Key Takeaways from McCarthy Tétrault Tax Perspectives: May 2026

In our recent McCarthy Tétrault Tax Perspectives tour, speakers from McCarthy Tétrault’s National Tax Group led a practical discussion of the evolving legislative and judicial tax landscape in Canada and provided attendees with strategic insights and actionable advice.

The May 2026 tour featured presentations on the following three topics: (i) a review of material tax updates in the Spring Economic Update, (ii) a synopsis of recent cases of interest, and (iii) an overview of the second package of Canada’s anti-hybrid mismatch rules.

Spring Economic Update – Mike Dolson, Jeremy Ho and Matthew Kraemer

Mike Dolson, Jeremy Ho and Matthew Kraemer began the tour with a review of the material tax updates in the Spring Economic Update, including the following:

1. Capital Gains Exemption on Transfers to Employee Ownership Trusts (EOT) Made Permanent

The temporary exemption for the first $10 million in capital gains arising on the transfer of shares to an EOT will be made permanent. The federal government estimates that making the exemption permanent will cost taxpayers $207 million from 2026 to 2031. Assuming that each exemption claimed is for the full amount $10 million, and that an average federal income tax rate of 16.5% would have otherwise applied (ignoring potential alternative minimum tax effects), this suggests that the government expects approximately 125 such transfers to occur over the next 5 years.

2. Temporary Immediate Expensing for Greenhouse Buildings Draft Legislation Introduced

Immediate expensing for greenhouse buildings was announced on January 26, 2026, together with the new Canada Groceries and Essentials Benefit. Bill C-30, which will implement temporary immediate expensing for greenhouse buildings, was tabled in Parliament on the same day that the Spring Economic Update was released.

According to the draft legislation, immediate expensing for greenhouse buildings will be available in respect of:

• new greenhouse buildings;
• acquired from an arm’s length person after November 3, 2025;
• located in Canada;
• included in Class 8 because of paragraph (m) of that class (i.e., greenhouse buildings constructed of a rigid frame and a replaceable, flexible plastic cover) or Class 6 because of paragraph (d) of that class (i.e., greenhouse buildings not included in any other class); and
• which become available for use before 2030.

3. Accelerated Capital Cost Allowance (CCA) for Liquified Natural Gas (LNG) Facilities Reinstated

The federal government indicated that it would reinstate accelerated CCA for LNG facilities in its November 2025 Budget. The Spring Economic Update includes additional details regarding this proposed measure.

In general, the proposed rules will increase the CCA rate for liquefaction equipment used in an LNG facility from 8% to 50%, and non-residential buildings used in an LNG facility from 6% to 10%, provided that such property is:

• new liquefaction equipment included in Class 47 because of paragraph (b) of that class, or a new non-residential building included in Class 1 because of paragraph (q) of that class;
• acquired after November 3, 2025, but before 2035; and
• used in an LNG facility that liquefies natural gas, provided that:
  • the facility’s on-site liquefaction activities have an emissions intensity that is less than or equal to 0.20 tonnes of carbon dioxide per tonne of LNG produced; and
  • the facility has been certified by the Minister of Energy and Natural Resources.

To obtain certification for a particular LNG facility, the owners of the facility will be required to submit a one-time report prepared by a qualified Canadian engineering firm to the Minister of Energy and Natural Resources. The report must include a front-end engineering design study, the expected emissions intensity of the LNG facility, and any other information that may be required by the Minister.

The proposed rules will not apply to property used exclusively for regasification; property acquired for the production of oxygen or nitrogen; electrical generating equipment, or a breakwater, dock, jetty, wharf or similar structure. In addition, accelerated CCA for eligible liquefaction equipment and buildings will only be deductible from income attributable to liquefaction activities carried on at the LNG facility where the property is located.

4. Cardon Dioxide (CO₂) Capture, Utilization and Storage Investment Tax Credit (CCUS ITC) Expanded to Apply to Enhanced Oil Recovery (EOR)

The expansion of the CCUS ITC to apply to EOR was originally announced in the Alberta-Canada Memorandum of Understanding dated November 27, 2025. The Spring Economic Update contains additional information regarding the expansion.

The CCUS ITC is a refundable tax credit calculated, generally, as a percentage of eligible capital expenditures incurred in respect of a project that is intended to support the process of CO₂ capture, utilization and storage (CCUS Project). The extent to which the CCUS ITC is available to offset such expenditures depends, among other things, on the nature of the expenditures and the end use of the CO₂ being captured.

