Ottawa, August 19, 2011

Archived - Government of Canada Releases Draft Foreign Affiliate Rules

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The Honourable Jim Flaherty, Minister of Finance, today released for consultation a package of draft legislative proposals relating to the Income Tax Act and Income Tax Regulations concerning the taxation of Canadian multinational corporations with foreign affiliates.

The package includes revisions to the foreign affiliate reorganization and distribution rules originally proposed in a February 27, 2004 release. It also includes new proposals in place of the 2004 proposals which suspended certain gains from the sale of shares and other assets of foreign affiliates for the purposes of the surplus accounting rules.

Consistent with the approach adopted in a December 18, 2009 release in which other measures from the 2004 proposals were revised and simplified, the legislative proposals being released today are intended to be easier for taxpayers to comply with and for the Government to administer.

In its December 2008 report to the Minister of Finance, the Advisory Panel on Canada’s System of International Taxation recommended fundamental changes to Canada’s system of international taxation, particularly in respect of its exemption system for foreign source business income earned by foreign affiliates.

At this time, however, the priority of the Government is to encourage countries to enter into Tax Information Exchange Agreements with Canada and to provide exempt surplus treatment as an incentive to those which choose to do so. The measures released today are aimed at improving the current international tax system, which the Panel characterized as a “good one that has served Canada well.”

The Government remains committed to continuing its review and analysis of all of the Panel’s recommendations and consideration of further legislative amendments.

The attached Annex outlines the key measures proposed in today’s package, while explanatory notes provide further details.

References to “Announcement Date” in the draft legislation and explanatory notes should be read as referring to today’s date.

Interested parties may submit comments on the package until October 19, 2011. The Government will then proceed with legislation at an early opportunity to implement the amendments, taking into account comments received.

Comments can be sent to or to:

Tax Policy Branch
Department of Finance
140 O’Connor Street
Ottawa, Ontario
K1A 0G5

For further information, media may contact:

Mary Ann Dewey-Plante
Press Secretary
Office of the Minister of Finance

Jack Aubry
Media Relations
Department of Finance

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The following provides the highlights of the income tax proposals relating to foreign affiliates that were announced by the Honourable Jim Flaherty, Minister of Finance, on August 19, 2011.

  • Hybrid surplus – a new surplus account to capture gains from the sale of foreign affiliate shares;
  • Upstream loans – a rule to protect the integrity of the hybrid and taxable surplus regimes by discouraging transactions designed to avoid taxation of taxable dividends through the use of loans from foreign affiliates to their Canadian shareholders;
  • Reorganizations – rules to
    • allow more generous foreign accrual property income (FAPI) rollover treatment of asset dispositions by a foreign affiliate in the context of mergers and liquidations by, for example, allowing all types of property, not just capital property, to qualify for rollover treatment; and
    • prevent the duplication of losses on certain share-for-share transactions;
  • Return of capital – rules to allow more generous and simplified treatment of distributions from the capital of a foreign affiliate by allowing taxpayers to elect to have the full amount of their cost of the shares be returned before any distributions become taxable;
  • Surplus reclassification – a rule to reclassify certain gains from business asset sales from exempt to taxable surplus in situations where a taxpayer forces the disposition of such an asset for the primary purpose of creating exempt surplus;
  • Stop-loss rules – amendments to
    • provide relief from loss denial rules that apply on the disposition of shares of a foreign affiliate by allowing a portion of such a loss to the extent the taxpayer realizes a foreign exchange gain on a related financial instrument; and
    • ensure that certain loss denial rules do not apply in the computation of foreign affiliate surplus balances and apply properly in the context of foreign accrual property losses;
  • FAPI capital losses – new rules to align the FAPI system with domestic rules by providing that capital losses can only be deducted against capital gains; and
  • Various technical matters all of which are described in the explanatory notes.