foreign affiliate dumping - thor.ca

Foreign Affiliate Dumping December 1, 2013

Ian Gamble, Partner Thorsteinssons, LLP

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Purpose

This Quick Update Report is intended to assist the reader in understanding Canada’s so‐called “foreign affiliate dumping” (FAD) rules.

The Beginning

2007 Expert Panel: “Debt‐Dumping” In the 2007 federal Budget, the Canadian government announced it would strike an independent (i.e., non‐government) panel of experts (the Panel) to review Canada's system of international taxation. The Panel's mandate was to make recommendations for an international tax policy framework, specifically with respect to cross‐border investment: i.e., Canadian businesses investing abroad (outbound) as well as foreign businesses investing into Canada (inbound). In December of 2008, the Panel released a comprehensive report, offering many constructive and forward‐looking recommendations. However, one of the Panel’s recommendations dealt with a perceived abuse of the existing system labeled as “debt‐dumping”. This was described as foreign‐owned Canadian companies borrowing funds and using those borrowed funds to acquire shares in a related foreign corporation in the group. In broad terms, the perceived abuse arose from the Canadian company’s ability to deduct interest on the borrowed funds – and thereby reducing its Canadian‐source income – while at the same time being able to earn tax‐free dividends from the foreign corporation’s active business income (exempt surplus). The Panel recommended that rules be introduced to curtail this practice, while at the same time “ensuring bona fide business transactions are not affected”. In the 2012 federal budget, Canadian government seized on this recommendation but also amplified it significantly.

Implementation and Escalation 2012 Federal Budget

The debt‐dumping transactions identified by the Panel were re‐framed in the 2012 federal Budget as “foreign affiliate dumping” transactions. The classic example was the transaction identified by the Panel: a Canadian subsidiary using borrowed funds to acquire shares of a foreign affiliate from its foreign parent corporation. Interest paid by



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the Canadian subsidiary on such borrowed money would be deductible while, at the same time, most dividends received by the Canadian subsidiary on the shares of the foreign affiliate would be exempt from taxation (under Canada’s exemption system for foreign active business earned in treaty countries). The Canadian government agreed this represented an erosion of the Canadian corporate tax base. It was further thought that thin capitalization rules did not provide adequate protection against these transactions. The government, however, went further to describe “variations of these transactions”, including the following:

the acquisition of shares of a foreign affiliate using internally generated funds of

the Canadian subsidiary;

the acquisition of newly‐issued shares of an existing foreign affiliate, whether financed with internal or borrowed funds, where previously‐issued shares of the foreign affiliate were owned by the foreign parent or another non‐resident member of the same corporate group;

the acquisition of foreign affiliate shares from a foreign subsidiary of the foreign

parent; and

the acquisition of foreign affiliate shares from an arm's length party at the request of the foreign parent.

Such transactions were seen as a way for the foreign parent corporation to effectively extract earnings from their Canadian subsidiaries free of Canadian dividend withholding tax (WHT).

The 2012 Budget proposed that, where certain conditions were met, a dividend would be deemed to be paid by a Canadian subsidiary to its foreign parent to the extent of any consideration given by the Canadian subsidiary for the acquisition of shares of a foreign affiliate. Any deemed dividend would be subject to non‐resident WHT, as reduced by any applicable tax treaty.



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The 2012 Budget further proposed to disregard the paid‐up capital (PUC) of any shares of the Canadian subsidiary that were issued by the Canadian subsidiary as consideration for the acquisition of shares of the foreign affiliate. In this respect, the new rule would effectively broaden a similar cross‐border “surplus stripping rule” (involving Canadian affiliates) to cover these new transactions involving foreign affiliates. Finally, the 2012 Budget announced an exception for certain transactions that satisfied a “business purpose” test. In general terms, the factors necessary for this exception were directed towards determining whether it was reasonable to conclude that the investment in, and ownership of, the foreign affiliate “belongs” under the Canadian subsidiary more than in any other entity in the foreign parent's group. The Canadian government readily admitted that determining whether such an exception might be available in any case would “not be straightforward”. The new rules as introduced in the 2012 budget would be applicable to transactions that occur on or after the day the budget was announced, subject to certain grandfathered transactions.

The Present FAD Rules High Level

Following the 2012 Budget, taxpayers made various representations that resulted in certain modifications to the rules as originally proposed. Changes were introduced in 2012 and August 2014. What follows is a brief overview of the underlying principles in the FAD rules.

Targeted Companies. The targeted companies are Canadian companies controlled by foreign companies. (Such a company is defined in the FAD rules simply as a “corporation resident in Canada”, or CRIC for short. Accordingly, you sometimes see these rules called the “CRIC rules”.)

Targeted Investments. The targeted investments by the Canadian companies include shares of a foreign affiliate, capital contributions to a foreign affiliate, loans to a foreign affiliate, and shares of a Canadian company the assets of which are substantially foreign affiliate shares. Supporting rules deal with certain corporate migrations into Canada, as well as certain equity contributions by the foreign parent into the Canadian company.



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Principal Tax Consequences. The targeted investment triggers a deemed dividend subject to WHT or an automatic reduction to available in‐bound, cross‐border paid up capital (PUC) of shares held by the foreign parent company in the Canadian company. The apparent tax policy is that any such available cross‐border PUC could otherwise have been used to return capital free of any deemed dividend (and withholding tax). Accordingly, the automatic reduction of PUC is essentially a proxy for this. The reduced PUC may be reinstated, in certain defined situations, if the targeted investment is later distributed back out of Canada.

Key Exceptions. Three exceptions are available in concept.

1. The PLOI Regime. An exception is provided for a “pertinent loan or

indebtedness” (PLOI). This allows the Canadian company to make certain loans to a foreign affiliate and elect that they be excluded from the FAD rules. The price of such an election is that the PLOI generally attracts the highest amount of deemed interest income under the existing interest imputation regime in Canada (generally the 3‐month Government of Canada Treasury Bill rate plus 4%, set quarterly – currently about 6%). Furthermore, if the PLOI has been funded with debt incurred by the Canadian company that has an interest rate that exceeds this deemed interest income on the PLOI, the deemed interest income on the PLOI increases to match this (higher) rate. In this respect, the PLOI rules ensure that the interest income included in the Canadian company’s income in respect of the PLOI is at least equal to the interest payable on any related debt owing by the Canadian company.

2. Certain Reorganizations. A corporate reorganization exception is generally aimed at excluding certain defined direct and indirect acquisitions of foreign affiliate shares from the FAD rules, essentially where the shares acquired do not represent a new investment by the Canadian company in the foreign affiliate from an economic perspective. These exceptions do not apply to some reorganizations. Accordingly, careful review of any proposed restructuring is typically required to avoid unwanted surprises.



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3. Canadian‐Centric Business Expansions. An exception for “strategic business expansions” allows Canadian subsidiaries to invest in foreign affiliates in certain narrowly‐defined circumstances. In concept, these contemplate (i) a Canadian subsidiary making a strategic acquisition of (or an investment in) a business that is “more closely connected” to its business than to those of foreign companies in the group, where (ii) the officers of the Canadian subsidiary, with the required Canadian nexus, are the predominant decision makers in both a commercial and economic sense. Unfortunately, this exception for strategic business expansions will be difficult to meet for many multinational groups.

The above high‐level points should provide a sufficient understanding to recognize when a FAD issue may arise. However, the application of these rules to any situation requires a more in‐depth understanding of the specific provisions that may be engaged. Accordingly, Appendix A attached walks through the specific provisions in the FAD rules in some detail.

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APPENDIX A1

The Present FAD Rules In Detail

A. Triggering Conditions The rule in s. 212.3(1) provides the conditions for the application of s. 212.3(2), the latter being the main operative rule. By virtue of s. 212.3(1), s. 212.3(2) will apply to an “investment” (as defined in s. 212.3(10)) in a non‐resident corporation (referred to in s. 212.3 and in this commentary as the “subject corporation”) by a corporation resident in Canada (referred to in s. 212.3 and this commentary as the “CRIC”) where three conditions are met. The first condition, in s. 212.3(1)(a), is that the subject corporation 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). By virtue of the “series of transactions” reference, s. 212.3(2) can also apply where a portfolio (non‐foreign affiliate) interest in a non‐resident corporation is acquired by a CRIC in contemplation of a future event as a result of which the non‐resident becomes a foreign affiliate of the CRIC. The second condition, in s. 212.3(1)(b), is that the CRIC must be controlled by a non‐resident corporation (referred to in s. 212.3 and in this commentary as the “parent”) at the time the investment is made (or become so controlled as part of a series of transactions or events that includes the making of the investment). This condition generally distinguishes between Canadian‐based multinationals, to which the rules do not apply, and foreign‐based multinationals with Canadian subsidiaries, to which the rules are intended to apply. On August 16, 2013, proposed changes were released for s. 212.3(1)(b). First, it is amended to ensure that if the parent does not control the CRIC at the investment time,

1 This narrative is taken to a large extent from the Technical Notes helpfully produced by the Department of Finance in connection with the FAD rules.



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the condition in that paragraph is satisfied – and s. 212.3(2) may therefore apply – only if the parent acquires control of the CRIC after the investment time and as part of the series that includes the investment. The rule in s. 212.3(2) will not apply where the CRIC becomes controlled by a non‐resident corporation prior to, and as part of the series of transactions or events that includes, the making of the investment, provided that:

the CRIC is not controlled by a non‐resident corporation at the investment time, and

the CRIC does not become controlled by a non‐resident corporation after the investment time and as part of the series that includes the making of the investment.

The second amendment provides a “safe harbour”, subject to certain restrictions where (i) the CRIC does not fully participate in the investment in the subject corporation (i.e., acquires preferred shares), or (ii) has its risk limited in respect of the investment in the subject corporation. Even with the addition of the safe harbour rule, s. 212.3(1)(b) will continue to be satisfied where a non‐resident corporation controls the CRIC at the investment time because the requirement in s. 212.3(1)(b)(i) would be met. Where a CRIC is not at the investment time controlled by a non‐resident corporation, but subsequent to the investment time and as part of a series becomes controlled by a non‐resident corporation, s. 212.3(1)(b) will apply provided any of the conditions set out in s. 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, 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 is to be determined as if all rights referred to in s. 251(5)(b) were immediate and absolute and the parent and each of those other persons had exercised those rights.

The investment is an acquisition of shares of a subject corporation to which s. 212.3(1)(b)(ii) applies because of subsection 212.3(19), i.e., the shares are in



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substance preferred shares and the subject corporation is not a subsidiary wholly‐owned corporation.

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. This condition would be met, 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 purpose of the safe harbor 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. These amendments apply in respect of transactions and events that occur after March 28, 2012, subject to an election to have them come into force on August 14, 2012. Example 1. 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.



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New shares of Canco 1 are put up for sale 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. 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 s. 212.3(1)(b) are not satisfied, and s. 212.3(2) will not apply, in respect of the investment by Canco 2 in the shares of Forco. Example 2. 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. The investment by Canco 1 in Forco is an investment to which s. 212.3(2) would apply if the requirements in s. 212.3(1)(b) were satisfied. With respect to the safe harbour in s. 212.3(1)(b), it will apply if none of the conditions in s. 212.3(1)(b)(i) to (iii) are satisfied. The condition outlined in s. 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 s. 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 s. 212.3(1)(b) and s. 212.3(2) will not apply.



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Example 3. 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. 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. The rule in s. 212.3(1)(b) will apply if any of the conditions in ss. 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 s. 212.3(1)(b) and s. 212.3(2) will apply. The third 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. In general terms, s. 212.3(16) provides an exception from the application of s. 212.3(2) in circumstances where the investment is made by the CRIC in the context of a “strategic business expansion”. The rule in s. 212.3(18) provides exceptions from the application of s. 212.3(2) where the CRIC's investment in the subject corporation is made in the context of certain reorganization transactions that do not involve a new investment by the CRIC in the subject corporation. These are discussed further below. B. Main Rule New s. 212.3(2) is the main (operative) rule and it applies when the three conditions in s. 212.3(1) are satisfied. The rule in s. 212.3(2) can apply to deem dividends to be paid to the parent by the CRIC or can cause the paid‐up capital (PUC) of the shares of the CRIC to be reduced.



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Additional rules ensure that contributed surplus arising in connection with a targeted investment receives the same treatment that would apply to PUC. The definition of “equity amount” in proposed s. 18(5) excludes such contributed surplus from the computation of a CRIC’s debt‐to‐equity ratio for the purposes of the thin capitalization rules. Similarly, ss. 84(1)(c.1)‐(c.3) ensure that a deemed dividend will arise if such contributed surplus is converted to PUC. The rule in s. 212.3(2)(a) deems a dividend to be paid by the CRIC to the parent in an amount equal to the fair market value of any properties transferred, obligations assumed or incurred, or benefits otherwise conferred, by the CRIC, or property transferred to the CRIC in repayment 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 s. 212.3(2)(a) is that the parent is subject to Part XIII dividend WHT under s. 212(2). The reference in s. 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 s. 15(1). (The contribution of capital rule in s. 212.3(10)(b) has corresponding language.) However, under the new “secondary adjustment” rules in s. 247, s. 212.3(2) will not apply to a benefit conferral to the extent that s. 247(12) applies in respect of the benefit conferral, as provided under s. 247(15). This avoids a double‐count. The rule in s. 212.3(2)(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. Accordingly, 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 s. 84(1)(c.1) to (c.3) would apply to prevent such contributed surplus from subsequently being converted into PUC.



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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. An election is available under s. 212.3(3) to have the dividend deemed to have been paid by certain other corporations resident in Canada rather than the CRIC and, in certain circumstances, to have a non‐resident corporation other than the parent be deemed to be the recipient of the dividend. It is also possible, in many cases, for a deemed dividend to be reduced by certain amounts of PUC, as discussed below under ss. 212.3(6) and (7). 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 s. 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. Where applicable, paragraph 212.3(2)(a) deems a dividend to be paid by a CRIC to its parent in an amount equal to the fair market value of any properties transferred, obligations assumed or incurred, or benefits otherwise conferred, by the CRIC, or property transferred to the CRIC in repayment 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). On August 16, 2013, an amendment was proposed to s. 212.3(2)(a) to replace the reference to “investment time” with “dividend time”, which is defined in s. 212.3(1.1) discussed below. This change ensures an appropriate result where a CRIC makes an investment in a foreign affiliate at a time when the CRIC is not yet controlled by a non‐



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resident corporation, and the CRIC subsequently becomes so controlled as part of the series of transactions or events that includes the making of the investment. 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 s. 212.3(1.1) as the time when the parent acquires control of the CRIC (as long as control is acquired within 180 days after the investment time) – rather than at the investment time, the amendment generally ensures that the parent may benefit from the most favorable withholding rate reduction under the applicable treaty. If the parent does not acquire control within 180 days of the investment time, s. 212.3(1.1) provides that the dividend time occurs 180 days after the investment time, which may result in a higher withholding tax rate (depending on the terms of the applicable tax treaty). This amendment applies in respect of transactions and events that occur after March 28, 2012, subject to an election to have it come into force on August 14, 2012. C. Dividend Time On August 16, 2013, proposed new s. 212.3(1.1) was added to define “dividend time” in respect of an investment for the purposes of s. 212.3. The dividend time in respect of an investment is

if the CRIC is controlled by the parent at the investment time (within the meaning of s. 212.3(1)), the investment time (s. 212.3(1.1)(a)); or

in any other case, the earlier of (i) the first time, after the investment time, at which the CRIC is controlled by the parent, and (ii) the day that is 180 days after the day that includes the investment time (s. 212.3(1.1)(b)).

If the CRIC is not controlled by the parent at the investment time, and the parent does not acquire control within 180 days of the investment time, the dividend time will occur 180 days after the investment time, which could have implications for the parent, as described in further detail in the commentary on s. 212.3(2)(a) and s. 212.3(7). Dividend time is relevant for the purpose of determining the time at which a dividend is deemed to be paid under s. 212.3(2)(a). It is also relevant in determining – for the



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purposes of the PUC offset rule in s. 212.3(7), which may reduce the amount of the deemed dividend under s. 212.3(2)(a) – the measurement time for the relevant PUC adjustment. Corresponding amendments are made to s. 212.3(2)(a) and s. 212.3(7), in each case replacing references to “investment time” with “dividend time”. This amendment applies in respect of transactions and events that occur after March 28, 2012, subject to an election to have it come into force on August 14, 2012. D. Shifting to Other Entities The rule in s. 212.3(3) provides an election that allows for all or a portion of a dividend that would otherwise be deemed, under s. 212.3(2)(a), to be paid by the CRIC to the parent to instead be deemed to be paid by certain other Canadian‐resident corporations in the corporate group (that are “qualifying substitute corporations”, as defined in subsection 212.3(4)), to either the parent or another non‐resident corporation in the group. The amounts of the dividends deemed to be paid by the qualifying substitute corporations and the CRIC are agreed to in the election, which, in order to be valid, must allocate the entire amount of the deemed dividend otherwise arising under s. 212.3(2)(a) to classes of shares of qualifying substitute corporations and of the CRIC. Where an election is made under s. 212.3(3), s. 212.3 (7) provides rules that, in certain circumstances, allow the deemed dividends to be offset against, and therefore reduce, the paid‐up capital (PUC) of the classes of shares of the qualifying substitute corporations and the CRIC in respect of which the dividends are deemed to be paid.

Significant changes were introduced to s. 212.3(3) on August 16, 2013. The most significant change is that the scope of the election under the rule is more limited: it no longer has any impact on the PUC offset under s. 212.3(7), which now applies without the need for an election (i.e., it applies automatically). As a result of this amendment, the election under s. 212.3(3) is limited to determining the payer and the payee of the deemed dividend under s. 212.3(2)(a). The subsection allows an election to be made to have the dividend deemed

to have been paid by either the CRIC or a qualifying substitute corporation, as agreed on in the election; and

to have been paid to, and received by, either the parent or a non‐resident corporation that does not deal at arm’s length with the parent, as agreed on in the election.



