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.
PRINCIPLE ISSUES: Whether debt forgiveness rules apply on settlement of loans in foreign affiliate context.
Reasons: Paragraph 95(2)(g.1).
XXXXXXXXXX (613) 957 2115
March 9, 2004
Re: Our Technical Interpretation on Foreign Affiliate Debt Forgiveness -
our file 2002-016519
This is further to our letter dated December 5, 2003, our file number 2002-016519 (the "Earlier Letter"). We regret to inform you that some of the analysis as set out in the Earlier Letter does not reflect the CRA view. The hypothetical situation in the Earlier Letter was as follows:
1. Canco is a corporation resident in Canada that has subsidiaries in the US and the UK. Canco has a US subsidiary ("CFA1") that qualifies as a "controlled foreign affiliate" of Canco under the definition of that term in subsection 95(1) and subsection 17(15) of the Income Tax Act (the "Act").
2. CFA1 has a US dollar non-interest bearing loan payable to Canco (the "CFA1 debt"). The CFA1 debt was used by CFA1 to:
(i) acquire shares of CFA1's US subsidiaries that are also "controlled foreign affiliates" as defined in subsections 95(1) and 17(15) of the Act, of Canco;
(ii) finance the operations of CFA1's US subsidiaries; and
(iii) finance CFA1's own expenses associated with the activities described in (i) and (ii).
3. All of the US subsidiaries of CFA1 carry on active business and earn no other type of income.
4. All of the US controlled foreign affiliates of Canco are residents of the US and would be considered US residents pursuant to the Canada-US Income Tax Convention.
5. CFA1 does not carry on active business. No part of the CFA1 debt was used by CFA1 to earn foreign accrual property income ("FAPI") and all of the debt was used to earn dividends from subsidiaries and interest income that was deemed active business income pursuant to subparagraph 95(2)(a)(ii).
6. The CFA1 debt is on account of capital i.e. any gain or loss on settlement thereof will be a capital gain or loss in the hands of Canco and/or CFA1 as the case may be.
In the Earlier Letter we indicated that based on the above hypothetical facts, the forgiveness of the CFA1 debt would not affect the computation of FAPI. The rationale given was that under the provisions of section of 80 of the Act as modified by paragraph 95(2)(g.1), the CFA1 debt would not be a "commercial debt obligation" for the purpose computing FAPI. This analysis is incorrect. In applying the definition of "commercial debt obligation" in subsection 80(1) as modified by paragraph 95(2)(g.1), had interest been payable in respect of the CFA1 debt, an amount would have been included in the computation of the amount described in "D" of the definition of FAPI in subsection 95(1). In computing CFA 1's income from the shares of other foreign affiliates of Canco, any dividend derived by CFA1 from those shares would be excluded from the amounts described in "A" and "D" of the definition of FAPI. However, the interest expense incurred on money borrowed to acquire those shares would nevertheless be deductible in computing its income or loss from such property. Accordingly, the CFA1 debt is a "commercial debt obligation" under the provisions of section 80, as modified by paragraph 95(2)(g.1), for the purpose of computing FAPI.
It appears however that in this case there is no effect on the FAPI computation as a consequence of the forgiveness of the CFA1 debt by virtue of the fact that after the application of paragraph 80(2)(g.1) of the Act, there may be no "forgiven amount" for the purposes of section 80.
We apologize for any inconvenience the error in our Earlier Letter may have caused you.
International and Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch
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