Application to cash-pooling arrangements (p. 755)
…In practice, it may be challenging for taxpayers and the CRA to determine the correct application of the upstream loan rules when cash-positive foreign affiliates are members of a cash pool that also includes specified debtors. [fn 23: There may not be any ultimate income inclusion under these rules if one of the exceptions in subsection 90(8) applies or if a full deduction can be claimed under subsection 90(9); however, where an upstream loan exists, the potential application of these relieving provisions will have to be considered.] Owing to the nature of cash pool arrangements, not only is it difficult to determine whether an upstream loan exists, but it can also be difficult to track repayments (and maintain that they are not part of a series of loans or other transactions and repayments), as well as to determine when a "new" upstream loan is made.
Series of loans and repayments (pp. 759-760)
…[After discussing Meeuse v. The Queen, 94 DTC 1397 (TCC)] …On balance, the case law suggests that for transactions to constitute a series, they require a common purpose.
Thus, the CRA seems to agree that a repayment of a loan made for a specific identifiable purpose followed shortly by another loan made for a different specific identifiable purpose should not be considered to be part of a series. Conversely, the CRA seems to be of the view that repayments made in the course of a series of upstream loans for on-specific reasons and repayments that are clearly of a temporary nature should be treated as being part of a series. [fn 42: CRA document no. 9219115, October 5, 1992… .]
…In Attis v. MNR [fn 43: 92 DTC 1128 (TCC)] and Hill v. MNR, [fn 44: 93 DTC 148 (TCC)] the Tax Court of Canada dealt with the situation where shareholders received loans from their respective corporations during a year, which were later repaid in whole or in part by the declaration of dividends or bonuses….
In Income Tax Technical News (ITTN) no. 3, the CRA confirmed that, consistent with these cases, bona fide repayments of shareholder loans that are the result of the declaration of dividends, salaries, or bonuses should not be considered to be part of a series of loans or other transactions and repayments. […see [also] 2010-0382431E5, January 20, 2011, and 2008-0267271E5, April 16, 2009.]
Relationships tested when upstream loan arose (pp. 761-2)
The application of subsection 90(6) and other upstream loan rules is based on the relationships and tax attributes that exist at the time an upstream loan arises, with no reference to, or relief provided for, any subsequent changes in relationships. This becomes an issue if, for example, foreign affiliates of a Canadian taxpayer are disposed of to a foreign parent company during the first two years after an upstream loan arises (and before its repayment), or if a specified debtor ceases to be a specified debtor (in situations where the specified debtor is not the Canadian taxpayer or a non-arms' length Canadian entity) prior to a repayment. [fn 48: The latter situation may be less likely to arise, because upstream loans are likely to be repaid prior to a third-party sale of the specified debtor or the upstream loan may be purchased by the acquirer. The sale of an upstream loan to a third party does not seem to meet the repayment requirement under the upstream loan rules.]
Uncertainties under s. 90(9) (p. 763)
The operation of subsection 90(9) raises a host of unanswered questions and is probably what will create the most uncertainty as taxpayers apply the rules. This uncertainty stems from a lack of clarity concerning the relationship between the rules applicable to a notional dividend and the basic distribution rules that apply to actual dividends.
The two sets of rules will often give different results. For example, subsection 90(11) considers the net surplus of the creditor affiliate for the purposes of the notional dividend to include the net surplus of all lower-tier affiliates. That is not the case for actual dividends. On the other hand, a deduction is available under paragraph 113(1)(a.1) in respect of the hybrid surplus component of an actual dividend whether there is any associated hybrid UFT or not. With respect to the notional dividend, a deduction is permitted only if there is sufficient hybrid UFT to result in the hybrid surplus dividend being fully sheltered. [fn 51: See clause 90(9)(a)(i)(B).] Yet another difference relates to the deduction under subsection 91(5) for previously taxed FAPI. This is available in respect of a notional dividend only if the specified debtor is a non-resident. [fn 52: See subparagraph 90(9)(a)(ii). At the 2013 IFA seminar, the CRA was asked to comment on whether a reserve would be available under subsection 90(9) in respect of previously taxed FAPI if Canco were the specified debtor; the CRA said that it may be prepared to develop an administrative position that an election can be made to change the ordering so that the notional dividend is considered to be a distribution coming out of preacquisition surplus.]
