22 May 2013 IFA Roundtable, 2013-0483791C6 - Upstream Loans

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: 1. Is the amount that was added to Canco's ACB of the shares of FA (in respect of previously-taxed FAPI) available for the deduction in proposed subsection 90(9)? 2. Will Canco have an income inclusion under proposed subsection 90(6) in the scenarios described below? 3. Will the CRA use its various positions on subsection 15(2) as a guide for administering proposed subsections 90(6) to (15)?

Position: 1. Yes under 90(9)(a)(i)(D) 2. Yes. 3. See below.

Reasons: 1. As expressed in the Explanatory Notes released with the NWMM on October 24, 2012, it is Finance's intention that the deduction that would have been available under subsection 91(5) if a dividend had been paid, will only be an element of the deduction in proposed subsection 90(9) where the specified debtor is a non-arm's length non-resident person (or partnership). However, if a deduction were not available in respect of a dividend from taxable surplus, it would be expected that the taxpayer would elect under proposed paragraph 5901(2)(b) of the Regulations to deem the dividend to be paid out of pre-acquisition surplus, such that a deduction would be available under paragraph 113(1)(d). 2. Proposed subsection 90(6) provides that the relevant time for determining whether a person receives a loan from a creditor that is an FA and determining whether the person is a specified debtor in respect of the taxpayer for the purpose of determining whether proposed subsection 90(6) will apply, is the time at which the loan is made, even though the creditor may cease to be a FA of the taxpayer resident in Canada before it can be determined whether the exception in proposed paragraph 90(8)(a) applies. 3. Application of proposed 90(6) is a question of fact and determined on a case by case basis.

2013 IFA Conference

Question 5: Upstream Loan Rules

Question 5(a)

Proposed subsection 90(6) generally applies to include an amount in the income of a corporation resident in Canada ("Canco") where a specified debtor receives a loan or becomes indebted to a foreign affiliate ("FA") of Canco and none of the exceptions in proposed subsection 90(8) apply. Proposed subsection 90(9) entitles Canco to a reserve to the extent that an actual dividend from the lending FA would have given rise to a deduction under section 113 (based on the surplus balances of the lending FA at the time the loan was made or the indebtedness incurred), and subsection 91(5) (in limited circumstances).

Assume that Canco owns all the shares of FA. FA has $100 of taxable surplus ("TS"), no exempt surplus and no underlying foreign tax ("UFT") balances. The TS is attributable to foreign accrual property income ("FAPI") of FA and has been fully included in the income of Canco and the ACB of FA's shares. Assume that FA makes a $100 loan to Canco and the "specified amount" in respect of the loan is included in Canco's income pursuant to proposed subsection 90(6). Will a reserve be available to Canco pursuant to the provisions of proposed subsection 90(9)?

Response 5(a)

Under the general ordering of surplus distributions, the notional dividend contemplated in proposed subsection 90(9) would, in the above case, be out of FA's TS.

Pursuant to proposed subparagraph 90(9)(a)(ii), the deduction that would be available under subsection 91(5) if a dividend were paid by the FA will be an element in computing the reserve in proposed subsection 90(9), only if the specified debtor is a person described in proposed sub-clause 90(9)(a)(i)(D)(I) or (II) (i.e. a non-resident person with which Canco does not deal at arm's length, or a partnership any member of which is a non-resident person with which Canco does not deal at arm's length). In the scenario described above, there is no amount included in the reserve under proposed subparagraph 90(9)(a)(ii) in respect of the previously taxed FAPI, because the specified debtor is Canco (which is not a person described in proposed sub-clause 90(9)(a)(i)(D)(I) or (II)).

If the notional dividend was out of FA's TS, no amount would be computed under clause 90(9)(a)(i)(C) because FA has no UFT and no deduction would be available under paragraph 113(1)(b) in respect of that notional dividend. Moreover, there would be no amount computed under clause 90(9)(a)(i)(D) because no portion of the notional dividend was out of FA's pre-acquisition surplus.

However, we note that firstly, the ACB of the shares of FA held by Canco is increased under paragraph 92(1)(a) as a result of the subsection 91(1) inclusion in respect of the FAPI of FA and secondly, proposed paragraph 5901(2)(b) of the Regulations allows a taxpayer to make an election to "side step" the normal ordering rules of subsection 5901(1) of the Regulations and instead, have the whole dividend deemed to be paid out of pre-acquisition surplus. Since Canco would have been in a position to make an election under proposed paragraph 5901(2)(b) of the Regulations to deem the dividend to be paid out of pre-acquisition surplus, it is our view that for the purposes of proposed subsection 90(9) an amount may "reasonably be considered to have been deductible" in respect of the dividend under paragraph 113(1)(d). Therefore an amount would be included in the subsection 90(9) reserve under proposed clause 90(9)(a)(i)(D).

Question 5(b)

Proposed subsections 90(6) to 90(15) generally apply in respect of loans received and indebtedness incurred after August 19, 2011. However, they also apply in respect of a particular loan received or indebtedness incurred on or before August 19, 2011 that remains outstanding on August 19, 2014 as if it was received or incurred on August 20, 2014 (footnote 1). There is an exception for loans repaid within two years of inception.

Consider a case where on September 1, 2011 a foreign affiliate (FA) of a corporation resident in Canada (Canco) made a loan to a "specified debtor" in respect of Canco. If Canco sells the shares of the FA such that FA ceases to be a foreign affiliate of Canco before September 1, 2013, and the loan is outstanding on September 1, 2013, will Canco be deemed to have an income inclusion pursuant to proposed subsection 90(6) on September 1, 2011?

Consider another case where prior to August 19, 2011 a foreign affiliate (FA) of a corporation resident in Canada (Canco) made a loan to a "specified debtor" in respect of Canco. If Canco sells the shares of the FA before August 19, 2014, will Canco be deemed to have an income inclusion pursuant to proposed subsection 90(6) on August 20, 2014, if the loan remains outstanding on August 20, 2016?

Alternatively, if Canco sells the shares of FA after August 20, 2014 but the loans remains outstanding on August 20, 2016, will subsection 90(6) apply?

Response 5(b)

In the first case, FA made a loan to a "specified debtor" in respect of Canco on September 1, 2011. Since proposed subsection 90(6) provides that the relationships between Canco, FA and the debtor are to be tested at the time the loan is received or the debt incurred (in this case, September 1, 2011), if the loan is not repaid by September 1, 2013 (even if FA is no longer a FA of Canco on September 1, 2013), the exception in proposed paragraph 90(8)(a) will not apply and proposed subsection 90(6) will apply, such that Canco will have an income inclusion on September 1, 2011. On a positive note, Canco will be entitled to a deduction pursuant to proposed subsection 90(14) when the indebtedness is repaid.

In the other case, the coming into force provisions instruct us to apply proposed subsections 90(6) to (15) as if the loan was received or indebtedness was incurred on August 20, 2014. If FA is not a FA of Canco at the time the loan is considered to have been made, proposed subsection 90(6) will not apply to Canco. Thus, where prior to August 19, 2011 a FA of Canco made a loan to a "specified debtor" in respect of Canco, if Canco sells the shares of the FA on or before August 19, 2014, even if the loan is outstanding on August 20, 2016, Canco will not have an income inclusion pursuant to proposed subsection 90(6) on August 20, 2014 (because on August 20, 2014, FA is no longer a foreign affiliate of Canco). However, if the sale of the shares of FA takes place on or after August 20, 2014 and the loan remains outstanding on August 20, 2016, since proposed subsection 90(6) provides that the relationships between Canco, FA and the debtor are to be tested at the time the loan is received or the debt incurred (in this case, August 20, 2014), it will apply, such that Canco will have an income inclusion on August 20, 2014, notwithstanding that those relationships are no longer in place on August 20, 2016. Note that Canco will get a deduction pursuant to proposed subsection 90(14) when the indebtedness is repaid.

While the wording of the proposed legislation is clear, we question whether a proposed subsection 90(6) income inclusion is appropriate where the lending corporation is no longer a foreign affiliate at the time the two year time limit referred to in proposed paragraph 90(8)(a) is reached. If the issue arises in the context of a ruling request or a referral from a CRA auditor, we will consult with the Department of Finance on this issue with a view to potentially taking an administrative position to alleviate the apparent anomaly.

Question 5(c)

Will the CRA use its various positions on subsection 15(2) as a guide for administering proposed subsections 90(6) to (15)? In particular, would the position in paragraph 38 of Interpretation Bulletin IT 119R4 which provides administrative relief from interest and penalties in respect of the requirement to remit withholding tax on dividends deemed paid to non-residents (by virtue of the application of subsection 15(2) and paragraph 214(3)(a)) be applied in the context of a case where proposed subsection 90(6) applies retroactively to include a specified amount in the income of a taxpayer resident in Canada (such that no interest and penalties will be applied when a previously filed return is reassessed)?

Response 5(c)

The determination of the application of proposed subsections 90(6) to 90(15) to a given situation is a question of fact and will be determined on a case by case basis. However, the CRA will generally look to its practices on the application of subsection 15(2) to deal with practical issues involving the application of proposed subsections 90(6) to 90(15) to a given situation.

Proposed subsection 90(6) only applies to include a "specified amount" in the income of a taxpayer resident in Canada. Therefore, consistent with its practice in the context of the application of subsection 15(2) to Canadian resident debtors, the CRA will not provide administrative relief from interest and penalties in the context of the application of proposed subsection 90(6). Instead, the CRA will exercise its right to enforce the payment of interest and penalties (if applicable), for any tax not paid by the Canadian resident taxpayer, by the balance due date for the year in which proposed subsection 90(6) applies to include a "specified amount" in its income.

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 In accordance with their coming into force provisions.

Angelina Argento
2013-048379