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.
950977
XXXXXXXXXX Olli Laurikainen
(613) 957-2116
Attention: XXXXXXXXXX
July 14, 1995
Dear Sirs:
Re: Amendments to the Foreign Affiliate Legislation
This is in response to your letter dated April 7, 1995 wherein you request several opinions concerning the operation of the amendments to the law affecting foreign affiliates set out in Bill C-70 which received Royal Assent June 22, 1995. As discussed in our July 6, 1995 telephone conversation (Major-XXXXXXXXXX), we require additional time to consider two issues, whether and how undrawn customer commitments to lend money correlate to the reserve funds necessary to carry on a banking business (i.e. to assess to what extent the income earned by a foreign affiliate holding such reserve funds is subject to subparagraph 95(2)(a)(i) of the Act) and whether corporations under the jurisdiction of the Barbadian Off-shore Banking Act are "regulated" for the purposes of the amendments relating to foreign affiliates in Bill C-70. We will respond on those matters in due course.
Investment Business Definition
A) You request clarification of the manner in which Revenue Canada proposes to make the determination of whether a business is "conducted principally with persons with whom the affiliate does not deal at arm's length" for the purposes of paragraph (a) of the definition of "investment business" in subsection 95(1) of the Act.
The question of whether or not a particular business is conducted principally with persons with whom the affiliate does not deal at arm's length is one of fact to be determined by an examination of all the facts surrounding each case scenario. In our view the comments set out in paragraph 2 of Interpretation Bulletin IT-290 and paragraph 7 of IT-371 issued by Revenue Canada which provide guidance for the determination of whether a particular business is the taxpayer's "principal business" would generally also be relevant in making the determination of whether a business is principally carried on with persons with whom the affiliate does not deal at arm's length. Therefore in order to support the contention that a particular business of a foreign affiliate of a taxpayer is not a business conducted principally with persons with whom the affiliate does not deal at arm's length, for the purposes of the "investment business" definition in subparagraph 95(1), the taxpayer must be prepared to establish that fact to the satisfaction of Revenue Canada based on the above criteria.
The criteria that are referred to in the above referenced interpretation bulletins are primarily directed at measuring sources of income, income earning activities, and the assets, etc., used in each business (i.e. the revenue side of corporate operations). This is in our view the correct approach and the fact that a foreign affiliate receives funding to carry on its income earning activity by way of debt or equity from a related party would have little if any relevance in the determination of whether its business is carried on with persons with whom it does not deal at arm's length.
B) You request our view whether the diverse activities of a foreign bank, as defined in subsection 95(1) of the Act, might be considered to constitute separate businesses for the purposes of the definition of "investment business".
Again, the question of whether the activities carried on by a foreign affiliate constitute a single business or two or more separate businesses is one of fact. However, the credit operations (moneylending, trade finance, financial guarantees), deposit taking, cheque clearing, cash and asset management, custodial or fiduciary services performed under contract (not as a trustee), financial product sales and the foreign exchange operations of a regulated foreign bank would generally be considered part of a single business for the purposes of the definition of "investment business". Nevertheless each particular situation will have to be considered to determine with regard to the amount of capital employed by the bank and the services provided by the bank whether a portion of its investment portfolio and activities constitute a separate business for the purposes of subsection 95(1) of the Act.
95(2)(a)(iv)
Subparagraph 95(2)(a)(iv) of the Act provides that in computing the income from an active business of a foreign affiliate of a taxpayer in respect of which the taxpayer has a qualifying interest throughout the year there shall be included income derived from loans or lending assets acquired by the affiliate from a non-resident corporation to which the particular affiliate and the taxpayer are related throughout the year to the extent the loans or lending assets arose in the course of an active business carried on in a country other than Canada by the non-resident corporation. You indicate that in certain circumstances, loans which require very little attention once negotiated by a wholly-owned foreign affiliate (the "First Affiliate") which carries on the active business of lending money in a high tax foreign jurisdiction are transferred to another wholly-owned affiliate (the "Second Affiliate") in a relatively low tax jurisdiction purely to reduce the amount of foreign taxes paid on the income from the loans and lending assets. You question whether in those circumstances the Department would view the loans to have been generating income to the First Affiliate from an adventure in the nature of trade since the transfer of the loan may not have been entirely unforseen at the time that the loan was negotiated.
It is a general principle that when a person habitually does a thing that is capable of producing a profit, then he is carrying on a trade or business. If it cannot be established through a review of the specific facts that the loans or lending assets arose in the normal course of activities habitually conducted by the First Affiliate, subparagraph 95(2)(a)(iv) of the Act will not apply to the income of the Second Affiliate from such loans or lending assets. Under the limited facts presented above, it is not clear that there would be any basis to argue that the loans and lending assets that were transferred to the Second Affiliate would not have arisen in the normal course of the First Affiliate's lending business.
Yours truly,
Director
Reorganizations and Foreign Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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