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: 1. Whether the gross asset value method or net asset value method should be used in determining whether more than 50% of the FMV of the shares of a corporation was derived from relevant Canadian property. 2. Whether the proportionate value method or another method should be used to determine whether more than 50% of the FMV of the share of a corporation owning shares of subsidiary corporations was derived directly or indirectly from one, or any combination of, RCP. 3. Whether intercompany receivables and payables in a wholly-owned corporate group should be excluded from the assets and liabilities in the determination of the relevant values.
Position: 1. The gross asset value method should be used in determining whether more than 50% of the FMV of the shares of a corporation was derived from relevant Canadian property. 2. The proportionate value approach should be used to determine the FMV of the shares of a subsidiary derived from relevant Canadian property for the purpose of applying the gross asset value method at the parent level. 3. Certain intercompany receivable and payable balances receive particular treatment when determining the relevant values.
Reasons: 1. CRA's long-standing position. 2. This method best reflects the value of underlying assets. 3. Certain intercompany indebtedness within the same corporate group, as described, could distort the calculations.
May 1, 2017
HEADQUARTERS HEADQUARTERS
Large Business Audit Division Income Tax Rulings
International and Large Business Directorate Directorate
Attention: Minh-Thi Truong
Legislative Application Section
2015-062451
Taxable Canadian Property - 248(1)(e)(ii)
This memorandum is a reply to your email dated December 29, 2015, wherein you requested our comments as to the determination of whether shares of non-resident corporations in the situation described below would be considered taxable Canadian property (“TCP”) as defined in subsection 248(1) of the Income Tax Act (the “Act”).
Unless otherwise noted, all statutory references herein are references to the Act.
Our understanding of the relevant facts is as follows (the facts are simplified for the purpose of this analysis):
- Prior to XXXXXXXXXX, a non-resident trust (“Trust”) held shares in various private XXXXXXXXXX corporations (“NRCos”).
- The only assets of the NRCos, other than intercompany receivables, if any, were shares in private operating corporations resident in Canada (“Opcos”).
- The Opcos held XXXXXXXXXX property within the meaning of subsection 13(21), real or immovable property situated in Canada, other properties not listed in the definition of TCP in subsection 248(1), and in some cases shares of lower tier Opcos.
- It is the Trust’s position that on XXXXXXXXXX, pursuant to paragraph 94(3)(c), it was deemed to have disposed of all of its property, other than property described in subparagraphs 128.1(1)(b)(i) to (iv), at fair market value (“FMV”) and to have reacquired that property on XXXXXXXXXX for an adjusted cost base (“ACB”) equal to that FMV. As the result, it is the Trust’s position that it received a tax free step-up in ACB of its non-TCP property while it maintained its historical ACB in its TCP property. In XXXXXXXXXX, in a reorganization referred to as the “drop down transactions”, the Trust transferred the shares of the NRCos to XXXXXXXXXX corporations resident in Canada under subsection 85(1) (footnote 1). The agreed amounts reported for the subsection 85(1) transfers were the ACB of the shares of the NRCos. The Trust filed Forms T2057, Election on disposition of property by a taxpayer to a taxable Canadian corporation, on the basis that the shares of the NRCos were TCP and reflected their ACB as being the FMV of the shares in XXXXXXXXXX when the Trust acquired them (i.e., the historical ACB). The Trust also filed Forms T2062, Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property, with the classification of the shares of the NRCos as TCP.
- On or about the day following the Trust’s filing of the above noted T2057s and T2062s, the Trust sent a letter to the CRA indicating that, in its view, the shares of the NRCos were not TCP on XXXXXXXXXX, and as such, the T2057s should have been prepared on the basis that the shares of the NRCos were not TCP and should have reflected their ACB as being the FMV of the shares on XXXXXXXXXX (i.e., a stepped up ACB).
- The Trust carried out a valuation and analysis of the shares of the NRCos to determine their status as at XXXXXXXXXX.
- By the end of XXXXXXXXXX, the valuation and analysis of the shares of the NRCos were completed. The Trust concluded that the shares of the NRCos were not TCP on XXXXXXXXXX and, therefore, for the purpose of the XXXXXXXXXX transfer of the shares of the NRCos described above, the shares should have had an ACB equal to their FMV on XXXXXXXXXX (pursuant to paragraph 94(3)(c)) rather than their FMV in XXXXXXXXXX.
For the purpose of this memorandum, the expression “relevant Canadian property” (“RCP”) will be used to describe property that is listed in subparagraph (e)(ii) of the definition of TCP in subsection 248(1) as it read for taxation years including XXXXXXXXXX. As such, a reference to RCP includes the XXXXXXXXXX property, and the real or immovable property situated in Canada, held by an Opco.
