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: (1) Is it necessary for an affiliate to be resident and subject to income tax in the same jurisdiction for clause 95(2)(a)(ii)(D) to apply?
Position: (1) Yes
Reasons: (1) Plain reading of 95(2)(a)(ii)(D).
CLHIA Round Table Question #12
Subparagraph 95(2)(a)(ii) of the Income Tax Act (the "Act") provides that certain income that would otherwise be income from property of a foreign affiliate will be included in the affiliate's income from an active business. Under clause 95(2)(a)(ii)(D), such re-characterization will apply to income derived from interest paid by a foreign affiliate (Borrower) on borrowed money used to acquire shares of another foreign affiliate (Subsidiary) provided that, among other conditions, Borrower and Subsidiary are resident in the same foreign country, and Borrower and Subsidiary are "subject to income taxation" in that same foreign country.
A particular foreign affiliate may not pay income tax in a particular year in a foreign country, such as where the affiliate has losses or where the country does not impose an income tax. A foreign affiliate may be subject to tax in a country that is different from the country in which it is resident, such as where the affiliate carries on an insurance business through a foreign branch or where the affiliate elects to have its income taxed in another country [such as under subsection 953(d) of the United States' Internal Revenue Code (the "IRC") where a corporation resident in a country other than the United States elects to be taxed as a resident of the United States and thus the affiliate may be included in the U.S. consolidated returns for a taxation year as opposed to having its Subpart F income included in the income of a U.S. affiliate for U.S. tax purposes, or U.S. source income included in a separate return for that taxation year. It is our understanding that by making such an election the affiliate is also not subject to an excise tax imposed on foreign insurance companies doing business in the U.S.]
Does the CRA consider clause 95(2)(a)(ii)(D) to apply where:
(a) Borrower and Subsidiary are resident in country A, and are liable to tax on a worldwide basis in country B?
(b) Borrower and Subsidiary are resident in country A and that country does not impose an income tax, but may impose some other form of taxation?
It is unclear from the facts above whether in example (a) the tests in clause 95(2)(a)(ii)(D) are met. Subclause (IV) of clause 95(2)(a)(ii)(D) of the Act requires that Borrower and Subsidiary be resident in the same country, under common law principles, for each of their relevant taxation years. Subclause (V) of clause 95(2)(a)(ii)(D) of the Act further requires, in respect of both Borrower and Subsidiary, for each relevant taxation year, that they be "subject to income taxation" in the country referred to in subclause 95(2)(a)(ii)(D)(IV) of the Act.
Consequently, in determining whether clause 95(2)(a)(ii)(D) will apply to interest Borrower pays to a particular affiliate in respect of its acquisition of Subsidiary it is necessary to look at how the residence state taxes both Borrower and Subsidiary. It is irrelevant how a country other than the residence country taxes Borrower and Subsidiary. In particular, it would be necessary to determine if Borrower and Subsidiary are subject to income tax in country A. This would also be the case in a situation where a corporation elected to be taxed and treated as a resident for tax purposes in a foreign country other than the country in which that corporation is resident under the common law tests. For example if Borrower and Subsidiary, which are resident in country A for tax purposes, elect to be taxed as a resident in the United States under subsection 953(d) of the IRC, and are consequently taxable on their worldwide income in the United States, it would still be necessary to determine whether each corporation was subject to income taxation in country A.
In general, for the purpose of subsection 95(2) of the Act, it is our view that "subject to income taxation" means that all the income earning activities of the corporation fall under the taxing jurisdiction of the relevant country. A corporation would be considered subject to income taxation notwithstanding that it does not pay any tax in a particular year because it has incurred a loss or because it has losses of other years available to offset net income that would otherwise be taxable.
With respect to (b), while both Borrower and Subsidiary will be resident in the same country as required by subclause (IV) of clause 95(2)(a)(ii)(D), since that country does not impose an income tax on Borrower and Subsidiary, it is our view that subclause (V) of clause 95(2)(a)(ii)(D) will not be met. As such, it is our view that clause 95(2)(a)(ii)(D) will not apply to re-characterize the income the particular foreign affiliate derives from the interest paid to it by Borrower.
May 1, 2009
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