2008 Ruling 2006-0212871R3 - Income of a Foreign Affiliate

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 certain income to be earned by a foreign affiliate of Parent will be income from a business other than an active business pursuant to paragraph 95(2)(a.3) of the Act.

Position: No.

Reasons: The income will fall within the subsection 95(2.4) exception to paragraph 95(2)(a.3) of the Act.

XXXXXXXXXX 						2006-021287

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in response to the XXXXXXXXXX request for an advance income tax ruling on behalf of the above. We also acknowledge receipt of the additional information provided to us on XXXXXXXXXX .

Unless otherwise stated, all statutory references herein are to the Income Tax Act, R.S.C. 1985, c.1 (5th Supplement) (the "Act"), as amended to the date of this advance income tax ruling.

The rulings given herein are based solely on the facts, proposed transaction and the purpose of the proposed transaction described below. Facts and proposed transactions described in the documents submitted with your request that are not set out below do not form part of the facts and proposed transactions on which this ruling is based and any reference to these documents is provided solely for the convenience of the reader.

Our understanding of the facts, proposed transaction and the purpose of the proposed transaction is as follows:

Definitions

(a) "Parent" means XXXXXXXXXX ;

(b) "Subco" means XXXXXXXXXX ;

(c) "Opco" means XXXXXXXXXX ;

(d) "CRA" means the Canada Revenue Agency;

(e) "Competitors" means the credit institutions and/ or investment firms that deal at arm's length with Subco and that engage in the trading or dealing of financial products and services in the Foreign Country;

(f) "Customer" means any person that enters into a Transaction with Opco;

(g) "Domestic Legislation" means XXXXXXXXXX

(h) "Exchanges" means XXXXXXXXXX ;

(i) "Foreign Country" means XXXXXXXXXX ;

(j) "Foreign Regulator" means the XXXXXXXXXX ;

(k) "Preferred Customer" means any Customer that is a resident of the Foreign Country and that deals at arm's length with Opco;

(l) "Reverse Repo" has the meaning set out in paragraph 7 below;

(m) "Transaction" means a Reverse Repo agreement to be entered into by Opco and a Customer or Opco and a Preferred Customer as more fully described in paragraph 7 below;

(n) "Treaty" means the XXXXXXXXXX ;

(o) "arm's length" has the meaning assigned by subsection 251(1) of the Act;

(p) "fiscal period" has the meaning assigned by subsection 249.1(1) of the Act;

(q) "non-resident" has the meaning assigned by subsection 248(1) of the Act;

(r) "public corporation" has, by virtue of subsection 248(1) of the Act, the meaning assigned by subsection 89(1) of the Act;

(s) "related persons" has the meaning assigned by subsection 251(2) of the Act; and

(t) "taxable Canadian corporation" has, by virtue of subsection 248(1) of the Act, the meaning assigned by subsection 89(1) of the Act.

Facts

1. Parent is a public corporation, a taxable Canadian corporation and a corporation that is described in the Domestic Legislation. The common shares of Parent trade on the Exchanges. Parent's business number is XXXXXXXXXX .

2. Subco is a corporation resident in the Foreign Country for purposes of the Act and the Treaty. The sole beneficial shareholder of Subco is Parent.

3. Opco is a corporation resident in the Foreign Country for purposes of the Act and the Treaty. The sole beneficial shareholder of Opco is Subco. Opco carries on business in the Foreign Country as a trader or dealer in securities and is regulated by the Foreign Regulator as an investment firm.

4. Opco's business activities consist of the trading of securities (including debt securities, shares, units in mutual funds and listed options), the managing of asset portfolios and the provision of other financial products and services and such business activities are conducted principally with persons with whom Opco deals at arm's length. Opco also provides such services to Parent and to subsidiaries of Parent. The business of Opco is currently principally carried on in the Foreign Country. Opco does not carry on any business in Canada. In its XXXXXXXXXX fiscal period, Opco employed approximately XXXXXXXXXX people full-time in the above business activities, Opco's "trading income" from the above business activities was in excess of U.S.$XXXXXXXXXX and the carrying value of Opco's trading securities was in excess of U.S.$XXXXXXXXXX . Opco is subject to income taxation in the Foreign Country in accordance with the laws of the foreign country.

5. With respect to all of Opco's business activities in the Foreign Country (including the proposed transaction described below), Opco will have Competitors that are resident in the Foreign Country and that have a material presence in the Foreign Country. The Competitors must also satisfy the requirements of the Foreign Regulator.

