2 November 1990 External T.I. 901355 F - U.S. Internal Revenue Code Re Treatment of Certain Interests in Corporations as Stock or Indebtedness

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.

19(1)

November 2, 1990

Dear Sirs:

Re:  United States Internal Revenue Code Section 385 "Treatment of certain interests in corporations as stock or indebtedness"

This is in reply to your letter dated June 15, 1990 whereby you requested our opinion as to whether interest paid to a Canadian corporation (Canco) by its United States subsidiary (USCo) on a loan made by Canco to USCo would be considered to be a dividend for purposes of the Income Tax Act in respect of which Canco would be entitled to a deduction under section 113 of the Act if such interest is re-characterized and deemed to be a dividend by and for purposes of the United States Internal Revenue Code.

In our opinion, the interest paid by USCo to Canco on the loan made by Canco to USCo would be considered to be interest and taxable as such under the Income Tax Act and Canco would not be entitled to a deduction under section 113 of the Act in connection therewith, irrespective of whether such interest is re-characterized and deemed to be a dividend by and for the purposes of the United States Internal Revenue Code.

Amounts paid by a corporation resident in the United States to a corporation resident in Canada that are deemed to be dividends by and for purposes of the taxation laws of the United States may, by virtue of paragraph 3 of Article X of the Canada-United States Income Tax Convention, 1980 (the "Convention"), be deemed to be dividends for purposes of Article X of the Convention. However, paragraph 3 of Article X only applies for purposes of that Article.

Consistent with paragraph 1 of Article X and paragraph 1 of Article XI and as provided by paragraph 2 of Article XXIX of the Convention, the Convention does not affect the manner in which Canada may tax residents of Canada in respect of interest and dividends and accordingly the taxation of residents of Canada in respect of interest and dividends arising in the United States is to be in accordance with the provisions of the Income Tax Act.

We cannot rule out the possibility that a taxpayer may be granted relief from taxation in a particular situation by virtue of the provisions of Article XXVI of the Convention and thus recommend that an application be made pursuant to paragraph 1 of Article XXVI of the Convention where a person considers that the actions of one or both of the Contracting States result or will result for him in taxation not in accordance with the provisions of the Convention. However, having regard particularly to paragraph 8 of Article XXV of the Convention, we very much doubt that an application in respect of Internal Revenue Code Section 385 will be entertained by the competent authority of the United States.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch