6 November 1995 External T.I. 9515345 - PASSIVE INCOME OF A FACTORING FOREIGN AFFILIATE

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.

Principal Issues:

Whether interest income earned from passive investments by a foreign affiliate with an accounts receivable factoring operation, the income from which is subject to 95(2)(a)(iii), is also deemed to be income from an active business.

Position:

95(2)(a)(iii) only applies to income derived directly from factoring receivables, therefore the passive income would have to qualify under 95(2)(a)(i) in order to be deemed active business income.

Reasons:

95(2)(a)(iii) deems the income to be from an active business; it does not deem the business to be an active business. Therefore passive income cannot pertain to or be incident to an active business.

XXXXXXXXXX 951534

Attention: XXXXXXXXXX

November 6, 1995

Dear Sirs:

Re: Paragraph 95(2)(a) of the Income Tax Act

This is in response to your letter dated June 9, 1995 wherein you request our views in reference to the application of the above provision to the following hypothetical scenario.

1) Canco is a corporation resident in Canada.

2) Finco is a wholly-owned subsidiary of Canco resident in a country other than Canada.

3) Manco is a non-resident corporation to which Finco and Canco are related throughout the year. Manco is resident in a country other than Canada.

4) Manco carries on an active business comprised of the manufacturing and sale of equipment to arm's length customers resident outside Canada.

5) Finco derives income from factoring of Manco's trade accounts receivable. That is, Finco purchases trade accounts receivable from Manco at a discount as they become available and collects them from Manco's customers as they become due.

6) Finco has a bank account with a bank under an agreement which includes overdraft provisions. As the amount of the trade receivables fluctuates and as the receipt by Finco of funds from the collection of trade receivables fluctuates, Finco's bank account is at times overdrawn with the result that Finco pays interest to the bank. At other times, Finco has funds that are not immediately required for the purchase of receivables and on which Finco earns interest income (the "Interest").

7) Finco regularly pays dividends to Canco out of any surplus funds in its bank account that are not reasonably required for the purchase of new receivables from Manco.

8) Subject to the application of paragraph 95(2)(a) of the Income Tax Act (the "Act") the income earned by Finco from its factoring activity would be considered income from property.

Our Comments

In the above circumstances it is our view that subparagraph 95(2)(a)(iii) would apply only to income derived by Finco directly from factoring of trade accounts receivable acquired from Manco and would not apply to any of the Interest referred to in paragraph 6 above. However, subparagraph 95(2)(a)(i) may apply to a portion of the Interest to the extent that it is reasonable to consider the funds in the bank account of Finco to which the Interest relates, to be at risk in the business of Manco. The funds in the bank account of Finco may be considered at risk in the business of Manco where the permanent removal of such funds would have a destabilizing effect on the business of Manco. Such would generally not be the case for example where Manco has sufficient working capital and does not necessarily need to factor its receivables (e.g. where the factoring operation is in place to accomplish an income shift from one jurisdiction to another) or where the funds in the bank account were to be used by Finco to pay dividends on its shares. In any case, since the question of whether a portion of the funds in the bank account of Finco could reasonably be considered at risk in the business of Manco is entirely a question of fact, we can provide no further comment.

We hope that the above is of assistance to you.

Yours truly,

for Director
Reorganizations and Foreign Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch