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: The meaning of non-portfolio earnings as that term is defined in subsection 197(1) of the ITA in a specific hypothetical situation. Is interest income on loans made to a foreign affiliate, that has no operations or property in Canada, by a SIFT partnership, which is not otherwise in the business of lending money, considered non-portfolio earnings of the SIFT partnership?
Position: Question of fact but unlikely given the facts in the hypothetical situation.
Reasons: Based on jurisprudence and given the facts in the hypothetical situation, it is unlikely that the SIFT would be considered to be carrying on a business in Canada in making the loans to the foreign affiliate and it is unlikely that the loans would be considered to be property used by the SIFT in the course of carrying on a business in Canada. Consequently, it is unlikely that the interest income from the loans would be considered non-portfolio earnings of the SIFT as defined in subsection 197(1).
XXXXXXXXXX
2010-037708
Chrys Tzortzis, CA
January 10, 2011
Dear XXXXXXXXXX :
Re: Meaning of Non-Portfolio Earnings
We are writing in reply to your email dated July 20, 2010, wherein you inquire about the meaning of "non-portfolio earnings" as that term is defined in subsection 197(1) of the Income Tax Act (the "Act") in a specific hypothetical situation. In particular, you ask whether interest income is considered non-portfolio earnings of a SIFT partnership where the interest income is from loans made by the SIFT partnership to a foreign affiliate that has no operations or property in Canada and the SIFT partnership is not otherwise in the business of lending money. We also acknowledge our telephone conversation with you on December 9, 2010 (Tzortzis/XXXXXXXXXX ).
Since your inquiry concerns an actual situation involving questions of fact, it should be dealt with by your local tax services office. If you wish to have the Canada Revenue Agency review your actual situation, you should submit all of the relevant information and documentation to the particular tax services office serving your area, a list of which is available on the "Contact Us" page of the CRA Web site at www.cra-arc.gc.ca. However, we are prepared to provide the following general comments to the hypothetical situation outlined in the letter attached to your email, which may be of assistance. Please note that the lack of comment on any particular issue should not be construed as assurance of the tax consequences relating to that issue.
Hypothetical Situation
- A SIFT partnership (the "SIFT"), within the meaning of subsection 197(1) of the Act, owns all the shares of a holding company in Canada whose sole activity consists of owning all the shares in the foreign affiliate (the "FA"). The shares in the holding company and in the FA are capital property.
- The SIFT has business operations in Canada. The SIFT also negotiates third party financing to cover the needs of the entire group on favourable terms and makes advances to the FA.
- The FA is not resident in Canada and it does not have any income from a source in Canada. The FA and its subsidiaries do not have any Canadian operations and do not own any Canadian property either directly or indirectly. Neither the FA nor any of its subsidiaries have a permanent establishment in Canada. The business carried on by the FA and its wholly owned subsidiary entities is neither the same nor similar to the business carried on by the SIFT.
- There are no inter-company transactions between the SIFT and the FA on account of trade activities. The SIFT has made three loans to the FA which were used by the FA to purchase two arm's length group of companies and acquire capital assets. One loan has been repaid. The other two loans are still outstanding and the FA has not made any principal repayments. The loans were made to ensure that the FA is sufficiently capitalized and to enhance the value of the SIFT's investment.
- The SIFT accounts for the loans to the FA on account of capital and the interest income on the loans is allocated to the partners of the SIFT as income from property.
- The SIFT is not otherwise in the business of lending money. Other than the three loans above, the SIFT does not hold any other property that is a loan or advance to a related or unrelated person.
- The loans to the FA made by the SIFT are not integral to the SIFT's own business carried on in Canada.
In relation to the above facts in the hypothetical situation, you enquire whether the interest income on the loans made by the SIFT to the FA would be considered "non-portfolio earnings" of the SIFT.
