Canada: 2012 Budget Implementation Bill – Foreign Affiliate Dumping And Upstream Shareholder Loan Update

On October 15, 2012, the Minister of Finance introduced a Notice of Ways and Means Motion (the Notice) to implement the "foreign affiliate (FA) dumping" rules. These new rules were first proposed in the March 2012 Budget (the Budget Proposals); detailed draft legislation was released August 14, 2012 for public consultation (the August 14 Proposals). The Notice received first reading in the House of Commons on October 18, 2012, as Bill C-45.

Broadly speaking, the FA dumping rules were introduced to prevent foreign multinational corporations from achieving tax advantages by causing their Canadian subsidiaries to hold investments in foreign affiliates (FAs). The specific tax advantages targeted by the government include not only the deduction of interest on debt incurred to acquire FAs, but also the ability to defer or avoid completely Canadian withholding tax (WHT) applicable to an upstream cross-border dividend or a transaction that results in a similar outcome. FAs are generally defined to mean foreign companies in which the Canadian shareholder has at least a 10% interest. Dividends paid by FAs out of foreign active business income earned in countries with treaties or tax information exchange agreements are generally excluded from taxable income when received by a corporation resident in Canada.

For a detailed discussion of the Budget Proposals, including the FA dumping rules as originally proposed, see our Budget 2012 Blakes Bulletin.

The August 14 Proposals made some changes to the Budget Proposals; while some of these changes were relieving, other new (and not previously announced) measures expanded the scope of the rules and raised new issues. As well, some of the relieving changes did not cover all possible circumstances in which relief may be thought to be warranted. For a detailed discussion of the FA dumping rules as contained in the August 14 Proposals, see our August 2012 Blakes Bulletin.

Generally, the FA dumping rules apply where a corporation resident in Canada (CRIC) that is controlled by a non-resident corporation (the parent) makes an "investment in a subject corporation". A subject corporation is a corporation that is or becomes an FA of the CRIC as part of the series of transactions that includes the investment. Where non-share consideration is given by the CRIC to acquire the investment, the CRIC will presumptively be deemed to have paid a dividend to its parent (except for the possibility of instead offsetting paid-up capital (PUC) as discussed below). The deemed dividend is subject to WHT, even though no amount is extracted from Canada. Where the form of consideration consists of shares of the CRIC, the PUC of such shares will be automatically deemed to be nil.

Bill C-45 contains further changes to the FA dumping rules, generally of a relieving nature, including:

  • an increase in the threshold for treating an investment in shares of a Canadian resident corporation as an indirect investment in underlying FA shares from 50% to 75%;
  • a new election to allow other Canadian members of the corporate group (qualifying substitute corporations or QSCs) to be treated as having paid the dividend, thereby potentially permitting access to a lower treaty rate on the deemed dividend;
  • making automatic (instead of elective) the rule which provides for PUC offset instead of a deemed dividend where certain requirements are met (the PUC offset rule);
  • the expansion of the rule that "reinstates" previously reduced PUC to allow the CRIC to distribute FA shares and certain other property free of WHT in certain circumstances (the PUC reinstatement rule);
  • a change in the elective relief for loans made by a CRIC to an FA (resulting in deemed interest income in the CRIC at a baseline rate) (the pertinent loan or indebtedness election or PLOI election) from a one-time election for all loans owing by the FA to the CRIC to a loan-by-loan election, and extension of the elective relief to loans outstanding before March 29, 2012 but whose maturity dates were extended after March 28, 2012; and
  • the expansion of the corporate reorganization exceptions to cover certain types of reorganizations and other internal transactions involving indirect acquisitions of FA shares by a CRIC by way of an acquisition of shares of a Canadian target company.

While these changes are generally welcome, the plethora of specific rules and exceptions has resulted in an extremely complex set of codified rules that need to be carefully considered in each situation where they might conceivably apply. The rules remain highly mechanical, and may well apply to a wide array of transactions that in fact pose no threat to the Canadian tax base.

The impact of the rules should be carefully considered by any foreign investor planning an acquisition of, or investment in, any Canadian company with foreign operations including in the context of a public offering of securities. In general, the rules apply to any investment made after March 28, 2012, subject to limited grandfathering for pre-existing contractual commitments. There is also an elective rule under which taxpayers may elect to be subject to the Budget Proposals for the interim period between March 29 and August 13.

Bill C-45 also contains changes to a new elective rule relating to upstream shareholder loans, first introduced in the August 14 Proposals.


