Section 95

Table of Contents

Paragraph 95(2)(a) (historical)

Administrative Policy

14 July 1995 T.I. 950977 (C.T.O. "6363-1 Foreign Affiliates - Investment Business")

Where loans, which require very little attention once negotiated by a wholly-owned foreign affiliate (the "First Affiliate") which carries on the active business of lending money in a high tax-rate foreign jurisdiction, are transferred to another wholly-owned affiliate (the "Second Affiliate") in a relatively low tax jurisdiction purely to reduce the amount of foreign taxes paid on the income from the loans of the lending assets, it is not clear that there will be any basis to argue that the loans so transferred to the Second Affiliate would not have arisen in the normal course of the First Affiliate's lending business.

24 May 1994 T.I. 940646 (C.T.O. "6363-1 Foreign Affiliate - Deemed Active Business Income")

Discussion of the implications of the 22 February 1994 Budget on the factual situation described below in 16 December 1993 T.I. 932563.

20 May 1993 T.I. (Tax Window, No. 31, p. 3, ¶2509)

Where funds are loaned by FA1 to FA2, which carries on business in the U.S. and, due to the application of the excess interest rule in s. 163(j) of the IRC, FA2 is unable to claim a current deduction for the interest paid to FA1, the full amount of the interest received will be active business income to FA1 and included in its earnings for purposes of Regulation 5907(1)(a)(ii). However, only the portion of the interest paid which is actually deducted by FA2 will reduce its earnings under Regulation 5907(1)(a)(i). Regulation 5907(2)(j)(i) would not be applicable in computing the earnings of FA2 for the year that the interest is paid because s. 163(j) only defers the deduction. However, Regulation 5907(2)(j)(i) would apply if FA2 was sold prior to claiming the deduction for the interest paid to FA1 or if the interest deduction was applied to passive income.

93 C.M.TC - Q. 2

Discussion of treatment of interest paid by one U.S. foreign affiliate to another where only part of the interest paid is deductible under s. 163(j) out of the Internal Revenue Code.

22 July 1991 T.I. (Tax Window, No. 5, p. 15, ¶1326)

Where an international shipping corporation charters a vessel on a bare boat basis from a related foreign affiliate that does not carry on an active business, s. 95(2)(a)(ii) will not apply to exclude the charter payments from the FAPI of that affiliate.

84 C.R. - Q.56

The provisions of s. 95(2)(a)(ii) do not apply where, in certain foreign countries, rules for consolidation permit expenses of one member of the consolidated group to be deducted from the income of another member of the consolidated group and the consolidated group is not recognized as a foreign affiliate for the purposes of s. 95(2)(a)(ii).

80 C.R. - Q.36

An example of income ancillary to an active business is interest earned on working capital that is temporarily invested in short-term bank deposits.

Under s. 95(2)(a)(ii), assuming that the payor is entitled to deduct interest (determined on the global basis set out in the Code) in computing its active business income, then the recipient may treat the interest as income an from active business.

Articles

Chapman, "Foreign Affiliate Amendments: Three Strikes and you are Done", 1995 Canadian Tax Journal, Vol. 43, No. 2, p. 433.

Subsection 95(1) - Definitions for this subdivision

Controlled Foreign Affiliate

Administrative Policy

2016 Ruling 2015-0571441R3 - Dutch Cooperative - 93.2 & 95(2)(c)

non-resident subsidiaries CFAs of bottom-tier Cdn partnership and FAs of Canadian corporate partners

Forco 1 is held through three stacked Canadian partnerships (the bottom one, “CanGP 3”) by two taxable Canadian corporations (Canco 1D and Canco 1A) which, in turn, are indirect wholly-owned subsidiaries of a non-resident parent (“Parent”). Forco 1, which is unlimited liability company resident in Foreign Country 3, wholly owns Forco 2, which is resident in Country 3 and wholly-owns Forco 3, which is a limited liability company resident in Foreign Country 2. Parent wholly owns Forco 4, which is a limited liability company resident in Country 2. Forco 5 is a private limited liability company resident in the Netherlands and is directly owned by Forco 2, Forco 3 and Forco 4.

In the factual description, Forcos 1, 2 3 and 5 are described as a CFA of CanGP 3 and also as a FA of Canco 1A and Canco 1B by virtue of s. 93.1(1).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(2) - Paragraph 95(2)(c) rollover is available on the drop-down of shares into a Dutch cooperative in consideration for a credit to the membership account 454
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Corporation Dutch cooperative whose articles limited member liability was a corp 252
Tax Topics - Income Tax Act - Section 93.2 - Subsection 93.2(2) membership interest in Dutch cooperative ruled to be shares 90

93 C.M.T.C - Q.1

It is not necessary to establish that the persons resident in Canada are acting in concert to control the affiliate. The threshold in s. 95(1)(a)(ii) is met if, through their collective holdings, they are in a position to control the affiliate.

Excluded Property

Administrative Policy

2015 Ruling 2014-0536661R3 - Disposition of property by a foreign partnership

still dormant mine as excluded property

CRA ruled that a distribution of the assets of a mine held by the partnership did not give rise to foreign accrual property income provided that the assets were excluded property. The mine in question had been previously shut down, but now further reserves had been identified and there was a plan to resume operations. See summary under s. 95(1) – foreign accrual property income.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(1) - Foreign Accrual Property Income reliance on excluded property exclusion on dissolution of Foreign LP as a result of the wind-up of its FA partners 377

6 March 2015 Internal T.I. 2014-0549761I7 - Internally generated goodwill & excluded property

unpurchased goodwill is taken into account

Is internally generated goodwill considered in determining whether shares of a foreign affiliate ("FA2") of a corporation resident in Canada qualify as "excluded property" of another foreign affiliate ("FA1") of the corporation?

CRA referred to the following position taken in 1988 respecting the "small business corporation" definition (after first referring to a similar position respecting s. 149(10)):

[T]he "all or substantially all" test will normally be satisfied if assets representing at least 90 percent of the fair market value of the assets of the corporation are used in an active business carried on by it. The assets of the corporation include goodwill, whether or not such goodwill has been purchased.

CRA then stated:

[I]nternally generated goodwill is property used by FA2 that should be taken into account in determining whether the shares of FA2 are "excluded property" of FA1. However, it must also be determined whether such goodwill is used by FA2 principally for the purpose of gaining or producing income from an active business carried on by FA2. This may, depending on the circumstances, require an apportionment of such use as between the active business of FA2 and the other activities of FA2

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 149 - Subsection 149(10) unpurchased goodwill is taken into account 92
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Small Business Corporation unpurchased goodwill is taken into account 97

15 January 2015 External T.I. 2014-0546581E5 - Partnership interest excluded property

foreign LP did not qualify as deemed NR corp where part of 10% interest held directly by related Canadian

Mr. B wholly-owns Canco 3 and Canco 4, and Mr. A, who is unrelated, wholly-owns Canco 1 and Canco 2. Canco 2 and Canco 3 each holds 50% of Forco, which has a 10% LP interest in foreign LP, whose assets are all used in an active business. Canco 1 and Canco 4 each have direct 5% interest in LP – and the other partners of LP are third parties. Would Forco's partnership interest in LP be excluded property? CRA stated:

[B]y virtue of paragraphs (d) and (e) of the definition "excluded property" in subsection 95(1), LP is deemed to be a non-resident corporation having 100 shares of capital stock of which Forco owns 10%, for the purposes of the definitions "foreign affiliate" and "direct equity percentage". Consequently, the equity percentage of Canco 3 in LP is 5%, thereby satisfying the requirement in paragraph (a) of the definition "foreign affiliate" in subsection 95(1).

However… the requirement in paragraph (b) of the definition "foreign affiliate" is not met… because Canco 4's 5% interest in LP is not to be taken into account. – Forco is the only partner of LP that is deemed to hold shares of LP for the purposes of the definition "excluded property". Consequently, LP would not be considered to be a "foreign affiliate" of Canco 3 and Forco's interest in LP would not qualify as "excluded property"… .

1 September 2009 External T.I. 2006-0168571E5 - Excluded property

2-tier application of para. (d), partnership not a corporation for related corporation purposes

Canco's wholly-owned subsidiary Forhold 2 has a 30% interest as general partner in LP1 which has a 15% LP interest in LP2 which, in turn, has 75% of the shares of Forco, substantially all of the asets of which are used principally for the purpose of producing income from an active business outside Canada. Cansub, which is wholly-owned by Canco, has a 25% LP interest in LP1. Forhold 1, which also is wholly-owned by Canco, directly holds 25% of Foco's shares. Would LP2 be considered to be a foreign affiliate of Canco for the purposes of the definition of "excluded property"? CRA stated:

LP1 is deemed to be a non-resident corporation under paragraph (d) of the definition of "excluded property" and paragraph (e) of the definition deems Forhold 2 to own 30% of the shares of that deemed corporation for the purposes of the definitions of "foreign affiliate and "direct equity percentage". Canco therefore has an equity percentage in LP1 of 30%, making LP1 a foreign affiliate of Canco for the purposes of the definition of "excluded property". As LP1 is deemed to be a foreign affiliate...LP2 is deemed to be a non-resident corporation under paragraph (d)...; LP1 is deemed to hold 15% of the issued shares of LP2 under paragraph (e).

…LP1 is considered to have a direct equity percentage of 15% in LP2. Accordingly, Canco has an equity percentage in LP2 that is not less than 1%, thereby fulfilling the requirement in paragraph (a) of the definition of "foreign affiliate". However… the requirement in paragraph (b) of the definition of "foreign affiliate" is not met in these circumstances and therefore LP2 cannot be considered a foreign affiliate of Canco. Paragraph (e) of the definition of "excluded property" only deems LP... [and] no other person...to hold shares in LP2... . [I]t follows that LP1 is the only holder of a direct equity percentage in LP2. ...[Respecting] if Canco is related to LP1 for the purposes of the definition of "excluded property" ... the deeming provisions in paragraphs (d) and (e) of the definition of "excluded property" do not speak to the matter of the de jure control of the "deemed corporation" and therefore do not apply to treat a partnership as a corporation for the purposes of determining if a partnership is related to a corporation. Accordingly, Canco would not be considered to be related to LP1 for the purposes of determining whether LP2 is a foreign affiliate of Canco for the purposes of the definition of "excluded property".

Having concluded that LP2 is not a foreign affiliate of Canco for the purposes of the definition of "excluded property", the shares of Forco held by LP2 are not property of a foreign affiliate of Canco and are therefore not excluded property.

21 September 2007 External T.I. 2007-0251651E5 - Excluded property

disposition of partnership interest as excluded property

A Canadian resident individual owns 100% of a corporation ("FA") resident in the Netherlands which, in turn, has an interest in a partnership, all or substantially all of the property of which is used or held principally for the purposes of gaining or producing income from an active business carried on in Canada. FA will immigrate to Canada, resulting in a deemed disposition of the partnership interest under s. 128.1(1)(b). Is the partnership interest excluded property, and would any capital gain resulting from its disposition be disregarded in computing the FAPI of FA? CRA stated:

Pursuant to the definition of "excluded property"…a partnership interest held by a foreign affiliate of a taxpayer…will be considered to be excluded property provided that the fair market value of the partnership interest held by the foreign affiliate is not less than 10% of the fair market value of all interests in the partnership and all or substantially all of the property of the partnership is used or held by the partnership principally for the purpose of gaining or producing income from an active business. The definition does not stipulate that the active business must be carried on outside Canada. Further, a taxable capital gain realized by a foreign affiliate on the disposition of an excluded property would not, subject to certain exceptions that do not appear to be relevant…, be included in a foreign affiliate's FAPI for a taxation year.

1 November 2000 External T.I. 1999-000972 -

A foreign affiliate ("Holdco") owns all the shares of a second foreign affiliate ("Subco A") which, in turn, owns all the shares of a third foreign affiliate ("Subco B"). Subco A carries on an active insurance business in a foreign jurisdiction, and some of the investments (e.g., treasury bills) that are required to meet the minimum capital requirements are held in Subco B. The removal of any portion of these investments would have a destabilizing effect on Subco A since it would not meet regulatory and licencing requirements, and on this basis Subco B's income would be deemed to be active under s. 95(2)(a)(i).

The shares of Subco B will be excluded property provided that all or substantially all its assets were used or held by it principally for the purpose of gaining and producing income which by virtue of s. 95(2)(a)(i) was income from an active business.

6 January 1999 T.I. 982978

Where a foreign subsidiary of Canco deposits a sum with a foreign bank to secure its guarantee of a loan made by the foreign bank to another foreign company in which Canco has an indirect 25% interest, with interest on the bank loan exceeding interest on the deposit by 22.5 basis points, income from the deposit will qualify under s. 95(2)(a)(ii)(B), with the deposit qualifying as excluded property.

10 March 1998 T.I. 980489

Where a grandchild foreign factoring subsidiary acquires substantially all its trade receivables from a foreign subsidiary of the taxpayer that itself carried on an active business, the trade receivables acquired by the factoring subsidiary would be excluded property "as those trade receivables are used principally for the purpose of gaining or producing income which is deemed to be active business income pursuant to subparagraph 95(2)(a)(ii)".

22 December 1997 T.I. 970977

Intangible property that is capital property and that is used by a controlled foreign affiliate principally in producing deemed active business income under s. 95(2)(a)(ii) where such income is included in its exempt earnings, will qualify as excluded property.

18 June 1996 External T.I. 18 June 1996 T.I. 9523595 - Excluded Property Status - Partnership Structures

“excluded property” expanded to include foreign Opco held by CFA through a partnership
Example A

Canco owns 100% of Forhold, which has a 90% interest in a partnership (P1), whose only assets are 25% of the shares of a foreign operating company (Forco) and a 90% interest in a second partnership (P2). Substantially all of the property of Forco and of P2 is used principally for the purposes of producing income from their active businesses. CRA stated:

Any capital gain realized by Forhold on a disposition of its 90% interest in P1 would be excluded from its foreign accrual property income ("FAPI") because the interest in P1 would be considered "excluded property" as defined in subsection 95(1)… . Furthermore, any capital gain realized by P1 on a disposition of its 25% interest in Forco or its 90% interest in P2 would be excluded from the FAPI of Forhold, since its interests in Forco and P2 would also be "excluded property".

As noted at the Round Table session of the 1992 Tax Executive Institute Conference, the definition of excluded property was amended to enable a non-resident corporation in which shares of the capital stock are held by a partnership to qualify as a foreign affiliate of a taxpayer for purposes of the excluded property rules. The Department commented as follows:

This position is consistent with the definition of "excluded property" in paragraph 95(1)(a.1) in that it was considered necessary to enact, for purposes of paragraphs 95(1)(d) and 95(4)(a) as they apply to paragraph 95(1)(a.1), the deeming provisions in subparagraphs 95(1)(a.1)(iv) and (v) in order that where a foreign affiliate had an interest in a partnership and the shares of the capital stock of a corporation in which all or substantially all the assets were used in an active business were partnership property such shares could be considered excluded property.

Example B

Canco 1 owns 100% and 65% of Canco 2 and Canco 3, respectively. Canco 2 and 3 own 100% of Forhold 2, and Forhold 3, respectively. Forhold 2 has an interest of 10% in a partnership (P1), and Canco 3 and Forhold 3 have interests of 65% and 25% respectively in P1. P1's only assets are 25% of the shares of Forco) and a 90% interest in a second partnership (P2), both of whose property is used principally for the purpose of producing income from their foreign active businesses. CRA stated:

For the purpose of the excluded property rules P1 and P2 would be considered non-resident corporations. For the same purpose, in interpreting the definition of foreign affiliate in subsection 95(1) of the Act, Canco 2 has an equity percentage of 2.5% in Forco and 9% in P2 for the purpose of paragraph (a) of that definition, and Canco 2 has an equity percentage of 0% in Forco and 0% in P2 for the purpose of paragraph (b) of that definition. However, P1 which is related to Canco 2 has an equity percentage of 25% in Forco and 90% in P2 for the purpose of paragraph (b) of the definition of foreign affiliate. Therefore, for the purpose of the excluded property definition, Forco and P2 are foreign affiliates of Canco. Accordingly, any capital gain realized by P1 on a disposition of its 25% interest in Forco or its 90% interest in P2 would be excluded from the FAPI of Forhold 2, since its interests in Forco and P2 would be excluded property pursuant to that definition in subsection 95(1) of the Act.

Articles

Paul Barnicke, Melanie Huynh, "FA's LP Interest: Excluded Property?", (2015) vol. 23, no. 4 Canadian Tax Highlights, 4-5

Alternative result in 2014-0546581E5 if additional partnership interest held by related Cdn corp through an FA (p. 5)

If Canco 4 [in 2014-0546581E5] owned its 5 percent interest in the LP through a wholly owned FA, presumably the CRA's answer might be different. If the postamble of the "excluded property" definition is applied to Canco 3 as a taxpayer, on these assumed facts Canco 3 should be able to count the 5 percent owned by Canco 4's FA. This result follows because the postamble in the "excluded property " definition refers to an interest in a partnership that is owned by an FA of a taxpayer, and that taxpayer can be any taxpayer (Canco 4, in this case) and not only the taxpayer (Canco 3) referred to in the preamble.

Shawn D. Porter, David Bunn, "Excluded Property and Foreign Rollovers: Interpretive Issues in the Partnership Context", International Tax Planning (Federated Press), 2010, p.1060

Potential bases for overcoming non-excluded property (“EP”) finding in 2006-0168571E5 re absence of related partnerships concept (p. 1063)

Notwithstanding the position taken by the CRA in the 2009 TI [2006-0168571E5] and the absence of relatedness rules for partnerships in the Act, the EP definition could be interpreted in a manner that better achieves its purpose. Two interpretive approaches are discussed below.

Inferring voting rights (p. 1063)

It is suggested that where a single class of shares is deemed, such class could reasonably be viewed as a class of voting shares. If this is the case, the common law principle of de jure control can be applied to the deemed corporation in determining whether the taxpayer and the deemed corporation are related. The fact that the mid-amble to the EP definition limits the deemed corporate fiction to the definitions of "foreign affiliate" and "direct equity percentage" should not be interpreted restrictively as the concept of related persons is fundamental in determining whether the 10% equity percentage threshold in paragraph (b) of the FA definition is met….

Control through GP (p. 1064)

Alternatively, one could argue that Forhold 2, in its capacity as the General Partner ("GP") of LP1, controls the affairs of LP1. Since paragraph (d) of the EP definition deems LP1 to be a corporation, it is suggested that Forhold 2, and consequently Canco, could be considered to be related to LP1 on the basis that Forhold 2 controls LP1. [fn 17: Paragraph 251(2)(b)] In other words, if the deemed shares of LP1 are not voting shares, then the private law results should govern for purposes of determining whether Forhold 2 controls LP1. a deemed corporation.

Foreign Accrual Property Income

See Also

A.G. Canada v. Le Groupe Jean Coutu (PJC) Inc., 2015 QCCA 838, SCC docket 36505, aff'd 2016 SCC 56

FAPI from loan by CFA to Canco

The taxpayer implemented a plan, to neutralize the effect of FX fluctuations on its investment in a U.S. sub, that overlooked FAPI considerations – so that interest on a loan made by the sub back to Canada was included in the taxpayer's income. Schrager JA found that rectification was not available. See summary under General Concepts – Rectification.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Rectification & Rescission transactions achieved purpose of neutralizing FX fluctuations and were not intended to avoid FAPI 242

Rostland Corp. v. The Queen, [1995] 2 CTC 2276 (TCC)

Two indirect wholly-owned foreign subsidiaries of the taxpayer ("Texas" and "BV") held non-recourse promissory notes of an arm's length partnership that had purchased a hotel previously owned by a third indirect subsidiary ("Arizona"). Mogan TCJ. found that in light of the highly leveraged nature of the purchase by the partnership, the passive character of the partnership's involvement in the hotel (in contrast with the extensive involvement of personnel of Arizona in the continued management of the hotel), and the terms of the note (including, the payment of interest only out of cash flow generated by the hotel in the taxation years in question, and the potential for substantial participation payments in future years), "that Texas and BV (as holders of the notes) were engaged in a kind of joint venture with the Partnership concerning the operation of the hotel business". Accordingly, the interest earned was income from an active business rather than property income.

Canada Trustco Mortgage Co. v. MNR, 91 DTC 1312 (TCC)

The taxpayer's Netherlands subsidiary, whose income was derived from Canadian mortgages which it had purchased from, and were administered by, its Canadian affiliates, and from related bank deposits, was found to be engaged in an active business. Although the rebuttable presumption that corporate income is business income had no application, what was done in Canada regarding the mortgages by the affiliates constituted the carrying on by the taxpayer of an active business "through the instrumentality of independent contractors". Searches for new business opportunities also constituted a commercial activity.

Alexander Cole Ltd. v. MNR, 90 DTC 1894 (TCC)

A wholly-owned U.S. subsidiary of the taxpayer, which had been engaged (through U.S. limited partnerships) in commercial real estate projects, sold the properties for consideration consisting primarily of long-term wrap-around mortgages. The net interest income derived from the wrap-around mortgages was not income from an active business given that the sales resulted from the decision of the U.S. subsidiary to get out of the active business of owning and managing commercial shopping and office enterprises, and in the absence of any evidence that the U.S. subsidiary was entering into an active investment business. "The active businesses ceased upon the sale of the capital assets. It cannot be said that the mortgages were incidental to the active businesses" (p. 1897).

King George Hotels Ltd. v. The Queen, 81 DTC 5082, [1981] CTC 87 (FCA)

It was "stressed that whether a business is an active or inactive one is ... [a question] of fact dependent on the circumstances of each case ... . It cannot be said ... that income from 'other than an active business' necessarily means that derived from a business that 'is in an absolute state of suspension'". [C.R.: 129(4)(a)(ii)]

Administrative Policy

2015 Ruling 2014-0536661R3 - Disposition of property by a foreign partnership

reliance on excluded property exclusion on dissolution of Foreign LP as a result of the wind-up of its FA partners

Current structure

Canco wholly owns Foreign Holdco, which wholly owns Foreign Subco1, the owner and operator of Mine 1 in Country X. Foreign Subco1 holds Foreign LP through two wholly owned subsidiaries: Foreign Subco3 as general partner; and Foreign Subco4 as limited partner. Foreign LP owns Mine 2, which was previously closed, but as a result of exploration and the identification of reserves, it is anticipated that further surface mining will be undertaken (and the relevant mining permits have been issued). Foreign LP also holds Foreign Corp, all or substantially all of whose assets are used in an active business, and a third-party note receivable previously received for a land sale (the "Note").

Proposed transactions
  1. Foreign LP will distribute Mine 2 to Foreign Subco3 and Foreign Subco4 in proportion to their respective partnership interests.
  2. Foreign Subco1 will authorize the liquidation and dissolution of Foreign Subco3 and Foreign Subco4, which will distribute all of their assets to Foreign Subco1 as liquidating distributions, and Foreign Subco1 will assume all their obligations and then be dissolved.
  3. As a result of Foreign Subco1 thereby becoming the sole member of Foreign LP, Foreign LP will effectively be dissolved so that its property will be considered to be distributed to Foreign Subco1, and Foreign Subco1 will assume all the obligations of Foreign LP.
Additional Information

The above steps will be non-taxable transactions under X's tax law. Each liquidations in 2 will be a designated liquidation and dissolution.The shares of Foreign Corp, the partnership interests in Foreign LP and the Mine 2 properties will be excluded property at the relevant times. The Note is not excluded property so that the taxable capital gain from its disposition will be FAPI. The disposition of the partnership interests upon the dissolution of Foreign LP will result in a capital gain determined under s. 95(2)(f). The fair market value of each of the Mine 2 buildings and the shares of Foreign Corp does not exceed their respective adjusted cost base to Foreign LP, so that no capital gain is anticipated on their disposition by Foreign LP.

Ruling

No FAPI will result from the distribution in 1 of Foreign LP's Mine 2 properties and from the disposition of the shares of Foreign Corp upon the dissolution of Foreign LP in 3 provided these properties are excluded property.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(1) - Excluded Property still dormant mine as excluded property 63

30 August 2004 External T.I. 2003-000135 -

A grandchild foreign subsidiary of Canco ("FA2") is wound-up into an immediate foreign subsidiary of Canco ("FA1") at a time that a note owing by FA2 to FA1 exceeds the asset value of FA2 net of other liabilities. The Directorate commented:

"If the fair market value of the FA1 Note at the time it is settled is less than the lesser of the principal amount of the FA1 Note and the amount for which the FA1 Note was issued, section 80 of the Act could apply if, had interest been paid or payable by FA1 to FA2 in respect of the FA1 Note, clause 95(2)(a)(ii)(D) of the Act would not apply. With respect to the application of section 80 and paragraph 95(2)(g.1) of the Act, it is our view that the FA1 Note is a 'commercial debt obligation' within the meaning assigned under subsection 80(1) of the Act unless, had interest been paid or payable in respect of the FA1 Note, such amount of interest would have been deemed to be nil for the purposes of computing foreign accrual property income ("FAPI") of FA2 under descriptions A and D of the definition of FAPI ...."

26 March 2004 External T.I. 2003-004706 -

Where a foreign affiliate earns foreign accrual property income (rental income) of U.S.$50,000 throughout a year, the average exchange rate for the year is 1.5 and the exchange rate the end of the year at the time a dividend of the earnings is paid to the Canadian taxpayer is 1.3, then the "A" amount in the fapi calculation would be Cdn.$75,000, but the fapi for the year would be Cdn.$70,000 due to a capital loss of Cdn.$10,000 (and deduction under "E" of $5,000) determined under s. 39(2).

27 November 1998 T.I. 982283

Where U.S. taxes are paid by U.S. C.-corp. (which is a foreign affiliate of the Canadian taxpayer) in respect of the investment business of a U.S. LLC in which it has a 90% interest, such taxes will not qualify as foreign accrual tax under subparagraph (a)(ii) of the definition in s. 95(1). However, when the U.S. LLC pays a dividend to the U.S. C.-corp and such dividend is attributable to the income in respect of which the U.S. tax was paid by the U.S. C.-corp., then at the time the dividend is paid the U.S. tax would qualify as foreign accrual tax under subparagraph (a)(ii) of the definition.

17 January 1991 T.I. (Tax Window, Prelim. No. 3, p. 2, ¶1094)

The interest income of a controlled foreign affiliate on a foreign currency deposit denominated in a currency which was depreciating rapidly relative to the Canadian dollar was to be measured on the basis of the average exchange rate for the year, without deduction for the accrued foreign exchange loss on the deposit, in light of the fact that s. 39(2) govern the recognition of foreign exchange losses on capital account.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 39 - Subsection 39(2) 40

85 C.R. - Q.15

After the Burri decision, whether income of a foreign affiliate is active business income or property income will continue to be determined by the facts of each case.

Articles

Mark Coleman, Daniel A. Bellefontaine, "Forgiveness, Foreign Affiliates and FAPI: a Framework", Resource Sector Taxation (Federated Press), Vol. X, No. 1, 2015, p.694

Application of forgiven amount only to reduce losses (p. 697)

[O]ne of the main distinctions between the FAPI debt forgiveness regime and the ordinary debt forgiveness regime is that an income inclusion can arise under the ordinary regime where the debtor does not have sufficient attributes to grind in the year. In contrast, under the FAPI regime, if the debtor does not have a sufficient amount of attributes to absorb the forgiven amount in the year the debt is forgiven, the excess will be carried forward indefinitely to reduce attributes that arise in the future.

Ordering of loss application (pp. 697-8)

[T]he FAPI regime does not specify the order in which attributes are reduced in the same way that subsections 80(3) to (12) do. However, this is not to say that FAPLs and FACLs are treated equally with respect to attribute reductions….

