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: Designating deemed dividends under s. 214(16)(b).
Position: General comments provided.
Reasons: The designation occurs pursuant to the mechanism outlined in that paragraph.
International Fiscal Association (IFA) Conference
Canada Revenue Agency Roundtable
May 23, 2013
Thin Capitalization
Question
Assume that a Canadian subsidiary has two loans outstanding to specified non-residents: its US Parent and a UK related company. A portion of the interest payable on the two loans is denied under the thin capitalization rules and is deemed to be a dividend under the changes to the rules. Can the taxpayer allocate the deemed dividend first to the US Parent such that the 5% dividend rate applies rather than the 15% rate applicable on a deemed dividend to the UK sister company?
Response
Subsection 18(4) prevents a corporation resident in Canada from deducting interest on certain debts owing to specified non-residents to the extent that the debts exceed a permissible debt-to-equity ratio, currently 1.5:1. Subsection 18(4) denies a deduction for a portion of a corporation's total interest paid or payable to specified non-residents through consideration of the appropriate portion of non-resident debt-to-equity.
Where a corporation is denied a deduction of interest by subsection 18(4), paragraph 214(16)(a) deems the appropriate portion of each amount of interest otherwise paid or credited by the corporation to the specified non-residents to be a dividend, and not to be interest for the purposes of Part XIII of the Act.
However, paragraph 214(16)(b) allows the corporation to designate all or a portion of each specific interest payment to a particular non-resident as a dividend, to the extent of the total amount of the interest payments to that non-resident that were otherwise deemed to be a dividend under paragraph (a). Paragraph 214(16)(b) effectively allows the corporation to determine the timing of the deemed dividends for Part XIII purposes, allowing some flexibility and certainty as to Canco's Part XIII withholding and remittance obligations in regards to the deemed dividend amounts. However, the paragraph does not allow the corporation to transfer a deemed dividend from one payee to another, to alter amounts paid to a specified non-resident, or to affect the timing of amounts paid.
Following from the example described in the question, assume that the Canadian resident corporation (Canco) has $1,000 in paid-up capital, and no other equity for the purposes of the thin capitalization rules throughout the entire year. Canco has two $1,000 loans outstanding, one from the US corporation (US-Co) bearing annual interest at 7%, and the other from the UK corporation (UK-Co) bearing annual interest at 5%. Both loans require semi-annual, interest-only payments at the end of Canco's second and fourth fiscal quarters. Canco and UK-Co are both wholly-owned subsidiaries of US-Co.
Under this scenario, the interest payments from Canco in respect of the two loans are:
| Quarter 2: |
Quarter 4: |
| $35 interest paid to US-Co |
$35 interest paid to US-Co |
| $25 interest paid to UK-Co |
$25 interest paid to UK-Co |
With the permitted 1.5-to-1 debt-to-equity ratio, Canco has $500 of total excess debt, calculated as ($2,000 1.5 x $1,000)/$2,000, or 25% of $2,000. Accordingly, 25% of the annual interest paid by Canco on the loans to US-Co and UK-Co will be denied deduction under subsection 18(4).
Pursuant to subparagraph 214(16)(a)(i), the appropriate portion (i.e., 25%) of each interest payment from Canco to US-Co and UK-Co is deemed to be a dividend for the purposes of Part XIII, absent a designation under paragraph 214(16)(b).
As such, absent a paragraph 214(16)(b) designation, the non-resident interest payments from Canco will be treated as:
| Quarter 2: |
Quarter 4: |
| $26.25 interest paid to US-Co |
$26.25 interest paid to US-Co |
| $ 8.75 dividend paid to US-Co |
$ 8.75 dividend paid to US-Co |
| $18.75 interest paid to UK-Co |
$18.75 interest paid to UK-Co |
| $ 6.25 dividend paid to UK-Co |
$ 6.25 dividend paid to UK-Co |
However, paragraph 214(16)(b) allows Canco to designate amounts of specific interest payments as dividends paid to the respective non-resident recipient, i.e., US-Co or UK-Co , up to the total amount of interest deemed to be a dividend to that respective payee.
More specifically, Canco was deemed to have paid $17.50 of total dividends to US-Co and $12.50 of total dividends to UK-Co pursuant to paragraph 214(16)(a). In this situation, Canco may prefer to designate $17.50 of its fourth quarter US-Co interest payment to be a dividend, and $12.50 of its fourth quarter UK-Co interest payment to be a dividend.
Therefore, following the designation, the non-resident interest payments from Canco will be treated as:
| Quarter 2: |
Quarter 4: |
| $35.00 interest paid to US-Co |
$17.50 interest paid to US-Co |
|
$17.50 dividend paid to US-Co |
| $25.00 interest paid to UK-Co |
$12.50 interest paid to UK-Co |
|
$12.50 dividend paid to UK-Co |
Eli Kae Moore
2013-048373
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