In light of the current-use test, borrowed money used to acquire shares that were not excluded property could satisfy s. 95(2)(a)(ii)(D)

FA Finco (a foreign affiliate of Canadian Parent) lends to FA Holdco (a Delaware subsidiary of Canadian Parent), which uses the borrowed money to acquire all of the shares of FA Target, which are not excluded property. FA Target is merged into FA Opco (wholly-owned by FA Holdco), so that FA Holdco receives shares of the merged corporation (Mergeco), replacing its shares of FA Target and FA Opco. After the merger, substantially all of the property of Mergeco is excluded property.

Is the interest on the loan recharacterized under s. 95(2)(a)(ii)(D) as active business income? The focus of the query was on s. 95(2)(a)(ii)(D)(I), which requires that such interest be payable “under a legal obligation to pay interest on borrowed money used for the purpose of earning income from property.” CRA indicated that the current use test established under s. 20(1)(c) was relevant in this context – and that, under this test, there was a reasonable argument that the current use of borrowed money was linked to the Mergeco shares and that, to the extent that there was a reasonable expectation that FA Holdco would receive dividends on those shares, the use test would be met after the merger.

An additional requirement under s. 95(2)(a)(ii)(D)(III) is that the property referenced under the current use test in s. 95(2)(a)(ii)(D)(I) is excluded property. Although CRA was not asked about this, it did not challenge the proposition that this test could be satisfied post-merger by the Mergeco shares even though the shares acquired with the borrowed money were not excluded property (presumably FA Target was small relative to FA Opco).

Neal Armstrong. Summaries of 25 November 2021 CTF Roundtable, Q.15 under s. 95(2)(a)(ii)(D)(I) and s. 95(2)(a)(ii)(B).