to Canadian income tax. Intermediary 
holding corporations in treaty 
jurisdictions may be used to reduce 
the rate of foreign withholding tax on 
distributions to Canada, and eliminate 
Canadian and foreign income tax on 
capital gains that may otherwise be 
payable on the disposition of the shares 
of the foreign corporation. Although 
the tax benefits of these structures 
may be substantial (see the discussion 
in 

Structuring Mining Investments – 

Foreign Affiliates

), they may be subject to 

challenge by foreign tax authorities under 
a “substance-over-form” doctrine or 
general beneficial ownership principles. 
Further, certain foreign jurisdictions have 
enacted specific anti-avoidance rules 
that could deny the benefits of a treaty 
to the intermediary holding corporation, 
by looking through the structure to the 
Canadian parent. Other countries have 
enacted rules of general application that 
deem capital gains derived from the sale 
of an offshore company to be subject 
to local tax if more than a specified 
percentage of the fair market value, 
assets, or income of the foreign holding 
corporation is directly or indirectly 
derived from domestic operations 
or assets. 

Foreign Affiliates 

As discussed above (see 

Structuring 

Mining Investments – Foreign 
Operations

), a Canadian-resident 

investor undertaking mining activities 
outside Canada must weigh the 
domestic and foreign tax consequences 
associated with the different business 
structures through which mining 
operations can be carried on. Where the 
mining venture is generating a profit, it 
can be advantageous to operate through 
a foreign affiliate. However, Canada’s 
foreign affiliate rules are complex, and 
careful planning is necessary to achieve 
the desired tax result. The summary that 

follows provides a simplified overview 
of the tax treatment of foreign affiliates 
under the ITA.

The Foreign Affiliate Regime

The ITA provides a combined exemption/
credit system for income earned by 
a Canadian-resident taxpayer through 
a foreign affiliate. A foreign affiliate 
of a Canadian resident is defined as 
a non-resident corporation in respect 
of which the Canadian resident owns:
• not less than 1%, and
• either alone or together with related 

persons, 10% or more

of the shares of any class of the 
corporation. A foreign affiliate is a 
controlled foreign affiliate if the 
Canadian resident:
• owns more than 50% of the voting 

shares of the foreign affiliate, or

• would own more than 50% of the 

voting shares if it held all the shares 
owned by related persons and up to 
four arm’s-length Canadian residents 
and persons related to them.

An exemption/credit applies to income 
received by the Canadian-resident 
corporation in the form of dividends paid 
by the foreign affiliate. A reduction of tax 
may also be available in respect of gains 
on a sale of shares of the foreign affiliate. 
The Canadian tax rules relating to 
foreign affiliates can be grouped into 
two categories: the surplus rules and 
the foreign accrual property income 
(FAPI) rules.

The Surplus Rules

The surplus rules are relevant in 
determining:

• the tax payable by a Canadian 

corporation on dividends 
received from both controlled and 
non-controlled foreign affiliates, and

• the gain that is subject to tax on a sale 

by a Canadian-resident corporation of 
shares of a foreign affiliate.

A Canadian-resident taxpayer that 
sells shares of a foreign affiliate is 
subject to tax on the taxable capital 
gain. A Canadian-resident taxpayer 
is also subject to tax on the taxable 
capital gain realized on the sale by one 
foreign affiliate of shares of another 
foreign affiliate unless the shares of 
the foreign affiliate that are sold are 
excluded property. Shares of a foreign 
affiliate are excluded property if they 
derive all or substantially all of their 
value from assets used in an active 
business. A Canadian corporation 
may elect to reduce the proceeds 
of disposition (which are relevant to 
computing the capital gain or capital 
loss) to the extent of the underlying 
surplus. Where an election is made, 
these rules deem a dividend to have 
been paid to the extent of the surplus, 
and consequently reduce the gain.

Regardless of its legal form, a pro 
rata distribution by a foreign affiliate is 
deemed to be a dividend except where 
the distribution is made:

• in the course of a liquidation and 

dissolution of the affiliate; 

• on a redemption, acquisition, or 

cancellation of a share of the affiliate; or 

• on a “qualifying return of capital” 

in respect of the share. 

On a distribution of paid-up capital of a 
foreign affiliate, which otherwise would 
be treated as a dividend, a taxpayer 
may elect to treat the distribution as a 
qualifying return of capital. Under this 
election:

• the distribution is received tax-free 

to the extent of the adjusted cost 
base of the taxpayer’s shares of the 
foreign affiliate, and 

© 2013 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms 
affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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 A Guide to Canadian Mining Taxation