Based on the above facts, you are asking how to determine whether, pursuant to the TCP definition in subsection 248(1), the shares of the NRCos were TCP of the Trust on XXXXXXXXXX. In particular, you ask the following questions:
1. Whether the gross asset value method or net asset value method should be used to determine whether more than 50% of the FMV of the share of a corporation was derived directly or indirectly from one, or any combination of, RCP?
2. Whether the proportionate value method or another method should be used to determine whether more than 50% of the FMV of the share of a corporation owning shares of a subsidiary corporation was derived directly or indirectly from one, or any combination of, RCP?
3. Whether intercompany receivables and payables in a wholly-owned corporate group should be excluded from the assets and liabilities of a particular corporation in the determination of the values relevant to the above two tests?
On XXXXXXXXXX, the definition of TCP in subsection 248(1) read as follows:
“‘taxable Canadian property’ of a taxpayer at any time in a taxation year means a property of the taxpayer that is
(a) real property situated in Canada,
(b) …
(c) …
(d) a share of the capital stock of a corporation resident in Canada (…) that is not listed on a designated stock exchange,
(e) a share of the capital stock of a non-resident corporation that is not listed on a designated stock exchange if, at any particular time during the 60-month period that ends at that time,
(i) the fair market value of all of the properties of the corporation each of which was,
(A) a taxable Canadian property,
(B) … to (E)
was greater than 50% of the fair market value of all of its properties, and
(ii) more than 50% of the fair market value of the share was derived directly or indirectly from one or any combination of
(A) real property situated in Canada,
(B) Canadian resource properties, and
(C) timber resource properties,
… ” (emphasis ours)
It is our understanding that, with respect to the shares of the NRCos, the Trust does not dispute that the condition in subparagraph (e)(i) of the definition of TCP was met. This is a reasonable conclusion given that on XXXXXXXXXX, the only property held by the NRCos, other than intercompany receivables, if any, were shares of private corporations resident in Canada (i.e., the Opcos) which were included in paragraph (d) of the definition of TCP noted above.
Therefore, your questions relate to the condition in subparagraph (e)(ii) of the definition of TCP (often referred to as the “Indirect Asset Test”), i.e., how to determine what proportion of the FMVs of the shares of the NRCos were derived from one, or any combination of, RCP.
Question 1
It has been our longstanding position that the gross asset value method should be used in determining the proportion of the value of shares of a corporation that is derived from certain properties for the purpose of the TCP definition in subsection 248(1). More specifically, the FMV of a property is to be determined without taking into account a corporation’s debts or other liabilities.
In the context of our tax treaties, we historically applied a broader interpretation and accepted both gross value and net value methods, as long as they were reasonable. We expressed our view with respect to the interpretation of the Capital Gains Article of our tax treaties in our response to Question 58 at the Revenue Canada Round Table at the 1984 Canadian Tax Foundation Conference (“CTF”). In answering the question “Is the value of the real property reduced by liabilities that are charged against such property?” our response was “The Department will accept a valuation method that assigns debt to the assets to which the debt reasonably relates.” We then changed this position at the 2011 CTF CRA Round Table during which our response to Question 2 (our document 2011-0425901C6) was that:
“In the context of tax treaties, the CRA is of the view that the determination whether a share of a company derives its value principally from real or immovable property situated in Canada should be made by reference to the value of the properties of the company without taking into account its debts or other liabilities. This approach is in line with paragraph 28.4 of the Commentary on Article 13 of the OECD Model Tax Convention. The same approach should be followed when interpreting the "taxable Canadian property" definition in subparagraph 248(1) of the Act.”
That change in position regarding our treaty interpretation coincided with the XXXXXXXXXX budget proposed (now enacted) amendments to the definition of TCP in subsection 248(1) and brought our treaty interpretation in line with both the OECD interpretation and the interpretation of the term TCP in the domestic context.
As a result, we are of the view that the gross asset value method should be used in the determination of whether more than 50% of the FMV of the share of an NRCo was derived directly or indirectly from one, or any combination of, RCP on XXXXXXXXXX.
Question 2
With respect to whether the proportionate value method or another method should be used to determine whether more than 50% of the FMV of the share of a corporation owing shares of a subsidiary corporation was derived directly or indirectly from one, or any combination of, RCP, we are of the view that the proportionate value approach should be used. More specifically, we are of the view that the gross asset value method, as described in our Comments regarding Question 1 above, should be applied at each entity level.
