Table of Contents...iii Introduction... 1 General Comments... 1 Legislation Scheme... 1 of Foreign Affiliate Taxation System... 2 Taxation of Foreign Affiliate Earnings... 2 FAPI Rules... 2 Additional Readings... 4 Dividends from Non-Resident Corporations (Section 90)... 5... 8 Application... 9 Distributions from Non-Resident Corporations... 9 General Comments (subsec 90(1))... 9 Stock Dividends... 9 Dividends from Foreign Affiliates (subsecs 90(2), (5))...10 Qualifying Return of Capital (subsecs 90(3), (4))...11 Transitional Rules...12 Additional Readings...12 Deductions in respect of Dividends...12 General Comments...12 Individuals...14 Corporations...14 Part IV Tax and the Dividend Refund...14 Upstream Loans...15 General Comments...15 Upstream Loan Income Inclusion Rules (subsec 90(6), (7), (15))...15 Back-to-Back Loans (subsec 90(7))...19 Upstream Loan Income Inclusion Exceptions (subsec 90(8))... 20 Deductions Available in respect of an Income Inclusion (subsecs (90(9) (12))... 21 Deduction upon Repayment of Loan (subsecs 90(13), (14))...25 Examples...26 Additional Readings...29 Amounts Included re Foreign Affiliates (Section 91)...30...32 Application...32 Arrangement of Subject...32 General Outline of FAPI Provisions...33 The Imputation of FAPI...33 What is FAPI?...34 Applicable Rules of Computation...34 Losses...36 Foreign Taxes...36 Relevant Tax Factor...36 Amounts to be Included in respect of a Share of a Foreign Affiliate...36 The Nature of FAPI...36 The Manner in Which the Imputation is Made...37 v
Foreign Affiliate...37 Controlled Foreign Affiliate...43 Participating Percentage...46 Reserve Where Foreign Exchange Restriction...50 Amounts Deductible in respect of Foreign Taxes...50 General Comments...50 Example...50 Foreign Accrual Tax (FAT)...51 Foreign Tax Credit Generators (FAT Denial Rules)...54 Amounts Deductible in respect of Dividends Received...58 Example...59 Non-arm s Length Transfer of Shares of a Foreign Affiliate...59 Acquisition of Shares of a Foreign Affiliate from a Partnership...59 Compliance Considerations...60 General Comments...60 Foreign Affiliate Compliance Calendar...60 Calendar Notes...64 Adjusted Cost Base of Share of Foreign Affiliate (Section 92)... 65...66 Application...67 Adjustments in respect of Imputed FAPI (subsec 92(1))...67 Example...68 Fill-the-Hole Rules (subsec 92(1.1), Regs 5905(7.1) 7.7))...68 General Comments...68 Surplus Adjustments...68 Cost Base Adjustments...71 Examples...72 Additional Readings...75 Deduction in respect of Dividends Paid out of Pre-Acquisition Surplus (subsec 92(2))...75 Example...75 Adjustments in respect of Elective Deduction under 113(2) (subsec 92(3))... 75 Recognition of Dividends Paid out of Pre-Acquisition Surplus on Shares Held by Partnership (subsecs 92(4) to (6))... 75 Transitional Rules Adjustments in respect of Section 93 Election (former subsecs 92(1.2) to (1.5))...76 Disposition of Shares in Foreign Affiliate (Section 93)... 78...86 Application...86 Election re Disposition of Shares in Foreign Affiliate...86 General Rules...86 Limitation in respect of Underlying Foreign Tax Applicable...87 Example...87 Other Considerations...88 Election where Shares Disposed of by Foreign Affiliate...88 Election where Shares Deemed Disposed of under Subsection 40(3)...89 Historical Note...89 Deemed Election where Shares Disposed of by Foreign Affiliate...89 Historical Note...90 Election where Shares Held by Partnership...90 General Election Mechanism (subsec 93(1.2))...90 vi
Disposition by an FA of Shares of Another FA (subsec 93(1.3))...91 Time and Manner of Election...92 Transitional Rules Amended Election...93 Loss Limitation on Disposition of Shares...93 Exempt Dividends (para 93(2.01)(a))...93 Foreign Exchange Losses (para 93(2.01)(b))... 94 Loss Limitation on Disposition of Shares by Partnership or on Disposition of Partnership Interest...96 Historical Note...97 Loss on Disposition of Shares of Foreign Affiliate...98 Additional Readings...98 Shares Held and Dividends Received by a Partnership (Section 93.1)... 99...100 Application...100 General Comments...100 Look-Through Rule Applicable to Dividends...101 Historical Note...102 Tiered Partnerships...102 Partnership Deemed to be Corporation...103 Computing FAPI in respect of a Partnership...103 Additional Readings...104 Non-Resident Corporations Without Share Capital (Section 93.2)... 105...105 Application...105 Rollovers...107 Related Partnership Rules...108 Transitional Rules...108 Australian Trusts (Section 93.3)...109...110 Application...110 Foreign Affiliate Dumping Rules...113 Amalgamations and Windups...113 Transitional Rules...113 Definitions and Rules (Section 95)...114...146 Advisory Panel on Canada s System of International Taxation...147 Application...147 Arrangement of Subject...147 Selected Definitions...149 Controlled Foreign Affiliate...149 Direct Equity Percentage (subsec 95(4))... 149 Entity (subsec 95(1))...149 Equity Percentage (subsec 95(4))... 149 Excluded Property (subsec 95(1))...149 Foreign Accrual Tax (subsec 95(1))... 151 Foreign Affiliate (subsec 95(1))...151 Participating Percentage (subsection 95(1))...151 Permanent Establishment (subsec 95(1))... 151 Relevant Cost Base (subsec 95(4))... 152 vii
Relevant Tax Factor (subsec 95(1))...152 Surplus Entitlement Percentage (subsec 95(1))...152 Taxation Year (subsec 95(1))... 152 Foreign Accrual Property Income (subsec 95(1))...153 Items Excluded from FAPI...155 Income from an Active Business (95(1) FAPI A)...155 Deemed Active Business Income Recharacterization Rules (para 95(2)(a))...156 Other Items Excluded from FAPI (FAPI A(a) (d), H)... 170 Interest Exempt under Paragraph 81(1)(m) (95(1) FAPI A(a))... 170 Inter-Affiliate Dividends (95(1) FAPI A(b), H)... 170 Taxable Dividends Deductible under Section 112 (95(1) FAPI A(c))... 171 Interest Benefits Included under Subsection 80.4(2) (95(1) FAPI A(d))... 171 Taxable Capital Gains Excluded from FAPI (95(1) FAPI B, paras 95(2)(f.1) (i))... 171 Items included in FAPI...179 Income from Property (95(1) FAPI A)... 179 Deemed Property Income Base Erosion Rules (95(1) FAPI A, paras 95(2)(a.1) (b))...190 Other Items Included in FAPI (95(1) FAPI A, A.1, A.2, B, C, E)... 209 Income from a Non-Qualifying Business (95(1) FAPI A)...209 Taxable Capital Gains Included in FAPI (95(1) FAPI B, E)... 211 Income from the Settlement or Forgiveness of Indebtedness (95(1) FAPI A.1, A.2, G, para 95(2)(g.1))... 212 Income in respect of an Offshore Investment Fund Property (95(1) FAPI C)... 212 Foreign Accrual Property Losses and Capital Losses...213 General Comments...213 Losses Deductible from FAPI (95(1) FAPI D)... 213 Allowable Capital Losses Deductible from FAPI (95(1) FAPI E)... 213 Carryover of Foreign Accrual Property Losses (95(1) FAPI F)... 213 Carryover of Foreign Accrual Capital Losses (95(1) FAPI F.1)... 216 Fresh-Start Rules (paras 95(2)(j.1) (k.2))... 217 Regulated Businesses...218 Transitional Rules...219 Reorganizations...219 General Comments...219 Inter-Affiliate Dispositions (para 95(2)(c))...219 Inter-Affiliate Foreign Mergers (paras 95(2)(d), (d.1))... 220 Inter-Affiliate Dissolutions (para 95(2)(e))...222 Distribution Received on a Foreign Spin-Off (para 95(2)(g.2))...225 Additional Readings...225 Special Rules...226 Income Bonds or Debentures Issued by FAs (subsec 95(5))...226 Where Rights or Shares Issued to Avoid Tax (subsec 95(6))...226 Stock Dividends (subsec 95(7))...229 Historical Note: Bill C-28 Elections... 229 Income from Foreign Affiliates (Section 113)...231...232 Application...234 Arrangement of Subject...234 Surplus Distribution Ordering Rules...235 Order of Surplus Distributions (Reg 5901)... 235 viii
Pre-Share Apportionment of Surplus Distributions (Reg 5900)...238 Dividends Paid Out of Exempt Surplus (para 113(1)(a))...238 Exempt Surplus...238 Deduction Available...239 Dividends Paid Out of Hybrid Surplus (para 113(1)(a.1))... 239 Hybrid Surplus...239 Deduction Available...239 Example...240 Dividends Paid Out of Taxable Surplus (paras 113(1)(b), (c))... 241 Taxable Surplus...241 Deduction Available in respect of Underlying Foreign Tax (UFT)...242 Deduction Available in respect of Non-Business-Income Tax...243 Example...243 Dividends Paid Out of Pre-Acquisition Surplus (para 113(1)(d))... 244 Additional Deduction in respect of 1975 Adjusted Cost Base (subsec 113(2))... 244 Computation of Exempt, Hybrid and Taxable Surplus... 245 General Comments (Regs 5907(1), (1.01), (7))... 245 Surplus Account Computation Period (Regs 5907(1), (3))... 245 Selection of Currency (Reg 5907(6))...245 Components of Exempt Surplus (Reg 5907(1))...246 Components of Hybrid Surplus (Reg 5907(1))...247 Components of Taxable Surplus (Reg 5907(1))...248 Exempt, Hybrid and Taxable Deficits (Reg 5907(1))... 249 Tax Payments and Tax Losses of Consolidated Groups (Regs 5907(1.1) (1.22))... 249 Adjusted Earnings from an Active Business...251 General Comments...251 Definition of Earnings (Reg 5907(1))... 251 Computation of Adjusted Earnings (Regs 5907(2) (2.6), (2.9), (4), 5908(13), (14), 5910)... 253 Allocation of Adjusted Earnings among Surplus Accounts (Regs 5906, 5907(11) (11.2))... 259 Other Components of Exempt and Taxable Earnings...261 General Comments...261 Foreign Accrual Property Income...261 Immigrating FA (Regs 5907(13) (15))... 262 Capital Gains and Losses (Regs 5907(5)-(6), (12))... 262 Disposition of Eligible Capital Property (Reg 5907(1) exempt earnings (a.1))... 264 Income from Property Recharacterized as Income from an Active Business (Regs 5907(1) exempt earnings (d)(ii), (1.02), (2.7))...264 Deemed Dividends under Section 93 (Reg 5902)...266 Amount of Whole Dividend Deemed to have been Paid (Reg 5902(1))...266 Anti-Circularity Rule (Reg 5902(2)(a))... 267 Surplus Account Adjustments in respect of Elected Dividends (Reg 5902(1)(b), (2)(b))... 268 Additional Readings...269 Historical Note...269 Surplus Account Adjustments...269 General Comments...269 Surplus Entitlement Percentage (Regs 5905(10) (13))...269 Acquisition of Additional Shares of an FA (Reg 5905(1))... 271 Mergers (Regs 5905(3), 5907(8), (9.1))... 272 ix
Non-Arm s Length Disposition of Shares of an FA (Regs 5905(5), (5.1))... 272 Change in Control of Parent (Regs 5905(5.2), (5.3), 5908(6))... 274 Prescribed Amount for Bump (Regs 5905(5.4), 5908(7))... 276 Tax-Free Surplus Balance (Regs 5905(5.5) (5.7))... 277 Dissolutions (Regs 5905(7), 5907(9))... 279 Fill-the-Hole Rules (Regs 5905(7.1) (7.7), 5908(11), (12))... 280 Special Rules Applicable to Partnerships (Reg 5908)...280 Consolidated Net Surplus Election...283 Additional Readings...284 Advisory Panel Comments...284 Income Tax Regulations Part LIX...285 Part LIX Foreign Affiliates...285 Foreign Affiliate Dumping (Section 212.3)...423...432 Application...433 Application of FAD Rules (subsec 212.3(1))...433 General Comments...433 Investment Definition (preamble to subsec 212.3(2), subsec 212.3(10))... 434 Foreign Affiliate Status of Subject Corporation (para 12.3(1)(a))... 440 Control by Non-Resident Parent (para 212.3(1)(b))... 440 Exceptions (para 212.3(1)(c))... 443 Exception for Wind-Ups and Vertical Amalgamations (subsec 212.3(22))... 449 Charging Provisions (subsec 212.3(2))... 450 General Comments...450 Deemed Dividend (para 212.3(2)(a))...450 Automatic PUC Suppression (para 212.3(2)(b))...451 Dividend Substitution Election (subsec 212.3(3))...451 General Comments...451 Law...452 Historical Note...452 PUC Offset Rules (subsec 212.3(7))...453 Law...453 Historical Note...455 PUC Reinstatement (subsec 212.3(9))...457 Law...457 Historical Note...460 Partnerships (subsec 212.3(25))...460 Index...463 x