Canada: Bill C-48, Technical Tax Amendments Act – Amendments To Foreign Affiliate Rules

The rules in the Income Tax Act (Canada) (the ITA) that govern the taxation of income earned by foreign affiliates (FAs) – generally a non-resident corporation in which the Canadian taxpayer has at least a 10% equity interest – have been the subject of numerous proposed amendments over the last decade.

The 945-page Notice of Ways and Means Motion introduced by the Canadian Minister of Finance on October 24, 2012 and tabled in the House of Commons on November 21, 2012 as Bill C-48, the Technical Tax Amendments Act, 2012 (the October 24 Proposals) includes most of the previously announced proposed amendments to the FA rules, including the measures announced in the August 19, 2011 draft legislation (the 2011 Proposals) and the December 18, 2009 draft legislation (the 2009 Proposals), as modified by the August 27, 2010 draft legislation (the 2010 Proposals). For a discussion of the 2011 Proposals, see our August 2011 Blakes Bulletin and for a discussion of the 2009 Proposals, see our January 2010 Blakes Bulletin.

The other amendments contained in the October 24 Proposals will be discussed in a future Blakes Bulletin.

While most of the FA-related amendments contained in the October 24 Proposals remain largely the same as previously announced, there are significant changes in some areas, including the following:

  • Changes (mostly of a relieving nature) to the upstream loan rules (the Upstream Loan Rules) which could give rise to an income inclusion to a Canadian taxpayer where an FA has made a so-called "upstream loan", including
    • extension of the repayment window for loans outstanding on August 19, 2011 (to avoid application of the rules) from two years to five years;
    • improved rules for computing the income inclusion to deal with certain inter-FA loans and to avoid multiple income inclusions in some situations; and
    • expansion of the amounts that may be claimed as a deduction in respect of the income inclusion.
  • Modifications to the foreign tax credit generator rules to slightly restrict their ambit as compared to the version contained in the 2010 Proposals.
  • A new provision to allow individuals, trusts and partnerships to elect that a dividend from an FA be treated as a return of capital.
  • A relieving technical change to the "fill-the-hole" rule.

While the government's efforts in addressing the backlog of proposed amendments are to be commended, the complexity of the FA rules has, if anything, increased as a consequence of the proposed changes. Taxpayers that are part of large multinational groups will require up-to-date information on inter-company transactions and tax attributes of FAs. Certain transactions, such as second-tier financing structures, may be caught by multiple sets of rules, including the Upstream Loan Rules and the proposed FA dumping rules. For a discussion of the latest version of the proposed FA dumping rules, see our October 2012 Blakes Bulletin. In addition, the various amendments have different effective dates, some with the ability to elect to have an earlier effective date apply and some dating as far back as 1999. Taxpayers with one or more FAs should carefully review past and future transactions in light of the amendments.



The October 24 Proposals contain a revised version of the Upstream Loan Rules. These rules were first introduced in the 2011 Proposals. For a detailed discussion of the Upstream Loan Rules as originally proposed, see our August 2011 Blakes Bulletin.

Prior to the introduction of the Upstream Loan Rules, FAs often repatriated funds by way of loans to their Canadian parent instead of by way of payment of dividends for various reasons. In some cases, the payment of dividends may not have been permitted under foreign corporate law or may have triggered foreign withholding tax. Where the cash was sourced from the FA's taxable surplus, such loans enabled the Canadian corporate taxpayer to defer the Canadian tax that would otherwise apply to the receipt of a taxable surplus dividend. Generally, dividends paid by an FA out of its taxable surplus balance to its Canadian corporate parent, net of a deduction in respect of underlying foreign taxes, are included in the Canadian corporation's income and subject to Canadian income tax. Such loans, being loans made to a Canadian-resident corporation, are specifically exempted from the rule in subsection 15(2) of the ITA that deems certain loans to shareholders to be shareholder benefits (the existing shareholder loan rule). The Canada Revenue Agency (the CRA) had also confirmed in a number of advance income tax rulings that a loan of taxable surplus by an FA to its Canadian corporate parent would not be subject to the general anti-avoidance rule (GAAR).

The Upstream Loan Rules are designed to prevent taxpayers from making synthetic dividend distributions from FAs in order to avoid what would otherwise be income inclusions arising from dividends paid out of taxable surplus or hybrid surplus that are not fully offset by deductions in respect of underlying foreign taxes. However, these rules are very broad and their application is not limited to upstream loans to a Canadian taxpayer or cases where the FA has taxable surplus or hybrid surplus.

The Upstream Loan Rules are modelled upon the existing shareholder loan rule. Generally, the Rules apply to include a "specified amount" in a Canadian taxpayer's income where a "specified debtor" receives a loan or becomes indebted to an FA of the taxpayer (creditor affiliate) or a partnership of which such FA is a member. A "specified debtor" includes the taxpayer, persons not dealing at arm's length with the taxpayer as well as certain partnerships, but does not include a controlled foreign affiliate (under the modified definition of that term in subsection 17(15) of the ITA) – essentially a Canadian-controlled FA of the taxpayer (a CFA).

Two exceptions to the Upstream Loan Rules are similar to the exceptions to the existing shareholder loan rule. The first exception applies to loans or indebtedness that are repaid within two years from the date on which the loan is made or the indebtedness arose, other than as part of a series of loans and repayments. The second exception applies to indebtedness that arose in the ordinary course of the business of the creditor or a loan made in the ordinary course of the creditor's ordinary business of lending money, provided that bona fide arrangements are made for repayment within a reasonable time.

Where the Upstream Loan Rules result in an income inclusion, an offsetting deduction may be claimed in each year that the loan or indebtedness is outstanding provided certain conditions are met. The amount claimed under this deduction by a taxpayer must be brought back into income in the following taxation year; however, the deduction can be claimed in such subsequent year provided the conditions for claiming the deduction continue to be met. The mostly relieving changes to these conditions contained in the October 24 Proposals are discussed below. Similar to the existing shareholder loan rule, where there has been an income inclusion under the Upstream Loan Rules, a deduction may be claimed when the loan is repaid provided that the repayment is not part of a series of loans and repayments.

While the October 24 Proposals address some of the issues with the Upstream Loan Rules raised in various submissions to the Department of Finance (Finance), the rules may lead to unexpected consequences where there are cash pooling arrangements or multiple loans among entities within multinational groups.

Extended Transitional Relief

One of the criticisms of the Upstream Loan Rules as contained in the 2011 Proposals was that they affected pre-existing debt. The 2011 Proposals deem loans and indebtedness outstanding on August 19, 2011 to have been made on that date, such that in order to avoid an income inclusion, taxpayers only had until August 19, 2013 to repay loans otherwise subject to the Upstream Loan Rules. The two-year period was not sufficient for many taxpayers to unwind their intra-group loan structures (often as part of a group cash redeployment arrangement) that were set up in reliance on previous CRA rulings.

A welcome change in the October 24 Proposals is the extension of the repayment window for loans received or indebtedness incurred on or before August 19, 2011 effectively from two years to five years. Such loans or indebtedness would not be subject to the Upstream Loan Rules if they are repaid before August 19, 2014. If such a loan or indebtedness remains outstanding on August 19, 2014, it would be deemed to be received or incurred on August 20, 2014, but would not be subject to the Upstream Loan Rules provided that the loan or indebtedness is repaid by August 20, 2016 and the repayment is not part of a series of loans and repayments.

The October 24 Proposals also include a temporary measure to allow taxpayers to offset foreign exchange gains or losses realized on the repayment of foreign currency-denominated upstream loans received from a creditor affiliate against related foreign exchange losses or gains of the creditor affiliate, to the extent of the taxpayer's economic entitlement to the FA's loss or gain. This measure applies only for loans and indebtedness outstanding on August 19, 2011 that are repaid, in whole or in part, on or before August 19, 2016.

Changes to Income Inclusion Computation

(i) Inter-FA Loans

Under the 2011 Proposals, the "specified amount" that is included in the taxpayer's income in respect of a loan caught by the Upstream Loan Rules was determined by multiplying the amount of the loan by the Canadian taxpayer's "surplus entitlement percentage" (SEP) in the FA that made the loan at the time the loan was made, without regard to the taxpayer's SEP in the specified debtor. Thus, under the 2011 Proposals, an income inclusion could occur where there is effectively no "synthetic distribution" to the Canadian taxpayer or outside of the Canadian-controlled group, for example, where the Canadian taxpayer's equity interest in the creditor affiliate is the same as that in the specified debtor.

The October 24 Proposals address this issue by defining "specified amount" to mean the amount of the loan multiplied by the difference, if any, between the taxpayer's SEP in the creditor affiliate and the taxpayer's SEP in the specified debtor. Thus, where the specified debtor under a loan is another FA of the taxpayer (i.e., not a CFA of the taxpayer), an income inclusion would arise in respect of the loan only to the extent that the taxpayer's SEP in the creditor affiliate exceeds the taxpayer's SEP in the specified debtor. No income inclusion would arise as a result of loans among FAs in which the taxpayer holds equal equity interests. This is a welcome change for taxpayers who redeploy funds among FAs that are not CFAs but in which the taxpayer has equivalent equity interests.

(ii) Back-to-Back Loans and Partnerships

The Upstream Loan Rules apply to each loan made by each FA of the taxpayer to each specified debtor. Thus, under the 2011 Proposals, back-to-back loans could result in multiple income inclusions to the taxpayer even though the loans originated from the same funds.

The October 24 Proposals introduce a new rule that is modelled upon subsection 17(11.2) of the ITA (the Back-to-Back Loan Rule). Under the Back-to-Back Loan Rule, if a person or partnership (an intermediate lender) makes a loan to another person or partnership (the intended borrower) because the intermediate lender received a loan from another person or partnership (the initial lender):

  • the loan made by the intermediate lender to the intended borrower is deemed to be made by the initial lender to the intended borrower to the extent of the lesser of the amounts of the two actual loans; and
  • the actual loans between the initial lender and the intermediate lender and between the intermediate lender and the intended borrower are deemed not to have been made to the extent of the deemed loan from the initial lender to the intended borrower.

The Back-to-Back Loan Rule operates iteratively such that two or more loans could, in applicable circumstances, be collapsed into one. While the Back-to-Back Loan Rule is primarily intended to be a relieving measure to prevent inappropriate consequences with respect to multiple loans, it could also work to the detriment of the taxpayer, in particular in the case of multiple loans among FAs in which the taxpayer has different SEPs. There is an ability to elect out of the application of the Back-to-Back Loan Rule, but the election is available only for loans made after August 19, 2011 and on or before October 24, 2012. Thus, taxpayers in large multinational groups would need to take extra care to ensure that unexpected adverse results do not arise as a result of the application of the Back-to-Back Loan Rule to multiple loans within the group, in particular, as part of a cash pooling arrangement involving a myriad of loans, deposits and cash movements.

The October 24 Proposals also address the concern under the 2011 Proposals that a loan made by an FA to a partnership that holds the FA or to a non-CFA or another related Canadian corporation could result in an income inclusion at both the partnership level and the Canadian corporate partner level.

However, it would appear that there may still be circumstances under which the Upstream Loan Rules could result in multiple income inclusions, for example, where a loan initially made by an FA to a taxpayer is subsequently assigned or sold by the FA to another FA or where the loan is assumed by another specified debtor.

Deduction in Respect of Income Inclusion

As mentioned above, an offsetting deduction structured as a reserve may be available in respect of an income inclusion under the Upstream Loan Rules, provided certain conditions are met. The concept is to allow a deduction if the cash could have been a tax-free dividend to the Canadian taxpayer. Finance has accommodated this, but there are "anti-double counting" rules that are intended to prevent inappropriate results. The conditions contained in the 2011 Proposals were very restrictive.

The October 24 Proposals contain a number of changes, mostly of a relieving or clarifying nature:

  • The deduction has been expanded to allow deductions for pre-acquisition surplus, but only where the specified debtor is not a non-resident non-arm's length person or partnership of which such non-resident is a member and only to the extent of the Canadian corporate taxpayer's adjusted cost base in the shares of the top-tier FA in the relevant chain from which the loan is made.
  • The deduction has been expanded to allow deductions for previously taxed FAPI, but only if the pre-acquisition surplus deduction is not available.
  • A new provision has been added to ensure that surplus amounts of lower-tier FAs "downstream" from (i.e., below) the creditor affiliate in the relevant chain are now counted in determining the amount of the deduction.
  • The previous prohibition against payment of any dividends in the relevant FA chain while the loan is outstanding has been removed. However, new anti-double counting rules are introduced. Under the anti-double counting rules, the taxpayer would be denied the deduction in a year and all future years essentially if the taxpayer uses some or all of the same amount of exempt surplus, hybrid surplus, taxable surplus or if applicable, adjusted cost base in the year while the relevant loan is outstanding to provide a deduction for any other loan or indebtedness, in respect of any actual or deemed dividend (i.e., under subsection 93(1) of the ITA), or for adjusted cost base, any other distribution.
  • It was not entirely clear under the 2011 Proposals whether a partial deduction is available where the available deductions on a hypothetical dividend are less than the specified amount and whether the deduction is determined based on the surplus amounts at the time the loan is made. The October 24 Proposals (and the accompanying explanatory notes (the Explanatory Notes)) clarify that a partial deduction is permitted and that the deductible amount is "locked in" at the time the loan is made, i.e., the deductible amount cannot be increased (or decreased) due to future earnings (or losses) of the relevant FAs.

While these changes generally improve the availability of the deduction, the deduction is still subject to a number of limitations:

  • Deficits in the relevant FA chain would reduce the deductible amount.
  • "Sidestream" surplus amounts, i.e., surplus amounts of FAs that are not in the same ownership chain as the creditor affiliate would not be taken into account in determining the deductible amount except in cases where the loan from the creditor affiliate is funded by one or more loans from the FA in the other ownership chain such that the Back-to-Back Loan Rule applies to deem the loan to be made by the other FA to the intended borrower.
  • Where there is even a dollar of double counting in a year, the deduction is denied for that year and all subsequent years.
  • Deductions in respect of pre-acquisition surplus are not available to the second-tier financing structures, a number of which have been the subject of favourable rulings from the CRA.
  • Deductions in respect of hybrid surplus would only be available if the gross-up hybrid underlying tax amount is greater than or equal to the hybrid surplus balance, i.e., where the hybrid surplus amounts are "fully covered" by hybrid underlying tax.

These limitations mean that taxpayers who wish to rely on this deduction each year, will not only have to maintain updated records of surplus amounts and adjusted cost base in shares of their FAs, but will also have to constantly monitor new loans and indebtedness that would be subject to the Upstream Loan Rules, as well as dividends and other distributions made by their FAs so as not to run afoul of the anti-double counting rules.

"Warning" Regarding Application of GAAR

Instead of drafting specific anti-avoidance rules, the government has chosen to include a GAAR "warning" in the Explanatory Notes. In particular, the Explanatory Notes state that "any attempts at circumventing [the Upstream Loan Rules] or fitting into one of the exceptions...or the deduction... that are not within the scope of the intended application of these rules, as set out in [the Explanatory Notes]" will be subject to review under GAAR. The Explanatory Notes specifically indicate that it is intended that back-to-back loans, and similar financial arrangements, that frustrate the intent of the Back-to-Back Loan Rule and the use of debt-like equity interests, such as preferred shares, or synthetic lending arrangements – such as factoring of receivables or sale of securities at a discount – in order to avoid the application of the Upstream Loan Rules, would be considered a misuse of the new provisions and an abuse of the ITA (including the regulations thereunder (the Regulations)) read as a whole for purposes of GAAR. It is highly questionable whether a court would defer to such self-serving statements in the Explanatory Notes. One would hope that, in the future, Finance would refrain from these sorts of vague "warnings" and, instead, draft legislation which is sufficiently clear that taxpayers may plan their affairs based on predictable and fair rules.


The October 24 Proposals included a revised version of rules intended to foreclose "foreign tax credit generator" schemes (the FTC Generator Rules). Originally proposed in the 2010 federal budget, the FTC Generator Rules operate to deny a Canadian taxpayer relief against Canadian tax for foreign tax where the Canadian taxpayer's proportionate direct or indirect ownership interest in a foreign corporation or partnership is considered to be less under relevant foreign tax law than would be the case under the ITA. As initially drafted, in the context of the FA rules, the FTC Generator Rules seemed to have significant unintended tax consequences. The October 24 Proposals include some modifications which will restrict the ambit of these rules.

A significant criticism of the version of the FTC Generator Rules contained in the 2010 Proposals was that, where the rules applied, they could deny recognition for foreign taxes paid by FAs of a taxpayer in a particular jurisdiction including in respect of FAs in a separate ownership chain. The October 24 Proposals include changes that address this issue. As a consequence, the FTC Generator Rules should generally only affect FAs in the same ownership chain except in certain circumstances where indirect "funding" arrangements between the chains are involved. Taxpayers should carefully review any transaction between different FA chains where one chain contains a hybrid investment potentially subject to the FTC Generator Rules.


