merger, with s. 212.3(2)(a) applying to that deemed investment by it in the common shares of FA1 (so as to result in a deemed dividend to Parent or a reduction under draft s. 212.3(7) of the PUC of its shares of CRIC).

There is a concern that s. 212.3(19) could apply to exclude the exemption in s. 212.1(3)(18)(b)(iv) on the basis that any increases in value of the project could be seen as, at least initially, accruing only or primarily for the benefit of the preferred shareholder.

Articles

Philip Halvorson, Dalia Hamdy, "An Overview of the Foreign Affiliate Dumping Rules", (OBA article), 23 February 2016

Preferred share exception (p. 10)

Subsection 212.3(19) overrides the bona fide business exception or the internal reorganization exception on an acquisition of shares of a subject corporation by a CRIC, to the extent that the shares do not fully participate in the profits and appreciation in value of the subject affiliate (i.e., preferred shares) unless the subject affiliate would be a subsidiary wholly-owned corporation of the CRIC (taking into account shares owned by a parent or subsidiary of the CRIC, in the case of a wholly-owned group).

Brett Anderson, Daryl Maduke, "Practical Implementation Issues Arising from the Foreign Affiliate Dumping Rules", 2014 Conference Report, (Canadian Tax Foundation), 19:1-49

s. 212.3(19) can extend to common shares (p. 16)

[C]ommon shares may also be caught if their participation rights are contractually restricted by borrowing terms, shareholders' agreements, or other similar arrangements.

FAD rules apply only to 1st tier FA investments (p. 34)

[A]s a result, certain transactions with similar economic results Can give rise to an investment for the purposes of the FAD Rules when the transaction is between a CRIC and a Subject Corporation but not when the transaction is between a Subject Corporation and a lower tier affiliate.

…[A]ssume a CRIC owns 80% of the common shares of a Subject corp. and an arm's length third party owns the remaining 20%. If the CRIC were to exchange its common shares for preferred shares of the Subject Corp., subsection 212.3 (19) would prevent subsection 212.3(18) from applying to protect the resulting new investment from subsection 212.3(2). As discussed above with respect to debt repayments, whether the disposition of one investment and the making of a new investment give rise to adverse consequences depends on whether the original investment caused a PUC reduction.

A different result arises if the assumptions are changed slightly. Assume the CRIC owns all of the common shares of the Subject Corp. and the Subject Corp. owns 80% of the common shares of a second tier foreign affiliate. The other 20% of the second tier foreign affiliate's shares are owned by an arm's length third party. In this case the Subject Corp. exchanges its common shares of the second tier foreign affiliate for preferred shares….[T]his second scenario should not give rise to a new investment for purposes of the FAD Rules….

Subsection 212.3(20) - Assumption of debt on liquidation or distribution

Commentary

S. 212.3(20) provides that the rules in ss. 212.3(18)(b)(v) to (vii) – which otherwise except certain types of reorganizations involving foreign affiliate distributions from the deemed dividend/PUC reduction rule in s. 212.3(2) – do not apply to the extent of any debt assumed by the CRIC in respect of the distribution. Accordingly, to that extent, s. 212.3(2) applies to an acquisition by a CRIC of foreign affiliate shares on such a distribution. The excepted reorganization transactions are the following acquisitions of shares of the subject corporation by the CRIC where such a debt assumption by it also occurs:

  • On a liquidation and dissolution to which s. 88(3) applies (s. 212.3(18)(b)(v)), e.g., the distribution of the shares of a "grandchild" foreign affiliate of the CRIC (viewed as the subject corporation) to the CRIC on the winding-up of an immediate non-resident subsidiary of the CRIC.
  • On a redemption of shares of a foreign affiliate of the CRIC (s. 212.3(18)(b)(vi)), e.g., the distribution of shares of a "grandchild" foreign affiliate of the CRIC through a redemption of shares of the "child" foreign affiliate held directly by the CRIC.
  • As a dividend (or as a qualifying return of capital as defined in s. 90(3)) in respect of the shares of a foreign affiliate of the CRIC (s. 212.3(18)(b)(vii)), e.g., a distribution to the CRIC of the shares of a "grandchild" foreign affiliate of the CRIC by a "child" foreign affiliate held directly by the CRIC (assuming, as appears likely, that such distribution would be deemed to be a dividend by s. 90(2) or a valid election was made for it to be a qualifying return of capital).

The last exclusion listed above for an in-kind dividend (and probably also a capital distribution) may be fanciful in that, in most or all jurisdictions, the payment of a dividend to a shareholder would not entail an assumption of liabilities by the shareholder.

The Explanatory Notes of the Department of Finance comment further on these exclusions:

…where a top-tier foreign affiliate is liquidated into a CRIC, and the shares of a lower-tier foreign affiliate are distributed to the CRIC in a transaction to which subsection 88(3) applies, the CRIC might in certain cases assume debt of the top-tier affiliate. Similarly, where the top-tier foreign affiliate distributes shares of a lower-tier affiliate to the CRIC, either on a redemption of shares or as a dividend or reduction of paid-up capital, the CRIC might assume debt of the top-tier affiliate in respect of the distributed shares. In all of the foregoing situations, where debt is assumed by the CRIC, paragraph 212.3(20) will cause subsection 212.3(2) to apply to the acquisition by the CRIC of the shares of the lower-tier foreign affiliate to the extent of the value of the debt assumed.

