Canada: Canada Revenue Agency Interprets Anti-Hybrid Rule

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Tax, November 2009

The Fifth Protocol to the Canada-U.S. tax treaty (the Treaty) was ratified in December 2008, and for most purposes came into force in 2009. One of the more controversial measures contained in the Protocol is the new "anti-hybrid" rule in Article IV(7) of the Treaty. This unprecedented rule takes effect on January 1, 2010.

The Anti-Hybrid Rule

There are two branches to the anti-hybrid rule.

The first branch deals with "reverse hybrid" entities. These are entities which are fiscally transparent in the source state but not in the state of residence. An example of such an entity is a partnership formed under Canadian law which has elected for U.S. tax purposes to be treated as a foreign corporation. This branch of the rule, found in Article IV(7)(a), applies to an amount paid to or derived by a U.S. person through an entity that is not a U.S. resident, where, by reason of the entity not being treated as fiscally transparent under U.S. law, the treatment of the amount under U.S. law is "not the same" as its treatment would be if that amount had been derived directly by that person. In other words, the rule could potentially apply to an amount derived by a U.S. person through a partnership formed under the laws of Canada where the treatment of the item differs from the hypothetical treatment that would have arisen had the person derived the amount directly rather than through the partnership. If the rule applies, the item of income paid to or derived by the U.S. person is not eligible for Treaty benefits.

The second branch of the rule, and the one arising more commonly in practice in Canada, deals with "hybrid" entities, namely entities that are not fiscally transparent in the source state, but fiscally transparent in the state of residence. An example is a Canadian unlimited liability company (ULC). This branch of the rule, found in Article IV(7)(b), applies to an amount that is paid to or derived by a U.S. person if the person is considered under Canadian law to have received the amount from an entity that is a resident of Canada, where, by reason of the entity being treated as fiscally transparent under U.S. law, the treatment of the amount under U.S. law is "not the same" as its treatment would be if the entity were not treated as fiscally transparent under U.S. law. The rule could potentially apply to an amount paid by a ULC to a U.S. person, but only if the treatment of the item differs from the hypothetical treatment that would have arisen had the ULC not been fiscally transparent for U.S. tax purposes. Where the rule applies, no Treaty benefits are available in respect of the item in question.

It is widely understood that the anti-hybrid rule, and in particular Article IV(7)(b), was drafted in a way that was overbroad and went well beyond the perceived mischief that gave rise to the rule. This has been observed by, among others, the Joint Committee on Taxation of the U.S. Congress, which noted that Article IV(7)(b) was overbroad, especially (though not exclusively) with respect to non-deductible payments such as dividends. Dividends paid by a ULC out of the after-tax earnings of the ULC clearly should not, as a matter of sound tax policy, be subjected to non-treaty rates of dividend withholding tax, and yet this seemed to be the result obtained by mechanically applying the language of Article IV(7)(b).

Meaning of "Same Treatment"

The anti-hybrid rules introduce a notion that is not well understood in Canadian tax law, specifically the concept of comparing the actual U.S. tax treatment of an item in question with its hypothetical U.S. tax treatment under assumed circumstances. This rule begs the obvious question as to what is meant by "treatment", and what criteria are to be applied when comparing actual treatment with hypothetical treatment, and determining whether they are the "same". In the U.S. Treasury Department's Technical Explanation (TE), released in July 2008, it was stated that this determination would be made from a U.S. point of view in accordance with the principles set forth in Code section 894. The TE added that although Canada does not have analogous provisions in its domestic law, "it is anticipated that principles comparable to those described [in section 894] will apply". The Minister of Finance of Canada has stated that Canada agrees with the TE.

On November 25, 2009, the Canada Revenue Agency (the CRA) released a copy of an internal technical interpretation commenting upon the Canadian approach to the question of "same treatment". In short, the CRA stated that three factors will be considered to determine whether the treatment of an amount is the same as its hypothetical treatment: (a) the timing of the recognition or inclusion of the amount; (b) the character of the amount; and (c) the quantum of the amount. Geographic source generally will not be relevant unless it affects the treatment of the amount as an item of income under U.S. tax law. The mere fact that the geographic source of an amount may affect the ability of a U.S. person to claim a foreign tax credit will not be relevant.


In both the technical interpretation noted above and at the "Round Table" session held at the Canadian Tax Foundation Annual Conference on November 24, 2009, the CRA commented on the application of the anti-hybrid rule to some fact patterns. Generally, these comments provide helpful guidance in dealing with the anti-hybrid rule.

Set out below is a description of some of these examples, and the comments made by the CRA.

Example 1: Payment of Dividends by ULC

Suppose the ULC is wholly owned by a U.S. corporation which qualifies for Treaty benefits (USco). Beginning January 1, 2010, any dividend paid by the ULC to USco will be subject to statutory 25% withholding tax. Clearly, this is anomalous from a tax policy perspective.

