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2004 Corporate Taxation Law Developments DISCLAIMER - The information provided here is of a general nature and may not apply to any specific or particular situation. It is not to be considered as a legal advice nor presumed to be indefinitely up to date. The past year has given tax practitioners significant draft legislation to digest. First came the October 2003 rules introducing the fourth version of the foreign investment entities and non-resident trusts rules, the new section 3.1 of the Income Tax Act (the "Act") introducing the reasonable expectation of profit requirement for deductibility of expenses, as well as the treatment of non-competition and similar payments, in response to the Manrell decision. While the tax community expected a legislative response on interest deductibility following the series of judgments in Singleton, Ludco, Stewart and Walls, the Minister of Finance opted for the unexpected approach, wrapping the deductibility of all expenses in the demonstration of a reasonable expectation of profit. This was followed by the February 27, 2004, Draft Technical Amendments (the "Draft Amendments"), which basically reiterated the October 2002 Draft Technical Amendments on foreign affiliates and additional technical issues. The March 23, 2004, federal budget (the "2004 Budget") delivered by the new Finance Minister, Ralph Goodale, also contained its share of surprises, with the introduction of limitations on the investments by pension funds in business income trusts. Quick and concerted reaction led to their suspension shortly thereafter. Finally, the income trust market was again targeted in the draft legislation and explanatory notes of September 16, 2004, implementing income tax measures of the 2004 Budget, although this specific measure had not been part of the 2004 Budget. 1. Legislative Initiatives Foreign Affiliate Rules The Draft Technical Amendments released in December 2002 proposed significant changes to the foreign affiliate rules. Many of these proposals have since been revised. There are also several entirely new measures. This article does not treat the amendments in detail, but simply draws attention to some areas that deserve attention before structuring transactions. The amendments introduce changes to the calculation of surplus accounts, the calculation of foreign accrual property income ("FAPI"), the determination of a foreign affiliate's income from depreciable property and eligible capital property, the rules governing foreign affiliate reorganizations, sections 92 and 93 of the Act as well as services income earned by a foreign affiliate. Definition of Controlled Foreign Affiliate The definition of "controlled foreign affiliate" has been significantly amended, by: aggregating shareholdings for purposes of determining control, in response to the decision of the Federal Court of Appeal ("FCA") in Silicon Graphics, where it had been suggested that group control required some common connection between the members of a group; aggregating shareholdings of up to four Canadian resi-dents, and persons who are not dealing at arm's length with those Canadian residents; and adopting "look-through" rules in order to reach shares held through corporations, partnerships and trusts. Foreign Affiliate Reorganizations There will be significant changes affecting foreign mergers and liquidations of foreign affiliates. The rules are complex and require careful review, but taxpayers should be alerted to the possibility that FAPI could now arise on many foreign reorganizations. New rules are introduced in respect of distributions of assets to Canadian shareholders by foreign affiliates. Distributions for these purposes include, under differing rules for each, liquidations and dissolutions, redemption of shares, dividends and others. The distribution of excluded properties that are shares of another foreign affiliate will be considered to have been made at cost; consequently, no FAPI will arise as a result of such distribution. On the other hand, the distribution of excluded properties that are not shares of another foreign affiliate, or for properties that are not excluded properties, will be deemed to take place at fair market value, thereby creating a potential gain, which may be partially sheltered by a section 93 election to deem it a dividend. The rules pertaining to deemed dividend elections and potential "bumps" to the basis of shares of a foreign affiliate on a winding up of its Canadian parent are amended to provide, inter alia, for an aggregation of surpluses and deficits and for a reduction of underlying surplus by the "bump" amount. Page 2 >>
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