Perennial reserve and inclusion mechanism (p. 6)
When the Canadian taxpayer (or the "specified debtor") finally repays the upstream loan or indebtedness (but not as part of a series of loans and repayments), the repayment amount may be deducted from income under subsection 90(14). As a result, each year while the upstream loan or indebtedness is outstanding, the prior year subsection 90(9) reserve is added back to the Canadian corporation's income, and a new subsection 90(9) reserve may be claimed only if and to the extent that the lending-time surplus and basis attributes remain available. The Canadian corporation can ultimately terminate this perennial reserve and inclusion mechanism by causing the upstream loan or indebtedness to be repaid, and claiming the subsection 90(14) deduction.
Consequences of not repaying grandfathered upstream loan by August 19, 2016
If grandfathered upstream loans are not repaid within two years of August 20, 2014,. i.e., August 19, 2016, subsection 90(6) will apply to any such grandfathered upstream loans. The Canadian taxpayer will be required to include the upstream loan amount in income on August 20, 2014, the deemed lending time for grandfathered loans. This may require adjustments to prior tax returns already filed for the relevant taxation year that includes August 20, 2014, depending on the filing position originally taken with respect to the upstream loans. Importantly, the deemed lending time of August 20, 2014, for grandfathered loans should also apply for the purposes of computing any offsetting deduction under subsection 90(9). This means that the Canadian corporation will be required to ascertain its surplus and basis attributes as at August 20, 2014, for purposes of the subsection 90(9) reserve, to demonstrate its hypothetical deductions under subsections 113(1) or 91(5) if a grandfathered upstream loan had instead been paid up the chain as a dividend. It is these August 20, 2014 surplus and basis attributes that must remain earmarked under paragraphs 90(9)(b) and (c) to shelter the grandfathered upstream loan. If these attributes as at August 20, 2014 are ultimately used to shelter any actual foreign affiliate dividend or other distribution, or are subsequently earmarked to shelter any other upstream loan, the Canadian corporation will lose its continued entitlement to the subsection 90(9) deduction and may find it necessary to actually repay the grandfathered upstream loan so as to instead claim a terminal deduction under subsection 90(14).
August 19, 2016 repayment deadline for pre-August 20, 2011 loans (p.7)
The paragraph 90(8)(a) carve-out from the upstream loan rules provides taxpayers with an effective and clear strategy to deal with grandfathered upstream loans. In particular, where a Canadian corporation has received a pre-August 20, 2011 upstream loan which under the transitional rule is deemed made on August 20, 2014, the loan can be repaid by August 19, 2016, with the effect that subsection 90(6) will not apply to such grandfathered loans.. This avoids the need to tie up the lending-time surplus and basis attributes with a subsection 90(9) deduction, and the ongoing administrative issues that would entail.
Purpose of eliminating FAPI whipsaw mismatch (e.g., where US dollar upstream loan) due to sub’s taxable capital gain or allowable capital loss not being off-settable against parent’s loss or gain (pp. 7-8)
[S]ubsection 39(2.1) and paragraph 95(2)(g.04)…appropriately recognize that taxpayers may have made historic upstream loans in a foreign currency, exposing themselves to the risk of the FAPI whipsaw mismatch but with the original intention of leaving the upstream loans outstanding indefinitely so as to defer any adverse consequences. The new upstream loan rules…may have caused taxpayers to accelerate repayment of pre-existing upstream loans, and consequently to realize the previously deferred adverse foreign exchange consequences.
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