25 November 1998 CTF Roundtable Q. 12, 9822340 - THIN CAPITALIZATION

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: Will RCT follow decision in Ontario Tax court re: Willdenburg?

Position: Yes. where facts are the same.

Reasons: Where there is a bona fide partnership and each partner is responsible for all P's debts joint and several then our 1992 R\T position would hold.

Canadian Tax Foundation Roundtable
982234
Questions and Responses

Re: Wildenburg Holdings Ltd. v. Ontario (Minister of Revenue)

Decision of the Ontario Court of Justice

Issue

Can a partnership be used to avoid the application of the “thin capitalization rules” in subsection 18(4) of the Income Tax Act?

Will Revenue Canada continue to maintain its administrative position described in the 1992 CTF round table at question #12?

Court findings

The Ontario Court of Justice found that the partnership of which the appellant was a member was merely a relationship between the partners who were the true debtors. In particular the partners themselves in the mortgage document had limited their liability to 50% of the debt. As such the appellant who was a corporate partner was subject to the thin capitalization rules with respect to its share of interest paid to a non-resident lender. The Court noted that:

- the objective of subsections 18(4) to (8) of the Act are to prohibit the avoidance of tax by Canadian corporations with a significant interest owned by foreigners, who use debt rather than equity to achieve the objective.

- subsection 96(1) was not intended to negate the intention of subsection 18(4).

Law

Section 96(1) of the ITA also incorporated by reference into the Ontario Corporation Tax Act reads as follows:

96.(1) Where a taxpayer is a member of a partnership, his income, net capital loss, non-capital loss and restricted farm loss, if any, for a taxation year, or his taxable income earned in Canada for a taxation year, as the case may be, shall be computed as if

(a) the partnership were a separate person resident in Canada;

(b) the taxation year of the partnership were its fiscal period;

(c) each partnership activity (including the ownership of property) were carried on by the partnership as a separate person, and a computation were made of the amount of

(i) each taxable capital gain and allowable capital loss of the partnership from the disposition of property, and

(ii) each income and loss of the partnership from each other source or from sources in a particular place

Subsection 18(4) of the ITA R.S.C. 1952 C.8 which was incorporated by reference into the Ontario Corporation Tax Act reads as follows:

18 -(4) Notwithstanding any other provision of this Act, in computing the income for a taxation year of a corporation resident in Canada from a business or property, no deduction shall be made in respect of that proportion of any amount otherwise deductible in computing its income for the year in respect of interest paid or payable by it on outstanding debts to specified non-residents that

(a) the amount, if any, by which

(i) the greatest amount that the corporation’s outstanding debts to specified non-residents was at any time in the year,

exceeds

(ii) 3 times the aggregate of

(A) the retained earnings of the corporation at the commencement of the year, except to the extent that those earnings include retained earnings of any other corporation,

(B) the corporation’s contributed surplus at the commencement of the year, and

(C) the greater of the corporation’s paid-up capital at the commencement of the year and the corporation’s paid-up capital at the end of the year.

(b) the amount determined under subparagraph (a)(i) in respect of the corporation for the year.

Facts

Wildenberg Holdings Ltd.(the “Appellant”) was a corporation incorporated under the laws of the Province of Ontario and at all material times was a resident of Canada for the purposes of the ITA and the Corporations Tax Act (Ontario) (the “Ontario Act”). All of the shares of the Appellant were owned at all material times by, an individual resident in Germany (the “Shareholder”).

Orlando Corporation (“Orlando”) was at all material times a corporation incorporated under the laws of the Province of Ontario.

The Appellant owned a 50% interest in a “Partnership”. The other 50% interest was owned by Orlando. The “partners” owned a parcel of land in Brampton to which title was held as the Appellant and Orlando.

The Appellant and Orlando granted a mortgage (the “Mortgage”) of the land to Metro International Inc., in Trust as security for a loan of $1,200,000.00. By a trust declaration dated December 15, 1981, Metro International Inc. declared that, with respect to the Mortgage, it was acting solely as a bare trustee for the Appellant’s sole shareholder.

The Mortgage limited each of the partners to 50% of the principal sum and 50% of any deficiency upon sale of lands subject to the Mortgage.

The borrowed money was used by “the Partnership” to earn income from its business and property.

The Partnership paid the Shareholder interest (the “Interest”) annually from 1981 to 1985 pursuant to the Mortgage. On September 1, 1985, the Partnership repaid the loan in full.

Pursuant to subsection 96(1) of the ITA, the Partnership’s net income was calculated at the partnership level and its expenses (including the Interest) were deducted from the Partnership’s revenues. Each partner then reported their respective 50% share of Partnership income for income tax purposes.

The Appellant included in its taxable income for 1981-1985 its share of the “Partnership” net income, as calculated above.

The Province of Ontario (the “Respondent”) reassessed the Appellant in respect of the 1981-1985 taxation years, and included in the Appellant’s income 50% of the Interest paid by the “Partnership” to the Shareholder for each year (the “Allocated Interest”), purportedly based on subsection 18(4) of the ITA (which is incorporated by reference in the Ontario Act by sec. 11 of the Ontario Act).

The Appellant appealed the assessment.

The Ontario Court of Justice dismissed the taxpayer’s appeal.

Taxpayer’s position

The taxpayer argued that it was the partnership which had borrowed the money and therefore subsection 18(4) did not apply to the appellant. The taxpayer also referred to the Revenue Canada response to question #12 at the 1992 CTF to support its position.

Department’s position

This case was the result of an assessment pursuant to the Ontario Corporation Tax Act. The case was decided based on the particular facts of the case, that being that the partner’s risk was contractually limited. In a case involving a similar set of facts Revenue Canada would likely take the same position that the corporation was not insulated from the application of subsection 18(4).

The 1992 round table answer was predicated on the existence of a bona fide partnership where each partner’s responsibility for all the partnership debts was joint and several. As such that position described therein remains in effect.