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.
Reasons: The dividend is not an amount that is income from an offshore investment fund property.
Principal Issues: How to determine whether an investment is Offshore Investment Fund Property?
Position: General guidance provided.
Maria Guerrera HEADQUARTERS
Team Leader Income Tax Rulings Directorate
Audit division
XXXXXXXXXX K. Graham
2019-081039
Subsection 94.1(1)
Further to a memorandum dated April 25, 2019 from the Abusive Tax Avoidance and Technical Support Division and subsequent discussion with you, this is in reply to your request asking for our views on certain elements of the offshore investment fund property rules found in subsection 94.1(1) of the Income Tax Act (the “Act”, all legislative references in this document are to the Act, unless otherwise specified).
In particular, you have asked the following questions:
1. What is a “portfolio investment”, as that term is used in paragraph 94.1(1)(b)?
2. Should tax attributes, such as interest deductions, foreign tax credits, or a loss pool, be taken into account to establish whether the “one of the main reasons” test in the mid-amble of subsection 94.1(1) that starts before paragraph 94.1(1)(c) and ends after paragraph 94.1(1)(e) is to achieve the tax benefits described in that provision?
Legislation
Section 94.1 was enacted in 1984 and was described in the Department of Finance’s explanatory notes (“Notes”), in part, as follows:
“New section 94.1 contains an anti-avoidance provision relating to investors in offshore investment funds. This provision applies where a taxpayer has invested in an offshore investment fund and one of the main reasons for such investment was to reduce or defer the tax liability that would have applied to the income generated from the underlying assets of the fund if such income had been earned directly by the taxpayer.”
The text of paragraphs 94.1(1)(a) and (b) describes the properties that are referred to in section 94.1 as “offshore investment fund property” and reads as follows:
“If in a taxation year a taxpayer holds or has an interest in property (referred to in this section as an “offshore investment fund property”)
(a) that is a share of the capital stock of, an interest in, or a debt of, a non-resident entity (other than a controlled foreign affiliate of the taxpayer or a prescribed non-resident entity) or an interest in or a right or option to acquire such a share, interest or debt, and
(b) that may reasonably be considered to derive its value, directly or indirectly, primarily from portfolio investments of that or any other non-resident entity in
(i) shares of the capital stock of one or more corporations,
(ii) indebtedness or annuities,
(iii) interests in one or more corporations, trusts, partnerships, organizations, funds or entities,
(iv) commodities,
(v) real estate,
(vi) Canadian or foreign resource properties,
(vii) currency of a country other than Canada,
(viii) rights or options to acquire or dispose of any of the foregoing, or
(ix) any combination of the foregoing…”
Portfolio investments
The term “portfolio investments” used in paragraph 94.1(1)(b) is not defined in the Act. The CRA has previously commented on the meaning of the term “portfolio investments.” At the 1986 conference of the Canadian Tax Foundation (“CTF”), the CRA stated that the term is to be given a broad meaning that will be informed by the context in which it is used and industry practices:
“It appears that, as used in section 94.1 and proposed paragraph 206(1)(d.1), the term “portfolio investments” has a very broad meaning. In general, the interpretation of that term will depend on the context in which it is used in the Act and on what a portfolio investment is considered to be in commercial practice by such persons as investors, investment managers, and investment promoters.”
At the 1990 CTF conference, the CRA reiterated that the term “portfolio investments” must be given a sufficiently broad meaning to encompass the types of different properties listed in paragraph 94.1(1)(b), and stated that “The department is of the opinion 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 or from those investments defined as portfolio investments in the CICA Handbook.”
In the case of Gerbro Holdings Company v. The Queen [2016 TCC 173] (“Gerbro”), as affirmed by the Federal Court of Appeal [2018 FCA 197], the Tax Court of Canada (“TCC”) contemplated the meaning of the term “portfolio investments” by considering various definitions, including those used in an international investment context. The sources of such definitions included Black’s Law Dictionary, Moneyterms online, the International Monetary Fund and the International Bureau of Fiscal Documentation. Some of those definitions contrasted the term “portfolio investment” with “direct investment,” where a “direct investment” is one made with the intention to exercise significant influence over the operations of the enterprises, and a “portfolio investment” being one which is not a direct investment.
