21 September 1995 CTF Roundtable Q. 1, 9517906 - TRANSFER OF DEBT BY NR (MEANING OF "IN LIEU OF")

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.

					September 21, 1995

	International Taxation Office			Income Tax Rulings
P. Schryburt			 and Interpretations
	Assistant Director			 Directorate
								Jim Wilson
								957-2123
	Attention: G. Thompson
									951790

Transfer of Debt Obligations by a Non-Resident

This is in reply to your memorandum dated November 18, 1994, addressed to the International Tax Programs Directorate ("ITPD"), concerning the application of paragraph 214(8)(c) of the Income Tax Act (the "Act"). ITPD forwarded your memorandum to us on July 6, 1995 for our action. Our understanding of the facts is as follows:

Facts

1.A Canadian corporation ("Canco") was incorporated under the Canada Business Corporations Act and carries on an active business in Canada.

2.The common shares of Canco have always been held by the original subscriber, a corporation incorporated and resident in France ("Aco").

3.Over the years Aco has funded the operations of Canco partly through share subscriptions, and partly by advancing loans to Canco. All such loans have no fixed terms of repayment but bear interest at market rates. At the present time, Canco is indebted to Aco in the amount of $XXXXXXXXXX of principal and $XXXXXXXXXX of accrued interest.

4.Canco has annually elected to capitalize the above noted accrued interest pursuant to subsection 21(2) of the Act. Canco has relied on the position enunciated in paragraph 4 of IT-109R2, to shield the accrued, but unpaid interest from the treatment it would otherwise receive pursuant to section 78 of the Act.

5.Non-resident withholding tax has never been remitted on these interest accruals on the basis that the interest has not been paid or credited to the non-resident.

6.In 1993 a transaction was consummated whereby:

a)A corporation ("Bco"), also incorporated and resident in France but completely unrelated to Aco, acquired the outstanding shares of Aco from their holders (also unrelated to Bco). By virtue of this transaction, Bco acquired control of Aco, and thereby Canco.

b)Bco separately purchased from Aco the outstanding balances of principal and interest owing by Canco for their face value.

7.Bco has an existing Canadian subsidiary "Subco" which actively carries on business in Canada, and which in turn has several Canadian subsidiaries of its own. Bco would like to transfer to Subco the outstanding debt, principal and accrued interest, owing from Canco.

Your Comments

You have indicated that the taxpayer suspects that paragraph 214(8)(c) of the Act "makes the debt an excluded obligation and therefore not subject to subsection 214(7) of the Act". You have requested that we "determine if this debt is an excluded obligation or if subsection 214(7) of the Act is applicable".

You have also noted that "this obligation was purchased by a non-resident corporation from another non-resident corporation" and you are concerned that "the deeming provision of subsection 214(9) of the Act may have been applicable on the purchase of the debt and tax under Part XIII should have been withheld at that time".

Our Comments

We agree with the taxpayer that the intercompany debt presently held by Bco is an "excluded obligation" pursuant to paragraph 214(8)(c) of the Act and therefore qualifies for the exception in paragraph 214(7)(b) of the Act. Through its interaction with paragraph 214(8)(c), subsection 214(7) of the Act essentially is a provision that affects long-term, deep-discount obligations issued by Canadian residents and would not normally apply in this type of scenario. However, the proposed assignment of the obligation by Bco to Subco would still be subject to Part XIII tax as explained below.

We have assumed, based on the fact that Canco has made an election pursuant to subsection 21(2) of the Act,¹ that the accrued interest is payable but presently unpaid. Accordingly, subsection 214(6) of the Act would not apply to the proposed assignment of the obligation from Bco to Subco because a condition in that provision is that "subsection 20(14) would, if Part I were applicable, require an amount to be included in computing the transferor's income". Subsection 20(14) of the Act only applies when a "transferee has become entitled to an amount of interest that accrued on the debt obligation for a period commencing before the time of transfer and ending at that time that is not payable until after that time".

Where interest has accrued and is payable to a non-resident of Canada, with respect to an obligation issued by a Canadian resident, but has not been paid or credited² to the non-resident, Part XIII does not apply. However, where the non-resident has transferred or assigned that obligation to a resident of Canada and the purchaser has made a payment to the non-resident as consideration for that obligation and the right to receive an interest payment in respect of that obligation, the portion of that payment that relates to the right to receive the interest payment would be considered an "amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to the non-resident person as, on account or in lieu of payment of, or in satisfaction of, interest". (underlining mine)

The phrase "in lieu of" is generally defined in dictionaries to mean "instead of" or "in place of."³ We are of the view that where a non-resident had a legal right to receive an interest payment,⁴ that is the interest has accrued and is payable to the non-resident, then subsection 212(1)(b) of the Act will apply, subject to the exceptions described therein, to the portion of the payment made by the Canadian transferee that relates to such interest. In the Hall case, it was concluded that the consideration received by a taxpayer on the sale of matured bond coupons to a third party constituted "amounts received.....in lieu of payment of....interest" in section 6(1)(b) of the pre-72 Act.

With respect to your comments regarding subsection 214(9) of the Act upon the assignment of debt from Aco to Bco, we note that as a prerequisite for this provision Bco would have to be considered to be carrying on business in Canada. The fact that Bco has a wholly-owned subsidiary ("subco") that is resident in Canada and carries on business in Canada would not be relevant with respect to that requirement. Accordingly, based on the facts provided, subsection 214(9) of the Act is not applicable.

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

ENDNOTES

¹ In order to make an election under subsection 21(2) of the Act, the interest must have otherwise been deductible. Such interest would have only been deductible under paragraph 20(1)(c) of the Act if there was an amount payable in respect of the year pursuant to a legal obligation to pay interest.

² See paragraph 5 of Information Circular 77-16R4 for the Department's views on the word "credited". Generally, an amount has to be set aside and made unconditionally available to the non-resident to be considered "credited". Also, see La Compagnie Miniere Quebec Cartier v. MNR, 84 DTC 1348 (TCC) and Roundtable Questions #17, #84 and #48 of the 1984, 1986 and 1991 Canadian Tax Foundation Conference Reports.

³ Hall v. MNR, 70 DTC 6333, at 6335 (Ex. Ct.); aff'd 71 DTC 5217 (SCC).

⁴ Where interest has accrued but is not payable, a legal right to receive interest has not arisen and any payment made as compensation for the accrued interest by a transferee (eg. Canadian resident) would not, arguably, fall within the wording of the subsection 212(1) pre-amble. Hence the need for subsection 214(6) of the Act.