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.
Revenue Canada Taxation Head Office
XXXX
K.B. Harding (613) 957-2129
April 12, 1988
Dear Sirs:
This is in reply to your letter of December 23, 1987 concerning the treatment of the loan when the right to repayment is waived in the following hypothetical situation.
1. Canco is wholly-owned subsidiary of Parent which is in turn owned by U.K. Co. Both Parent and U.K. Co. are corporations resident in the United Kingdom.
2. In Year 1 Canco makes a loan to U.K. Co. The borrowed funds are not used by U.K. Co. in connection with any business carried on by it in Canada.
3. The loan is not repaid by the end of Year 2 with the result that subsection 15(2) and paragraph 214(3)(a) apply to deem the amount of the loan to be a dividend paid by Canco to U.K. Co. in Year 1. The deemed dividend is subject to a 10% withholding tax pursuant to the provisions of the Canada-U.K. Tax Convention.
4. In Year 4 Canco agrees to waive its right to repayment of the loan. U.K. Co. is fully capable of repaying the loan. The waiver is designed to avoid Canadian withholding tax being applied for a second time on a repayment of the loan and a subsequent distribution of the proceeds to Parent (as a dividend or as a deemed dividend on the winding up of Canco).
It is our opinion that in the above hypothetical situation when Canco agrees to waive its right to repayment that the debt has been settled or extinguished without any payment and U.K. Co. will be subject to section 80 of the Income Tax Act. However, for purposes of Canco, the company would have a disposition of property by virtue of clause 54(c)(ii)(B) of the Act and subparagraph 69(1)(b)(i) would apply to deem Canco to have received proceeds of disposition equal to the fair market value of the debt. Since U.K. Co. has the ability to repay its indebtedness to Canco, we are of the view that the proceeds of disposition of the loan would probably be equal to principal amount of the loan. Where the proceeds from the disposition of the loan is different from the adjusted cost base, a gain or loss may be realized by Canco. In addition, if the loan is in foreign currency a capital gain or loss may arise in accordance with subsection 39(2) of the Act.
It is our view that in the above situation where the loan is settled or extinguished without any payment to Canco, such cancellation of the loan will not result in the application of subsections 15(1), 245(2) or 247(1) of the Act.
Generally speaking, when a debt is settled or extinguished the provisions of section 80 of the Act will generally apply to the non-resident corporation but will generally not result in any tax consequences unless the non-resident corporation is subject to Part I tax in Canada. Since we do not have all the details to determine whether or not U.K. Co. meets all the requirements for the exemption set out in paragraph 80(1)(d) of the Act, we are not in a position to make that determination.
You have also questioned whether our views would remain the same if U.K. Co. were not resident in a country having a tax treaty with Canada. It is our view that subsection 15(2) would apply in the same manner, however, the amount included in the income of U.K. Co. would be subject to withholding tax at the rate of 25% rather than the rate provided for in the Convention with the United Kingdom.
It is our opinion that if Canco were to transfer its loan due from U.K. Co. to Parent for nominal consideration, Canco will be considered to have proceeds of disposition equal to fair market value by virtue of subparagraphs 54(c)(i) and 69(1)(b)(i) of the Act and the results would parallel those set out above. If Canco were to declare a dividend in kind, when it transfers the loan due from U.K. Co. to its parent, the dividend would be equal to the fair market value of the loan receivable transferred to its parent and would be subject to withholding tax in accordance with the Canada-U.K. Tax Convention.
We trust these comments are suitable for your purposes.
Yours truly,
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch
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