30 November 1997 Ruling 9807063 - FOREIGN AFFILIATE - LOANS OF TAXABLE SURPLUS

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:

1) Whether the GAAR applies where a foreign affiliate loans its taxable surplus to its Canadian parent corporation for an indefinite term.

2) Whether a disposition occurs where the terms of a loan are amended so as to eliminate the obligation to pay interest and the lender is given the right to demand repayment within 10 days after the right is exercised.

Position:

1) No

2) No

Reasons:

1) Subsection 15(2) is in place to prevent a corporation from conveying its surplus to its shareholders without payment of a taxable dividend. That provision has an exception for loans to a shareholder that is a corporation resident in Canada. As a result, the transaction cannot be viewed as resulting in a misuse or abuse of the provisions of the Act for the purposes of subsection 245(4).

2) These changes to the original loan agreement were not considered to amount to the settlement of the original debt obligation and the creation of a new obligation.
XXXXXXXXXX 						980706

Attention: XXXXXXXXXX

XXXXXXXXXX, 1998

Dear Sirs:

Re: XXXXXXXXXX Advance Income Tax Ruling

This is in reply to your letter dated XXXXXXXXXX requesting an advance income tax ruling on behalf of the above referenced taxpayer. We also acknowledge your subsequent letters dated XXXXXXXXXX and our several telephone conversations.

XXXXXXXXXX. files its T2 return with the XXXXXXXXXX Tax Services Office.

To the best of your knowledge and that of the taxpayer involved, none of the issues involved with this request:

a) is involved in an earlier return of the taxpayer or a related person,

b) is being considered by a tax services office or a taxation centre in connection with a tax return already filed by the taxpayer or a related person,

c) is under objection,

d) is before the courts or, if a judgement has been issued, the time limit for appeal has not expired, or

e) is the subject of a ruling previously issued by the Income Tax Rulings and Interpretations Directorate.

Definitions

In this letter the following terms have the meanings specified:

a) “Act” means the Income Tax Act R.S.C. 1985 c.1 (5th Supp.), as amended to the date hereof, and unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provisions of the Act.

b) “Canco” means XXXXXXXXXX a public corporation and a taxable Canadian corporation which is subject to the Canada Business Corporations Act. The last taxation year of

XXXXXXXXXX

XXXXXXXXXX

c)

XXXXXXXXXX

Facts

1. Canco is a corporation resident in Canada which is engaged in the XXXXXXXXXX.

2. Canco owns all of the issued and outstanding shares of XXXXXXXXXX, a corporation that is resident in XXXXXXXXXX and which is not resident in Canada for purposes of the Act. XXXXXXXXXX is therefore a foreign affiliate and a controlled foreign affiliate of Canco.

3. XXXXXXXXXX is engaged in the business of the insurance and reinsurance of risks. In the course of this business, XXXXXXXXXX insures and reinsures risks of, and receives premiums from, Canco and other foreign affiliates of Canco. XXXXXXXXXX does not insure or receive premiums from any persons with whom it deals at arm’s length. The insuring and reinsuring of the Canadian risks of Canco began at the commencement of XXXXXXXXXX in order that XXXXXXXXXX could lower its costs of reinsurance by increasing the volume of its reinsurance business.

4. Provided the conditions of paragraph 95(2)(a) are satisfied, the income derived by XXXXXXXXXX from premiums paid by the other foreign affiliates of Canco constitutes income from an active business and not foreign accrual property income. Paragraph 95(2)(a.2) will apply to income derived by XXXXXXXXXX from premiums paid by Canco in respect of the insuring of risks of Canco. The amount determined under that paragraph will be included in the foreign accrual property income of XXXXXXXXXX and within its taxable surplus vis-a vis Canco. As XXXXXXXXXX is not resident in XXXXXXXXXX for the purpose of the XXXXXXXXXX Income Tax Agreement XXXXXXXXXX its income from an active business is also included in its taxable surplus vis-a-vis Canco.

5. Commencing in XXXXXXXXXX began to realize cash surpluses that were in excess of its immediate cash requirements. It therefore began to lend amounts to Canco by way of loans (collectively referred to herein as the “Inter-Company Loans”) which are evidenced in writing by debt instruments described as “Promissory Notes”, the relevant terms and conditions of each of which are as follows:

a) All of the loans have been made in United States dollars and are repayable in United States dollars. The principal amount of each loan is due and payable on XXXXXXXXXX except that Canco may at its option repay prior to maturity any portion of the principal outstanding plus accrued but unpaid interest.

b) The Inter-Company Loans bear interest at a rate equal to the prime rate of the XXXXXXXXXX. Interest accrues daily on principal and is payable in United States dollars on the last business day of each year. Interest also accrues daily at the same rate on interest that is not paid when due.

c) The terms and conditions of the Inter-Company Loans are governed by the laws of XXXXXXXXXX.

6. On XXXXXXXXXX, the total outstanding principal amounts of the Inter-Company Loans was U.S. $XXXXXXXXXX. Interest on the Inter-Company Loans has accrued and is payable in accordance with the terms described in paragraph 5 above but, except as described in paragraph 9 below, no interest has actually been paid on the Inter-Company Loans. On XXXXXXXXXX, the total amount of accrued and unpaid interest on the Inter-Company Loans was approximately U.S. $XXXXXXXXXX.

7. Canco has used the proceeds from the Inter-Company Loans for the purpose of earning income from its business, and has deducted the interest that has accrued on the principal amount of the Inter-Company Loans in accordance with paragraph 20(1)(c). If Canco pays interest on interest that has accrued, Canco would claim a deduction in accordance with paragraph 20(1)(d).

8. Where any amount of interest under the Inter-Company Loans remains unpaid at the end of the second taxation year of Canco following the taxation year of Canco in which the interest accrued and was deducted by Canco, as described in paragraph 7 above, Canco and XXXXXXXXXX, pursuant to and in accordance with paragraph 78(1)(b), may file an agreement in the form prescribed therefor on or before the day on or before which Canco is required by section 150 to file its income tax return for the third taxation year following the taxation year in which that amount accrued. The effect of the filing of the agreement is that the amount of interest is deemed, for purposes of the Act, to have been paid by Canco and received by XXXXXXXXXX on the first day of that third taxation year. Where such an agreement is not filed, Canco includes the amount of interest in its income for that third taxation year in accordance with paragraph 78(1)(a).

9. Where any amount of interest is deemed to be paid by Canco to XXXXXXXXXX pursuant to paragraph 78(1)(b), as described in paragraph 8 above, Canco remits to the Receiver General, in accordance with subsection 215(1), 25% of that amount on account of the liability of XXXXXXXXXX under Part XIII. Pursuant to the terms of the Inter-Company Loans, the liability of Canco to XXXXXXXXXX in respect of accrued but unpaid interest is reduced by the amount so remitted to the Receiver General.

10. The value of the United States dollar has increased relative to the Canadian dollar during the period of time that amounts have been outstanding under the Inter-Company Loans. Accordingly, the fair market value of each of the Inter-Company Loans, if converted to Canadian dollars at the exchange rate applicable as of the date of this Ruling letter, would exceed the adjusted cost base thereof to XXXXXXXXXX expressed in Canadian dollars.

11. Canco has included in its income for each relevant taxation year, in accordance with subsection 91(1), the foreign accrual property income of XXXXXXXXXX resulting from the interest income earned by XXXXXXXXXX on the Inter-Company Loans for the taxation year of XXXXXXXXXX ending in that taxation year. For the purpose of determining the foreign accrual property income, the interest income of XXXXXXXXXX under the Inter-Company Loans has been calculated on the accrual basis and not the cash basis. Canco has also deducted amounts pursuant to subsection 91(4) in respect of the foreign accrual tax applicable to the amounts included in income pursuant to subsection 91(1), including any Part XIII tax paid as described in paragraph 9 above in respect of interest payable on the Inter-Company Loans.

12. Canco currently expects to have sufficient deductions in computing its income and taxable income such that it will not have any tax payable under Part I at least until its XXXXXXXXXX taxation year.

13. XXXXXXXXXX currently has a cash surplus on hand of approximately $XXXXXXXXXX, most of which represents net insurance premiums received in XXXXXXXXXX plus an amount of interest earned on a short-term loan which was made to Canco in XXXXXXXXXX and was repaid in XXXXXXXXXX. This cash surplus has been invested by XXXXXXXXXX with an arm’s length institution in a short-term interest bearing investment payable in Canadian dollars.

Propsed Transactions

14. Canco and XXXXXXXXXX would amend the terms of the Inter-Company Loans as evidenced by the Promissory Notes in the following manner.

a) The obligation to pay interest would be removed so that interest would no longer accrue on either the principal payable under the Inter-Company Loans or on the accrued but unpaid interest payable thereunder. That is to say, the total amount of principal and interest owing under each of the Inter-Company Loans as of the date of the amendment would continue to remain owing by Canco to XXXXXXXXXX but would no longer accrue interest.

b) An option would be added so that XXXXXXXXXX would have the option of requiring full repayment of all or any portion of the outstanding amounts owing, including accrued interest (i.e. interest accrued up to the effective date of the amendment) as well as principal, XXXXXXXXXX days after demand for repayment. That is to say, XXXXXXXXXX would have the option to require Canco to repay amounts owing under the Inter-Company Loans XXXXXXXXXX days after demand for repayment made by XXXXXXXXXX.

15. The amendments referred to in paragraph 14 above, would be accomplished by Canco and XXXXXXXXXX entering into an agreement (the “Amending Agreement”) which would amend the terms of the Promissory Notes, the essential and relevant terms of which would be as follows.

a) From and after the date of the Amending Agreement, interest would no longer accrue on any amount outstanding under the Inter-Company Loans, including any amount of accrued but unpaid interest outstanding.

b) An option would be added to each Promissory Note whereby XXXXXXXXXX would have the option to require that any amount payable pursuant to that Promissory Note or any portion thereof, including accrued but unpaid interest, become due and payable on the day that is XXXXXXXXXX days after a demand by XXXXXXXXXX for repayment of that amount or portion.

c) All outstanding amounts owing by Canco to XXXXXXXXXX under the Inter-Company Loans as of the effective date of the Amending Agreement, including accrued but unpaid interest, would continue as outstanding obligations of Canco to XXXXXXXXXX.

d) The Amending Agreement would clearly state that nothing in the Amending Agreement will constitute or be considered as constituting a repayment by Canco of any amount or any portion of any amount owing by it to XXXXXXXXXX whether on account of principal or interest, and the parties would acknowledge and agree that with the exception of the amendments to the terms thereof referred to in paragraphs a) and b) above, the obligations of Canco to XXXXXXXXXX in respect of all amounts outstanding under the Inter-Company Loans would continue as the same obligations and would not constitute new obligations.

16. With respect to an amount of interest accrued on the Inter-Company Loans to the date of the Amending Agreement which is or was unpaid at the end of the second taxation year of Canco following the year in which the interest accrued and was deducted by Canco, as described in paragraph 7 above, Canco and XXXXXXXXXX would either file the agreement in respect of the interest pursuant to paragraph 78(1)(b) as referred to in paragraph 8 above, or Canco would include the amount of interest in its income for the third taxation year in accordance with paragraph 78(1)(a), as described in paragraph 8 above.

17. Where an agreement is filed in respect of the interest, Part XIII tax would be paid and the liability of Canco to XXXXXXXXXX in respect of accrued but unpaid interest would be reduced by the Part XIII tax, as described in paragraph 9 above. Canco would be entitled to a deduction under subsection 91(4) in respect of the Part XIII tax withheld since the interest would have been included in Canco’s income as foreign accrual property income in the year it accrued. Where an agreement is not filed and the amount of interest is included in Canco’s income pursuant to paragraph 78(1)(a), XXXXXXXXXX may, at its option and not pursuant to any agreement, cancel the liability of Canco to XXXXXXXXXX in respect of the interest without payment by Canco to XXXXXXXXXX.

18. XXXXXXXXXX will loan to Canco an amount in Canadian dollars equal to the principal amount of the short-term investment referred to in paragraph 13 above, plus accrued interest on the investment to the date the money is loaned. The loan will be made by XXXXXXXXXX assigning to Canco the full amount of the short-term investment. The terms of the loan will be as described below.

a) The loan will be made in Canadian dollars and will be repayable in Canadian dollars. The loan will be evidenced in writing.

b) The loan will not bear interest.

c) All or any portion of the principal amount of the loan will be repayable by Canco to XXXXXXXXXX days after demand by XXXXXXXXXX for repayment. Canco will also be able to repay all or any portion of the principal amount of such loan at any time.

Canco will redeem the short-term investment as soon as possible after the assignment is effected.

Purpose of the Proposed Transactions

The primary objective of the proposed transactions is to enable Canco to access the excess funds of XXXXXXXXXX and to eliminate the obligation to pay interest on the existing inter-company debt owed by Canco to XXXXXXXXXX in order to eliminate the Canadian withholding tax that would arise if interest were paid to XXXXXXXXXX.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. The Amending Agreement will not result in a disposition or deemed disposition by XXXXXXXXXX of any amount owing to it under the Inter-Company Loans and there will, therefore, be no gain or loss realized by XXXXXXXXXX under the Act as a result of the Amending Agreement. Accordingly, no amount will be included in the foreign accrual property income of XXXXXXXXXX as a result of the elimination of the requirement to pay interest under the Inter-company Loans or as a result of the the addition of the option of XXXXXXXXXX to require repayment XXXXXXXXXX days after demand.

B. The Amending Agreement will not result in the realization by Canco of a foreign exchange gain or loss pursuant to subsection 39(2) in respect of the settlement of an amount owing by it under the Inter-Company Loans.

C. Section 80 will not apply to Canco as a result of the Amending Agreement.

D. Should XXXXXXXXXX cancel without consideration any interest owing to it under the Inter-Company Loans to which paragraph 78(1)(a) has applied, as described in paragraph 17 above the amount of interest so canceled will not be treated as a benefit to Canco pursuant to subsection 15(1) or subsection 246(1), and section 80 will not apply to the amount of interest so canceled. However, should XXXXXXXXXX cancel without consideration any loan deemed to have been made pursuant to subparagraph 78(1)(b)(ii), section 80 will apply to the amount canceled.

E. Canco will not be treated as realizing a benefit under subsections 15(1) or 246(1) as a result of:

a) the Amending Agreement, or

b) XXXXXXXXXX lending amounts to Canco on an interest-free basis payable 10 days after demand, as described in paragraph 18 above.

F. Subsection 245(2) will not be applied to redetermine the tax consequences confirmed in the rulings given above as a result of the completion of the proposed transactions, in and by themselves.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996, and are binding on Revenue Canada provided that the proposed transactions are completed by XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

Other Comment

As the International Tax Directorate is responsible for Revenue Canada’s practices as they relate to the application of transfer pricing legislation, we have taken the liberty of referring your request for technical interpretation concerning the application of proposed subsection 247(2) to Gary Zed, Director of the Transfer Pricing and Competent Authority Division of that Directorate

Yours truly,

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