2 October 1996 Income Tax Severed Letter 9617815 - Thin capitalization — back-to-back loans

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:

When would the Department not apply subsection 18(6) to a back-to-back loan.

POSITION:

Generally when it is in a position to apply subsection 18(4) to the first loan, the back-to-back loan is within a related corporate group and is not designed to artificially move income from one corporation to another.

REASONS:

961781 XXXXXXXXXX O. Laurikainen (613)957-2116

Attention: XXXXXXXXXX

October 2, 1996

Dear Sirs:

Re: Subsections 18(4) and 18(6) of the Income Tax Act

This is in reply to your letter dated May 13, 1996 wherein you request our views concerning the application of the above provisions of the Income Tax Act (the "Act") to the follow hypothetical arrangement.

1) A non-resident corporation ("Parent") owns all the shares of two corporations resident in Canada ("Opco 1" and "Opco 2"). 2) The equity of Parent computed under subparagraph 18(4)(a)(ii) vis-a-vis Opco 1 is $500 while the equity of Parent computed vis-a-vis Opco 2 thereunder is only $100.

3) Parent has made a loan of $1,000 (the "first loan") to Opco 1 on condition that Opco 1 make a loan of $1,000 (the "second loan") to Opco 2. Opco 1 has no other outstanding debts to specified non-residents as defined in subsection 18(5).

You question whether the Department would apply the provisions of subsections 18(4) and (6) to deny a deduction in respect of a portion of the interest paid on either of the loans described above.

In our opinion since Parent has sufficient equity as computed under subparagraph 18(4)(a)(ii) vis-a-vis Opco 1, subsection 18(4) would not apply to deny any portion of the interest paid to Parent by Opco 1 on the first loan. In addition, the Department would not apply the provisions of subsections 18(4) and (6) to the interest paid on the second loan by Opco 2 provided that the interest rate charged on the first loan is equal to the interest rate charged on the second loan. The following is the Department's current administrative position with respect to the application of subsection 18(6).

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