Pursuant to the definition of FAPI, the amounts included in elements E and F.l (i.e., an affiliate's FACLs and FACL carryforwards and carrybacks) are limited to the total taxable capital gains included in element B for that year. In other words, if there is no taxable capital gain included in element B for the year, elements E and F. 1 will be equal to nil, even if the affiliate has current or prior year allowable capital losses that are otherwise deductible in computing FAPI. Thus, there is a preference within the FAPI debt forgiveness regime to reduce FAPLs, since only FAPLs will be reduced in a year where no taxable capital gain arises to the affiliate. Moreover, in years where FACLs are available for reduction, there should always be an offsetting taxable capital gain, meaning that the forgiven amount will still absorb the affiliate's FAPLs or result in an unsheltered taxable capital gain.

Immediate FAPI for income account forgiveness (p. 699)

[F]rom the FAPI perspective, it is therefore important to identify income account debts incurred in the course of earning income from property or from a business other than an active business, as the forgiveness of such debts could result in net FAPI as opposed to merely reducing the affiliate's FAPLs or FACLs.

Mitchell Sherman, Kenneth Saddington, "100 1 Damnations!", Corporate Finance, Volume XVIII, No. 3, 2012, p. 2126, at 2129

"Now that the provision [s. 100(1)] applies to dispositions to non-residents, with which a CFA is almost certain to transact, FAPI implications warrant greater consideration."

Gordon Funt, Joel A. Nitikman, "FAPI and Debt Forgiveness - Now You See It, Now You Don't", CCH Tax Topics, No. 1724, 24 March 2005.

Melanie Huynh, Eric Lockwood, "Foreign Accrual Property Income: A Practical Perspective", International Tax Planning, 2000 Canadian Tax Journal, Vol. 48, No. 3, p. 752.

Paragraph (b)

Administrative Policy

5 October 2017 Internal T.I. 2015-0614021I7 - 214(16) deemed dividend

s. 214(16) does not recharacterize interest as dividends for FAPI purposes

A portion of the interest paid by CanCo to ForCo, which is a controlled foreign affiliate of the Canadian parent of CanCo, is not deductible pursuant to s. 18(4) and is deemed by s. 214(16) to have been paid as a dividend (with CanCo designating under s. 214(16)(b) which particular payment is deemed to be the dividend.)

CRA noted that, as per its preamble, s. 214(16) only applies for Part XIII purposes, so that s. 214(16) would have no effect on CanCo’s LRIP or GRIP balances nor alter the character of the income received by ForCo as interest for foreign accrual property income purposes.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 214 - Subsection 214(16) Interest that is denied under the thin cap rules and recharacterized as dividends is still interest for FAPI and LRIP/GRIP purposes 196

Foreign Accrual Tax

Administrative Policy

11 June 2013 STEP Roundtable, 2013-0480321C6 - 2013 STEP Question 6 US LLCs - FAPI, FAT and FTCs

Is the US tax paid by a Canadian-resident taxpayer on the income (which also is foreign accrual property income) of an LLC which is owned by it (and is a controlled foreign affiliate) considered to be foreign accrual tax in respect of the LLC?

CRA noted that as the US tax paid is a tax paid by the taxpayer and not by the LLC, it would not qualify as FAT and, furthermore, that arranging for the LLC to actually makes the tax payments to the IRS would not change this result as "it is implicit that any tax paid by the affiliate is, in fact, the affiliate's tax and not simply a payment on behalf of another person… ."

However, any amount included under s. 91(1) in respect of the FAPI would be considered income from sources in the US for purposes of ss. 20(11) and 126(1), so that an individual taxpayer could deduct under s. 20(11) any portion of the US tax paid for the year in excess of 15% of the s. 91(1) income inclusion. "Any excess [i.e., the 1st 15%] will be eligible for a foreign tax credit under subsection 126(1) and any of the excess US tax paid that cannot be utilized by the foreign tax credit may be deducted from income pursuant to subsection 20(12)." If, the taxpayer is a corporation:

any US tax paid in respect of [its] share of the income of the LLC would not be creditable for purposes of subsection 126(1) nor deductible for purposes of subsection 20(12) because the tax would be paid by a corporation in respect of income from a share of the capital stock of a foreign affiliate of the corporation. However…a deduction under paragraph 113(1)(c) would be available in respect of the US tax paid by a corporation resident in Canada in respect of the income of an LLC where a dividend distribution out of taxable surplus is received from the LLC.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 113 - Subsection 113(1) - Paragraph 113(1)(c) 168
Tax Topics - Income Tax Act - Section 20 - Subsection 20(12) deduction for US tax on LLC income which also is FAPI 157

5 September 2013 External T.I. 2011-0431031E5 - Guatemala's taxes

A Guatemalan-resdent foreign affiliate paid tax on gross revenue at a rate (for 2013) of 5% up to a low threshold (approx. Cdn. $3,925) and 6% above that. This tax qualified as an "income or profits tax" given that it was imposed under the same "Guatemalan Income Tax Law" which:

...allows the taxpayer to annually choose whether to pay tax on its gross revenue or to pay tax on its net income or profits. ... In this way the amount of tax that would be paid on net income or profits acts as the maximum amount of tax that would be payable in a particular year.

8 April 2004 Internal T.I. 2003-0037291I7 - US LLC and Regulation 5907(1.3)

no deduction for LLC sub income unless distributed

A wholly-owned US C-corp subsidiary (US Holdco) of a taxable Canadian corporation wholly-owned two LLCs, which earned only foreign accrual property income, with their income being included in that of US Holdco for Code purposes. Under a tax sharing agreement, each group member paid its respective tax costs as if it had filed a separate return, with the amount of this hypothetical tax distributed accordingly - e.g. should an LLC be in a loss position, that LLC would receive compensatory payments from the other group members that represented the hypothetical ‘tax refund.

As all the US tax paid by US Holdco was on its own account and not that of the LLCs (who were flow-through entities), the compensatory payments would not qualify as foreign accrual tax under s. (a)(i) of the FAT definition in s. 95(1), given the requirement that the tax be paid by the particular foreign affiliates (the LLCs). However:

[W]hen the LLCs distribute income to US Holdco such distribution would be characterized as a dividend. The portion of any income or profits tax paid by US Holdco that pertains to the earnings of an LLC which are distributed to US Holdco by way of dividend would, in our view, qualify as FAT under subparagraph (a)(ii)....

15 December 1998 External T.I. 9819355

U.S. tax on sale of replacement property viewed as tax on gain deferred on sale (triggering FAPI) of predecessor property

Usco (100% owned by Canco) realized FAPI on the gain from the disposition in Year 1, of a partnership in which it has a 50% interest, of a rental property. No gain was realized for Code purposes as a replacement property was acquired. In Year 2, the replacement property was sold giving rise to U.S. tax but no further FAPI. CRA stated:

[B]ecause the FAPI of a foreign affiliate is computed pursuant to the provisions of the Act while the foreign taxes paid by a foreign affiliate are determined in accordance with foreign tax law, there may result many reconciling items and timing differences between the FAPI reported by a taxpayer and the foreign taxes paid by the particular affiliate. The Act alleviates this problem with the above broad wording defining FAT and by providing, in subsection 91(4) of the Act, for a six year period to match the foreign taxes paid with the FAPI reported. …

[T]he U.S. tax paid by Usco on its share of the portion of the gain computed pursuant to the Code from the disposition of the Consideration Property by the Partnership that could reasonably be regarded as the gain and/or recaptured depreciation determined pursuant to the Code that was deferred on the disposition of the Rental Property by the Partnership would qualify as FAT. Canco would be entitled to a deduction pursuant to subsection 91(4) of the Act in respect of such portion because the FAT arose within the time limitations set out therein.

27 November 1998 External T.I. 9822835 - Foreign Affiliates - Foreign Accrual Tax

US tax paid by USco on income of LLC not FAT unless income distributed to USco

USco1 paid US tax on its share of property income of US LLC (which is a partnership for Code purposes) for 1997. Its Canadian shareholder (Canco) includes the FAPI of US LLC in its income. At the beginning of the following year (1998), US LLC distributes all its earnings to its shareholders. Would the US tax paid by USco1 qualify as foreign accrual tax? CRA responded:

[T]he FAPI included in income by Canco is in respect of US LLC. Since the U.S. tax was paid by Usco1, such tax would not qualify as FAT under subparagraph (a)(i) of the definition in subsection 95(1) of the Act. However, when US LLC distributes (i.e. pays a dividend) to Usco1 and such dividend was attributable to the income in respect of which the U.S. tax was paid by Usco1, it is our view that at the time the dividend was paid the U.S. tax would then qualify as FAT under subparagraph (a)(ii) of the definition in subsection 95(1) of the Act. Provided the requirements of subsection 91(4) were otherwise satisfied, Canco would then be entitled to a deduction in respect of such FAT in computing its income. …

[I]t is a question of fact what portion of the total U.S. income tax paid by Usco1 under the Code for its taxation year ended December 31, 1997 is attributable to its share of the income of US LLC for that year. However once such portion is determined, that portion may reasonably be regarded as applicable to the dividend received by Usco1 from US LLC on January 1, 1998 because that dividend comprises all the earnings of US LLC on which U.S. tax has been paid by Usco1.

19 October 1997 External T.I. 9719055 - Foreign Accrual Tax

FAT determined on pro rata basis/FAT paid in Year 3 not related back to Years 1 and 2 FAPI

What is the "foreign accrual tax applicable" in the following scenario?

Income of Affiliate

Year 1

Year 2

Year 3

Total

Fapi income

$100

$100

$100

$300

Active business Income

(50)

(130)

500

320

Net income (loss)

50

(30)

600

620

Loss carried forward

n/a

n/a

(30)

n/a

Taxable Income

$50

$nil

$570

$620

Foreign tax paid or payable @ 36%

$18

$nil

$205

$223

CRA responded:

In order for a foreign income or profits tax to qualify as foreign accrual tax it must be paid. Although the tax may not be paid at the affiliate's year end, provided it is paid in due course when the affiliate's tax return is filed, the tax will be considered paid in respect of the year to which it relates. ...

[T]he foreign accrual tax for Year 1 would be $18, while the foreign accrual tax for Year 3 would be $90 ($250 x 36%). This is based on the fact that over the three year period the total Fapi is $300 and the total active business income is $320. In these circumstances, it is our view that the total tax of $223 should be allocated to the Fapi on a 300/620 ratio (300/620 x $223 = $108). As the $18 paid in Year 1 clearly relates to the Fapi, it is our opinion that $90 of the tax paid in Year 3 reasonably relates to the Fapi for that year.

5 June 1996 T.I. 961803 (C.T.O. "Income or Profits Tax for Foreign Affiliate Rules")

"'Income or profits tax' for the purpose of the definition 'foreign accrual tax' ... may include Canadian income tax paid by a foreign affiliate of a taxpayer if the tax may reasonably be regarded as applicable to an amount included in computing the taxpayer's income by virtue of subsection 91(1)."

3 September 1991 External T.I. 9111825 -

foreign tax considered applicable to capital gain to extent required to eliminate Canadian tax thereon

In 1990, FA disposed of capital property giving rise to a $10,000 capital gain for ITA purposes and a gain for Code purposes of $20,000). After deduction of $8,000 under s. 40(1)(a)(iii) and a deductible loss under s. 95(1)(b)(v), FA has no FAPI in 1990. Under the Code, $15,000 of the $20,000 gain is deferred until 1991.

In computing its 1991 FAPI, FA recognizes a $6,000 taxable capital gain ("TCP") under s. 40(1)(a)(ii). Its total FAPI is $10,000 due to interest income of $6,000 less a s. 95(1)(b)(v) deductible loss of $2,000. Under the Code, FA computes taxable income of $16,000 (subject to 38% tax) comprising the $15,000 deferred gain plus the $6,000 of interest less a loss carry-forward of $5,000.

What portion of this tax can be reasonably regarded as applicable to the 1991 FAPI? CRA stated:

[F]oreign tax paid in respect of a capital gain may reasonably be regarded applicable to an amount included in computing a taxpayer's income by virtue of subsection 91(1)… to the extent that such foreign tax is required to eliminate the Canadian income tax that would otherwise be payable in respect of the gain under the FAPI rules… .

In order to determine what portion of the net FAPI was attributable to the TCG…it is necessary to allocate the deductible loss to the two types of FAPI income. In our view this should be done on a pro rata basis thereby producing a figure of $5,000 for the TCG portion of the FAPI (i.e. $6,000 - [6000/(6,000 + 6,000) x $2,000]).

The total U.S. tax paid in the year was $6080 (i.e. the taxable income for U.S. tax purposes of $16,000 multiplied by the U.S. tax rate of 38%) The portion of such amount that is applicable to the capital gain computed pursuant to Canadian tax law is in our view $2,316 (i.e. the proportion of the U.S. tax that the capital gain for Canadian tax purposes is of the U.S. taxable income before the application of the U.S. loss carry-forwards). …

The portion of the $2,316 that would need to be considered reasonably applicable to the 1991 FAPI TCG in order to eliminate Canadian tax in respect thereof would be $1,900 as this amount multiplied by the relevant tax factor for the purposes of paragraph 91(4)(a) produces a deduction equal to the 1991 FAPI TCG ($5,000). A further deduction in respect of U.S. tax paid on the balance of the capital gain reported for U.S. tax purposes may be available under subsection 91(4) of the Act if the original disposition of the property gave rise to an income inclusion under subsection 91(1) of the Act in the 5 immediately preceding years. …

The amount included in computing Canco's income in 1991 by virtue of subsection 91(1) of the Act in respect of the passive interest earned by FA after the deduction of the relevant portion of the deductible loss is $5,000 (i.e.$6,000-[6,000/(6,000 + 6,000) x $2,000]). The U.S. tax that may be reasonably regarded as applicable to such interest is $1,737 (i.e. the proportion of the U.S. tax that the interest income for Canadian tax purposes before the deduction of the deductible loss is of the U.S. taxable income before the application of U.S. loss

84 C.R. - Q.57

A "personal holding company" special tax is a tax on retained earnings of a particular foreign affiliate and is not "income or profits tax".

