18 March 1992 Income Tax Severed Letter 9206635 - Loan Guarantee Fee and Shareholder Benefit

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Subject: LOAN GUARANTEE FEE AND SHAREHOLDER BENEFIT Section(s): 15(1), 69(3), 214(3)]

XXX 920663 S. Shinerock (613) 957-2108

Attention: XXX

March 18, 1992

Dear Sirs:

Re: Loan Guarantee Fee

We refer to your letter of February 27, 1992, in which you requested our views on a situation involving a client of yours that is the subject of consideration by the Vancouver District Office in respect of an assessment under subsections 214(3) and 89(3) of the Income Tax Act (the “Act”). Our understanding of the facts of the situation as set out in your letter is described in the following paragraphs.

Your client is the wholly-owned Canadian subsidiary of its U.S. parent company. Some years ago, the U.S. parent wanted to arrange for additional borrowings from its U.S. bankers. It instructed its U.S. attorneys to prepare legal documentation so that its 100% shareholding in its Canadian subsidiary would be available as security for the additional borrowings. However, the hypothecation of the subsidiary's shares became more complicated than originally envisaged by the attorneys for the U.S. parent and the attorneys for the U.S. Bank. There was also a pressing deadline at the time, and as the deadline approached, it was decided that a guarantee given by the subsidiary would be simpler and quicker to accomplish. The subsidiary duly executed the guarantee.

According to your letter, the Vancouver District Office (the “VDO”), proposes to assess the Canadian subsidiary under subsection 214(3) of the Act, since the VDO views the guarantee as a benefit given by the subsidiary to its U.S. parent such that the amount that would be required by subsection 15(1) of the Act to be included in computing the income of the U.S. parent had it been resident in Canada would be deemed to have been paid by the subsidiary to the U.S. parent as a dividend. Consequently, the dividend would be subject to withholding tax pursuant to subsections 212(2) and 215(1) of the Act, subject to the provisions of the Canada-U.S. Income Tax Convention (1980).

You believe that the proposed assessment is founded upon Question 3 of the Revenue Canada Round Table Discussion that took place at the 43rd Tax Conference held in November 1991 in Toronto. In this question, the Department took the position that if a Canadian subsidiary of a foreign parent guarantees the loan obligations of its parent, then:

• (a) Subsection 15(1) would apply to any benefit conferred on the parent if Part I of the Act was applicable to non-residents with the result that subsection 214(3) will apply to the benefit.
• (b) The amount of the benefit is a question of fact which can only be decided on a case by case basis.
• (c) Subsection 69(3) will apply to deem the amount that would have been reasonable in the circumstances, if the corporations had been dealing at arm's length, to have been received or receivable by the Canadian subsidiary.

In your view, Question 3 was broadly worded, and was not intended to apply to a situation such as yours. You mention that if the U.S. parent had persevered with the legal documentation and arranged security by way of a pledge of the Canadian subsidiary's shares, then there would not be any question of a benefit to the U.S. parent, and there would be no resulting income to the subsidiary. You also distinguish between a subsidiary's guarantee of its parent's borrowings and a guarantee given by a third party, such as a bank, for a fee. In the case of a guarantee given by a subsidiary, you believe that the assets of the subsidiary are no more at risk by having entered into the guarantee than if it had not, since if the parent was unable to repay its debt, it could wind up the subsidiary and use its assets to repay the debt. Therefore, from the point of view of the Canadian subsidiary, its risk of economic loss was not increased by guaranteeing the debt of its U.S. parent.

You also question the application of subsection 89(3) of the Act to your situation. In the first instance, you infer that the giving of a guarantee by the Canadian subsidiary to the U.S parent may not represent “other services” in the context of the subsection. Secondly, on the assumption that subsection 89(3) would apply, and in the context of your arguments given above, you consider that the amount of consideration for those services that would have been reasonable in the circumstances in respect of the loan guarantee would be nominal, since the parent derives little or no benefit from the loan guarantee.

In summary, you are of the view that the Canadian subsidiary has given up nothing by signing the loan guarantee referred to above, and no benefit has therefore been conferred on its U.S. parent. You also state that it does not seem reasonable that structuring the loan guarantee in a different form with essentially the same economic results should yield different income tax consequences. Here, you appear to equate the risk of the Canadian subsidiary in honouring the guarantee with the winding-up of the subsidiary into the U.S. parent.

Opinions

Normally, we do not comment on any situation that is under active consideration by a District Office, unless the District Office has referred it to us for our opinion. However, we are able to offer the following general comments on your situation.

In our opinion, the response given to Question 3 at the 1991 Revenue Canada Round Table was not too broad. Here, we would point out that part (a) of our response merely mentions that subsection 15(1) of the Act will apply to any benefit conferred on the parent. If, as a question of fact, there is no benefit, then subsection 15(1) does not apply.

The issue of whether a loan guarantee constitutes “other services” has been settled in the tax case “Melford Developments Inc. v. Her Majesty The Queen (80 DTC 8075 FCTD)”. In setting out the facts of this case at pages 8078/77, the court said that:

• “The guarantee given...was part of its ordinary business and the fees paid to it for such service were receipts earned by it in its normal banking operations.”

The decision of the FCTD was affirmed by the FCA (81 DTC 5020) and by the Supreme Court of Canada (82 DTC 6281) without, however, commenting on the aspect of the guarantee as a service. Accordingly, we consider the FCTD decision in Melford to be good law, and are of the view that the providing of a loan guarantee constitutes a service.

In principle, we are unable to agree with your view that structuring a transaction in one particular manner to yield the same economic results that might have been achieved had the transaction been structured in a different manner should also yield the same tax consequences. This argument was considered in Charles Perrault v. Her Majesty the Queen (78 DTC 6272 FCA). In rendering its decision, the court stated that:

• “...The incidence of taxation depends on the manner in which a taxpayer arranges his affairs. Just as he may arrange them to attract as little taxation as possible, so he may unfortunately arrange them in such a manner as to attract more than is necessary.”

If the Canadian subsidiary had not signed the loan guarantee, it is possible that the loan to the U.S. parent may not have been granted. Furthermore, in signing the guarantee, the subsidiary has put itself at risk. In this regard, no person dealing at arm's length with another person would act as guarantor to a loan of that other person unless he received valuable consideration for the risk involved. Consequently, in our view, a benefit may be conferred on the parent notwithstanding that the subsidiary has not given up its beneficial ownership of any of its property.

Therefore, based on the facts presented above, we conclude that a basis exists for an assessment under subsections 214(3) and 89(3) of the Act in the event that a benefit has been conferred by the Canadian subsidiary on its U.S. parent. This is a question of fact on which we offer no comment. As indicated in our response to Question 3 of the Revenue Round Table Discussion referred to above, the amount of the benefit and the amount referred to in subsection 89(3) that would be reasonable in the circumstances are also questions of fact on which we are unable to comment.

We trust that these comments will help to clarify our views on this matter.

Yours truly,

Director General
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch