8 April 1992 External T.I. 9200375 F - Whether Hypothecation Of Treasury Bills A Loan (6797-1)

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.

Attention: XXXXXXXXXX

April 8, 1992

Dear Sirs:

Re: Thin Capitalization

This is in reply to your letter of December 17, 1991 wherein you requested our opinion whether the thin capitalization and withholding tax rules would apply to the following hypothetical situation.

(a)     Holdco is a non-resident corporation and owns all of the issued shares of Canco.

(b)     Canco is a company that is incorporated, resident and carrying on business in Canada.

(c)     Canco makes application to borrow funds (say $1,000,000) from a Canadian chartered bank (the Bank) to be used for the purpose of earning income from its business.

(d)     The Bank agrees to lend the funds to Canco on the condition that Holdco guarantees repayment of the loan and provides as security for its guarantee a hypothecation of Canadian government treasury bills in the amount of $1,000,000.

(e)     Holdco agrees to provide its guarantee and the required security and the Bank proceeds to lend Canco $1,000,000 with interest at the Bank's prime lending rate. The only security for the loan is Holdco's guarantee and hypothecation.

Generally, the Department would not consider the mere hypothecation of Canadian government treasury bills, as security for the Bank to make a loan to Canco, to constitute a loan for purposes of subsection 18(6) of the Income Tax Act (the "Act").  Accordingly, subsection 18(4) of the Act would likely not have application to this arrangement as the Bank is not a "specified non-resident".  However, in a particular transaction the Department would reserve its right to review all of the facts in order to assure that the granting of such security by a specified non-resident shareholder could not be considered the making of a loan to the Bank.

Where subsection 18(6) of the Act does not apply to the above situation there would be no requirement for Canco to withhold tax under paragraph 212(1)(b) of the Act on any interest paid to the Bank under the loan agreement as the Bank is a resident of Canada.

It should be noted that where an arrangement is structured in such a manner as to circumvent subsection 18(6) of the Act the Department would have to consider the possible application of section 245 of the Act to such an arrangement.

We trust the above comments are adequate for your purposes.

Yours truly,

for DirectorReorganizations and Foreign Division Rulings DirectorateLegislative and IntergovernmentalAffairs Branch