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Ottawa, July 20, 1995
1995-057

Draft Technical Income Tax Amendments on Foreign Property

Related documents:

• Draft Amendments Relating to Foreign Property.
• Explanatory Notes to Draft Amendments Relating to Foreign Property.

Finance Minister Paul Martin today announced proposed technical changes to the Income Tax Act affecting the 20% foreign property limit for deferred income plans.

The existing rules generally provide that "foreign property" includes shares and debt issued by a Canadian corporation where the shares issued by the corporation derive their value primarily from "portfolio investments" in foreign property. The investment community has expressed concerns that the use of the expression "potfolio investment" in this context may give rise to penalty taxes for excess foreign property.

The amendments released today provide that shares and debt issued by a Canadian corporation will not be foreign property whenever the corporation has a substantial presence in Canada. A Canadian corporation will be considered to have a substantial Canadian presence where it satisfies one of two tests set out in the draft legislation.

The amendments also provide that, subject to the substantial Canadian presence exception and grandfathering rules, shares and debt issued by a Canadian corporation will be considered to be foreign property where the shares issued by the corporation derive their value primarily from any foreign property (not merely "portfolio investments" in foreign property). This change is effective only with respect to property acquired after 1995.

Mr. Martin indicated that the proposed amendments are being released in draft form, together with explanatory notes, to provide taxpayers and their advisors an opportunity to consider and comment on the proposed changes in a timely manner. It is intended that these amendments will ultimately be packaged with the draft technical amendments issued on April 26, 1995.

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

___________________

For further information:

Martine Lemire
Tax Legislation Division
(613)992-3031

Draft Amendments Relating To Foreign Property

1.(1) The definition "specified active business" in section 204.8 of the Income Tax Act is replaced by the following:

"specified active business"
«entreprise déterminée exploitée activement»

"specified active business", at any time, means an active business that is carried on in Canada where

• (a) at least 50% of the full-time employees employed at that time in respect of the business are employed in Canada, and

  (b) at least 50% of the salaries and wages paid to employees employed at that time in respect of the business are reasonably attributable to services rendered in Canada by the employees;

  (2) Subsection (1) applies after 1988.

2.(1) Paragraphs (d.1) and (e) of the definition "foreign property" in subsection 206(1) of the Act are replaced by the following:

• (d.1) except as provided by subsection (1.1), any share (other than an excluded share) of the capital stock of, or any debt obligation issued by, a Canadian corporation (other than an investment corporation, mutual fund corporation or registered investment), where shares of the corporation can reasonably be considered to derive their value, directly or indirectly, primarily from foreign property,

  (e) except as prescribed, any share of the capital stock of a mutual fund corporation or investment corporation that is not a registered investment,

  (2) Subsection 206(1) of the Act is amended by adding the following definitions in alphabetical order:

"affiliate"
«société affiliée»

"affiliate" of a particular corporation at any time is any other corporation

• (a) to which the particular corporation is related at that time, otherwise than because of a right referred to in paragraph 251(5)(b), or

  (b) where, at that time, the particular corporation owned

  • (i) shares of the capital stock of the other corporation that would give the particular corporation 25% or more of the votes that could be cast under all circumstances at an annual meeting of shareholders of the other corporation, and

    (ii) shares of the capital stock of the other corporation having a fair market value of 25% or more of the fair market value of all the issued shares of the capital stock of the other corporation,

and for the purpose of this paragraph, a particular person is deemed to own at any time each share of the capital stock of a corporation that is owned, otherwise than because of this paragraph, at that time by another person to whom the particular person is related (otherwise than because of a right referred to in paragraph 251(5)(b));

"carrying value"
«valeur comptable»

"carrying value" of a property of a corporation or partnership at any time means

• (a) where a balance sheet of the corporation or the partnership as of that time was presented to the shareholders of the corporation or the members of the partnership and the balance sheet was prepared using generally accepted accounting principles and was not prepared using the equity or consolidation method of accounting, the amount in respect of the property reflected in the balance sheet, and

  (b) in any other case, the amount that would have been reflected in a balance sheet of the corporation or the partnership as of that time if the balance sheet had been prepared in accordance with generally acceptable accounting principles and neither the equity nor consolidation method of accounting were used;

"designated value"
«valeur désignée»

"designated value" of a property at any time means the greater of

• (a) the fair market value at that time of the property, and

  (b) the carrying value at that time of the property;

"excluded share"
«action exclue»

"excluded share" means

• (a) a share that is of a class of shares listed on a prescribed stock exchange in Canada, where no share of that class has been issued after December 4, 1985 (otherwise than pursuant to an agreement in writing entered into before 5:00 p.m. Eastern Standard Time on December 4, 1985), and

  (b) a share last acquired after 1995 that is of a class of shares listed on a prescribed stock exchange in Canada, where

  • (i) no share of that class has been issued after Announcement Date (otherwise than pursuant to an agreement in writing entered into on or before Announcement Date), and

    (ii) the share would, if it had been last acquired before 1996, not be foreign property;

"qualified property"
«bien admissible»

"qualified property" of a corporation means a property (other than a debt obligation or share issued by an affiliate of the corporation) owned by the corporation and used by it in a specified active business carried on by it;

"specified active business"
«entreprise déterminée exploitée activement»

"specified active business", at any time, means an active business that is carried on in Canada where

• (a) at least 50% of the full-time employees employed at that time in respect of the business are employed in Canada, and

  (b) at least 50% of the salaries and wages paid to employees employed at that time in respect of the business are reasonably attributable to services rendered in Canada by the employees

but does not include a business the principal purpose of which is to derive income from, or from the disposition of, shares and debt obligations the value of which can reasonably be considered to derive, directly or indirectly, primarily from foreign property;

"specified proportion"
«proportion détérminée»

"specified proportion" of a member of a partnership for a fiscal period of the partnership means the proportion that the member's share of the total income or loss of the partnership for the partnership's fiscal period is of the partnership's total income or loss for that period and, for the purposes of this definition, where such income or loss for a period is nil, that proportion shall be computed as if the partnership had income for that period in the amount of $1,000,000.

(3) Section 206 of the Act is amended by adding the following after subsection (1):

Exception where substantial Canadian presence

(1.1) Foreign property at a particular time of a taxpayer does not include a share or debt obligation that was issued by a Canadian corporation (other than a mutual fund corporation or investment corporation), where

• (a) immediately before the time (in this subsection referred to as the "acquisition time") that the property was last acquired before the particular time by the taxpayer or immediately before the corporation's taxation year that includes the acquisition time, the total of all amounts each of which is the designated value of a qualified property of the corporation or an affiliate of the corporation exceeded $50,000,000;

  (b) the particular time and the acquisition time are in the same taxation year of the corporation, and

  • (i) immediately before the acquisition time, or

    (ii) immediately before that year

  the total of all amounts each of which is the designated value of a qualified property of the corporation or another corporation related (otherwise than because of paragraph 251(5)(b)) to the corporation exceeded 50% of the lesser of the fair market value of all of the corporation's property and the carrying value of all of the corporation's property; or

  (c) the particular time is after the corporation's taxation year that includes the acquisition time and, at the end of that year, the total of all amounts each of which is the designated value of a qualified property of the corporation or another corporation related (otherwise than because of paragraph 251(5)(b)) to the corporation exceeded 50% of the lesser of the fair market value of all of the corporation's property and the carrying value of all of the corporation's property.

Partnerships

(1.2) For the purposes of subsection (1.1) and this subsection,

• (a) a member of a partnership
  • (i) is deemed not to own any interest in the partnership at any time, and

    (ii) is deemed to own the member's specified proportion for the first fiscal period of the partnership ending at or after that time of each property that would, if the assumption in paragraph 96(1)(c) were made, be owned by the partnership at that time; and

  (b) the carrying value at that time of that specified proportion of a partnership's property is deemed to be that specified proportion of the carrying value at that time to the partnership of that property.

Interpretation

(1.3) For the purposes of determining whether a property owned by a taxpayer is foreign property at any time because of paragraph (f) or (h) of the definition "foreign property" in subsection (1), it shall be assumed that any other property not owned at that time by the taxpayer was acquired immediately before that time by the taxpayer.

Identical property

(1.4) Notwithstanding paragraphs (d.1), (f) and (h) of the definition "foreign property" in subsection (1), a property shall not be considered to be foreign property at a particular time of a taxpayer because of any of those paragraphs where

• (a) the property is
  • (A) a share or debt obligation issued by a Canadian corporation, or

    (B) an interest in, a right to, a property that is convertible into or a property that is exchangeable for a share or debt obligation issued by a Canadian corporation, and

  (b) the share or obligation is identical to another property owned at the particular time by the taxpayer that is not foreign property at the particular time of the taxpayer.