Having considered the various definitions, the TCC in Gerbro stated, at paragraph 101, that “the ordinary commercial meaning of portfolio investment in the international investment context is an investment in which the investor (non-resident entity) is not able to exercise significant control or influence over the property invested in.”
At paragraph 102 of the Gerbro decision, the TCC suggested that an investor having anywhere from 10% to 25% ownership could have a controlling interest in its investees, but that such a determination would have to be made on the facts.
The description in paragraph 101 of the Gerbro decision quoted above is not a complete definition of what constitutes a “portfolio investment” but rather excludes some types of property from that definition. To that extent, the meanings suggested by the various definitions considered by the TCC, as well as by the CRA prior to the Gerbro decision, continue to be relevant. As previously noted, CRA’s view is that the term “portfolio investment” must be given a broad meaning and is not limited to passive investments. In paragraph 94.1(1)(b), the word “portfolio” modifies the word “investment” to specify that the investment in particular assets by the investor is one in which the investor does not have an active role in the management of the item invested in. This is so, regardless of the number, value or length of ownership of such assets by the investor.
The determination of whether a particular investment is a “portfolio investment” for the purpose of section 94.1 must be made with regard to all relevant facts and circumstances. The elements relevant to that determination may include, amongst others, consideration of the number of assets invested in, the intention and objectives sought, the relative value of those investments, the degree of influence that the investor has on the management of the particular assets invested in, and the taxpayer’s direct and indirect ownership interest in the investor.
At paragraph 105 of the Gerbro decision, the TCC stated the following:
“According to the definition I have accepted, the same investment could be classified differently with respect to different persons. For example, a minority shareholder with a small block of shares may be deriving value from a portfolio investment, whereas another shareholder, who has a controlling interest, will not be.”
The test in paragraph 94.1(1)(b) is whether the taxpayer’s interest in the property identified in paragraph 94.1(1)(a) “may reasonably be considered to derive its value, directly or indirectly, primarily from portfolio investments of that or any other non-resident entity” in the property listed in subparagraphs 94.1(1)(b)(i) to (ix). As pointed out by the TCC in paragraph 119 of the Gerbro decision, that test might still be met even if some of the investments of the non-resident entity are not “portfolio investments” listed in subparagraphs 94.1(1)(b)(i) to (ix):
“The Funds need only primarily derive their value from portfolio investments. This means that holding a minimal amount of controlling interests that are not portfolio investments or that are portfolio investments in non-listed assets is insufficient to result in the Value Test not being met.”
Tax attributes and the “one of the main reasons” test
The “one of the main reasons” test (hereafter referred to as the “Motive Test”) in subsection 94.1(1) reads:
“and it may reasonably be concluded, having regard to all the circumstances, including
(c) the nature, organization and operation of any non-resident entity and the form of, and the terms and conditions governing, the taxpayer's interest in, or connection with, any non-resident entity,
(d) the extent to which any income, profits and gains that may reasonably be considered to be earned or accrued, whether directly or indirectly, for the benefit of any non-resident entity are subject to an income or profits tax that is significantly less than the income tax that would be applicable to such income, profits and gains if they were earned directly by the taxpayer, and
(e) the extent to which the income, profits and gains of any non-resident entity for any fiscal period are distributed in that or the immediately following fiscal period,
that one of the main reasons for the taxpayer acquiring, holding or having the interest in such property was to derive a benefit from portfolio investments in assets described in any of subparagraphs (b)(i) to (ix) in such a manner that the taxes, if any, on the income, profits and gains from such assets for any particular year are significantly less than the tax that would have been applicable under this Part if the income, profits and gains had been earned directly by the taxpayer…”
The part of the midamble the follows paragraph 94.1(1)(e) embodies the core of the Motive Test. It will be met and result in the application of section 94.1 to a taxpayer where it may reasonably be concluded that one of the main reasons for the taxpayer acquiring, holding or having an interest in a non-resident entity was to derive a benefit from portfolio investments in assets described in subparagraphs 94.1(1)(b)(i) to (ix) in such manner that the foreign taxes on the income, profits and gains from the portfolio investments of the investor (i.e., non-resident entity) for any particular taxation year are significantly less than the Part I tax that would apply on those income, profits and gains had they been earned directly by the taxpayer.
