CRA confirms that where a partnership with FA1 as a 40% partner pays interest to FA2, only 40% of the interest can be recharacterized as active under s. 95(2)(a)(ii)(B)(II)
Canco wholly-owns two non-resident corporations (“FA1” and “FALuxco”). FA1 is the 40% partner of “MLP,” whose other non-resident partners are not FAs of Canco. MLP borrows $200M from FALuxco, bearing interest of $10M per annum, for use in its active U.S. business.
CRA found that only 40% of the $10M interest received by FALuxco should be recharacterized as income from an active business under s. 95(2)(a)(ii)(B)(II) (resulting in FALuxco having FAPI of $6M - because only $4M of interest would be deductible in computing FA1’s earnings). CRA stated that from a policy perspective:
[S]ince a partnership is treated as a flow-through for Canadian tax purposes, for the purpose of subclause 95(2)(a)(ii)(B)(II) the interest paid by a partnership should be viewed as interest paid proportionately by each of its members. [Accordingly] to the extent that a portion of the interest paid to FALuxco by MLP is considered to be paid by a member that is not described in subclause 95(2)(a)(ii)(B)(I) [i.e., the non-FA members of MLP], that portion should not be recharacterized as income from an active business since it would not be so recharacterized if it had been paid directly by that member.
Neal Armstrong. Summary of 31 August 2017 Internal T.I. 2016-0680801I7 under s. 95(2)(a)(ii)(B)(II).