Articles

Michael Black, "Cross-Border Consolidation and the Foreign Affiliate Rules", Canadian Tax Journal (2017) 65:1, 173-89

CCCTB proposal in European Commission draft EU directive package of October 2016 (pp.175-6)

[I]ncluded in that package is a proposal to revamp the way that companies are taxed by adopting a common consolidated corporate tax base (CCCTB)….

1. Companies that are tax-resident in the European Union and EU-located branches of third-country companies would have one common set of rules for computing taxable income….

2. Companies within the same group would consolidate their individual results. On consolidation, transactions carried out between group members would be eliminated in order to compute consolidated taxable income. Under the proposed definition of a group, a common EU parent is not required.

3. The group's consolidated taxable income would be allocated among the individual group members on the basis of a set formula. The proposed formula gives equal weight to three factors: sales, labour, and assets. The labour factor is further divided and gives equal weight to two factors: payroll and number of employees….

Distorting FAT effect of European taxes being computed on a potentially radically-different base than FAPI (pp. 182-3)

[T]he calculation of taxable income under the CCCTB proposals would only affect the calculation of FAT and not the calculation of FAPI, because in computing FAPI taxpayers must use Canadian rules. Thus, the amount of the income inclusion would not be altered by the allocation under the CCCTB. This mismatch of income and FAT could cause adverse results for taxpayers.

Difficulties under CCCTB in satisfying equity percentage test (pp. 185-6)

[C]onsider the wording in subparagraph (a)(ii) of the definition of FAT. The conditions in this subparagraph are met if another foreign affiliate that has an equity percentage in the particular foreign affiliate pays the taxes and it is that other foreign affiliate that is liable for the taxes under the laws of its country of residence….

[I]f EU Parent owned EU Sub and the FAPI was earned by EU Parent, but under the CCCTB formula, the majority of the income was allocated to EU Sub. In this case, the taxes paid by EU Sub would also not meet the condition above because EU Sub does not own any shares in EU Parent and does not have an equity percentage in EU Parent.

In the absence of compensating payments, in order to allow foreign taxes paid by a group member under the CCCTB to qualify as FAT, the Department of Finance would have to consider further amendments to the FAT definition. However, other issues arise even if compensating payments are made…

Mark Coleman, Daniel A. Bellefontaine, "Forgiveness, Foreign Affiliates and FAPI: a Framework", Resource Sector Taxation (Federated Press), Vol. X, No. 1, 2015, p.694

Whether foreign tax on forgiven amount can be FAT (p. 699)

[T]he definition of FAT requires that the relevant foreign income tax reasonably be regarded as applicable to the subsection 91(1) amount. It is not obvious whether this condition could be met if foreign tax is paid on a forgiven amount that reduces the debtor's FAPLs or FACLs in a particular year and the debtor realizes FAPI in a future year as a result. Can the foreign tax "reasonably be regarded as applicable" to the resulting subsection 91(1) income? Arguably, it can be. The CRA has previously opined, in a different context, that it is necessary to consider all of the facts and potentially a number of taxation years in order to determine when foreign tax will be FAT. [fn :15:CRA Document 2002-013420117]…

Mark Coleman, "Treaty Shopping and Back-to-Back Loan Rules", Power Point Presentation for 28 May 2015 IFA Conference in Calgary.

Non-Treaty Co makes a non-interest-bearing loan to its parent (Treaty Co) to fund an interest-bearing loan to the Canadian-resident parent of Treaty Co (CanCo). The interest on the latter loan will be subject to 25% withholding tax on the basis that it is deemed by s. 212(3.1) to be paid to a non-arm's length person (Non-Treaty Co). The interest received by Treaty Co will be foreign accrual property income to it. Quaere whether CanCo will be entitled to a foreign accrual tax deduction under s. 91(4) for the s. 212(3.1) withholding tax which is factually applicable to the interest received by Treaty Co but which may be considered to be payable by Non-Treaty Co under s. 212(1)(b).

Michael G. Bronstetter, Douglas R. Christie, "The Fickle Finger of FAT: An Analysis of Foeign Accrual Tax", Canadian Tax Journal, (2003) Vol 51, No. 3, p. 1317

[I]t can be difficult to envision how any foreign tax could be appliable to an amount incuded as a taxpayer's share of FAPI pursuant to subsection 91(1). Presumably, the provision is intended to mean "the foreign income tax paid in repsect of amounts that are included in the computation of FAPI."

Foreign Affiliate

Administrative Policy

18 February 2013 External T.I. 2012-0467121E5 - Associated corporations, Debt Forgiveness

Husband and Wife own 51% and 49% of the shares of a non-resident corporation (ForeignCo) and 49% and 51% of the shares of CanadaCo. The two corporations are associated, but ForeignCo is not a foreign affiliate of CanadaCo.

15 July 2011 Internal T.I. 2010-0388621I7 - Entity Classification - Liechtenstein Anstalt

A Liechtenstein anstalt did not issue shares within the meaning of s. 248(1), as there was only one beneficiary. However, a division of the capital of the anstalt into shares was unnecessary so that it was reasonable to consider that the interest of the Canadian resident beneficiary (the taxpayer) was the equivalent of a share. "For Canadian tax purposes, it should suffice that the interest is what accords him the same rights as are normally conveyed by a share."

The taxpayer, as the bearer of the founder's rights, had the power to appoint, remove and discharge the board of directors, so that the taxpayer also controlled the anstalt. Accordingly, it was eminently arguable that the anstalt was a controlled foreign affiliate of the taxpayer, so that the taxpayer could be assessed for fapi generated by the anstalt.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Corporation anstalt a corp 96
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Share division of capital not necessary for "shares" 126

2004 Ruling 2004-010311 -

Ruling that a U.S. LLC would be considered a corporation, that the ownership interest of a member would be considered shares, and that distributions would be considered to be dividends.

5 October 2001 Comfort Letter 2001 1005B

Proposed amendment to deem for purposes of s. 95(2)(a) a non-resident corporation to be a foreign affiliate of a particular corporation resident in Canada in respect of which the particular corporation has a qualifying interest if various conditions are met (respecting, generally, the concern that where a taxpayer resident in Canada owns its foreign affiliates indirectly through two or more corporations resident in Canada and, as a result, while all the corporations may be related to one another, one or more of the non-resident corporations may not be foreign affiliates of the particular corporation resident in Canada).

27 June 1994 T.I. 940600 (C.T.O. "Corporate Status of a Delaware LLC (4093-U5-100-4)")

If a Delaware limited liability company is treated as a partnership rather than a corporation for purposes of the Internal Revenue Code, with the result that the shareholders rather than the company are liable to tax under the Code on the income of the company, paragraph 3 of Article IV of the Canada-U.S. Convention will not apply, s. 250(5) of the Act will not apply, the company will not be a foreign affiliate and will be taxed under the Act as a resident of Canada.

16 December 1993 T.I. (C.T.O. "6363-1 Foreign Affiliate Deemed Active Business Income")

A Wyoming limited liability corporation that indirectly was owned 50% by each of two Canadian corporations dealing at arm's length with each other would be a foreign affiliate of the Canadian corporation under consideration, with the result that s. 95(2)(a)(i) would apply to certain interest income earned by the limited liability corporation.

93 C.M.TC - Q. 12

The limited liability companies for the two states that RC has reviewed (Wyoming and Florida) are considered to be corporations rather than partnerships.

December 1992 B.C. Tax Executives Institute Round Table, Q.14 (October 1993 Access Letter, p. 482)

A foreign corporation is a foreign affiliate of a partnership of corporations, and not of the corporate partners.

88 C.R. - Q.11

A corporation resident in a listed country all of whose shares are "owned" by a partnership is not a foreign affiliate of a 30% partner, because the partner does not own the shares.

Foreign Bank

See Also

CIT Group Securities (Canada) Inc. v. The Queen, 2016 TCC 163, 2017 TCC 86

no requirement to be regulated as a bank

The question of whether an indirect Barbados subsidiary (“CCG”) of a Canadian company in the CIT group was earning property income and, thus, generating foreign accrual property income to the Canadian company, turned on whether it came within the “foreign bank” exception in s. 95(2)(l)(iii), given the concession of the Crown that it did not carry on an investment business and that it satisfied s. 95(2)(l)(iv). Its business did not include accepting deposits or cheques and entailed borrowing money from Barbados (IBC) affiliates and using the borrowed funds to lend money, or purchase debt obligations, in arm’s length transactions.

Owen J noted the breadth of the definition of “foreign bank,” which included a foreign corporation which uses the word “bank” to describe its financial services business, and a foreign corporation which “engages, directly or indirectly, in the business of providing financial services and is affiliated with another foreign bank.” CCG had a U.S. sister company which used the word “bank” in its name and took in deposits and lent out money, so that the “affiliated” part of the quoted definition was satisfied - and CCG’s lending/debt purchasing activities came within the broad concept of “financial services.” Finally, the basic oversight by the Barbados central bank of CCG (whose buisness required it to be registered as a Barbados trust and finance company) nonetheless satisfied the requirement in s. 95(2)(l)(iii) that CCG be regulated.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(2) - Paragraph 95(2)(l) - Subparagraph 95(2)(l)(iii) regulated Barbados subsidiary which invested in corporate debt qualified under the s. 95(2)(l) exclusion for foreign banks 698
Tax Topics - General Concepts - Evidence hearsay evidence could support expert opinion 114

Income from Property

Articles

John Lorito, Trevor O'Brien, "International Finance – Cash Pooling Arrangements", 2014 Conference Report, (Canadian Tax Foundation), 20:1-33

Cash risked in active business (p.20:24-25)

Interest earned by a foreign affiliate on cash/deposits risked in the active business of the foreign affiliate should be treated as income that pertains to or is incident to that active business and therefore should not be included in computing its income from property. This should be the case irrespective of who is paying the interest, be it an unrelated bank or a related party as part of a cash-pooling arrangement.

Powrie, "The Potential for Realizing Foreign Accrual Property Income in Structuring Foreign Exploration and Development Ventures", International Tax Planning, Vol. VI, No. 1, p. 379

Includes a discussion of the distinction between income from an adventure or concern in the nature of trade, and income from an active business.

Investment Business

See Also

R&C Commrs v. Lockyer & Anor (for Pawson Estate), [2013] UKUT 050 (Tax and Chancery Chamber)

actively-managed rental property an investment business

The deceased taxpayer and her three children held equal interests in a bungalow ("Fairhaven"), which they rented out as a holiday property. The Inheritance Tax Act provided that, when the taxpayer died, she would be exempt from inheritance tax on the Fairhaven interest if it was "property consisting of a business or interest in a business," but that this exemption did not apply where the business consisted "wholly or mainly of ... making or holding investments." The estate contended that the taxpayer's active management of the business meant that the business was not mainly the holding of an investment. The taxpayer's activities included having the property maintained and cleaned, advertising, and decoration, as well as continually re-letting the property (virtually all stays were two weeks or less).

The Upper Tribunal reversed a finding by the First-tier Tribunal that the investment business exclusion did not apply. As the taxpayer's interest thus represented an investment business, it was subject to inheritance tax. Henderson J. stated (at para. 42):

...I take as my starting point the proposition that the owning and holding of land in order to obtain an income from it is generally to be characterized as an investment activity. Further, it is clear from the authorities that such an investment may be actively managed without losing its essential character as an investment....Accordingly, the fact that the Pawsons carried on an active business of letting Fairhaven to holidaymakers does not detract from the point that, to this extent at least, the business was basically one of an investment nature.

Although the providing of "additional services" such as the provision of a cleaner, heating and hot water, television and telephone, and being on call to deal with emergencies, were not part of the maintenance of the property as an investment:

The critical question, however, is whether these services were of such a nature and extent that they prevented the business from being mainly one of holding Fairhaven as an investment. (para. 45)

The answer was negative (at para 46):

[T]here was...nothing to distinguish it from any other actively managed furnished letting business of a holiday property, and certainly no basis for concluding that the services comprised in the total package preponderated to such an extent that the business ceased to be one which was mainly of an investment nature.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 125 - Subsection 125(7) - Specified Investment Business actively-manged holiday property an investment 385

Indema Ltd. v. The Queen, 92 DTC 6244 (FCTD)

The taxpayer was incorporated in 1972 in order to act as a distributor, but four years later its objects were extended and in 1978 it agreed to provide management and administrative services to two connected companies and in the taxation years in question it derived over 97% of its gross income as fees from those corporations. Jerome A.C.J. found that the taxpayer was not carrying on a "non-qualifying business" for purposes of former s. 125(6)(f), i.e., a "business the principal purpose of which is to provide managerial, administrative, financial, maintenance or other similar services ..." to connected businesses given that it was brought into existence to fulfill a genuine business purpose unrelated to the current dispute, it continued to enjoy distributor status in the taxation years under dispute and it fulfilled an objective of obtaining efficiency from a financial and accounting point of view. Accordingly, there are other sound business purposes, some predating and some entirely independent, of those described in s. 125(6)(f).

Words and Phrases
principal business

Administrative Policy

2009 Ruling 2009-0308961R3 - Principal Purpose of Business

A CFA ("CFA1") which has been developing IP, manufacturing products for distribution by affiliates and employing more than five-full time employees will not be considered to have commenced carrying on an investment business by virtue of subcontracting out the maufacturing work to related an unrelated parties and elininating its workforce, notwithstanding its licensing of some of its IP to related persons.

14 December 2008 Internal T.I. 2008-0299161I7 - five employees

test satisfied with 5 full-time and 1 part-time

When asked whether it would apply the finding in 489599 B.C. Ltd. v. The Queen, 2008 TCC 332, that the requirement for "more than five full time employees", in the definition of "personal services business" in subsection 125(7), could be satisfied with five full time employees and two part time employees, to para. (c) of the "investment business" definition, CRA stated that it will be:

applying the decision in 489599 B.C. Ltd. to the "more than five employees full time" requirement in paragraph (c)...where a foreign affiliate employs five full-time employees and one part time employee. This position supersedes the positions set out in paragraph 15 of IT-73R6 and any technical interpretation issued by the CRA prior to the decision rendered in 489599 B.C. Ltd.