The part of the midamble that precedes paragraph 94.1(1)(c) provides that the Motive Test should be applied taking into account all circumstances, including those listed in paragraphs 94.1(1)(c) to (e). As pointed out by the TCC in Gerbro, surrounding circumstances form the benchmark against which the reasonability of the stated reasons for investing are tested:
“153. While the Motive Test is not a purely subjective test, a finding as to intention and the importance of an intention is a factual determination intrinsically linked to the evidence provided at trial: Minister of National Revenue v. Furnasman Ltd., [1973] F.C. 1327, [1973] C.T.C. 830 (Fed. T.D.) at pages 1336-37 F.C., 836-37 C.T.C. The stated reasons must be objectively reasonable, taking into account the surrounding circumstances of the investments in the fund, notably the factors listed in paragraphs 94.1(1)(c) to (e).”
As the TCC outlined in the general summary of different cases in paragraph 157, when considering whether tax motivation is “one of the main reasons” for actions, there is no single test. The relevant facts and circumstances need to be reviewed with recognition that taxpayers are unlikely to make representations adverse to their interests. The more surrounding circumstances support that that non-tax motivations drove a decision, the more it might be reasonable to conclude that tax motivations were not a “main reason” (Honeywood Ltd. v. R., [1981] C.T.C. 38 (T.R.B.) and Jordans Rugs Ltd. v. Minister of National Revenue, [1969] C.T.C. 445 (Can. Ex. Ct.)). Conversely, where non-tax reasons alone do not explain why a particular decision was made, it might be reasonable to conclude that tax motivation was a “main reason” (Continental Stores Ltd. v. R. (1978), 79 D.T.C. 5213 (Fed. T.D.) at 5217). Even if non-tax reasons may be sufficient to explain why a decision was made, that does not necessarily mean that tax motivation was not a main reason (Groupe Honco Inc v. The Queen, 2013 FCA 128, 2014 DTC 5006, at paragraph 24, aff'g 2012 TCC 305, 2013 DTC 1032).
As pointed out by the TCC in that decision, whether a tax deferral intention is a secondary reason or a main reason has to be determined based the surrounding circumstances particular to each situation:
161. The line between a main reason and a secondary reason is difficult to draw, especially if the reason is undeclared, since it must then be inferred from the relevant circumstances that a particular reason could perhaps be elevated to “main reason” status. Once it has been determined what the requisite benefit is for the purpose of the Motive Test, the determination of whether tax deferral was one of Gerbro's main reasons is entirely factual.
After a lengthy description and discussion of the particular facts, surrounding circumstances and evidence presented, the Court concluded that “the business reasons for investing in the Funds overshadowed any tax benefit obtained incidentally.”
Where applicable, paragraph 94.1(1)(e) results in the inclusion of the amount described in paragraph 94.1(1)(f) in the income of the taxpayer for a year in which the taxpayer holds the offshore investment fund property. That will be the case irrespective of whether the Motive test is satisfied in that year or in any other year when the taxpayer acquired, held or had an interest in the offshore investment fund property and also irrespective of the year in which the actual tax benefit would be derived. For example, if a taxpayer acquires an interest in a non-resident entity in a particular year, but the requisite benefit could be realized in a future year, the Motive Test could be met in the year of acquisition, as the benefit is tested in respect of “any particular year.” Thus, if the Motive Test is met in the year of acquisition, it does not have to be considered again in a future year.
A taxpayer’s Part I tax liability is computed on the basis of the taxpayer’s taxable income computed under division C for any particular taxation year under general principles. Consistent with the open ended nature of the list of circumstances described in paragraphs 94.1(1)(c) to (e) that inform the Motive test, the elements that inform the tax benefit contemplated by a taxpayer are relevant. The impact of a taxpayer’s tax attributes, such as non capital or net capital losses, should not be disregarded but the existence of such tax attributes does not automatically result in making section 94.1 inapplicable. What is required is a determination of the main reasons for the taxpayer acquiring, holding or having the interest as supported by an analysis of the relevant facts and circumstances to determine what reasons in fact motivated the transactions. If, based on all the facts and circumstances of a particular case, a taxpayer had tax attributes but could not have used them to offset the income from the offshore investment fund property had those investments been held directly by the taxpayer, or that the tax attributes could be used by the taxpayer to offset other income, then section 94.1 may still be applicable.
We trust our comments are of assistance.
Yours truly,
Charles Taylor
Section Manager
for Director
International division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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