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.
Principal Issues: Whether a benefit would be considered to have been conferred where a loan receivable of a wholly-owned foreign subsidiary from its foreign parent is settled without payment upon the winding-up of the wholly-owned foreign subsidiary into the foreign parent?
Position: It depends on the fact of the situation.
Reasons: The exception in paragraph 15(1)(a) of the Income Tax Act may not apply depending on the fact of the situation.
XXXXXXXXXX 2003-000135
August 30, 2004
Dear XXXXXXXXXX:
Re: Subsection 15(1) of the Income Tax Act (the "Act")
We are writing in reply to your letter of February 27, 2003 in which you requested our view as to whether a benefit would be considered to have been conferred under subsection 15(1) of the Act in the hypothetical situation outlined below. We apologize for the delay in replying.
The Hypothetical Situation
1. Canco is a corporation incorporated and resident in Canada.
2. Canco owns 100% of the shares of a foreign affiliate ("FA1") which owns directly 100% of the issued and outstanding shares of two foreign affiliates ("FA2" and "FA3").
3. FA1, FA2 and FA3 are all holding companies, the principal purpose of which is to own shares of other foreign affiliates or to make loans to affiliate companies.
4. FA2's only significant asset is a loan receivable of $100 from FA1, in the form of a non-interest bearing demand promissory note (the "FA1 Note").
5. FA1 has used the borrowed funds to invest in common shares of FA3 and FA3 in turn invested the $100 in shares of another foreign affiliate ("Opco") which carries on an active business.
6. The Opco shares were subsequently sold at fair market value for $50. As a result, the consolidated financial position of FA1, FA2 and FA3 reflects combined net assets of less than $100.
7. FA2 then liquidates and dissolves into FA1.
The situation outlined in your letter appears to relate to an actual situation involving identifiable taxpayers. Accordingly, the applicable Tax Services Office should be consulted with respect to the income tax liabilities of such taxpayers. Where the transactions described in the situation outlined in your letter are proposed transactions, they should be the subject matter of an advance income tax ruling request. However, we can offer the following comments that, because of the lack of information concerning the facts and circumstances of the situation, are inevitably general in nature.
On the liquidation and dissolution of FA2, we do not have sufficient information to determine whether paragraph 95(2)(e.1) of the Act would or would not apply in the situation described above. If that paragraph does not apply, and the FA1 Note is not settled prior to the wind-up, subsection 69(5) of the Act will generally apply and FA2 would be deemed to have disposed of the FA1 Note for proceeds of disposition equal to its fair market value and FA1 to have acquired it for the same amount. It is a question of fact what the fair market value of the FA1 Note would be at that time.
Where the FA1 Note was settled or extinguished on the liquidation and dissolution of FA2, it is a question of fact whether a benefit has been conferred by FA2 to FA1. Subsection 15(1.2) of the Act provides that, for purposes of subsection 15(1), the value of the benefit where an obligation issued by a debtor is settled or extinguished at any time shall be deemed to be the forgiven amount at that time in respect of the obligation. You seem to agree with this result and you requested that we comment on whether the exception contained in paragraph 15(1)(a) of the Act would apply such that subsection 15(1) would not apply. Paragraph 15(1)(a) of the Act reads as follows:
"Where at any time in a taxation year a benefit is conferred on a shareholder, or on a person in contemplation of the person becoming a shareholder, by a corporation otherwise than by
(a) the reduction of the paid-up capital, the redemption, cancellation or acquisition by the corporation of shares of its capital stock or on the winding-up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which section 88 applies,"
Based on the limited facts provided in your letter, we do not have enough information to determine whether FA2 actually carried on a business and whether there was a winding-up or discontinuance of that business on the liquidation and dissolution of FA2. A determination of this sort would have to be made in the context of an advance income tax ruling where all the facts and circumstances of the situation could be thoroughly examined. It would also be helpful to know more about how and when the FA1 Note was settled in relation to FA2's liquidation and dissolution process.
With respect to whether the benefit is conferred by a "redemption, cancellation or acquisition by" FA2 of shares of its capital stock, and therefore whether FA1 is eligible for the exception in paragraph 15(1)(a) of the Act, it is our preliminary view that any benefit conferred by FA2 on FA1 is a direct result of the settlement of the FA1 Note, not the redemption, cancellation or acquisition of the shares of FA2 at its dissolution. Paragraph 15(1)(a), as we understand it, is intended to provide certain exceptions to the application of subsection 15(1) where the transaction or transactions leading to what otherwise would be a conferral of a benefit fall within the purview of sections 84 and 88 of the Act. Since the situation outlined in your letter involves non-resident corporations to which neither section 84 or section 88 applies, the Canada Revenue Agency will generally adopt a narrow interpretation of that provision.
If the fair market value of the FA1 Note at the time it is settled is less than the lesser of the principal amount of the FA1 Note and the amount for which the FA1 Note was issued, section 80 of the Act could apply if, had interest been paid or payable by FA1 to FA2 in respect of the FA1 Note, clause 95(2)(a)(ii)(D) of the Act would not apply. With respect to the application of section 80 and paragraph 95(2)(g.1) of the Act, it is our view that the FA1 Note is a "commercial debt obligation" within the meaning assigned under subsection 80(1) of the Act unless, had interest been paid or payable in respect of the FA1 Note, such amount of interest would have been deemed to be nil for the purposes of computing foreign accrual property income ("FAPI") of FA2 under descriptions A and D of the definition of FAPI in subsection 95(1) of the Act. However, to the extent that subsection 15(1) requires an income inclusion, there will be a corresponding reduction in the "forgiven amount" for section 80 purposes.
Yours truly,
Jim Wilson
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch
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