August 2011 Foreign Affiliate Amendments - Upstream Loans

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Episode 42: August 2011 Foreign Affiliate Amendments

Upstream Loans

Release date: January 3, 2012
Guest: Ken Buttenham
Running time: 11:12 minutes

In this episode of Tax Tracks Ken Buttenham discusses the proposed foreign affiliate amendments that were released on August 19, 2011 with particular attention to the introduction of the “upstream loan” rules.

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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.

August 2011 Foreign Affiliate Amendments: Upstream Loans

You’re listening to another episode of PwC’s Tax Tracks at This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.

Gerry Lewandowski: Today we’re joined by Ken Buttenham, a partner with PwC Canada’s International Tax Services practice. Ken is based in Toronto and specializes in outbound and inbound consulting services to large multinational corporations. Ken regularly assists Canadian clients with the acquisition, structuring, reorganization and financing of their foreign affiliates. Ken is here today to talk to us about the proposed foreign affiliate amendments released on August 19th.
Thanks for joining us, Ken.

Ken: Thank you Gerry. It’s great to be here.

Gerry: Ken, I understand this isn’t the first time we have seen proposed amendments to our foreign affiliate rules?

Ken: That’s an understatement Gerry! Since 2002 Canada’s foreign affiliate rules-and I’m really talking about here the rules that deal with foreign subsidiaries of Canadian multinationals- have been in a constant state of evolution or flux. The most recent proposals, announced in August 2011, contain significant changes from the last version we saw in 2004 and also contain certain new provisions that weren’t expected.

Gerry: Now, will these go through further evolution or are they likely to stick as is?

Ken: Well, we can never be entirely sure. This is a question I have been getting for almost 10 years now! What I can say is that when the proposals were released, the Department of Finance did request submissions from interested parties, and these submissions had to be made by October 19th. This was the tax community’s chance to comment on all aspects of the proposals. I know Finance did receive several submissions, including one from PwC, and a copy of our firm submission can be found on our website. I know from comments made by Finance at the 2011 Canadian Tax Foundation Conference that officials at the Department of Finance are still considering these submissions and whether they believe any changes to the proposals are warranted. At this point we’ll need to wait and see whether any changes are proposed.

I know that Finance is under pressure from the Auditor General and others to pass these rules that have been in a state of flux for almost 10 years and, and given the fact there is a majority federal government, my guess is that we’ll see some form of these rules passed in the not too distant future.

Gerry: I understand the August amendments contained a number of changes. You mentioned earlier that there were certain unexpected changes. Did any of these come as a surprise?

Ken: Well Gerry, the biggest surprise, for me at least, was the introduction of what are being commonly referred to as the “upstream loan” rules. At a very high level, these rules can apply to include the principle amount of loans from foreign affiliates to either a Canadian taxpayer or other related entities in the income of the Canadian taxpayer if the loans remain outstanding for longer than 2 years. These rules can also apply to amounts owing other than loans.

Gerry: Is that as harsh as it sounds?

Ken: Well, it can be, Gerry. If the amount in question is not repaid or otherwise settled within the two-year time frame, taxpayers will be caught by these rules. Fortunately, some relief is offered in the form of a reserve that may be claimed against an income inclusion, but to qualify taxpayers have to meet specific conditions and these can be very restrictive – especially from a treasury perspective. In addition, the amount of the reserve is dependent on the existence of certain tax attributes in the taxpayer’s foreign affiliate structure. I am referring here of course to the surplus and underlying foreign tax accounts of a taxpayer’s foreign affiliates. Determining the quantum and location of these surplus pools within the taxpayer’s foreign affiliate structure can involve a significant amount of work.

Historically, I have found that many companies have not kept these calculations up to date; however, in some cases, it won’t be possible to delay any longer if they hope to claim reserves against any upstream loan income inclusions.

Gerry: Well Ken, clearly it is important for companies to pay attention to these rules. Are there any non-tax implications?

Ken: Yes there are. Beyond the treasury implications I just briefly touched on, there can be important accounting implications that will need to be considered as soon as these rules become substantively enacted. When these rules become substantively enacted, the future tax implications of these rules will need to be determined in relatively short order. For example, if the decision is made to repay certain “upstream loans” prior to the two-year window to avoid the application of these rules, the tax implications of the repayment of the loans – and here I’m thinking of things like foreign exchange – will need to be determined and, in many cases, booked currently for accounting purposes. If the decision, on the other hand, is made to leave certain “upstream loans” outstanding and claim a reserve against the income inclusion, the necessary work will need to be completed to ensure sufficient tax attributes exist to support the ability to claim the reserve. This may involve a lot of work that will need to be completed in a very short period of time.

Gerry: So what direction can you give our listeners regarding this?

Ken: The first thing I have been advising companies to do is to undertake a detailed review of their structure to inventory all of the “upstream loans” existing in their structures. This sounds easy but can be challenging for some groups depending on their level of visibility to what is going on within their foreign affiliate group. It is also important to involve other groups, such as the treasury group, in this exercise to ensure you are getting the full picture.
After the relevant “upstream loans” are identified, companies will need to decide on the course of action for each – for example, repayment within two years or live with the loans and claim a reserve against the income inclusion. Again, these decisions should not be made in a vacuum and input from treasury, accounting, and perhaps even business development groups will be important. You can see how this process could be very time consuming and require a lot of information.

Gerry: Once this initial review is completed is that it? I mean is there any requirement to monitor the situation on an on-going basis?

Ken: Gerry, that is a very good question. There are two important points. First, as I mentioned before, if you choose to go the reserve route, there are restrictions as to the payment of dividends going forward. So one needs to continually monitor that the necessary conditions are met to claim the reserve.
Second, these rules effectively remove a tool from our tool belt when it comes to the repatriation of funds from foreign affiliates to the Canadian shareholder. In the past, CRA let taxpayers loan funds up to the Canadian shareholder and these new restrictions will need to be kept in mind when planning for the future repatriation of cash to Canada.

Gerry: What does PwC think of this? Are we taking a stand?

Ken: Yes – PwC made a submission to Finance and has assisted certain clients with their own submissions. PwC also had input into the CICA/Canadian Bar Association joint committee submission to Finance. We also continue to have ongoing discussions with Finance regarding our submission and other items that have come up.

Gerry: Apart from new upstream loans rules Ken, can you touch on any other significant aspects of the August 2011 amendments?

Ken: Gerry, three points come to mind:

First, there are proposals to change certain share-for-share rollover provisions relating to transfers of foreign affiliate shares. These rules have always allowed, in the past anyway, for what we call a “pure rollover”, which is a transfer at cost. The new proposals will not allow for a rollover at cost where the shares being transferred have an inherent loss, in other words, these provisions will force the inherent loss to be realized (subject of course to the relevant stop-loss rules). This may require taxpayers to undertake valuations of foreign affiliate shares to determine whether an inherent loss exists prior to any share-for-share transfers.

Second, a rule was introduced that deems all pro-rata distributions from foreign affiliates to be treated as dividends. In the past the Canadian tax treatment of a distribution from a foreign affiliate was based on the foreign corporate law characterization of the distribution. This sometimes resulted in certain Canadian tax issues or uncertainties, where a distribution was not neatly characterized as a dividend or return of capital under the foreign corporate law. I think this new proposal is a welcomed change and it now provides some certainty.

Lastly, the proposals introduce a new rule that effectively streams capital losses realized by foreign affiliates that would otherwise give rise to foreign accrual property losses, or FAPL’s, such that they can only be used against capital gains that would give rise to foreign accrual property income. To accomplish this they have introduced a new notional foreign affiliate account called foreign accrual capital losses. This change may affect the FAPI computations of certain taxpayers starting in 2011.

Gerry: What I’m hearing is that the changes to the foreign affiliate rules – upstream loans and otherwise – are far-reaching, full of surprises, not easy to deal with, and many companies should be paying close attention.

Ken: That’s it in a nutshell Gerry. PwC is continuing to stay on top of the developments relating to these foreign affiliate amendments. I’m pleased to say that we have some extra insight into how these rules are intended to work and the policy reasons behind them because John Meek has recently joined us fresh from a multi-year contract with Finance, where he helped work on many of the August proposals. So PwC is uniquely positioned, and has a lot of insight into how the rules are intended to work and the policy reasons behind them.

Gerry: Thank you for joining us today Ken.

Ken: You’re welcome.

Gerry: For further information, PwC has prepared a Tax Memo “Long-awaited foreign affiliate amendments released” that you can find on our website at Also, PwC hosted a webcast shortly after the amendments were released, which is also available on the International Tax page of our website  

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