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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. Subsection 212.3(3) is also amended to ease the filing requirements for the election by

removing the requirement that all qualifying substitute corporations in respect of the CRIC be parties to the election; the only qualifying substitute corporation that is required to be a party to the election is a qualifying substitute corporation that the CRIC elects to be the payer of the deemed dividend; and

providing that the election must be filed on or before the filing‐due date of the CRIC for its taxation year that includes the dividend time, rather than, under the current rules, by the earliest of the filing‐due dates of the CRIC and the qualifying substitute corporations for their taxation years that include the time the investment is made.

These amendments apply in respect of transactions and events that occur after March 28, 2012, subject to an election to have them come into force on August 14, 2012. A “qualifying substitute corporation” is defined in s. 212.3(4), in respect of a CRIC, for the purposes of s. 212.3. A qualifying substitute corporation is defined as a Canadian‐resident corporation that is controlled by the parent corporation of the CRIC and that has an equity percentage (as defined in s. 95(4)) in the CRIC, where at least one share of the capital stock of the corporation is owned by the parent or a non‐resident corporation with which the parent does not deal at arm's length. This definition is relevant for the purposes of the dividend substitution election in s. 212.3(3) and the dividend/PUC set‐off rules in ss. 212.3(6) and (7). Generally, the qualifying substitute corporation and dividend substitution concepts are meant to accommodate structures where one or more other Canadian‐resident corporations are situated between the parent and the CRIC in the corporate chain. On August 16, 2013, the rule was amended to provide that a Canadian‐resident corporation will satisfy the control requirement in this rule if it is controlled either by



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the parent or by a non‐resident corporation with which the parent does not deal at arm’s length. This amendment addresses, in particular, the situation where a qualifying substitute corporation is not controlled by the parent because the actual parent corporation that controls the related group is deemed by s. 212.3(15)(a) to not control the CRIC and thus is not the parent for purposes of s. 212.3. This amendment applies in respect of transactions and events that occur after March 28, 2012, subject to an election to have it come into force on August 14, 2012. E. PUC Offset Rules The rules in s. 212.3(6) and (7) allow for dividends that are otherwise deemed to arise under ss. 212.3(2)(a) or (3)(b) to be offset against the PUC of the shares of the CRIC, or qualifying substitute corporations in respect of the CRIC, in certain circumstances. The rule in s. 212.3(6) provides the conditions for s. 212.3(7) (the operative rules) to apply. The August 16, 2013, proposals would repeal s. 212.3(6). Substantial amendments were also made to s. 212.3(7), which now contains both the operative PUC offset rules and the conditions for their application. The most significant change is that, in all cases where the conditions for their application are satisfied, the PUC offset rules now apply automatically to offset the PUC in respect of relevant shares against the dividend otherwise deemed under s. 212.3(2)(a). Corresponding amendments are made to s. 212.3(3) to reflect the fact that an election is no longer required in order to have a PUC offset. The elimination of the election does not constitute a substantive change. The election only allowed the CRIC to choose whether to have the PUC offset apply. It did not generally permit the CRIC to choose the specific classes of shares whose PUC is used to offset the deemed dividend or the amount of PUC from each such class of shares used for the offset. Amended s. 212.3(7) contemplates two types of situations. The first is where the amount of the dividend that would, in the absence of s. 212.3(7), be deemed under s. 212.3(2)(a) to have been paid and received 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:



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the amount of the deemed dividend is reduced by the total PUC of the cross‐

border classes immediately before the dividend time, and the PUC of each of the cross‐border classes – having reduced, and been offset

against, the deemed dividend – is reduced to nil. For the purposes of s. 212.3(7), a class of shares in the capital stock of the CRIC, or of a qualifying substitute corporation, is a “cross‐border class” if any shares of that class are owned at the dividend time by the parent or another non‐arm’s length non‐resident corporation. The second type of situation is where the amount of the deemed dividend, determined without reference to s. 212.3(7), 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, as it is fully offset by the PUC in respect of the cross‐border classes, and

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 qualifying substitute corporation, there is to be deducted, in total, the amount of the dividend.

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 in respect of shares of cross‐border classes that are owned by the parent or another non‐arm’s length non‐resident corporation.

Under ss. 212.3(7)(b)(ii) and (iii), the deemed dividend must be allocated first to the class of shares of the CRIC or qualifying substitute corporation 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. The rule in s. 212.3(7)(c) also provides a filing requirement where the amount of the deemed dividend otherwise arising under s. 212.3(2)(a) is reduced because of s. 212.3(7)(a)(i) or s. 212.3(7)(b)(i). In that case, the CRIC must file with the Minister of



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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 before the dividend time, of the paid‐up capital of each cross‐border class;

the paid‐up capital of the shares of each cross‐border class 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 ss. 212.3(7)(a)(ii) or (b)(ii) in respect of each cross‐border

class. These amendments apply in respect of transactions and events that occur after March 28, 2012, subject to an election to have them come into force on August 14, 2012. F. PUC Reinstatement Rules The rule in 212.3(9) allows for a reinstatement of PUC in respect of a class of shares of a CRIC or a qualifying substitute corporation immediately before a reduction of capital in certain circumstances where the PUC was initially reduced by the operation of ss. 212.3(2)(b) or (7)(b). The amount by which the PUC may be reinstated is the least of three amounts. The first is the amount of the distribution or reduction of PUC by the particular corporation. The second is the amount by which the PUC of the particular corporation was reduced by the operation of s. 212.3(2)(b) or (7)(b). The third amount is based on the extent to which the distribution is traceable to property acquired as an investment (referred to here as the “original property”) in a subject corporation. For this purpose, two situations are contemplated: either i) the original property consists of foreign affiliate shares, and those shares or substituted shares are distributed by the particular corporation, in which case the amount is based on the fair market value of the distributed shares; or ii) proceeds from a disposition of subject corporation shares or of a debt owing by a subject corporation, or dividends or reductions of capital in respect of such shares, are distributed, in which case the amount is based on the amount of the proceeds, dividends or reductions of capital. In the latter case, the particular corporation is required to trace the proceeds, dividends or



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reductions of capital to the distribution and to establish that they occurred within 180 days of the distribution. On August 16, 2013, the rule in s. 212.3(9) was amended in four respects. First, in order to clarify that the PUC reinstatement can apply not only where the particular Canadian corporation reduces PUC as part of a return of capital, but also where such PUC is reduced as a result of a redemption, acquisition or cancellation of shares by the particular Canadian corporation, the following amendments are made:

The existing requirement in the preamble to s. 212.3(9) that the particular corporation “reduces” the PUC in respect of the relevant class of shares is modified to require that the PUC “is reduced”, to clarify that the requirement can be met where the PUC is reduced as a result of a redemption, acquisition or cancellation of shares.

Minor changes are also made to s. 212.3(9)(a) to clarify its application in context of a redemption, acquisition or cancellation of shares.

The reference in s. 212.3(9)(c)(i) to “the property distributed on the reduction of

paid‐up capital” is replaced with “the paid‐up capital is reduced at the subsequent time as part of or because of a distribution of property”. This change reflects the fact that in the case of a share redemption, for example, the paid‐up capital reduction might be considered to occur because of a distribution of property.

Second, s. 212.3(9)(b)(i) is amended to recognize that both s. 212.3(2)(b) and s. 212.3(7) may apply in respect of the same investment to reduce the PUC of shares and that a reinstatement of the PUC reduced under both provisions is potentially available. Third, the preamble to s. 212.3(9) is amended to refer to investments described in any of ss. 212.3(10)(a) to (f), and s. 212.3(9)(c)(ii)(A)(III) is introduced, to extend the application of the PUC reinstatement rules to certain circumstances where the original property is a debt owed by a subject corporation, as described in ss. 212.3(10)(c) or (d) or s. 212.3(10)(e)(i). This permits the PUC reduced under s. 212.3(2)(b) or s. 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.