Eligible expenditures include amounts laid out to acquire property and equipment described in Class 57 and Class 58 of Schedule II to the Income Tax Regulations—generally, property and equipment used to capture CO₂, transport captured CO₂, store captured CO₂, or use captured CO₂ in industrial processes.^[1] Prior to the expansion, CO₂ captured as part of a CCUS Project had to be stored in a geological formation (i.e., rock) or used to produce concrete using a qualified concrete storage process. Following the expansion, CO₂ captured as part of a CCUS Project may be stored through EOR process, provided that:

• the CCUS Project in respect of which the expanded CCUS ITC is being claimed is located in a jurisdiction designated by the Minister of Environment (which jurisdictions currently include British Columbia, Saskatchewan and Alberta);
• the taxpayer seeking to claim the expanded CCUS ITC can show that it has a process in place to capture and reinject the CO₂ that is mixed with the oil when the EOR is performed, and that said process results in the permanent storage of 95% or more of the captured CO₂ intended for EOR storage.

The expanded CCUS ITC will apply in respect of eligible expenditures incurred during the period from April 28, 2026 to December 31, 2040. During the period from April 28, 2026 to December 31, 2035, the expanded CCUS ITC rates will be equal to one half of the CCUS ITC rates applicable to eligible expenditures incurred in respect of CCUS Projects stores CO₂ in rock or concrete:

During the period from January 1, 2036 to December 31, 2040, the applicable credit rates will be as follows:

Additional details regarding the kind of equipment that is eligible for the expanded CCUS ITC will be made available through technical guidance published by Natural Resources Canada.

For more information regarding the CCUS ITC, please see Clean Economy Tax Credits: Investment Tax Credit for Carbon Capture, Utilization and Storage.

5. CRA Will Prioritize Advance Income Tax Ruling Requests Related Nation-Building Projects

The Spring Economic Update includes an announcement that the CRA will prioritize requests for advance income tax rulings related to:

• large-scale, nation-building projects (such as housing and infrastructure);
• investments that enhance productivity and strengthen critical sectors of Canada’s economy (including clean economy initiatives); and
• projects of national importance.

Recent Cases of Interest – Mike Dolson, Jeremy Ho and Matthew Kraemer

Mike Dolson, Jeremy Ho and Matthew Kraemer continued the tour with a review of recent cases of interest from Canadian courts:

1. ExxonMobil Canada Resources Company, 2026 TCC 42

The Tax Court of Canada released its decision in ExxonMobil Canada Resources Company on March 6, 2026. This case sets an important precedent regarding the deductibility of feasibility study costs in the context of the North American pipeline industry, and serves as a reminder of the importance of well-reasoned expert reports in transfer pricing disputes.

The taxpayer, ExxonMobil Canada Resources Company (Exxon Canada), is indirectly owned by US-resident ExxonMobil Corporation (Exxon). On December 5, 2000, Exxon entered into an agreement with BP Exploration (Alaska) Inc. and Phillips Alaska, Inc. for the purpose of evaluating and progressing the construction of a pipeline that could be used to transport natural gas from Alaska to Western Canada and the rest of the United States (Project Agreement). On June 15, 2001, Exxon entered into a Partial Assignment and Cost Allocation Agreement (PACA Agreement) with Exxon Canada, pursuant to which Exxon assigned 68% of its 1/3 interest in the Project Agreement to Exxon Canada effective December 5, 2000. Thereafter, Exxon Canada held a 22.67% indirect interest in the Project Agreement.

To evaluate and progress the proposed pipeline, the parties to the Project Agreement agreed to undertake a feasibility study (Feasibility Study). Pursuant to the terms of the PACA Agreement, Exxon Canada was responsible for up to 22.67% of the costs associated with the study. Accordingly, in computing its income for its 2001 taxation year, Exxon Canada claimed a deduction of $36,207,810 in respect of such costs (Feasibility Study Costs).