(4) Paragraph (d.1) of the definition "foreign property" in subsection 206(1) of the Act, as enacted by subsection (1), subsection (2) and subsections 206(1.1) and (1.2) of the Act, as enacted by subsection (3), apply to shares and indebtedness acquired after December 4, 1985 (otherwise than pursuant to an agreement in writing entered into before 5:00 p.m. Eastern Standard Time on December 4, 1995) except that, with respect to shares and indebtedness last acquired before 1996, the expression "primarily from foreign property" in that paragraph shall be read as "primarily from portfolio investments in property that is foreign property".

(5) Paragraph (e) of the definition "foreign property" in subsection 206(1) of the Act, as enacted by subsection (1), applies to months after June 1995 and subsections 5000(3) and (4) of the Income Tax Regulations are deemed to have been made pursuant to that paragraph and to be effective after June 1995.

(6) Subsection 206(1.3) and (1.4) of the Act, as enacted by subsection (3), apply after December 4, 1985.

Explanatory Notes To Draft Amendments Relating To Foreign Property

ITA
204.8
"specified active business"

Section 204.8 of the Income Tax Act sets out the rules for registered labour-sponsored venture capital corporations (RLSVCCs). Under section 127.4, individuals acquiring Class A shares issued by RLSVCCs are entitled to a tax credit. RLSVCCs must ultimately invest sufficient amounts in qualifying securities issued by eligible business entities (as defined by section 204.8), in order to avoid penalty taxes levied under section 204.82. One of the requirements for a corporation or partnership to qualify as an "eligible business entity" is that it, or a related entity, carry on a "specified active business".

"Specified active business" is defined in section 204.8 as an active business (as defined by subsection 248(1)) carried on in Canada, where at least 50% of the full-time employees of the business are employed in Canada and at least 50% of the wages and salaries paid to employees of the business are attributable to services rendered in Canada by employees.

The definition of "specified active business" in section 204.8 of the Act is amended to clarify that qualification at any time as a "specified active business" is determined with reference to those individuals employed at that time in respect of the business. This amendment is made only to be consistent with the wording of the proposed definition of "specified active business" in subsection 206(1) of the Act.

This amendment applies after 1988.

ITA
206

Section 206 of the Act imposes a tax on the amount of "foreign property" (as defined in subsection 206(1)) held by pension funds and others in excess of defined limits.

ITA
206(1)
"foreign property"

"Foreign property" is defined in subsection 206(1) of the Act. Under paragraph (d.1) of the definition, foreign property includes certain shares and debts issued by Canadian corporations, if shares of the corporation may reasonably be considered to derive their value primarily from "portfolio investments" in foreign property. Under paragraph (e) of the definition, foreign property includes, except as prescribed by regulation, shares of the capital stock of mutual fund corporations (other than investment corporations or registered investments).

Paragraph (d.1) of the definition is amended to provide that any share or debt issued by a Canadian corporation is, subject to the exceptions described below, considered to be foreign property where shares of the corporation can reasonably be considered to derive their value primarily from foreign property (whether or not the foreign property is a "portfolio investment"). The purpose of this amendment is to remove the uncertainty regarding the application of the foreign property rules in cases where a Canadian corporation acquires minority or controlling interests in corporations deriving their value from foreign property. This amendment applies to property acquired after 1995.

Paragraph (d.1) of the definition is also amended so that shares and debts issued by a Canadian corporation are not considered as foreign property where the Canadian corporation has a substantial presence in Canada. The determination of substantial Canadian presence is set out in new subsection 206(1.1).

Paragraph (d.1) of the definition is also amended so that it does not apply to shares or debts issued by mutual fund corporations, investment corporations or registered investments. Mutual fund corporations and investment corporations that are not registered investments are subject to a stricter foreign property regime as a consequence of amended paragraph (e) of the definition and Part 50 of the Income Tax Regulations. A "registered investment" is subject to tax under Part XI with respect to its own investments, so it is not necessary for shares or debts issued by registered investments to be considered as foreign property.

Paragraph (d.1) of the definition is also amended so that certain shares, described in the new definition of "excluded share" in subsection 206(1), are not considered to be foreign property under paragraph (d.1). An "excluded share" is defined as:

• a share that is of a class of shares listed on a prescribed stock exchange in Canada, where no share of that class has been issued after December 4, 1985 (otherwise than pursuant to an agreement in writing entered into before 5:00 p.m. Eastern Standard Time on December 4, 1985), and
• a share last acquired after 1995 that is of a class of shares listed on a prescribed stock exchange in Canada, where
  • the share would, if it had been last acquired before 1996, not be foreign property, and
  • no share of that class has been issued after Announcement Date (otherwise than pursuant to an agreement in writing entered into before Announcement Date).

