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.
April 16, 1993
Toronto District Office Head Office G.A. Taylor Financial Industries DivisionDirector S.J. Tevlin (613) 957-2746
Attention: J. McNamara
Classification of Income: Domestic vs Foreign
This is in response to your memorandum received by us on August 11, 1992. We apologize for the delay in responding to your request.
We agree with your position that Section 260 of the Income Tax Act (the "Act") would not apply to the transactions described in your memorandum provided all the transactions are between non-arm's length parties. Whether the participants are not at arm's length is a question of fact.
In regard to the your request for our opinion as to whether certain income is to be classified as Foreign or Domestic we offer the following comments:
Security Lending Arrangements ("SLA's")
In a typical SLA one party (the "borrower") will borrow certain securities from another party (the "lender"). The securities will be registered in the borrower's name and the borrower will be entitled to receive any interest or dividends that are paid by the issuer. As part of the SLA the borrower will agree to pay the lender compensation equal to any interest or dividends that would have been received by the lender on the securities lent ("compensation payment"). The borrower will often have to pledge security ("collateral") such as cash or a bank letter of credit in favour of the lender to secure the return of the securities to the lender. The lender would be named agent of the borrower with respect to the collateral and collect interest or dividends (if any) on the borrowers behalf and remit same to the borrower. Usually, the borrower pays the lender a fee ("lending fee") in consideration for entering into the arrangement.
(A)(i) Canadian corporation ("Canco", a registered securities dealer) lends Canadian securities to a non-arm's length non-resident that has no permanent establishment in Canada.
As section 260 of the Act does not apply, the loan of the securities to the borrower will result in a disposition and their subsequent return will result in an acquisition of the securities by the lender.
The result of this transaction is that there has been an acquisition of both legal and beneficial ownership of the security by the borrower. As such the borrower is the registered owner of the security and therefore entitled to any dividend\interest payment from the issuer.
Since the borrower is considered to have acquired the securities at the time the transaction occurs, and has agreed as part of the SLA to compensate the lender, an indebtedness would be incurred between the borrower and the lender. As such, any compensation payments made by the non-resident borrower would therefore represent foreign source income to Canco.
If it can be said that the lending of securities is a regular part of Canco's securities business in Canada and Canada is the situs where the lending decisions are made, then we would agree that the lending fee would represent domestic income to Canco (see IT-270R2 par.26).
(A)(ii) Canco lends Foreign securities to a non-arm's length non-resident that has no permanent establishment in Canada.
In respect to the compensation payment and the lending fee for the foreign securities, the classification of income would be similar to (A)(i).
(B)(i) Canco borrows Canadian securities from non-arm's length non-resident and gives Canadian collateral.
We agree that any income from the collateral would be classified as domestic income to Canco.
We agree that both the compensation payment and the lending fee would be domestic expense to Canco.
Any income from the borrowed securities would be considered domestic source income to Canco.
As you have noted, there may be situations where the receipt of a dividend is subject to either of subsections 112(1) or (2) and is part of a dividend rental arrangement. Where this is the case such arrangement would be subject to the application of subsection 112(2.3).
(B)(ii) Canco borrows Foreign securities from non-arm's length non-resident and gives Foreign collateral.
We agree that the compensation payments made to the non-resident would be deductible in calculating the income of Canco.
As described in paragraph 29 of IT-270R2, where interest is earned, other than in the course of carrying on a business in a foreign country, the residence of the debtor ordinarily determines the territorial source of the income.
In respect to dividends received on foreign securities, paragraph 30 of that bulletin states that where the shares are shares of a corporation which is resident in a foreign country and not resident in Canada, the dividend will normally be recognized as being from a source in that foreign country.
Where the income from the securities is a dividend received by Canco on shares of a foreign affiliate, we agree that subsection 113(1) would have application.
Repurchase Agreements ("Repo")
A repo transaction is similar to an SLA, except the vendor sells a security at fair market value to a purchaser for cash consideration ("cash proceeds") and at the same time agrees to repurchase the security at a predetermined time at a repurchase price that will be equal to the fair market value of the security at the time of the repurchase, plus a profit margin to the purchaser ("repo spread"). The vendor pays the cost of interest on short term money over the period to the purchaser and the purchaser agrees to pay a lending fee to the vendor. The repo spread will be the amount of "interest" payable by the vendor to the purchaser on the cash proceeds, net of the "lending fee" that the purchaser has agreed to pay the vendor for use of the security. The vendor has full use of the cash proceeds until the time of repurchase and any income from those amounts is income of the vendor. As with the SLA, the purchaser will receive any dividends or interest from the issuer of the security and will compensate the vendor for any such dividends or interest that the vendor would have received on the disposed security ("compensation payment").
(A) Canco sells Government of Canada Bonds to a non-arm's length non-resident (Southbound Repo) and receives cash proceeds.
(I) On the initial disposition by Canco any accrued interest would be considered income to Canco pursuant to subsection 20(14). See comments in IT-410R paragraphs 3 and 4.
(II) On the repurchase of the bonds by Canco it is our opinion that the resulting income would be classified as follows:
(i) Accrued Interest Income Expense against income in acquired at time of year interest received Repurchase to extent amount was included in computing income for the year (paragraph 20(14)(b))
(ii) Compensation Payment Foreign Source Income (foreign indebtedness see SLA comments above)
(iii) Repo Spread:
(a) Lending Fee from Non-Resident Domestic Income (see IT 270R2 par.26)
(b) Interest payable to N\R Domestic Expense re: cash proceeds
(B) Canco purchases Government of Canada Bonds from a non-arm's length non-resident (Northbound Repo) and pays cash proceeds.
(I) On the acquisition of the bonds by Canco from the non-resident any accrued interest or "purchased income" would be deductible by Canco when subsequently received (paragraph 20(14)(b)).
(II) On the repurchase of the bonds by the non-resident it is our opinion that the resulting income of Canco should be classified as follows:
(i) Accrued Interest Income Domestic Income (ss.20(14)) To Time of Repurchase
(ii) Interest Income Received Domestic Income While Bonds Held By Canco
(iii) Compensation Payment Domestic Expense
(iv) Repo Spread:
(a) Lending Fee Paid to Domestic Expense Non-Resident
(b) Interest from N\R Foreign Income re: cash proceeds
Should you have any questions regarding the above comments please contact Steve Tevlin at (613) 957-2746.
for DirectorFinancial Industries DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch
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