Subsection 212.3(21) - Persons deemed not to be related

Commentary

S. 212.3(21) deems persons to be unrelated for the purposes of the reorganization exceptions in subsection 212.3(18) if it can reasonably be considered that one of the main purposes of one or more transactions or events was to cause those persons to be related so that one of those exceptions would apply. The Explanatory Notes of the Department of Finance note that this rule is similar to that in s. 55(4).

Obvious examples of transactions that sought to make corporations related for these purposes would typically fail even before considering the application of s. 212.3(21) due to the breadth of the concept of a series of transactions, discussed above under s. 212.3(1).

Example 21-A (making Canadian target related at series' commencement)

A newly-incorporated subsidiary of Parent (Buyco) is issued multiple voting shares of Canco (whose only asset is shares of FA) for a nominal subscription price, so that Buyco and Canco become related. Due to the small quantum of this investment, there are no material consequences under s. 212.3(2). The existing shareholders of Canco were amenable to losing a majority of the voting rights as there is a binding commitment of Buyco as part of the same plan of arrangement to effect the second stage transaction below.

Buyco then acquires all the remaining shares of Canco.

Canco likely would be considered to be dealing at arm's length with Buyco at the commencement of this series of transactions, so that (even before considering the exclusion in s. 212.3(21)), the acquisition of the remaining shares of Canco by Buyco would not be exempted under s. 212.3(18)(a)(i), by virtue of s. 212.3(18)(a)(i)(B), and would be viewed as an indirect investment by Buyco in FA under s. 212.3 (10)(f).

Subsection 212.3(22) - Mergers

Commentary

Continuation/no-acquisition

S. 212.3(22)(a)(i) provides for purposes of s. 212.3 and 219.1(3) and (4) that the "new" corporation resulting from a vertical amalgamation to which s. 87(11) applies is deemed to be the same corporation as and a continuation of the predecessors; and s. 212.3(22)(a)(ii) deems the new corporation not to have acquired any property of the predecessors for such purposes as a result of the amalgamation.

A parallel rule is provided in s. 212.3(22)(b) with respect to windings up to which s. 88(1) applies so that: under s. 212.3(22)(b)(i), the parent is deemed for purposes of s. 212.3 and 219.1(3) and (4) to be the same corporation as and a continuation of the subsidiary which is wound-up; and s. 212.3(22)(a)(ii) deems it not to have acquired any property of the subsidiary for such purposes as a result of the winding-up.

As a result of s. 212.3(22)(a)(ii), an amalgamation to which s. 87(11) applies does not result in an acquisition by the amalgamated "new" corporation of any shares or debt of a foreign affiliate held by a predecessor, or options to acquire such property, so that there is no resulting investment by the new corporation under s. 212.3(10)(a) (acquisitions of subject corporation shares), (d) (acquisitions of subject corporation debts)or (g) (options). Furthermore, as a result of s. 212.3(22)(a)(ii), there also is deemed to be no resulting acquisition of shares by the new corporation of a Canadian subsidiary of a predecessor which, in turn, held shares of a foreign affiliate, so that there is no resulting indirect investment in that foreign affilite by the new coporation under s. 212.3(10)((f). The Explanatory Notes of the Department of Finance curiously state that s. 212.3(22) effectively excludes, from the application of the rule in s. 212.3(2), acquisitions by a CRIC of foreign affiliate shares resulting from a merger to which s. 87(11) applies (or winding-up to which s. 88(1) applies), rather than referring also to other types of securities of a foreign affiliate.

S. 212.3(10)(c) provides (subject to exceptions respecting ordinary-course loans, and pertinent loans or indebtedness - see 212.3(11)) that a transaction where an amount becomes owing by a subject corporation to a CRIC represents an investment in it by the CRIC. It would appear to follow, from the deeming by s. 212.3(22)(a)(i) of the amalgamated corporation as a continuation of the predecessors, that the amalgamation does not result in an amount, previously owing by a subject corporation to a predecessor, to have "become" owing to the amalgamated corporation, i.e., that amount effectively is deemed to have been owing to the "new" corporation all along.

Similarly, by virtue of s. 212.3(22)(b)(ii), a winding-up to which s. 88(1) applies does not result in a direct acquisition of securities of a foreign affiliate by the parent, or an indirect acquisition of shares of a foreign affiliate "through" an intermediate acquisition of shares of an Canadian-resident company, so that, again, there is no resulting investment by it under s. 212.3(10)(a), (d), (f) or (g); and it would appear that by virtue of s. 212.3(22)(b)(i), there would be no resulting investment by the parent under s. 212.3(10)(c).

The Explanatory Notes also state that the "continuity" rules in s. 212.3(22)(a)(i) and s. 212.3(22)(b)(i) are similar to the rules in subsections 87(1.2) and 88(1.5).

Indirect investments

The current versions of ss. 212.3(22)(a) and 212.3(18)(c)(ii) do not prevent there being an indirect investment to which s. 212.3(10)(f) applies in the situation where there is a CRIC-shareholder on a s. 87(11) amalgamation. This is to be remedied by draft s. 212.3(22)(a)(iii), which provides that each shareholder of the new corporation formed by a s. 87(11) amalgamation is deemed not to acquire indirectly any property of the parent, or of any subsidiary, as a result of the amalgamation.

Example 22-A (FA held by subsidiary in s. 87(11) amalgamation)

Parent holds all the shares of CRIC, which holds all the shares of Canco2 which holds all the shares of Canco1, whose only asset is shares of FA. Canco2 and Canco1 amalgamate to form Amalco, as described in s. 87(11).

CRIC is deemed by s. 87(4) to have acquired the shares of Amalco at a cost equal to the adjusted cost base of its shares of Canco2. Under current law, this results in an indirect investment (equal to such deemed cost) in the shares of FA.

Under draft s. 212.3(22)(a)(iii), CRIC is deemed not to have acquired the shares of FA.

See also Example 18c-A.

The Explanatory Notes of the Department of Finance give further background on the draft s. 212.3(22)(a)(iii) rule:

In the case of a vertical amalgamation to which subsection 87(11) applies, subparagraph 212.3(22)(a)(ii) ensures that subsection 212.3(2) does not apply, as a result of the amalgamation, to a CRIC that is formed by the amalgamation. The new corporation formed by the amalgamation is deemed not to acquire any property of the parent or of any subsidiary as a result of the amalgamation, and thus does not make an investment described in subsection 212.3(10).

New subparagraph 212.3(22)(a)(iii) is added to ensure that subsection 212.3(2) does not apply, as a result of the amalgamation, to a CRIC that is a shareholder of the parent and that acquires, on the amalgamation, shares of the new corporation. Each shareholder of the new corporation formed by the amalgamation is deemed not to acquire indirectly any property of the parent, or of any subsidiary, as a result of the amalgamation. This ensures that where the parent or a subsidiary owns, directly or indirectly, shares of a foreign affiliate, the amalgamation does not result in a CRIC that is a shareholder of the new corporation making an investment described in paragraph 212.3(10)(f) by indirectly acquiring shares of a subject corporation.

Comparison to s. 212.3(18)

An amalgamation to which s. 87(11) applies is a type of amalgamation to which s. 87(1) applies. In particular, s. 87(1.1) provides that a vertical amalgamation can satisfy the requirements of s. 87(1) notwithstanding that there is no change to the issued share capital of the parent amalgamating corporation following the amalgamation.

Given this overlap, there also is an overlap between the field of operation of s. 212.3(22)(a) and that of:

  • s. 212.3(18)(a)(ii), which could apply to deem Amalco not to have directly acquired shares of a foreign affiliate held by a predecessor corporation – similarly to the operation of s. 212.3(22)(a)(ii);
  • s. 212.3(18)(c)(ii), which could apply to deem Amalco not to have indirectly acquired shares of a foreign affiliate through a direct acquisition of shares of a "Canco" holding the foreign affiliate – also similarly to the operation of s. 212.3(22)(a)(ii).
  • draft s. 212.3(18)(c)(ii), which could apply to deem a Canadian-resident shareholder of Amalco not to have acquired shares of Amalco, thereby resulting in an indirect investment by that shareholder in a foreign affiliate of Amalco – similarly to the operation of draft s. 212.3(22)(a)(iii).

One difference betwen these provisions is that s. 212.3(22)(a)(ii) deems the new corporation not to have acquired any property of a predecessor for purposes of s. 212.3, rather than its operation being restricted to shares.

A second significant difference is that s. 212.3(22)(a) does not contain a requirement similar to that in s. 212.3(18)(a)(ii)(B) or s. 212.3(18)(c)(ii)(B) that none of the amalgamating corporations dealt at arm's length (determined without reference to s. 251(5)(b)) with any other amalgamating corporation at any time during the series of transactions or events which included the making of the investment in the foreign affiliate otherwise arising from the amalgamation, other than the portion of that period which was on or after the investment time. Accordingly, the exclusion in s. 212.3(22)(a) can operate on an amalgamation with a wholly-owned target which was acquired from arm's length investors as part of the same series of transaction. See Example 22-B below.

S. 87(3.1) election

S. 212.3(22)(a)(i) deems the amalgamated corporation to be a continuation of the predecessors, but does not deem its shares to be of the same class of the amalgamating parent under the s. 87(11) amalgamation, as required under the PUC-reinstatement rule in draft s. 212.3(9). In order to avoid uncertainty under this point, the amalgamated corporation could make an election under s. 87(3.1), so as to deem its shares of a particular class to be a continuation of the equivalent class of shares of a predecessor for purposes of computing their paid-up capital (including, it would appear, under draft s. 212.3(9).)

Example 22-B (potential need for s. 87(3.1) election in conventional buy, bump and sell transaction)

Parent incorporates and capitalizes a Canadian subsidiary (Buyco) with $100 of common share capital, and Buyco acquires all the shares of a Canadian corporation (Canco) from arm's length vendors. The only asset of Canco are shares of two wholly-owned foreign affiliates (FA1 and FA2) with a fair market value of $70 and $30, respectively. Buyco and Canco amalgamate as described in s. 87(11) to form Amalco. Amalco distributes its shares of FA2 to Parent as a stated capital reduction of $30.

The $100 purchase by Buyco is deemed under s. 212.3(10)(f) to be a $100 investment in FA1 and 2, so that the paid-up capital of the shares of Buyco is ground by $100 to nil under s. 212.3(7). In order for $30 of this PUC to be restored under draft s. 212.3(9) on the distribution of FA2, it must be considered that this distribution occurred on the same class of shares which sustained the s. 212.3(7) grind. S. 212.3(22)(a)(i) deems Amalco to be a continuation of Buyco, which may imply that Amalco's shares are of the same class as those of Buyco. In order to avoid uncertainty under this point, Amalco could make an election under s. 87(3.1) in respect of its common shares. Such election would deem that class of shares to be a continuation of the common shares of Buyco for purposes of computing their paid-up capital.

As discussed further above, s. 212.3(22)(a)(ii) deems the amalgamation not to entail an investment by Amalco in FA1 and FA2 notwithstanding that Canco dealt at arm's length with Buyco prior to its acquisition by Buyco.

Subsection 212.3(23) - Indirect investment

Commentary

S. 212.3(23) applies to deny the exemption from the application of s. 212.3(2) which otherwise would apply under s. 212.3(16) to an investment by a CRIC in a subject corporation where property received by that subject corporation from the CRIC as a result of the investment (or property substituted therefor) may reasonably be considered to have been used by it (directly or indirectly as part of a series of transactions or events that included the making of that investment) in a transaction (or event) to which s. 212.3(2) would have applied if the CRIC had entered into the transaction (or participated in the event) directly.

The Explanatory Notes of the Department of Finance state that s. 212.3(23):

...is an anti-avoidance rule targeted at situations where a CRIC uses a "good" foreign affiliate as a conduit to make an investment in a "bad" foreign affiliate. A "good" foreign affiliate would be a subject corporation an investment in which, by the CRIC, would satisfy the exception in subsection 212.3(16); an investment by the CRIC in a "bad" foreign affiliate would not satisfy that exception. …Thus, subsection 212.3(23) can apply to, effectively, override subsection 212.3(16).

Subsection 212.3(24) - Indirect funding

Commentary

Object

The availability of the exemption in s. 212.3(16), from the application of s. 212.3(2) to an investment by a CRIC in a subject corporation, is determined by applying the tests in s. 212.3(16) (e.g., a more closely-related business, and exercise of investment decision-making by officers of the CRIC) by reference to that investment. This is so even where all such proceeds are immediately applied by the subject corporation to make an investment in another controlled foreign affiliate of the CRIC that would have been exempted under s. 212.3(16) had such investment been made directly by the CRIC.

S. 212.3(24) partially addresses this gap in the scope of s. 212.3(16).

Three conditions

In order for an investment in a subject corporation by a CRIC to qualify for the exception in s. 212.3(24), the CRIC must "demonstrate" the satisfaction of the three tests set out in ss. 212.3(24)(a) to (c):

  • all of the property received by the subject corporation from the CRIC as a result of the investment was used, at a particular time that is within 30 days after the time the investment was made and at all times after the particular time, by the subject corporation to make a loan to a controlled foreign affiliate (as defined in s. 17(15)) of the CRIC (imaginatively referred to as the "particular corporation"): s. 212.3(24)(a)
  • throughout the portion of the period during which the series of transactions that includes the making of the inter-affiliate loan occurs that is after the investment time, the particular corporation qualifies as a corporation in which a direct investment by the CRIC would have qualified for the exception in s. 212.3(16): s. 212.3(24)(b)
  • throughout the period during which the loan is outstanding, the particular corporation used the loan proceeds in an active business (as defined in s. 95(1)) that it carried on in its country of residence.

Double-dip structure

S. 212.3(24)(a) accommodates the traditional "double-dip" financing of foreign affiliates carrying on an active business

Example 24-A (traditional double-dip structure)

CRIC (a subsidiary of Parent) uses the proceeds of a bank borrowing to subscribe $100 for common shares of Finco, a wholly-owned non-resident subsidiary. Finco immediately uses the $100 to make an interest-bearing loan to Opco, also a non-resident wholly-owned subsidiary of CRIC. Opco carries on an active business (as defined in s. 95(1)) in its country of residence and uses the loan proceeds in that business at all relevant times.

S. 212.3(16) would have exempted a direct investment by CRIC in Opco. In particular, Opco does not have an equity percentage in Finco, so that it is not relevant (in applying the tests in s. 212.3(16)(a) to this notional investment by CRIC in Opco) that a direct investment by CRIC in Finco might not be exempted from application of the foreign-affiliate dumping rules in the absence of s. 212.3(24).

S. 212.3(24)(a) applies to exempt the $100 investment of CRIC in Finco. It does not matter if Finco and Opco are resident in different countries.

Stringency of active business requirement

S. 95(2)(a)(ii)(D) (among other things) generally deems interest income received by one wholly-owned foreign affiliate of a Canadian corporation from another wholly-owned foreign affiliate to be active business income even if the second affiliate – rather than using the loan proceeds directly in active business – uses the loan proceeds to subscribe for shares of a wholly-owned subsidiary which carries on an active business in the same country. However, this operation of s. 95(2)(a)(ii)(D) does not appear to have the effect of deeming the second affiliate (whose business is that of a holder of share investments) to not have an "investment business," as defined in s. 95(1) – which, in turn, would mean that its business does not qualify as an investment business. If this is correct, s. 212.3(24) will not apply to exempt an investment made by the CRIC in the first foreign affiliate which is used to make such a loan.

Example 24-B (indirect investment by subject corporation in foreign Opco)

The facts are the same as Example 24-A above (i.e., CRIC uses borrowed money to subscribe $100 for Finco shares, with the funds on-lent), except that the CFA borrower (Holdco) is a holding company for Opco (which is resident in the same country), and Holdco uses the loan proceeds to subscribe for shares of Opco. The shares of Opco are excluded property as defined in s. 95(1) (i.e., essentially deemed active business assets).

Although s. 95(2)(a)(ii)(D) might very well apply to deem the loan interest received by Finco to be active business income, this does not appear to be sufficient to deem Holdco to have used the loan proceeds in an active business "carried on by it," as required by s. 212.3(24)(c). If this is correct, s. 212.3(24) does not exempt the investment by CRIC in Finco, even if a direct investment by CRIC in Opco would have been exempted under s. 212.3(16).