There are many other situations that the upstream loan rules do not address. The question for taxpayers in these cases is whether the normal distribution provisions can be relied on or not. The following paragraphs touch briefly on four of the more pressing questions.
Is 90-day rule available under s. 90(9)? (p. 764)
Assume that a foreign affiliate (FA) makes an upstream loan of $1,000 when it has no net surplus. Further assume that the loan was advanced more than 90 days from the beginning of FA's taxation year and that FA earns net exempt earnings of $1,000 in that taxation year. The 90-day rule in regulation 5901(2) will apply to characterize an actual dividend as being paid from FA's exempt surplus, making a full deduction available under paragraph 113(1)(a). However, it is not clear that a similar result arises under subsection 90(9). Clause 90(9)(a)(i)(A) refers to the exempt surplus of the affiliate in respect of the taxpayer at the lending time. [fn 53: Comparable language in respect of hybrid, taxable, and preacquisition surpluses is contained in clauses 90(9)(a)(i)(B), (C) and (D), respectively.] At the lending time, there is no exempt surplus balance, unless the provision is read expansively to incorporate the operation of the 90-day rule.
Are notional dividend elections available under s. 90(9)? (p. 764)
The Act includes a number of elections that provide taxpayers with considerable flexibility in managing the consequences of actual dividends, including the following:
- the election in regulation 5900(2) that deems a dividend to be paid from taxable surplus ahead of exempt surplus;
- the election in regulation 5901(1.1) that deems a dividend to be paid from taxable surplus ahead of hybrid surplus;
- the preacquisition surplus election in regulation 5901(2)(b) that deems a dividend to be paid from preacquisition surplus; and
- the disproportionate election in respect of UFT under paragraph (b) of the definition of "underlying foreign tax applicable" in regulation 5907(1).
The question for taxpayers is whether these elections are available to them as notional elections when assessing the deductions available under subsection 90(9) in respect of notional dividends. Subsection 90(9) does not address this question. However, the October 2012 explanatory notes make it clear that the Department of Finance intended that the disproportionate election be taken into consideration when determining the hypothetical deduction under paragraph 113(1)(b).
Is upstream surplus available to lending affiliate under s. 90(9) and are s. 40(3) gains beneath the taxpayer relevant? (pp. 765-766)
Assume that Canco owns 100 percent of the shares of FA 1, and FA 1 owns 100 percent of the shares of FA 2. FA 2 makes a loan to Canco of $1,000 when FA 1 has a net exempt surplus balance of $750 and FA 2 has nil net surplus. Also assume that the ACB of FA 1 in the shares of FA 2 is nil.
If FA 2 were to pay an actual dividend of $1,000 up the chain to Canco, FA 1 would experience a gain of the same amount pursuant to subsection 40(3). This gain would have surplus consequences for FA 1 that would depend on whether the shares of FA 2 were excluded property or not. Those surplus consequences could also affect the character of future dividends received by Canco.
This example raises two questions:
- Is surplus upstream of the lending affiliate available for the purposes of subsection 90(9)?
- Are downstream subsection 49(3) gains ignored for the purposes of subsection 90(9)?
On the basis of the examples in the October 2012 explanatory notes, the answer to both questions appears to be yes.
…In example 1 in the explanatory notes, FA 2 does not have sufficient surplus to support a hypothetical dividend of $800. A portion of the dividend hypothetically paid to FA 1 in that example would be from preacquisition surplus. The example also states that there is no ACB in the shares of FA 2. Consequently, an application of the entire foreign affiliate regime when assessing the implications of this hypothetical dividend would result in subsection 40(3) gain to FA 1. The example does not address that possibility, but concerns itself only with the movement of surplus from affiliate to affiliate. On the basis of this example, ACB appears to be relevant only when the notional dividend is paid from a top-tier affiliate to a taxpayer, at which point a notional deduction under paragraph 113(1)(d) becomes a consideration.
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