In the domestic context, section
84.1 is designed to prevent surplus stripping in
non-arm's-length situations. The following broad example
illustrates this provision.
Assume that individual X, a
Canadian resident, owns all of shares of Opco, a corporation
resident in Canada, having an FMV of $100,000, an adjusted cost
base (ACB) of $20,000 and paid-up capital (PUC) of $1.00. If X were
to transfer the shares of Opco to a non-arm's-length Holdco and
did not wish to realize a taxable amount, X could receive non-share
consideration with a maximum FMV of $20,000, being the greater of
the ACB ($20,000) and the PUC ($1.00). This would be true even if
the gain on the disposition were sheltered by the capital gains
exemption. If X were to receive, say, a note of $100,000, X would
be deemed to have received a dividend of $80,000. If X were to
receive shares of Holdco with a PUC of $100,000, the PUC would be
ground down to $20,000 to prevent the tax-free extraction of
If X were a non-resident (whether
an individual or a corporation (Forco)), section 212.1 would
operate in a similar, but not identical fashion.
If X were to receive non-share
consideration with an FMV greater than the $1.00 PUC (not the
$20,000 ACB), from a Holdco resident in Canada, X would be deemed
to have received a dividend equal to the excess. While a capital
gain on the disposition would not have been taxed in Canada unless
the shares were "taxable Canadian property" (and even
then only if the gain was not exempted by a tax treaty), the deemed
dividend would be subject to Canadian withholding tax.
If X were to receive shares of
Holdco with an FMV greater than the $1.00 PUC (not the $20,000
ACB), the PUC would be ground down to $1.00 to prevent the tax-free
extraction of surplus.
Subsection 212.1(4) provides an
exception to section 212.1 where a Forco disposes of shares of Opco
to a Holdco that controls Forco. The Department of Finance feels
that this exception has been abused. As a consequence, with respect
to dispositions on or after Budget Day, the exception in subsection
212.1 will not apply where Forco owns, directly or indirectly,
shares of Holdco and does not deal at arm's-length with
Section 247 contains rules to
ensure that cross-border charges among non-arm's length
entities generally reflect prices that would be negotiated by
arm's-length parties. In this regard, certain recommendations
of an international study, the Base Erosion and Profit Sharing
(BEPS) project, are consistent with existing CRA practices and
require no Canadian changes at this time.
The Budget proposes
country-by-country reporting requirements that would allow
inter-company pricing to be monitored more easily. The new rules
will apply to taxation years that begin after 2015, but only to
groups with consolidated revenues of at least €750
The BEPS project addressed
"treaty shopping," i.e., the abuse of tax treaty networks
whereby an international organization establishes a corporation in
a second jurisdiction only for the purpose of taking advantage of a
tax treaty between that second jurisdiction and a third
The Budget indicates that future
Canadian tax treaties will contain anti-avoidance provisions to
counter such abuses.
Subsection 18(6) contains an
anti-avoidance measure intended to curtail the avoidance of the
"thin capitalization" rules by interposing an ostensibly
arm's-length lender between a Canadian borrowing entity and the
real non-arm's-length lender. A similar anti-avoidance rule is
found in subsection 212(3.1) where an attempt is made to avoid
Canadian withholding tax on the payment of interest to a
non-arm's-length lender by interposing an ostensibly
arm's-length lender between a Canadian borrower and the real
The Budget indicates that Canada
will strengthen existing rules to prevent tax avoidance in
connection with back-to-back arrangements. The new rules will
apply, for example, where back-to-back arrangements are intended to
reduce Canadian withholding tax in connection with rents and
royalties, to avoid the "upstream loan" rules (where a
Canadian corporation receives a loan from a foreign affiliate to
avoid receiving a taxable dividend from that affiliate) and in
other more complex circumstances.
International Tax Rulings
The Budget confirms that,
commencing in 2016, Canada will begin spontaneously exchanging tax
rulings with other jurisdictions that agree to do the same.
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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