The issues before the Court were whether:

1. the Feasibility Study Costs were deductible under paragraph 18(1)(a);
2. the transfer pricing rules in section 247 applied to deny  the deduction of the Feasibility Study Costs;
3. the transfer pricing rules in section 247 applied to adjust the deduction of the Feasibility Study Costs;
4. payment of the Feasibility Study Costs by Exxon Canada constituted a benefit to Exxon such that the Feasibility Study Costs were deemed to be a dividend paid by Exxon Canada to Exxon subject to Part XIII withholding tax;
5. the Minister’s assessment was statute-barred; and
6. Exxon Canada’s request for summary judgement and non-suit relief should be allowed.

The Court found in favor of Exxon Canada on issues one through four, and in favor of the Minister on issues five and six.

The Court held that the Feasibility Study Costs were deductible because Exxon Canada had a source of business income from which to deduct the Feasibility Study Costs, and the Feasibility Study Costs were incurred for the purpose of gaining or producing income from that business. In coming to this conclusion, the Court found that: (i) the purpose of the Feasibility Study was to evaluate and progress a potential pipeline project, (ii) that Exxon Canada’s business included exploring for, producing, transporting and selling crude oil and natural gas in Canada and that the Feasibility Study Costs were clearly related to that business, (iii) that the Feasibility Study was conducted in a commercial manner, and (iv) that it was reasonable for Exxon Canada to expect to earn a profit by undertaking the Feasibility Study.

The Court further held that the transfer pricing rules in section 247 did not apply to deny or adjust the deduction of the Feasibility Study Costs. The evidence did not establish that parties would not have entered into the PACA Agreement if they had been dealing at arm’s length. In coming to this conclusion, the Court was especially critical of the expert evidence led by the Minister. Of particular note are the Court’s observations that the Minister’s expert inappropriately applied a subjective (as opposed to objective) test in determining what the parties to the PACA Agreement would have done had they been dealing at arm’s length, and used hindsight to suggest that the terms of the PACA Agreement would be too uncertain for arm’s length parties.

The Court dismissed the Minister’s argument that the Feasibility Study Costs by Exxon Canada constituted a benefit to Exxon under subsection 56(2) or paragraph 246(1)(b) such that the Feasibility Study Costs were deemed to be a dividend paid by Exxon Canada to Exxon subject to Part XIII withholding tax. Exxon Canada paid the Feasibility Study Costs pursuant to its obligation to do so under the PACA Agreement—an obligation that it undertook in exchange for certain benefits. It therefore paid the Feasibility Study Costs for its own benefit, and not for the benefit of Exxon.

Finally, the Court confirmed that the Minister’s assessment was not statute-barred, and denied Exxon Canada’s application for summary judgment and non-suit relief.

The Court’s decision in this case was highly detailed. For a more thorough overview of the Court’s findings and their implications, please see ExxonMobil: Tax Court of Canada Finds that Feasibility Study Costs are Deductible.

2. Cineplex Inc., 2026 TCC 15

American Multi-Cinema Inc. (“AMC”)  operated eight movie theatres in Canada through its subsidiary, AMC Ventures Inc. (“Ventures”). The theatres were not profitable, and the decision was made to sell Ventures’ remaining assets and wind it up. Ventures sold two of the theatres to Empire Cinemas. Subsequently, AMC and Cineplex Inc. (“Cineplex”) entered into a share purchase agreement pursuant to which Cineplex agreed to acquire all the shares of Ventures subject to Ventures divesting itself of two theatres: the Kennedy Commons Theatre and the Interchange Theatre. Ventures was unable to negotiate an early exit from its leases of the Kennedy Commons and Interchange Theatres.

Accordingly, in order to meet the conditions of the sale to Cineplex, AMC caused Ventures to transfer the Kennedy Commons and Interchange Theatres to a related corporation called AMC New Jersey. Ventures then made a $26 million compensatory payment to AMC New Jersey for the estimated cost of closing the two theatres. Cineplex acquired the shares of Ventures, and Ventures was wound-up into Cineplex so that Cineplex could take advantage of certain losses incurred by Ventures.

AMC New Jersey included the compensatory payment in computing its taxable income earned in Canada for its 2012 taxation year. Ventures recorded the compensatory payment as a business expense in computing its taxable income for 2012 taxation year, which produced a non-capital loss that was deducted by Cineplex after the winding-up of Ventures. The Minister reassessed Cineplex’s 2014 taxation year, disallowing the $26 million non-capital loss carry-forward attributable to the compensatory payment.

