Section 17

The beneficiaries of CdnTrust, a trust resident in Canada that wholly-owns Canco, and of NRTrust, a factually non-resident trust that wholly-owns LLC1, are Canadian-resident and U.S.-resident members of the same family. Canco makes an interest-free loan to LLC1.

The Directorate concluded that Canco thereby was rendered a resident contributor to NRTrust (so that NRTrust was deemed to be a s. 94-resident trust) because it would be reasonable to view there as having been a resulting increase in the fair market value of the LLC1 shares.

In the Directorate’s view, this result obtained even if s. 17 (or s. 247(2)) applied to that loan, stating: would not change the conclusion that NRTrust was tainted as a deemed s. 94-resident trust, stating:

First, any income deemed to be included in the income of Canco by virtue of subsection 17(1) would not have any impact on the fair market value of the shares of LLC1. Second, the increase in fair market value of the shares of LLC1 only needs to occur at the time of the loan in order for paragraph 94(2)(a) to apply to deem there to be a contribution. The wording of paragraph 94(2)(a) requires that you determine whether there has been an increase in fair market value at the time the loan was made. Therefore, any transactions or events that occur subsequent to the time the loan was made will not change the determination regarding the application of paragraph 94(2)(a).

The phrase "owes an amount" in s. 17(1) is not limited to money that is loaned, and includes unpaid consideration, amounts owing to a corporation in Canada, accrued liabilities in its favour and unpaid dividends. In determining how long an amount has remained outstanding, the relevant period commences when the amount becomes owing to the corporation resident in Canada. For example, if a foreign corporation transfers a loan to a Canadian corporation, s. 17(1) does not apply if the loan is repaid less than 12 months later, even if the loan was outstanding for more than a year.

Where the non-resident subsidiary subsequently becomes resident in Canada, s. 17(1) will cease to apply to any amounts still outstanding after that time.

The reasonable rate of interest should reflect the amount that the lender would expect to receive if the loans were made on an arm's length basis.

With respect to an advance made by a Canadian licensor to a U.S. licensor that was repayable only out of royalties to be earned by the licensor, RC stated that "generally where the agreements in question do not contain an unconditional covenant to repay the principal amount of money advanced, the transaction cannot be considered to represent the loaning of money".

An advance by a Canadian corporation to an unrelated U.S. corporation to assist the U.S. corporation in the development of specific computer software programs, where the advance is recoverable by the Canadian corporation by way of set-off against its royalty obligations to the U.S. corporation, the advance will not be a loan because there is no unconditional covenant to repay the principal amount of the advance and because the Canadian corporation must look exclusively to the commercial success of the software for reimbursement.

S.17(1) will not apply if it is determined that nil is the reasonable rate of interest in the particular situation.

CRA indicated that even though a cross-border loan from Canco to a CFA was subject to s. 17 (so that interest income was imputed at 1%), the total imputed interest inclusion would be 3%, if that were the s. 247(2) arm’s length rate. However, if the loan was of the type described in s. 17(8), but did not (in CRA’s view) technically come within the s. 247(7) safe harbour because it was outstanding for less than a year, CRA would consider that loan to be shielded from the application of s. 247(2).

underline;">: Existing structure.

A Canadian public company (Pubco) has x% (apparently, over 50%) of its common shares held by a non-resident public company (Norco1). Pubco holds a y% indirect equity interest in a non-resident corporation (Opco), which holds the "Project" in Country 3 (perhaps, a development stage mining project), and is also resident in Country 3. A local government-owned corporation (Stateco), which has an entitlement to elect certain of the Opco directors, holds the balance of the shares of Opco. The indirect equity stake of Pubco in Opco is held partly through Forco2 (resident in Country 2), which is a subsidiary of Forco1 (also resident in Country 2), which is held by Pubco and a Canadian subsidiary of Pubco ("Cansub"). The balance of the equity stake is held through a chain of non-resident holding companies (Holdco1, holding Holdco2, holding Holdco3) resident in three different non-Canadian jurisdictions.

Proposed transactions

Additional internal debt and equity financing will be provided to Opco in accordance with the thin capitalization rules of the local country (Country 3), in accordance with two sets of transactions.

• Pubco (acting through a branch in Country 1 – assumed here to be Luxembourg) will subscribe with cash for common shares and/or mandatorily redeemable preferred shares ("MRPS") of Finco. Finco is a Luxembourg company (likely, a S.à r.l.). The MRPS are voting, do not bear dividends, are convertible at any time into a fixed value of Finco common shares or another class of MRPS at the holder's option, are redeemable before the maturity date at the holder's option and are required to be redeemed by Finco on the specified maturity date. They are debt for Luxembourg tax purposes, but shares for Luxembourg corporate purposes.
• Finco will lend the net proceeds (as the Finco Loan) to Forco2 which, in turn, will use the proceeds to make the Forco2 Loan (bearing interest at a positive spread) to "XXXX" which, in turn, will acquire common shares of Opco, to be used by Opco for its operational and capital requirements.
• Forco2 will transfer a portion of its shares of Opco to XXXX in exchange for an interest-bearing limited recourse obligation (Note A)
• Finco, upon a further subscription by the Luxembourg branch of Pubco for common shares or MRPS, will lend the net proceeds (as Loan X, bearing interest at a positive spread) to Forco2 which, in turn, will use the proceeds to make Loan Y to Opco for its operational and capital requirements.
• Pubco (and/or Cansub) will subscribe cash for Equity Investment A in Forco1, which will use such proceeds to make Equity Investment B in Forco2, which will use such proceeds to make Equity Investment C in Opco

Rulings

• Application of s. 95(2)(a)(i) to income on Forco2 Loan and Note A, and s. 95(2)(a)(ii)(B) to Finco Loan
• Non-application of ss. 17(1) and (2) to Pubco
• Non-application of ss. 95(6)(b) and 17(4)(b) to Pubco's direct acquisition of shares in Finco or its indirect acquisition of shares of Forco2
• Non-application of s. 258(3)
• Opinion that s. 212.3(2) may apply as "the exception provided for in subsection 212.3(16) may not be met here"
• Finco is a corporation, ownership interests in Finco are shares, and distributions of its profits are dividends (and similarly re Forco2 and Opco)

RC's answer to Question 10 of the 1988 Revenue Canada Round Table remains the same.

In light of the meaning given to the word "belongs" by the trial judge in Massey-Ferguson, the term "subsidiary controlled corporation" does not include a second-tier foreign affiliate.

CRA considers a deposit with a bank or other financial institution to be a loan to the institution, including for the purposes of s. 17(11.2).