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 CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: Would income of a foreign affiliate derived from the leasing of boats to another non-resident corporation be foreign accrual property income ("FAPI") or income from an active business?
Position: Insufficient information to determine the issue.
Reasons: The income in question would be FAPI unless the exclusion to the definition of "investment business" in subsection 95(1) applies or subparagraph 95(2)(a)(ii) applies. We have not been provided with enough information to determine whether one of these two exceptions apply, however, details of the conditions that must be satisfied for these exceptions to apply are set out in the attached reply.
XXXXXXXXXX 2002-013814
S. Wong
October 22, 2002
Dear XXXXXXXXXX:
Re: Active Business Income or Foreign Accrual Property Income
We are writing in reply to your letter of April 29, 2002 requesting our views as to whether net income earned by B Co. from the leasing of boats to A Co. in the following situation is income from an active business or foreign accrual property income ("FAPI") as defined in subsection 95(1) of the Income Tax Act (the "Act"). We apologize for the delay in replying to your letter.
The Situation
Based on the information you provided, we understand that the relevant facts are as follows:
1. A Co. is an offshore company located in a non-treaty jurisdiction ("Country X"). We have assumed that A Co. is not resident in Canada but is resident in Country X for purposes of the Act.
2. The shares of A Co. are currently owned by two Canadian residents ("A Co. Shareholders").
3. A Co. is in the business of operating a charter boat service (presumably to arm's length parties); its principal assets are boats.
4. A Co. Shareholders wish to transfer an equity interest in A Co. to one of its senior employees, but do not want to give the employee any interest in the boats. The employee is a resident of Country X. A Co. Shareholders are concerned about the protection of their assets (potential civil lawsuits and possible shareholder disputes with the new shareholder).
5. A Co. Shareholders are considering transferring the boats to a new company, B Co., for purpose of asset protection. We have assumed that B Co. is not resident in Canada but is resident in Country X or some other foreign jurisdiction for purposes of the Act. It is not clear from the information you have provided who will own the shares of B Co, however, we have assumed for purposes of this letter that B Co. will be a foreign affiliate of each of A Co. Shareholders and a controlled foreign affiliate of at least one of the A Co. Shareholders, as defined in subsection 95(1) of the Act.
6. B Co. will lease the vessels to A Co., which will continue to operate the charter boat service business. We have assumed that B Co.'s only activity is the leasing of the vessels to A Co.
The particular situation outlined in your letter appears to relate to a factual one, involving specific taxpayers. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. Should your situation involve specific taxpayers and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views.
As discussed below, we do not have sufficient information to determine whether income earned by B Co. from the leasing of boats to A Co. is income from an active business or FAPI as defined in subsection 95(1) of the Act. However, we are prepared to offer the following general comments which may be of assistance.
"Investment business" of a foreign affiliate of a taxpayer is defined in subsection 95(1) of the Act to mean, inter alia,
"a business carried on by the affiliate in a taxation year (other than a business deemed by subsection (2) to be a business other than an active business carried on by the affiliate) the principal purpose of which is to derive income from property (including...rents,...or any similar returns or substitutes therefor),...unless it is established by the taxpayer or the affiliate that, throughout the period in the year during which the business was carried on by the affiliate,
(a) the business (other than any business conducted principally with persons which whom the affiliate does not deal at arm's length) is...
(ii) the development of real estate for sale, the lending of money, the leasing or licensing of property or the insurance or reinsurance of risks, and
(b) the affiliate...employs
(i) more than 5 employees full time in the active conduct of the business, or
(ii) the equivalent of more than 5 employees full time in the active conduct of the business taking into consideration only the services provided by its employees of
(A) a corporation related to the affiliate (otherwise than because of a right referred to in paragraph 251(5)(b)),...
where the corporation...referred to in clause (A) receive compensation from the affiliate...for the services provided to the affiliate...by those employees the value of which is not less than the cost to such corporation...of the compensation paid or accruing to the benefit of those employees that perform the services during the time the services were performed by those employees." [Emphasis Added]
Based on the facts and assumptions outlined above, it would appear that B Co. would carry on a business the principal purpose of which is to derive income from rents, as described in the preamble to the definition of "investment business" in subsection 95(1) of the Act. Accordingly, the income of B Co. from the leasing of boats to A Co. would be FAPI1 unless:
(a) all the conditions set out in subparagraph (a)(ii) and paragraph (b) of the exclusion to that "investment business" definition are met; or
(b) subparagraph 95(2)(a)(ii) of the Act applies to deem such income to be income from an active business.