The Minister argued that Ventures’ transfer of the Kennedy Commons and Interchange Theatres to AMC New Jersey constituted a disposition on capital account, and that the compensatory payment therefore constituted “negative proceeds of disposition” as opposed to a current business expense. In the alternative, the Minister argued that the compensatory payment was not made for the purpose of gaining or producing income from a business as required under paragraph 18(1)(a).

The Tax Court of Canada rejected the Minister’s primary argument, finding that based upon a textual, contextual, and purposive analysis of the provisions of the Income Tax Act (Canada), “capital gains” and “proceeds” must refer to a positive amount. The Court observed that it is well-established that costs associated with winding down a business are costs incurred for the purpose of earning income from the business. The fact that the compensatory payment was made in the context of a sale and that the share purchase agreement required Ventures to divest itself of the two theatres did not transform the compensatory payment into a capital expenditure.

Please see Cineplex: A Payment to Cease Operations was Deductible, for more details.

3. Suncor Energy Inc., 2026 FCA 33

In this case, the Federal Court of Appeal had to determine whether the deeming rule in subsection 13(31) applies to a transferee that did not exist when the transferor acquired the depreciable property in question.

Pursuant to subsection 13(26), a taxpayer cannot add the capital cost of newly acquired depreciable property of a prescribed class to the undepreciated capital cost (UCC) to the taxpayer of depreciable property of that class (or make any corresponding deduction under paragraph 20(1)(a)) until the newly acquired depreciable property has become available for use within the meaning of subsections 13(27) to (29). Pursuant to paragraphs 13(27)(a) and (b), depreciable property is considered to have become available for use at the earlier of the time when the property is used by the taxpayer for the purpose of earning income, and the first taxation year (or fiscal period) of the taxpayer that begins more than 357 days after the end of the taxation year (or fiscal period) of the taxpayer in which the taxpayer acquired the property. Where a taxpayer acquires depreciable property from a non-arm’s length party, subsection 13(31) deems the transferee to have acquired that property on the day the transferor did.

In January 2005, Suncor Energy Inc. (Suncor) acquired Class 41 depreciable property having a fair market value of $34,368,000 (MCU Properties). On February 1, 2005, Suncor, together with its wholly-owned subsidiary, Suncor Energy Oil Sands Inc. (Sub), formed a new limited partnership having a fiscal year-end of January 31, 2006 (LP). On January 1, 2006, Suncor transferred the MCU Properties to the newly formed LP. The transfer occurred at fair market value. On January 31, 2007 (at the end of its second fiscal period) the LP added to $34,368,000 to the UCC of its Class 41 property, and made a corresponding deduction under paragraph 20(1)(a) on the basis that the MCU Properties were available for use during its 2007 fiscal period by virtue of paragraph 13(27)(b) and subsection 13(31). The LP subsequently allocated 99.9% of its income to Suncor.

The Minister reassessed Suncor’s income on the basis that the MCU Properties were not available for use at any time during the LP’s fiscal period ended January 31, 2007. The Minister argued that subsection 13(31) could not deem the LP to have acquired the MCU Properties on the day that Suncor acquired the MCU Properties because the LP did not exist at that time.

Finding in favor of Suncor, the Federal Court of Appeal held that there is a necessary implication in subsection 13(31) of notional tax years for newly formed transferees that have acquired depreciable property from a non-arm’s length transferor. In other words, in order to provide new entities with the rolling start, recognizing an artificial tax year (or years), predating the existence of the transferee, may be required to give subsection 13(31) effect. In the Court’s view, this implication was derived from the ordinary interpretation of the rule, as well as the relevant statutory scheme.

4. DAC Investment Holdings Inc., 2026 FCA 35

In DAC Investment Holdings Inc., the Federal Court of Appeal held that the general anti-avoidance rule (GAAR) applied to certain transactions carried out by DAC Investment Holdings Inc. (DAC) in 2016. This decision overturned the Tax Court of Canada’s conclusion that the transactions were not abusive.

The relevant facts were as follows: Mr. Civiero controlled DAC. DAC was a Canadian-controlled private corporation (CCPC), and was therefore subject to the refundable tax regime in Part I of the Act in respect of its aggregate investment income. In 2011, Mr. Civiero acquired the shares of Soberlink Inc. (Soberlink), which he subsequently transferred to a holding corporation (Holdco). In 2014, Mr. Civiero caused Holdco to transfer the Soberlink shares to DAC on a tax-deferred basis pursuant to subsection 85(1). DAC was then continued into the British Virgin Islands. This caused DAC to cease to be a CCPC such that it was no longer subject to the refundable tax regime. DAC subsequently sold the Soberlink shares, realizing a capital gain. However, being a non-CCPC, DAC was not required to pay the refundable tax on aggregate investment income that would have otherwise applied to the taxable ½ of the capital gain.

The Minister reassessed the taxpayer under the GAAR, assessing refundable tax of $91,003 under section 123.3 and denying the general rate reduction of $148,226 claimed by DAC on the basis that DAC should be treated as a CCPC. The Tax Court of Canada found that there are two regimes under the Income Tax Act (Canada): one for CCPCs and one for non-CCPCs, both of which have advantages and disadvantages in different circumstances. A taxpayer may choose between them by causing a corporation to cease to be a CCPC without abusing or misusing the provisions of the Act.

In reversing the Tax Court’s decision, the Federal Court of Appeal defined the purpose of the refundable tax regime broadly. According to the Court of Appeal, the purpose of the refundable tax regime is not only to prevent individuals from deferring tax on investment income using a CCPC, but to prevent individuals from deferring tax on investment income using a corporation. DAC’s continuation into the British Virgin Islands therefore circumvented the refundable tax regime in a matter that frustrated its object, spirit, and purpose. According to the Court, the fact a corporation can take steps to cease to be a CCPC does not mean that the GAAR cannot apply to those steps.

DAC Investment Holdings Inc. is the first decision relating to any form of “non-CCPC planning”. The Federal Court of Appeal limited its decision to the taxpayer’s particular plan, so it is yet to be determined if different non-CCPC plans will be held to be abusive.

Anti-Hybrid Mismatch Rules – Stefanie Morand

Stefanie Morand concluded the presentation by providing an overview of the second package of Canada’s anti-hybrid mismatch rules (Hybrid Mismatch Rules):

1. Background

In 2013, the Organisation for Economic Co-operation and Development (OECD), together with the Group of 20 (G20), adopted a 15-point Action Plan to address base erosion and profit shifting (BEPS Action Plan). Action 2 of the BEPS Action Plan was set out in a 2015 report titled “Neutralising the Effects of Hybrid Mismatch Arrangements” (Action 2 Report) and a 2017 report titled “Neutralising the Effects of Branch Mismatch Arrangements” (Branch Supplement). The Hybrid Mismatch Rules are Canada’s response to the Action 2 Report and the Branch Supplement. The federal government announced its intention to implement the Hybrid Mismatch Rules in the 2021 Budget.

Draft legislation implementing the first package of Hybrid Mismatch Rules (First Package) was released for consultation on April 29, 2022. The First Package was implemented by Bill C-59, which received royal assent on June 20, 2024, and generally applies to payments arising on or after July 1, 2022.  The First Package implemented recommendations in Chapters 1 and 2 of the Action 2 Report (i.e., rules intended to neutralize D/NI mismatches arising from payments made in respect of hybrid financial instruments).

The Department of Finance released draft legislation to implement the second package of Hybrid Mismatch Rules (Second Package) for consultation on January 29, 2026.

The Second Package is intended to implement recommendations in the Action 2 Report that were not addressed in the First Package, as well as recommendations in the Branch Supplement.  In general, the Second Packages addresses mismatches  arising as a consequence of the hybrid status of the entities involved. The rules in the Second Package are proposed to apply to payments arising on or after July 1, 2026. At present, there are no grandfathering provisions for existing arrangements. It is unlikely that the Second Package will be enacted exactly as proposed. However, especially given that the rules in the First Package were enacted retroactively, we recommend that taxpayers who may be affected by these amendments familiarize themselves with the Second Package as soon as possible.

2. General Purpose

The Hybrid Mismatch Rules are generally intended to neutralize arrangements that exploit the differences between the tax treatment of an entity, permanent establishment or financial instrument under the tax laws of two or more jurisdictions to achieve “deduction/non-inclusion” (D/NI) or “double deduction” (D/D) mismatches. A D/NI mismatch generally arises where an amount may be deducted from income in one jurisdiction without being included in income in another jurisdiction. A D/D mismatch generally arises where the same amount may be deducted from income in more than one jurisdiction.