As discussed in our August 2012 Blakes Bulletin, the August 14 Proposals significantly broadened the scope of "investment in a subject corporation" made by a CRIC in a number of respects, including deeming an acquisition by a CRIC of shares of another CRIC to be an "investment in a subject corporation" where, essentially, more than 50% of the fair market value (FMV) of the other CRIC's property is derived from the value of FA shares.

Bill C-45 contains a relieving change that increases the 50% threshold to 75%. Thus, an acquisition by a CRIC of shares of another CRIC will be deemed to be an indirect acquisition of the shares of a subject corporation only where the FMV of all FA shares owned directly or indirectly by the other CRIC exceeds 75% of the total FMV of all properties owned by the other CRIC. This determination is to be made without reference to debt obligations of any Canadian resident corporations in which the other CRIC has a direct or indirect interest.

This change is a welcome one particularly in the context of typical structures where a foreign purchaser (Foreign Purchaser) incorporates a Canadian acquisition company (Canco) to acquire a Canadian target company (Canadian Target). In the typical structure, Canco is capitalized by Foreign Purchaser with equity (or debt and equity), and then Canco acquires the Canadian Target shares. Upon the amalgamation of Canadian Target with Canco (or the liquidation of Canadian Target into Canco), a step-up (or "bump") in the tax cost of non-depreciable capital property, including shares of FAs, is available in some circumstances. The bump enables FA shares to be distributed by Amalco without recognition of gain, and the distribution may be effected free from WHT by way of return of PUC or debt repayment.

Since the ongoing funding of any FAs retained under Canada could result in additional tax costs under the FA dumping rules, the ability to extract the FAs post-acquisition has become more important. Under Bill C-45, the FA dumping rules will not apply to the acquisition by Foreign Purchaser of shares of Canadian Target unless the 75% threshold is breached. In such a case, the Foreign Purchaser will have more flexibility in structuring a tax-efficient extraction of the FA shares post-acquisition.

In cases where the 75% threshold is breached, Canco will be considered to have indirectly acquired shares of the underlying FAs. Subject to the PUC reduction rule discussed below, the acquisition would result in a deemed dividend. However, as explained below, the new rules generally provide a method whereby, with careful planning, adverse consequences can be avoided and the traditional "bump and distribute" model still works in most cases.


Bill C-45 contains a new "QSC" election which is intended to address some specific problems with the August 14 Proposals, specifically:

  • under the August 14 Proposals, if the FA investment were made by a lower-tier CRIC (i.e., a CRIC owned by another Canadian holding company instead of being owned directly by the foreign parent), then two problems arose:
  • the potentially lower (often 5%) treaty rate on cross-border dividends could not be accessed under some treaties (including the Canada-U.S. treaty), so the deemed dividend would be taxed at a higher rate (often 15%); and
  • no PUC offset was available; and
  • under the August 14 Proposals, even if the investing CRIC was first-tier (i.e., owned directly by the foreign parent), no PUC offset was available if any shares of the CRIC (even one share) happened to be owned by another member of the corporate group.

The QSC election is somewhat technically complex, but in essence it enables the group to "move" the deemed dividend to one or more other Canadian members of the group that have shares owned by the parent or other foreign members of the group. The deemed dividend can then be elected to be treated as having been paid either directly to the parent or to another foreign corporation controlled by the parent, thereby providing the group with flexibility to decide where in the group the consequence should arise.

The PUC offset rule - originally a purely elective rule in the August 14 Proposals - now applies automatically to:

  • any cross-border PUC of the CRIC and/or any elected QSC where a QSC election is made;
  • any cross-border PUC of the CRIC where the CRIC is a top-tier CRIC with only one class of shares; or
  • any cross-border PUC of a top-tier CRIC with more than one class of shares where the PUC is created as a result of funding the CRIC's investment.

Special rules attempt to steer the PUC offset as much as possible to classes of shares owned by the parent or other foreign members of the group, but because PUC is calculated on a class-wide basis, the possibility remains of unrelated foreign shareholders suffering an adverse consequence (specifically a reduction to the PUC of shares they own). Participants in any cross-border joint venture involving a CRIC with foreign operations should carefully consider the consequences of these rules; in some cases, the possibility of adverse consequences may be mitigated by carefully designating which classes of shares will be owned by different participants.