Our Comments
As noted in your correspondence, "non-portfolio earnings" of a SIFT partnership for a taxation year as defined in subsection 197(1) of the Act includes "...income for the taxation year from a business carried on by it in Canada or from a non-portfolio property...." The term "non-portfolio property" is defined in subsection 122.1(1) of the Act and, pursuant to paragraph (a) of that definition, means "a security of a subject entity...." A "subject entity" is defined in subsection 122.1(1) to mean "a person or partnership that is (a) a corporation resident in Canada; (b) a trust resident in Canada; (c) a Canadian resident partnership; or (d) a non-resident person, or a partnership that is not described in paragraph (c), the principal source of income of which is one or any combination of sources in Canada." Pursuant to paragraph (c) of the definition of "non-portfolio property" in subsection 122.1(1), this term also means "a property that the trust or partnership, or a person or partnership with whom the trust or partnership does not deal at arm's length, uses at that time in the course of carrying on a business in Canada." Therefore, given the above facts in the hypothetical situation and these definitions, the interest income on the loans made by the SIFT to the FA would be considered "non-portfolio earnings" of the SIFT if the interest income is from a business carried on by the SIFT in Canada or if the loans to the FA are property that the SIFT uses in the course of carrying on a business in Canada.
In Morflot Freightliners Ltd. v. R, 89 D.T.C. 5182 (FCTD), Judge Strayer stated, "Normally payments made by a parent company to a subsidiary to help finance the operations of a subsidiary are regarded as capital payments." In Easton v R, 97 D.T.C. 5464 (FCA), Judge Robertson provided two recognized exceptions to this general proposition. The first exception is the case where the loan was made in the ordinary course of the shareholder's business (for example, the shareholder is in the business of lending money or the loan was made for income-producing purposes related to the shareholder's own business and not of the corporation in which it owns shares). The second exception is where the shares are held as a trading asset and not as an investment (i.e. an adventure in the nature of trade). Further, based on Canadian Marconi v R, 86 D.T.C. 6526 (SCC), the characterization of income as income from a business or income from property must be made from an examination of the taxpayer's whole course of conduct viewed in the light of the surrounding circumstances. In following this method, the courts have examined the number of transactions, their volume, their frequency, the turnover of the investments and the nature of the investments themselves. Therefore, it is a question of fact whether the lending activities of a taxpayer can be identified as a business. Furthermore, a taxpayer may carry on a business of lending money in addition to another business.
The Canada Revenue Agency's position on whether a taxpayer's business included the lending of money is summarized in paragraph 11 of Interpretation Bulletin IT-442R, Bad Debts and Reserves for Doubtful Debts, wherein it is stated that when determining whether a taxpayer's business included the lending of money it is not sufficient merely to find that loans are made; they must be made as an integral part of a business operation. It is required that there be a certain system and continuity in the making of loans, and the purpose must not be the occasional investment of surplus funds, accommodation to friends or customers or advances that are intended to remain a part of the capital of the borrower.
It is also a question of fact whether a property is used in the course of carrying on a business in Canada. Paragraph 6 of Interpretation Bulletin IT-73R6, The Small Business Deduction, states that the issue of whether property was used or held by a corporation in the course of carrying on a business was considered by the Supreme Court of Canada in Ensite Limited v. Her Majesty the Queen, 86 D.T.C. 6521. The court held that the holding or using of property must be linked to some definite obligation or liability of the business. The property had to be employed and risked in the business to fulfill a requirement which had to be met in order to do business. In this context, risk means more than a remote risk. If the withdrawal of the property would have a decidedly destabilizing effect on the corporate operations, the property would generally be considered to be used in the course of carrying on a business. In other words, the property has to be an integral part of the financing of the business or necessary to the overall business operations.
In our view, based on the above jurisprudence and given the facts in the hypothetical situation, it is unlikely that the SIFT would be considered to be carrying on a business in Canada in making the loans to the FA. It is also unlikely that the loans would be considered property used by the SIFT in the course of carrying on a business in Canada. Consequently, in our view, it is unlikely that the interest income from the loans made by the SIFT to the FA would be considered "non-portfolio earnings" of the SIFT as defined in subsection 197(1) of the Act. However, this determination is essentially a question of fact to be made from an examination of the SIFT partnership's whole course of conduct viewed in the light of the surrounding circumstances. Generally, this information would be obtained in the normal course of an audit carried out by a Tax Services Office.
We trust that these comments will be of assistance.
Yours truly,
G. Moore
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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