Basic Structure

The Hybrid Mismatch Rules function based on two main operative provisions:

• Primary Rule: subsection 18.4(4), which functions to neutralize a D/NI mismatch (and, following the implementation of the Second Package, a D/D mismatch) arising from a payment made under a “hybrid mismatch arrangement” by restricting the deduction; and
• Secondary (Defensive) Rule: subsection 12.7(3) (and, following the implementation of the Second Package proposed subsection 12.7(4)), which functions to neutralize a mismatch by including an amount in income.

3. Application of Second Package

The new rules contained the Second Package are extremely broad. While some arrangements or structures are more obviously within the scope of these rules than others, the rules have potential broad-spread application.

4. Outline of Second Package

Among other things, the Second Package:

• expands the Hybrid Mismatch Rules to address four additional types of “hybrid mismatch arrangements”:
  • “reverse hybrid arrangements” (proposed subsections 18.4(15.1) and (15.2));
  • “disregarded payment arrangements” (proposed subsections 18.4(15.3) and (15.4));
  • “hybrid payer arrangements” (proposed subsections 18.4(15.5) through (15.7)); and
  • “imported hybrid arrangements” (proposed subsections 18.4(15.8) through (15.95));
• amends the interpretive provision in subsection 18.4(2) (which states that the Hybrid Mismatch Rules are to be interpreted in a manner that is consistent with the Action 2 Report) to include a reference to the Branch Supplement; and
• extends the deemed dividend rule in subsection 214(18) (which, simplified, deems certain interest payments that are not deductible because of subsection 18.4(4) to be dividends subject to Part XIII withholding tax) to apply to:
  • payments arising under the additional “hybrid mismatch arrangements” set out above (with a narrow exception for certain payments arising under “hybrid payor arrangements”); and
  • payments made by a partnership in respect of a which a corporation resident in Canada is an “investor” (as proposed to be defined in subsection 18.4(1)).

New Hybrid Mismatch Arrangement Rules

The Second Package expands the Hybrid Mismatch Rules to address three additional types of “hybrid mismatch arrangements”, and adds a new concept of “imported hybrid arrangement”:

• Reverse Hybrid Arrangement: A payment will generally fall within the scope of a “reverse hybrid arrangement” where:
  • the payment is made to a “reverse hybrid entity” (“RHE”) (generally, an entity that is considered fiscally transparent by the country of residence, and fiscally opaque by the country in which its parent or other investor is resident);
  • the payer does not deal at arm’s length with the RHE, or the payment arises under (or in connection with) a “structured arrangement”;
  • the payment gives rise to a D/NI mismatch; and
  • the amount of D/NI mismatch exceeds the amount that would, if the payment were received by the direct “investors” of the RHE, be a D/NI mismatch that would not be denied under the rules in the First Package.

Where the foregoing conditions are met, the Hybrid Mismatch Rules will deny the deduction in respect of the payment under subsection 18.4(4) to the extent of the excess amount, and the payment may be deemed to be a dividend subject to Part XIII withholding tax.

• Disregarded Payment Arrangement: A payment will generally fall within the scope of a “disregarded payment arrangement” where:
  • the payer is a “hybrid entity” (“HE”) (generally, an entity that is considered fiscally opaque by the jurisdiction of residence, and fiscally transparent by the country of its parent);
  • the payer does not deal at arm’s length with the recipient, or the payment arises under (or in connection with) a “structured arrangement”;
  • the payment gives rise to a D/NI mismatch; and
  • the D/NI mismatch can reasonably be considered to arise, whether in whole or in part, because the payment is disregarded under the laws of the country in which a recipient of the payment is resident.

Where the foregoing conditions are met, the Hybrid Mismatch Rules may deny the deduction in respect of the payment under subsection 18.4(4) or cause the payment to be included in the payer’s income under subsection 12.7(3) unless the payer has sufficient dual inclusion income (or DII) as described below. If the Hybrid Mismatch Rules apply to deny the deduction under subsection 18.4(4), then the payment may also be deemed to be a dividend subject to Part XIII withholding tax.

