Tax memo: Canadian federal budget targets Canadian subsidiaries of foreign multinationals

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Memo No. 2012-18

Although the 2012 Canadian federal budget, released on March 29, 2012, did not change corporate tax rates, it included unexpected policy changes that will affect Canadian subsidiaries of foreign multinationals.

New “foreign affiliate dumping” proposals
The budget introduced sweeping rules to curtail a variety of transactions it describes as “foreign affiliate dumping” transactions. These transactions involve an investment in a foreign affiliate (FA) by a corporation that is:

  • resident in Canada; and
  • controlled by a non-resident of Canada.

Those corporations are referred to in this Tax memo as CRICs.

When certain conditions are met, a dividend will be deemed to have been paid by the CRIC to its foreign parent to the extent of any non-share consideration given by the CRIC for the “investment” in the FA. The proposals define “investment” broadly to include:

  • an acquisition of shares or contribution of capital;
  • transactions where the FA becomes indebted to the CRIC (or a related Canadian company); and
  • an acquisition of certain options in shares or debt of the FA.

Any deemed dividend will be subject to Canadian withholding tax (as reduced by the applicable treaty). As currently worded, the proposals do not provide for relief from additional withholding tax when funds invested in a FA are actually repatriated to its foreign parent. In addition, the paid-up capital of any shares of the CRIC that are given as consideration is disregarded (including for purposes of the thin capitalization rules). These proposals extend an existing cross-border surplus stripping rule to cover transactions involving FAs. The proposals generally apply to transactions occurring after March 28, 2012.