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 business conducted with depositors, by a foreign affiliate which is carrying on a banking business, is relevant in the determination of whether the business is conducted principally with persons with whom the affiliate does not deal at arm's length for the purposes of the investment business definition in subsection 95(1).
Position: Such business is relevant in the determination.
Reasons: Unlike in most other businesses, in the banking business, persons who lend money to the bank (i.e. the depositors) are clients of the bank to whom services are provided.
XXXXXXXXXX 2000-000656
Olli Laurikainen
Attention: XXXXXXXXXX
June 22, 2000
Dear Sirs:
Re: Subsection 95(1) of the Income Tax Act (the "Act") - Definition of "Investment Business"
This is in reply to your letter dated February 7, 2000 and subsequent correspondence wherein you request our views in reference to whether a hypothetical business falls under the definition of "investment business" in subsection 95(1) of Act. You provide the following hypothetical facts.
1) A Canadian bank ("Bank") owns all of the shares of a foreign affiliate ("FA").
2) FA is incorporated and resident in a country other than Canada. FA carries on certain foreign banking business operations which are all carried on outside Canada.
3) In the course of its banking business, FA solicits, accepts and administers deposits from third-party clients (the "Arm's Length Depositors") and invests the proceeds from the deposits in the inter-bank market and in non-arm's length loans. It also manages foreign exchange positions with respect to client accounts. FA's total liabilities and equity are comprised mainly of the $3 billion in private banking deposits belonging to Arm's Length Depositors which are serviced and administered by more than 60 employees who are resident in the country in which the foreign affiliate is incorporated and is carrying on business. FA also has $500 million of deposits from other controlled foreign affiliates of Bank and a small amount of other liabilities. FA's shareholder's equity is $100 million.
4) On the asset side, FA has $3 billion invested in the inter-bank market and on loan to other controlled foreign affiliates of Bank. The balance of the $600 million of assets are invested in certificates of deposit. FA has 3 employees administering its non-arm's length loans.
You request our view whether the banking business of FA could be considered to be a business conducted principally with arm's length persons notwithstanding that from time to time more than half of its assets may be invested in loans to non-arm's length persons. You suggest that it would be appropriate to do so on the basis of the volume of business which is conducted with the Arm's Length Depositors.
Our Views
We have previously taken the position that the criteria set out in paragraph 2 of Interpretation Bulletin IT-290 and paragraph 7 of Interpretation Bulletin IT-371 issued by the Canada Customs and Revenue Agency which deal with the determination of whether a particular business is the taxpayer's "principal business", would generally also be relevant in making the determination of whether a business is conducted principally with persons with whom the affiliate does not deal at arm's length. The criteria that are referred to in those interpretation bulletins are directed at measuring sources of income, employee time and effort and assets used in each business and no indication is given whether or how the amount of the debt or equity or the amount of time that is spent by employees administering debt or equity associated with a business would be relevant.
We would maintain that the criteria in the above referenced interpretation bulletins are in most cases, a complete set of relevant criteria in the determination of whether a business is conducted principally with persons with whom the affiliate does not deal at arm's length and the source of a corporation's debt and equity financing would generally not be material to that determination. This is so because we consider business generally to be conducted with business clients and business clients are generally persons for whom services are performed or to whom products are sold in exchange for monetary consideration. A person who invests funds in the shares of a corporation or loans funds to the corporation is generally not considered a client of the corporation's business. However, the banking business is unlike most other businesses. In the banking business, banking services are performed for certain clients for a fee but a bank's business clients also include persons who have loaned money to the bank (e.g. by way of a deposit) where contact with such clients only contributes to the expense side of the income statement. Services performed for these clients reduce the cost of debt financing obtained in this fashion and contribute to the overall profitability of the business not unlike services performed in exchange for a fee.
Therefore we are of the view that in the banking business, business conducted with depositors would be very relevant in the determination of whether the business was conducted principally with persons with whom the affiliate does not deal at arm's length. Once it is accepted that such business is relevant in the determination, the tests using the criteria listed in the bulletins would have to be adjusted in order to make the determination in reference to a banking business. For example, employee time, attention and effort would be a very relevant criterion because employees would be engaged in providing services to all of the clientele of a banking business. On the other hand, profit would be a less reliable criterion if the test only measured the business conducted with clients who borrow money and not the business conducted with clients who lend money to the bank.
While we are prepared to concede that business conducted by a bank with its depositors is very relevant in the determination of whether the bank's business is conducted principally with persons with whom the bank does not deal at arm's length, we are not prepared to come to a definitive conclusion on the basis of facts provided in a technical interpretation request. The determination of whether a business is conducted principally with which persons with whom the affiliate does not deal at arm's length is one of fact to be made by an examination and analysis of all the facts of a particular case concerning both the business conducted with arm's length clients and non-arm's length clients. It is not possible to make such determination in the context of a technical interpretation request.
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.
Yours truly,
for Director
Reorganizations and International Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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