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. Do loans from the Canadian branch of an authorized foreign bank to a related company form part of the Canadian banking business of the branch for the purposes of the definition of outstanding debts to specified non-residents in subsection 18(5)?
2. Does subsection 18(6) apply to the advance from the head office to the branch and the loan from the branch to the related company?
Position: 1. In this case, yes.
2. No.
Reasons: 1. As long as the loan is held or used in the Canadian banking business of the branch, it satisfies the wording of the definition of outstanding debts to specified non-residents in subsection 18(5).
2. There is only one loan. Subsection 18(6) only applies to multiple loans.
March 12, 2010
XXXXXXXXXX TSO HEADQUARTERS
Large Case File Auditor Income Tax Rulings
Directorate
Attention : XXXXXXXXXX Terry Young
(613) 948-5273
2010-035569
Canadian Branch of Authorized Foreign Bank
This is in response to your follow-up inquiry in respect of your memorandum of July 29, 2009 (XXXXXXXXXX ), wherein you requested our views on whether loans from a Canadian branch of an authorized foreign bank, as defined in subsection 248(1) of the Income Tax Act ("the Act"), were subject to the thin capitalization rules in subsections 18(4) to 18(6) of the Act. We also acknowledge our various conversations (Young / XXXXXXXXXX ).
Background:
- XXXXXXXXXX ("ACO") is a US corporation, and an authorized foreign bank that operates in Canada through a permanent establishment in Canada (the "Branch"). ACO is an indirect subsidiary of XXXXXXXXXX ("ParentCo"), a US corporation.
- XXXXXXXXXX ("BCO") is a US corporation and is a subsidiary of ACO.
- XXXXXXXXXX ("CCO") is a Canadian corporation and is subsidiary of BCO.
- Prior to XXXXXXXXXX , CCO operated a XXXXXXXXXX business in Canada.
- As part of a reorganization of its XXXXXXXXXX business on XXXXXXXXXX :
- DCO was incorporated as a subsidiary of BCO with share capital of $XXXXXXXXXX ;
- ACO's US head office advanced approximately $XXXXXXXXXX to the Branch (the "Branch Advances");
- CCO borrowed $XXXXXXXXXX from the Branch (the "Branch Debt");
- CCO used the funds to repay existing arm's length debt;
- CCO rolled over its XXXXXXXXXX assets to DCO pursuant to subsection 85(1) of the Act;
- DCO assumed the Branch Debt as part of that transaction;
- DCO began operating the XXXXXXXXXX business in Canada.
The issue is whether DCO, which has over XXXXXXXXXX % of its capital provided by way of debt, is affected by the thin capitalization rules of subsections 18(4) to 18(6).
You have asked us two questions:
1. Does the Branch Debt form part of the Canadian banking business of the Branch, where the Branch Debt makes up approximately XXXXXXXXXX % of the Branch's assets (assuming that the terms of the loans are documented and are on commercial terms and conditions)?
2. Are the Branch Advances and the Branch Debt separate loans to which subsection 18(6) applies? In other words, could the Branch Advances be considered loans from a specified non-resident shareholder (ACO) to a person (the Branch)?
Analysis:
1. Does the Branch Debt form part of the Canadian banking business of the Branch?
Generally speaking, subsection 18(4) disallows interest expenses paid or payable in respect of "outstanding debts to specified non-residents" to the extent that more than two-thirds of the taxpayer's capital is financed by way of debt owing to specified non-residents or persons operating non-arm's length with specified shareholders. In general terms, a "specified non-resident shareholder", which is defined in subsection 18(5), is someone who, alone or with non-arm's length persons, either controls at least 25% of the votes of the corporation or at least 25% of the FMV of the outstanding shares of the corporation.
Subparagraph (b)(ii) of the definition of "outstanding debts to specified non-residents" in subsection 18(5) specifically excludes from debt to which subsection 18(4) applies:
(b) an amount outstanding at the particular time as or on account of a debt or other obligation to pay an amount to
(ii) an authorized foreign bank, if the bank uses or holds the obligation at the particular time in its Canadian banking business; (emphasis added)
In other words, if the Branch Debt is held or used in the Canadian banking business of the Branch, the restriction on the amount of interest deductible by DCO in subsection 18(4) does not apply.
Canadian banking business is defined in subsection 248(1) to mean;
the business carried on by an authorized foreign bank through a permanent establishment (as defined by regulation) in Canada, other than business conducted through a representative office registered or required to be registered under section 509 of the Bank Act; (Note: section 509 was repealed in 2007)
The requirement in subparagraph (b)(ii), above, that the authorized foreign bank "uses or holds the obligation..." is a low standard to meet. It suggests only that the authorized foreign bank account for and manage the obligation within the Branch. Based on our discussions, it is our understanding that the Branch Debt is held by and administered by the Branch. There is nothing in the above provisions or elsewhere to say that the business of the Branch cannot include the making of loans to related companies. We are not aware of any such restrictions in the Bank Act.
Therefore, the Branch Debt is not an outstanding debt to specified non-residents for purposes of subsection 18(5).
2. Are the Branch Advances and the Branch Debt separate loans to which subsection 18(6) applies?
Subsection 18(6) deems loans made by a specified non-resident shareholder or non-arm's length non-resident to a person other than the taxpayer to be a loan made directly to the taxpayer if the loan was made on the condition that the other person make a loan to the taxpayer. Subsection 18(6) states:
Loans made on condition - Where any loan (in this subsection referred to as the "first loan") has been made
(a) by a specified non-resident shareholder of a corporation, or
(b) by a non-resident person, or a non-resident-owned investment corporation, who was not dealing at arm's length with a specified shareholder of a corporation,
to another person on condition that a loan (in this subsection referred to as the "second loan") be made by any person to a particular corporation resident in Canada, for the purposes of subsections (4) and (5), the lesser of
(c) the amount of the first loan, and
(d) the amount of the second loan
shall be deemed to be a debt incurred by the particular corporation to the person who made the first loan.
For subsection 18(6) to apply to this situation, there would have to be a loan from ACO to the Branch. Since they are the same person, there is, in fact, no loan, only an allocation (to use the wording of the definition of branch advance in subsection 20.2). Accordingly, subsection 18(6) cannot apply.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We trust that these comments will be of assistance.
Lee Workman
Manager
Charitable and Financial Institution Sectors
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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