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: (i) Whether the clause "which for the purpose of this paragraph includes the earning of interest on indebtedness" in paragraph 95(2)(l) is meant to apply only to the interest earned on the indebtedness in which the foreign affiliate is trading or dealing? (ii) Whether the principal purpose of the business of the foreign affiliate described in the various scenarios in the letter is to derive income from trading or dealing in indebtedness? (iii) Is there any difference in meaning of the words "trading or dealing" found in the English version and the words "commerce de dettes" found in the French version of paragraph 95(2)(l)?
Position: (i) No. (ii) Not determinable. (iii) No difference in this context.
Reasons: (i) Interpretation of the law and policy (ii) Insufficient information to make a determination. (iii) They both give the notion of business and profession.
XXXXXXXXXX 2004-009311
S. Leung, C.A.
June 18, 2007
Dear XXXXXXXXXX:
Re: Paragraph 95(2)(l) of the Income Tax Act (the "Act")
We are writing in reply to your email transmission in which you requested our interpretation of paragraph 95(2)(l) of the Act. We apologize for the delay in replying. Specifically, you are concerned about whether the words "the earning of interest on indebtedness" (the "Phrase") found in the second parenthesis in the pre-amble of that paragraph refer only to interest that was earned on the indebtedness in which a foreign affiliate is trading or dealing or also to interest that was earned on indebtedness in general such as interest earned which is ancillary to other sources of income not related to the trading or dealing in indebtedness. In addition, you enquired whether under any one of the three scenarios set out below one would consider that the principal purpose of the business of the foreign affiliate is to derive income from trading or dealing in indebtedness for the purposes of paragraph 95(2)(l) of the Act. The three scenarios are as follows:
(a) The foreign affiliate made only one loan during the year and had never made any other loans in the past;
(b) The foreign affiliate realizes interest income only from government obligations, bonds or bank deposits; and
(c) The foreign affiliate invests in mutual fund units.
Lastly, you requested that we consider whether there is any difference in meaning of the words "trading or dealing in indebtedness" found in the English version and the words "commerce de dettes" found in the French version of paragraph 95(2)(l) of the Act.
The preamble of paragraph 95(2)(l) of the Act states:
"In computing the income from property for a taxation year of a foreign affiliate of a taxpayer there shall be included the income of the affiliate for the year from a business (other than an investment business of the affiliate) the principal purpose of which is to derive income from trading or dealing in indebtedness (which for the purpose of this paragraph includes the earning of interest on indebtedness) other than"
The Meaning of the Phrase "the earning of interest on indebtedness"
It is our view that the Phrase found in the second parenthesis in the above-noted preamble of paragraph 95(2)(l) includes the earning of interest on any indebtedness used by the foreign affiliate in the relevant business. The clause "which for the purpose of this paragraph includes the earning of interest on indebtedness" qualifies the activity of trading or dealing in indebtedness, not the income from that activity. If that clause were to qualify the words "income from trading or dealing in indebtedness", it would not have needed the words "the earning of" in the phrase "the earning of interest on indebtedness". The word "earning" implies that there is an activity being carried on which activity, in the context of the preamble of paragraph 95(2)(l), is included in the term "trading or dealing in indebtedness". As a result, a business the principal purpose of which is to earn interest on indebtedness that is generally held to maturity could be caught under paragraph 95(2)(l). Had the Department of Finance intended to include only the earning of interest on the indebtedness that is traded, it could have used wording similar to that found in the first parenthesis in paragraph 95(2.4)(b) of the Act (that is, the words "interest earned by the affiliate during a short term holding period on indebtedness acquired by it for the purpose of the trading or dealing").
The Principal Purpose of the Business
With respect to the three scenarios outlined in your letter, it should be noted that it is a question of fact whether a business actually exists and, if it does, whether the principal purpose of that business of the foreign affiliate is to derive income from trading or dealing in indebtedness (which includes the earning of interest on indebtedness). The term "the principal purpose of the business" is different from the term "the principal business". The latter term implies that there may be more than one business1 and the business in question must be the principal business.2 The term "the principal purpose of the business" makes reference primarily to the purpose of a particular business. For the purposes of paragraph 95(2)(l), the business at issue may not necessarily be the principal business of the foreign affiliate but if the principal purpose of that business is to derive income from trading or dealing in indebtedness, it is caught. It should be noted that the principal purpose test in paragraph 95(2)(l) is to be applied to each business of the foreign affiliate.
