Section 212.3

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.

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).

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 1^st 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.

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.

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 (3^rd 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

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.

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 3^rd 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.

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.

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).

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.

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.

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.

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.

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).

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.

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).

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.