While the automatic nature of the PUC offset rule may be helpful in some cases, there are situations where multinationals might actually prefer deemed dividend treatment, particularly if any resulting WHT is creditable in the home jurisdiction. Cross-border PUC may be critical under the thin capitalization rules to maintaining deductibility of interest on cross-border related party debt. Careful consideration of the precise manner in which to make the QSC election and the manner of funding an investment by a top-tier CRIC may assist in mitigating unwanted PUC offsets.


As in the August 14 Proposals, Bill C-45 includes a "PUC reinstatement" rule. The intent of this rule is to allow a recovery or reinstatement of PUC that was reduced under the PUC offset rule. In the context of a typical cross-border "bump and distribute" structure, as described above, this rule could enable the acquisition company to recover the PUC that was "lost" due to the basic FA dumping rule, in order to permit a return-of-PUC distribution of the underlying FAs.

In general, Bill C-45 expands the PUC reinstatement rule as follows:

  • to apply to automatic PUC reduction where share consideration was given by the CRIC for the investment;
  • to apply to PUC reductions arising from the indirect acquisition of FAs by way of an acquisition of a Canadian company that breaches the 75% threshold;
  • to apply to contributions of capital to FAs;
  • to apply to PUC of QSCs that has been suppressed;
  • to allow PUC reinstatement for distributions that occur 180 days (previously 30 days) after the disposition of the underlying FA shares the proceeds of which are being distributed, and also to allow for distributions of proceeds realized from the disposition of shares substituted for the original FA shares; and
  • to apply where returns of capital by the CRIC consist of amounts traceable to dividends/returns of capital by underlying FAs.

Unfortunately, even with this broadening, there are still some potential traps, including:

  • the rule does not apply to any situation where the original "investment" in the FA is not an acquisition of shares of the FA, a contribution of capital to the FA or an indirect acquisition of FAs as described above (for example, where the original investment is a loan to the FA);
  • PUC can only be reinstated on the particular class of shares which was previously subject to a PUC offset - so an intervening reorganization of capital may disentitle the CRIC from taking advantage of PUC reinstatement; and
  • the concept of substituted property has been narrowed from that in the August 14 Proposals.


The August 14 Proposals contained three exceptions to the FA dumping rules:

  • the "pertinent loans or indebtedness" (PLOI) exception;
  • exceptions for certain corporate reorganizations; and
  • an exception for strategic business expansions.

Bill C-45 modifies the scope of the exceptions in a number of ways.


The definition of "investment" in the Budget Proposals included both loans and other acquisitions of debt owing by a subject corporation. The rules provided an exception for an amount owing or acquisition made in the ordinary course of the business of the CRIC.

The August 14 Proposals introduced the concept of a PLOI. A PLOI (as defined in such proposals) was an amount owing by a subject corporation to a CRIC that arose after March 28, 2012, that was not already carved-out under the ordinary course of business exception described above, provided that the CRIC and its parent had made a joint election in respect of all amounts owing to the CRIC by such subject corporation. PLOIs are carved-out of the FA dumping rules but result in income arising in the CRIC equal to at least a baseline amount of interest as described below.

Bill C-45 revises the PLOI regime by broadening the PLOI definition to include an amount owing before March 29, 2012 for which the maturity date was extended after March 28, 2012. Thus, a historical debt obligation that becomes an "investment" after March 28, 2012 because the maturity date was extended will now qualify as a PLOI provided the election is made.

Bill C-45 also introduces a relieving provision that provides for no interest imputation under the PLOI regime for the first 180 days following the acquisition of control of a CRIC by a parent where the CRIC was not controlled by a non-resident corporation before such acquisition of control. In other words, limited transition time is provided for previously Canadian-controlled companies that are acquired by a foreign buyer.

The tax consequences to a CRIC of electing into the PLOI regime are discussed further below.

Corporate Reorganizations

The FA dumping rules contained in the Budget Proposals did not contain an explicit mechanism to allow for corporate reorganizations and other internal transactions that do not fundamentally result in any incremental investment in or change in ultimate ownership of FAs.

The August 14 Proposals introduced a number of exceptions to the FA dumping rules for corporate reorganizations, although submissions made to the Department of Finance outlined a number of examples demonstrating that the exceptions did not go far enough.

Bill C-45 expands the scope of the corporate reorganization exception. As expected, it will now include an indirect acquisition of subject corporation shares by a CRIC (through the direct acquisition of shares of another CRIC that breaches the 75% threshold). The circumstances in which the exception for indirect acquisitions applies are generally analogous to those for direct acquisitions.

The corporate reorganization exception will also now apply to the acquisition of shares where such shares are the sole consideration for the exchange of non-convertible debt owing to the CRIC. This appropriately results in the same treatment as the conversion of convertible debt.

Notably absent from the corporate reorganization exceptions are provisions which clearly and explicitly permit certain common transactions.

For example, when the acquisition of a Canadian public corporation by a CRIC proceeds by way of take-over bid, it might be necessary to effect an "amalgamation squeeze-out" in order for the CRIC to eliminate minority investors. While each case needs to be carefully considered, there could still be some unresolved FA dumping issues in an amalgamation squeeze-out where the target company breaches the 75% threshold.

Strategic Business Expansions

The Budget Proposals contained a so-called "business purpose" exception to the FA dumping rules that included certain enumerated factors to be given "primary consideration" when determining whether the exception was met. These factors were generally perceived by the business and tax communities to be unrealistic, and concerns were expressed that there was considerable uncertainty in how to interpret the factors.

The August 14 Proposals significantly narrowed the business purpose exception by turning the list of factors into a list of conditions, all of which must be met. Bill C-45 further modifies the exception. Overall, the conditions for this exception to apply are numerous, and we are skeptical as to its practical utility in most real-world cases.

In general, the conditions (as modified by Bill C-45) look to whether:

  • The business activities of the FA (and all other corporations in which the FA has an interest - "subject subsidiary corporations") are more closely connected to the business activities of the CRIC (and related Canadian corporations) as compared to the business activities of the parent (and any other non-resident corporation in the group other than the FA, subject subsidiary corporations and corporations that were controlled FAs (CFAs) of the CRIC before the investment was made). The main change here from the August 14 Proposals is to allow a consideration of not only the CRIC's own business activities, but also those of downstream companies. However, suggestions that the test be re-formulated as an "at least as closely connected" test were evidently rejected;
  • The principal decision-making authority in respect of the making of the investment was made by officers of the CRIC, the majority of whom are resident and work principally in Canada or a country in which a CFA of the CRIC carries on business activities that are closely connected to the activities of the FA and its subject subsidiary corporations on a collective basis (a connected affiliate). This novel test requires an inquiry as to which officers in the overall organization made the "decision" to invest - a question that would seem to rarely have a straightforward answer in real-world multinational organizations; and
  • Such officers will continue to have ongoing principal decision-making authority and their performance evaluation and compensation must be based on the results of the operations of the subject corporation to a greater extent than the performance evaluation and compensation of any officers of a non-resident corporation other than the subject corporation, its subsidiaries and any connected affiliates but within the broader corporate group. This extremely strict requirement would apparently make it difficult to meet the test where the relevant officers' compensation is not performance-based at all, or where it is based on performance of the group as a whole, as would very frequently be the case.

For this purpose, officers of both a CRIC and a related non-resident corporation (other than the subject corporation, a subject subsidiary corporation or a connected affiliate) that are resident in the same country as a connected affiliate cannot be counted towards the majority requirement.

Bill C-45 also introduces a relieving rule that provides an exception from the FA dumping rules for an investment by a CRIC in an FA to fund a loan by the FA to a CFA of the CRIC in circumstances where the business purpose exception would have applied had the investment been made directly in the CFA (and will continue to apply during the life of the loan). The CFA must use the proceeds of the loan in an active business carried on by it in its country of residence. This change accommodates certain downstream financing arrangements.


Subject to a few narrow exceptions, under current rules, a Canadian corporation will generally face adverse tax consequences if it makes loans to its foreign shareholder and other non-Canadian members of a corporate group. The August 14 Proposals contained a previously unannounced companion rule to the PLOI exception described above that allow a CRIC that is controlled by a non-resident corporation to make a loan after March 28, 2012 to its parent or another non-resident corporation within the group (other than an FA of the CRIC) where the CRIC and the parent jointly elect in respect of all loans and indebtedness owing by the borrower corporation.

The August 14 Proposals also separately describe this type of shareholder loan or indebtedness as a "pertinent loan or indebtedness" (SPLOI). As originally proposed, the election was to be:

  • made on a borrower-by-borrower basis (in respect of all loans or indebtedness);
  • permanent; and
  • made in writing on or before the filing due date of the CRIC for its taxation year that includes the day on which such a loan or indebtedness amount first became owing.

This new rule applies whether or not the CRIC has any FAs. SPLOIs result in income of at least a baseline amount of interest as described below.