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Fourth, s. 212.3(9)(c)(ii)(B) is introduced. It effectively provides that, where s. 212.3(9)(c)(ii)(A) applies, a PUC reinstatement is available only if the property received by the particular corporation is traceable to the original property and is not acquired as part of an investment in a subject corporation to which s. 212.3(2) does not apply. This ensures that there is no PUC reinstatement where, for example, a particular Canadian corporation receives shares or another interest in a foreign affiliate if s. 212.3(2) does not apply to the investment because of an exception in s. 212.3(16) or (18). In that case, the newly‐acquired shares or other interest in the foreign affiliate would not be expected to enhance the income‐earning capacity of the CRIC’s Canadian operations in a manner warranting a PUC reinstatement. If the particular Canadian corporation replaces the original property with a new property, the new property was acquired as part of an investment in a subject corporation to which s. 212.3(2) does not apply, and the particular Canadian corporation subsequently distributes other property, then the PUC reinstatement rule will not apply because the amount determined under s. 212.3(9)(c)(ii) will be nil. However, the restriction in s. 212.3(9)(c)(ii)(B) would not apply, for example, if the original property is disposed of for cash because the cash would not be property acquired as part of an investment in a subject corporation. In addition, the restriction would not apply if the new property acquired was acquired as part of an investment in a subject corporation to which s. 212.3(2) applies. These amendments apply in respect of transactions and events that occur after March 28, 2012, subject to an election to have them come into force on August 14, 2012, except that s. 212.3(9)(c)(ii)(B) applies only in respect of transactions and events that occur on or after August 16, 2013. G. Types of Investment in Foreign Affiliate An “investment” in a subject corporation made by a CRIC is defined in s. 212.3(10). By virtue of s. 212.3(10)(a), an investment includes an acquisition of shares of the subject corporation by the CRIC. This includes acquisitions by the CRIC of newly issued shares of the subject corporation. It also includes acquisitions by the CRIC of issued and outstanding shares of the subject corporation from the CRIC's non‐resident parent corporation, another corporate group member or an arm's length person or partnership.



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By virtue of s. 212.3(10)(b), an investment includes a contribution of capital to the subject corporation by the CRIC. Thus, a transfer of property by the CRIC to the subject corporation is an investment even if the CRIC does not take back any shares or debt of the subject corporation. In addition, for these purposes, s. 212.3(10)(b) deems a contribution of capital to include any transaction or event under which a benefit is conferred on the subject corporation by the CRIC. This benefit conferral rule is similar to the rule in s. 15(1) that applies in the shareholder benefit context. By virtue of s. 212.3(10)(c), an investment includes a transaction under which an amount becomes owing by the subject corporation to the CRIC, unless the amount owing satisfies either of two exceptions. The first exception, in s. 212.3(10)(c)(i), is for an amount that becomes owing to the CRIC in the ordinary course of the CRIC's business and is repaid, other than as part of a series of loans and repayments, within 180 days of the day it becomes owing. The “ordinary course of business” exception could apply, for example, where the CRIC supplies property to the subject corporation on credit in the ordinary course of the CRIC's business operations (and the resulting debt is repaid in the manner required by that exception). The second exception, in s. 212.3(10)(c)(ii), is for an amount owing that the CRIC and the parent have jointly elected under paragraph 212.3(11)(c) to have treated as a “pertinent loan or indebtedness” (PLOI). This is discussed below. Subject to the foregoing two exceptions, s. 212.3(10)(c) is generally intended to include, as investments the following: loans made by the CRIC to the subject corporation; transactions resulting in trade debts or other unpaid purchase price owing by the subject corporation to the CRIC; and any other transaction as part of which an amount becomes owing by the subject corporation to the CRIC. Paragraph 212.3(10)(c) is amended to add a third exception for an amount that is owing by a subject corporation to a CRIC because a dividend has been declared, but not yet paid, by the subject corporation (within the meaning of s. 212.3(1)).

By virtue of s. 212.3(10)(d), an investment includes an acquisition of a debt obligation of the subject corporation by the CRIC from another person, subject to two exceptions. The first exception, in s. 212.3(10)(d)(i), is for an acquisition made in the “ordinary course of the business” of the CRIC from a person with which the CRIC deals, at the time of the acquisition, at arm's length. The second exception, in s. 212.3(10)(d)(ii), is for an



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amount owing that the CRIC and the parent have jointly elected under paragraph 212.3(11)(c) to have treated as a PLOI. The rule in s. 212.3(10)(d) is intended to include acquisitions of outstanding debts of a subject corporation from any person (or, by virtue of the look‐through rules in s. 212.3(25), any partnership), whether dealing at arm's length or non‐arm's length with the CRIC. The rule in s. 212.3(10)(e) provides that an investment includes an extension of either the maturity date of a debt obligation owing by the subject corporation to the CRIC (other than a debt obligation that is a pertinent loan or indebtedness, as defined in s. 212.3(11), immediately after the extension) or the date on which shares of the subject corporation held by the CRIC are to be redeemed, acquired or cancelled by the subject corporation. For example, where the subject corporation issued a debt obligation or preferred shares to the CRIC before March 29, 2012 (i.e., the effective date of the foreign affiliate dumping rules) that would have been an investment under s. 212.3(10)(c) or s. 212.3(10)(a), respectively, had they instead been issued after March 28, 2012, an extension of the maturity date of the debt or the redemption date of the preferred shares would constitute an investment. Where, instead, the debt obligation or the shares are issued by the subject corporation to the CRIC after March 28, 2012, and s. 212.3(2) applies to such investment, a subsequent extension of the maturity or redemption date, as the case may be, would result in a second investment to which s. 212.3(2) would apply. For the purposes of determining the quantum of a dividend the CRIC is deemed to pay to its non‐resident parent under s. 212.3(2)(a) in respect of an investment described in s. 212.3(10)(e), s. 212.3(5) deems the CRIC to have transferred property to the subject corporation (that relates to the investment) with a fair market value equal to the amount owing on the debt obligation, or the fair market value of the shares, immediately after the investment. These rules are intended to give results similar to those that would occur had the debt been repaid and re‐loaned, or had the shares been redeemed and re‐issued, as the case may be, instead of being extended. The rule in s. 212.3(10)(f) provides that an investment includes certain indirect acquisitions of foreign affiliate shares by a CRIC, through the direct acquisition of shares



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of another Canadian‐resident “target” corporation. (For these purposes, it is important to take into account the partnership “look‐through” rules in s. 212.3(25).) Specifically, where a CRIC acquires directly shares of another Canadian‐resident target corporation — which itself holds, directly or indirectly, shares of one or more foreign affiliates — the indirect acquisition of each such foreign affiliate by the CRIC will be considered a separate investment in a subject corporation if the total fair market value of all the foreign affiliate shares held, directly or indirectly, by the Canadian target corporation comprises more than 75% of the total fair market value of all the properties owned by the Canadian target. The parenthetical language in s. 212.3(10)(f) requires that the computation of the total fair market value of all the properties owned by the Canadian target corporation be made without taking into account any debts of any Canadian corporation in which the Canadian target has a direct or indirect interest. As a result, where the Canadian target owns shares of another Canadian corporation, the fair market value of those shares is to be determined for these purposes without taking into account any debts of that other corporation. The debts of the Canadian target are also not taken into account because the 75% test is applied based on the “properties” of the Canadian target. The other computation required to be made in applying the 75% test in s. 212.3(10)(f) is of the total fair market value of all the shares the Canadian target corporation owns, directly or indirectly (i.e., through shareholdings of other corporations), of its foreign affiliates. This computation includes only the value of the Canadian target's proportionate equity interest in its foreign affiliates, rather than the total value of each foreign affiliate. In addition, since the parenthetical language in s. 212.3(10)(f) excludes only debts of Canadian corporations, any debts of foreign affiliates will be reflected in their share values for these purposes. Finally, where a foreign affiliate itself owns shares of another foreign affiliate of the Canadian target, such that the value of the upper‐tier foreign affiliate's shares reflects that of the lower‐tier affiliate, the rule against “double counting”, in s. 212.3(14)(b), precludes taking the value of the lower‐tier foreign affiliate into account more than once. The rule in s. 212.3(14) provides tests for applying the “indirect acquisition” rule in s. 212.3(10)(f). The rule in s. 212.3(14)(a) provides an anti‐avoidance provision that effectively extends the time for applying the 75% test in s. 212.3(10)(f) to the entire



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series of transactions that includes the acquisition of the Canadian target shares by the CRIC. Even if the condition in s. 212.3(10)(f) is not satisfied because the 75% threshold is not exceeded at the time of the acquisition, s. 212.3(14)(a) deems the condition to have been satisfied at that time if properties of the Canadian target corporation are subsequently disposed of as part of the series of transactions that includes the acquisition and such dispositions cause the 75% threshold to be exceeded at any time in the series. This rule is meant to address situations where, for example, the CRIC intends, at the time of the purchase, to retain the foreign affiliate investments while divesting itself of the Canadian business assets of the Canadian target corporation. The rule is also meant to address situations where the Canadian target, in anticipation of its acquisition by the CRIC, “stuffs” itself with non‐foreign affiliate assets that have no long‐term use in the company and will be disposed of shortly after the acquisition. The second rule is found in s. 212.3(14)(b) and is a rule against “double counting” in applying the 75% test in paragraph 212.3(10)(f). In computing the total fair market value of all the foreign affiliate shares owned directly or indirectly by the Canadian target, if a foreign affiliate itself owns shares of another foreign affiliate of the Canadian target such that the value of the upper‐tier foreign affiliate's shares reflects that of the lower‐tier affiliate, s. 212.3(14)(b) precludes the value of the lower‐tier foreign affiliate's shares from being taken into account separately. In effect, this rule is meant to achieve a form of consolidation for the purposes of the indirect acquisition rule. If the condition in s. 212.3(10)(f) is satisfied, then for the purposes of s. 212.3(2), the CRIC will be considered to have made a separate investment in a subject corporation for each foreign affiliate of the Canadian target corporation (all of which were indirectly acquired by the CRIC). As noted above in the commentary on s. 212.3(2), the CRIC must reasonably allocate the consideration paid for the Canadian target corporation to the foreign affiliate shares in order to determine the appropriate consequences under s. 212.3(2). Even if the condition in s. 212.3(10)(f) is not met at the time of the CRIC's investment in the Canadian target, s. 212.3(14)(a) will deem it to have been met at that time if property of the Canadian target corporation is subsequently disposed of as part of the same series of transactions as the investment.



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By virtue of s. 212.3(10)(g), an investment includes an acquisition by a CRIC of an option or interest in respect of either shares or debt (other than the kinds of debt excepted from the definition of investment under any of s. 212.3(10)(c)(i), (c)(ii), (d)(i) and (d)(ii)) of a subject corporation. The reference to an “interest” in this paragraph is not intended to include, in and of itself, an acquisition by a CRIC of shares of another Canadian corporation that itself holds shares or debt of a subject corporation. H. PLOI Exception New s. 212.3(11) defines PLOI, at any time, for the purposes of s. 212.3(10)(c)(ii), (d)(ii) and (e)(i), as an amount owing, at that time, by a subject corporation to a CRIC where certain conditions are met. There are two general categories of PLOI under s. 212.3(11). The first category includes amounts that become owing after March 28, 2012, and thus meet the condition in s. 212.3(11)(a)(i). In order for such an amount owing to be a PLOI, the condition in s. 212.3(11)(c)(i) must also be satisfied, by the CRIC and the parent filing a joint election in respect of that amount owing by the filing‐due date of the CRIC for the taxation year in which the amount became owing. The second category includes debt obligations that became owing before March 29, 2012 and to which s. 212.3(10)(e) would otherwise apply (i.e., absent the election to treat the debt obligation as a PLOI), as a result of an extension of the term of the debt obligation, at any time before the time when the PLOI status is tested. Such a debt obligation will be 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 is extended. In order for an amount owing that falls in either category to qualify as a PLOI, it must also satisfy the condition in s. 212.3(11)(b) that it not be described in either s. 212.3(10)(c)(i) or (d)(i) — as these provide their own exceptions from subsection 212.3(2). The result of being a PLOI is that such debts, instead of being subject to s. 212.3(2), will be subject to the high rate of interest imputation set out in s. 17.1(1) (generally the lowest prescribed rate plus 4%).



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I. Multiple Levels of Control by Non‐Resident Group

The rules in s. 212.3(15) determine control, for the purposes of s. 212.3 and the corporate immigration rule in s. 128(1)(c.3). The rule in s. 212.3(15)(a) provides 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. The rule in s. 212.3(15)(a) is a relieving provision. It is intended to prevent multiple dividends from being deemed under s. 212.3(2) or s. 128(1)(c.3). Multiple dividends could otherwise arise under s. 212.3(2) due to the fact that s. 212.3(2)(a) deems the CRIC to have paid a dividend to the “parent”, which is defined in s. 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 s. 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), s. 212.3(2)(a) could deem a separate dividend to have been paid to each such non‐resident. Similarly, in the absence of s. 212.3(15)(a), multiple dividends could be deemed under s. 128(1)(c.3) in similar circumstances since that paragraph deems an immigrating corporate taxpayer to have paid a dividend to a “particular non‐resident corporation”, which term refers to any non‐resident corporation that controls the CRIC. The rule in s. 212.3(15)(a) applies unless its application would result in the CRIC not being controlled by at least one non‐resident corporation. This exclusion addresses situations where corporate groups organize themselves so that all non‐resident “controllers” control each other. The rule in s. 212.3(15)(b) is also a relieving provision. It applies where a CRIC is controlled by a non‐resident corporation, and the non‐resident corporation is ultimately controlled by a Canadian‐resident corporation and not by any non‐resident. In these circumstances, the CRIC will be deemed not to be controlled by a non‐resident. As a consequence, the conditions of s. 212.3(1) will not be met and the foreign affiliate dumping rules will not apply to the CRIC.



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This subsection is amended in three respects. First, it is restructured by converting ss. 212.3(15)(a) and (b) into ss. 212.3(15)(a)(i) and (ii), respectively. Second, s. 212.3(15)(a)(i), which generally provides that a CRIC that is controlled by more than one non‐resident corporation is deemed not to be controlled by any non‐resident corporation that controls another non‐resident corporation that controls the CRIC, is amended to add a reference to “a taxpayer to which s. 128.1(1)(c.3) applies”, and the new term “specific corporation”, which refers to a CRIC or a taxpayer to which s. 128.1(1)(c.3) applies. These changes clarify that the rule in s. 212.3(15)(a)(i) applies for the purpose of determining the parent corporation in respect of an immigrating corporate taxpayer referred to in s. 128.1(1)(c.3). The third amendment to s. 212.3(15) introduces a deeming rule. New s. 212.3(15)(b) ensures that s. 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. The rule applies if 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 these conditions are met, the rule 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 amendments to s. 212.3(15)(a) apply in respect of transactions and events that occur after March 28, 2012, subject to an election to have them come into force on



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August 14, 2012. New s. 212.3(15)(b) applies in respect of transactions and events that occur on or after August 16, 2013. J. “More Closely Connected Business” Exception The rule in s. 212.3(16) provides an exception from the operative foreign affiliate dumping rule in s. 212.3(2). This exception generally recognizes that certain foreign affiliate investments made by foreign‐controlled CRICs may have been made by the CRIC even if the CRIC had not been foreign‐controlled. The exception is intended to allow a Canadian subsidiary of a foreign multinational corporation to invest in foreign affiliates where the Canadian subsidiary is making a strategic acquisition of a business that is more closely connected to its business than to that of any non‐resident member of the multinational group.

The onus is on the CRIC to demonstrate that the conditions in s. 212.3(16), as described below, are met. Also, the exception will not be available where the shares acquired are what are commonly referred to as “preferred shares”. The “preferred shares” carve‐out is discussed in the commentary on s. 212.3(19) below. The exception applies where five conditions are met. The first condition, in s. 212.3(16)(a), generally requires that the business activities of the subject corporation, and any corporation (referred to in s. 212.3(16) and in this commentary as a “subject subsidiary corporation”) in which the subject corporation has an equity percentage, be, collectively, more closely connected to the business activities carried on by the CRIC (or a Canadian‐resident corporation that does not deal at arm's length with the CRIC) in Canada than to those of any other non‐resident corporation that does not deal at arm's length with the CRIC (other than the subject corporation, a subject subsidiary corporation and any corporation that is a controlled foreign affiliate (CFA) of the CRIC for the purposes of s. 17). For these purposes, “business activities” is intended to refer to active business operations rather than simply investing in shares in other companies and the management and governance activities that may relate thereto. The concept of “connectedness” is not defined, but for the purposes of these rules it is intended that the business activities of two corporations be considered “connected” in either of two circumstances. First, business activities can be considered connected



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where they are similar in nature or “parallel”. For example, two businesses could be closely connected where they both involve the manufacture and distribution of similar types of products, or the provision of similar services. Second, business activities can be considered connected where they are integrated, in the sense of one corporation's business being “upstream” or “downstream” to the business of the other corporation, or in the sense of one business using technology of the other in its operations. Thus, for example, two corporations could be considered to have connected business activities if the primary activity of one corporation consists of selling the output of, or providing inputs to, the manufacturing process of the other corporation. In each case, the question is whether the businesses are connected in a manner indicative of the investment in the subject corporation being a logical expansion of the CRIC's business. In order for the condition in s. 212.3(16)(a) to be satisfied, it is not sufficient that the CRIC's and the subject corporation's businesses be connected or even closely connected — the businesses must be more closely connected to one another than the subject corporation's business is to the business of any other non‐resident corporate group member (other than the subject corporation, a subject subsidiary corporation or a CFA). Thus, this condition would not be met where, for example, the subject corporation's business is equally closely connected to that of the CRIC as it is to that of another non‐resident group member (other than a subject subsidiary corporation or a CFA). This requirement reflects the intention that the exception from s. 212.3(2) apply only where the relationship between the CRIC's and the subject corporation's businesses clearly justify the investment in the subject corporation being made by the CRIC rather than by another member of the multinational group. The rule in s. 212.3(16)(a) further requires that the parties have an expectation, at the time of the investment, that the closer business connection described above will continue for the foreseeable future. This requirement acts as a check to ensure that the connection to Canada is not temporary or contrived. The second condition, in s. 212.3(16)(b), is that officers of the CRIC must have had and exercised the principal decision‐making authority in respect of the making of the investment and a majority of those officers must be persons that are resident, and work principally, in Canada or the residence country of a “connected affiliate” (defined in s. 212.3(16)(b) to mean a corporation that is a CFA whose business activities are, and are expected to remain, at least as closely connected to those of the subject corporation



