News of Note
Flash crypto loans generate unusual tax issues
Email this ContentIn flash loans of cryptocurrency (which may occur in order for the borrower to arbitrage between different cryptocurrencies), the loan and its repayment occur at exactly the same time. This is because the loan advance of the cryptocurrency is contingent on the repayment occurring in the same block. Since either all of the steps are to be competed (i.e., added to the blockchain) or none, the loan and repayment simultaneously occur on such completion.
Thus, there is an issue as to whether compensation payable to the lender is deductible to the borrower under s. 20(1)(c) (if it is considered to have received the loan on capital account), given that there is no period of time over which interest could accrue.
Ian Caines, “Very-Short-Term Crypto Loans,” Canadian Tax Focus, Vol. 11, No. 2, May 2021, p.3 under s. 20(1)(c)(i).
Income Tax Severed Letters 12 May 2021
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA indicates that s. 90(9)(b) does not preclude annual s. 90(9) deductions for an upstream loan from CFA based on its ES followed by using that ES to repay the upstream loan
Canco received a loan from a controlled foreign affiliate (“CFA”) that remained outstanding at the end of years 1, 2 and 3, and was then repaid in year 4 by means of a dividend distributed out of CFA's exempt surplus. In years 1 to 3, Canco included the loan amount under s. 90(6) (in year 1) or s. 90(12) (in years 2 and 3), and claimed a new deduction under s. 90(9) in each of those years, based on CFA having sufficient exempt surplus when the loan was made.
Did the stipulation in s. 90(9)(b), that the CFA exempt surplus must be “not relevant in applying this subsection in respect of ... any deduction under subsection ... 113(1) in respect of a dividend paid, during the period in which the particular loan … is outstanding” signify that Canco could not access the s. 90(9) deductions in years 1 to 3, because the loan was still outstanding in year 4 at the time that the dividend was paid out of exempt surplus?
CRA indicated that it considers this stipulation to be targeted at the years in which the s. 90(9) deduction is claimed so that, if in one of those years the surplus was relevant to taking a s. 90(9) deduction regarding another loan or to a s. 113(1) deduction for a dividend paid in the year, the s. 90(9) deduction would thereupon cease to be available. Since the s. 90(9)(b) condition was met during the years (1 to 3) for which the s. 90(9) deductions were claimed, such deductions were permitted for those years, and s. 90(9)(b) only applied during year 4 to prohibit a s. 90(9) deduction in that year.
Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.8 under s. 90(9)(b).
CRA states that a non-interest-bearing loan from a CFA to a NR sister of the Canadian taxpayer generated double tax (FAPI and Pt. XIII tax)
A wholly-owned foreign subsidiary (FS) of CanCo uses funds generated from its operations to make a non-interest bearing loan to a foreign borrower (FB), which is wholly owned by the foreign parent (FP) of CanCo. The loan is repaid within 2 years so that the upstream loan rules in s. 90(6) do not apply.
CRA stated its “long-standing view” that s. 247(2) can generally apply to transactions between a foreign affiliate and another non-resident in computing the FA’s FAPI. Here, it would apply s. 247(2) to impute interest income to FS and, thus, FAPI to CanCo.
CRA went on to find that this application of s. 247(2) to generate imputed interest to FS did not preclude imputing a s. 80.4(2) benefit to FB. In its view, the s. 80.4(2) benefit would be deemed by s. 15(9) to be a benefit conferred on “a” shareholder (FB), with s. 214(3)(a) deeming this benefit to be paid “to the taxpayer [FB] as a dividend from a corporation resident in Canada.” Thus, in addition to generating FAPI, the interest-free benefit would be subject Part XIII tax, which FS would be required to withhold and remit. As in 2015-0622751I7 , there is no mention of Oceanspan or principles of territoriality.
Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.7 under s. 214(3)(a).
We have published 10 more CRA translations
We have published a further 10 translations of CRA interpretation released in the period going back to April, 2008. Their descriptors and links appear below.
These are additions to our set of 1,526 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 13 years of releases of Interpretations by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall.
CRA indicates that a s. 17(8) exception for a loan by a partnership of two related Cancos to an FA does not imply a s. 247(7) exclusion of s. 247(2)
A limited partnership (LP) between two resident related corporations (ACo and BCo) made a non-interest bearing loan to FA, which was wholly-owned by ACo. FA used the loan proceeds for the purpose of earning income from an active business, so that there was no imputed income to the partners under s. 17(1) by virtue of ss. 17(4), (8), and (13). However, s. 247(7), which generally avoids the imputation under s. 247(2) of interest on indebtedness that is covered by s. 17(8), is only stated to apply to amounts owing to a resident corporation, and not to a Canadian partnership.
CRA stated that it was “not prepared to take an administrative position to consider that subsection 247(7) would apply in respect of the loan between the FA and LP … .” In this regard, it indicated that:
- Ss. 17 and 247 “each have a distinct and separate role,” so that “the exception from application of one of these sections” does not generally establish “an intention to preclude the application of the other section.”
- Further, “adopting the requested administrative position could potentially facilitate the use of structures using hybrid entities to achieve a tax benefit.”
Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.5 under s. 247(7).
CRA acknowledges that Cameco may limit the use of s. 247(2)(d) recharacterization – and that s. 247(2)(c) must take into account the parties’ relationship
Regarding the CRA response to the TCC and FCA decisions in Cameco , CRA stated “that these decisions may limit situations where the re-characterization provision in paragraphs 247(2)(b) and (d) could be applied … [h]owever, the CRA will continue to consider the application of the re-characterization provision where appropriate.”
