New foreign affiliate dumping rules deserve attention

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The most recent Canadian federal budget (March 29, 2012) brought with it broad new regulations that, when enacted, will apply to certain non-Canadian multinationals with investments in Canada.

Under the proposals, when a foreign parent company uses its Canadian affiliate (referred to as a corporation resident in Canada or a “CRIC”) to invest in another foreign affiliate, the payment may be deemed to be a dividend paid to the Canadian company’s foreign parent and thus subject to a withholding tax. Some foreign affiliates investments that may now be subject to a withholding tax include:

  • acquisition of shares;
  • contribution of capital; or,
  • any transaction where the foreign affiliate becomes indebted to the CRIC.

Alternatively, if the CRIC issues shares in respect of the investment, there will be no increase in the paid up capital in respect of the shares issued by the CRIC.

Testing business purpose: Is your company subject to taxation?

In general, Canadian companies affected by the FA dumping rules will need to meet the conditions of the federal government’s “business purpose test.” While phrased as a business purpose test, it is important to note that the test is more like a closer connection test than that of a business purpose, and this test will essentially require the CRIC to act similar to a typical Canadian resident multinational corporation that is not foreign-owned. In other words the CRIC’s investments must relate more to Canada than to other non-Canadian companies within the multinational parent company group in order to meet the test’s conditions.

Unfortunately, as currently drafted, the “business purpose test” is fairly subjective, creating some uncertainty around the process. Based on comments by the Department of Finance, the government will likely be refining the test, and may likely make it less subjective. However, it is expected the overall intent of the test will remain the same.

The reasoning

The federal government wants to stop so-called foreign affiliate dumping, where a foreign multinational company leverages its Canadian operations with debt that is used to invest in other foreign subsidiaries of the multi-national and take advantage of Canada’s foreign affiliate system while at the same time minimizing Canadian tax.

How can PwC help?

We advise our clients not to underestimate how broadly these rules will apply: While we expect the Department of Finance to make changes to the proposals, any transactions or investment between a CRIC and its foreign affiliates could be subject to these new rules.

We suggest clients with foreign operations examine any transactions from March 29 forward, and review any future plans to meet the cash needs of its foreign affiliates, with these new rules in mind, as they will severely restrict the ability of the CRIC to manage its foreign affiliates

With in-house expertise on this issue, we have already assisted clients across Canada affected by these new proposals. We can help your company determine if the rules apply to your transactions. If so, there may be another way to execute plans without resulting in an immediate tax consequence.

If your company needs further assistance, please contact one of our experts:

Jason Durkin
Tax Partner (International Tax Services)
+1 403 509 7598

James Merkowsky
Tax Partner (Cross-border Tax)
+1 780 441 6858