9 January 2001 External T.I. 1999-0011405 - foreign affiliates - deemed active

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Whether income derived by a controlled foreign affiliate from trade receivables purchased from a related controlled foreign affiliate would be included in its income from active business pursuant to paragraph 95(2)(a).

Position: Paragraph 95(2)(a) would apply to the income.

Reasons: All of the income of the foreign affiliate is income described in one of subparagraphs 95(2)(a)(i), (iii) or (iv) of the Act.

XXXXXXXXXX  							1999-001140
								Olli Laurikainen
Attention:  XXXXXXXXXX 

January 9, 2001

Dear Sirs:

Re: Paragraph 95(2)(a) of the Income Tax Act (the "Act")

This is in reply to your letter wherein you request our views concerning the application of paragraph 95(2)(a) of the Act to the following hypothetical arrangement.

1) Canco is a taxable Canadian corporation.

2) Each of FA1 and FA2 is a wholly-owned foreign affiliate of Canco.

3) FA1 carries on an equipment manufacturing business in a country other than Canada which is an active business.

4) In the course of carrying on its active manufacturing business, FA1 sells equipment to arm's length third parties on terms which give rise to two main types of indebtedness - namely indebtedness on which payment is due within 60 days, with no interest payable in the interim (the "non-interest bearing debts") and indebtedness on which payment is due within one year with interest payable at market rates on the outstanding balance unless the indebtedness is settled within 30 days (the "interest-bearing debts). Any interest earned by FA1 on the interest-bearing debts would be included in computing the amount prescribed to be its earnings or loss from an active business carried on in a country other than Canada if such debts were held by it until they were settled.

5) FA2 carries on a business which is an "investment business" as defined in subsection 95(1) of the Act.

6) In the course of carrying on its business, FA2 acquires from FA1 the debts described in paragraph 4 above, and holds them until they are settled. FA2 acquires these debts at discounts from their face amounts which are determined in accordance with arm's length principles. In particular, the discounts on the interest-bearing debts are lower than the discounts on the non-interest-bearing debts reflecting the fact that the former generally (i.e. unless settled within 30 days) bear interest at market rates. Thus, in the course of its business, FA2 derives income from holding the debts in the form of interest income and discounts in respect thereof. The transactions between FA1 and FA2 constitute true sales of the debts and not some form of lending from FA2 to FA1. FA2 acquires no debts or other properties in the course of its business other than the debts which it acquires from FA1.

You request our view whether the provisions of paragraph 95(2)(a) of the Act would recharacterize the income of FA2 as income from an active business.

Our Comments

In the hypothetical case described above it would appear that the income earned by FA2 on the non-interest bearing debts purchased by FA2 from FA1 at a discount would be income derived from factoring of trade accounts receivable described in subparagraph 95(2)(a)(iii) of the Act. The income derived from the interest-bearing debts purchased by FA2 from FA1 would not be from factoring of trade accounts receivable since it would appear to be, all or substantially all, interest income. It is not clear that such interest would be income described in subparagraph 95(2)(a)(iv) of the Act because the facts provided are insufficient for us to determine whether the interest-bearing debts would be "lending assets" for the purposes of that provision. In particular, the concern would be whether such debts are prescribed property for the purposes of the definition of "lending assets" in subsection 248(1) of the Act and paragraph 6902(b) of the Regulations.

In the event that the income of FA2 derived from the interest-bearing debts fell outside subparagraph 95(2)(a)(iv) of the Act, it is our view that in the above circumstances it would nevertheless be income described in subparagraph 95(2)(a)(i) of the Act. Accordingly, the income derived by FA2 from both the non-interest-bearing debts and the interest-bearing debts would be included in FA2's income from an active business pursuant to the application of paragraph 95(2)(a) of the Act.

The foregoing comments are given in accordance with the practice referred to in paragraph 22 of information Circular 70-6R3 and are not binding on the Canada Customs and Revenue Agency.

We hope that the above is of assistance to you.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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