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:
Application of clause 95(2)(a)(ii)(B) in a back to back loan situation.
Position:
See letter.
Reasons:
Law.
XXXXXXXXXX 982978
J. Stalker
Attention: XXXXXXXXXX
January 6, 1999
Dear Sirs:
Re: Financing of Foreign Affiliate (Clause 95(2)(a)(ii)(B))
We are writing in response to your letter of November 16, 1998 in respect of the application of clause 95(2)(a)(ii)(B) of the Income Tax Act (Canada) (the “Act”) to the following hypothetical situation:
1. Canco is a corporation resident in Canada.
2. FA1 is a corporation resident in country X and is not resident in Canada for the purposes of the Act. Canco owns 100% of the shares of FA1.
3. FA2 is a corporation resident in country X and is not resident in Canada for the purposes of the Act. Canco owns 100% of the shares of FA2.
4. FA3 is a corporation resident in country Y and is not resident in Canada for the purposes of the Act. FA3 has only issued shares of one class. Twenty-five per cent of the issued shares of FA3 are owned by FA2. The remaining 75% of the issued shares of FA3 are held directly or indirectly by corporations unrelated to Canco, FA1 and FA2 and which are residents of Canada.
5. Bank is a financial institution which is not resident in Canada and which carries on a banking business around the world.
6. Bank will agree to make a US dollar loan to FA3 (the “Loan”) up to a certain maximum. A written condition of the Bank making any advance on the Loan to FA3 will be that FA1 place a US dollar amount on deposit with the Bank equal to the Bank advance. The amount of the Loan is proportionate to the amounts the other shareholders of FA3 will arrange will be loaned to FA3. Under the Loan documents, when, but only when, the amount is placed on deposit by FA1, will an advance be made on the Loan. The Loan documents will require that the total of all amounts on deposit (the “Deposit”) be at all times an amount equal to the total advance made on the Loan. FA1 will make the Deposit from funds it has on hand.
7. FA1 will provide an unconditional guarantee of the Loan, with the guarantee secured by a pledge of the Deposit. If FA3, for any reason, fails to make payments when due to Bank, Bank will have the right to set off the amount due on the Loan against amounts owed by Bank to FA1 on the Deposit.
8. The interest rate charged on the Loan will be at a rate of LIBOR plus 400 basis points. The interest rate paid on the Deposit will be at a rate of LIBOR plus 387.5 basis points. Interest on the Deposit will be paid based on the Loan principal outstanding in a period (that is, should the Deposit for some reason exceed the Loan, interest will be paid only on the amount of the Deposit equal to the amount of the Loan). Interest on the Loan and the Deposit will be paid quarterly. As interest is paid on the Loan, interest will be paid on the Deposit. There may be a short time lag (at most, five business days) between the two payments.
9. The interest on the Loan will be deductible in computing the amount prescribed to be FA3’s earnings from an active business under section 5907 of the Income Tax Regulations.
In our view, in the above circumstances, where the flow of payments can be directly traced, the interest income earned by FA1 on the Deposit would be included in computing the income of FA1 from an active business pursuant to clause 95(2)(a)(ii)(B), and the Deposit would be excluded property as defined in subsection 95(1) of the Act.
We hope our comments are of assistance.
Yours truly,
for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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