5 February 1997 External T.I. 9635625 - FOREIGN AFFILIATES - RELEVANT, LIABILITY FOR TAX

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 deducted by a group of affiliates in computing income from a particular source under the tax laws of the country in which the affiliates are resident would be considered "relevant in computing the liability for income tax" for the purposes of clause 95(2)(a)(ii)(D), if no income tax would have been payable in the foreign country in respect of such income source even if the interest had not been deducted against such income.

Position:

Yes.

Reasons:

If an amount is deductible in computing income for income tax purposes, it would generally be considered to be relevant in computing the liability for income tax notwithstanding that there may not be a reduction in the amount of taxes paid in the particular year.

		963562
XXXXXXXXXX	O. Laurikainen

Attention: XXXXXXXXXX

February 5, 1997

Dear Sirs:

Re: Clause 95(2)(a)(ii)(D) of the Income Tax Act

This is in reply to your facsimile dated October 25, 1996. You request our view whether the addition of the underlined words in paragraph 11 below, would change the technical interpretation concerning the operation of the above provision set out in our letter to you dated October 10, 1996.

The hypothetical circumstances are as follows.

1)Canco is a corporation resident in Canada.

2)Holco and Finco are wholly-owned foreign affiliates of Canco.

3)Finco makes a loan (the "Loan") to Holco. All the funds from the Loan are used by Holco to purchase all of the shares of a non-resident corporation ("Opco"). The interest paid on the Loan satisfies the conditions set out in subclauses 95(2)(a)(ii)(D)(I) and (II) of the Income Tax Act (the "Act").

4)The shares of Opco are "excluded property" for the purposes of the definition in subsection 95(1) of the Act.

5)Holco and Opco are resident the same "designated treaty country" ("Country X") as defined in proposed subsection 5907(11) of the Regulations.

6)Holco owns all the shares of another non-resident corporation ("Fopco") which is resident in another designated treaty country ("Country Y").

7)Fopco derives all of its income from an active business carried on by it in Country Y.

8)Fopco pays a dividend (the "Dividend") to Holco.

9)The liability for income taxes of Holco and Opco (together the "Group") is computed in Country X on a consolidated basis.

10)As the income or loss of Fopco is not included in the consolidated results of the Group for the purposes of computing the liability for income tax of the Group in Country X, Fopco is not a member of that "group of corporations" for the purposes of subclause 95(2)(a)(ii)(D)(V) of the Act.

11)The determination of the liability for income tax of the Group under the income tax laws of Country X is made as follows. A computation of the income liable for tax of the Group is made separately for domestic (i.e. Country X) source income and foreign source income (i.e. income from a source outside "Country X"). The Dividend represents foreign source income of the Group and a portion of the interest paid on the Loan (the "Allocated Interest") is allocated against such income and is therefore not deductible against income of the Group from sources in Country X. Had such interest allocation not been made, the Group would not have been liable for tax on the Dividend in Country X because foreign tax credits in respect of withholding taxes paid to Country Y on the Dividend and in respect of underlying corporate taxes paid to Country Y by Fopco with respect to the income of Fopco from which the Dividend is derived would have been sufficient to eliminate the Country X tax liability that would have otherwise been computed vis-a-vis the Dividend. Country Y withholding taxes on the Dividend that are not claimed by the Group in the year may be carried forward and may be creditable in Country X in a future taxation year.

Accordingly, while the Allocated Interest does not reduce the liability of the Group for income taxes in Country X in the year the interest is paid, it increases the amount of a foreign tax credit carry-forward otherwise computed which may be deductible against the liability for income tax of the Group in Country X for future taxation years.

You question whether in the above circumstances the Allocated Interest paid by Holco would be considered "relevant in computing the liability for income taxes" of the Group in Country X for the purposes of clause 95(2)(a)(ii)(D)(V) of the Act.

Our Comments

In our opinion the addition of the underlined words in paragraph 11 above would not affect the technical interpretation given in our letter to you dated October 10, 1996. It is our view that the full amount of the interest paid by Holco on the Loan including the Allocated Interest would be relevant in computing the liability for income taxes of the Group. Therefore, the full amount of the interest paid by Holco would be included in income from an active business of Finco pursuant to clause 95(2)(a)(ii)(D) of the Act.

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 trust the above is the information you require.

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