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and subject subsidiary corporations as are the Canadian business activities of the CRIC or any Canadian‐resident corporation that does not deal at arm's length with the CRIC) at the time the investment is made. The reference in s. 212.3(16)(b) to “principal” decision‐making authority is intended to ensure that this condition will be met only where substantive responsibility for the decision to make the investment, and with respect to the terms of the investment, rests with and is exercised by relevant officers of the CRIC. Where the CRIC's officers have and exercise only formal authority to approve the investment, but the real decision‐making authority with respect to the making of the investment resides with officers of a non‐resident corporation, then this condition will not be met. Similarly, where the formal decision‐making authority with respect to an investment in a foreign affiliate made by a CRIC is exercised by officers or directors of the non‐resident parent of the CRIC, the condition could still be met if, for example, the substantive business decisions with respect to the investment are made by the relevant officers of the CRIC, based on their execution of the business plan of the CRIC and having undertaken or managed all of the commercial and investment due diligence relating to the acquisition or investment in the subject corporation. The officers will be considered to work principally in Canada, or in the residence country of a connected affiliate, if they spend the majority of their working time in Canada or the connected affiliate's country, and also carry out a majority of their important functions, and make most of their important decisions, with respect to the CRIC in that country. The third and fourth conditions, in s. 212.3(16)(c)(i) and (ii), are that, at the time the investment is made, there must be a reasonable expectation that, at all times following the time of the investment, officers of the CRIC will have and exercise the ongoing principal decision‐making authority in respect of the investment and that a majority of those officers will be persons that are residents of, and work principally in, Canada or the residence country of a connected affiliate. This requirement will be met only where the relevant CRIC officers are expected to have and exercise the principal authority in respect of the key decisions concerning the ongoing investment in the subject corporation. The particular matters over which they would be expected to hold and exercise such authority would generally depend on the relative size and nature of the CRIC's



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investment in the subject corporation. For example, where the CRIC owns a controlling interest in the subject corporation, the range of matters in respect of the subject corporation over which the CRIC's officers can be expected to exercise principal decision‐making authority will be greater than where the CRIC does not own a controlling interest in the subject corporation. The commentary on s. 212.3(16)(b) above, regarding the nature of the decision making authority expected of the officers of the CRIC, is also relevant for s. 212.3(16)(c)(i). The fifth condition, in s. 212.3(16)(c)(iii), is that it must reasonably be expected, at the time of the investment, that the performance evaluation and compensation of officers of the CRIC (who are resident, and work principally, in Canada or in the residence country of a connected affiliate) will be based on the operating results of the subject corporation to a greater extent than will be the performance evaluation and compensation of any officer of another non‐resident group member (other than the subject corporation, a corporation controlled by the subject corporation or a connected affiliate). The extent to which an officer's performance evaluation or compensation is based on operating results would generally be expected to be determined based on a proportion of the officer's overall performance or compensation. Thus, where, for example, officers of the CRIC and officers of the non‐resident parent corporation both receive comparable bonus amounts that are linked (e.g., by a compensation formula) to the performance of the subject corporation, the compensation of the CRIC's officers may nevertheless be considered to be connected to the subject corporation's results to a greater extent than that of the parent's officers if such bonuses constitute a greater proportion of the overall compensation of the former than of the latter. As discussed above, it is expected that an officer's performance evaluation and compensation will reflect, to some extent, the operating results of the subject corporation. The extent to which the operating results of the subject corporation affect the performance evaluation and compensation of an officer would depend on the relative size and complexity of the subject corporation's operations and the level of responsibility the officer has over those operations. Where the CRIC acquires control of the subject corporation in circumstances where the investment in the subject corporation constitutes a strategic expansion of the CRIC's business, it is expected that the relevant officers of the CRIC would have a high level of



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responsibility over the subject corporation's operations and that a greater proportion of their compensation would be based on the operations of the subject corporation than any other officer's compensation in the multinational group. The same expectation exists where the CRIC does not have or acquire control of the subject corporation but the subject corporation is controlled by the multinational group of which the CRIC is a member. For a discussion of the requirement that the relevant officers be “resident, and work principally, in Canada”, see the commentary on s. 212.3(16)(b) above. For these purposes, s. 212.3(17) provides that any person that is an officer of the CRIC and of a non‐resident corporation that does not deal at arm's length with the CRIC (other than the subject corporation, a subject subsidiary corporation or a connected affiliate) is deemed to not be resident, and to not work principally, in a country in which a connected affiliate is resident. The condition in s. 212.3(16)(b) will be satisfied only where the relevant officers have the decision‐making authority and actually exercise such authority. Where this is the case, the CRIC would be, in this respect, acting in a manner similar to a Canadian (non‐foreign controlled) multinational corporation undertaking a strategic foreign expansion of its business. The August 16, 2013proposals include amendments to the conditions in ss. 212.3(16)(b) and (c). The condition in s. 212.3(16)(b) is that officers of the CRIC must have and exercise the principal decision‐making authority in respect of the making of an investment and a majority of those officers must be persons that are resident, and work principally, in Canada or the country of residence of a connected affiliate (within the meaning of s. 212.3(16)(b)(ii)) at the time the investment is made. The rule in s. 212.3(16)(b) is amended to provide that the condition in that provision can also be satisfied where officers of a corporation resident in Canada that does not deal at arm’s length with the CRIC at the investment time satisfy the requirements in that paragraph with respect to principal decision‐making authority and residence. This amendment makes s. 212.3(16)(b) more consistent with the existing s. 212.3(16)(a), which allows business activities of Canadian‐resident corporations that do not deal at arm’s length with the CRIC to be taken into account in determining whether the “closer connection” condition in that paragraph is met.



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Consistent with the amendment to s. 212.3(16)(b), s. 212.3(16)(c) is also amended to allow officers of a corporation resident in Canada with which the CRIC does not deal at arm’s length to be taken into account in determining whether the conditions in ss. 212.3(16)(c)(i) and (ii) are satisfied. The rule in s. 212.3(17) is amended consequential on the amendments to ss. 212.3(16)(b) and (c), to extend the deeming rule in the subsection to officers of a corporation resident in Canada that does not deal at arm’s length with the CRIC at the investment time.

These amendments apply in respect of transactions and events that occur after March 28, 2012, subject to an election to have them come into force on August 14, 2012. K. Indirect Funding The rule in s. 212.3(24) generally provides an exception from s. 212.3(2) that applies, in certain circumstances, where a CRIC funds one foreign affiliate indirectly through another foreign affiliate, and the exception in s. 212.3(16) would have applied had the CRIC instead funded the other foreign affiliate directly. 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 three things. First, under s. 212.3(24)(a), the CRIC must demonstrate that all of the property received by the subject corporation as a result of the CRIC's 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 section 17). Second, under s. 212.3(24)(b), 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 corporation that is being indirectly funded must be a corporation in which a direct investment by the CRIC would have qualified for the exception in s. 212.3(16). Finally, under s. 212.3(24)(c), the CRIC must demonstrate that, throughout the period during which the loan is outstanding, the indirectly funded corporation used the loan proceeds in an active business that it carried on in its country of residence.



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The rule in 212.3(23) is an anti‐avoidance measure 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 s. 212.3(16); an investment by the CRIC in a “bad” foreign affiliate would not satisfy that exception. More specifically, s. 212.3(23) provides that s. 212.3(2) applies to an investment by a CRIC in a subject corporation where the subject corporation may reasonably be considered to have used, directly or indirectly as part of a transaction or event or series of transactions or events that includes the investment, a property it received from the CRIC (or any property substituted for such property) to make an investment in a non‐resident corporation to which s. 212.3(2) would have applied had the investment been made directly by the CRIC. Thus, s. 212.3(23) can apply to, effectively, override s. 212.3(16). L. Reorganization Exception The rule in s. 212.3(18) provides a number of exceptions to the foreign affiliate dumping rules for various forms of corporate reorganizations and distributions that result in the direct or indirect acquisition of shares of a subject corporation by a CRIC. The underlying premise for these exceptions is that if no incremental value is being transferred from a CRIC to a subject corporation, s. 212.3(2) should not apply. However, a subset of these exceptions (found in s. 212.3(18)(b) and (d)) will not apply to transactions involving what are commonly referred to as “preferred shares”, notwithstanding that no incremental value may be transferred. The “preferred shares” carve out is discussed in the commentary on s. 212.3(19) below. The rule in s. 212.3(18)(a)(i) deals with acquisitions of foreign affiliate shares by one Canadian‐resident corporation from another. Where the two companies are related at the time of the acquisition, s. 212.3(2) will not apply unless the companies deal at arm's length at any time before the acquisition and within the series of transactions that includes the acquisition. This paragraph is intended to cover, among other things, situations where foreign affiliate shares are transferred by a Canadian corporation on a winding up into its Canadian‐resident parent (subject to the arm's length/series test). Whether the two companies are related and deal at arm's length is to be determined without regard to rights referred to in s. 251(5)(b).



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The rule in s. 212.3(18)(a)(ii) is virtually identical to s. 212.3(18)(a)(i) but applies to acquisitions of foreign affiliate shares by a CRIC that is formed on the amalgamation of two or more Canadian‐resident corporations. The rule in s. 212.3(18)(b) lists a number of exceptions relating to share‐for‐share transactions at the foreign affiliate level and certain distributions made by a foreign affiliate. In this regard, the exceptions will only apply to foreign affiliate shares that are received — s. 212.3(2) is intended to apply to the extent that debt or other forms of non‐share consideration are also received as a result of the share‐for‐share or distribution transaction. As noted above, these exceptions do not apply to “preferred share” acquisitions, as set out in s. 212.3(19). Also, regard must be had to s. 212.3(20) for distributions described in ss. 212.3(18)(b)(v) to (vii). The rule in s. 212.3(18)(c) provides exceptions for internal reorganizations that involve an indirect acquisition of shares of a subject corporation by a CRIC, described in s. 212.3(10)(f), resulting from a direct acquisition by the CRIC of shares of another corporation resident in Canada. The rules in ss. 212.3(18)(c)(i) and (ii) are analogous to ss. 212.3(18)(a)(i) and (ii), respectively, in that they provide exceptions for indirect acquisitions of foreign affiliate shares by one Canadian‐resident corporation from another, where similar conditions are satisfied. The rules in ss. 212.3(18)(c)(iii) and (iv) are similar to ss. 212.3(18)(b)(i) and (iii), respectively, and provide exceptions for exchanges and reorganizations under s. 51(1) and s. 86(1), respectively, of shares of a Canadian‐resident corporation that are held by a CRIC, which result in an indirect acquisition by the CRIC of foreign affiliate shares. The rule in s. 212.3(18)(c)(v) provides an exception that it is intended to prevent s. 212.3(2) from applying more than once, in certain circumstances, where funds are transferred through tiers of Canadian corporations and invested in a foreign affiliate. More specifically, this provision provides that s. 212.3(2) does not apply to an investment that is an indirect acquisition of shares of a subject corporation by a CRIC (to which s. 212.3(10)(f) applies), resulting from a direct acquisition by the CRIC of shares of another Canadian‐resident corporation, if the other Canadian‐resident corporation (or a particular Canadian‐resident corporation related to the CRIC and the other corporation) in turn uses the property transferred by the CRIC to make a direct investment in a subject corporation (i.e., not one to which s. 212.3(10)(f) applies). In order to qualify for



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this exception, the relevant investments must occur within 30 days of each other and as part of the same series of transactions or events. The rule in s. 212.3(18)(d) prevents s. 212.3(2) from applying where debt is exchanged for equity and is intended to supplement the rules in ss. 212.3(18)(b)(i) and (c)(iii) that deal with s. 51(1) conversions of debt into equity. In contrast to s. 51(1), s. 212.3(18)(d) does not require that a conversion feature exist in the terms of the debt instrument. The rule in s. 212.3(19) provides that the exceptions in s. 212.3(16) and ss. 212.3(18)(b) and (d) are not available in respect of a CRIC's acquisition of shares of a subject corporation if the CRIC does not have a fully participating equity interest in the subject corporation. In other words, the exceptions are not available where the CRIC acquires what are commonly referred to as “preferred shares”. For the purposes of s. 212.3(19), the determination of whether the 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. However, even if the shares of the subject corporation acquired by the CRIC are less than fully participating, s. 212.3(19) further provides that this fact will not preclude the availability of the exceptions in s. 212.3(16) and ss. 212.3(18)(b) and (d) if the subject corporation is a “subsidiary wholly‐owned corporation” of the CRIC, as defined in s. 248(1). The rule in s. 212.3(19) is amended to provide that s. 212.3(1)(b)(ii) applies to an acquisition of preferred shares described in s. 212.3(19).

For the subject corporation to be a “subsidiary wholly‐owned corporation”, the CRIC, together with certain subsidiary wholly‐owned corporations of the CRIC and corporations of which the CRIC is a subsidiary wholly‐owned corporation, must own all of its shares (except directors' qualifying shares). Thus, if this requirement is met, the CRIC would be considered to have a fully participating interest in any preferred shares of the subject corporation that the CRIC acquires. For these purposes, it is intended that the existence of preferred shares, in and by itself, would not preclude a CRIC that acquires common shares from being considered to have acquired fully participating shares.



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The rule in s. 212.3(20) overrides the rules in ss. 212.3(18)(b)(v) to (vii) — which otherwise except certain foreign affiliate distributions from the rule in s. 212.3(2) — by making s. 212.3(2) apply to an acquisition by a CRIC of foreign affiliate shares on such a distribution to the extent of any debt assumed by the CRIC in respect of the distribution. On August 16, 2013, s. 212.3(18) was proposed to be amended in three respects. First, a reference to s. 212.3(18.1) was added to the preamble, making s. 212.3(18) subject to s. 212.3(18.1). Second, s. 212.3(18)(c)(ii) was proposed to be amended. The rule currently provides an exception for an amalgamation described in s. 87(1) of two or more predecessor corporations to form a CRIC. Such an amalgamation could result in the CRIC making an investment described in s. 212.3(10)(f) where, as a result of the amalgamation, the CRIC indirectly acquires shares of a subject corporation by directly acquiring, from one of the predecessor corporations, shares of another corporation resident in Canada that in turn owns shares of the subject corporation. The rule in s. 212.3(18)(c)(ii) is amended to extend the exception in the provision to situations where the corporation formed on the amalgamation is not the CRIC but is instead a corporation resident in Canada of which the CRIC is a shareholder. This situation could arise, for example, where a Canadian‐resident corporation that is a shareholder of a predecessor corporation acquires shares of the corporation formed on the amalgamation, which in turn owns shares of the subject corporation. It is also possible that, in respect of a single amalgamation, both the corporation formed on the amalgamation and one or more shareholders of that corporation could be CRICs in respect of different indirect investments, which are described in s. 212.3(10)(f) and occur on the amalgamation. A similar amendment is made to s. 212.3(22)(a)(iii). Third, the rule in s. 212.3(18)(d) is proposed to be amended. The rule currently prevents s. 212.3(2) from applying where debt is exchanged for equity, and it supplements the rules in ss. 212.3(18)(b)(i) and (c)(iii) that deal with s. 51(1) conversions of debt into equity. In contrast to s. 51(1), s. 212.3(18)(d) does not require that a conversion feature exist in the terms of the debt instrument. The amendment clarifies that the exception in s. 212.3(18)(d) applies only where a bond, debenture or note issued by a subject corporation is exchanged for shares of the subject corporation, and s. 51(1) would apply to the exchange if the terms of the debt conferred on the holder the right to make the exchange.



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The amendment to s. 212.3(18)(c)(ii) applies in respect of transactions and events that occur after March 28, 2012, subject to an election to have it come into force on August 14, 2012. The addition of the reference to s. 212.3(18.1) and the amendment to s. 212.3(18)(d) apply in respect of transactions and events that occur on or after August 16, 2013. M. Exchange – PLOI New s. 212.3(18.1) of the Act provides that the exceptions in s. 212.3(18), which generally prevent s. 212.3(2) from applying to various forms of corporate reorganizations and distributions, do not apply to certain investments by a CRIC in a subject corporation. In particular, s. 212.3(18.1) provides that s. 212.3(18) does 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)). As a consequence, s. 212.3 could potentially apply to the investment. When a loan made by a CRIC to a subject corporation is treated as a PLOI, s. 212.3(2) does not apply in respect of the PLOI. The rule in 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. Without the new rule, the intended consequences under the foreign affiliate dumping rules in s. 212.3, and the related PLOI regime under s. 17.1, could potentially be avoided (subject to the general anti‐avoidance rule in s. 245). The rule in s. 212.3(18.1) applies in respect of transactions and events that occur on or after August 16, 2013.

N. Mergers For the purposes of s. 212.3 and ss. 219.1(3) and (4), s. 212.3(22) provides “continuity” rules – similar to the rules in s. 87(1.2) and 88(1.5) – that apply to amalgamations under s. 87(11) and windings‐up under s. 88(1). It also contains complementary deeming rules that are intended to exclude from the application of the rule in s. 212.3(2) an investment by a CRIC in a foreign affiliate that results from a merger to which ss. 87(11) or 88(1) applies.



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In the case of a vertical amalgamation to which s. 87(11) applies, s. 212.3(22)(a)(ii) ensures that s. 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 s. 212.3(10). New s. 212.3(22)(a)(iii) is added to ensure that s. 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 s. 212.3(10)(f) by indirectly acquiring shares of a subject corporation. This amendment applies in respect of transactions and events that occur after March 28, 2012, subject to an election to have it come into force on August 14, 2012. O. Indirect Investment As noted above, the rule in 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 s. 212.3(16); an investment by the CRIC in a “bad” foreign affiliate would not satisfy that exception. Thus, s. 212.3(23) can apply to, effectively, override s. 212.3(16). A reference to s. 212.3(24) is added to s. 212.3(23). As a result, s. 212.3(23) may also override the exception from s. 212.3(2) in s. 212.3(24). This change is made as a consequence of the amendments to s. 212.3(24) that expand the scope of the exception in that subsection. This amendment ensures that s. 212.3(2) cannot be avoided by a CRIC, for example, investing in a subject corporation that, in turn, makes a loan to a “good” foreign affiliate, where the latter then uses the loan proceeds to acquire shares of a “bad” foreign affiliate.



