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.
Dear Sirs:
This is in reply to your letter of June 20, 1986 in which you requested our opinion on the application of certain provisions of the Income Tax Act (the "Act") in connections with the following assumed facts:
In 1971, a taxable Canadian corporation (Canco) incorporated a company in the Netherlands (BV). This company was and continues to be resident in the Netherlands and acts as the centre for the international operations of Canco including, initially, its internationally financing arrangements.
In 1978 BV incorporated a subsidiary company in the Netherlands Antilles (NV). The purpose of NV was to take over from BV the administration of the existing loans of BV and to control further financing arrangements primarily into the United States. All such loans were made from NV to related corporations which were generally second or third tier subsidiaries of Canco. NV carried on an active business as that corn is defined in paragraph 125(7)(a) of the Act. All loans made by NV were to compani-es that carried on an active business and who used the funds loaned from NV in their active business.
At the time of incorporation, BV invested Dutch guilders (Df1) into NV which were in turn loaned to the U.S. companies by NV in the form of U.S. Dollar denominated loan agreements. Although the unit of currency in the Netherlands Antilles is the Netherlands Antilles guilder (NAf), NV maintains its books and records in U.S. Dollars, prepares financial statements in U.S. Dollars and reports its income tax position to the Netherlands Antilles authorities based on U.S,. Dollars through to the computation of -income taxes payable which is then covered to NAf.
For purposes of computing taxable income in the Netherlands Antilles, NV is permitted an annual statutory deduction based on a reserve computed as 7.5% of the outstanding loan portfolio of NV at the end of a taxation year. A special ruling was obtained from the Netherlands Antilles taxation authorities that on the liquidation of NV in lieu of a full recapture of the amounts of reserve previously deducted, as is contemplated under the tax legislation, only 10% of such amount would be recaptured and taxed i-n the Netherlands Antilles. The remaining 90% of the reserve is effectively tax exempt.
NV was liquidated in 1987. The tax law of the Netherlands Antilles permits the liquidation on a tax-free basis subject to the recapture of a reserve as described above.
In your letter you addressed sixteen issues (paragraphs A to P), analyzed each of them and gave your opinion. In responding we will give you our views on each of these issues. Our comments are as follows:
A) We agree that based on these facts U.S. currency would appear to be reasonable in the circumstances in determining the surplus accounts of NV.
B) We agree that in accordance with clause 5907(1)(a)(i)(A) of the Income Tax Regulations (the "Regulations") the bad debt reserve reduces the earnings of NV. Subsection 5907(2) of the Regulations will not normally apply to cause the reserve to be added to earnings. In the year the special ruling received by the Netherland Antilles taxation authorities applies subsection 5907(2) of the Regulations would apply (see comments in paragraph K).
C) We agree that paragraph 95(2)(e.1) if the Act is not applicable on the liquidation as BV and NV are not both resident in the same country. Provided NB did not own shares in a foreign affiliate immediately before the liquidation, we also agree that neither subsection 88(3) of the Act not paragraph 95(2)(e) of the Act are applicable with respect to the liquidation.
D) We agree that in the absence of specific rules to the contrary, subsection 69(5) of the Act is applicable on the liquidaries of NV. Provided the shares of NV are "excluded property", as defined in paragraph 95(1)(a.1) of the Act, we agree that on the disposition of the shares of NV by BV subsection 93(1.1) of the Act will deem on election under subsection 93(1) of the Act to be made. The amount of the deemed election is determined under subsection 5902(6) of the Regulations.
E) We agree that subsection 5907(9) of the Regulations is applicable on the liquidation and therefore subsection 5907(5.1) of the Regulations is not applicable. Your comments on a deemed taxation year for NV are in accordance with paragraph 5907(9)(a) of the Regulation.
F) We agree with your comments as they are in accordance with paragraph 5907(9)(b) of the Regulations.
G) We agree that the earnings computed under paragraph 5907(1)(a) of the Regulations for the 1982 taxation would be determined under the tax laws of the Netherlands Antilles and would not include accrued unrealized gains on the property of NV. As a result of the liquidation of NV we agree that if the property is inventory, pursuant to subsection 5907(9) and paragraph 5907(2)(f) of the Regulations the earnings will be adjusted to include any accrued gains on the property distributed to BV on the liquidation. If the property is capital property, pursuant to subsection 69(5) and paragraph 95(2)(f) one-half of the post November 12, 1981 gain will be included in taxable surplus and the remaining portion of the gain will be included in exempt surplus.
H) It is our opinion that if the property would be inventory then we would agree with your analysis that using U.S. currency in the situation described would be appropriate. If the property is capital property it is reasonable in the circumstances that any gain or loss should be determined in U.S. currency (see comments in paragraph A) in accordance with paragraph 95(2)(f) of the Act.
I) We do not agree that solely because U.S. currency will be used no gain or loss will be realized on the deemed dispositions of the loan portfolio. The fair market value proceeds of the loans in U.S. Dollars may differ from the original cost in U.S. Dollars. This will depend on the terms and conditions of the loans (i.e. a loan with an interest rate of 15% for a fixed term of 10 years may have a fair market value in excess of its principal amount). Subsection 65(4) of the Act would deny any capital loss realized.
- We agree that there is not provision in the Act or the Regulations to require that the original principal amount of a particular loan be reduced in respect of a particular statutory reserve such as that contemplated under the Netherland Antilles tax legislation.
J) We agree that the 10% of the reserve recaptured under the tax laws of the Netherland Antilles would be included in the computation of earnings in NV's 1982 taxation year.
K) It is our opinion that the 90% of the reserve not subject to recapture pursuant to a tax ruling would not be included in earnings as determined in paragraph 5907(1)(e) of the Regulations. However, we believe that an adjustment to earnings pursuant to paragraph 5907(2)(f) of the Regulations would result in the 90% of the reserve being included in earnings in the 1982 taxation year.
L) See comments in paragraph N
M) Provided the shares of NV are excluded property, the currency need is determining any gain or loss on the disposition of the shares of NV by BV should be determined in accordance with subparagraph 95(2)(f)(ii) of the Act. BV is resident in the Netherlands and taking into consideration your analysis it would appear that the Dutch guilder is the currency that should be used to determine any gain or loss on the disposition of the shares of NV.
N) Provided the shares of NV are excluded property, by virtues of subparagraph 95(1)(b)(ii) no portion of any gain realized on the disposition of the shares of NV will be included in the foreign accrual property income of BV as it is determined in paragraph 95(1))b) of the Act.
O) We agree with your analysis that paragraph 95(2)(h) of the Act does not apply to deem any capital gain or capital loss by BV on the disposition of the shares of NV to be nil. However, as stated in paragraph I, a gain or loss may result from something other than fluctuations in currency.
P) Provided the shares of NV are excluded property, by virtue of clause 5907(1)(b)(i)(N), subparagraph 5907(1)(f)(iv) and clause 5907(1)(i)(ii)(N) of the Regulations one-half of any gain realized on the disposition of the shares of NV would be included in exempt earnings and one-half of any gain would be included in taxable earnings.
We trust this information will be of assistance to you.
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