May 1, 2018
###
Dear ###:
I am writing in response to your recent letter to, and subsequent discussions with, officials of the Tax Legislation Division concerning an issue you have identified in respect of the "upstream loan" rules in subsections 90(6) to (15) of the Income Tax Act (the "Act"). This issue arises in the context of impending refinancing transactions involving a Bermuda-resident foreign affiliate (“FA l") of your client, ### (“Canco”).
You have described the following financing structure involving FA 1 and other members of Canco's ###-parented group. FA 1 has made loans (the "FA 1 Loans") to ### (“Forco 1”), which, in turn, has made loans (the "Forco 1 Loans") to ### (“Forco 2"). Forco 1 and Forco 2 are specified debtors, as defined in subsection 90(15), in respect of Canco and are not foreign affiliates of Canco. The FA 1 Loans and the Forco 1 Loans are back-to-back loans described in subsection 90(7), with the result that, for the purposes of subsections 90(6) to (15), paragraph 90(7)(a) has deemed the Forco 1 Loans to have been made by FA 1 to Forco 2 (each a "Deemed Loan"), and paragraph 90(7)(b) has deemed each actual FA 1 Loan and Forco 1 Loan not to have been made.
For each taxation year in which a Deemed Loan has been deemed to be made, subsection 90(6) has applied to include a specified amount in respect of the Deemed Loan in Canco's income and Canco has claimed an offsetting deduction under subsection 90(9) in respect of FA 1's exempt surplus. In each subsequent year, the amount so deducted has been brought back into Canco's income under subsection 90(12) and another offsetting deduction has been claimed under subsection 90(9).
As part of the impending refinancing transactions, Forco I will repay the FA 1 Loans and FA 1 will use the proceeds of such repayments to make loans to another specified debtor in respect of Canco (the "FA 1-New Specified Debtor Loans").
You note that there are no provisions in the Act that provide, for the purposes of paragraph 90(8)(a) and subsection 90(14), for the repayment of a loan that is deemed to have been made under subsection 90(7). You are therefore concerned that the repayment of the FA 1 Loans as part of the refinancing transactions may not be considered to result in the repayment of the Deemed Loans. In that case, the repayment, combined with the subsequent redeployment of the proceeds in the FA 1-New Specified Debtor Loans, could result in a double income inclusion to Canco for the year, with subsection 90(12) applying to bring into income the amount claimed in the previous year as a deduction in respect of each Deemed Loan under subsection 90(9), and subsection 90(6) applying to bring the amount of each FA 1-New Specified Debtor Loan into Canco's income for the year. This would be an adverse result since FA 1 does not have sufficient exempt surplus to support a deduction by Canco under subsection 90(9) equal to the amount of the two income inclusions.
Our Comments
We agree that, in policy terms, the transactions described above ought not to give rise to two concurrent upstream loans, and two related income inclusions under the upstream loan rules. We are therefore prepared to recommend to the Minister of Finance that the Act be amended to introduce rules - similar to the deemed repayment rules in subsections 15(2.18) and (2.19) (which apply for the purposes of the back-to-back shareholder loan rules in subsections 15(2.16) and (2.17), but with such modifications as are required by the context of the upstream loan rules - that would deem all or a portion of a loan that is deemed to be made under subsection 90(7) to be repaid for the purposes of paragraph 90(8)(a) and subsection 90(14) if certain conditions are met.
These conditions would be similar to those in subsection 15(2.18). In general terms, a loan deemed to have been made under subsection 90(7) would be deemed to be repaid, in whole or in part, as a result of certain repayments, in whole or in part, of one or both of the loans between the "initial lender" and the "intermediate lender", and the "intermediate lender" and the "intended borrower" (as those terms are defined in subsection 90(7)).
As in the case of a deemed repayment under subsection 15(2.19), the determination whether a deemed repayment is part of a series of loans or other transactions or repayments for purposes of paragraph 90(8)(a) and subsection 90(14) would need to be made on a case-by-case basis, having regard to all of the facts and circumstances.
We will recommend that this proposed amendment apply to repayments occurring after April 10, 2018.
While we cannot offer any assurance that either the Minister of Finance or Parliament will agree with our recommendations in respect of this matter, we hope that this statement of our intentions is helpful.
Yours sincerely
Brian Ermewein
General Director - Legislation
Tax Policy Branch
