Undermining our mining industry?
Canada’s leading position for the formation and listing of mining companies with worldwide assets may be in jeopardy as a result of proposed new “foreign affiliate dumping rules” released by the Department of Finance (Canada) in August 2012 and modified in October 2012. Since being introduced in the 2012 federal Budget, these rules have been criticized by both the tax and business communities. Although the modifications released in October alleviate some of the harsh and unintended results of the rules, the current proposals still go far beyond the perceived mischief the rules are intended to prohibit.
The Budget states that these rules are intended to discourage foreign multinational corporations from transferring (“dumping”) “foreign affiliates” into their Canadian subsidiaries in a manner that erodes the Canadian tax base. One “dumping” transaction considered offensive occurs when a Canadian corporation (Canco) incurs debt on the acquisition of a foreign subsidiary from Canco’s foreign parent, creating interest deductions that reduce Canadian-source income. Similar structures involve the acquisition by Canco of a foreign subsidiary in return for shares, creating “paid-up capital” (PUC) that can be used to distribute funds from Canada without withholding tax.
With certain exceptions, the rules apply whenever a corporation resident in Canada (CRIC) that is or becomes controlled by a foreign corporation (Parent) makes an “investment” in a foreign corporation (Subsidiary) if the Subsidiary is or becomes a “foreign affiliate” of the CRIC. “Investment” is defined broadly to include acquiring shares of Subsidiary, contributing capital to Subsidiary and, in certain cases, loaning or otherwise becoming a creditor of Subsidiary. The rules also apply to indirect investments by the CRIC in another Canadian corporation where more than 75% of the value of that other corporation is derived from shares of foreign affiliates of that other corporation. The rules do not affect investments in foreign affiliates on or before March 28, 2012.
Where the rules apply:
- the CRIC is deemed to have paid a dividend (subject to withholding tax) to the Parent equal to the value of property (other than CRIC shares) transferred, obligations assumed, or benefits conferred by the CRIC in respect of the investment; and
- no amount may be added to the PUC of CRIC shares issued in connection with the investment.
The draft legislation contemplates exceptions for internal corporation reorganizations and, in certain cases, reduces or eliminates a deemed dividend by automatically reducing the PUC of the CRIC shares.
The rules also include a “safe harbour” exception that is intended to apply where the business of the Subsidiary is more closely connected to the business of the CRIC than to any other non-resident member of the corporate group (other than Subsidiary and certain other non-resident corporations in which the CRIC has a direct or indirect interest). Unfortunately, certain requirements for this exception will only be met in a small number of cases and may lead to corporate procedures and policies being adopted which may be purely artificial. (For example, the safe harbour is only available if officers of the CRIC exercise principal decision-making authority in respect of the investment).
The rules will impact any foreign-controlled Canadian corporation with foreign subsidiaries. Given the significant number of Canadian mining companies with assets in foreign jurisdictions that are either currently foreign-controlled or are potential acquisition targets for foreign corporations, the current proposals could disproportionately effect Canada’s mining sector and the investment and other service industries that rely on it.
Specifically, existing foreign-controlled Canadian mining corporations with foreign affiliates should be immediately cautious when making any changes to their corporate structure or undertaking further investments or re-financings in foreign affiliates.
Existing mining companies incorporated in Canada that have foreign subsidiaries will be affected if they are acquired by a foreign corporation. The onerous consequences of these rules would make it prudent for such companies to reorganize immediately after acquisition to extract foreign assets from Canada. For start-up operations, these rules may reduce the attractiveness of Canada as a jurisdiction to incorporate and list, particularly junior mining entities aspiring to be a future acquisition target of a foreign corporation.
At this time Finance has not requested further submissions on the current proposals and it is unknown how the rules, if enacted, will be applied administratively or how they will be interpreted by the courts. It is hoped that consideration is given to the chilling effect these rules may have on investment in Canada’s healthy mining sector going forward.
Adrienne Oliver is a partner and co-chair of Norton Rose’s tax team in Canada. Glenn Hines is an associate on the tax team. Both are based in Norton Rose’s Toronto office.