25 October 2016 Internal T.I. 2016-0658241I7 - Application of 95(2)(a.1) to a capital gain

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.

Principal Issues: Can paragraph 95(2)(a.1) apply to the disposition of an intangible which generates a capital gain?

Position: No.

Reasons: Variable B of FAPI is more specific, thus a capital gain cannot be income from a business other than an active business, which feeds into variable A of FAPI.

								October 25, 2016

Marian Young						HEADQUARTERS
International Division					Income Tax Rulings
International, Large Business and				 Directorate
Investigations Branch					Yves Grondin

								2016-065824

Paragraph 95(2)(a.1) and capital gains

We are writing in response to your correspondence of July 18, 2016 wherein you requested our views in respect of the application of paragraph 95(2)(a.1) to a capital gain on the disposition of an intangible.

Unless otherwise stated, all statutory references in this letter are to the Income Tax Act (the “Act”).

Summary of the Relevant Facts

The facts relating to your question can be summarized as follows:

• The taxpayer (“Canco”) is a corporation resident in Canada which owns all of the units of a U.S. limited liability company (“LLC”).
• LLC acquired an intangible (XXXXXXXXXX) from an unrelated party in XXXXXXXXXX.
• In XXXXXXXXXX, LLC sold the intangible to another corporation resident in Canada (“CanParent”) that is related to Canco and LLC and is the ultimate parent company of the group.

You have asked us to assume that the disposition of the intangible by the LLC is on account of capital and therefore generates a capital gain.

Question

You would like our views as to whether a capital gain from the disposition of an intangible can be considered to be income from a business other than an active business under paragraph 95(2)(a.1).

Comments

Unless certain exceptions apply, paragraph 95(2)(a.1) provides that income of a foreign affiliate from the sale of property is to be considered income from a business other than an active business where it is reasonable to conclude that the cost to any person of the property is relevant in computing the income from a business carried on by the taxpayer, or by a person resident in Canada with whom the taxpayer does not deal at arm's length, or is relevant in computing the income from a business carried on in Canada by a non-resident person with whom the taxpayer does not deal at arm’s length.

More specifically, subparagraph 95(2)(a.1)(iii) deems the sale of such property to be a separate business, other than an active business, carried on by the affiliate and subparagraph 95(2)(a.1)(iv) deems any income that pertains to or is incident to that business to be income from a business other than an active business. Income from a business other than an active business is one of the categories of income that is included in a foreign affiliate’s foreign accrual property income (“FAPI”), under variable A of the FAPI definition in subsection 95(1).

For the purposes of paragraph 95(2)(a.1), it might be possible, under certain circumstances, for a gain on the disposition of an intangible to be considered business income and not a capital gain and, because it is incident to or pertains to a business other than active business carried on by the foreign affiliate, it could be included in FAPI. However, we understand that, in your fact pattern, it would be difficult to argue that the gain is not a capital gain.

Since capital gains are also income within the meaning of section 3, you are wondering whether it might be possible to argue that this capital gain is income from, that is incident to, or that pertains to, a business other than an active business.

In our view, it is not possible for a capital gain to be considered income from a business other than an active business under paragraph 95(2)(a.1). The FAPI rules generally contemplate four categories of income: income from property, income from an active business, income from a business other than an active business, and capital gains.

Variable B of the FAPI definition applies specifically to capital gains, whereas income from a business other than an active business, such as income from the sale of property which meets the conditions of paragraph 95(2)(a.1), would fall under variable A of that definition. Although the FAPI definition does specifically contemplate some overlap between variables A and B, that overlap is with respect to gains on income account and not capital gains. As such, given that the capital gains rule is more specific, it is our view that capital gains of a foreign affiliate must be tested for inclusion under variable B and that they are not within the scope of variable A.

Thus, the treatment of the capital gain on the sale of the intangible as FAPI should be driven by a determination as to its status as excluded property, per the definition of “excluded property” in subsection 95(1). If the gain is from the disposition of an “excluded property”, no FAPI should arise.

Unless exempted, a copy of this letter will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request a modification to this 90-day waiting period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the Taxpayer. The Taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca, in which case a copy will be sent to you for delivery to the Taxpayer.

We trust that these comments will be of assistance, and thank you for your enquiry.

Yours truly,

Dave Beaulne, CPA, CA
Section Manager
for Director
International Division
Income tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch