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: Loan to non-resident to fund return of capital, whether exception in clause 17(8)(a)(i)(A) applies.
Reasons: Loan used to fund return of capital, not used in active business income.
October 23, 2001
Re: Section 17 of the Income Tax Act
This is in reply to your letter of December 6, 2000, wherein you requested our views as to the application of clause 17(8)(a)(i)(A) of the Income Tax Act (the "Act") to the following hypothetical transactions:
1. Canco is a taxable Canadian corporation resident in Canada.
2. Canco owns all but one share of a controlled foreign affiliate ("CFA") as that expression is defined in subsection 17(15) of the Act. CFA carries on active business in the country in which it is resident. One share of CFA is owned by the parent of Canco, also a resident of Canada.
3. The issued and outstanding shares of CFA are common shares with a paid-up capital that is greater than their fair market value. Canco's adjusted cost base of the shares of CFA also exceed their fair market value.
4. The paid-up capital of CFA has been used by it to earn income from an active business, as defined in subsection 95(1) of the Act.
5. CFA does not currently have accumulated profits but has realized losses.
6. Canco will make a non-interest bearing loan to CFA.
7. CFA will use the proceeds received from Canco to fund a return of capital either by redeeming a certain number of issued shares or by reducing the paid-up capital of issued shares.
8. The purpose of converting equity investment into debt investment is related to the tax laws of the country in which CFA is resident.
You state that there is a view that subsection 17(1) could apply in these circumstances to impute interest income to Canco on the amount owing by CFA, unless one of the exceptions in section 17 is applicable, in particular the exception in clause 17(8)(a)(i)(A). You state a view that clause 17(8)(a)(i)(A) is applicable to your facts. This is because although the loaned funds would be used to reduce capital, it would be considered to be used for the purpose of earning income from an active business as replacement for funds that were used for the purpose of earning income from an active business. You state a view that clause 17(8)(a)(i)(A) is applicable where the loan amount does not exceed accounting capital. You further draw an analogy to CCRA's position regarding the application of paragraph 20(1)(c) to funds borrowed by the company to reduce capital, redeem shares or pay a dividend, following the decision in Trans-Prairie Pipelines Ltd. v. Minister of National Revenue 70 DTC 6351 (Exch. Ct.). You state that Technical Interpretation 9931735 is contrary to our position regarding the application of paragraph 20(1)(c) as described.
Based on the limited information you have provided to us, it is our view that subsection 17(1) is applicable in this case. It is also our view that clause 17(8)(a)(i)(A) would not except the amount owing by CFA to Canco. This is because CFA did not use the loaned funds for the purpose of earning income from its active business but rather used the funds to return capital.
It is our view that there is no analogy to be drawn to your facts from our position regarding the application of paragraph 20(1)(c) to interest on funds borrowed by a company to reduce capital, redeem shares or pay a dividend. As you are aware, proposed section 20.2 is expected to replace our position in that context. In addition, it is our view that the principle established in Trans-Prairie Pipelines Ltd. in reference to the application of paragraph 20(1)(c) of the Act is restricted to facts that are exactly in conformity with the facts of that case. Accordingly, we are not prepared to concede that the case is of assistance in the interpretation of paragraph 17(8)(a). As a result, in our view, there is no conflict between our position regarding paragraph 20(1)(c) as described and Technical Interpretation 9931735.
We trust these comments will be of assistance.
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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