Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: Does subsection 17(1) of the Income Tax Act apply to each taxation year during which the amount owing in question was outstanding, even though at the end of the first taxation year the amount had not yet been outstanding for more than 12 months?
Position: Yes, provided that the amount ultimately was outstanding for more than 12 months.
Reasons: The wording of subsection 17(1) could be interpreted to apply to each taxation year during which the amount owing in question was outstanding provided that the amount ultimately remains outstanding for more than 12 months. This interpretation is also consistent with the Department of Finance's intention.
August 2, 2002
Burnaby-Fraser Tax Services Office Headquarters
International Tax Directorate Income Tax Rulings Directorate
9737 King George Hwy
Surrey BC V3T 5W6 S.Wong
(613) 957-9231
Attention: Robert Thomson
Regional Advisor 2002-014854
Subsection 17(1) Application of Imputed Interest
We are writing in reply to your e-mail correspondence of June 20, 2002 (enclosing a memorandum from Brian Ellis of International Audit) in which you requested our comments on whether subsection 17(1) of the Income Tax Act (the "Act") would apply to impute interest income to the Canadian corporate taxpayer ("Canco1") for the 1999 taxation year in the following situation.
The Situation
1. Canco1 is a XXXXXXXXXX corporation that is resident in Canada for purposes of the Act. Canco1's 1999 and 2000 taxation years begin on January 1 and end on December 31 of 1999 and 2000 respectively.
2. During its 1999 and 2000 taxation years, Canco1 made a series of loans totalling approximately $XXXXXXXXXX to its U.S. subsidiary holding company ("USholdco"). The loans made by Canco1 to USholdco during Canco1's 1999 taxation year and 2000 taxation year are referred to herein as the "1999 Loans" and "2000 Loans" respectively, and the "Canco1-USholdco Loans" collectively.
3. USholdco in turn loaned approximately $XXXXXXXXXX of the proceeds of the Canco1-USholdco Loans to its XXXXXXXXXX subsidiary ("USco").
4. USholdco and USco are not resident in Canada for purposes of the Act.
5. USco did not carry on an active business until 2002.
6. In XXXXXXXXXX 2000, Canco1's Canadian parent incorporated a numbered company in Canada ("Canco2"). Canco1 bought shares in Canco2 for approximately $XXXXXXXXXX. On XXXXXXXXXX, 2000, the Canco1-USholdco Loans were paid off. Canco2 then loaned approximately $XXXXXXXXXX to USholdco who in turn loaned the same amount to USco. The effect of these transactions undertaken in 2000 was such that the 2000 Loans were outstanding for less than 12 consecutive months and therefore subsection 17(1) of the Act would not apply to impute any interest income to Canco1 for the 2000 taxation year in respect of the 2000 Loans. As agreed with Brian Ellis (Ellis / Wong, July 30, 2002), we do not discuss in this reply the potential avoidance issues relating to these transactions undertaken in 2000, since these issues have been referred to Tax Avoidance.
The Taxpayer's Position
Canco1's position is that subsection 17(1) of the Act should only apply to taxation years during or after which the relevant loan has already been outstanding for more than a period of 12 consecutive months. In other words, Canco1's position is that where the more than 12 consecutive month-long term of the loan (the 1999 Loans in this case) straddles two taxation years (the 1999 and 2000 taxation years in this case) such that at the end of the first taxation year (the 1999 taxation year in this case) the loan had not yet been outstanding for more than 12 months, subsection 17(1) does not apply to the first taxation year (the 1999 taxation year in this case), but would only apply to the second taxation year (the 2000 taxation year in this case). In support of this position, Canco1 made the following arguments:
1. The references to "the year" in subsection 17(1) of the Act, when read in the context in which that phrase appears, should be interpreted to mean the taxation year rather than the period of twelve consecutive months during which the relevant loan was outstanding (the "loan year") which can straddle two taxation years of the taxpayer. In support, Canco1 argues that since these references are references to a year in which amounts are included in income and since these amounts are included in income only in respect of a taxation year, these references to "the year" mean the taxation year rather than the loan year. Canco1 further argues that this interpretation is supported by the fact that the reference to the prescribed rate in paragraph 17(1)(a) of the Act is to the prescribed rate for the period in the year during which the indebtedness was outstanding, that is, if the references to "the year" in subsection 17(1) of the Act are to the loan year, the reference in that provision to "the period in the year during which the indebtedness is outstanding" would not be logical because, by definition, the indebtedness is outstanding throughout the loan year.
2. Canco1 also cited the reasoning used by the Tax Appeal Board in Bain Wagon Company Ltd. V. MNR, 70 DTC 1507 as support for the argument that the references to "the year" in subsection 17(1) of the Act mean the taxation year. In Bain Wagon, the Tax Appeal Board held that the reference to "a year" in subsection 17(1), as it was prior to it being amended by Bill C-72 effective for taxation years commencing after February 23, 1998 (the "1998 amendments"), means a period of 12 consecutive months commencing at any time in a calendar year. The Board's reasoning for this conclusion is that the reference to "a year" appears without any descriptive adjective appearing before it. It should be noted that subsection 17(1), as amended by the 1998 Amendments, contains references to "a year" as well as "the year" (see below for an excerpt from that provision). It does not appear that Canco1 is arguing that the reference to "a year" in subsection 17(1) is a reference to the taxation year. Rather, it appears that Canco1 is arguing that, unlike the reference to one year in subsection 17(1) as it was prior to the 1998 Amendments, the references to "the year" in that provision after the 1998 Amendments do appear after the descriptive adjective - "taxation year" - and therefore should mean taxation year.
3. In support of its position, Canco1 also cited an article written by Evelyn P. Moskovitz, "Financing of Non-Residents and the Recent Amendments to Section 17" in the 1999 Canadian Tax Foundation Conference Report at pp.43:1-61.
International Audit's Position
It is International Audit's view that the term "year" on its own refers to 365 days rather than "taxation year" and that the taxpayer's interpretation of subsection 17(1) of the Act is not consistent with the Department of Finance's intention with respect to the change in the wording of that provision as a result of the 1998 Amendments. You have therefore asked for our comments as to whether subsection 17(1), as amended by the 1998 Amendments, applies retroactively to any taxation year during which the loan in question was outstanding, provided that it was ultimately established that the loan was outstanding for more than 12 consecutive months. In particular, you would like our views as to whether subsection 17(1) applies to Canco 1 for the 1999 taxation year with respect to the 1999 Loans, even though at the end of the 1999 taxation year, the 1999 Loans had not yet been outstanding for more than 12 months.
Subsection 17(1) of the Act provides, inter alia, that:
"Where, at any time in a taxation year of a corporation resident in Canada, a non-resident person owes an amount to the corporation, that amount has been or remains outstanding for more than a year and the total determined under paragraph (b) for the year is less than the amount of interest that would be included in computing the corporation's income for the year in respect of the amount owing if that interest were computed at a reasonable rate for the period in the year during which the amount was owing, the corporation shall include an amount in computing its income for the year equal to the amount, if any, by which
(a) the amount of interest that would be included in computing the corporation's income for the year in respect of the amount owing if that interest were computed at the prescribed rate for the period in the year during which the amount was owing
exceeds
(b) the total of all amounts each of which is
(i) an amount included in computing the corporation's income for the year as, on account of, in lieu of or in satisfaction of, interest in respect of the amount owing,....
(iii) An amount that is included in computing the corporation's income for the year or a subsequent year under subsection 91(1) and that can reasonably be attributed to interest on the amount owing for the period in the year during which the amount was owing." (Emphasis added)
We have assumed that the total determined under paragraph 17(1)(b) of the Act for each of Canco1's 1999 and 2000 taxation years in respect of the Canco1-USholdco Loans (that is, the interest actually received or receivable by Canco1 on such Loans and the amount of any foreign accrual property income ("FAPI") that was included Canco1's income in those years or any subsequent year and that was reasonably attributable to interest on such Loans) is less than the amount of interest that would be included in Canco1's income for each of those years in respect of such Loans if that interest were computed at a reasonable rate for the period in the year during which such Loans were outstanding.
We have also assumed that none of the exceptions to subsection 17(1) contained in section 17 of the Act would apply to the Canco1-USholdco Loans. In particular, we have assumed that the exception in subsection 17(8) of the Act would not apply to such Loans on the basis that USholdco did not use any part of the proceeds of such Loans for the purpose of earning income from an active business or income that would be included in computing its income from an active business under subsection 95(2) of the Act; or for the purpose of making a loan to another controlled foreign affiliate of Canco1 where, if interest were payable on such loan, it would not be included in USholdco's FAPI.1
Accordingly, the sole issue to be determined is whether subsection 17(1) applies to Canco1 for the 1999 taxation year with respect to the 1999 Loans, even though at the end of the 1999 taxation year, the 1999 Loans had not yet been outstanding for more than 12 months. Based on the Bain Wagon decision, it is clear that the reference to "a year" in the phrase, "that amount has been or remains outstanding for more than a year" in subsection 17(1) means a period of 12 consecutive months commencing at any time in a calendar year, since that reference is not modified by any descriptive adjective. In addition, subsection 37(1) of the Interpretation Act provides that the expression "year" means any period of twelve consecutive months.
With respect to the meaning of the underlined references in the excerpt from subsection 17(1) above to "the year", while we agree with the taxpayer's arguments that it should be interpreted to mean "the taxation year" when read in the context of the other words of that subsection, we are of the view that this does not resolve the issue of whether subsection 17(1) applies retroactively to any taxation year during which the amount owing in question was outstanding. In order to determine this issue, one must also interpret the following phrases at the beginning of subsection 17(1):
"Where, at any time in a taxation year of a corporation resident in Canada, a non-resident person owes an amount to the corporation, that amount has been or remains outstanding for more than a year and the total determined under paragraph (b) for the year..."
E. Moskovitz, in the article that was cited by Canco1, suggested that the issue was whether the phrase "at any time in a taxation year of a corporation resident in Canada" is modified only by the phrase "a non-resident person owes an amount to the corporation" or whether it is modified by both of the next two following phrases, that is, by "a non-resident person owes an amount to the corporation" and by "that amount has been or remains outstanding for more than a year".
E. Moskovitz took the position that the latter interpretation was the correct one, based on the presence of the comma that follows the introductory phrase, "where, at any time in a taxation year of a corporation resident in Canada".2
In our view, the phrase, "that amount has been or remains outstanding for more than a year" stands on its own. In other words, these first few phrases of subsection 17(1) can be read as follows:
? where, at any time in a taxation year of a corporation resident in Canada, a non resident person owes an amount to the corporation;
? that amount has been or remains outstanding for more than a year; and
? the total determined under paragraph (b) for the year...
On this reading, the phrase "that amount has been or remains outstanding for more than a year" does not modify the term "taxation year". This means that subsection 17(1) applies to any taxation year during which a non-resident owes an amount to a Canadian corporation, whether or not such taxation year is also one during which the amount has been or remains outstanding for more than 12 months. This interpretation can be borne by the words of subsection 17(1) (we do not agree with Moskovitz that the comma is a decisive factor) and is consistent with our understanding of the policy behind subsection 17(1).
In addition, even if the phrase "that amount has been or remains outstanding for more than a year" does modify the term "taxation year", the words "remains outstanding" suggest that subsection 17(1) would apply to a taxation year even though at the end of the taxation year, the amount in question has not yet been outstanding for more than 12 months, provided that the amount ultimately remains outstanding for more than 12 months. Based on an informal discussion with the Department of Finance (Hall / Wong, July 25, 2002), this interpretation is consistent with Finance's intention that subsection 17(1) apply retroactively to any year during which the amount in question was outstanding, provided that the amount ultimately remains outstanding for more than 12 months.3 This intention is also evidenced in the following excerpt from the Technical Notes to the 1998 Amendments:
"Subject to the exceptions in new subsections (7), (8) and (9), new subsection 17(1) will apply to all amounts owing by a non-resident person to a corporation resident in Canada where at any time an amount owing has been outstanding for more than a year, or an amount owing at any time ultimately remains outstanding for more than a year, and a reasonable amount of interest has not been included in computing the corporation's income in respect of the amount owing for the portion of the corporation's taxation year during which the amount owing was outstanding." (Emphasis added)
Prior to the 1998 Amendments, subsection 17(1) applied where a corporation resident in Canada had lent money to a non-resident and that loan remained outstanding for one year or longer without the corporation including interest on the loan, computed at a reasonable rate, in computing its income. Where old subsection 17(1) applied, it treated the corporation as having received interest on the loan, computed at a prescribed rate, at the end of each taxation year during which the loan was outstanding. Thus, prior to the 1998 Amendments, where a loan year straddled two taxation years, it was clear that subsection 17(1) applied to the first of such taxation years.
Based on the1998 Budget Proposals and Technical Notes to the 1998 Amendments as well as our informal discussions with the Department of Finance, the 1998 Amendments were not intended to change this retroactive nature of subsection 17(1). Rather, the 1998 Amendments were introduced to:
(i) extend the rule in subsection 17(1) to apply to all amounts (not just loans) owing by non-residents to corporations resident in Canada, trusts with corporate beneficiaries and partnerships with such corporate partners where interest is not paid at a reasonable rate;
(ii) ensure that subsection 17(1) applies to amounts owing either directly or indirectly by a non-resident;
(iii) add an active business requirement to the exception in old subsection 17(3); and
(iv) provide some recognition of the amount, if any, the corporation has included in income in respect of interest on the amount owing under other provisions of the Act.
Based on all of the foregoing, we are of the opinion that subsection 17(1) should be interpreted to apply to each taxation year during which the amount owing in question was outstanding even though the amount had not yet been outstanding for more than 12 months at the end of the first taxation year, provided that it is ultimately established that the amount was outstanding for more than 12 months. Accordingly, we are of the view that subsection 17(1) would apply to Canco1 for its 1999 taxation year in respect of the 1999 Loans that ultimately remained outstanding for more than 12 months.
We trust that our comments have been helpful.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity.
Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Jim Wilson
Section Manager
For Director
International and Trust Division
Income Tax Rulings Directorate
Policy and Legislation Branch
ENDNOTES
1 We note that most of the proceeds of the Canco1-USholdco Loans were used by USholdco to make a loan to USco (the "USholdco-USco Loan"). Since USco did not carry on an active business throughout the time the USholdco-USco Loan was outstanding, interest, if any, payable on the USholdco-USco loan would not be included in USholdco's active business income under subsection 95(2) of the Act but would rather be included in USholdco's FAPI.
2 For a detailed discussion of Moskovitz's position on why this comma is pivotal in interpreting subsection 17(1), please refer to footnote no. 31 in the article referred to above.
3 We note that Moskovitz acknowledged in her article that the Department of Finance does not agree with her interpretation of subsection 17(1).
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