6. We understand that, to the best of your knowledge and that of Parent, none of the issues involved in this ruling letter:

(i) is in an earlier return of Parent or related persons of Parent,

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of Parent or related persons of Parent,

(iii) is under objection by Parent or related persons of Parent, or

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

Proposed Transaction

7. Opco proposes to enter into Transactions with Customers that will involve Canadian debt obligations. Each Transaction will be a reverse re-purchase transaction (a "Reverse Repo") and each Transaction will be governed by standard re-purchase transaction documentation. Under a Reverse Repo, Opco will initially acquire a debt obligation from a Customer in exchange for a cash payment. Legal title and beneficial ownership of the debt obligation acquired will be transferred to Opco when it purchases the debt obligation. Opco will have the right to sell the acquired debt obligation to a third party if it so chooses. Opco will also have the right to receive any interest paid on, or other distribution made in respect of, the debt obligation while it is held by Opco. Under the Reverse Repo, Opco agrees to sell to the customer, upon the termination of the Reverse Repo, a debt obligation with the same terms and conditions (e.g. same bond issuer, same aggregate principal amount) as the debt obligation acquired by Opco from that Customer, with the possible exception of the face value of the debt obligation(s). None of the Customers will be a resident of Canada for purposes of the Act. Only the Preferred Customers will be residents of the Foreign Country. All of the Customers will deal at arm's length with Opco.

Additional Information

8. Opco's sale price of any debt obligation sold to a Customer will consist of the purchase price paid by Opco for such debt obligation plus an additional amount (referred to as the "Spread"). The Spread will be equal to the product obtained by multiplying the fair market value of a debt obligation at the time the Reverse Repo Transaction is entered into by a percentage that represents an interest rate and then subtracting therefrom any interest or other distribution received by Opco while it held the debt obligation. The Spread will not reflect the fair market value of a debt obligation at the time that it is sold to a Customer. After the completion of each Reverse Repo Transaction, Opco's profit will be equal to the Spread computed for that particular Reverse Repo Transaction plus any fee that Opco may receive for entering into the Reverse Repo Transaction.

9. The debt obligations referred to in paragraphs 7 and 8 above will include debt obligations of the federal, or a provincial, government of Canada. Some of the debt obligations referred to in paragraphs 7 and 8 above may be issued by corporations that are resident in Canada. Although the quantity of Reverse Repo Transactions involving debt obligations issued by Canadians will depend upon factors such as the availability of such debt obligations and the currency required by the Customers of Opco, the aggregate principal amount of such debt obligations acquired by Opco in Reverse Repo Transactions will at all times be less than XXXXXXXXXX % of the aggregate principal amount of Opco's total portfolio of debt obligations. However, it is possible that Opco's gross revenue in respect of Reverse Repo Transactions involving debt obligations issued by Canadian residents may exceed XXXXXXXXXX % of Opco's total gross revenue from Opco's entire portfolio of debt obligations.

10. The specific terms of any reverse repo transaction are determined by the counterparties and, to a certain extent, dictated by general market conditions. In general, reverse repo transactions are short-term transactions that are typically outstanding for periods not exceeding three months. While the terms of a particular Reverse Repo Transaction entered into by Opco will be determined at the time the transaction is entered into, it is expected that the average term of a Reverse Repo Transaction will be three months or less. A Reverse Repo Transaction would only exceed three months in unusual circumstances, such as unfavorable market conditions.

11. Each Reverse Repo Transaction described in paragraph 7 above will be undertaken by Opco in the course of carrying on an active business that is not part of any business carried on in Canada by Parent, Subco, Opco or any other related persons of Parent. Furthermore, none of Parent, Subco, Opco or any other related persons of Parent will use a Reverse Repo Transaction as part of an arrangement that effectively results in the lending of money to the issuer of any Canadian debt obligation that is the basis for any particular Reverse Repo Transaction.

Purpose of the Proposed Transaction

12. Opco's objective in entering into the proposed transaction is to earn a profit with comparatively less risk than attends many other forms of investment. The Reverse Repos, which are financial instruments commonly used in the money markets and are analogous to collateralized loans, will provide Opco with an opportunity to invest cash in a relatively secure investment that has a competitive yield.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, the proposed transaction and the purpose of the proposed transaction, and provided further that the proposed transaction is completed in the manner described above, our rulings are as follows:

A. Subsection 95(2.4) of the Act will apply, such that paragraph 95(2)(a.3) of the Act will not apply, to Opco in respect of its income, being the Spread, derived from Reverse Repo Transactions that Opco will enter into with Preferred Customers.

B. Subsection 245(2) of the Act will not be applied as a result of the Proposed Transaction described in paragraph 7 above, in and by itself, to re-determine the tax consequences confirmed in ruling A above.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5, issued by the CRA on May 17, 2002, and are binding on the CRA provided that the proposed transaction is commenced prior to XXXXXXXXXX .

Except as expressly stated, this advance income tax ruling does not imply acceptance, approval or confirmation of any other income tax implications of the facts or proposed transactions described herein.

These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the ruling provided herein.

Yours truly,

XXXXXXXXXX
for Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch