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 an investment in a foreign affiliate that carries on an active business can be a "portfolio investment" for purposes of section 94.1?
Position: No conclusion
Reasons: The purposes test in the midamble between paragraphs 94.1(e) and (f) would likely not be met anyway.
January 10, 2011
HEADQUARTERS
Lynda Gibson Income Tax Rulings
Non-Resident Trusts & Foreign Investment Directorate
Entities Section S.E. Thomson
Aggressive Tax Planning Division (613) 957-2122
International & Large Business Directorate
2009-034286
Meaning of "Portfolio Investments" in Paragraph 94.1(1)(b)
We are responding to a letter from Nicole Cliche on September 29, 2009, in which she asked for our views on the meaning of the term "portfolio investments", as used in paragraph 94.1(1)(b) of the Income Tax Act (the "Act"), when applied to the following scenario.
Facts
1. Canco is a corporation resident in Canada that operates as XXXXXXXXXX in Canada.
2. Canco owns XXXXXXXXXX% of the interests of BCo, a limited liability company formed in XXXXXXXXXX.
3. BCo owns XXXXXXXXXX% of the Class B interests of CCo, a limited liability company formed in XXXXXXXXXX. The Class B interests provide BCo with XXXXXXXXXX% of the votes, and XXXXXXXXXX% of the value of CCo. The adjusted cost base to BCo of the shares in CCo was approximately $XXXXXXXXXX.
4. Foreign Investor owns XXXXXXXXXX% of the Class A interests of CCo, providing it with XXXXXXXXXX% of the votes and XXXXXXXXXX% of the value of CCo. Foreign Investor is not resident in Canada and is not related to Canco or BCo.
5. CCo owns XXXXXXXXXX% of Partnership1, and XXXXXXXXXX% of DCo, both of which were established in XXXXXXXXXX. Non-Resident Investors own the remaining interests in Partnership1 and DCo. Non-Resident Investors are not resident in Canada and are not related to Canco, BCo or CCo or the Foreign Investor.
6. Partnership1 owns XXXXXXXXXX% of Partnership2, and XXXXXXXXXX% of the beneficial ownership in ECo. DCo owns XXXXXXXXXX% of the legal title of the ownership interests in ECo. Both Partnership2 and ECo were established in XXXXXXXXXX.
ECo owns XXXXXXXXXX% of the legal title of the ownership interests in Opco, XXXXXXXXXX operating in XXXXXXXXXX. Partnership2 owns XXXXXXXXXX% of the beneficial ownership interest in Opco.
Your Question
Nicole wanted to know if section 94.1 of the Act applies to this scenario.
The facts set out above indicate that BCo is a "controlled foreign affiliate" of Canco, as that term is defined in subsection 95(1) of the Act. Paragraph 94.1(1)(a) of the Act will apply where a taxpayer holds a share of the capital stock of a non-resident entity, other than a controlled foreign affiliate of the taxpayer. Therefore, section 94.1 does not apply to Canco on the interest it holds or has in BCo.
In computing the foreign accrual property income ("FAPI") as defined in subsection 95(1) of the Act of BCo in respect of Canco, there must be included any amount determined under variable C of that definition. Variable C is the amount that would be included in computing BCo's income if section 94.1 of the Act applied to BCo.
Section 94.1 will apply in computing the FAPI of BCo if BCo holds a share of a non-resident entity (CCo) that may reasonably be considered to derive its value, directly or indirectly primarily from portfolio investments of that entity (CCo) or any other non-resident entity, and all of the other conditions in section 94.1 are met. The test is not whether the shares of CCo are "portfolio investments" to BCo, but whether the shares of CCo (i.e. the "non-resident entity" that we are testing) derive their value primarily from portfolio investments of "that entity" (i.e. CCo), or "any other non-resident entity".
At the 1990 Canadian Tax Foundation annual conference, Revenue Canada-Taxation (as we were at the time) said that the meaning of the term "portfolio investments" is not confined to interests in non-resident entities that derive their value directly or indirectly from passive investments, and must be given a meaning that is sufficiently broad to encompass the types of different properties listed in paragraph 94.1(1)(b) of the Act. Since some of the properties listed may be used in a business, as defined in subsection 248(1) of the Act, the term "portfolio investments" will include any of the listed properties used in carrying on a business.
However, in its 1984 federal Budget, the government stated that the rules in section 94.1 will not apply to investments in non-resident entities whose principal business is a bona fide active business. In the scenario described above, we assume that Opco's principal business is an active business, and income from Opco's business would be added to Opco's exempt surplus vis-à-vis Canco, as computed in Part LIX of the Income Tax Regulations.
Section 94.1 will apply in computing the FAPI of BCo (i.e., the "taxpayer" in this case) only if the taxes under Part I of the Act are significantly less than they would be if the income, profit or gains from the assets had been earned directly by Canco.
If Canco held the Opco shares directly, and Opco were a foreign affiliate of Canco earning active business income, dividends paid to Canco by Opco would be deductible by Canco under paragraph 113(1)(a). On the sale of the Opco shares, Canco could make a subsection 93(1) election to deem a portion of the proceeds of disposition to be a dividend paid out of exempt
surplus of Opco in respect of Canco to reduce the capital gain realized by Canco. Accordingly, even if it can be said that the shares of CCo derive their value from portfolio investments, it appears that the provisions of section 94.1 would not apply to BCo, since the earnings of Opco could be paid to Canco without tax.
In arriving at this conclusion, we make the assumption that Opco continues to be considered as a foreign affiliate of Canco for purposes of making the hypothetical test in paragraph 94.1(1)(d) as modified by paragraph (b) of variable C of the definition of FAPI in subsection 95(1). We note that Opco is a foreign affiliate of Canco XXXXXXXXXX, and BCo's equity percentage (as defined in subsection 95(4)) in Opco is therefore greater than 10%. XXXXXXXXXX. If Canco's economic investment in Opco were substantially less than 10%, then we suggest that the CRA might consider the application of subsection 95(6) or the General Anti-Avoidance Rule to say that the Class B shares were issued only to take advantage of the foreign affiliate status.
We trust that we have been of some assistance.
Yours truly,
Olli Laurikainen, Manager
For Director
International & Trusts Division
Income Tax Rulings Directorate
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