While the business of B Co. will be the leasing of property, it appears that its business will be conducted principally with A Co. It is not clear from the facts whether B Co. deals at arm's length with A Co. If B Co. does not deal at arm's length with A Co., subparagraph (a)(ii) of the exclusion to the subsection 95(1) "investment business" definition will not be met.
Even if it is established that B Co. deals at arm's length with A Co., we do not know how many employees, if any, B Co. will employ and therefore cannot determine whether paragraph (b) of the exclusion to the subsection 95(1) "investment business" definition is satisfied.
Assuming either subparagraph (a)(ii) (because B Co. does not deal at arm's length with A Co.) or paragraph (b) (because B Co. will not employ more than 5 or the equivalent of more than 5 employees full time in the active conduct of its business) of the exclusion to the subsection 95(1) "investment business" definition is not met, B Co.'s income would be FAPI unless subparagraph 95(2)(a)(ii) of the Act applies.
Generally, subparagraph 95(2)(a)(ii) of the Act deems income of a foreign affiliate in which the taxpayer has a qualifying interest throughout the year from sources in a country other than Canada that would otherwise be income from property for the year to be income from an active business to the extent that the income is derived from amounts that were paid or payable, directly or indirectly, to the affiliate by:
(a) a non-resident corporation to which the affiliate and taxpayer are related throughout the year, or
(b) another foreign affiliate of the taxpayer in respect of which the taxpayer has a qualifying interest throughout the year,
to the extent that those amounts that were paid or payable are for expenditures that were or would be, if the non-resident corporation were a foreign affiliate of the taxpayer, deductible in the year or a subsequent year by the other foreign affiliate or non-resident corporation in computing amounts prescribed to be its earnings or loss from an active business, other than an active business carried on in Canada.
Again, we do not have sufficient information to determine whether subparagraph 95(2)(a)(ii) of the Act applies to the income of B Co. from the leasing of boats to A Co. However, we have set out below the specific conditions that must be satisfied for subparagraph 95(2)(a)(ii) of the Act to apply to such income of B Co. in respect of the relevant A Co. Shareholder (the taxpayer in this case):
(a) The relevant A Co. Shareholder must have a qualifying interest in B Co. Qualifying interest is defined in paragraph 95(2)(m) of the Act and generally means ownership of not less than 10% of the issued and outstanding shares (having full voting rights under all circumstances) of the affiliate, and shares of the affiliate having a fair market value of not less than 10% of the fair market value of all the issued and outstanding shares of the affiliate. More information about the ownership structure of B Co. is required to determine this issue;
(b) A Co. must be: (i) a foreign affiliate of the relevant A Co. Shareholder in respect of which the Shareholder has a qualifying interest; or (ii) a non-resident corporation to which B Co. and the A Co. Shareholder are related. More information about the ownership structure of A Co. and B Co is required to determine this issue;
(c) A Co.'s "charter boat service" business must be an active business carried on outside Canada. It should be noted that this question depends on all the facts and circumstances. For instance, if the principal purpose of A Co.'s business is to derive income from property (i.e., rents from the leasing of the boats), rather than the provision of a service, A Co would be considered to be carrying on an "investment business" and not an active business unless it meets the conditions of the exclusion to the definition of "investment business" described above; and
(d) The lease payments payable by A Co. to B Co. must be deductible by A Co. in computing amounts prescribed to be its earnings or loss from its active business carried on outside Canada. Earnings of a foreign affiliate from an active business is defined in Income Tax Regulation 5907(1). Assuming that A. Co's charter boat business is an active business and A Co is required by the income tax law of Country X to compute its income from the charter boat business, it would appear that, subject to any adjustments in Income Tax Regulation 5907(2), this issue would require a determination of whether such lease payments are deductible by A Co. under Country X's income tax laws.
If any of these conditions for subparagraph 95(2)(a)(ii) is not satisfied and the exclusion to the definition of "investment business" described above does not apply, the income of B Co. from the leasing of boats to A Co. would be FAPI.
We trust that our comments will be of assistance to you.
Yours truly,
Jim Wilson
Section Manager
for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch
ENDNOTES
1 Income from an "investment business" (unless deemed by paragraph 95(2)(a) of the Act to be income from an active business) is included in "income from property" as defined in subsection 95(1) of the Act and included in FAPI under clause A of the definition of FAPI in subsection 95(1).
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