5 February 1997 External T.I. 9611725 - FOREIGN AFFILIATE - FACTORING BUSINESS

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 incidental income of a foreign affiliate from a non-arm's length factoring business can be deemed to be income from an active business.

Position:

Question of fact.

Reasons:

Must meet both tests in subparagraph 95(2)(a)(i).

		961172
XXXXXXXXXX	O. Laurikainen

Attention: XXXXXXXXXX

February 5, 1997

Dear Sirs:

Re: Subparagraph 95(2)(a)(i) - Factoring Operation

This is in reply to your letter wherein you request our views concerning the operation of subparagraph 95(2)(a)(i) of the Income Tax Act (the "Act").

In the hypothetical example you describe, a foreign affiliate ("FA") factors receivables of only one client ("Manco"). The circumstances are such that the income of FA derived directly from the factoring of the receivables of Manco would be income from property as defined in subsection 95(1) of the Act were it not for the application of subparagraph 95(2)(a)(iii) of the Act, which applies to include such income in FA's income from an active business.

You seek clarification whether any interest income of FA from the investment of funds temporarily not needed in the factoring operation would qualify under subparagraph 95(2)(a)(i) of the Act to be included in computing the income of FA from an active business.

Our Comments

In order to satisfy the provisions of subparagraph 95(2)(a)(i) of the Act, the interest must satisfy the two separate tests therein. Clause 95(2)(a)(i)(A) of the Act requires that the interest must be derived by FA from activities that can reasonably be considered to be directly related to the active business activities of Manco and clause 95(2)(a)(i)(B) makes the requirement that the interest would be included in computing the amount prescribed to be the earnings or loss of Manco from an active business carried on by it in a country other than Canada if it were a foreign affiliate of the taxpayer and the interest were earned by it.

Whether or not the income of a foreign affiliate satisfies the tests in subparagraph 95(2)(a)(i) is a question of fact. The brief hypothetical facts provided above are insufficient to make such a determination. Given that Manco is FA's only client, it would appear that the interest earned by FA may be considered to be derived from activities that are directly related to the active business activities of Manco for the purposes of clause 95(2)(a)(i)(A) of the Act. However, in order to meet the test in clause 95(2)(a)(i)(B) of the Act it would in our view be necessary to establish that if the funds on which the interest was earned had been held by Manco, such funds would be employed or at risk in the business of Manco (i.e. not excess funds). Thus, for example in circumstances where Manco itself has funds that are not employed or risked in its active business, we are not aware of a case where the funds held by FA would pass this test. That is, if FA's funds were held by Manco they would be viewed as additional excess funds. Therefore the interest earned by FA may not qualify under 95(2)(a)(i) of the Act notwithstanding that it may be considered to have been derived from activities that are directly related to the activities of Manco.

Based on our understanding of non-arm's length factoring arrangements such as the one described above, we would generally expect that income from the investment of profits by a factoring foreign affiliate would be foreign accrual property income and we would generally not accept the argument that the profits were set aside in contemplation that the business of Manco would expand such that the funds may be required at some future point in time.

Atlas Industries v. the Minister of National Revenue, 1986 DTC 1756 and McCutheon Farms Limited v. the Queen, 1991 DTC 5047, are cases which deal with the issue of whether interest from term deposits is income from an active business. In our view the discussion in those cases would generally be helpful for making an assessment of whether funds are employed or at risk in the business of a foreign affiliate for the purposes of the tests embodied in clauses 95(2)(a)(i)(A) and (B) of the Act in a case such as the hypothetical one herein question.

The foregoing comments are given in accordance with the practice referred to in paragraph 22 of information Circular 70-6R3 and are not binding on Revenue Canada.

We hope that above information is of assistance to you.

Yours truly,

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