International Tax Planning: The Foreign Affiliate Surplus Reclassification Rule

Bill C-48, the Technical Tax Amendments Act, 2012, introduced, among other things, several significant changes to the foreign affiliate surplus rules, including the adoption of the surplus reclassification rule in regulation 5907(2.02). The surplus reclassification rule is a broadly worded specific anti-avoidance rule that can apply to reclassify a foreign affiliate's exempt earnings (and exempt surplus) into taxable earnings (and taxable surplus) when the exempt earnings arise from certain tax-motivated dispositions of property. On the basis of a textual, contextual, and purposive interpretation of this provision, the author maintains that the rule should apply only in circumstances involving foreign affiliate surplus stripping—that is, tax-free transactions designed to convert low-taxed taxable surplus into exempt surplus that can be distributed or otherwise relied on to achieve Canadian tax savings.