Bill C-45 expands the SPLOI exception to apply to loans:

  • received or indebtedness incurred by a partnership of which the parent or another non-resident corporation within the group is a member; or
  • made by a partnership, each member of which is the CRIC or a corporation resident in Canada that is related to the CRIC (a qualifying Canadian partnership).

Under existing shareholder loan rules, a CRIC can make an upstream shareholder loan without adverse tax consequences if the loan is repaid within one year after the end of the tax year in which the loan is made, provided that the repayment is not "part of a series of loans or other transactions and repayments". Many multinational groups avail themselves of this exception from time to time in order to repatriate cash in a manner that defers or avoids WHT. The submissions made in response to the August 14 Proposals requested that the SPLOI rules be revised to make it clear that a SPLOI that was made in connection with the refinancing of a loan that relied on this exception would not be considered to be part of a series of loans or other transactions and repayments, so as to avoid any risk that the repayment-within-one-year exception would be invalidated.

Bill C-45 does not offer any relief from this risk. There is no bright-line period of time that must elapse between transactions for them to be considered not part of the same series. Careful planning is required in the case of CRICs that made upstream loans before March 29, 2012 and that now wish to convert those loans into loans governed by the new SPLOI regime.


Bill C-45 also significantly relaxes the election requirements for both the PLOI regime and the SPLOI regime, in that the election is now to be made in respect of each PLOI or SPLOI on a loan-by-loan basis, and it can be late-filed up to three years after the deadline (subject to a late-filing penalty capped at C$3,600).

In the case of a PLOI, the deadline is now the filing due-date of the CRIC for its tax year when the applicable amount became owing (or the maturity date was extended).

In the case of a SPLOI, the deadline is now the filing due-date of the CRIC for its tax year when the applicable amount became owing (or in the case of an amount owing to a qualifying Canadian partnership, the filing due-date of the CRIC for its tax year in which the fiscal period of the partnership in which the amount became owing ended). Where the amount became owing to a qualifying Canadian partnership, the election is made jointly by the parent and all members of the qualifying Canadian partnership.

These are welcome changes as they remove the possibility that a CRIC could miss the one-time filing deadline in respect of a particular subject corporation under the August 14 Proposals and be forever precluded from utilizing the PLOI or SPLOI exception in that regard. Further, the CRIC can choose which obligations will be subject to the PLOI regime (rather than the FA dumping rule regime) or the SPLOI regime (rather than the pre-existing shareholder loan rules), as the case may be. However, because the elections are now made on an obligation-by-obligation basis, this may increase the administrative compliance burden for some CRICs.


PLOIs and SPLOIs taking advantage of the new exception will be subject to a new rule that deems the interest earned by the CRIC on the amount owing to be no less than the greater of a prescribed interest rate and the interest cost of any amount borrowed by the CRIC (or another Canadian resident not dealing at arm's length with the CRIC) that directly or indirectly funds the PLOI or SPLOI. Essentially this means that loans structured to take advantage of these rules should generally have an interest rate no less than the baseline rate.

The prescribed rate (which is a floating rate that is set quarterly and is currently approximately 5%) slightly lower than the rate payable by taxpayers on late-paid taxes; it is approximately 4% higher than the rate generally prescribed in respect of interest payable between taxpayers to avoid the deemed conferral of a benefit or as a measure of a fair return on capital.

Under the August 14 Proposals, the prescribed rate of interest was rounded up to the next whole percentage. The resulting economic impact was a point of significant concern for the business community, as reflected in the submissions made to the Department of Finance. Bill C-45 proposes instead that the prescribed rate be rounded to two decimal places.

In some cases, foreign transfer pricing rules may not allow a full deduction to a foreign borrower of interest set at this "high" prescribed rate. Bill C-45 introduces a new rule that denies the application of the PLOI or SPLOI regime where, because of the application of a tax treaty, the amount included in the income of the CRIC for any taxation year (or a qualifying Canadian partnership for any fiscal period) is less than it would be absent the application of the tax treaty.

This provision appears to be intended to deter a CRIC from applying to the competent authority for any treaty-based adjustment where the CRIC is relying on the application of the PLOI or SPLOI regime. Thus a multinational group with a CRIC that provides intercompany financing outside of Canada may be forced to choose between the PLOI/SPLOI regime, and the risk of double taxation. It will be interesting to see whether any of Canada's treaty partners take exception to this provision, which effectively impedes the operation of mutual agreement procedure provisions intended to relieve double tax.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions