On August 19, 2011, the Department of Finance released a signifi cant package of proposed amendments (the « Proposals ») to Canada’s tax rules applicable to Canadian corporations with foreign affi liates. In addition to some new measures, the Proposals also replace many proposed amendments that were released at different times over the past decade, and in many cases they will have retroactive effect. It is anticipated that a number of further (more minor) changes to the foreign affi liate rules could be included in a separate package of proposals to be released in the near future. The Department of Finance are accepting comments on the Proposals until October 19, 2011.
Some of the highlights of the Proposals include:
- Upstream Loans: New rules will generally deem a loan from a foreign affi liate to its Canadian parent or an entity related to its Canadian parent to be an income inclusion to the Canadian shareholder if it remains outstanding for at least two years, subject to exceptions (such as for loans made in the ordinary course of business or loans repaid within two years) and the ability to claim reserves against the income inclusion in certain cases.
- Hybrid Surplus: A new « hybrid surplus » regime was introduced to track capital gains realized by a foreign affi liate from dispositions of certain shares and partnership interests, where such gains are not taxed in Canada on an accrual basis as foreign accrual property income (FAPI). This new regime replaces the internal gain suspension regime that was introduced in 2004 and is now abandoned.
- Foreign Affi liate Reorganizations: The Proposals amend (and in some cases expand) the rules applicable to mergers and liquidations of foreign affi liates.
- Return of Capital/Distributions: New rules will treat all pro rata distributions in respect of shares of a foreign affi liate to be dividends (other than amounts received on a liquidation of a foreign affi liate or on a redemption, acquisition or cancellation of shares). In most circumstances, a taxpayer will be able to elect to ignore the normal surplus ordering rules and have dividends paid by a foreign affi liate deemed to be paid out of pre-acquisition surplus, which effectively allows taxpayers to repatriate amounts up the tax basis of the shares before surplus.
- Foreign Accrual Capital Losses: New rules that stream FAPI capital losses to FAPI capital gains, preventing those capital losses from being used to shelter other FAPI amounts.
- Stop-Loss Rules: Various stop-loss rules would be modifi ed, mainly with the effect of precluding their application in respect of the recognition of losses on « excluded property ». As a result, losses on excluded property would be recognized (and reduce surplus), but losses on passive assets arising from internal dispositions would be suspended until specifi c conditions are met.