Trading or Dealing in Indebtedness
The Act does not define the term "trading or dealing in indebtedness" although the phrase "trading or dealing in (the) indebtedness" also occurs several times in subsection 95(2.4) of the Act. However, the term "trader or dealer in securities" has been dealt with in several court cases and in Interpretation Bulletin IT-479R Transactions in Securities, dated February 29, 1984. That term can be found in many provisions of the Act such as in paragraphs 39(5)(a), 95(2) (l) and 95(2.4)(a) and the definition of "investment business" in subsection 95(1) of the Act.
It is stated in part in paragraph 5 of IT-479R:
"For the purposes of subsection 39(5) the Department interprets the term "trader or dealer in securities" to mean a taxpayer who participates in the promotion or underwriting of a particular issue of shares, bonds or other securities or a taxpayer who holds himself out to the public as a dealer in shares. ... Any person who, as a result of special knowledge of a particular corporation not available to the public, utilizes that knowledge to realize a quick gain is considered by the Department to be a "trader or dealer in securities" for those particular securities. Any corporation whose prime business activity is trading in shares or debt obligations is also considered to be a "trader or dealer" in securities, but this does not include a corporation whose prime business is the holding of securities and which sells such investments from time to time."
For the court's interpretation of that term you may want to refer to cases like Vancouver Art Metal Works3 , Arcorp Investments4 , Sandnes5 and Rajchgot6 . Although IT-479R and the cases cited above all dealt with the term "trader or dealer in securities" used in paragraph 39(5)(a) of the Act, in our view, the meaning of that term would be helpful in interpreting the words "trading or dealing in indebtedness" used in paragraph 95(2)(l) of the Act.
The Above Three Scenarios
As mentioned above, whether a foreign affiliate's principal purpose of a business is to derive income from trading or dealing in indebtedness is a question of fact and can only be determined after all the facts and circumstances of a particular situation are examined. In the three scenarios described in the beginning of this letter, because of the lack of sufficient information to make a determination, it is not possible to reach a definitive conclusion whether any one of those activities would constitute a business or meet the expanded meaning of "trading or dealing in indebtedness" (expanded by the words in the parenthesis immediately after that term) or whether the principal purpose of the business (i.e., assuming there is a business) is to derive income from such trading or dealing. The information missing includes such things as whether there are other activities carried out by the foreign affiliate other than those described in the beginning of the letter. Furthermore, we do not have information about whether in Scenario (a) the foreign affiliate plans to make more loans in the future and whether in Scenario (b) it trades and deals in government obligations and bonds regularly. In the latter case, we see no reason to distinguish government obligations and bonds from other indebtedness for the purpose of determining whether the principal purpose of the business is to derive income from trading or dealing in indebtedness. Suffice it to say that if any of the activities above were a business and the income derived from that business was interest on indebtedness, the business may well be caught by paragraph 95(2)(l) of the Act.
Words used in the English and French Versions of Paragraph 95(2)(l)
We do not think that there is a difference in meaning between the words "trading or dealing in indebtedness" in the English version of paragraph 95(2)(l) of the Act and the words "commerce de dettes" in the French version. Even if there were a difference, it would be necessary to assess the effect of such difference in the context of real transactions before one could determine whether the difference is significant enough to cause uncertainty regarding the interpretation of those words for the purposes of that paragraph.
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, the opinions expressed in this letter are not rulings and are consequently not binding on the Canada Revenue Agency.
Yours truly,
Olli Laurikainen, C.A.
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
ENDNOTES
1 For what constitutes a separate business, please refer to IT-206R.
2 For factors to be considered for the determination of which business is the principal business, please refer to paragraph 8 of IT-371.
3 Her Majesty the Queen v. Vancouver Art Metal Works Limited 93 DTC 5116 (FCA).
4 Arcorp Investments Limited v. Her Majesty the Queen, 2000 DTC 6690 (FCTD).
5 Ronald D. Sandnes v. Her Majesty the Queen, 2004 DTC 2466 (TCC).
6 David Rajchgot and Jacqueline Lacey v. Her Majesty the Queen, 2004 DTC 3090 (TCC).
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