Onus

As noted in Newmont (and similarly in numerous other cases):

In tax cases, the taxpayer has an initial onus to demolish the Minister's assumptions. This onus is met if the taxpayer establishes a prima facie case that the Minister's assumptions are wrong. Once the taxpayer establishes a prima facie case, then the burden shifts to the Minister to prove its assumptions on a balance of probabilities.

The stated requirement for the CRIC to "demonstrate" the satisfaction of the three conditions in ss. 212.3(24)(a) to (c) likely does not alter the normal incidence of onus of proof on the taxpayer notwithstanding this somewhat peculiar language: "demolition" of CRA's assumptions likely is cognate with a "demonstration" of the contrary.

Subsection 212.3(25) - Partnerships

Paragraph 212.3(25)(a)

Commentary

S.212.3(25) provides "look-through" rules for the application of the foreign affiliate dumping rules to partnerships. These rules also apply for purposes of the immigration and emigration rules in ss. 128.1(1)(c.3) and subsection 219.1(2), respectively, and for the purposes of the application of the "pertinent loans and indebtedness" rules (in s. 212.3(11)) to s. 17.1(1).

For those purposes, s. 212.3(25)(a) deems each member of a partnership to have entered into any transaction entered into by the partnership itself, in proportion to the relative fair market value of the member's direct and indirect interests in the partnership (held directly or through one or more partnerships) as compared to the fair market value of all direct interests in the partnership. Therefore (in the words of the Explanatory Notes of the Department of Finance), "where a CRIC is a member of a partnership that enters into any of the transactions described in paragraphs 212.3(10)(a) to (g), the CRIC is deemed to enter into the partnership's transaction, which would generally result in the CRIC being considered to have made an investment in a subject corporation." The Explanatory Notes also stated:

The reference in paragraph 212.3(25)(a) to an "event participated in" is intended to capture any event described in paragraphs 212.3(10)(a) to (g) that cannot be considered to be a transaction, which may include certain benefit conferrals described in paragraph 212.3(10)(b) or term extensions described in paragraph 212.3(10)(e).

It likely is intended that the look-through aspect of s. 212.3(25)(a) permits a partner which is a CRIC to benefit from the exemptions in s. 212.3(18). For example, if a partnership of which the CRIC is a member acquires shares of a subject corporation from a corporation resident in Canada which is related to the CRIC, the CRIC should be able to benefit from the related-corporation exemption in s. 212.3(18)(a)(i); and if the partnership exchanges shares of a subject corporation for other shares of the subject corporation as described in s. 51(1) or 86(1), the CRIC generally will benefit from the exemption for such transactions under s. 212.3(18)(b)(i) or (iii).

One of the effects of s. 212.3(7)(a) is to deem an investment by a partnership in a CRIC to be a pro rata investment in the CRIC by its partners.

Example 25a-A(non-resident partnership investment in CRIC)

Two non-resident corporations (NR1 and NR2) capitalize a partnership with contributions of $55 and $45, respectively, so that their partnership interests have a relative fair market value of 55/45. The partnership capitalizes CRIC with common share subscriptions of $40 and interest-bearing debt of $60. CRIC acquires all the common shares of Target (whose only asset is shares of a foreign non-resident subsidiary (FA)) for $100, and then amalgamates with it to form Amalco (with a s. 87(3.1) election being made).

Such investment is deemed by s. 212.3(25)(a) to entail be a direct equal investment by each of NR1 and NR2 of $55 and $45 in Target so that, under s. 212.3(10)(f), NR1 is deemed to have made a $55 investment in FA. Accordingly, the PUC of the common shares of CRIC (which under s. 212.3(25)(b) is treated as a cross-border class of shares) is ground to nil by draft s. 212.3(7)(a) (thereby denying interest deductions to Amalco under the thin capitalization rule in s. 18(4)), and NR1 is deemed by s. 212.3(2) to have received a dividend of $15. As NR2 is not considered under the look-through rule in s. 212.3(25)(b) to own a majority of the shares of CRIC (and assuming there is no relevant unanimous shareholders' agreement which changes this conclusion), s. 212.3(2) does not apply to the $45 investment of NR2.

Administrative Policy

18 June 2014 T.I. 2014-0534541I7 [PLOI election re debt owing to partnership]: Under the "look-through" rule in s. 212.3(25), where a foreign controlled CRIC is a member of a partnership and that partnership enters into a transaction resulting in an amount owing from a subject corporation to the partnership, the CRIC is deemed to enter into the partnership's transaction in proportion to the FMV of the CRIC's direct and indirect interests in the partnership, so that the CRIC would be considered to have invested in the subject corporation unless one of exceptions in ss. 212.3(10)(c) (i) or (ii) applied. Accordingly, rather than the partnership making the s. 212.3(11) PLOI election, it would be filed jointly by the CRIC and the non-resident corporation which controlled the CRIC, and the election would be in respect of the amount owing deemed to be owing to the CRIC in proportion to the FMV of the CRIC's direct and indirect interests in the partnership.

Paragraph 212.3(25)(b)

Commentary

S. 212.3(25)(b) deems (for the various purposes discussed above in relation to s. 212.3(25)(a)) partnership property to be owned by each partner in the proportion in proportion to the relative fair market value of that partner's direct and indirect interests in the partnership (held directly or through one or more partnerships) as compared to the fair market value of all direct interests in the partnership.

Effect on control of general partner

S. 212.3(25)(b) may act as a relieving measure where a partnership with a non-resident general partner would otherwise be considered to control a CRIC. In this situation, no partner may be a non-resident corporation which (on the look-through basis described in s. 212.3(25)(b)) would be considered to own a majority of the voting shares of the CRIC. The point is not clear, in part, because in the Example 2 provided by the Department of Finance's Explanatory Notes on s. 212.3(16), the Department assumed that a CRIC acquired by a private equity fund which was a limited partnership would be controlled by the general partner.

Furthermore, Duha (see also Bagtech) likely established that a shareholder of another corporation which does not hold a majority of that corporations' voting shares nonetheless potentially could control that corporation under the terms of a unanimous shareholders' agreement (USA) for that corporation. Accordingly, use of a USA potentially could complicate the availability of relief in these circumstances under s. 212.3(25)(b).

Example 25b-A (Canco controlled by non-resident partnership; USA effect)

A non-resident partnership (the Fund) with a non-resident general partner (GP) and mostly non-resident unaffiliated partners (none of which owns more than 50% of the Fund units) owns all the shares of Canco, which makes an investment in a non-resident subsidiary (FA). In light of its rights (under a "carry") to participate in Fund returns above specified levels, the relative fair market value of GP's interest in the Fund is 5%. There is no USA for Canco.

GP might be considered to control Canco on general principles (see 2000 APFF Roundtable, Q. 21, 2000-0038055), so that s. 212.3(2) applied to the investment. However, s. 212.3(25)(b) deems the Canco shares to be owned on a pro rata basis by the Fund's members, so that GP might effectively be deemed not to control Canco and no other non-resident partner would control Canco.

If instead there were a USA for Canco under which the directors delegated the exercise of substantially all their duties to Canco's registered shareholder (GP), the application of s. 212.3(25)(b) might not detract from the de jure control of Canco by GP, so that s. 212.3(2) might apply to the investment by the Fund.

There is no rule providing that a partnership interest lacking in voting or management rights (e.g., most limited partner interests) should not be assigned a minority discount for these purposes. Where the partners do not share on a pro rata basis in all distributions (e.g., where a managing general partner or an affiliate has a "carry,") it may be difficult to determine the relative fair market value of the carry, and complications may very well arise if there are resulting changes over time in the relative fair market values of the partners' interests.

Partnership interest transfers and windings-up

Given that the general effect of s. 212.3(25)(b) is for the partners to look through a partnership to the shares which are partnership property, the receipt of shares which were partnership property by a partner on a partnership winding-up will not result in an acquisition of those shares for purposes of engaging the rules in s. 212.3. Furthermore, the transfer of an interest in a partnership holding shares can access the exemptions in s. 212.3(18)(a) or (c) for related-corporation transfers of shares.

Example 25b-B (look-through on partnership winding-up)

CRIC, which is owned by a non-resident corporation has a 99% interest in a limited partnership (LP) holding the shares of Canco which, in turn, has a non-resident subsidiary (FA). The other 1% interest in LP (having a fair market value of 1% of the total partnership interests) is held by a Canadian subsidiary of CRIC (GP).

GP is wound-up into CRIC under s. 88(1), so that LP is wound-up into CRIC under s. 98(5).

Consequences

Under s. 212.3(25)(b), GP is deemed to have owned 1% of the shares of Canco before its winding-up. Accordingly, for s. 212.3 purposes, the transfer of GP's partnership interest to CRIC on its winding-up represents the transfer of a 1% shareholding in Canco from GP to a related corporation (CRIC) and, conversely, under s. 212.3(25)(c), if CRIC is regarded as acquiring that partnership interest (rather than LP already being considered to have dissolved by operation of law at that instant in time), it is regarded as having acquired such shares. This related corporation transfer between Canadian corporations, which otherwise would represent an indirect acquisition by CRIC of shares of FA as described in s. 212.3(10)(f), is deemed by s. 212.3(18)(c) to not be subject to s. 212.3(2).

Under s. 212.3(25)(b), CRIC is deemed to have owned 99% of the shares of Canco. Accordingly, there is no acquisition of those shares for purposes of the indirect acquisition rule in s. 212.3(10)(f) when CRIC commences to hold those shares directly on the winding-up of LP.

This example essentially is included in 2013 Ruling 2013-0491061R3 below.

Example 25b-C (transfer to 2nd partnership with higher CRIC interest)

Partnership 1 of which CRIC has a 50% partnership interest (with the other interest held by a 3rd party) transfers its holding of 100% of the shares of FA, having a fair market value of $100, to Partnership2, in which CRIC and the 3rd party have 90% and 10% partnership interests, respectively, in consideration for the assumption of $100 of third party debt. The combined effect of ss. 212.3(25)(a) and (b) appears to be that CRIC would be treated as having made a $40 investment in FA.

Administrative Policy

2013 Ruling 2013-0491061R3 - Upstream Loans

s. 212.3(25)(b) avoids acquisition on partnership winding-up

Non-resident subsidiaries (perhaps resident in the US) of a non-resident public company ("Parent") hold stacked non-resident companies (FA 1 to 4 in a mystery jurisdiction, which in turn hold stacked US companies, namely, US Holdco 1 to 3) through a structure of stacked Canadian companies (Can Holdco and Can Opco 1 to 3). A US marketing subsidiary of US Holdco 1 ("US Salesco") is owed amounts by Can Opco 3 under a cash-pooling arrangement. Under a largely-unwound "tower" structure, a ULC, held by Can Opco 2 through a resident partnership ("Partnership" - which is a corporation for Code purposes), holds preference shares of US Holdco 3.

In connection with unwinding this "sandwich" structure:

  1. Can Opco 1 repays the payable owing by it to US Salesco;
  2. Can Opco 3 transfers its shares of US Holdco 1 under s. 85.1(3) to FA 3 for common shares of FA 3
  3. Can Opco 3 transfers its shares of FA 2 and FA 3 to FA1 under s. 85.1(3) for common shares of FA 1;
  4. ULC transfers its pref shares of US Holdco 3 to a new US subsidiary for shares of US Newco (under s. 85.1(3));
  5. The general partner of Partnership is wound-up so that Partnership, in turn, is wound-up;
  6. ULC is wound-up into Can Opco 2;
  7. Can Opco 3, Can Opco 2 and Can Holdco sell their shares of FA 1, US Newco and US Holdco 1 to Parent for cash;
  8. US Salesco (which now is a "sister" rather than indirect sub of Can Opco 1) relends the amount received by it in 1 to Can Opco 1.

Rulings:

  • the exemption in s. 212.3(18)(b)(ii) applies to steps 2 and 3
  • respecting the acquisition of the general partner's partnership interest in step 4, the exemption in s. 212.3(18)(c)(i) applies to the deemed indirect acquisition by Can Opco 2 of US Newco resulting from the application of s. 212.3(25)(c) to such acquisition by Can Opco 2 of the general partner's interest
  • upon the dissolution of Partnership in step 5, such indirect acquisition by Can Opco 2 of the shares of US Newco will be exempted under s. 212.3(25)(b)
  • the exemption in s. 212.3(18)(a)(i) applies to step 6
  • by virtue of its coming into force provisions and s. 90(8)(a), s. 90(6) will not include any amount in respect of the loan by US Salesco in the income of Can Opco 3 (and similarly re "Treasuryco Debts" not described above)
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 90 - Subsection 90(8) - Paragraph 90(8)(a) yo-yo transaction: US Salesco is repaid upstream loan by Can Opco 1, and then relends to Can Opco 1 when no longer a parent 361

Articles

Ian Bradley, "Living with the Foreign Affiliate Dumping Rules", Canadian Tax Journal (2013) 61:4, 1147-66.

Control by general partner (pp. 1152-3)

[P]aragraph 212.3(25)(b)…suggests that when applying the control test in subsection 212.3(1), CRIC shares that are held by a partnership should be allocated to the partners in proportion to their partnership interests. …

If a CRIC owned by a limited partnership is considered to be controlled by the general partner, the FA dumping rules could produce unexpected results. This can be illustrated by a limited partnership in which the general partner holds a 1 percent interest and the remaining 99 percent is held by the limited partners. The partnership holds all of the shares of a CRIC. If the general partner is a non-resident corporation, it could be argued that the control test in subsection 212.3(1) is satisfied, even if the limited partners are Canadian residents or unrelated non-residents. On the other hand, if the general partner is a Canadian corporation, it could be argued that the control test is not satisfied, even if the limited partners are related non-resident corporations.

CRIC held through partnership (p. 1158)

The QSC test may not apply as intended where a Canadian holding structure includes a partnership. The equity percentage concept considers shares that are indirectly held through other corporations, but does not consider shares held through partnerships. While subsection 212.3(25) provides look-through rules for partnerships, these deeming rules apply only for the purposes of section 212.3… .

…If this argument were accepted, a CRIC whose shares were held by a Canadian partnership would have no QSCs, even if the partnership interests were owned by related Canadian corporations….

Paragraph 212.3(25)(c)

Commentary

S. 212.3(25)(a) addresses activities, such as investments in subject corporations, effected at the level of the partnership and does not address the effect of investments in the partnership itself. S. 212.3(25)(c)(i) provides that where there is an increase (including from zero) in the portion of a partnership property that paragraph 212.3(25)(b) deems a member to own, the member is deemed to acquire the additional portion of the property. Accordingly, an increase in the partnership interest held by a CRIC in a partnership holding a subject corporation (or holding a Canadian corporation which in turn, is 75% invested, as described in s. 212.3(10)(f), in a subject corporation) will be treated in the same manner as a direct acquisition of such shares by the CRIC. The Explanatory Notes of the Department of Finance state:

This rule ensures that where there is an increase in a CRIC's proportionate interest in a partnership that owns, directly or indirectly, foreign affiliate shares, this will result in an investment by the CRIC in a subject corporation under subsection 212.3(10).

On such an increase in interest in a partnership, s. 212.3(25)(c)(ii) deems the CRIC to "transfer property that relates to the acquisition" that has a fair market value equal to the fair market value of the additional portion of the partnership property. The Explanatory Notes of the Department of Finance state:

This is intended to ensure that the investment by the CRIC in the foreign affiliate results in appropriate consequences under paragraph 212.3(2)(a), which deems the CRIC to pay a dividend equal to the portion of the fair market value of "property transferred" by the CRIC that can "reasonably be considered to relate to" the investment.

The rule in s. 212.3(25)(c)(ii) is anomalous in that it deems the property transferred in respect of the deemed investment in the underlying partnership property to be equal to that property's fair market value, notwithstanding that the quantum of the investment in the partnership might be reduced to take into account partnership-level debt.

Example 25c-A (partnership level debt)

CRIC, which is controlled by non-resident Parent and whose shares have a PUC of $100, acquires the units of LP (and the shares of the general partner thereof having a nominal general partner interest) for $100. The assets of LP consist of the shares of a foreign subsidiary (FA) having a fair market value of $120 and the shares of Cansub (a Canadian subsidiary) having a fair market value of $80. LP has debt of $100.

