On May 10, 2012 we hosted a webcast on the Foreign Affiliate Dumping (FAD) proposals (if you missed the webcast see our Tax Memo “Canadian federal budget targets Canadian subsidiaries of foreign multinationals” for background on these proposals). Clearly, the proposals are targeted at new investments made by foreign-controlled Canadian corporations in foreign affiliates. However, they are very broadly worded. There is another aspect of the proposals touched on during the webcast that I would like to comment on in this note; namely the extent to which the proposals, as drafted, appear to prevent a Canadian corporation from managing its current foreign affiliate structure.
When considering investments in foreign affiliates, private corporations have a difficult decision to make: whether to hold such investments directly and thereby potentially benefit from the capital dividend account provisions; or to hold them indirectly through a foreign holding company and take advantage of the many commercial and foreign tax benefits such structures afford.
Currently enacted subsection 88(3) applies when a top-tier affiliate is wound up and shares of a second-tier affiliate are distributed to the Canadian shareholder. A rollover is provided for the shares of the second-tier affiliate that are deemed disposed at their adjusted cost base (acb). However, even in the simplest situations, the Canadian shareholder can have a gain or a loss on the shares of the liquidating affiliate.
Two posts back, I discussed some of the implications the August proposals would have for share-for-share rollover transactions and in the last post I discussed the proposed changes to certain of the rules governing offshore liquidations of foreign affiliates.
Today’s topic is a significant change to the “relevant cost base” (RCB) definition.
In the last post, I offered a few comments on the changes planned for the share-for-share rollover provisions. For decades these provisions have been pure rollovers. Under the August 2011 proposals, an accrued loss in the transferred shares will now be realized.
If enacted in their current form, the August 2011 proposals are going to change the way certain basic rules in the foreign affiliate regime have operated for decades.
What I am referring to is the share-for-share provisions in subsection 85.1(3) and paragraph 95(2)(c) – a pair of familiar old friends. The former allows a taxpayer to transfer shares of a foreign affiliate to another foreign affiliate on a rollover basis. The latter operates when the transferor is a foreign affiliate. Both of these provisions have, for decades, provided a pure rollover whether there is an accrued gain or loss on the transferred shares.
In an earlier post I commented briefly on the proposed new rules concerning upstream loans. As we continue to think about these proposals, issues with them are becoming apparent.
A real attention grabber in the just-released foreign affiliate proposals is the new rules concerning upstream loans (see item 2 in the PwC Tax Memo for background). For many years, the CRA has allowed taxpayers to loan funds representing taxable surplus from foreign affiliates to Canadian taxpayers. Well, that now appears to be over. After August 19, 2011, and subject to various exceptions, upstream loans from a foreign affiliate will result in an income inclusion equal to the amount of the loan with an offsetting deduction available to the extent of available tax-free surplus. The upshot of these rules is that it will no longer be possible for a taxpayer to access the low-taxed taxable surplus of a foreign affiliate through loans and indefinitely defer an income inclusion.
The Dutch cooperative is increasingly popular with Canadian tax planners. It is quick and easy to form, requiring a minimum of formal procedural hokum, very flexible and can be designed to meet just about any objective. The main advantage of a coop, over the Dutch BV, is that distributions are not subject to a domestic withholding tax. For this reason, coops are most often used as a holding company for European investment, although they have many other uses.
Hi, my name is Eric. I am an Associate Partner in International Tax Services. I help clients sort through the implications of the Canadian foreign affiliate system whenever they buy or sell businesses, restructure, expand or contract operations and, of course, the tax compliance aspects of all these things. This is pretty much all I have been doing for the last 15 years and I still find it fascinating and completely engaging. There is something new to learn every day.
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