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: Whether a borrower-lender relationship exists between the issuer and holder of a promissory note where the note is issued to pay the dividend
Reasons: There is no lending of money so there is no borrower-lender relationship, only debtor-creditor relationship.
November 5, 1999
Bill Waddy International Section
International Tax S. Leung
Calgary Tax Services Office 957-2115
We are writing in reply to your memorandum of April 6, 1999 in which you requested our view as to whether a borrower-lender relationship exists where a demand promissory note bearing interest is issued by a corporation for payment of a dividend to its Canadian parent company which is a non-resident-owned investment corporation as defined in subsection 133(8) of the Income Tax Act (the "Act").
On XXXXXXXXXX a dividend in the amount of $XXXXXXXXXX was declared by XXXXXXXXXX to be payable to its sole shareholder, XXXXXXXXXX, a non-resident-owned investment corporation. To pay the dividend, XXXXXXXXXX issued in XXXXXXXXXX to XXXXXXXXXX a demand promissory note equal to the amount of the dividend. The note bore interest at the rate of prime plus XXXXXXXXXX%. No dividends in turn were paid by XXXXXXXXXX to its U.S. parent company, XXXXXXXXXX had no activity in XXXXXXXXXX other than the holding of the note and the shares of XXXXXXXXXX.
The issue is whether XXXXXXXXXX principal business is the making of loans as described in subparagraph (d)(i) of the definition of "non-resident-owned investment corporation" in subsection 133(8) of the Act as a consequence of its acceptance of the promissory note issued by XXXXXXXXXX as full payment for the dividend.
It is our view that the principal business of XXXXXXXXXX in its XXXXXXXXXX taxation year was not the making of loans as referred to in subparagraph (d)(i) of the definition of "non-resident-owned investment corporation" under subsection 133(8) of the Act. We arrived at the above conclusion by analyzing the relevant provisions of the Act and certain court cases, some of which were cited by the representative of XXXXXXXXXX.
In McVey v. The Queen (96 DTC 1225 (TCC)), Mogan, T.C.C. J. referred to the following definition of a "loan" in Bradley v. Canada ( T.C.J. No. 4 ):
"In law, a loan has been defined as follows:
A "loan" is a contract by which one delivers a sum of money to another and the latter agrees to return at a future time a sum equivalent to that which he borrows.
A "loan" within the law of usury is the delivery of a sum of money to another under a contract to return at some future time an equivalent amount with or without an additional sum agreed upon for its use.
To constitute a "loan", there must be an express or implied agreement whereby one person advances money to another, who agrees to repay it on such terms as to time and rate of interest, as parties may agree." (Emphasis added)
Charles, A.C.J.T.C., stated in Simmonds & Sons Ltd.v. M.N.R. (89 DTC 707, at 709):
"Definitions of a loan of money are to be found in a number of publications, but to my mind this definition in Black's Law Dictionary, 5th (1979) ed. is as useful as any: "Delivery by one party to and receipt by another party of a sum of money upon agreement, express or implied, to repay it with or without interest." This is not, in my opinion, descriptive of the transactions involving letters of credit that are under consideration in this appeal." (Emphasis added)
As Marjorie Brown of your office noted in her letter of September 14, 1998 to XXXXXXXXXX representative, in each of the definitions above, a loan involves an initial delivery, advancement or transfer of money. We would also add that a loan also involves a repayment or return at a future time of that sum of money originally advanced or delivered with or without interest. In the situation of XXXXXXXXXX, no money was advanced or delivered by XXXXXXXXXX to XXXXXXXXXX and the payment of money, if any, at the future time by XXXXXXXXXX to pay off the note could not normally be said to be a repayment because XXXXXXXXXX did not borrow any money from XXXXXXXXXX to require a repayment of that sum of money to XXXXXXXXXX.
A loan, it and by itself, implies that there must be a borrower-lender relationship between the person who delivers the sum of money and the person who repays it at the future time. It should be noted that in one of the definitions of "loan" mentioned above, the word "borrows" was actually used. When a person makes a loan to another person, the first-mentioned person is a lender and the other person is the borrower. The money loaned is the "borrowed money". Note that in T.E. McCool Ltd. v. M.N.R. (49 DTC 700;  Ex. C.R. 548), Mr. Justice Estey stated:
"Terms such as "borrowed capital", "borrowed money", in tax legislation have been interpreted to mean capital or money borrowed with a relationship of lender and borrower between the parties.... It is necessary in determining whether that relationship exists to ascertain the true nature and character of the transaction. In this case the promissory note arises out of an exchange in which, as already detailed, the purchase price was paid by assuming outstanding obligations, a small payment of cash, allotment of capital stock and the execution and delivering of this promissory note. Under such circumstances it cannot be held that the relationship of lender and borrower in respect to this note exists between the respondent company and the payee of the note.
It is not sufficient to say that if the company had borrowed the amount of the note and paid McCool it would have been entitled to the deduction. However that may be, that was not done and the statute does not apply."
Therefore, in McCool, it was decided that the issuance of a promissory note as part of the payment to acquire property does not create a borrower-lender relationship between the purchaser and the seller of the property.
The fact pattern of a more recent case, Parthenon Investments Limited v. M.N.R. (97 DTC 5343 (FCA); 93 DTC 1171 (TCC)) is similar to the one at hand. In Parthenon, a corporate taxpayer declared a dividend payable to its parent corporation in the amount of $2.6 million during its 1985 taxation year. It then substituted for such dividend owing by the issuance of an interest-bearing promissory note which the parent subsequently assigned to another of its subsidiaries and a sister corporation of the taxpayer. The issue is whether the interest paid by the taxpayer to that sister corporation on the promissory note is deductible for income tax purposes under paragraph 20(1)(c) of the Act. MacGuigan, J.A. stated for the Appeal Court :
"We all agreed that the learned Tax Court Judge was right in holding that the appellant did not borrow money on which it could deduct interest as required by subparagraph 20(1)(c)(i) of the Act. In the words of Locke, J. in M.N.R. v. T.E. McCool Limited (1949), (49 DTC 700, 712), in interpreting the same provisions, "in order to qualify under the statute the taxpayer would have to be in the position of a borrower and some other person would have to be a lender."...The appellant's witness Abdulezer acknowledged that there was no such borrowing by the appellant from "outside the family" (Appeal Book, App.I, I, 96-97, 115, 158), and like the Trial Judge, we are unable to interpret the promissory note as anything more than evidence of a debtor-creditor relationship. The unsubstantiated use of the word "repay" rather [than] "pay" in the tripartite document is not enough to prove otherwise, nor is the mere fact of a novation, if there was a novation, sufficient in itself to establish that the new arrangement was a borrowing."1
Although the issue in Parthenon regarding whether subparagraph 20(1)(c)(i) of the Act applied to allow an interest deduction is different from the issue at hand of determining whether XXXXXXXXXX principal business is the making of loans for the purposes of subparagraph (d)(i) of the definition of "non-resident-owned investment corporation" under subsection 133(8) of the Act, one thing is similar in that in both cases a determination has to be made as to whether a borrower-lender relationship exists as a result of the issuance of a promissory note by the debtor to the creditor to pay the dividend. In Parthenon, all the judges of the Appeal Court agreed with the Trial Judge that a relationship between a borrower and a lender did not exist as a consequence of the issuance of the note and therefore subparagraph 20(1)(c)(i) of the Act did not apply because there was no "borrowed money" for the purposes of that subparagraph.
The issuance of a promissory note to pay the dividend in this case is like the issuance of a note to pay for part of the purchase price of the property in McCool or to pay the dividend in Parthenon. There was no money being borrowed in each of those cases and consequently there was no borrower-lender relationship. Therefore, in this case, there is no making of loans by XXXXXXXXXX in XXXXXXXXXX.
As it is our view that XXXXXXXXXX did not make a loan in XXXXXXXXXX to XXXXXXXXXX because there is no borrower-lender relationship created as a result of the issuance of a promissory note by XXXXXXXXXX to XXXXXXXXXX, it is not necessary to deal with the second question you raised in your memorandum with respect to whether one single loan transaction amounts to a "business of making loans".
If you have any question regarding the above, please do not hesitate to contact us.
Reorganization and International Division
Income Tax Rulings and
Policy and Legislation Branch
P.S.: For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Department's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their database. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Request for this latter version should be made by you to Jackie Page at (819)994-2898. The severed copy will be sent to you for delivery to the client.
1 Note that in the judgments of both the Tax Court of Canada and the Federal Court of Appeal in Parthenon, no question was raised as to whether the dividend was considered to have been paid where a promissory note was issued to pay the dividend. It is therefore assumed that such issuance of a promissory note to the shareholder who was entitled to the dividend was adequate in law as full payment of the dividend.
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