September 13, 2012
On September 13,2012, TEI President Carita R. Twinem submitted the following comments to Canadian Minister of Finance James Flaherty in respect of draft legislation released by the Canadian Department of Finance on August 14. The legislation will implement the Foreign Affiliate dumping proposal announced in the 2012 Budget message. (TEI's earlier comments on the foreign affiliate proposals in the Budget rewere reprinted in the May-June 2012 issue of The Tax Executive.) TEI's letter also addressed the draft legislation's cutbacks in the tax incentives for Scientific Research & Experimental Development (SR&ED) costs and the withholding tax treatment of certain deemed dividends. TEI's comments were prepared under the aegis of its Canadian Income Tax Committee, whose chair is Bonnie Dawe of Finning International, Inc. Contributing substantially to the development of TEI's comments were Carolyn Mulder of Wal-Mart Canada Corporation, Inc. and Marvin E. Lamb of Imperial Oil Limited. Also contributing were Carmine A. Arcari of the Royal Bank of Canada, David V. Daubaras of General Electric Canada, Doug Powrie of Teck Resources Limited, and Winston C.K. Woo of AGS Automotive Systems. Jeffery P. Rasmussen, the Institute's Senior Tax Counsel and liaison to the Canadian Income Tax Committee, coordinated the preparation of the comments.
On August 14, the Department of Finance released draft legislation that will amend the Income Tax Act, Canada (the Act) to implement tax measures set forth in the 2012 Budget message as well as other previously announced tax initiatives. Tax Executives Institute is writing to provide comments on the Department's "foreign affiliate dumping" proposal, the reductions in the Scientific Research & Experimental Development (SR&ED) tax incentives, and the non-resident withholding taxes imposed on deemed dividends under the transfer pricing and thin capitalization rules.
Background on Tax Executives Institute
TEI is the preeminent association of in-house business tax executives worldwide. The Institute's 7,000 professionals manage the tax affairs of 3,000 of the leading companies in North America, Europe, and Asia. Canadians constitute 10 percent of TEI's membership, with our Canadian members belonging to chapters in Montreal, Toronto, Calgary, and Vancouver, which together make up one of our nine geographic regions. Many of our non-Canadian members, including those in Europe and Asia, work for companies with substantial activities in Canada. Thus, both Canadian resident and non-resident members must contend daily with the planning and compliance aspects of Canada's business tax laws, including the foreign affiliate provisions, SR&ED, and dividend withholding taxes. The comments set forth in this letter reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.
Foreign Affiliate Dumping A. Background of Draft Section 212.3
The 2008 Advisory Panel on Canada's System of International Taxation (the Advisory Panel) identified certain "debt dumping" transactions involving foreign affiliates as abusive. To curtail transactions viewed as eroding the Canadian tax base, the 2012 Budget message outlined a sweeping anti-abuse proposal intended to curtail a broader scope of "foreign affiliate dumping" transactions. Draft section 212.3, released on August 14, 2012, to implement the foreign affiliate dumping provision, generally mirrors the Budget proposal, but proscribes a broader range of transactions --imposing even more Draconian conditions and consequences--while adding several helpful, though narrow, relieving measures and exceptions.
The draft legislation includes two measures that apply to investments in nonresident corporations (the subject corporation) by a corporation resident in Canada (CRIC) controlled by a non-resident parent corporation. First, where non-share consideration is given by a CRIC, the CRIC will be deemed to have paid a dividend to the parent equal to the fair market value of any property transferred, or obligation assumed or incurred, by the CRIC in respect of its investment in the subject corporation. Second, where shares of the CRIC are given as consideration, no amount is added to the paid-up capital (PUC) of the shares of the CRIC in respect of the investment (the so-called PUC suppression rule) and no amount will be added to the contributed surplus of the CRIC for purposes of determining its capital under the thin capitalization rules. Under the draft legislation, an investment in a subject corporation includes the acquisition of any shares (or options on shares), a contribution to capital, a transaction that creates an amount owing from the subject corporation to the CRIC, or an acquisition of the subject corporation's debt by the CRIC.
Three relieving provisions permit CRIC's to undertake certain business transactions without being ensnared by the rules. Broadly, the exceptions encompass (1) pertinent loans or indebtedness (PLI), which can be excluded from the foreign affiliate dumping provision on an elective basis, subject to the imposition of a prescribed interest income imputation regime; (2) certain corporate reorganizations that do not represent "new" investments in a foreign affiliate; and (3) strategic business expansions, as long as the CRIC documents that the investment satisfies multiple conditions.
TEI's Overriding Tax Policy Concern about the Draft Legislation
The Overview of draft section 212.3 states--
In general, ... these rules are designed to deter Canadian subsidiaries of foreign-based multinational groups from making investments in non-resident corporations that are, or become as a result of the investment or a series of transactions that includes the investment, foreign affiliates of the Canadian subsidiary in situations where these investments can result in the inappropriate erosion of the Canadian tax base. In addition--
In the case of Canadian subsidiaries of foreign-based multinational groups, the result of planning that exploits Canada's system of foreign affiliate taxation is inappropriate, particularly when undertaken without providing any significant economic benefits to Canada. TEI fully supports the government's targeting of abusive tax-motivated "foreign affiliate dumping" transactions. TEI also supports, with some recommendations for improvements, the relieving measures introduced in the draft legislation for pertinent loans and indebtedness (PLI) and the companion rules under subsection 15(2) affording relief for upstream loans to parent shareholders and other non-resident members of the parent's corporate group.
That said, TEI remains concerned about the effect of this overbroad legislation on legitimate transactions and investments. Specifically, we see no abuse of the Canadian tax system where cash generated by a CRIC's business is invested downstream in the common shares of a controlled foreign affiliate and the CRIC is entitled to both the growth potential of the downstream investment and future cash repatriations on those common shares. Ultimately, the economic return from a downstream common share investment will flow back to Canada, either as dividends for ultimate repatriation to the foreign parent (subject to Canadian withholding tax) or as a gain on the sale of the foreign affiliate common shares.
The Institute has several technical recommendations on the draft legislation that are discussed in the ensuing pages. More fundamentally, we urge the government to consider why foreign-owned multinationals should be subjected to a higher administrative bar (such as the conditions imposed for strategic business expansions) for additional investments outside of Canada or be subjected to risks of withholding taxes on additional investments in and through Canada...