26 October 2000 Internal T.I. 2000-004438 -

A controlled foreign affiliate of the taxpayer ("USCo") has several wholly-owned subsidiaries (Landcos) resident in the United States each of which holds a parcel of land for the purposes of development and each of which has no employees. The employees of USCo provide managerial, administrative, financial, maintenance and other services to each of the Landcos.

Paragraph (b) of the exclusion to the investment business definition would only be satisfied if the taxpayer could establish that each particular Landco employed the equivalent of more than five employees full-time in the active conduct of its business throughout the period in question taking into consideration the services provided by the employees of USCo. "In this respect, it would be insufficient to demonstrate that the activities of a particular Landco required the equivalent of, for example, six employees during a short period of time and only the equivalent of two employees full-time for the remainder of the period in question."

24 August 1999 T.I. 9701345

employees prorated based on how they spend their time

Mr X, a Canadian-resident individual, owns all of FA1 which, in turn owns 100% of FA2. FAl carries on a US business of acquiring and developing real estate for sale to arm's length persons. FAl employs more than five employees full time in the active conduct of this business and has at the particular time two real estate development projects under way. FA2 was formed to hold a real estate development project for liability reasons, has no employees, its project is managed by FAl's employees and it reimburses FA1 for its related payroll costs.

After indicating that the question as to whether s. 95(2)(a)(i) would apply to deem income of FA2 to be from an active business would turn, in part, on whether FA1 employed the equivalent of more than five employees full time in the development of its own real estate projects, CRA stated that:

had FA1 had only six employees, the real estate development business of FA1 would have been an "investment business" as defined in subsection 95(1) of the Act for the reason that it would not have employed more than five or the equivalent more than 5 employees full time in the active conduct of that business. This is because one of its employees devotes 100% of his time to supervising or managing the development of FA2's real estate project and two other employees spend part of their time doing so and this would have left the equivalent of less than 5 employees employed full time in the active conduct of FAl's real estate development business.

1 December 1997 Tax Executives Institute Roundtable Q. IX 8M17870F

A bank as part of its investment banking activities purchases LP interests in limited partnerships that actively trade non-Candian debt and equity instruments in order to hedge its issuance of total return swaps which track the performance of such LP interests. Before indicating that the business of the limited partnership would be an investment business, CRA stated that "a business carried on by a partner through a partnership is always separate and distinct from any business that the partner may carry on directly."

13 November 1997 T.I. 972253

In a situation where a foreign affiliate develops resource property and derives profits from the disposition of such resource properties once developed, RC stated that "if in the above case, the principal purpose of the business of the foreign affiliate was to develop resource property for sale at a profit, it is our view that the business would be an 'investment business'. If on the other hand, the principal purpose of the business was to derive income from the sale of production (e.g., oil or ore) from resource property and in the course of such business, certain resource properties were sold for profit, it is our view that the business would generally fall outside the 'investment business' definition".

10 November 1997 T.I. 971117

An International Business Corporation incorporated in Barbados whose business consisted solely of marketing and the collection of receivables performed in connection with the sale by its U.S. parent of its products to customers residing outside the United States, including persons resident in Canada who dealt at arm's length with its Canadian grandparent would not fall within the definition of investment business in s. 95(1).

10 November 1997 T.I. 972226

If a commissionaire through whom a foreign affiliate did business was merely an agent, the foreign affiliate would be considered to be doing business with the customers to whom the relevant products were sold and licensed, rather than with the commissionaire, for purposes of the arm's length business test in paragraph (8).

22 September 1997 T.I. 964161

Regarding a foreign affiliate of a Canadian corporation that was in the business of buying and selling natural gas and that hedged uncovered exposure on its contracts for the purchase and the sale of natural gas through transactions in natural gas on a commodity futures exchange, RC indicated that "if an examination of the facts of a particular case showed that the hedging activities were incidental to the business of buying and selling of natural gas and thus not a separate activity, then the income from such hedging activities would be active business income".

26 July 1995 T.I. 950977 (C.T.O. "6363-1 Meaning of the Term "Regulated")

Where a foreign affiliate is licensed under the Barbadian Off-Shore Banking Act to carry on business activities defined under that Act as 'off-shore banking', such activities will be considered "regulated" in Barbados for purposes of s. 95.

14 July 1995 T.I. 950977 (C.T.O. "6363-1 Foreign Affiliates - Investment Business")

The fact that a foreign affiliate receives funding to carry on its income earning activity by way of debt or equity from a related party would have little if any relevance in the determination of whether its business is carried on with persons with whom it does not deal at arm's length ... .

The question of whether the activities carried on by a foreign affiliate constitutes a single business or two or more separate businesses is one of fact. However, the credit operations (moneylending, trade finance, financial guarantees), deposit taking, cheque clearing, cash and asset management, custodial or fiduciary services performed under contract (not as a trustee), financial product sales and the foreign exchange operations of a regulated foreign bank would generally be considered part of a single business ..."

28 June 1995 T.I. 9505615

In response to the question as to whether a particular foreign affiliate is able to include the services provided to it by its own employees in making the determination of whether it employs "the equivalent of more than 5 employees full time in the active conduct of the business" in subparagraph (b)(ii) [now (c)(ii)]of the definition in circumstances where each of its employees spends a part of his or her time performing duties relating to another business of the particular affiliate or the business of related entities and no services of employees of related entities (i.e. referred to in clauses (b)(ii)(A) and (B) of the definition) are provided to the particular affiliate, CRA responded:

Yes, the particular foreign affiliate can include the services of its own employees in such circumstances. The particular affiliate will meet the test provided that it uses the equivalent of more than 5 employees full time in the active conduct of the business for the purposes of subparagraph (b)(ii) of the definition. It does not matter that those same employees have other duties or that the particular foreign affiliate does not have services performed for it by employees of other entities.

6 December 1995 No. 9530400

CRA repeated the position set out in 6363-1 immediately below that:

a part-time employee who is employed in the active conduct of the affiliate's business would be considered for the purposes of the "equivalent" test in subparagraph (b)(ii) of the "investment business" definition. In the situation described, provided the person is employed in the active conduct of the business carried on by the two affiliates, the person would count for a 0.8 employee full-time equivalent in respect of the business of Company A and a 0.2 full-time equivalent in respect of the business of Company B.

It summarized its position as follows:

PRINCIPAL ISSUES: Does the Department consider part-time employees in the "equivalent" test for purposes of the "investment business" definition.

POSITION: Yes. (this is a different position than the Department would take with repsect to the definition of "specified investment business")

REASONS: The wording arguably allows it. It was the intent of the Department of Finance to allow part-time equivalence. (This identical query was already dealt with by section 13 (Olli Laurikainen - see files in HAA 6363-1).)

1995 International Fiscal Association Conference, Q. 3 6363-1

In response to a question as to how Revenue Canada assesess whether a foreign affiliate employs more than five employees full time in the active conduct of the business, CRA stated:

Whether or not a foreign affiliate employs more than five full-time employees in the active conduct of its business is a question of fact and in order to make this determination it would be necessary to review all the facts surrounding the particular situation under consideration. Paragraphs 14, 15, and 16 of Interpretation Bulletin IT-73R4 provide guidance on the Department's interpretation of the phrase "five full time employees". Essentially, in order to qualify as a full time employee a person must work a full business day on each working day subject to normal absences due to illness or vacation. Generally, it does not matter what facet of the business the employee is engaged in, provided all of the employee's duties as such are directly related to the active conduct of the business under consideration. "In order to qualify as a full-time employee a person must work a full business day in each working day subject to normal absences due to illness or vacation."

1995 Tax Executives Institute Round Table, Q. 13 No. 9530400

When an employee is employed directly by Company A under a 80% part-time employment contract and is also employed directly by Company B under a 20% part-time employment contract, such person would count for a 0.8 employee full-time equivalent in respect of the business of Company A and a 0.2 full-time equivalent in respect of the business of Company B.

31 October 1995 T.I. 9526255

Two foreign affiliates (Aco and Bco) each carries on the business of real estate development and employ individuals in the active conduct of that business. Ms. X works a full business day on each working day of each year subject to normal absences due to vacation and illnesses for either Aco or Bco. During a particular taxation year, she spent 80% of her time employed by Aco and 20% of her time employed by Bco in the active conduct of their respective real estate development businesses. CRA stated:

for the purposes of the employee test in paragraph (b)(ii) [now (c)(ii)] of the "investment business" definition in subsection 95(1) for the taxation year in question, Ms. X would count for a 0.8 employee equivalent in respect of the business of Aco and a 0.2 employee equivalent in respect of the business of Bco.

Articles

Tasso Lagios, Arda Minassian, "Foreign Accrual Property Income: Pitfalls for the Unwary", 1999 Conference Report, c. 3.

Jack Bernstein, "Canadian Taxation of Technology: Part II", Tax Profile, Vol. 5, No. 15, November 1997, p. 169

Discussion of utilization of international licensing companies.

Ahmed, "The Investment Business Definition", Canadian Current Tax, Vol. 6, No. 8, May 1996, p. 71.

Investment Property

See Also

Barejo Holdings ULC v. The Queen, 2015 DTC 1216 [at 1405], 2015 TCC 274, aff'd on other grounds 2016 FCA 304

"notes" which tracked actively-managed reference pool of assets were "debt" and "indebtedness"

An offshore fund ("SLT"), in which the taxpayer had an interest, invested in instruments (styled as "Notes") of non-resident subsidiaries of Canadian banks. The Notes did not bear interest and provided for a payment on maturity that reflected the performance of a matching actively-managed portfolio of assets held by affiliates of the obligors. If the Notes constituted "debt obligations" under s. 95(1) or "debt" under s. 94.1, the taxpayer (a unitholder of SLT) would be required to recognize its share of resulting foreign accrual property income of SLT.

Boyle J found that the Notes were debt for ITA purposes notwithstanding that the offshore fund could not ascertain what it would receive on maturity until that day arrived, as it was sufficient that there be a "liquidated amount" only on such maturity. The Notes satisfied his basic criteria for what is debt: an amount is advanced or "credited" to acquire the investment; a liquidated amount is payable when it matures (which could be a nil amount); and there is interest (albeit of nil). See summary under s. 12(11) – investment contract.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 12 - Subsection 12(11) - Investment Contract "notes" which tracked actively-managed reference pool of assets were "debt" 697
Tax Topics - Income Tax Act - Section 94.1 - Subsection 94.1(1) "notes" which tracked actively-managed reference pool of assets were "debt" and "indebtedness" 176
Tax Topics - Statutory Interpretation - Interpretation Act - Section 8.1 quaere whether there is a federal law of "debt" or "charity" 320

Leasing Obligation

Administrative Policy

31 July 2014 Internal T.I. 2014-0536581I7 - Foreign affiliate fresh start rules

licensed IP

Canco acquired a non-resident corporation (FA2) which was engaged in a non-Canadian business of licensing intellectual property to third parties and also to a subsidiary (FA3) for use in its active business. This business was deemed to be a separate non-active business under s. 95(2)(a.3) as the IP came within the extended definition of "lease obligations." See detailed summary under s. 95(2)(k).

Taxation Year

Administrative Policy

2012 Ruling 2012-0449941R3 - 95(1) - taxation year

FA2 (which owns directly or indirectly all of the shares of the "AFAs" resident in "Foreign Country") is a controlled foreign affiliate and indirect sbusidiary of a chain of Canadian unlimited liability companies, including Canco2, which in turn are indirect subsidiaries of Forco2. Prior to the sale described below, FA2 was the "head company" in a consolidated group in Foreign Country, consisting of it and the AFAs, so that it was required to file a tax return for each foreign tax year (perhaps, the calendar year) reporting all income and loss of the consolidated group for that period. FA2 also apparently had a calendar fiscal year for accounting purposes.

In order (para. 21) "to achieve consolidation for Foreign Country income tax purposes with Forco2 as the head company of a consolidated group that includes FA2 and the AFAs" (and with FA2 no longer being such consolidater), FA1 (another CFC of the Cancos) and Canco2 sold all their shares of FA2 to Forco2. Immediately before the sale, FA2 and the AFAs settled various intercompany balances among them "in order to simplify the determination of whether the shares of FA2 were excluded property" (para. 12). "FA2's foreign tax year is not deemed by the laws of Foreign Country to have ended on the sale date as a result of its shares being purchased by Forco2, and FA2 is not obligated under Foreign Country's income tax law to file any income tax return in respect of a period ending on that date" (para. 17).

The proposed transaction is that Forco2 will elect in a Foreign Country return for the year of sale to be the head office of a consolidated group comprising it, FA2 and the AFAs.

Rulings that the taxation years of FA2 and the AFAs as defined in s. 95(1) were not affected by the sale, so that such taxation years ended on XXX (presumably, December 31 of the year of sale), the same as before. In its summary, CRA stated:

...the taxation year of the foreign affiliate under the subsection 95(1) of the Act is the taxation year of the foreign affiliate under the taxation laws of its country of residence. If the foreign affiliate does not have to report its income to the foreign home jurisdiction, the taxation year will be determined based on the relevant accounting principles of its home jurisdiction and in accordance with its corporate statutes.

28 January 2008 External T.I. 2005-0165131E5 - Taxation year of a foreign affiliate

The taxation year of a foreign affiliate, for FAPI and surplus account computation purposes, should generally, be the same as the taxation year used for foreign income tax reporting.

12 July 2000 External T.I. 2000-003677 -

A change in the statutory and taxation year end (from December 31 to June 30) used by a foreign affiliate for corporate law and foreign taxation purposes would also result in a change to its taxation year for purposes of the Act.

1 February 1990 T.I. (July 1990 Access Letter, ¶1323)

In light of its specific wording, s. 95(1)(g) is not overridden by s. 249(4).