CRA further stated:
The CRA will continue to administer … 247(2)(a) and (c) in a manner consistent with the guidance … [in] General Electric [para. 54]:
“…The task in any given case is to ascertain the price that would have been paid in the same circumstances if the parties had been dealing at arm’s length. This involves taking into account all the circumstances which bear on the price whether they arise from the relationship or otherwise.”
CRA also noted the consultation process that commenced with the 2021 Budget.
Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.4 under s. 247(2)(a).
CRA finds that the C$5M threshold in s. 247(3)(b)(ii) is to be translated into a functional currency on the basis that it is not “in respect of a penalty”
A Canadian corporation (“Canco”) with an elected functional currency is subject to transfer pricing income adjustments respecting a functional currency year. What is the relevant spot rate to be used in converting the C$5,000,000 threshold in s. 247(3)(b)(ii) into the elected functional currency? S. 261(5)(b) generally requires that the relevant spot rate for the first day of the particular taxation year in issue be used in a converting a dollar amount, except where that amount is “in respect of a penalty or fine.”
CRA found that, in light of the quoted exclusion, the threshold amount was to be converted using the relevant spot rate for the first day of Canco’s particular taxation year in respect of which the transfer pricing income adjustments are made. In this regard, CRA noted that the C$5M threshold amount in s. 247(3)(b)(ii) was only one of the two components for establishing the threshold above which a penalty might be assessed, and that the penalty itself is equal to 10% of the amount determined under s. 247(3)(a), and does not take into account s. 247(3)(b). Thus, the C$5M threshold was in respect of determining whether a penalty might apply, but was not in respect of the penalty itself.
Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.3 under s. 261(5)(b).
CRA deferred a PPT ruling request until the Alta decision
Regarding whether CRA has issued any assessments based on the MLI principal purpose test (“PPT”), CRA noted that it was premature for any assessments to have been issued (the first deadline for NR4 filings for payments to which the PPT might apply was March 31, 2021; and the returns for the earliest 12-month taxation years to which the MLI could apply have a filing due date of November 30, 2021).
Regarding a query on any PPT ruling requests received by CRA, it indicated that it had received one pre-ruling consultation request involving the payment of a dividend by a Canco to a corporation, residing in a Treaty country, which was not engaged in commercial activities other than holding the Canco shares and managing assets, and which was wholly-owned by a resident of a non-Treaty country. CRA concluded that it would await the decision in Alta before entertaining a ruling request. that the Treaty reduced dividend withholding to 5%.
Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.2 under Treaties – MLI – Art. 7(1).
Finance provides pointers on the proposed earnings-stripping rules
Points made by Shawn Porter at the IFA Finance Roundtable on May 5, 2021 on the proposed earnings-stripping rules included:
- There is not contemplated to be a specific safe harbour for mostly Canadian firms – instead they likely will not be caught simply because their interest expense all fundamentally relates to the Canadian business and its earnings capacity and therefore comes in below the fixed ratio of 30% (or a higher group ratio rule applies).
- Part of the impetus for adopting these rules is that other countries are adopting them as well, and Canada wants to protect against more debt being pushed into Canada.
- The framework of the default 30% fixed ratio rule will be rooted in ITA concepts of what is a group and an entity.
- Each entity will determine whether it has net interest expense in a year, so that if that is less than 30% of its EBITDA, it has excess or unused capacity; if it is more, it has excess interest which would be denied.
- It is contemplated that what gets transferred within the group is the unused capacity of some members – rather than the excess interest being transferred, so that the interest can be deducted (if at all) only in the entity that incurred it.
- If excess interest remains in that group in the year after all unused capacity of other group members has been transferred within it, then the carryover rules come into play - the entity with the excess interest can look back three years to see whether it, or other group entities, have capacity in that time window to reduce the excess interest in the current year. If there is insufficient capacity looking back, then the denied interest can be carried forward for 20 years and deducted to the extent of the group’s unused capacity in those future years.
- “Net interest expense” is broader than the legal meaning of “interest,” and will includes interest expense, equivalents to interest expense, and financing expenses. This will only be partially informed by the concept of “equivalents” in BEPS Action 4.
- Capacity that emanates from net interest income of a group member would be eligible for transfer to other group entities – which would suggest that banks and insurers (if they have net interest income) would not be subject to these rules. In this regard, there potentially might be some sort of ring fencing around transfers of excess capacity by financial institution members to other members in a different business.
- The concept of EBITDA would start with taxable income, but it would make sense to provide for an add-back of deductions in computing taxable income, such as under s. 110(1)(k), for items that represent taxes rather that economic losses.
- The rules will accommodate tax loss transfer transactions according with CRA policies in that regard.
- In contrast to the 30% default fixed ratio, consolidated GAAP measures will be used for both the numerator, and denominator in determining whether external leverage permits using a higher ratio. Design issues include the choice of the appropriate ultimate parent (including the related issue of the provision of credit-support to the consolidated group, as so defined, by someone outside of the group), distortions to the extent that the group is loss-making overall, and different kinds of distortions if there are constituent entities within the group that are loss-making, as well as averaging effects for diversified multinationals in very different business-lines.
Neal Armstrong. 5 May 2021 IFA Finance Roundtable.