21 June 1995 External T.I. 9510915 - 6363-1 FOREIGN AFFILIATES - DEEMED ABI

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

		951091
XXXXXXXXXX		Olli Laurikainen
(613) 957-2116
Attention:  XXXXXXXXXX

June 21, 1995

Dear Sirs:

Re: Draft Foreign Affiliate Legislation

This is in response to your facsimiles dated April 20, 1995 and May 19, 1995 wherein you requested our views in relation to the interpretation of the words "derived from amounts that were paid or payable, directly or indirectly" in proposed subparagraph 95(2)(a)(ii) set out in Bill C-70.

You submitted the following hypothetical facts.

1)Canco is a corporation resident in Canada.

2)FA is a corporation not resident in Canada. Canco owns 100% of the issued and outstanding shares FA.

3)NR1 and NR2 are corporations that are not resident in Canada which were related to Canco and FA throughout FA's taxation year. Neither NR1 nor NR2 is a foreign affiliate of any person resident in Canada.

4)FA, NR1 and NR2 are each resident in a "designated treaty country" as that term is defined in the Revised Draft Amendments to the Income Tax Act issued by the Department of Finance in January 1995 (the "January Amendments") and are not resident in any other country.

5)FA makes an interest bearing loan (the "First Loan") to NR1 which uses the funds to make an interest bearing loan (the "Second Loan") to NR2. NR2 uses the funds in an active business it carries on in its country of residence and the interest paid by NR2 to NR1 on the Second Loan is deductible in computing its income from the active business under the tax law of that country.

6)Subject to the application of proposed paragraph 95(2)(a), the interest earned by FA from the First Loan is "income from property" as defined in subsection 95(1) of the proposed legislation. In addition, if NR1 were a foreign affiliate of a taxpayer resident in Canada, the interest from the Second Loan would be "income from property" under proposed subsection 95(1).

7)While it is outstanding, the First Loan will have a fair market value equal to its amortized cost as defined in subparagraph 248(1) of the Act read without paragraph (i) thereof, to FA.

You question whether in the above circumstances, proposed paragraph 95(2)(a) would apply to the interest earned by FA from the First Loan.

Provided it can be established that the interest payments received by FA from NR1 are directly linked to the interest payments made by NR2 in the above circumstances, it is our view that the interest income of FA from the First Loan would be "derived from amounts that were paid or payable directly or indirectly" by NR2 such that proposed clause 95(2)(a)(ii)(A) would apply to include such interest in the income of FA from an active business. Such income would accordingly be included in the "exempt earnings" of FA in respect of Canco pursuant to draft subclause 5907(1)(b)(iv)(B)(III) of the Regulations as set out in the January Amendments.

However, in the event the above transactions were part of a series of transactions that was designed to avoid the application of subsection 15(2) to moneys acquired by a shareholder or a corporation connected to the shareholder of Canco, the series of transactions may be considered a misuse of subsection 15(8) of the Act and subsection 245(2) may apply.

Yours truly,

for Director
Reorganizations and Foreign Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch