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:
Under what circumstances will the Department not seek to apply the provisions of subsection 18(6) to a back-to-back loan arrangement.
Position:
When each of the loans in such arrangement are made to corporations resident in Canada controlled (de jure) by the non-resident person who made the first loan.
Reasons:
In such case the provisions of subsections 18(4) and 18(5) are not otherwise frustrated or circumvented.
XXXXXXXXXX Olli Laurikainen
(613) 957-2116
Attention: XXXXXXXXXX
March 24, 1998
Dear Sirs:
Re: Thin Capitalization Rules
This is further to our technical interpretation letter October 2, 1996 concerning the application of subsection 18(4) of the Income Tax Act (the “Act”).
Our interpretation of subsection 18(4) of the Act in reference to the hypothetical set of facts described in the earlier letter remains as stated in that letter. However, the purpose of this letter is to bring to your attention a change in the Department’s position concerning the application of subsection 18(6) of the Act. We concluded the October 2, 1996 letter by setting out the Department’s position concerning the application of subsection 18(6) to a back - to - back loan arrangement as follows:
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 Department has subsequently withdrawn the above position. Moreover, the Department has concluded that if condition 2) above were satisfied, the result would generally be that a deduction in respect of the interest paid on the first loan could be denied under paragraph 20(1)(c) of the Act on the basis that the borrowed money was not used by Canco 1 to earn income. That is, the interest revenue of Canco 1 on the second loan less the interest expense attributable to the first loan yields no income for Canco 1 and, based on the facts, there is no indication whether Canco 1 is able to benefit in another manner by virtue of having made the second loan.
The Department will nevertheless stand by paragraph 3 of Interpretation Bulletin IT-59R3. In our view, paragraph 3 of IT-59R3 contemplates a case where a non-resident person ("NRP") which has de jure control over a corporation resident in Canada ("C1"), makes a loan ("Loan 1") to C1 and C1 makes a loan ("Loan 2") in the same amount to another corporation resident in Canada ("C2") over which NRP has de jure control. In such a case the Department would not seek to apply the provisions of subsections 18(4) and 18(6) of the Act to interest paid on Loan 2. However, the interest earned on the second loan would generally have to exceed the interest paid on the first loan in order for the interest paid on the first loan to be deductible pursuant to paragraph 20(1)(c) 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.
Yours truly,
for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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