recognition of foreign tax credits where
the foreign tax burden is not ultimately
borne by the taxpayer. However, the
rules are broadly drafted and can apply in
unexpected circumstances. Specifically,
there is no requirement for a direct link
between the hybrid instrument and
the transaction generating the FAPI;
the rules will apply whenever there is
a hybrid instrument in the same chain
of ownership as the affiliate earning
the FAPI. Thus, if a hybrid instrument
or entity is present in a foreign affiliate
group, the implications for all affiliates
in the same ownership chain need to be
considered.
The Foreign Affiliate Dumping Rules
The foreign affiliate dumping rules deter
certain arrangements that allowed
non-residents of Canada with Canadian
subsidiaries to undertake transactions
that reduced their liability for Canadian
tax without, in the government’s view,
providing an economic benefit to Canada.
The foreign affiliate dumping rules apply
to an “investment” in a foreign affiliate
by a corporation resident in Canada
(CRIC) that is controlled by a non-resident
corporation. An “investment” in a foreign
affiliate includes:
• an acquisition of shares of the
foreign affiliate;
• a contribution of capital to the
foreign affiliate;
• an acquisition of shares of another
corporation resident in Canada
whose shares derive more than
75 percent of their value from
foreign affiliate shares;
• a loan to or an acquisition of a debt
of a foreign affiliate;
• the extension of the maturity date of
a debt obligation owing by a foreign
affiliate to a CRIC; and
• the extension of the redemption,
acquisition, or cancellation date of
shares of a foreign affiliate held by
a CRIC.
Certain trade debts and debts acquired
from an arm’s-length person in the
ordinary course of business are
excluded. In certain cases, an election
is available to treat a debt obligation
as a “pertinent loan or indebtedness”
(PLOI). The foreign affiliate dumping
rules do not apply to the PLOI, but the
CRIC must include in income interest on
the PLOI at a prescribed rate (less any
interest actually charged pursuant to the
terms of the debt obligation).
Where the rules apply, the following
consequences may result:
• If the CRIC paid non-share
consideration for the investment,
the CRIC is deemed to have paid
to its foreign parent a dividend in
the amount of such consideration.
Canadian withholding tax applies
to the deemed dividend. In certain
circumstances, under an offset
mechanism, the paid-up capital
in the shares of the CRIC can be
reduced to decrease or eliminate
the deemed dividend.
• If the CRIC issued shares in
consideration for the investment,
the paid-up capital in such shares
is reduced by the amount of the
investment in the foreign affiliate.
The elimination of paid-up capital
restricts thin capitalization room
to limit the ability of the CRIC
to deduct interest expense on
cross-border debt and restricts the
amount that can be repatriated as
a return of capital free of Canadian
withholding tax.
There are two main exceptions that will
preclude the application of the rules
where a CRIC makes an investment in
a foreign affiliate. The first exception
is intended to exempt investments
that are strategic expansions of a
Canadian business abroad; however, this
exception is unlikely to be useful since
its scope is very narrow. The second
exception applies where the investment
is part of an internal reorganization that
is not considered to result in a new
investment in a foreign affiliate.
Where the paid-up capital in the shares
of the CRIC is reduced under the rules,
such paid-up capital can be reinstated
immediately before:
• a return of capital by the CRIC to its
foreign parent, or
• an in-kind distribution of:
– the shares of the foreign affiliate
that constituted the original
investment,
– shares of another foreign affiliate
substituted therefor, or
– the proceeds of disposition of
such shares or certain other
distributions from another foreign
affiliate.
The paid-up capital reinstatement before
the return of capital avoids a deemed
dividend arising on the transaction to the
extent that the amount distributed on
the return of capital exceeds the paid-up
capital in the shares of the CRIC.
© 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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