• Hybrid Payer Arrangement: While the “reverse hybrid arrangement” rule and the “disregarded payment arrangement” rule target payments that give rise to a D/NI mismatch, the “hybrid payer arrangement” rule targets payments that give rise to D/D mismatch. A payment will generally fall within the scope of a “hybrid payer arrangement” where:
  • the payer is a “hybrid payer”—i.e., a HE, a “dual resident” (an entity that is resident in two or more jurisdictions) or a “multinational entity” (“MNE”) (an entity that is resident in one jurisdiction, but has a permanent establishment in another jurisdiction);
  • if the “hybrid payer” is a HE that is resident in Canada:
    • the payer does not deal at arm’s length with an “investor”, or the payment arises under (or in connection with) a “structured arrangement”; and
    • at least one “investor” is not subject to a “foreign hybrid payer mismatch rule”;
  • if the “hybrid payer” is a non-resident MNE, no foreign hybrid payer mismatch rule applies to the MNE; and
  • the payment gives rise to a D/D mismatch (determined after thin-cap/EIFEL).

Where the foregoing conditions are met, the Hybrid Mismatch Rules may deny the deduction in respect of the payment under subsection 18.4(4) or cause the payment to be included in income under proposed subsection 12.7(4) unless there is sufficient DII or “investor DII”. If the Hybrid Mismatch Rules apply to deny the deduction under subsection 18.4(4), then the payment may also be deemed to be a dividend subject to Part XIII withholding tax.

Proposed ordering rules clarify that the jurisdiction where the parent entity is resident (if the hybrid payer is an HE) or the jurisdiction where the entity is resident (if the hybrid payer is an MNE) should apply its anti-hybrid mismatch rules first, with the “subsidiary” jurisdiction or the “permanent establishment” jurisdiction (as the case may be) applying its Secondary (Defensive) Rule only if the former jurisdiction fails to apply its Primary Rule. The proposed rules in the Second Package do not include an ordering rule that would apply to a hybrid payer arrangement where the hybrid payer is a dual resident.

• Imported Hybrid Arrangements: The proposed rules regarding “imported hybrid arrangements” are intended to address situations where a Canadian entity makes a deductible payment to a non-resident entity that is fully included in the non-resident entity’s income (and thus does not give rise to a D/NI mismatch or a D/D mismatch), but the deductible payment is part of a series of transactions that includes a hybrid arrangement between two or more non-resident taxpayers.

The “imported hybrid arrangement” rule is generally triggered where:

• there is an “offshore mismatch”;
• the benefits of the “offshore mismatch” are “imported” to Canada; and
• the participants in the series do not deal at arm’s length, or payments arise under (or in connection with) a “foreign structured arrangement”.

Where the foregoing conditions are met, Canada’s Hybrid Mismatch Rules will deny the deduction in respect of the otherwise deductible payment made by the Canadian entity to the non-resident entity. In addition, the otherwise deductible payment may be deemed to be a dividend subject to Part XIII withholding tax.

Exceptions to New Hybrid Mismatch Arrangement Rules

The Second Package contemplates two key exceptions to the application of certain of the new “hybrid mismatch arrangement” rules:

• Dual Inclusion Income Exception: Very generally, “dual inclusion income” (DII) is income that is taxed in more than one jurisdiction. As noted above, DII is relevant for purposes of the “disregarded payment arrangement” rule and the new “hybrid payer arrangement” rule.

The Second Package proposes to define DII on an entity-by-entity basis. DII of a HE that is resident in Canada is proposed to be defined to include “the total of all amounts each of which is an amount that is both (a) ordinary income of the entity, in respect of Canada for the taxation year; and (b) ordinary income of an investor in the entity, in respect of a country other than Canada, for a foreign taxation year that begins on or before the day that is 12 months after the end of the taxation year.”

• Foreign Hybrid Payer Mismatch Rule Exception: The Second Package proposes to define a “foreign hybrid payer mismatch rule” as a “rule that can reasonably be considered to (a) have been enacted or otherwise brought into effect by a country with the intention of implementing, in whole or in part, Chapter 6 or 7 of [the Action 2 Report], as amended from time to time; or (b) have an effect that is substantially similar to that of a provision under this section [18.4] or section 12.7 that is intended to implement, in whole or in part, a chapter referred to in paragraph (a).”

The CBA-CPA Joint Committee has identified numerous potential issues with these definitions, and the proposals more generally, which are beyond the scope of this blog post. However, it is worth noting that many of these issues were identified and addressed by other jurisdictions such as the United Kingdom and Australia in implementing their anti-hybrid mismatch rules.

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