3 December 2024 CTF Roundtable Q. 3, 2024-1038151C6 - Notifiable Transactions

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: Various questions regarding CRA's interpretation of the Designated Transactions in "NT 2023-05" (Back-to-back arrangements), including the meaning of "financing" for these purposes.

Position: See below.

Reasons: See below.

2024 CTF Annual Conference

CRA Roundtable

Question 3: Notifiable Transactions

Further to the introduction paragraphs, effective November 1, 2023, the following transactions (NT 2023-05) were designated for the purposes of section 237.4 as “notifiable transactions” (emphasis added):

In certain circumstances, the thin capitalization rules in subsections 18(4) to (8) and paragraph 12(1)(l.1) of the Income Tax Act deny a deduction, or provide for the inclusion of a deemed amount of income, in respect of an amount of interest that is paid or payable by a taxpayer or partnership on debts owing to certain non-residents specified in those rules, (generally, non-residents that hold a significant interest in the taxpayer, or that do not deal at arm’s length with a person that holds such an interest – in these notes referred to as a “relevant non-resident”). Supporting rules help to ensure the thin capitalization rules cannot be circumvented through the use of certain back-to-back lending arrangements involving intermediaries.

Parallel rules in subsections 212(3.1) to (3.3) help to ensure that withholding tax under Part XIII is not circumvented through the use of back-to-back lending arrangements, or back-to-back arrangements in respect of rents, royalties and similar types of payments. There are also character substitution rules in the Part XIII context.

Thin capitalization

Non-resident 1 (NR1) is a relevant non-resident in respect of a taxpayer. NR1 enters into an arrangement with an arm’s length non-resident (NR2) to indirectly provide financing to the taxpayer. The taxpayer files, or anticipates filing, its income tax returns on the basis that the debt or other obligation owing by it, and the interest paid thereon, is not subject to the thin capitalization rules.

Part XIII tax

A non-resident person (NR1) enters into an arrangement to indirectly provide financing to a taxpayer through another non-resident person (NR2). If interest had been paid by the taxpayer directly to NR1, it would be subject to Part XIII tax. The taxpayer’s income tax reporting reflects, or is expected to reflect, the assumption that the interest it pays in respect of the arrangement is either not subject to withholding tax at all or is subject to a lower rate of withholding tax than the rate that would apply on interest paid directly by it to NR1.

Alternatively, similar arrangements are entered into in respect of rents, royalties or other payments of a similar nature, or to effect a substitution of the character of the payments.

The above Designated Transactions are broken up into two segments: the “Thin capitalization” segment and the “Part XIII tax” segment. Both segments make reference to an “arrangement to indirectly provide financing.”

A. What is the scope of the term “financing”? Is this limited to the advancing of debt or could equity subscriptions also be caught?

B. What, if any, role does taxpayer intent/purpose play in determining whether such a transaction is a notifiable transaction?

C. Is there an inherent materiality concept?

D. Public shareholders (including non-residents) wholly own Foreign Parent (a non-resident corporation) which in turn owns all of the shares of Foreign Opco (a non-resident corporation). Foreign Opco owns all of the shares of Canco (a Canadian resident corporation).

The public shareholders subscribe for shares of Foreign Parent. Foreign Parent uses the share subscription proceeds received to (i) make an interest bearing loan to Foreign Opco and (ii) subscribe for shares of Foreign Opco. Foreign Opco uses all of the loan and equity proceeds received to make an interest-bearing loan to Canco. Interest paid by Canco to Foreign Opco is subject to a 10% withholding tax rate. If the interest had been paid by Canco to Foreign Parent a 15% withholding tax rate would apply. The arrangement does not meet the conditions of the character substitution rules in subsection 212(3.6) and there are no “specified shares” as defined in subsection 212(3.8).

In the above scenario, what parties would be considered NR1 and NR2, respectively, and what are their reporting obligations under subsection 237.4(4)?

CRA Response (A)

The wording of each segment is premised on the notion that there is interest paid or payable on a debt or other obligation owing by the taxpayer to NR2.

With respect to the nature of the financing provided by NR1 (the ultimate funder) to NR2 (the intermediary), the following considerations are relevant.

The Thin capitalization segment is premised on the back-to-back loan rules in subsection 18(6.1) which provide the Canadian thin capitalization implications of a back-to-back loan arrangement that meets the conditions in subsection 18(6). Therefore, this segment includes an arrangement that involves interest-bearing debt financing from NR1 to NR2 and from NR2 to the taxpayer, provided that the other conditions of this segment are met. However, this does not mean that there cannot be an equity component to the arrangement. For instance, if NR1 provided financing in the form of debt to NR2 while also investing equity in NR2 and the latter loaned the funds to the Canadian taxpayer, such arrangement could meet the conditions of the Thin capitalization segment of NT 2023-05.

The Part XIII tax segment is premised on the back-to-back loan rules in subsection 212(3.2) which provide the withholding tax implications in respect of interest that is paid as part of a back-to-back arrangement that meets the conditions in subsection 212(3.1). Therefore, this segment includes an arrangement that involves interest-bearing debt financing from NR1 to NR2 and from NR2 to the taxpayer. However, this does not preclude the existence of other forms of financing in addition to the aforementioned debt financing. This can be inferred from the words of the Part XIII tax segment, read in the context of subsection 212(3.1) (including the character substitution rules in subsections 212(3.6) and (3.81)).

The conditions of NT 2023-05 are not considered to be met where NR2 does not receive any interest-bearing debt financing. As an example, if NR2 receives equity financing through the issuance of its shares and uses all or a portion of such proceeds to make an interest-bearing loan to the taxpayer, the arrangement would not fall within the Part XIII tax segment in the context of subsection 212(3.1) provided it is clear that such shares (1) are not specified shares (as defined in subsection 212(3.8)) and (2) do not meet the conditions of the character substitution rules (in subsection 212(3.6)).

Further to describing the conditions required to be met under the Thin capitalization segment and the Part XIII tax segment in the context of interest-bearing debt, NT 2023-05 also states, “Alternatively, similar arrangements are entered into in respect of rents, royalties or other payments of a similar nature, or to effect a substitution of the character of the payments.” Accordingly, back-to-back arrangements that include rents, royalties or other or other payments of a similar nature (premised on subsection 212(3.9)) including the substitution of the character thereof are arrangements that may fall within the Part XIII tax segment of NT 2023-05.

CRA Response (B)

Further to the definition of “notifiable transaction” in subsection 237.4(1) and the description of the Designated Transactions in NT 2023-05, the transactions are not conditioned on intent or purpose. As noted in the CRA roundtable response at the 2024 IFA conference, the description of the Designated Transactions in NT 2023-05 does not differentiate between a situation where the back-to-back loan rules do not apply based on the requirements noted therein and a situation where the back-to-back loan rules were ignored. Accordingly the Designated Transactions as described, identify arrangements that have not been subjected to the rules in subsections 18(6.1) and/or 212(3.2) (or the rules in subsection 212(3.91) in the context of rents, royalties or other payments of a similar nature), regardless of why those provisions were not applied by the Taxpayer.

CRA Response (C)

No, there is no de minimis exception in section 237.4. Further to subsection 237.4(6) and as noted in the CRA MDR Guidance, a person who obtains or expects to obtain a tax benefit from a notifiable transaction and a person who enters into such transactions for the benefit of such a person will not have a reporting obligation if that person has exercised the degree of care, diligence and skill to determine whether a transaction is a notifiable transaction that a reasonably prudent person would have exercised in comparable circumstances. In addition, with respect to advisors, promoters and certain non-arm’s length persons, subsection 237.4(7) provides that a reporting obligation will not arise unless the person knows or should reasonably be expected to know that the transaction was a notifiable transaction. In regards to the penalty provisions in subsection 237.4(12), the application of penalties will be subject to Headquarters’ oversight and approval requiring mandatory referrals as outlined in the CRA MDR Guidance.

CRA Response (D)

In the context of the Part XIII tax segment of NT 2023-05, Foreign Parent would be NR1 as Foreign Parent is considered to be the ultimate funder of the debt financing and Foreign Opco would be NR2 as the intermediary. Provided that the following conditions are met, the arrangement would constitute a “notifiable transaction”:

(1) if interest had been paid by the taxpayer directly to NR1, it would be subject to Part XIII tax; and

(2) the taxpayer’s income tax reporting reflects, or is expected to reflect, the assumption that the interest it pays in respect of the arrangement is either not subject to withholding tax at all or is subject to a lower rate of withholding tax than the rate that would apply on interest paid directly by it to NR1,

The first condition would be met as, if the interest had been paid by the taxpayer directly to NR1 it would be subject to Part XIII tax. If the taxpayer determines that the arrangement does not meet the conditions in subsection 212(3.1) and therefore remits and reports withholding tax in respect of interest paid to NR2 at a rate of 10%, the second condition would also be met. Accordingly, the arrangement would constitute a “notifiable transaction” and would be subject to the reporting requirements in subsection 237.4(4).

Subsection 237.4(4) provides that an information return in prescribed form and containing prescribed information in respect of a notifiable transaction must be filed with the Minister by

(a) every person for whom a tax benefit results, or for whom a tax benefit is expected to result based on the person's tax treatment of the notifiable transaction, from

(i) the notifiable transaction,

(ii) any other notifiable transaction that is part of a series of transactions that includes the notifiable transaction, or

(iii) a series of transactions that includes the notifiable transaction;

(b) every person who has entered into, for the benefit of a person described in paragraph (a), the notifiable transaction;

(c) every advisor or promoter in respect of the notifiable transaction; and

(d) every person who is not dealing at arm's length with an advisor or promoter described in paragraph (c) and who is or was entitled, either immediately or in the future and either absolutely or contingently, to a fee in respect of the notifiable transaction.

With respect to the words “every person for whom a tax benefit results” in paragraph (a) of subsection 237.4(4), Foreign Parent would be considered to have received a “tax benefit” based on the meaning of that term in subsection 245(1) read in the context of the Part XIII tax segment of NT 2023-05. Foreign Parent would be required to file an information return pursuant to paragraph (a) of subsection 237.4(4) and Foreign Opco and Canco would also be required to file pursuant to paragraph (b).

Komal Patel
2024-103815
December 3, 2024

Response prepared in collaboration with:

Richard Archambault & Joseph Armanious
Tax Avoidance Division, International and Large Business Directorate
Compliance Programs Branch