Reprinted from Tax Notes Int'l, February 7, 2011, p. 415
The Canada Revenue Agency has confirmed in a January 19 advance tax ruling1 that the conversion of a Dutch company (BV) into a cooperative under the Dutch Civil Code could qualify as a tax-deferred reorganization of capital under section 86 of the Canadian Income Tax Act. Thus, the conversion itself would not trigger Canadian tax on Canadian resident members of the BV. The ruling provides much-needed clarification of what types of transformative transactions can be undertaken in the context of a foreign affiliate reorganization.
As a vehicle through which to carry out an active foreign business or to hold investments in other foreign affiliates, a Dutch co-op can provide tax advantages not available to other foreign companies. Most notably, dividends paid by a Dutch co-op to a Canadian shareholder are exempt from Dutch domestic withholding tax. (Contrast this with dividends from a BV to a Canadian shareholder, which are generally subject to 5 percent dividend withholding tax under the Canada- Netherlands tax treaty.) The imposition of foreign dividend withholding tax is typically a significant concern to Canadian resident shareholders because this tax is usually not creditable in Canada under Canada's exempt surplus regime. Therefore, it is not surprising that Canadian multinationals have increasingly sought to reorganize their foreign operations by transferring shares of foreign affiliates to a newly created Dutch co-op.
In a typical Dutch co-op structure, and in the context of a typical foreign affiliate reorganization involving a Dutch co-op, it is usually important for the co-op to be characterized as a corporation (and, consequently, a foreign affiliate for Canadian tax purposes) as opposed to, for example, a partnership. This isn't always a straightforward analysis because Dutch co-ops usually have some characteristics that are similar to partnerships under Canadian law. Fortunately, the CRA has issued numerous rulings confirming that such entities can qualify as corporations for Canadian tax purposes as long as certain general criteria are satisfied. Moreover, the CRA has ruled in a number of circumstances that the transfer by a Canadian corporation of shares of a foreign affiliate to a newly created Dutch co-op in exchange for additional membership interests in the co-op will qualify as a tax-deferred ''share-forshare exchange'' for purposes of the ITA. These rulings are significant because they confirm that not only can a Dutch co-op be used as a holding company to repatriate profits to Canada in a tax-efficient manner but that Canadian multinationals can, in certain circumstances, reorganize their existing foreign operations by transferring shares of foreign affiliates to a co-op on a tax-deferred basis.
Nevertheless, there has been some uncertainty concerning the Canadian tax characterization of certain foreign ''transformative'' transactions involving co-ops, including the conversion under Dutch law of a BV to a co-op. In some circumstances, such conversions may facilitate and simplify the planning and implementation of foreign affiliate reorganizations; however, there has long been a question of whether for Canadian tax purposes a conversion could result in a disposition of the BV's assets to the co-op or a disposition of the Canadian corporation's shares of the BV (either of which may be a taxable event for Canadian tax purposes). The ruling provides significant clarification of these issues, specifically:
- On the conversion, the BV will not be considered to have disposed of any of its property for purposes of the ITA. This conclusion is premised on the understanding that under the Dutch Civil Code, the co-op will be regarded as the same corporation as, and a continuation of, the BV and the BV will not be considered to have disposed of any of its property to any person on the conversion. Presumably, if a new corporation were to have been created on the conversion under Dutch law or if the co-op were to be regarded as a partnership under Canadian law, the CRA's conclusion regarding the disposition of the BV's assets would have been quite different.
- The cancellation of the BV's shares and the issuance of additional membership interests in the co-op as a result of the conversion will qualify as a tax-deferred reorganization of capital for purposes of section 86 of the ITA. Here the CRA confirmed not only that a membership interest in the co-op will qualify as a share for Canadian tax purposes (which is a significant prerequisite for the application of section 86), but that the cancellation of the BV's shares in exchange for membership interests in the co-op will qualify as a reorganization of capital. This is significant because the term ''reorganization of capital'' lacks a precise meaning under Canadian tax law in even the seemingly most straightforward domestic circumstances.
The ruling builds on prior CRA rulings regarding foreign affiliate reorganizations involving Dutch co-ops and confirms that a broader range of transactions can be implemented on a tax-deferred basis other than (and in addition to) the usual share-for-share exchange. Of course, the ruling is limited to its facts and there is no guarantee that the same result would flow from every conversion transaction. Thus, taxpayers should carefully review any proposed co-op structure because there is often a small margin for error and the Canadian income tax consequences can be significant.
1CRA Document No. 2010-0373801R3.
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