The first part of the "excluded share" definition corresponds to grandfathering formerly provided in paragraph (d.1) of the definition. The second part extends similar grandfathering for shares acquired after 1995 that are affected by the expansion of "foreign property" under amended paragraph (d.1) of the definition.

Paragraph (e) of the definition is amended to provide that a share issued by an investment corporation (as defined by subsection 130(3)) is considered to be "foreign property", except as prescribed by regulation. For this purpose, existing subsection 5000(3) and (4) of the Regulations set out the circumstances where such a share is not considered to be foreign property. This amendment applies to months after June 1995. Subsections 5000(3) and (4) of the Regulations are, for this purpose, also considered to have become effective after June 1995.

Except as noted above, these amendments apply to shares and debts that were acquired after December 4, 1985 (otherwise than pursuant to an agreement in writing entered into before 5:00 p.m. Eastern Standard Time on December 4, 1985). This comingintoforce provision corresponds to the cominginto-force with respect to the introduction of paragraph (d.1) of the definition.

ITA
206(1)
"affiliate"
"carrying value"
"designated value"
"excluded share"
"qualified property"
"specified active business"
"specified proportion"

Subsection 206(1) of the Act is amended to introduce definitions of "affiliate", "carrying value", "designated value", "qualified property", "specified active business" and "specified proportion". These definitions are used only in new subsection 206(1.1) or (1.2) and explained in the commentary below.

Subsection 206(1) is also amended to introduce the definition of "excluded share", which is used only in amended paragraph (d.1) of the definition "foreign property" in subsection 206(1). It is explained in the commentary above.

ITA
206(1.1) and (1.2)

New subsection 206(1.1) of the Act provides relief from the application of paragraph (d.1) of the definition "foreign property" with respect to shares and debts issued by Canadian corporations that have a substantial Canadian presence, in accordance with the tests below.

In this context, a share or debt obligation issued by a Canadian corporation will not be considered to be foreign property of a taxpayer where, immediately before the acquisition of the share or debt or at the end of the issuing corporation's last taxation year that ends before the acquisition, the designated value of qualified property of the corporation and affiliates of the corporation exceeded $50 million. The italicized expressions are explained below.

The $50 million test is designed to be a one time test. If a share or debt satisfies the $50 million test at the time of its acquisition, the share or debt will subsequently not be considered to be foreign property of the purchaser while continuously held by the purchaser.

Even if the $50 million test is not met at the time of acquisition of a share or debt, paragraph 206(1.1)(b) provides an alternative test that will allow a share or debt issued by a corporation to be temporarily considered as not being foreign property until the end of the issuing corporation's first taxation year that ends after the time of acquisition. This relief applies in respect of shares or debts issued by a corporation, where the total designated value of qualified property of the corporation (and related corporations) exceeds 50% of the lesser of the fair market value of all the corporation's property and its carrying value. This test must be satisfied either immediately before the acquisition time or at the end of the issuing corporation's first taxation year that ends before the time of the acquisition. As described below, a share or debt that is excluded from foreign property classification under paragraph 206(1.1)(b) can continue to be so excluded under paragraph 206(1.1)(c).

Paragraph 206(1.1)(c) allows for a share or debt issued by a corporation to be excluded from foreign property classification for a taxpayer after the end of the issuing corporation's taxation year in which the taxpayer acquired the property. In order for a share or debt to be so excluded, it must satisfy the test described above at the end of the issuing corporation's first taxation year that ends after the time of acquisition. (In the event that a share or debt initially excluded from foreign property because of paragraph 206(1.1)(b) becomes foreign property because it fails to satisfy paragraph 206(1.1)(c), relief is provided under existing subparagraph 206(2)(a)(iii). This relief has the effect of ignoring such foreign property for 24 months for the purposes of computing the Part XI tax.)

For the purposes of paragraphs 206(1.1)(a) to (c):

• "carrying value" of a property of a corporation or partnership at any time means
  • where a balance sheet of the corporation or the partnership as of that time was presented to the shareholders of the corporation or the members of the partnership and the balance sheet was prepared using generally accepted accounting principles and was not prepared using the equity or consolidation method of accounting, the amount in respect of the property reflected in the balance sheet, and
  • in any other case, the amount that would have been reflected in a balance sheet of the corporation or the partnership as of that time if the balance sheet had been prepared in accordance with generally acceptable accounting principles and neither the equity nor consolidation method of accounting were used,
• "designated value" of a property is defined in subsection 206(1) as the greater of the fair market value of the property and its carrying value,
• "qualified property" of a corporation is defined in subsection 206(1) as any property (other than a share or debt issued by an affiliate of the corporation) owned by the corporation and used by it in a "specified active business" carried on by it, and
• "specified active business" is defined in subsection 206(1) as an active business (as defined by subsection 248(1)) carried on in Canada, where at least 50% of the full-time employees of the business are employed in Canada and at least 50% of the wages and salaries paid to employees of the business are attributable to services rendered in Canada by employees, except that a "specified active business" does not include a business the principal purpose of which is to derive income from, or from the disposition of, shares and debt obligations the value of which can reasonably be considered to derive, directly or indirectly, primarily from foreign property.