We described the proportionate value approach in our response to Question 5 at the 2012 CRA Roundtable during the International Fiscal Association (“IFA”) Conference (our document 2012-0444091C6) as follows:
“Where a non-resident disposes of shares of a Parent corporation that has a Subsidiary the CRA uses the proportionate value approach in determining to what extent the shares of the Subsidiary represent real or immovable property of the Parent. A determination will need to be made of the fair market value (FMV) of the shares of the Subsidiary. Moreover, a determination will need to be made of the proportion of the total gross assets of the Subsidiary that comprises of real or immovable property situated in Canada.
[…]
…[A]n amount equal to that same proportion of the FMV of the shares of the Subsidiary will be considered real or immovable property situated in Canada of the Parent in the determination of whether the shares of the Parent derive their value principally from real or immovable property situated in Canada.”
As a result, we are of the view that the proportionate value approach should be used to determine the proportion of the FMVs of the shares of the Opcos that derived from RCP for the purpose of applying the gross asset value method to the shares of the NRCos in order to determine whether more than 50% of the FMV of the share of an NRCo was derived directly or indirectly from one, or any combination of, RCP on XXXXXXXXXX.
Question 3
Regarding whether intercompany receivables and payables in a wholly-owned corporate group should be excluded from the assets and liabilities of a particular corporation in the determination of the relevant values for the tests described above, we note that this was addressed in our response to Question 5 at the 2012 IFA Conference CRA Roundtable (our document 2012-0444091C6) as follows:
“Indebtedness between a Parent and a wholly-owned Subsidiary has no impact on the determination of whether the value of the shares of the Parent was derived directly or indirectly from real or immovable property situated in Canada. If the shares of the Parent would be TCP had the Parent capitalized its wholly-owned Subsidiary with only equity, then such shares will be considered TCP if the Parent capitalizes the Subsidiary in part with equity and in part with debt.”
The remainder of our comments will expand on the position described above in the context of a wholly-owned corporate group. Examples of different types of loans (downstream, upstream, etc.) are discussed below in order to assist the reader in determining whether any particular intercompany balance in a factual wholly-owned corporate group has an impact on the determination of whether more than 50% of the value of the shares of a particular corporation was derived directly or indirectly from one, or any combination of, RCP.
Over and above the fact that the gross asset value method inherently requires the elimination of all payable balances, when determining the FMV of the assets held by a particular corporation, we are of the view that, generally, the value of any intercompany receivable balances pertaining to loans made downstream should be attributed to the relevant wholly-owned subsidiary’s shares. Put another way, for the purpose of a particular parent corporation’s gross asset value test, any intercompany receivable balance pertaining to a loan made downstream is not, in our view, a distinct asset of the particular parent corporation but, rather, its value increases the relevant FMV of its asset that is shares of a particular wholly-owned subsidiary. This will result in the same outcome for the parent corporation as if it had capitalized its subsidiaries with all equity as opposed to in part with equity and in part with debt. Therefore, to the extent a loan is made to a wholly-owned subsidiary, the value of the parent corporation’s intercompany receivable balance generally increases the relevant FMV of its asset that is shares of that subsidiary.
However, if a loan made to a subsidiary is similar in nature to a loan made to a sister corporation of that subsidiary (i.e., the loan is part of a back-to-back loan because the funds are on-loaned by the subsidiary to another wholly-owned subsidiary of the particular parent corporation), the value of the parent corporation’s intercompany receivable balance generally increases the relevant FMV of its asset that is shares of the sister corporation rather than of the subsidiary.
Intercompany receivable balances pertaining to loans made upstream, on the other hand, may have an impact on the determination of whether the value of the shares of the lending corporation was derived directly or indirectly from one, or any combination of, RCP. If the shares of the lending corporation would not be TCP had the corporation not made the upstream loan (e.g., if it had kept its internally generated excess funds in a bank account), then such shares will not be considered TCP if the corporation has made the upstream loan. Therefore, we are of the view that the value of an intercompany receivable balance pertaining to a loan made upstream should, generally, be included as a distinct asset when determining the FMV of the lending corporation’s assets.
That being said, in a case when the pertinent TCP test is for a corporation with wholly-owned subsidiary corporations (e.g., an NRCo), including the value of an intercompany receivable balance pertaining to a loan made upstream as a distinct asset when determining the FMV of the wholly-owned lending subsidiary’s assets would result in the double counting of the value of that receivable again at the parent level. This is so because when carrying out the gross asset value test for the parent corporation the value of the related intercompany payable balance is (as all liabilities are) ignored while the funds the parent received from the upstream loan would be included as a distinct asset of the parent based on the manner in which the parent utilised those funds (e.g., cash on hand, purchase price of RCP, etc.). Therefore, when the pertinent TCP test is for a corporation with wholly-owned subsidiary corporations, when applying the proportionate value method to a particular subsidiary corporation, the value of an intercompany receivable balance pertaining to a loan made upstream is not, in our view, a distinct asset of the particular subsidiary corporation but, rather, its value decreases the relevant FMV of the shares of the particular wholly-owned subsidiary.
Intercompany receivable balances pertaining to loans made to a sister corporation need to be considered on a case by case basis to ascertain if there is an impact on the determination of whether the value of the shares of the particular lending corporation was derived directly or indirectly from one, or any combination of, RCP. To the extent a loan made to a sister corporation is similar in nature to a loan made downstream (e.g., the loan is part of a back-to-back loan because the funds are on-loaned by the sister corporation to a subsidiary of the particular lending corporation), the intercompany receivable balance pertaining to the loan made to the sister corporation is not, in our view, a distinct asset of the particular lending corporation but, rather, its value increases the relevant FMV of its asset that is shares of its subsidiary.
Whereas, if a loan made to a sister corporation is not similar in nature to a loan made downstream and the shares of the particular lending corporation would not be TCP had it not made the loan (e.g., if it had kept its internally generated excess funds in a bank account), generally, the value of the intercompany receivable balance should be included as a distinct asset when determining the FMV of the particular lending corporation’s assets.
Lastly, if a loan made by a particular lending corporation to a sister corporation is part of a back-to-back loan from the parent of the particular lending corporation to the sister corporation (because funds borrowed by the particular lending corporation from its parent are on-loaned by the particular lending corporation to the sister corporation), in our view, the value of the particular lending corporation’s receivable balance pertaining to the loan made to the sister corporation is not a distinct asset and should not be included when determining the FMV of the particular lending corporation’s assets. At this time we would remind the reader of our comments above that in such a situation, the value of the parent corporation’s receivable balance pertaining to the loan to the particular lending corporation increases the relevant FMV of the parent’s asset that is shares of the sister corporation rather than of the particular lending corporation.
Summary
Based on our comments above, in order to determine whether the shares of the NRCos were TCP on XXXXXXXXXX, the computation would start from the bottom of the corporate chain underneath the NRCos, and would involve the following steps:
Step 1:
The first step is to determine for each lowest tier Opco the proportion of its assets that was comprised of RCP. For this purpose, the gross asset value method is to be applied and:
Step 2:
The second step is to apply the proportionate value approach to each lowest tier Opco. For this purpose:
- once the FMV of the shares of a particular lowest tier Opco is determined through normal business valuation methods, the following should be deducted or added, as the case may be, to the FMV of the shares to arrive at a relevant FMV:
-
- Deducted:
- the value of any intercompany receivable balances of the particular lowest tier Opco pertaining to loans made upstream; and
- Added:
- the value of any intercompany payable balances of the particular lowest tier Opco pertaining to loans received from upstream to the extent the loan is not part of a back-to-back loan from the parent of the particular lowest tier Opco to a sister corporation, and
- the value of any intercompany payable balances of the particular lowest tier Opco pertaining to loans received from a sister corporation to the extent the loan is part of a back-to-back loan from the particular lowest tier Opco’s parent;
- the percentage of RCP of the particular lowest tier Opco calculated in Step 1 should be multiplied by the relevant FMV of the shares; and
- the resulting product of this step is the prorated FMV of the shares of the particular lowest tier Opco which represents the FMV of RCP indirectly held by the parent of the particular lowest tier Opco. The remaining FMV of the shares of the particular lowest tier Opco is attributable to a non-RCP asset indirectly held by its parent.
Step 3:
The third step is to determine for each next tier Opco the proportion of its assets that was comprised of RCP. For this purpose, the gross asset value method is to be applied and:
Step 4:
The fourth step is to apply the proportionate value approach to each next tier Opco. For this purpose:
- once the FMV of the shares of a particular next tier Opco is determined through normal business valuation methods, the following should be deducted or added, as the case may be, to the FMV of the shares to arrive at a relevant FMV:
- Deducted:
- the value of any intercompany receivable balances of the particular next tier Opco pertaining to loans made upstream; and
- Added:
- the value of any intercompany payable balances of the particular next tier Opco pertaining to loans received from upstream to the extent the loan is not part of a back-to-back loan from the parent of the particular next tier Opco to the sister corporation, and
- the value of any intercompany payable balances of the particular next tier Opco pertaining to loans received from a sister corporation to the extent the loan is part of a back-to-back loan from the particular next tier Opco’s parent;
- the percentage of RCP of the particular next tier Opco calculated in Step 3 should be multiplied by the relevant FMV of the shares; and
- the resulting product of this step is the prorated FMV of the shares of the particular next tier Opco which represents the FMV of RCP indirectly held by the parent of the particular next tier Opco. The remaining FMV of the shares of the particular next tier Opco is attributable to a non-RCP asset indirectly held by its parent.
