Section 18.4

Subsection 18.4(1)

Canadian Ordinary Income

Paragraph (a)

Subparagraph (a)(iii)


Joint Committee, "Hybrid Mismatch Arrangements Proposals", 30 June 2022 Submission of the Joint Committee

Ambiguity as to whether general deductions come within the (a)(iii)(A) and (B) exclusions (under 4. “Canadian Ordinary Income” & “Foreign Ordinary Income” Definitions”)

  • The relevant portions of the definitions of Canadian ordinary income (e.g., (a)(iii)(A) and (B) and foreign ordinary income should be clarified so that inclusions for a particular amount are not reversed as a result of any deductions or other relief that may be applicable as a result of other payments – that is, payments other than the payments that give rise to the included amounts. - For example, if a taxpayer borrows money at interest from a third party for the purpose of making an interest-bearing loan to a subsidiary, the taxpayer’s interest revenues would be expected to result in Canadian ordinary income, so that there would be considered to be an income inclusion in Canada.

Specified Entity


Joint Committee, "Hybrid Mismatch Arrangements Proposals", 30 June 2022 Submission of the Joint Committee

More explicit exclusion needed for mere security arrangements (under “9. Proposed Subsection 18.4(17) & Security Interests”)

The “specified entity” rules should contain an express exclusion for arrangements that secure indebtedness, equivalent to the exclusion provided in subsection 18(5.1).

Subsection 18.4(3)


Joint Committee, "Hybrid Mismatch Arrangements Proposals", 30 June 2022 Submission of the Joint Committee

Recommended exclusion of ss. 12.7 and 18.4 from the foreign affiliate context (under “3. Application to Foreign Affiliates”)

  • Where, for example, a FAPI-earning controlled foreign affiliate has issued a financial instrument that is treated as debt from a Canadian perspective and as equity from a foreign tax perspective, it seems inappropriate to deny a deduction in computing such FAPI through an extension to such context of the proposed hybrid mismatch rules, given that if this instrument had instead been treated as equity from a Canadian perspective, such that there would not have been any deduction in computing FAPI for the “interest” payments, the existence of the instrument would have in any event resulted in a reduction of the Canadian taxpayer’s participating percentage in respect of the affiliate, and thus a corresponding reduction of attributed FAPI.
  • It is recommended that s. 95(2)(f.11)(ii)(A) be expanded to exclude the application of ss. 12.7 and 18.4 in computing a foreign affiliate’s income from property, income from a business other than an active business and income from a non qualifying business.

Subsection 18.4(9)


Joint Committee, "Hybrid Mismatch Arrangements Proposals", 30 June 2022 Submission of the Joint Committee

Potential double taxation through considering there to be a mismatch where the amount is deductible (but not actually deducted) in the foreign jurisdiction (under “6. Proposed Subsection 18.4(6): Application to Deductible Amounts)

Variable “C” of proposed paragraph 18.4(6)(b) determines whether a payment gives rise to a deduction/non-inclusion mismatch by reference to whether the payment would be, or would reasonably be expected to be, in the absence of any foreign expense restriction rule, deductible in computing foreign income. It appears the test of “deductible” as opposed to a test of “deducted” could give rise to double taxation due to the application of proposed section 12.7 where there is in fact no deduction taken in the foreign jurisdiction. This issue is particularly relevant for the notional interest expense rule in proposed subsection 18.4(9), which does not require an actual payment. ...

We recommend that the test of “deductible” be changed to a test of “deducted”, at the very least, in proposed subsection 18.4(9).

Subsection 18.4(10)


Simon Townsend, Silvia Wang, "Can the Hybrid Mismatch Rules Affect Canadian ULCs?", International Tax Highlights, Vol. 3, No. 1, February 2024, p. 5

Example 1 (p. 5)

  • A US C corporation (“US Parent”) wholly owns a Canadian ULC (“Cansub”) that is disregarded in the U.S. and to which it made an interest-bearing loan. The interest payments are deductible in Canada by Cansub.

Example 1: non-application of hybrid financial instrument rules (pp. 5-6)

  • Although there is a deduction in Canada but no recognition of income in the United States, resulting in a deduction/non-inclusion (D/NI) mismatch, this structure may not represent a hybrid financial instrument under the hybrid mismatch arrangement (HMA) rules in Bill C-59 ( the “first package”) given inter alia that the D/NI mismatch arises primarily because of the difference between the countries in their tax treatment of Cansub (that is, regarded/disregarded), not because of a difference in the tax treatment of the financial instrument as such and that the OECD Action 2 Report states that “[a] payment cannot be attributed to the terms of the instrument where the mismatch is solely attributable to the status of the taxpayer or the circumstances in which the instrument is held.”

Example 1: potential application of second package (p. 6)

  • The portion of the BEPS Action 2 Report that might be included in a second package of amendments (the “second package”) provides (in Chapter 3) that no mismatch will arise to the extent that the payer’s deduction is set off against “dual-inclusion income,” being an item included in income under the laws of both the payer and payee jurisdictions.
  • Under the second package, interest expense might be disallowed in Canada to the extent that Cansub was in a net loss position.
  • A deeming rule might be introduced to deem the interest payment to be a dividend paid to US Parent, which would be subjected to a 25% withholding tax rate based on the anti-hybrid rule in Art. IV(7)(b) of the Treaty.

Example 2 (p. 6)

  • In a variation of Example 1, the loan to Cansub (again, a disregarded ULC subsidiary of US Parent ) is made by a US C-corp. subsidiary of US Parent (US Sub) out of its own funds rather than by US Parent. (See 2010-0376751E5.)

Example 2: non-application of first package (p. 6)

  • As in Example 1, it is arguable that the first package will not apply.

Example 2: potential application of second package (p. 7)

  • Respecting the second package, under Chapter 6 of the Action 2 Report, although Cansub would be a “hybrid payer” (its interest payments are deductible in Canada and also generate a duplicate deduction for the US investor, viz., US Parent, in the US), the Chapter 6 “deductible payments rule” does not apply if a deduction can be offset against an amount that will be included in income in both jurisdictions, so that if the interest expense can be offset against income of Cansub (which is taxed in both jurisdictions), the rule may not apply – but may apply if Cansub is in a loss position.

Example 3 (p. 7)

  • Example 3 is the same as Example 2, except that Cansub receives the loan from a third party rather than US Parent. There is a double interest deduction: by Cansub in Canada, and by US Parent in the US.

Example 3: non-application of first package (p. 7)

  • If it was not a structured arrangement (which would entail it being reasonably considered that a portion of the economic benefit arising from the D/NI mismatch is reflected in the pricing of the transaction giving rise to a D/NI mismatch, or the transaction or series was otherwise designed to give rise to the D/NI mismatch), then it would not be considered a hybrid financial instrument arrangement and would not be caught by the first package.

Example 3: non-application of second package (p. 7)

  • Chapter 6, which is relevant to the application of the second package, includes, in its overview, a scoping rule, which denies a deduction in the payer jurisdiction (Canada) only where the parties are in the same control group or are part of a structured arrangement – so that if this loan is not a structured arrangement, chapter 6 may not apply, and the interest deduction may not be disallowed in Canada.