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 foreign affiliate's income from the development of real estate was subject to subparagraph 95(2)(a)(i).
Position: NO
Reasons: The test in clause 95(2)(a)(i)(B) was not satisfied.
October 26, 2000
Vancouver Tax Services Office Income Tax Rulings Directorate
Olli Laurikainen
(613) 957-2116
Attention: Peter Ling
International Tax
2000-004438
XXXXXXXXXX
This is in response to your memorandum wherein you request our comments in reference to the tax implications of the foreign affiliate structure adopted by the above taxpayer to conduct its land development operations in the United States.
You provide the following facts.
1. XXXXXXXXXX ("Canco") is a corporation resident in Canada.
2. XXXXXXXXXX ("USCO") is a controlled foreign affiliate of Canco resident in the United States.
3. USCO has several wholly-owned subsidiaries (Landcos) resident in the United States. ach of the Landcos holds a parcel of land for the purpose of development. None of the Landcos has any employees.
4. USCO has XXXXXXXXXX employees throughout the period in question. Such employees provide managerial, administrative, financial, maintenance, and other services to each of the Landcos. The services enable the Landcos to acquire raw, undeveloped land, make rezoning applications for development, subdivide the property, fully service the property by putting in place utility connections such as water, sewage, hydro, gas, telephone and build roads so as to provide fully serviced lots available for sale individually or en bloc to building contractors. Management fees are charged by USCO to recoup its cost of providing the services to the Landcos.
5. No land is held by USCO for development on its own behalf.
Based on the above facts it would appear that USCO carries on an active management service business and the income that it derives from management fees charged to the Landcos would qualify as income from an active business for the purposes of the definition in subsection 95(1) of the Act.
On the other hand, it would appear that the Landcos carry on a business described in the preamble to the "investment business" definition in subsection 95(1) of the Act. Accordingly, the income of each such Landco would be foreign accrual property income ("FAPI") unless the taxpayer is able to establish that the conditions set out in paragraphs a) and b) of the exclusion to that definition are met or subparagraph 95(2)(a)(i) of the Act applies.
Provided the developed land is sold by the Landcos to arm's length persons it would appear that the condition in paragraph a) of the "investment business" definition is met because the business of each Landco is the development of real estate for sale. However, paragraph b) of the exclusion to the investment definition is satisfied only if the taxpayer is able to establish that the particular Landco employed the equivalent of more than 5 employees full-time in the active conduct of its business throughout the period in question taking into consideration the services provided by the employees of USCO. In this respect, it would be insufficient to demonstrate that the activities of a particular Landco required the equivalent of, for example, six employees during a short time period of time and only the equivalent of two employees full-time for the remainder of the period in question. It must be demonstrated that more than 5 full-time employee equivalents were employed throughout the period in question.
If the taxpayer cannot establish that a particular Landco qualifies for exclusion from the investment business definition, its income would be income from property (i.e. FAPI) unless subparagraph 95(2)(a)(i) of the Act applies. In applying subparagraph 95(2)(a)(i), the activities of each of the affiliates would be considered individually to determine whether the two conditions therein have been satisfied.
The Technical Notes provided by the Department of Finance contemplate the application of subparagraph 95(2)(a)(i) in two categories of situations. One category is where the business activities of the two corporations constitute a single foreign active business and the second category is where the assets of one of the corporations are at risk in the active business of the other. The business arrangement hereunder consideration more close resembles the first category. However, as is illustrated by the examples provided by the Department of Finance in its Technical Notes, it is insufficient that an argument may be made that the activities of the group made up of USCO and all of the Landcos together could be considered one active business. The examples in the Technical Notes, contemplate situations where the businesses of the two corporations are the same (e.g. both in land development business) except that the volume of activity in one of the two corporations is insufficient to require the services of the equivalent of more than 5 employees full-time. The examples do not contemplate a case where the activities of one corporation comprise a management service business while the activities of the other comprise a different business (e.g. land development business). Moreover, the words of subparagraph 95(2)(a)(i) of the Act direct that the tests be applied to each Landco individually as opposed to viewing the activities of the group as a whole.
In order for the income from the activities of a particular Landco to reasonably be considered directly related to the active business activities carried on by USCO, the activities of USCO must be of such importance to the activities of the Landco in question that the Landco's activities would not have taken place were it not for the activities of USCO. In the above case, it would appear that the activities of USCO are critical to the profitability of each Landco and the activities of each Landco would for that reason be considered as being "directly related" to the activities of USCO for the purposes of the test in clause 95(2)(a)(i)(A) of the Act. However, the second test in 95(2)(a)(i)(B) of the Act requires that the income of the Landco would be active business income if it were earned by USCO. In this case, USCO is carrying on an active business comprised of providing management services to the Landcos. Therefore if the investment business income of one of the Landcos was earned by USCO, it would be considered to be derived from a separate business (i.e. investment business) apart from its management service business and would not qualify as active business income of USCO and the test in clause 95(2)(a)(i)(B) would not be satisfied. Accordingly, the income earned by each of the Landcos would not qualify as income from an active business as a result of the operation of subparagraph 95(2)(a)(i) of the Act.
We hope that the above clarifies our views concerning the operation of the foreign affiliate provisions to the above case.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the CCRA's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (819) 994-2898. The severed copy will be sent to you for delivery to the client.
for Director
Reorganizations and International Division
Rulings Directorate
Policy and Legislation Branch
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