1 August 1986 Income Tax Severed Letter 5-1379 - [860801]

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.

XXXX

K.B. Harding (613) 957-2129

August 1, 1986

Dear Sirs:

This is in reply to your letter of April 1, 1986 wherein you requested our opinion concerning section 126 of the Income Tax Act.

You outlined a hypothetical situation where a Canadian corporation makes a non-interest bearing loan to a wholly-owned U.S. subsidiary. The loan is used in the subsidiary for the purposes of gaining or producing business income.

For U.S. income tax purposes, the subsidiary must accrue interest on the loan pursuant to section 482 of the Internal Revenue Code. However, the interest is not deemed to have been paid by the U.S. subsidiary until it is in a financial position where it could have paid the interest had it been legally obligated to do so. When the interest is deemed to have been paid, it is subject to U.S. withholding tax at the prescribed rates in section 881 and 1442 of the Code and subject to the provisions of the Canada-U.S. Income Tax Convention (Convention).

You are concerned whether the withholding tax paid on the imputed interest qualifies as a "non-business income tax" of the Canadian parent and to which year the tax relates, (i.e. the year the withholding tax arises or the year in which the interest is accrued).

It is our view that the definition of the word "interest" as defined in paragraph 4 of Article XI of the Convention is broad enough to cover amounts which are considered as interest under U.S. domestic law. Paragraph 1 of Article XI (Interest) refers to interest arising in a Contracting State and paid to a resident of the other Contracting State. If the United States deems such amounts paid in the particular circumstances this Article would limit the amount deductible to 15 per cent. Furthermore, we are in agreement that the withholding tax paid by the subsidiary on interest it accrues would qualify as a tax paid pursuant to paragraph 2(b) of Article II (Taxes Covered) of the Convention since the tax on the imputed interest is a tax imposed under the Internal Revenue Code.

The tax withheld on the imputed interest will qualify as a non-business income tax for purposes of the Canadian parent company and as such will be eligible for a foreign tax credit pursuant to paragraph 126(1)(a) of the Act. However, since the imputed interest does not give rise to income for Canadian tax purposes, the Canadian parent would not be considered to have foreign source income and would therefore not be eligible for a foreign tax credit.

It should be noted that no deduction will be permitted under section 20(11) since the tax paid to the U.S. will not exceed 15 per cent. It is our view that a deduction claimed under subsection 20(12) may only be deducted from business or property income and then, because by the working of paragraph 4(1)(a) of the Act, only from source (both nature and geographic) of income to which the taxes relate. In addition, a subsection 20(12) deduction cannot, in our view, be considered to stand on its own as a loss for the year from an office, employment, business or property for purposes of paragraph 3(d) of the Act since it does not represent a loss from business or property.

Your letter indicates that you are of the view that the year to which the tax relates is the year in which the liability to pay the withholding tax arises and not the year in which the interest is accrued for U. S. income tax purpose. Paragraph 126(1)(a) refers to any non-business income tax paid for the year to a country other than Canada. It is our opinion that the underlined words refers to the year in which the income arises and not the year in which the tax is paid. If the subsidiary is never in a position to pay the tax no foreign tax will be paid and no problem exists. However, if it is in a position to pay all or a portion of the foreign tax, the tax clearly relates to the years in which the income was deemed to be earned and is in fact paid in respect of a year in which the income arose. Accordingly, if the taxpayer is in a position where certain years may become statute-barred, they should file waivers in respect to those particular years to ensure that an adjustment could be made at a later date. Paragraphs 14 and 15 of Interpretation Bulletin IT-270R discusses Revenue Canada's position concerning this matter. We trust this is satisfactory for your purpose.

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch