Canada: Canadian International Tax Rules: June 2014 Foreign Affiliate Tax Elections

June 2014 is the deadline for Canadian corporations to make potentially important tax elections relating to recently enacted changes to the foreign affiliate reorganization rules in the Income Tax Act (Canada) which are retroactive to December 20, 2002. Companies whose foreign affiliates have undertaken distributions, mergers, or liquidations should review their historic transactions now to determine whether any of these elections should be made.

New Foreign Affiliate Reorganization Rules

A process of amending the rules dealing with foreign affiliate mergers, liquidations and distributions has been in flux since the release of a comprehensive package of draft proposals on February 27, 2004, building on more modest proposals from December 2002. The Department of Finance subsequently issued a series of comfort letters proposing to further modify these draft rules in significant respects. As a result, Canadian corporations faced a high level of uncertainty when planning and implementing reorganizations involving their foreign affiliates, having to consider consequences under multiple possible regimes, including the then-current rules and various versions of the proposed rules and their modifications.

On August 19, 2011, the Department of Finance released its definitive package of these foreign affiliate reorganization proposals. This package included new and broader rules governing foreign affiliate mergers (paragraph 95(2)(d.1)), lower-tier foreign affiliate liquidations (paragraph 95(2)(e)), and top-tier foreign affiliate liquidations (subsection 88(3)). In addition, it included new subsection 90(2) deeming most pro rata foreign affiliate distributions to be dividends, together with new Regulation 5901(2)(b) permitting dividends to be electively treated as pre-acquisition surplus dividends. With some modifications, these August 19, 2011 foreign affiliate proposals were incorporated into a massive technical bill (Bill C-48), and ultimately enacted into law on June 26, 2013.

Opportunities to Elect Retroactive Application

The new foreign affiliate rules are generally effective after August 19, 2011. However, the Department of Finance recognized the difficulty taxpayers had faced in carrying out transactions over the extended period of uncertainty, when it was not known which version of the foreign affiliate rules would ultimately apply. To address these circumstances, Bill C-48 included a number of important, one-time transitional election opportunities allowing taxpayers to apply the final amendments (or modified versions) retroactively to transactions occurring after December 20, 2002. Some of the available elections are due on or before June 26, 2014 (one year after Bill C-48 received Royal Assent), while others are due by the taxpayer's 2013 tax return filing deadline (June 30, 2014 for calendar year corporations).

The key election opportunities are:

  • Regulation 5901(2)(b) permits specific post-August 19, 2011 foreign affiliate distributions to be electively treated as pre-acquisition surplus dividends that reduce adjusted cost base, rather than as dividends that draw up surplus balances. Taxpayers may now elect generally to apply this rule retroactively to foreign affiliate distributions after December 20, 2002, which will allow designated historic distributions to be electively treated as pre-acquisition surplus dividends.
  • Paragraph 95(2)(d.1) can be applied retroactively to foreign affiliate mergers after December 20, 2002, for broader rollover treatment than under the old rules.
  • Paragraph 95(2)(e) can be applied retroactively to lower-tier foreign affiliate liquidations after December 20, 2002, for broader rollover treatment than under the old rules.
  • Subsection 88(3) provides broad rollover treatment for property distributions in the course of a top-tier foreign affiliate liquidation commencing after February 27, 2004 that is retroactively elected to be a qualifying liquidation and dissolution (a QLAD). Moreover, taxpayers can now make a retroactive "suppression election" under subsection 88(3.3) to minimize or avoid capital gains in respect of the cancellation of the shares of the liquidating foreign affiliate in the course of a QLAD.

With this package of retroactive election opportunities, the Department of Finance has given Canadian corporate taxpayers an important, one-time choice for their historic, pre-August 19, 2011 foreign affiliate transactions. They can disregard the foreign affiliate proposals up to that point, and simply apply the old rules that were in effect at the time, together with all their acknowledged restrictions and defects. Or instead, taxpayers can now elect to apply the new, and generally more favourable foreign affiliate reorganization rules retroactively to those historic, pre-August 19, 2011 transactions.

Corporations with foreign affiliates should consider carefully whether they wish to clarify, protectively confirm, or perhaps even strategically change the tax consequences of post-December 20, 2002 transactions involving foreign affiliate dividends, capital reductions, share repurchases, liquidations or mergers, by making one or more of these elections before the applicable June 2014 deadline.

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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