The following solution was accepted by the CRA at the Round Table: Instead of paying a dividend, the ULC undertakes a two-step transaction. First, the ULC increases its paid-up capital without distributing any cash or other property. This increase in paid-up capital gives rise to a deemed dividend for Canadian tax purposes, but no tax consequence for U.S. tax purposes. Because the U.S. treatment (no consequence) is the same as the hypothetical treatment of that transaction that would have arisen had the ULC not been fiscally transparent, the anti-hybrid rule does not apply. Accordingly, the CRA confirmed that Treaty withholding rates (5%) would apply. Immediately after the foregoing step, but in a clearly separate step, the ULC makes a distribution to USco in the form of a return of the paid-up capital that was just created in the first step. A distribution structured legally as a return of paid-up capital is not subject to Canadian withholding tax, and therefore there is no need to have recourse to the Treaty. This two-step procedure effectively accomplishes a distribution without giving rise to a problem under the anti-hybrid rules.

The CRA commented that while the application of the general anti-avoidance rule (GAAR) depends on all the facts and circumstances, it would "not normally" apply GAAR to this type of planning where the ULC is used by USco to carry on an active branch operation in Canada and the arrangement is used by the ULC to qualify for the reduced Treaty rate of withholding tax on the distribution of the ULC's after-tax earnings to USco. While this is a welcome statement, it obviously leaves some room for the CRA to selectively seek to apply GAAR if it believes the circumstances so warrant. It is critically important to ensure that all necessary corporate law formalities are complied with, including any restrictions on the circumstances in which paid-up capital may be increased under the applicable corporate law. It should also be noted that this planning will not work in a situation where the shares of the ULC are held by a fiscally transparent limited liability company (LLC). In that case, alternative approaches should be considered.

Example 2: Luxembourg Intermediary

The CRA also confirmed that the inter-position of a Luxembourg resident company between USco and the ULC normally will result in any dividends paid to Luxco being eligible for the 5% treaty rate of withholding tax under the Luxembourg-Canada Tax Treaty, provided of course the dividend is "beneficially owned" by Luxco. The CRA indicated that its comments on the application of GAAR in Example 1 would also apply to this example.

Example 3: Payment of Interest to "Grandparent"

In this example, "Grandparent" is a U.S. resident company, entitled to Treaty benefits, which wholly owns USco, which in turn wholly owns the ULC. The ULC pays interest on a debt owing directly to Grandparent. The CRA confirmed that the treatment of the interest is considered to be the same as the hypothetical treatment that would have arisen had the ULC not been fiscally transparent (even in the case where Grandparent and USco elect to file a consolidated group tax return for U.S. tax purposes), and that Treaty benefits are therefore available. However, the CRA cautioned that it may apply GAAR to this type of arrangement where the arrangement results in the creation of a "double deduction" or "double dip" or an internally generated interest deduction in one country without offsetting interest income in the other country.

Example 4: ULC with Two Shareholders

This example, which is contained in the technical interpretation, could be extremely helpful in many circumstances. The example sets out a situation in which USco owns 90% of the shares of the ULC. The other 10% is owned by USsub, a U.S. corporation wholly owned by USco. The ULC pays interest to USco on debt owing to USco. It is clear that the anti-hybrid rule would have applied had USco been the sole owner of the ULC.

This is because the actual treatment of the interest under U.S. tax law (it is disregarded) differs from the hypothetical treatment that would have arisen had the ULC not been fiscally transparent.

However, in this example, the introduction of a second shareholder transforms the ULC from being a disregarded entity for U.S. tax purposes into being a partnership for U.S. tax purposes. This makes a critical difference. The CRA confirmed that the treatment of the interest in the hands of USco is the same as the hypothetical treatment that would have arisen had the ULC not been fiscally transparent. Therefore, the anti-hybrid rule does not apply, and Treaty benefits are available.

This suggests it might be possible to defeat the antihybrid rule through the use of ULCs with multiple owners rather than single owners. One critical caveat, however, is that the CRA clearly pointed out in the technical interpretation that it reserves the right to challenge planning of this nature under GAAR. Based on comments made by senior officials of the CRA at the Round Table (including the comment on the potential application of GAAR to the type of arrangement described in Example 3), it is likely that the CRA will be more prone to challenge such planning where the effect is to create a "double deduction" or "double dip". Conversely, if there is no "double dip", it appears the CRA is less likely to take the position that the planning undermines the object, spirit and purpose of the antihybrid rules, and therefore can be challenged under GAAR.


The above is but a brief summary of some of the recent guidance provided by the CRA on the anti-hybrid rule. As the anti-hybrid rule takes effect on January 1, 2010, it is expected that considerably more authority will develop over time.

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
27 Oct 2016, Seminar, Toronto, Canada

Please join members of the Blakes Commercial Real Estate group as they discuss five key provisions of a commercial real estate purchase agreement that are often the subject of much negotiation but are sometimes misunderstood.

1 Nov 2016, Seminar, Toronto, Canada

What is the emotional culture of your organization?

Every organization and workplace has an emotional culture that can have an impact on everything from employee performance to customer or client satisfaction.

3 Nov 2016, Seminar, Toronto, Canada

Join leading lawyers from the Blakes Pensions, Benefits & Executive Compensation group as they discuss recent updates and legal developments in pension and employee benefits law as well as strategies to identify and minimize common risks.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

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.