Interaction of the Foreign Affiliate Surplus and Safe-Income Regimes: Selected Anomalies, Issues, and Planning Considerations

In the 2015 budget, the Canadian government introduced sweeping amendments to section 55 of the Income Tax Act. These amendments include two new purpose tests that apply in determining whether subsection 55(2) applies to recharacterize an otherwise "tax-free" intercorporate dividend paid between two Canadian-resident corporations as a capital gain that is subject to tax. Given the broad scope of, and the uncertainty arising from, these new purpose tests, it will now likely be more common for corporations to, where possible, rely on the safe-income exception. These circumstances could include, for example, the payment of an intercompany dividend by a wholly owned Canadian subsidiary to its parent company. Furthermore, if that subsidiary owns, directly or indirectly, one or more foreign affiliates, it is possible that all or a portion of the surplus pools of one or more of those affiliates could, in certain circumstances, form an integral part of a safe-income calculation. This article provides a comparison of the fundamental aspects of these two regimes, with a particular focus on some of the more commonly encountered anomalies, issues, and planning considerations that can arise in the context of their interaction. The analysis presented by the author shows that, although the two regimes have a similar computational objective, the interplay between them can at times be uneasy and can give rise to unexpected results.