The requirement to repay an upstream loan, and the effect of a blocking deficit in a top-tier FA, can result in anomalous income inclusions

The only permanent way of eliminating an upstream loan made by FA, the non-resident subsidiary of Canco, is repaying it. Other situations in which it would be appropriate to offset the income inclusion to Canco under s. 90(6) are not addressed, for example:

• Canco sells FA, which has made a loan to Canco’s non-resident parent, to that parent (so that the loan proceeds effectively have been repatriated to Canco on a taxable basis);
• FA sells the loan (without novation) to a Canadian subsidiary of Canco; and
• Canco acquires all the shares of its non-resident sister to which FA had made the loan, so that the loan is now owing between two controlled foreign affiliates of Canco.

The notional deduction for pre-acquisition surplus dividends under s. 90(9)(a)(i)(D) is limited to the adjusted cost base of Canco’s shares in FA, so that there is no ability to create a negative ACB gain under s. 40(3) that can then be eliminated through a s. 93(1) election so as to access exempt surplus of a non-resident subsidiary of FA. Accordingly, a small exempt deficit in FA, the top-tier foreign affiliate, may result in an income inclusion under the upstream loan rules even in situations where a series of dividends could have been paid free of Canadian tax due to large exempt surplus balances lower in the chain. Furthermore, the deficit can have the same blocking effect on multiple upstream loans.

Neal Armstrong. Summaries of Ian Bradley, Marianne Thompson, and Ken J. Buttenham, "Recommended Amendments to the Upstream Loan Rules", Canadian Tax Journal, (2015) 63:1, 245-67 under s. 90(14) and s. 90(9).