8 February 2006 External T.I. 2004-0064811E5 - Subsection 15(2)

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.

Principal Issues: (i) Whether subsection 15(2.3) would apply to Situation A and (ii) whether subsection 15(2.1) would apply to Situation B and Situation C as described in the letter and whether GAAR would be applied?

Position: (i) not determinative, depending on whether the loans were made in the ordinary course of Cansub's ordinary business of lending money. (ii) Depending on the facts of the particular situation, paragraph 95(6)(b) may be applied such that subsection 15(2.1) would not apply. GAAR may also be applied because there appears to be a tax benefit, an avoidance transaction and a misuse of subsection 15(2.1).

Reasons: See above

XXXXXXXXXX 							2004-006481
S. Leung, CA
February 8, 2006

Dear XXXXXXXXXX:

Re: Subsection 15(2) of the Income Tax Act (the "Act")

We are writing in reply to your letter in which you requested our opinion as to whether subsections 15(2.1) and 15(2.3) of the Act would apply to the following situations such that subsection 15(2) and paragraph 214(3)(a) of the Act would not apply.

The Situations

1. MNC is a multi-national company incorporated and resident outside of Canada.

2. MNC has a direct interest in several wholly-owned foreign subsidiaries as follows:

(a) F1, F2 and F3 (collectively, "Foreign Subs"), which were incorporated and are resident in various foreign countries; and

(b) Canco, which was incorporated and is resident in Canada.

MNC and its subsidiaries are hereafter referred to collectively as the "Group".

3. MNC currently manages its worldwide intra-group treasury functions directly through its own employees located at MNC. These treasury functions include managing surplus cash, hedging, engaging in foreign exchange transactions, borrowing and lending.

Situation A

1. In order to take advantage of certain provincial government tax incentives provided under new International Financial Centre legislation, MNC moves all the treasury functions for the Group to Cansub, a new subsidiary of Canco incorporated in Canada. All of MNC's treasury personnel are relocated to Cansub. Subsequently, Cansub performs all the treasury activities for the Group, including cash pooling and management, hedging, borrowing and financing.

2. As part of the treasury functions, Cansub loans money to the Foreign Subs at market rates of interest, and bona fide arrangements are made for repayment of the loans within a reasonable period of time.

Situation B

(i) Canco does not incorporate Cansub. Instead, all of the treasury personnel of MNC are transferred to Canco and Canco performs all the treasury activities for the Group.

(ii) Canco subscribes for common shares of the Foreign Subs such that it holds 1% of the issued shares of each of the Foreign Subs.

(iii) Canco subsequently loans money to each of the Foreign Subs in the year at market rates of interest, and bona fide arrangements are made for repayment of the loans within a reasonable period of time.

Situation C

The same facts apply as in Situation B, except that instead of holding 1% interest in each of the Foreign Subs, Canco subscribes for shares of the Foreign Subs such that it holds a 10% interest in each of the Foreign Subs.

Our Comments

The situation outlined in your letter appears to relate to an actual situation involving identifiable taxpayers. Accordingly, the applicable Tax Services Office should be consulted with respect to the income tax liabilities of such taxpayers. However, we can offer the following general comments.

Subsection 15(2.3) of the Act reads as follows:

"Subsection (2) does not apply to a debt that arose in the ordinary course of the creditor's business or a loan made in the ordinary course of the lender's ordinary business of lending money where, at the time the indebtedness arose or the loan was made, bona fide arrangements were made for repayment of the debt or loan within a reasonable time."

In Situation A, it is a question of fact whether the ordinary business of Cansub is the lending of money and whether the loans to the Foreign Subs were made by Cansub in the ordinary course of its ordinary business of lending money. The lending of money to the Group is but one of the many functions performed by Cansub in the course of carrying out the "treasury functions" described in your letter. Therefore, the activities of Cansub may comprise much more than just an ordinary business of lending money. If the lending of money is considered a separate business of Cansub, it remains an issue whether such business is its ordinary business. In addition, Cansub only lends money to the members of the Group with whom it does not deal at arm's length. One would expect that in an ordinary business of lending money, loans would be made to arm's length persons. Hence, it may be that any loan made by Cansub to the Foreign Subs cannot be said to be made in the ordinary course of Cansub's ordinary business of lending money.

Nevertheless, as the determination of whether a loan made by Cansub is in the ordinary course of its ordinary business of lending money is ultimately a question of fact and as all the facts and circumstances of the situation have to be thoroughly examined before such a determination can be made, we cannot offer any definitive answer to this question in the context of a hypothetical situation.

In the event that a corporation's business includes the making of loans but those loans cannot be viewed as having been made in the corporation's ordinary business of lending money, it is our view that those same loans cannot be considered as "debts that arose in the ordinary course of the creditor's business". It is our view that, where a loan is made by a taxpayer as a lender, the phrase "a debt that arose in the ordinary course of the creditor's business" in subsection 15(2.3) is not applicable to that taxpayer in respect of the loan. That phrase is meant to cover situations where an indebtedness other than a loan occurs, although the word "debt" is broad enough to include a loan and the word "creditor" a lender. This is so because a lender/borrower relationship is more specific than a creditor/debtor relationship. Where a loan is involved, it gives rise to a lender/borrower relationship, not only a creditor/debtor relationship. Therefore, if the word "debt" in the above mentioned phrase were intended to mean a loan, the word "lender" would have been used rather than the word "creditor". More importantly, if the phrase "a debt that arose in the ordinary course of the creditor's business" in subsection 15(2.3) includes a loan, there is no need to include in that subsection the phrase "a loan made in the ordinary course of the lender's ordinary business of lending money" because the phrase "a debt arose in the ordinary course of the creditor's business" where the business of the creditor is money lending, will cover such a loan.

It is an important interpretative rule that every word of a statute has a meaning. Parliament would not include words in a statute that do not add any meaning. It is therefore our view that two separate scenarios are meant to be covered under subsection 15(2.3): a debt (other than a loan) that arose in the ordinary course of the creditor's business and a loan made in the ordinary course of the lender's ordinary business of lending money. Only the latter scenario applies to the facts outlined in Situation A above as Cansub is making loans to the Foreign Subs. This interpretation is supported by the words used in subsection 15(2) of the Act where it refers to a case where "a person or partnership receives a loan from or has become indebted to the particular corporation ..." and to "the amount of the loan or indebtedness". It is clear that subsection 15(2) also deals with two separate situations: a loan and an indebtedness (other than a loan). Because of the above interpretation, we do not need to consider whether the loans resulting from financing the Foreign Subs by Cansub in Situation A constitute debts that arose in the ordinary course of Cansub's business as a creditor because in that case the loans are made by Cansub as a lender, not as a creditor.

With respect to Situation B and Situation C, we may have some concerns about the tax avoidance aspect of the situations. We may consider the possible application of paragraph 95(6)(b) of the Act in those situations such that the acquisition of the shares of the Foreign Subs by Canco would be deemed to not have occurred. We note that that subsection applies only for the purposes of subdivision i of Division B of the Act (other than section 90). Subdivision i in part deals with the definition of "foreign affiliate" and the share acquisition has a direct impact on whether the Foreign Subs are foreign affiliates of Canco. We are of the view that paragraph 95(6)(b) of the Act could be applied to those situations with consequences to the application of subsection 15(2.1).

We would also consider invoking the GAAR provisions under section 245 of the Act because the share acquisition is not undertaken or arranged primarily for bona fide purposes other than to obtain a tax benefit. Depending on the facts, it may be that the transaction or the series of transactions would result in a misuse of the provisions of the Act such as subsection 15(2.1).

Yours truly,

Olli Laurikainen, CA
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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