CRA rules on further cross-border technique for avoiding Canadian withholding (or U.S. tax) on internal leveraging of a subsidiary Canadian business

CRA has now ruled on a 4^th technique for a U.S. group to shelter Canadian business income with internal leverage while avoiding U.S. tax on interest income.  (For three others, see Cardarelli/Keenan.)

US Parent Co carries on a Canadian active business through a (virtually) wholly-owned Canadian LP which has elected to be a corporation for Code purposes.  It will transfer its LP units to a wholly-owned U.S. sub (US Sub) for an interest-bearing promissory note and shares of US Sub.

CRA ruled that the interest on the note (which domestically would be sourced to Canada under s. 212(13.2)) will be Treaty-exempt.  Presumably, US Sub will be able to deduct that interest for Canadian purposes subject to the thin cap rules (and not be subject to current U.S. tax on the LP’s earnings), whereas the interest will not be subject to U.S. tax in the hands of US Parent Co as it and US Sub will file a U.S. consolidated return.

Neal Armstrong.  Summary of 2014 Ruling 2014-0521831R3 under Treaties, Art. 11.