Subsection 206(1) also defines, for the purpose of subsection 206(1.1), an "affiliate" of a corporation. An "affiliate" of a particular corporation is, in general terms, another corporation in respect of which the particular corporation has at least 25% of the votes and value. More specifically, an "affiliate" of a particular corporation at any time is any other corporation

• to which the particular corporation is related at that time, otherwise than because of a right referred to in paragraph 251(5)(b), or
• where, at that time, the particular corporation owned
  • shares of the capital stock of the other corporation that would give the particular corporation 25% or more of the votes that could be cast under all circumstances at an annual meeting of shareholders of the other corporation, and
  • shares of the capital stock of the other corporation having a fair market value of 25% or more of the fair market value of all the issued shares of the capital stock of the corporation.

For the purposes of the second part of the definition of "affiliate", a particular person is deemed to own at any time each share of the capital stock of a corporation that is actually owned at that time by another person to whom the particular person is related (otherwise than by reason of a right referred to in paragraph 251(5)(b)).

Subsection 206(1.2) provides a specific rule, relevant for the purposes of applying the tests above, to take into account partnerships. For the purposes of subsection 206(1.1), a member of a partnership is deemed not to own any interest in the partnership at any time. Instead, the member is deemed to own the member's "specified proportion" (for the first fiscal period ending at or after that time) of each partnership property owned at that time. The "specified proportion" of a member of a partnership for a fiscal period of the partnership means the proportion that the member's share of the total income or loss of the partnership for the partnership's fiscal period is of the partnership's total income or loss for that period. However, where such income or loss for a period is nil, the "specified proportion" is computed as if the partnership had income for that period in the amount of $1 million. The "carrying value" of the member's specified proportion of partnership property is likewise deemed to be the member's specified proportion of the carrying value of the partnership's property.

These amendments apply to shares and indebtedness acquired after December 4, 1985.

ITA
206(1.3)

Paragraphs (f) and (h) of the definition "foreign property" in subsection 206(1) of the Act apply in the event that a taxpayer has a right to, or a non-ownership interest in, another property. Paragraph (f) also generally applies where a taxpayer has property that is convertible into, or exchangeable for, another property. In these circumstances, the property owned by a taxpayer is generally treated as foreign property if the other property is foreign property.

New subsection 206(1.3) provides that, in these circumstances, the determination of whether property owned by a taxpayer is foreign property at any time is based on whether the other property would be foreign property if it had been acquired immediately before that time. This provision is necessary because the tests for substantial Canadian presence in new subsection 206(1.1) are predicated on there being an acquisition of a share or debt obligation.

This amendment applies after December 4, 1985.

ITA
206(1.4)

Subsection 206(1.4) of the Act is a rule which is provided for administrative convenience and ensures that properties owned by a single taxpayer are treated consistently for the purposes of the foreign property rules.

Subsection 206(1.4) provides that, where a share or debt obligation issued by a Canadian corporation is excluded from classification as a foreign property of a taxpayer, any identical property held by the taxpayer is likewise excluded. This would be relevant, for example, if a taxpayer acquired shares of a corporation at the time the $50 million test was satisfied and subsequently the same taxpayer acquired shares when the $50 million test was not satisfied.

Subsection 206(1.4) also provides that, where a taxpayer has an interest in or right to a share or debt issued by a Canadian corporation (or property that is exchangeable for or convertible into a share or debt issued by a Canadian corporation), the interest, right or property is not considered to be foreign property because of paragraph (f) or (h) of the definition "foreign property" in subsection 206(1) if the taxpayer actually owns another property identical to the share or debt that is not considered to be foreign property. This would be relevant, for example, if a taxpayer has an option to acquire a share issued by a Canadian corporation and also has an identical share that is not classified as foreign property because of subsection 206(1.1). Where this is the case, there would be no need to test the classification of the option as a foreign property on an ongoing basis under new subsection 206(1.3).

These amendments apply after December 4, 1985.