Under s. 212.3(25)(c)(i), CRIC is deemed to have acquired the shares of FA; and under s. 212.3(25)(c)(ii), it is deemed to have transferred $120 of property in respect of that acquisition. This will result in Parent being deemed by s. 212.3(2) to receive a dividend of $120. After applying draft s. 212.3(7), the PUC of the shares of CRIC is reduced to nil, and the deemed dividend is reduced to $20.

A deemed acquisition under s. 212.3(25)(c) by an investing partner of shares or other securities of a subject corporation (or of a Canadian-resident-corporation substantially invested in a subject corporation) that are partnership property can potentially benefit from exemptions in s. 212.3(18)(c), namely, where the partner investment causes it to be deemed to acquire shares of a Canadian holding company for a non-resident subsidiary. See 2013 Ruling 2013-0491061R3 above.

S. 212.3(25)(c) is engaged only when there is an increase in the percentage interest of the partner. Accordingly, it will not apply to a cash contribution of capital by a partner to a unitized partnership (as contrasted to a partnership where the partners' respective entitlements are based on their capital accounts) or to proportionate cash subscriptions by all the partners for partnership units.

Paragraph 212.3(25)(d)

Commentary

For the purposes of s. 212.3 and other specified sections, s. 212.3(25)(d) deems an amount owing by a partnership to instead be owed by each member of the partner based on the relative fair market value of the members' interests in the partnership (whether held directly or through another partnership). This rule can affect the operation of the indirect acquisition rule in s. 212.3(10)(f).

Example 25d-A (Effect of s. 212.3(25)(d) debt look-through on s. 212.3(10)(f) indirect acquisition rule)

CRIC, which is controlled by non-resident Parent, acquires all the shares of Canco for $100 in an arm's length acquisition. Canco has no liabilities and its assets comprise shares of a non-resident subsidiary (FA) with a fair market value ("FMV") of $80, and shares of Cansub (a Canadian-resident subsidiary) with a FMV of $20. Cansub's only significant asset is a 99.99% interest in a limited partnership (LP) which holds assets with a FMV of $40 and which is obligated for third party debts of $20.

In the absence of the operation of ss. 212.3(25)(b) and (d), the acquisition by CRIC of Cansub would engage the s. 212.3 rules by virtue of s. 212.3(10)(f), as FA would represent more than 75% of the assets of Cansub. Ss. 212.3(25)(b) and (d) deem Cansub to own assets with a FMV of approximately $40 and to have debt obligations of approximately $20. However, s. 212.3(10)(f) stipulates that those debt obligations are to be ignored for purposes of its 75% relative value test. Therefore, Cansub effectively is deemed to have a FMV of $40. As FA represents $80/($80+$40) or 67% of the assets of Canco, there is no indirect acquisition by CRIC of FA under s. 212.3(10)(f).

Paragraph 212.3(25)(e)

Commentary

S. 212.3(25)(e) curtails the scope of s. 212.3(25)(a) by providing that it does not apply to the extent of transactions between a partner and the partnership. More specifically, where a a member of a partnership enters into a transaction with (or "participate in an event" with) a partnership, s. 212.3(25)(e) overrides the deeming rule in s. 212.3(25)(a) by providing that s. 212.3(25)(a) does not apply "to the extent" that it otherwise would have deemed the member to have entered into the transaction (or participated in the event). The Explanatory Notes of the Department of Finance provide the following example.

[W]here a CRIC sells its shares of a foreign affiliate to a partnership of which it owns a 50% interest, paragraph 212.3(25)(e) will prevent paragraph 212.3(25)(a) from treating the CRIC as having acquired, through the partnership, 50% of those foreign affiliate shares.

Example 25e-A (Explanatory Notes Example)

As CRIC is a 50% partner of the partnership, s. 212.3(25)(a) would treat the acquisition by the partnership of FA as an acquisition by CRIC to the extent of that 50% interest. However, s. 212.3(25)(e) overrides this result to that same extent, so that s. 212.3(25)(a) has no application.

Paragraph 212.3(25)(f)

Commentary

S. 212.3(25)(f) deems a person or partnership that is (or is deemed under that paragraph to be) a member of a particular partnership, that itself is a member of another partnership, to be a member of the other partnership. The Explanatory Notes of the Department of Finance state:

In other words, this rule ensures that a member of an upper-tier partnership is also considered to be a member of a lower-tier partnership of which the upper-tier partnership is a member.

Example 25f-A (Winding-up of intermediate partnership)

CRIC holds 100% of the interests in Partnership 2 (directly with the exception of a nominal general partner interest held through a subsidiary) which, in turn, holds a 50% general partner interest in Partnership 1, with the other interest held by a 3rd party. The assets of Partnership 1 include all the shares of a non-resident corporation (FA).

Partnership 2 is wound-up so that CRIC now directly holds a 50% interest in Partnership 1.

S. 212.3(25)(f) deems CRIC to be a member of Partnership 1 for purposes of s. 212.3. It may follow from this that (under a double application of s. 212.3(25)(b)) that upon the winding-up of Partnership 2, CRIC already is deemed to own approximately 50% of the shares of FA, so that such winding–up does not result in any change in its investment in FA. Alternatively, s. 212.3(25)(e) may deem the acquisition by CRIC of FA through an acquisition of an approximate 50% interest in Partnership1 on the winding-up of Partnership 1 not to be an investment by CRIC.