Steps 3 and 4 are repeated as necessary moving up the corporate chain until an NRCo is reached.
Step 5:
The fifth step is to determine for each NRCo whether more than 50% of the FMV of its shares was derived directly or indirectly from one, or any combination of, RCP. For this purpose, the gross asset value method is to be applied and:
- regarding the assets of a particular NRCo which are shares of an Opco, the product resulting from Step 2, or Step 4 as the case may be, for that Opco is the prorated FMV of the shares of the Opco which represents the FMV of a RCP asset indirectly held by its parent (i.e., the particular NRCo). The remaining FMV of the shares of the Opco is attributable to a non-RCP asset indirectly held by its parent (i.e., the particular NRCo);
- in determining the FMV of both RCP and all of the assets of a particular NRCo, no payable balance is to be considered (intercompany or otherwise);
- in determining the FMV of all of the assets of a particular NRCo:
- the value of any intercompany receivable balances pertaining to loans made downstream should not be included (the value of such balances were considered in Step 2, or Step 4 as the case may be, in determining the relevant FMV of the shares of a particular Opco held by the NRCo), and
- any intercompany receivable balance pertaining to loans made to sister corporations should be assessed on a case by case basis. For example:
- o to the extent the loan is similar in nature to a loan made downstream (e.g., the loan is part of a back-to-back loan because the funds are on-loaned by the sister corporation to an Opco held by the particular NRCo), the value of the intercompany receivable balance pertaining to the loan made to the sister corporation should not be included (the value of such balances were considered in Step 2, or Step 4 as the case may be, in determining the relevant FMV of the NRCo’s asset that is shares of the Opco held by the particular NRCo), and
- o to the extent the loan is not similar in nature to a loan made downstream and the shares of the NRCo would not be TCP had it not made the loan (e.g., if it had kept its internally generated excess funds in a bank account) the value of the receivable balance pertaining to the loan made to the sister corporation should be included as a distinct asset of the particular NRCo; and
- the percentage of RCP is calculated as: FMV of the NRCo’s RCP/ FMV of all of the NRCo’s assets.
If the percentage of RCP calculated in Step 5 is more than 50%, in our view, more than 50% of the FMV of the NRCo shares was derived directly or indirectly from one, or any combination of, RCP and, therefore, the shares of the particular NRCo would be TCP.
As noted at the outset of our Comments regarding Question 3, examples of different types of loans (downstream, upstream, etc.) were discussed in order to assist the reader in determining whether any particular intercompany balance in a factual wholly-owned corporate group has an impact on the determination of whether more than 50% of the value of the shares of a particular corporation was derived directly or indirectly from one, or any combination of, RCP. We acknowledge that not all types of intercompany balances have been discussed above. To the extent an intercompany balance is identified in a factual circumstance which is not described above, in our view, the principles discussed above should be considered and should help in the determination of the impact, if any, that particular intercompany balance has on whether the shares of a particular corporation derive more than 50% of their value directly or indirectly from one, or any combination of, RCP.
It is our further view that notwithstanding our general views described above regarding the treatment of intercompany receivables and payables in a wholly-owned corporate group for the purpose of the TCP definition in subsection 248(1), there may be circumstances in which the application of the general anti-avoidance rule (“GAAR”) would be appropriate. In our view, it would be appropriate to seek to apply the GAAR to situations where TCP status is artificially avoided, or achieved as the case may be, through the use of intercompany indebtedness within a corporate group. For example, it may be appropriate to apply the GAAR to deny the inclusion of artificially created assets in the form of intercompany receivables when determining the FMV of all of the properties of a particular corporation. A determination of whether the GAAR would apply to any particular circumstances would require full knowledge of the specific facts of the situation.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca. In such cases, a copy will be sent to you for delivery to the taxpayer.
Yours truly,
Lori Michele Carruthers CPA, CA
Section Manager
For Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Cc. XXXXXXXXXX
Large File Case Manager
Audit Division
XXXXXXXXXX TSO
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 The subject of this internal interpretation is the TCP definition in subsection 248(1) and not the overall tax consequences of the “drop down transactions”. As such, we are not expressing any views on the overall tax consequences of those transactions including any issues related to cross-border paid-up capital.
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