(1)

STIKEMAN ELLIOTT

BASIC RULE

> corporation resident in Canada cannot deduct interest on debtowing to a specified non-resident to the extent that such debtexceeds 2x equity

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STIKEMAN ELLIOTT

> Why do we have such rules?

> Why do they only apply to specified non-resident shareholders?

> Why aren't guarantees from foreign parents caught?

STIKEMAN ELLIOTT LLP ^ SLIDE 2

STIKEMAN ELLIOTT

Why such rules?

> to prevent erosion of the domestic tax base by not allowing foreignshareholders to thinly capitalize Canadian subsidiaries

STIKEMAN ELLIOTT LLP ^ SLIDE 3

STIKEMAN ELLIOTT

Why is only debt to specified non-residents included?

> The rules appear aimed at preventing shareholders from convertingtoo much of their equity into debt and are not meant to disrupt third-party borrowings.

STIKEMAN ELLIOTT LLP ^ SLIDE 4

STIKEMAN ELLIOTT

Why is guaranteed debt not caught?

> per Mintz Committee: "While it is clear, from a tax policy viewpoint,that back-to-back financing should be addressed by the thin-capitalization rules, the treatment of guaranteed debt is not asevident....the inclusion of guaranteed debt might often disruptnormal commercial financing arrangements."

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STIKEMAN ELLIOTT

Recommendations of the Mintz Committee (December 1997)

1) move from 3 to 1 to a 2 to 1 ratio, which has been done

2) extend rules to Canadian branches of foreign corporations and topartnerships and trusts

3) strengthen back-to-back rules to include all indebtedness (such asdeposits) to extent that it may reasonably be considered to haveindirectly funded the Canadian business

STIKEMAN ELLIOTT LLP ^ SLIDE 6

STIKEMAN ELLIOTT

Recommendations of the Advisory Panel on Canada's System ofInternational Taxation (December 2008)

> reduce ratio from 2:1 to 1.5:1> expand to include partnerships, trusts and branches> curtail tax-motivated debt dumping

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STIKEMAN ELLIOTT

not ok

ok

Bank > Foreigncoguarantee

Bank E--- Foreignco

Canco

Canco

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STIKEMAN ELLIOTT

not ok

ok?

Bank <--..---loan

Foreignco

Bank <-.. deposit

Foreignco

Canco Canco

STIKEMAN ELLIOTT LLP l SLIDE 9

STIKEMAN ELLIOTT

Quantum of Interest Rate

> transactional approach vs. functional analysis

> would a third-party lend on such terms

> would borrower accept funds on such terms from a third-party

- as a stand alone company

- as a member of its corporate group

> inherent or implied parent guarantee

STIKEMAN ELLIOTT LLP ( SLIDE 10

STIKEMAN ELLIOTT

The opening words of 18(4) are "Notwithstanding any otherprovision of this Act".

Does this mean that section 245 cannot be applied to alter thetechnical results that follow from 18(4)?

Former 18(13) had the same language and counsel got absolutelynowhere arguing this point.

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STIKEMAN ELLIOTT

amount of debt under 18(4)(a)(i) is: the average for each calendarmonth of the greatest amount at any time in the month of debt tospecified non-residents

• Does this include interest bearing and non-interest bearingdebt?

• be careful when replacing debt that old and new debt are notoutstanding for any period of time

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STIKEMAN ELLIOTT

equity under 18(4)(a)(ii) is: 2x the total of:

• retained earnings at the beginning of the year on anunconsolidated basis

• average of contributed surplus at the beginning of each month,to the extent contributed by a specified non-residentshareholder

• average of puc at the beginning of each month, excluding pucof shares not owned by specified non-resident shareholders

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STIKEMAN ELLIOTT

• paid-up capital is at the beginning of each month, but debt ishighest amount during month

• retained earnings only at beginning of year- rules create problems for the month in which a new company is acquired

• paid-up capital and contributed surplus only if "belonging to" thenon-resident - so only applies to first tier Canadian companies- all retained earnings are counted

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STIKEMAN ELLIOTT

"specified shareholder"

> either alone, or with non-arm's length parties, owns 25% or more of

votes or value

> options, warrants held by such person deemed to have beenexercised

- even if all shareholders have options, only those held by specific non-resident deemed to be exercised

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STIKEMAN ELLIOTT

subsection 18(5.1)

• safe harbour where lender became a shareholder to safeguardposition re indebtedness

subsection 18(6)

• where specified non-resident shareholder loans funds toanother on condition that a loan be made by any person to acorporation resident in Canada, the lesser of the 2 loans shallbe deemed to have been made by the specified non-residentshareholder to the corporation resident in Canada

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