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This amendment applies in respect of transactions and events that occur after March 28, 2012, subject to an election to have it come into force on August 14, 2012. P. Indirect Funding As noted above, s. 212.3(24) generally provides an exception from s. 212.3(2) that applies, in certain defined circumstances, where a CRIC funds one foreign affiliate indirectly through another foreign affiliate, and the exception in s. 212.3(16) would have applied had the CRIC instead funded the first foreign affiliate directly. The rule in s. 212.3(24) is proposed to be amended in two respects. First, the condition in s. 212.3(24)(b) is moved to s. 212.3(24)(c). This condition generally requires that the particular corporation (i.e., the corporation that is being indirectly funded) must be a corporation in which a direct investment by the CRIC would have qualified for the exception in s. 212.3(16). Second, s. 212.3(24) is modified by replacing the condition in existing s. 212.3(24)(c) with a new condition in s. 212.3(24)(b) that expands the scope of the exception in s. 212.3(24). The condition in existing s. 212.3(24)(c) requires the CRIC to demonstrate that, throughout the period during which the loan made by the subject corporation to the particular corporation is outstanding, the particular corporation uses the loan proceeds in an active business that it carries on in its country of residence. This is replaced with a new condition in s. 212.3(24)(b) that requires the CRIC to demonstrate that all or substantially all of the income from the loan made by the subject corporation is, or would be if there were income from the loan, treated as income of the subject corporation from an active business because of the rule in s. 95(2)(a)(ii), which, in certain circumstances, re‐characterizes interest and other passive income as active business income. For example, s. 212.3(24) may apply where the particular corporation uses the loan proceeds for the purpose described in s. 95(2)(a)(ii)(D) – generally, to earn income from property that is shares of another qualifying interest foreign affiliate of the CRIC, that are excluded property of the particular corporation. As a consequence of the amendments to s. 212.3(24), a reference to that subsection is also added to s. 212.3(23).



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This amendment applies in respect of transactions and events that occur after March 28, 2012, subject to an election to have it come into force on August 14, 2012. Q. Partnerships The rules in s. 212.3(25) contains “look‐through” rules for partnerships for the purposes of the foreign affiliate dumping rules in s. 212.3, the immigration and emigration rules in s. 128.1(1)(c.3) and s. 219.1(2), respectively, and s. 17.1(1), as it applies in respect of PLOI referred to in s. 212.3(11). R. Thin Capitalization The rule in s. 18(5) defines certain terms for purposes of the thin capitalization rules in ss. 18(4) to (7). In certain defined circumstances, the thin capitalization rules deny a corporation’s deduction of interest expense. The application of the rules depends, in part, on the amount of the corporation’s “outstanding debts to specified non‐residents” (as defined in s. 18(5)). Paragraph (b) of the definition “outstanding debts to specified non‐residents” provides exclusions for certain obligations owing to non‐resident insurers and authorized foreign banks. The paragraph is amended to provide a new exclusion that addresses the interaction between the thin capitalization rules and the new PLOI rules. The new exclusion is for a debt obligation described in subparagraph (ii) of A in s. 17.1(1)(b) to the extent that the proceeds of the debt obligation can reasonably be considered to directly or indirectly fund, in whole or in part, an amount owing to the corporation that is a PLOI. The reference to “a debt obligation described in subparagraph (ii) of A in paragraph 17.1(1)(b)” is to a debt obligation entered into as part of a series of transactions or events that includes the transaction by which the PLOI that is owing to the corporation arises. The amendment ensures that the thin capitalization rules do not impede the ability of a non‐resident corporation that controls a corporation resident in Canada (a CRIC) to use debt to finance the CRIC, provided the CRIC in turn uses the borrowed funds to lend to its foreign affiliate and elects to have the PLOI regime apply to the latter debt. Absent the amendment, the thin capitalization rules could, in certain defined circumstances, deny the CRIC a deduction for the interest it pays in respect of its debt owing to the



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non‐resident that controls it. At the same time, the CRIC would, by virtue of having made the PLOI election in respect of its loan to its foreign affiliate, be required to include in its taxable income an amount that is equal to the greater of a prescribed amount of interest income in respect of the debt owing by the foreign affiliate and the interest payable by it (or certain non‐arm’s length persons) on the debt that funds the PLOI. Subjecting interest payable on such debt owing by the CRIC to the thin capitalization rules is not necessary while the PLOI is outstanding because the PLOI rules ensure that the interest income included in the CRIC’s income in respect of the PLOI is at least equal to the interest payable on the debt owing by the CRIC. This amendment applies to taxation years that end after March 28, 2012. S. Immigration The rule in s. 128.1(1)(c.3) is intended to prevent structures similar to those targeted by the FAD rules from being set up while a corporation to which they would otherwise apply is non‐resident. It applies if a corporation controlled by a non‐resident corporation immigrates to Canada, and immediately prior to immigrating it owned shares in a “subject affiliate”. A subject affiliate is defined as a corporation that was a foreign affiliate immediately after the corporation immigrates, or became a foreign affiliate as part of a series that includes the immigration. Note that proposed s. 212.3(15), discussed above, would apply for the purpose of s. 128.1(1)(c.3). If it applies, s. 128.1(c.3) grinds the immigrating corporation’s PUC by the FMV of the shares it holds in the subject affiliate and the FMV any debts owed to it by the subject affiliate. To the extent that the corporation’s PUC would otherwise be reduced below zero, it would instead be deemed to have paid a dividend to its non‐resident parent immediately after immigrating, which would generally be subject to Part XIII withholding tax. The rule in s. 128.1(3) is amended to reinstate PUC reduced by s. 128.1(c.3) to the extent that the reduction would otherwise increase the amount of a deemed dividend under s. 84(3), 84(4) or 84(4.1).



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As mentioned above, the amendments to s. 212.3(15) apply in respect of transaction occurring after March 28, 2012, subject to an election to have them apply as of August 14, 2012.

T. Emigration The rule in s. 219.1 generally imposes a tax on an emigrating corporation equal to 25% of its assets minus its PUC and liabilities. It is intended to tax amounts available for distribution that would be subject to Part XIII withholding tax had they been distributed as dividends. The rule in s. 219.3 reduces the departure tax to the withholding rate on dividends in an applicable tax treaty. The rule in s. 219.1(2) is intended to prevent structures similar to those targeted by the FAD rules from being set up while what would otherwise be the subject corporation is still resident in Canada. It deems an emigrating corporation’s PUC to be nil for the purposes of calculating the departure tax if it three conditions are met:

A corporation resident in Canada owns shares in the emigrating corporation at the time of emigration;

The corporation resident in Canada is controlled at that time by a non‐resident

corporation; and

The emigrating corporation is, immediately after emigrating, or becomes, as part of a series that includes the emigration, a foreign affiliate of the corporation resident in Canada.

The rule in s. 219.1(4) provides relief for emigrating corporations which would otherwise suffer increased departure tax due to PUC reductions imposed by the FAD regime. It applies to an emigrating corporation if three conditions are met, as specified in s. 219.1(3):

The rule in s. 212.3(2)(b) or (7)(b) previously reduced the PUC of shares of the corporation because of an investment made by a CRIC described by ss. 212.3(10)(a), (b), or (f), which include acquisitions of shares, contributions of capital, or indirect acquisitions of shares through direct acquisitions of shares in a corporation resident in Canada.



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The rule in s. 212.3(9) has not applied in respect of any reduction of the paid‐up

capital of shares of the capital stock of the corporation or a predecessor corporation, and

The rule in s. 219.1(2) does not apply to the emigration.

Where it applies, s. 219.1(4) reinstates, immediately prior to the computation of departure tax, the reduced PUC of an emigrating corporation to the extent of:

the FMV of shares of the subject corporation owned by the CRIC immediately

prior to emigrating, and

the portion of the FMV of shares in a foreign affiliate that may reasonably be considered to relate to a share of the subject corporation previously owned by the corporation and for which the share in the foreign affiliate was substituted.

The August 16, 2013 proposals extend the PUC reinstatement rule in s. 219.1(4) to investments in respect of debt obligations owed by a subject corporation. The rule in s. 219.1(3) is amended so that the rule applies if an emigrating corporation has had its PUC reduced by s. 212.3(2) in respect of any investment described by s. 212.3(10). The rule in s. 219.1(4) is amended so that PUC will be reinstated to the extent of the fair market value of all debt obligations owed to the corporation by a subject corporation at the time of emigration, other than PLOIs. This is in addition to any reinstatement in respect of the FMV of shares of a subject corporation. These amendments apply to corporations that cease to be resident in Canada after March 28, 2012.

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