2 October 1996 External T.I. 9313325 F - Thin Capitalization - Equity of Canadian Corporate Group

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.

PRINCIPAL ISSUES:

Whether the paid-up capital invested by a non-resident in one Canadian subsidiary will be considered when applying subsection 18(4) to a loan to another Canadian subsidiary.

POSITION:

No

REASONS:

Only the equity invested by a specified non-resident in the Canadian debtor is relevant in the application of 18(4).

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Attention:  XXXXXXXXXX

Dear Sirs:

RE:  Thin Capitalization Rules

This is in reply to your letter wherein you request our view whether the Department would apply subsection 18(4) of the Canadian Income Tax Act (the "Act") in the hypothetical fact situation described below.

1)      A corporation not resident in Canada (N/Rco) owns all the shares of a Canadian corporation ("Holdco"). The shares of Holdco which is completely financed with equity, have "paid-up capital" as defined in subsection 89(1) of the Act of $11 million.

2)      Holdco owns all the shares of a second Canadian corporation ("Opco").

3)      N/Rco also owns all the shares of a non-resident-owned investment corporation ("NRO") as defined in section 133(8) of the Act.

4)      NRO is also wholly financed with equity.

5)      Opco has no retained earnings.

6)      Opco is indebted to Holdco and NRO in the amount of $11 million and $33 million respectively. Both of the above debts bear interest.

You question whether the paid-up capital invested by N/Rco in Holdco would be relevant in determining the application of subsection 18(4) of the Act in the above circumstances.

It is our opinion that the paid-up capital of the shares of Holdco would not be a factor in the application of subsection 18(4) to the interest paid by Opco on its indebtedness in the above case. A deduction in respect of interest paid by Opco on the debt to Holdco would not be denied under subsection 18(4) since such debt is not part of Opco's "outstanding debts to specified non-residents" as defined in subsection 18(5) nor is it part of an arrangement described in subsection 18(6) of the Act. On the other hand, Opco's debt to NRO does fall under the definition of "outstanding debts to specified non-residents" under clause (a)(i)(B) thereof. Moreover, since Opco's equity was invested by Holdco a corporation resident in Canada and since Opco has no retained earnings, the amount computed under subparagraph 18(4)(a)(ii) is nil. Therefore, the full amount of the interest paid by Opco on its debt to NRO would be denied pursuant to subsection 18(4) of the Act. In conclusion, the paid-up capital of the shares of Holdco held by N/Rco in this case have no bearing on the application of subsection 18(4) of the Act to the interest paid by Opco on either of the above debts.

The following is the Department's current administrative policy concerning the application of subsection 18(6) of the Act.

While 18(4) of the Act may nevertheless apply to deny all or a portion of the interest paid on the "first loan" referred to in that provision, subsection 18(6) of the Act will not be applied to the "second loan" in circumstances where such loan is made by a corporation resident in Canada ("Canco 1") to a second corporation resident in Canada ("Canco 2") provided that:

1)     the person who made the "first loan" referred to in that provision is a specified non-resident shareholder of Canco 1 and qualifies as a specified shareholder of Canco 1 otherwise than by virtue of a right referred to in paragraphs (c) or (d) of the definition of specified shareholder in subsection 18(5),

2)     the first loan and the second loan bear the same rate of interest and

3)     Canco 1 is related to Canco 2.

The foregoing comments are given in accordance with the practice referred to in paragraph 21 of information Circular 70-6R2 and are not binding on Revenue Canada.

We trust the above is the information you require.

Yours Truly,

for DirectorReorganizations and International DivisionIncome Tax Rulings and Interpretations DirectoratePolicy and Legislation Branch