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:
A foreign affiliate is in the business of lending money to related non-resident companies in circumstances where the interest on the loans subject to 95(2)(a)(ii) of the Act. The loans are on income account. Would the foreign affiliate's foreign exchange gains and losses on repayment of those loans and gains and losses from hedging such loans be included in its active business income pursuant to 95(2)(a)(i)?
Position:
No
Reasons:
The test in clause 95(2)(a)(i)(B) is not satisfied in respect of either gain of loss. Therefore the gains and losses realized on the repayment of loans and settlement of hedges would be included in the computation of FAPI (income from investment business).
963957
XXXXXXXXXX Olli Laurikainen
Attention: XXXXXXXXXX
January 22, 1998
Dear Sirs:
Re: Foreign Affiliates - Paragraph 95(2)(a)
This is in reply to your letter wherein you describe a hypothetical situation where a foreign affiliate is created for the purpose of acting as a finance company for a group of related non-resident corporations. You request our view in reference to the application of subparagraph 95(2)(a)(i) of the Income Tax Act (the "Act"). The hypothetical situation is as follows.
1. FA is a foreign affiliate of a corporation ("Canco") resident in Canada.
2. Canco and FA are related to several other non-resident corporations ("NRCs") all of which reside and carry on an active business in a designated treaty country.
3. The sole activity of FA is the making of loans to the NRCs (i.e. business conducted with persons with whom the affiliate does not deal at arm's length). Accordingly its activity constitutes an "investment business" as defined in subsection 95(1) of the Act.
4. Funds borrowed by the NRCs are used by them in current account operations of their respective active businesses.
5. The interest derived by FA from loans made to the NRCs is included in its income from an active business pursuant to subparagraph 95(2)(a)(ii) of the Act.
6. FA carries on its activity in U.S. dollars.
7. FA lends L100,000,000 (the "Loan") to one of the NRCs ("NR1") resident in the United Kingdom. In order to eliminate foreign exchange exposure (re: movements of the U.K. pound vis-A-vis the U.S. dollar), FA purchases a foreign exchange forward contract that enables it to buy U.S. dollars at a future date with L100,000,000 at the exchange rate in effect on the date the Loan is made.
8. On repayment of the Loan and on the closing out of the forward contract, the U.S. dollar has appreciated relative to the U.K. pound. As a result, FA has a foreign exchange gain on the closing out of the forward contract (measured in both U.S. and Canadian dollars).
You request our view whether in the above circumstances, the gain realized by FA on the closing out of the forward foreign exchange contract would be included in the income of FA from an active business pursuant to paragraph 95(2)(a) of the Act.
It is a question of fact whether in the above circumstances the Loan would be on income or capital account vis-A-vis FA. For the purposes of our response we are assuming that the loan is on income account.
As a result of the transactions described in paragraph 8 above, not only does FA realize a gain on the closing out of the forward foreign exchange contract, it realizes a foreign exchange loss on the repayment of the Loan. Since the forward foreign exchange contract is a hedge in reference to the Loan, the character of the gain on the settlement of the forward foreign exchange contract would match the character of the loss on the repayment of the Loan (i.e. it would be on income account). Both amounts would in our view be computed in Canadian dollars and included in computing the income of FA from an investment business. It is our view that neither of the these two amounts are subject to the provisions of subparagraph 95(2)(a)(i) of the Act because the test in clause (B) thereof is not met. In order to satisfy the test in subparagraph 95(2)(a)(i)(B) of the Act, it would have generally been necessary for NR1 to have been in the active business of lending money. We note that each gain or loss realized by FA on the repayment of a loan and a gain or loss on the settlement of the related hedge results from money lending activities of FA. Moreover, each hedging transaction entered into by FA is to protect FA not a particular NRC from fluctuation in the value of the currency in which the related loan is denominated. Therefore assuming a particular NRC to whom a loan was made, is not in the business of lending money, the gains and/or losses of FA, if realized by such NRC, would not qualify as active business income and the test in clause 95(2)(a)(i)(B) would generally not be satisfied.
Our position that subparagraph 95(2)(a)(i) of the Act is not broad enough to apply in such case is supported by the existence of subparagraphs 95(2)(a)(iii) and (iv). Those provisions were deemed necessary in spite of the fact that they arguably deal with amounts of income which are shifts of a portion of the active business income of a related non-resident corporation to the particular foreign affiliate. In the case at hand there is no such shift of income and in the absence of FA the NRCs would not have earned the income in question.
Furthermore, if clause 95(2)(a)(ii)(A) of the Act must be relied upon to deem income derived from interest payments on loans to be income from an active business, we would conclude that subparagraph 95(2)(a)(i) of the Act should not be considered to do so. In such case, it would not be appropriate to conclude that subparagraph 95(2)(a)(i) of the Act could be interpreted broadly enough to include the foreign exchange gains and losses on the repayment of those loans and it would be even less reasonable to conclude that it applies to gains and losses on the settlement of hedges related to those loans.
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 this is the information you require.
Yours truly,
for Director
Reorganisations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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