29 November 2001 External T.I. 2001-0110985 - TEI, Question 21

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: substitution of administrative position for purpose test in subsection 85(1.11)

Position: no comment will be provided

Reasons: no experience with administering subsection, will consider ruling if necessary facts etc are provided

2001 TEI Round Table

Question #21

Subsection 85(1.11)

"The recently enacted exception to the definition of eligible property in subsection 85(1.11) provides that subsection 85(1) cannot be used in a transfer of a foreign resource property held by a taxpayer (hereinafter the 'transferor') to a non-arm's length Canadian subsidiary (hereinafter the 'transferee') where 'it is reasonable to conclude that one of the purposes of the disposition...is to increase the extent to which any person may claim a deduction under section 126' (e.g. a foreign tax credit (FTC)). (Emphasis added.) The technical notes to Bill C-22 indicate that this provision is 'intended to counter the avoidance of income-based limits on the foreign tax credit in section 126 that might be achieved through the sale of direct or indirect interests in foreign resource property at less than fair market value.'

The roll down of tax paying foreign oil and gas assets to a transferee within the same Canadian corporate group will almost always results in an increase in the FTC claim of the transferee because, for example, it may not have previously owned any foreign tax paying properties. Hence, for purposes of subsection 85(1.11), the roll-down will almost always increase the extent to which at least one person (the transferee) may claim a deduction under section 126. Accordingly, on each transfer of a foreign resource property in a transaction otherwise qualifying under subsection 85(1), it will be necessary to determine whether it is reasonable to conclude that the increase to the transferee's (or any other person's) FTC was one of the purposes of the disposition.

TEI is concerned that the CCRA could almost always assert that the 'purpose test' in subsection 85(1.11) is satisfied, which would extend the reach of the statute far beyond the stated reason for introducing subsection 85(1.11). At a minimum, the 'purpose test' creates uncertainty. One of the principal reasons Canadian oil and gas companies transfer foreign branches to Canadian subsidiaries is to limit exposure to the additional legal liabilities that can arise when a foreign operation moves from the exploration stage to development and production. Another non-tax reason to transfer the assets is to ease compliance with various obligations arising under foreign operating agreements. Inappropriate or uncertain tax results arising from the application of the 'purpose test' may well inhibit, or even preclude, Canadian oil and gas companies from continuing to employ this traditional and prudent form of financial management.

In order to minimize ambiguity and uncertainty from the administration of subsection 85(1.11), TEI recommends that, where the elected amount pursuant to subsection 85(1) is not less than the lesser of the fair market value of the transferred property and the aggregate of unamortized Foreign Exploration and Development Expense and unamortized Cumulative Foreign Resource Expense that is reasonably allocable to the transferred property, subsection 85(1.11) should not be applied. We believe this represents a reasonable interpretation of the policy underlying the subsection and invite the Agency to comment on whether adoption of the recommendation would improve the administration of the provision.

The CCRA Response

Subsection 85(1.11) is a new rule applicable to dispositions which occur after December 21, 2000. The determination of whether an anti-avoidance rule such as this has application requires a full examination of all the facts and circumstances of the particular case. The CCRA does not have the experience in administering this rule which would be necessary in order to be in a position to provide general guidelines in reference to when it will, or will not, be applied. However, the Rulings Directorate would be prepared to provide a ruling if presented with a specific set of facts and proposed transactions.

Prepared by: Dan Yuen
November 29, 2001
2001-011098
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