The 2011 Proposals introduced a general rule that treated essentially all pro rata distributions in respect of shares of an FA as dividends for Canadian tax purposes (without regard to their foreign legal classification) other than on the liquidation of the FA or a redemption or purchase for cancellation of shares. Also included in the 2011 Proposals was an election for Canadian corporate shareholders of FAs to have a dividend be deemed to be paid out of the FA's pre-acquisition surplus. This would enable a Canadian corporate taxpayer to avoid an income inclusion that would result under the general rule and instead reduce the adjusted cost base of the FA shares held by such corporation.

Such elective treatment was not available to Canadian taxpayers that were not corporations. The October 24 Proposals introduce a new provision which would allow individuals, trusts and partnerships to elect that a dividend from an FA be treated as a return of capital. Such a return of capital would not be included in the income of the Canadian taxpayer, but would instead reduce its adjusted cost base in the shares of the FA. To the extent that the adjusted cost base becomes negative as a result, the taxpayer would be deemed to realize a capital gain. This is a welcome change although it should be noted that the distribution must be out of the FA's "paid-up capital". This would generally not include share premium or contributed surplus.


The surplus or deficit balances of a taxpayer's FAs are relevant to how much Canadian tax will apply dividends paid or deemed to be paid by FAs to their direct or indirect Canadian parent corporation. The 2009 Proposals introduced the "fill-the-hole" rules which were meant to ensure that where exempt deficits that would otherwise "block" the repatriation of exempt surplus dividends from lower-tier FAs were present, such "blocking deficits" could not be avoided through restructuring the Canadian taxpayer's FA ownership structure, for example, by liquidating the top-tier FA that has an exempt deficit.

The October 24 Proposals retain largely all of the elements of the "fill-the-hole" rules as set out in the 2010 Proposals. A new provision has been introduced to mitigate the inappropriate reduction of consolidated surplus where a Canadian corporation owns shares of an FA through more than one chain of ownership.


The 2011 Proposals included a new anti-avoidance rule that would recharacterize exempt earnings to be taxable earnings in circumstances where such earnings could be considered to arise from an "avoidance transaction". As originally drafted, it seemed possible that the proposed rule might be applied to recharacterize amounts that would otherwise be specifically deemed to be exempt earnings (such as interest earned in an intra-group financing context) to be taxable earnings. Some comfort may be derived from a change to the proposed rule to limit its application to dispositions of property other than money by an FA. That being said, the breadth of this proposal and its questionable necessity given the existence of GAAR remain topics of concern.


In addition to the proposals discussed above, the October 24 Proposals included numerous proposals that were included in either the 2011 Proposals or the 2009 Proposals. Generally speaking, these proposals have not been materially changed from the versions previously introduced although some technical modifications are included. For a discussion of the previous versions of these proposals, see our January 2010 Blakes Bulletin and our August 2011 Blakes Bulletin.

These previously announced proposals include the following:

  • a new rule that will adjust the surplus accounts of an FA directly owned by a Canadian corporation when control of the Canadian corporation has been acquired;
  • new rules that limit the ability of a Canadian taxpayer to increase the adjusted cost base of shares of an FA where such shares were owned by a Canadian corporation that has been wound-up or amalgamated with its Canadian parent;
  • "hybrid surplus" rules dealing with the surplus implications from an FA's gains and losses from the disposition of shares of FAs and certain other property that are excluded property;
  • revisions to the rules governing acquisitions, dispositions and reorganizations of FAs including:
    • liquidations of first-tier FAs;
    • liquidations of lower-tier FAs;
    • foreign mergers; and
    • exchanges of shares of one FA for shares of another FA;
  • changes to stop-loss rules including the dividend stop-loss rule applicable on dispositions of FA shares; and
  • the streaming of capital losses in the determination of FAPI.

The lack of any changes to some of these proposals will be disappointing for some. For example, it had been widely hoped that the restrictions on the availability of an exception to the dividend stop-loss rules for foreign exchange-related losses would be relaxed from those that had been introduced in the 2011 Proposals.

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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