CRA finds that corporate partners cannot avoid income inclusions under the thin cap rules by selling their interests to non-resident affiliates before year end

Ss. 12(1)(l.1) and 18(7) provide for the inclusion in a Canadian corporate partner’s income of a proportionate share of "deductible" partnership interest expense on debt subject to the thin cap rules. S. 96(1) only requires the computation of income (and of deductions such as interest) for a partnership which has "taxpayers" as members.

Someone argued that where the two Canco partner sell their interests to two non-resident sisters who are not "taxpayers," so that none of the partnership income for the year is allocated to taxpayers, no s. 96(1) computation is required so that the partnership has no "deductible" interest for the year – with the result that there is no income inclusion to them under s. 12(1)(l.1).

After noting that each partner’s "specified proportion" of the partnership debt is based on its share of partnership income for the previous year, CRA rejected the above argument on the basis that s. 96(1.01)(a) deemed each Canco to continue to be a member of the partnership at the year end for s. 96(1) purposes.

Neal Armstrong. Summary of 28 June 2015 T.I. 2015-0567811E5 under s. 12(1)(l.1).