21 April 1999 External T.I. 9810055 - FOREIGN AFFILIATES- DEEMED ABI

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: Treatment under the Act of an income transfer payment made in accordance with Swedish Tax Law by a subsidiary foreign affiliate to its parent foreign affiliate.

Position: In the circumstances set out in the opinion it would be reasonable to view the payment as income from property to the parent foreign affiliate which, pursuant to 95(2)(a)(ii) would be included in its income from active business.

Reasons: The payment is attributable to the shares of the subsidiary foreign affiliate held by the parent foreign affiliate and is deductible in computing income from an active business carried on by the subsidiary affiliate in Sweden.

		981005
XXXXXXXXXX 	Olli Laurikainen
(613) 957-2116
Attention:  XXXXXXXXXX 

April 21, 1999

Dear Sirs:

Re: Foreign Affiliates - The Swedish Income Transfer System

This is in reply to your letter wherein you request our comments in reference to the application of the foreign affiliate provisions of the Income Tax Act (the “Act”) in the following hypothetical circumstances.

1) Canco is a corporation resident in Canada.

2) Canco owns 100% of the shares of two foreign affiliates(FA1 and FA2).

3) FA2 owns 100% of the shares of third foreign affiliate of Canco (FA3).

4) FA2 and FA3 are both resident in Sweden.

5) FA2 borrows money from FA1 at an arm’s length interest rate and uses the money to acquire additional shares of FA3. Subject to the application of subsection 95(2) of the Act, the interest income earned by FA1 from FA2 is income from property.

6) All of the assets of FA3 are used by it to carry on an active business in Sweden.

7) FA2 has no assets other than the shares of FA3. Therefore the interest paid to FA1 gives rise to a loss in FA2.

8) Under Swedish tax law, in order to enable the Swedish corporate group (i.e. FA2 and FA3) to make use of FA2’s loss, FA3 may make a tax deductible payment (“Income Transfer Payment”) to FA2 equal to such loss. Under Sweden’s income transfer system an Income Transfer Payment is treated as an income inclusion in FA2.

You request our views in reference to the application of the provisions of section 95 of the Act and the related Regulations of the Act, to the interest income earned by FA1 from FA2 and to the Income Transfer Payment made by FA3 to FA2.

Our Views

In the above case it is our view that the Income Transfer Payment is deducted in computing the “earnings” of FA3 from an active business as determined pursuant to the rules in subparagraph (a)(i) of the definition in subsection 5907(1) of the Regulations. Therefore the Income Transfer Payment will have the effect of reducing the “exempt earnings” and “exempt surplus” of FA3.

The income derived by FA2 from the Income Transfer Payment in our view represents income from property (i.e. the shares of FA3) to FA2. However, clause 95(2)(a)(ii)(B) of the Act will apply to include the income derived from the payment in the income of FA2 from an active business. Such income would be included in FA2’s “earnings” from an active business pursuant to paragraph (b) of the definition of “earnings” in subsection 5907(1) of the Regulations and under clause (d)(ii)(E) of the definition of “exempt earnings”, the income derived from the Income Transfer Payment would be included in the “exempt earnings” of FA2 and therefore its “exempt surplus”. Since interest paid by FA2 to FA1 is directly related to FA2’s acquisition of shares of FA3, such interest would be deducted from the revenue derived FA2 from those shares (i.e. the Income Transfer Payment) in arriving at the income “derived from” the Income Transfer Payment for the purposes of the preamble to paragraph 95(2)(a)(ii) of the Act and the above surplus computations.

Since the interest is deductible by FA2 in computing the amount prescribed to be its earnings or loss from an active business for the purposes of clause 95(2)(a)(ii)(B) of the Act, that clause would apply to include the income derived from the interest payments from FA2 by FA1 in its income from an active business.

The foregoing comments reflect our views specifically in reference to the hypothetical scenario described herein and should not be considered as providing guidance in other situations. Our 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