5 September 2002 External T.I. 2000-0007425 - FAPI - Swedish Group contribution; Merger

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 CCRA.

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

Principal Issues:

(1) Whether clause 95(2)(a)(ii)(D) will apply on the given fact scenario where an income transfer payment as made by one Swedish foreign affiliate to another Swedish foreign affiliate in an amount that is equal to the amount of loss in the latter affiliate?

(2) Assuming there is no income transfer payment and the foreign affiliates merged part way through the year, whether (a) on the given fact scenario and with regard to Swedish income tax law, clause 95(2)(a)(ii)(D) could apply for the first half of the year; or (b) clause 95(2)(a)(ii)(B) could apply to the whole year?

Position: (1) No (2)(a) Yes; (b) No but to latter part of the year.

Reasons: (1) There is no "group" created in the case where there must be a tax deductible payment; (2)(a) under Swedish income tax law, a group exists from the beginning of the merger year so clause 95(2)(a)(ii)(D) can apply; (b) after the merger, clause 95(2)(a)(ii)(B) will apply to payments made by FA3.

XXXXXXXXXX 	2000-000742
		Suzanie Chua
September 5, 2002

Dear XXXXXXXXXX:

Re: FAPI Aspects of Swedish Group Contribution

This is in reply to your letter regarding FAPI implications of contributions made by one Swedish foreign affiliate to another Swedish foreign affiliate that in part requested further clarification of our technical interpretation (Document 981005) to a similar income transfer payment between two Swedish foreign affiliates.

The hypothetical facts you outlined are as follows:

1. Canco is a Canadian corporation that owns a 100% interest in a foreign affiliate resident in a designated treaty country, FA1;

2. FA1 owns a 100% interest in FA2, a corporation resident in Sweden;

3. FA2 owns a 100% interest in FA3, a corporation resident in Sweden;

4. FA1 made loans in year 1 to FA2 and the money was used by FA2 to purchase shares of FA3;

5. FA3's assets consist solely of related company receivables the interest on which qualifies for re-characterization to active business income pursuant to subparagraph 95(2)(a)(ii). No active or any other business is conducted by FA3;

6. Under Swedish income tax law, FA3 is entitled to make a tax deductible contribution of assets to FA2 in order to achieve a form of tax consolidation. This payment would be treated as an income inclusion in FA2 and an expense deduction in FA3. Such a payment is made in year 1;

7. Part way through year 2, FA2 and FA3 merge under Swedish law with FA3 as the surviving corporation. For Swedish income tax purposes but not for corporate law purposes, the merger is deemed to have occurred at the beginning of year 2.

The questions you request our interpretation of the provisions of the Income Tax Act (the "Act") are:

A. Assuming that an income transfer payment equal to the amount of the loss in FA2 is made by FA3 to FA2 in year 1, whether clause 95(2)(a)(ii)(D) would apply to re-characterize the interest income of FA1 as active business income?

B. Assuming no income transfer payment is made in year 2, in determining whether the interest income of FA1 will be re-characterized as active business income, whether clause 95(2)(a)(ii)(D) would apply for the part of the year preceding the merger? Or will clause 95(2)(a)(ii)(B) apply for the whole year in the year of merger?

You have stated that the hypothetical facts you have outlined are distinguishable from the hypothetical facts in Document 981005 because FA3 is not carrying on an active business such that Swedish income tax concepts of expense deductibility would not be relevant in determining whether FA2's income from the transfer payment would be deemed active business income. Therefore, you consider that clause 95(2)(a)(ii)(B) cannot apply to your hypothetical facts. Rather, with respect to Question A above, you say that clause 95(2)(a)(ii)(D) is intended to deal with all forms of loss consolidation regimes in foreign countries and that there are three general types of such regimes: first, fiscal unity or consolidation as in France and the U.S.; group relief as in Ireland and the UK; group consolidation as in Sweden and Norway. You have referred to fiscal unity and group relief regimes as transferring income and losses on notional basis only and contrasted group contribution regimes as that which effects income transfers through actual payments. However, you say that an amount paid by any member of the foreign group is relevant in computing the foreign income tax of the group members on an overall basis as required by subclause 95(2)(a)(ii)(D)(V) since deduction for that amount can be used to reduce the taxable income of any member of the group, in an indirect manner, depending on which one has income for the relevant year. Therefore, you argue that clause 95(2)(a)(ii)(D) would apply to re-characterize the interest received by FA1 from FA2.

With respect to Question B above, you say a two-part analysis is appropriate: one in respect of the period before the time of the merger and then for the period after the merger. You also say that for the part of the year prior to the merger, clause 95(2)(a)(ii)(D) would apply because the interest paid by FA2 would be relevant in computing the foreign tax liability of the group consisting of FA2 and FA3 because Swedish tax law effectively consolidates the two entities into one. You also say that the interest received by FA1 in the second part of the year should qualify under clause 95(2)(a)(ii)(B) on the assumption that interest paid by FA3 (i.e. the corporation surviving the merger) is deductible from its deemed active business income that is derived from interest paid by other foreign affiliates of Canco in which Canco has a qualifying interest throughout the year which is deductible from amounts prescribed to be their earnings or loss from an active business.

Comments

The situation outlined in your letter appears to involve actual proposed transactions and identifiable taxpayers and, therefore, should be the subject of an advance income tax ruling. Confirmation as to the income tax consequences of proposed transactions will only be given in the context of an advance income tax ruling. The procedures for making a request for an advance income tax ruling are outlined in Information Circular 70-6R5, dated May 17, 2002, issued by Canada Customs and Revenue Agency. We can, however, offer the following general comments.

With respect to the application of clause 95(2)(a)(ii)(D) in your question A, in our opinion, that clause cannot apply to your hypothetical situation because FA3 and FA2 were not part of a "group" within the meaning of subclause 95(2)(a)(ii)(D)(V) because Swedish law does not allow these corporations to actually combine their operational results. Instead, a payment must be made to effect the income transfer and then as you say, FA2 reports for Swedish tax, an income inclusion in respect of such payment while FA3 reports an expense deduction. In our view, in such case the interest paid by FA2 to FA1 is relevant in computing the liability for income taxes of only FA2.

We agree with your statement that in the context of question A, clause 95(2)(a)(ii)(B) cannot apply. Our reasons are as follows: FA3 has deemed active business income through the re-characterization provisions of paragraph 95(2)(a). The reference to "income" in the preamble to paragraph 95(2)(a) is "income" as determined under the provisions of the Act. As the income of FA2 is derived from a payment made by FA3 whose income is deemed to be income from an active business by subparagraph 95(2)(a)(ii), the determination of whether clause 95(2)(a)(ii)(B) applies to the income of FA2 requires one to consider whether the income transfer payment made by FA3 to FA2 would be "deductible" in computing the income of FA3 under the provisions of the Act. Therefore, Canadian income tax law applies to determine the nature of the "contribution of assets" i.e. income transfer payment made by FA3 to FA2, as stated in your hypothetical facts. In our view, this payment would constitute shareholder appropriation under Canadian rules and would be income from property in the hands of FA2. However, these payments would not be "deductible in the year or a subsequent taxation year" by FA3 in computing the amounts prescribed to be its earnings or loss from an active business, within the meaning of clause 95(2)(a)(ii)(B). Therefore, this amount would not be re-characterized as active business income in the hands of FA2.

It follows then that clause 95(2)(a)(ii)(B) would not apply to re-characterize the interest income of FA1 derived from payments by FA2 as income from an active business.

With respect to question B, a split year analysis is appropriate in the circumstances you described. For the purposes of the Act, following Swedish corporate law FA2 is considered to exist and be the payer of the interest payments to FA1 until the time of the merger. On the other hand you state that Swedish tax law, allows the income of FA2 and FA3 to be reported by FA3, i.e. the surviving corporation post-merger, from the commencement of the year in which the merger occurred. It would appear from these hypothetical facts that the requirements of clause 95(2)(a)(ii)(D) would be fulfilled in respect of interest paid by FA2 to FA1 prior to the merger in year 2. However, we would only consider clause 95(2)(a)(ii)(D) to apply to the first part of year 2 up to the time immediately before the merger because on the merger, FA2 would cease to exist. Thereafter, FA3 would be making interest payments to FA1. Based on your hypothetical facts, the interest income earned by FA1 would be re-characterized as active business income pursuant to clause 95(2)(a)(ii)(B) provided the payments from which the income is derived are "deductible in the year or subsequent taxation year" by FA3 in computing the amounts prescribed to be its "earnings" or "loss" within the meaning of Regulation 5907(1).

We trust these comments will be of assistance.

Yours truly,

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