Trust Company

Administrative Policy

15 October 2001 External T.I. 2000-003735 -

An Alberta trust company that offers services to the public as executor, administrator, trustee, bailee etc. and is not authorized to carry on a deposit-taking business would qualify as a trust company for purposes of s. 95(2)(1) given that the definition is an inclusive one.

Subsection 95(2) - Determination of certain components of foreign accrual property income

Paragraph 95(2)(a)

Subparagraph 95(2)(a)(i)

Administrative Policy

2016 Ruling 2015-0604451R3 - 95(2)(a)(i)

where CFAs hold commercial properties needed for their regulated active businesses through individual property subsidiaries of a Holdco proportionately owned by them, the property rents are s. 95(2)(a)(i) income
Background

FA6, which is an indirect wholly-owned subsidiary of Canco, directly or indirectly holds eight other wholly-owned subsidiaries (the “Regional FAs”), including FA1 and FA9, which own offices used in their regulated businesses, while FA5 owns commercial real estate whose income is included in computing its income from an active business. Although the other Regional FAs (FA3, FA4, FA7 and FA8) do not own any commercial real estate, each may acquire commercial real estate prior to the proposed transactions.

Proposed transactions

FA6 will establish FA Holdco, which will establish one or more Property Cos that will be held by it directly or indirectly. The property owned by FA1 will be transferred to a Property Co in exchange for cash or shares of that Property Co, with any such shares then being transferred by FA1 to FA Holdco in exchange for FA Holdco shares – and similarly for the real estate of FA5 and FA9.

For new property acquisitions, FA1, FA2, FA3 and FA4 will subscribe for shares of FA Holdco in cash equal to the FMV of the relevant property to be acquired, FA Holdco in turn will, directly or indirectly, subscribe in cash for shares of the relevant Property Cos and each Property Co will then acquire the relevant property for cash equal to the property’s FMV. Due to local regulatory requirements, FA5, FA7, FA8 and FA9 may directly acquire shares in a Property Co that holds real estate in the jurisdiction in which FA5, FA7, FA8 and FA9, respectively, carries on its business rather than acquiring shares of FA Holdco. At the completion of the Proposed Transactions, all of the outstanding voting shares of FA Holdco, having a limited value, will be held by FA6, and all of the outstanding non-voting common shares of FA Holdco will be held by FA1, FA2, FA3 and FA4.

The investments in FA Holdco by FA1, FA2, FA3 and FA4, or in a Property Co by FA5, FA7, FA8 and FA9, will be determined based on the needs of their respective active businesses from time to time. Specifically, each such investment will be held as part of the active regulated businesses carried on by the Regional FAs and to support such business within the quantum and in the manner required by the relevant local regulatory authority.

Purpose of proposed transactions

They will create a combined pool of real estate investments that will facilitate real estate acquisitions and reduce risks to the various regulated companies in the group through diversification.

Ruling

S. 95(2)(a)(i) will apply to include in computing the income or loss from an active business of a particular Property Co for the taxation year a portion of the income or loss that would otherwise be the income or loss from property of the particular Property Co. Specifically, s. 95(2)(a)(i) will apply to the proportion of the income or loss that the average of all amounts each of which is the FMV of the shares of the particular Property Co that are held (either directly or indirectly) by the Regional FAs (taking into account, where applicable, their pro rata share of the FA Holdco shares) at the beginning of each month throughout the relevant taxation year is of the average of all amounts each of which is the FMV of all the outstanding shares of the particular Property Co at the beginning of each month throughout the relevant taxation year.

2015 Ruling 2015-0573141R3 - Subparagraph 95(2)(a)(i)

US sub servicing the collection of both its own debt portfolios and that of a U.S. sister was a good mothership to the sister

Current structure

Canco (an indirect subsidiary of Parentco) holds the shares of FA4 (a U.S. corporation) through three stacked U.S. subsidiaries (FA1 down to FA3), which are wholly-owned excepting some group management employees. The business of FA4 consists mainly of the acquisition of portfolios of debt receivables across the delinquency spectrum for the purposes, essentially, of the liquidation of these portfolios on a profitable basis through collections, or perhaps resale. Such portfolios are held by FA4, and an LP of which FA4 is a limited partner, through trusts (the “FA4 Trusts,” and “LP Trusts”) of which FA4 or LP, as the case may be, is the settlor, and sole beneficiary and administrator. The acquisition and collection of these portfolios (and apparently other group entities) are handled by employees of FA4.

FA5 (a U.S. subsidiary of FA3) holds the FA5 Subsidiaries, which over time have acquired various debt portfolios for collection. They have no employees, and all activities required to acquire, own and collect their portfolios (as well as for administrative support) are performed by the FA4 employees. The group portfolios are split among different entities due to differing state licensing requirements, and also to limit risk.

Transaction

Using funding received from FA6 (a Finco LLC subsidiary of FA3), an FA5 Subsidiary acquired from an arm’s length person, the FA5 New Portfolio, being a secured loan portfolio.

Rulings

Provided inter alia LP is a partnership for purposes of the Act and FA4, FA5 and the FA5 Subsidiary continue to be resident in the U.S. for Treaty purposes:

  • The income earned by the FA5 Subsidiary from the accounts of the FA5 New Portfolio (the “Income”) will be included in computing the income or loss from an active business of the FA5 Subsidiary pursuant to s. 95(2)(a)(i).
  • The Income will be added to the exempt earnings of the FA5 Subsidiary pursuant to Reg. 5907(1) – exempt earnings – s. (d)(ii)(A)(I).
Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(1) - Exempt Earnings - Paragraph (d) - Subparagraph (d)(ii) - Clause (d)(ii)(A) - Subclause (d)(ii)(A)(I) US sub, by servicing both its own debt portfolios and that of a U.S. sister, generated exempt earnings to the sister 142

30 September 2013 Internal T.I. 2012-0439661I7 - Income earmarked for future use & 95(2)(a)(i)

funds earmarked for future projects of sister affiliates

A CFA of Canco held funds generated from projects which were owned and operated by FA1, with the funds being "earmarked" for future investment in projects to be carried out by other CFAs of Canco. Earmarked funds for such future project investments which had been generated from existing projects also were held by FA2, which served as a principal global finance and treasury centre within the Canco group of companies, or by another CFA of a predecessor of Canco which previously had served that function.

The Directorate considered that the income on such earmarked funds was not deemed to be active business income by s. 95(2)(a)(i).

The "directly related" test in s. 95(2)(a)(i)(A) (which "can be examined through the use of a ‘but for' test") was not satisfied as:

Canco has not demonstrated that the income from property earned within FA1, FA2, or FA3 is dependent upon the occurrence of the active business activities of the related foreign affiliates. The earmarking of investment property for use in future years in the active business activities of related foreign affiliates does not support the conclusion that the income from property would not have otherwise have been generated but for the active business activities taking place.

Furthermore, the requirement in s. 95(2)(a)(i)(B) that the income on the earmarked funds would have been active business income to the other foreign affiliates, if earned by them, also was not satisfied, as:

the amounts on deposit were for the purpose of…future business expansion…and not for expenses incidental to or pertaining to the carrying on the other foreign affiliates' active business…[and] removal of the earmarked funds would [not] be decidedly destabilizing…[as] the operations of Canco and its affiliates could continue despite the removal of these investment funds, albeit at some inconvenience and potentially at lower profitability… .

Words and Phrases
directly related

16 May 2007 May 16, CLHIA Roundtable Q. 19, 2007-0229841C6 - Foreign affiliates - deemed active business income

reinsurer sister FA of Opco FA

FA1 enters into insurance or reinsurance contracts in the course of carrying on an active business outside Canada, and reinsures the risk associated with the contracts with a second foreign affiliate (FA2) for regulatory reasons, with the risks assumed by FA2 then being further retroceded to a third foreign affiliate (FA3). The income derived by FA2 from payments received from FA1 in consideration for reinsuring the contracts of FA1 are stated in the question to be deemed to be income from an active business income under s. 95(2)(a)(ii), as is the income derived by FA3 from payments received from FA2 in consideration for reinsuring the risks assumed by FA2.

CRA confirmed that:

To the extent that it can be established that the income of FA3 is attributable to investment of assets that it is required to have on hand, for example by virtue of regulatory requirements, to support the risks assumed under the contracts ceded by FA1, the CRA agrees that such income would be from activities of FA3 that are directly related to the active business activities of FA1 as required by clause 95(2)(a)(i)(A) and would be included in the earnings from an active business of FA1 if it were earned by FA1 as required by clause 95(2)(a)(i)(B). Therefore provided that the other requirements for the application of subparagraph 95(2)(a)(i) are satisfied, that provision would apply to include such income of FA3 in its income from an active business.

9 January 2001 External T.I. 1999-001140 -

factoring of sister Opco receivables

FA2 purchases at a discount long-term interest-bearing receivables of FA1 that were generated by sales made by FA1 in the course of its active business, and purchases at a deeper discount non-interest bearing receivables of FA1 that arose from such sales.

The income earned by FA2 on the non-interest bearing debt would be income derived from factoring of trade accounts receivable described in s. 95(2)(a)(ii). The interest derived from the interest-bearing debts would not be from factoring as it would appear to be substantially all interest income and it is not clear that such interest would be income described in s. 95(2)(a)(iv) because of the "lending assets" requirement (Regulation 6209). If such interest income did not so qualify

it would nevertheless be income described in subparagraph 95(2)(a)(i) of the Act. Accordingly, the income derived by FA2 from both the non-interest-bearing debts and the interest-bearing debts would be included in FA2's income from an active business pursuant to the application of paragraph 95(2)(a) of the Act.

26 October 2000 Internal T.I. 2000-0044387 -

directly earned property income of managementco would not be active

A U.S. controlled foreign affiliate ("USco") of Canco provides management services to various wholly-owned subsidiaries ("Landcos") resident in the United States, each of which holds a parcel of land for the purpose of development and none of which has any employees. "Because the activities of USco are critical to the profitability of each Landco ... the activities of each Landco would for that reason be considered as being 'directly related' to the activities of USco for the purposes of the test in clause 95(2)(a)(i)(A) ... . However, the second test in 95(2)(a)(i)(B) of the Act requires that the income of the Landco would be active business, income if earned by USco. In this case, USco was carrying on an active business comprised of providing management services to the Landcos. Therefore, if the investment business income of one of the Landcos was earned by USco it would be considered to be derived from a separate business (investment business) apart from its management service business, it would not qualify as active business income of USco and the test in clause 95(2)(a)(i)(B) would not be satisfied. Accordingly, the income earned by each of the Landcos would not qualify as income from an active business as a result of the operation of subparagraph 95(2)(a)(i) ... ."

2 September 1999 TI 9622545 [resource group mananagementco did not have resource business]

resource group mananagementco did not have resource business

FA3 has six full time employees who provide geological and administrative services to FA1 and FA2, which are developing resource properties and have no employees of their own. S. 95(2)(a)(i) does not apply to deem the fees earned by FA3 (equal to its payroll costs) from FA1 and FA2 to be active business income.

The business of providing geological and administrative services is different from the resource exploration and exploitation business (the "Resource Business") carried on by FAl and FA2. Therefore had the Resource Business income of either FAl or FA2 been earned by FA3, such income may be viewed as having been earned by FA3 from a separate business other than the Service Business. As neither FAl nor FA2 employ more than five employees full time in the active conduct of their respective Resource Businesses, the income of FAl or FA2, if earned by FA3, would be income from an investment business to FA3 and the test in clause 95(2)(a)(i)(B) would not be met. In addition, ...[respecting] the test in clause 95(2)(a)(i)(A)...[i]n order for the activities of FAl and FA2 to be considered "directly related" to the active business activities of FA3, it would generally be necessary to establish that FA3 employees conducted the full range of all the day-to-day activities necessary to explore the foreign resource property of FAl and FA2 and that were it not for the availability of the services of FA3, FAI and FA2 would not have acquired their respective foreign resource properties.

24 August 1999 T.I. 9701345 [one development project held though subsidiary]

one development project held though subsidiary

Mr X, a Canadian-resident individual, owns all of FA1 which, in turn owns 100% of FA2. FAl carries on a US business of acquiring and developing real estate for sale to arm's length persons. FAl employs more than five employees full time in the active conduct of this business and has at the particular time two real estate development projects under way. FA2 was formed to hold a real estate development project for liability reasons, has no employees, its project is managed by FAl's employees and it reimburses FA1 for its related payroll costs.

CRA noted that Mr. X could establish that s. 95(2)(a)(i) would apply to deem income of FA2 to be from an active business if the activities of FA1 and FA2 could together be viewed as a single business (in which regard, CRA noted that "[t]he services provided by the employees of FAl to FA2 comprise the full range of day-to-day activities that would have been conducted if the project held by FA2 had been held by FAl") and FA1 employed the equivalent of more than five employees full time in the development of its own real estate projects.

5 February 1997 T.I. 9611725 [notional excess cash of mothership not used in its business]

notional excess cash of mothership not used in its business

A foreign affiliate ("FA") factors receivables of only one client ("Manco"), a related foreign affiliate. The income of FA derived directly from the factoring of the receivables of Manco is deemed by s. 95(2)(a)(iii) to be active business income. Would interest income of FA from the investment of funds temporarily not needed in the factoring operation qualify under s. 95(2)(a)(i) as active business income? CRA stated:

[I]t would appear that the interest earned by FA may be considered to be derived from activities that are directly related to the active business activities of Manco for the purposes of clause 95(2)(a)(i)(A)… . However, in order to meet the test in clause 95(2)(a)(i)(B) … it would … be necessary to establish that if the funds on which the interest was earned had been held by Manco, such funds would be employed or at risk in the business of Manco (i.e. not excess funds). Thus, for example in circumstances where Manco itself has funds that are not employed or risked in its active business, we are not aware of a case where the funds held by FA would pass this test. That is, if FA's funds were held by Manco they would be viewed as additional excess funds. Therefore the interest earned by FA may not qualify under 95(2)(a)(i)… .

21 May 1996 T.I. 9526865

Discussion of the application of the "directly or indirectly" test where a loan made by a foreign affiliate of Canco ("FA") to a related non-resident corporation that is not a foreign affiliate uses the funds solely to acquire intellectual property which it licenses to NR2, which also is a related, but unaffiliated, corporation.

11 October 1996 APFF Roundtable Q. 1.5 7M12910

A Finance representative stated:

When it is established that the business conducted by the affiliate is a business carried on actively, certain activities of the business may be exercised within another company to which the affiliate is related without tainting its income from an active business.

16 August 1995 T.I. 952123 (C.T.O. "6363-1 Deemed Active Business Income")

S.95(2)(a)(i) would apply to interest income earned by a foreign affiliate of Canco from financing purchases by arm's length non-resident customers of products sold by a related non-resident marketing corporation that purchased products manufactured in Canada by persons related to Canco for fair market value consideration.

16 December 1993 T.I. 932563 (C.T.O. "6363-1 Foreign Affiliate - Deemed Active Business Income")

Subparagraph 95(2)(a)(i) will apply to interest income received by a Wyoming limited liability company (that is 50% owned by two arm's length Canadian-resident corporations) on a U.S. state bond issue the proceeds of which were used by the state to finance the construction of a manufacturing plant which is leased to a manufacturing partnership that also is indirectly owned on a 50/50 basis.

Articles

Bruce Sinclair, "Current Topics in the Taxation of Real Estate Development", 2014 Conference Report, (Canadian Tax Foundation), 12:1-24.

Non-application of hypothetical income test where mother ship is subsidiary management LP (p. 12:21)

[C]lause (B)…does not have to be met where the income is income of the "directly related" affiliate, or a partnership of which it is a member, whose income is to be recharacterized.

No need for 5 full time employees where subsidiary management lP services sister development LPs (pp. 12:21-22)

[I]t is not uncommon that Services LP may employ more than five employees. However, Development LP may have no employees if work is given to contractors. As a result, when several development projects are undertaken at once, each separate development entity may not meet the "more than five employees" test in the definition of "investment business" in subsection 95(1) (based on the use of employees of Service LP being shared among a number of projects), and so the separate entity's activity may be an investment business. The business of providing services is an active business… . Thus…the treatment of the income of the development partnership as active business income under amended subparagraph 95(2)(a)(i) does not depend on meeting the "more than five employees" test in paragraph (c)….

Grant J. Russell, "'Mothership' Revisited - Canada's Foreign Affiliate Regime and Active Business Income", International Tax Planning, Vol. XV, No. 4, 2010, p. 1076

Criticizes the CRA position that the activities caried on by a management co. would represents a separate business rather than being assimilated with the managed business.

Paul C. Barnicke, Melanie Huynh, "Mother Ship in Foreign Affiliate's Partnership", 2009 Canadian Tax Highlights

Angelo Nikolakakis, "The Taxation of Foreign Affiliates in the Resource Sectors", 2008 Conference Report

Nikolakakis, "Foreign Exchange Fluctuations: Comprehensive Rules are Needed", Corporate Finance, Vol. V, No. 1, 1997, p. 342

Discussion of application of s. 95(2)(a) to the hedging by one foreign affiliate of an income stream received for another foreign affiliate through a currency swap.

Subparagraph 95(2)(a)(ii)

Clause 95(2)(a)(ii)(B)

Administrative Policy

2 March 2017 External T.I. 2017-0682291E5 - Swedish/Finnish Profit Transfer Agreements

s. 95(2)(a)(ii) can recharacterize a profit transfer payment that is not deemed a dividend under s 90(2)

Many foreign jurisdictions, such as Germany, Sweden and Finland, have profit transfer agreement (“PTA”) mechanisms that allow for full or partial combination of the tax results of entities under common control. CRA has considered (e.g., in 2001-0093903) that a payment under such a PTA could, in certain circumstances, be “income from property” to the foreign affiliate recipient that is recharacterized as “income from an active business” under s. 95(2)(a)(ii) (the “General Approach”) Following 26 May 2016 IFA Roundtable Q. 6, 2016-0642081C6, does CRA no longer follow the General Approach, for example, where a profitable operating subsidiary in Finland or Sweden (“FA-Sub”) makes PTA payments to a grand-parent (“FA-GP”)? After noting that this IFA position found that a PTA payment made by a German-resident subsidiary to its wholly-owning German-resident parent would be considered to be a pro rata distribution respecting all of its shares and, as such, would be deemed to be a dividend under s. 90(2), CRA stated:

We… are hereby confirming that the proposal to limit the application of the General Approach to PTA payments made before 2017 was only meant to apply to situations where the PTA payment is deemed under subsection 90(2) to be a dividend. For any other PTA situations, such as the one you illustrate above concerning FA-Sub and FA-GP, the CRA will continue to apply the General Approach.

22 June 2016 Internal T.I. 2016-0632821I7 F - 93(2.01) & Capital Contribution

inter-affiliate loan generating deemed active business funded out of an interest-free loan from Canco

A wholly-owned foreign affiliate (“Luxco1”) of Canco held 1/3 of the shares of a corporation ("NRco"), which was resident in a Treaty country and carried on an active business there. Another wholly-owned affiliate of Canco (“Luxco2”), used the proceeds of an interest-free loan from Canco to make an interest-bearing loan to NRco. In addressing a s. 93(2.01) issue respecting a subsequent disposition of the shares of Luxco1, the Directorate proceeded on the basis that the interest payable by NRco to Luxco2 resulted in deemed active business income to Luxco2 under s. 95(2)(a)(ii)(B), so that dividends paid by Luxco2 to Canco were exempt dividends.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 93 - Subsection 93(2.01) a contribution of FA1 shares to FA2 causes the FA2 shares to be substituted property for s. 93(2.01) purposes 183
Tax Topics - Income Tax Act - Section 248 - Subsection 248(5) ordinary meaning of “substituted” 113

26 May 2016 IFA Roundtable Q. 8, 2016-0642041C6 - s. 95(2)(a)(ii)(B) and borrowing to return capital

tracing approach to determining whether interest on money borrowed to return capital is considered for s. 95(2)(a)(ii)(B) to be deductible in computing exempt earnings

Where FA1 borrows $350,000 from a sister (FA3) to make a capital distribution to its Canadian shareholder (Canco) on its Class A common shares, which had previously been issued by it to Canco solely to use the subscription proceeds of $800,000 to finance FA1’s active business, CRA would accept that the interest on the $350,000 loan would be received as deemed active business income by FA3 under s. 95(2)(a)(ii)(B). CRA indicated that this result would obtain even if FA1 had issued shares of another class (its Class B common shares) to Canco, to finance the $200,000 acquisition of shares (of FA2) which were not excluded property, at the same time as it issued the Class A common shares. In the situation where FA1 was required to compute its income (pursuant to Reg. 5907(1) – earnings – (a)(iii)) under Part I of the Act, CRA indicated that the interest was deductible under s. 20(1)(c) “because the borrowed funds replaced capital that…had been used by FA1 for the purpose of earning income from an active business,” whereas in the situation where the earnings were computed pursuant to (a)(i) or (iii) of the earnings definition under local tax law and the interest was non-deductible under such law, CRA simply stated that the interest would be deductible under Reg. 5907(2)(j).

If instead, shares of only one class had been issued to fund the two (exempt earnings and non-exempt earnings) uses of funds, CRA would consider that “the portion to which clause 95(2)(a)(ii)(B) applies should be determined on a pro-rata basis based on the current use of the capital (i.e., prior to its replacement with the borrowed funds)…[so that] 20% of the interest income of FA3 would not be recharacterized.” Before so concluding, CRA stated:

If FA1 computes its earnings from its active business pursuant to subparagraph (a)(i) or (a)(ii) of the definition of “earnings” in subsection 5907(1) and the full amount of the interest paid to FA3 were deductible in computing such earnings under the relevant foreign tax law, a portion of that amount would be added back to earnings pursuant to subsection 5907(2). In this situation, because a portion of the interest would give rise to a foreign accrual property loss, that portion would be added back to earnings from the active business pursuant to paragraph 5907(2)(c). As such, that portion of the interest would not be deductible in computing the amount prescribed to be FA1’s earnings from the active business as required by clause 95(2)(a)(ii)(B).

If FA1 computes its earnings from its active business pursuant to subparagraph (a)(iii) of the definition of earnings, only the interest on the portion of the borrowed funds that were used to return capital used to earn income from that source would be deductible under paragraph 20(1)(c) in computing those earnings.

Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(2) - Paragraph 5907(2)(j) interest used to fund return of capital that had been used in an active buisness deductible under Reg. 5907(2)(j) 215

26 May 2016 IFA Roundtable Q. 6, 2016-0642081C6 - German Organschafts

profit transfer payments made by a German sub to German parent are s. 90(2) dividends not within s. 95(2)(a)(ii)(B) after 2016

Under an “Organschaft,” a German parent (“Parentco”) and its German subsidiary (“Subco”) can enter into an agreement under which Subco agrees to annually transfer its entire profit determined in accordance with German (statutory) GAAP to Parentco, and Parentco agrees to compensate Subco for any loss incurred under German GAAP. CRA confirmed that, at least in the simple case where Parentco wholly-owns Subco through ownership of a single class of shares, the annual profit transfers will be deemed to be dividends under s. 90(2). This supplants an earlier position (e.g., 2001-0093903) that a profit transfer payment made by Subco to Parentco could be re-characterized as income from an active business of Parentco under s. 95(2)(a) to the extent that Subco had earnings from an active business before taking into account the profit transfer payment – so that this previous position will only apply to profit transfer payments made before 2017.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 90 - Subsection 90(2) profit transfer payments by German sub to its German parent deemed to be dividends under s. 90(2) 303
Tax Topics - Income Tax Act - Section 53 - Subsection 53(1) - Paragraph 53(1)(c) German profit transfer payment to loss subsidiary is contribution of capital 154
Tax Topics - Income Tax Act - Section 12 - Subsection 12(1) - Paragraph 12(1)(x) loss compensation payment under Organschaft 121

28 May 2015 IFA Roundtable Q. 11, 2015-0581571C6 - IFA 2015 Q11: Application of clause 95(2)(a)(ii)(B)

interest on borrowing to distribute accumulated profits

"Borrower FA," which exclusively carries on an active business, borrows money from "Lender FA" to pay a dividend in an amount not exceeding its accumulated profits used in its business. Assuming the other s. 95(2)(a)(ii)(B) conditions are met, is the interest deductible by Borrower FA in computing the amount prescribed to be its earnings or loss from an active business, so that it will be included in the active business income of Lender FA? In responding affirmatively, CRA stated:

If the interest expense is not deductible by Borrower FA in any taxation year under the relevant foreign country's income tax law, it will nevertheless be deductible…pursuant to paragraph 5907(2)(j)… because it will be considered to have been made or incurred by Borrower FA for the purpose of gaining or producing earnings from an active business carried on by it as determined under subparagraphs (a)(i) or (ii) of the definition of "earnings" in subsection 5907(1)… .

Furthermore, the interest paid by Borrower FA will be deductible under paragraph 20(1)(c) in computing Borrower FA's earnings if those earnings are computed under subparagraph (a)(iii) of the definition of "earnings" in subsection 5907(1)… .

…[Accordingly] the interest paid by Borrower FA will be "deductible" in computing the amount prescribed to be its earnings from an active business regardless of whether those earnings are computed under the tax laws of a country other than Canada or under the provisions of the Act.

Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(2) - Paragraph 5907(2)(j) interest on borrowing to distribute accumulated profits 164

31 July 2014 Internal T.I. 2014-0536581I7 - Foreign affiliate fresh start rules

licensed IP

Canco acquired a non-resident corporation (FA2) which was engaged in a non-Canadian business of licensing intellectual property to third parties and also to a subsidiary (FA3) for use in its active business.

After concluding that there was a deemed eligible capital expenditure on the IP under the fresh start rule, Headquarters noted that the s. 20(1)(b) and other applicable deductions would be made first before determining the allocation of FA2's business income which was recharacterized under s. 95(2)(a)(ii) and that portion which remained as FAPI. See detailed summary under s. 95(2)(k).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(1) - Leasing Obligation licensed IP 62
Tax Topics - Income Tax Act - Section 95 - Subsection 95(2) - Paragraph 95(2)(k) extends to arm's length acquisition/deemed ECE respecting licensed IP 556

2002 Ruling 2001-0093903 - German Organschaft

application of s. 95(2)(a)(ii)(B) to profit transfer payments made by German subs to German parent under an Organschaft
Background

Canco, a Canadian public company, holds all the shares of a German Gesellschaft mit beschränkter Haftung (“FA Holdco”) which, in turn, holds shares of two controlled foreign affiliates ("FA Opco1," and “FA Opco2”), each of which is a German Gesellschaft mit beschränkter Haftung, as well as interest-bearing debt of FA Opco1 and FA Opco2 (the "FA Opco1 Debt" and “FA Opco2 Debt”), with the balance of the shares of FA Opco1 and 2 held by unrelated German companies. All of FA Opco1 and 2’s assets are used in carrying on an active business in Germany. Interest-bearing debt of FA Holdco is held by another CFA of Canco (“Finco”).

Proposed transactions

FA Holdco will acquire the XX % interest in FA Opco1 held by the unrelated German companies.

Under German corporate law FA Opco1 and FA Opco2 will each enter into a profit transfer agreement (the "Profit Transfer Agreements") with FA Holdco pursuant to which it will be agreed that all income from the operations of FA Opco1 and FA Opco2 will be transferred on an annual basis to FA Holdco and FA Holdco will agree to compensate FA Opco1 and FA Opco2 for any losses which they incur in operating their respective businesses. As a result, at each year end of FA Opco1 and FA Opco2 each company will record a liability to FA Holdco (or a receivable from FA Holdco) in their respective balance sheets equal to the amount of their profit (or loss) computed under German generally accepted accounting principles, less certain statutory reserves that may be claimed under German corporate law. This liability (or receivable) will be settled on an annual basis once the amount of the liability (or receivable) has been finally determined by FA Opco1 and FA Opco2 and accepted by FA Holdco. Furthermore, as a result of being party to the Profit Transfer Agreements, the taxable income of FA Opco1 and FA Opco2 will be reduced to nil on an annual basis under German income tax law and any income generated by FA Opco1 and FA Opco2 and transferred to FA Holdco under the Profit transfer Agreements will be taxable to FA Holdco. Interest paid by FA Opco1 and FA Opco2 to FA Holdco will be deducted in computing the income of FA Opco1 and FA Opco2 both before and after the Profit Transfer Agreements are in effect.

Rulings

The amounts payable by FA Opco1 or FA Opco2 to FA Holdco under the Profit Transfer Agreements for a particular taxation year will, to the extent the amount is reflected in FA Opco1's or FA Opco2's respective "earnings" from an active business for the year or a subsequent year (computed before the application of the Profit Transfer Agreements), be considered, for purposes of s. 95(2)(a)(ii)(B), deductible in computing the "earnings" of FA Opco1 or FA Opco2, respectively, from an active business.

Provided that FA Holdco carries on an "investment business" (as per s. 95(1) and that the aggregate amounts payable by FA Opco1 and FA Opco2 to FA Holdco for a particular taxation year under the Profit Transfer Agreements and the amount of the interest payable by FA Opco1 and FA Opco2, respectively, to FA Holdco for that year are greater than the aggregate of the interest payable by FA Holdco to Finco for that year and any other deductible expenses of FA Holdco, to the extent that such income was derived from amounts that were deductible by FA Opco1 or FA Opco2 in computing their respective "earnings" for the year or a subsequent year from an active business, such income will be included in computing FA Holdco's income from an active business pursuant to s. 95(2)(a)(ii)(B) and (based on their deductibility in computing the "exempt earnings" for that year or a subsequent year of FA Opco1 and FA Opco2) will be included in computing the "exempt earnings" of FA Holdco for that year.

Comparable ruling re Finco.

29 June 2012 Internal T.I. 2012-0441601I7 - "directly or indirectly"

Luxco (a Lux subsidiary of Canco) makes an interest-bearing loan (Loan1) to Mereco (which is the non-resident parent of Canco and does not caary on an active business). Mereco lends the proceeds on a non-interest bearing loan (Loan2) to US Co, which is a subsidiary of Canco and carries on an active business in the US. After dealing with the (since-repealed) language of former s. 95(2)(a)(ii)(A), CRA then found

although the words "directly or indirectly" in subparagraph 95(2)(a)(ii) are meant to deal with back-to-back loan arrangments [footnoted reference to Conway], since Loan2 is non-interest bearing, there is no indirect inerest payment by US Co which is deductible from its income from an active business carried on in the US, which could be traced from US Co to Luxco. Thus, the conditions of clause 95(2)(a)(ii)(B) are not satisfied...

2004 Ruling 2004-010311 -

Ruling that s. 95(2)a)(ii)(B) would apply where a controlled French foreign affiliate made lease payments to a groupement d'intérêt économique which, in turn, made corresponding payments of principal and interest to a U.S. LLC subsidiary.

25 October 2002 Internal T.I. 2002-014997 -

Where Irishco (a foreign affiliate in which Canco has a qualified interest) lends at a market rate of interest to U.S. Holdco (a wholly-owned subsidiary of Canco) and U.S. Holdco uses the funds to contribute capital to a U.S. partnership, then provided that the U.S. partnership is carrying on business in Canada or a designated treaty country, under subparagraph (a)(i) of the definition of "earnings" in Regulation 5907(1), the interest on the loan will be deductible from U.S. Holdco's earnings from an active business. Even if the interest were not deductible for U.S. federal income tax purposes, Regulation 5907(2)(j) would provide that the interest was deductible in computing the prescribed earnings from an active business.

5 September 2002 External T.I. 2000-00742 -

FA1 lends money to FA2 (a Swedish company) which uses the borrowed funds to acquire the shares of FA3 (another Swedish company) whose sole source of income is related company receivables giving rise to interest that is recharacterized as active business income under s. 95(2)(a)(ii). FA3 makes an asset transfer to FA2 which is deductible to FA3 and includable in the income of FA2 under Swedish income tax provisions providing for income transfers.

Clause 95(2)(a)(ii)(B) does not apply to the asset transfer payment because, under Canadian income tax law, the transfer payment would not be deductible in computing the income of FA3 under the provisions of the Act.

10 October 2000 External T.I. 2000-005038 -

A sub of Canco in Country B ("Finco") lends money to a wholly-owned subsidiary of Canco in Country A ("Holdco"). Holdco on-lends the money, at a slightly higher rate of interest, to a partnership ("LLP") in which a wholly-owned subsidiary of Holdco ("LPCo") has a 50% limited partnership interest and in which a general partner ("GPCo") has a nominal interest. LLP uses the funds in its active business operated in Country A.

The interest received by Finco from Holdco will be included in computing its active business income (by virtue of s. 95(2)(a)(ii)(B)) provided that Canco has a qualifying interest in GPCo throughout the year in question and GPCo is a foreign affiliate. The Agency stated:

"Notwithstanding that GPCo only has a nominal interest in LLP, subclause 95(2)(a)(ii)(B)(II) of the Act applies to the interest paid by LLP to Holdco such that the income derived from that payment by Holdco is deemed to be included in computing the active business income of Holdco. The tracking of funds from LLP to Finco is not necessary in this case because the payment of interest from Holdco to Finco is deductible in computing the active business income of Holdco (refer to paragraph (b) of the definition of 'earnings' in subsection 5907(1) of the Income Tax Regulations)."

6 January 1999 T.I. 982978

Where a foreign subsidiary of Canco deposits a sum with a foreign bank to secure its guarantee of a loan made by the foreign bank to another foreign company in which Canco has an indirect 25% interest, with interest on the bank loan exceeding interest on the deposit by 22.5 basis points, income from the deposit will qualify under s. 95(2)(a)(ii)(B), with the deposit qualifying as excluded property.

7 August 1996 T.I. 9605735

After being referred to an arrangement under which a foreign affiliate ("Forco"), which has made a loan to a related foreign subsidiary ("Xco"), assigns the loan to a foreign bank in consideration for a cash deposit that it maintains at the bank, and the bank lends an equivalent amount to Xco, RC stated:

"In our view, in order to meet the words 'the income is derived from amounts that were paid or payable, directly or indirectly' in subparagraph 95(2)(a)(ii) of the Act, the amounts in question would have to be able to be directly traced. For example, subparagraph 95(2)(a)(ii) will apply in a back-to-back loan situation where the agreement set out clearly that one loan is conditional on the other loan or deposit, and the documentation for the transactions establish clearly that the flow of income can be directly traced and that the bank or third party involved in a back to back loan is acting as a conduit and is in effect receiving an accommodation fee for that service."

1 February, 1996 T.I. 951744 (C.T.O. "Meaning of 'Directly or Indirectly' in 95(2)(a)")

The words "directly or indirectly" in s. 95(2)(a)(ii)(B) "were meant to deal with back-to-back loans in certain fronting arrangements involving insurance", and the object of s. 95(2)(a)(ii) was "to keep the active business income of certain affiliated or related groups of corporations whole where there are payments amongst its members". Accordingly, "where an arm's-length intermediary is involved in a payment flow, an amount would be considered to be paid or payable directly or indirectly by another qualified foreign affiliate to a particular foreign affiliate where the payment can be traced and shown to be a payment made directly or indirectly to a particular foreign affiliate that was deductible by the other foreign affiliate in computing its earnings or loss from an active business".

21 June 1995 T.I. 951091

Where a corporation resident in Canada ("Canco") has a wholly-owned subsidiary that is resident in a designated treaty country ("FA"), and FA makes an interest-bearing loan to NR1, which, in turn, makes an interest-bearing loan to NR2 for use in an active business carried on by it in its country of residence, (where both NR1 and NR2 are resident in a designated treaty country, and are related to Canco but are not foreign affilites of any person resident in Canada), then provided the interest payments received by FA from NR1 are directly linked to the interest payments made by NR2, the interest income of FA would be "derived from amounts that were paid or payable directly or indirectly by NR2".

25 April 1995 T.I. 942987 "C.T.O. 6363-1 Foreign Affiliates - Deemed ABI")

Where one wholly-owned U.S. subsidiary ("B") of a Canadian corporation ("A") loans money on an interest-bearing basis to a second wholly-owned subsidiary ("C") of A, and the interest paid by C to B is added to the cost of C's inventory for the purposes of the Internal Revenue Code, s. 95(2)(a)(ii)(B) will deem the interest to be included in the income from an active business of B.

Articles

Jack Bernstein, Francesco Gucciardo, "Canada-U.S. Hybrid Financing – A Canadian Perspective on the U.S. Debt-Equity Regs", 26 September 2016, p. 1151

Recharacterization rules under Code s. 385 (p.1152)

Most fundamentally, the proposed regulations would automatically treat what would otherwise be classified as a debt instrument as equity when a debt instrument is part of some distributions or related-party transactions. The proposed regulations identify: (i) debt instruments that are distributed by a corporation to a related corporate shareholder, (ii) debt instruments that are issued by corporations in exchange for affiliate stock, and (iii) debt instruments that are issued by corporations under some internal asset reorganizations, as transactions that may result in the subject debt instrument being recharacterized as equity under the general rule for U.S. income tax purposes.

Further, the proposed regulations also contain a funding rule that would treat related-party debt instruments as equity when a corporation issues a debt instrument to a related party with a principal purpose of funding a distribution or acquisition described in the above-noted general rule, which principal purpose is determined based on all the facts and circumstances. The proposed regulations also contain a general though rebuttable presumption that the principal purpose test will be satisfied when the debt instrument is issued during the period beginning 36 months before, and ending 36 months after, any distribution or acquisition is made….

Description of Luxembourg structure for financing U.S. Opco (p. 1157)

Canada forms a Luxembourg société à responsabilité limitée (SARL) to facilitate a double-dip financing into the U.S. that Canada wants to finance its U.S. subsidiary's active business. Canada borrows funds and invests in sufficient common shares of U.S. Opco to satisfy U.S. thin capitalization and earnings stripping rules. Canada invests the balance in the minimum amount of common shares of the Lux SARL to satisfy Luxembourg thin capitalization. The balance of the funds invested by Canada in the Lux SARL would be by way of share subscriptions for private equity certificates (PEC), convertible private equity certificates (CPEC), mandatorily redeemable preferred shares (MRPS), or interest-free loans… .

Luxembourg rulings for MRPS (p. 1157)

Recently, Luxembourg stopped issuing rulings on MRPS but has now started again on a limited basis. Luxembourg tax rulings were essential as the accounting and tax treatment would differ. For accounting purposes, PEC, CPEC, and MRPS may be regarded as equity, while for tax purposes with the comfort of a ruling these hybrid instruments are treated as debt. For accounting purposes, MRPS have recently been accepted as debt for accounting purposes in Luxembourg. Distributions on PEC, CPEC, and MRPS are deductible as interest in Luxembourg….

Luxembourg deduction for imputed interest/no s. 17 imputation (p. 1157)

Canada would generally treat PEC, CPEC, and MRPS as shares and the distributions as dividends. If instead interest-free loans were made by Canada to Lux SARL, Luxembourg would impute interest on the loans and allow a deduction for the imputed interest. The deductible interest on the PEC, CPEC, and MRPS, or imputed interest on the interest free loans, are intended to shelter the interest income realized in Luxembourg,…

No interest is paid for Canadian tax purposes and no income is included for the imputed interest….

Art. XI exemption on U.S. Opco interest/s. 95(2)(a)(ii) exclusion (p. 1158)

The Lux SARL would lend funds to U.S. Opco at a reasonable interest rate. Interest would be deducted in the U.S. and not be subject to U.S. withholding tax. The derivative benefit exemption from the limitation on benefits provision in the Luxembourg-U.S. treaty allows a Lux SARL to be wholly owned by a Canadian taxpayer and still benefit from the Luxembourg-U.S. treaty. Article XI of the Canada-U.S. treaty provides an exemption from withholding tax on all nonparticipating loans from related parties.

As Canada does not gain a U.S. withholding tax advantage by interposing a Luxembourg SARL, the LOB provision does not apply. Moreover, interest paid by a U.S. Opco to the Lux SARL is recharacterized for Canadian tax purposes from income from property to income from an active business….

Potential non-application of proposed Code s. 385 Regs. (p. 1158)

[T]here is a new advance of money being invested in the U.S. operations — the debt from the Luxembourg SARL to U.S. Opco arises as a consequence of a real advance of money that is sourced from an arm's-length lender bank through Canada. The debt would not appear to be issued as part of any distribution or redemption, in exchange for stock of a member of the expanded group, as part of a tax-free reorganization or a multistep transaction designed to circumvent the above noted in order to fund distributions or acquisitions. But, as noted above, the presumption underlying the funding rule would still need to be overcome as distributions or acquisitions are (or had been) made within the requisite 72-month period.

Note: the Article also discusses the potential non-application of these Regs. to other hybrid arrangements, viz., forward subscription arrangements for a USCo financing of Canco, and a tower or repo structure for the financing of U.S. Opco by Canco.

Ian Gamble, "Income from a Business or Property: General Principles and Current Issues", 2014 Conference Report, Canadian Tax Foundation, 5:1-32

CFA holding company can hold shares of CFA subs as an investment business (p. 5:19)

[A] top-tier holding affiliate in a foreign country may have activities similar to that of a parent corporation of a Canadian corporate group: that is, it may hold shares in other foreign affiliates as part of its overall business of equity and debt financing, strategic oversight, capital management, and technical services provided to and in respect of the other group companies….the holding affiliate should be considered to have a business. Furthermore, if the revenues of that business are principally interest and dividends, the holding affiliate should also be considered to have an investment business as its source of income in the first instance.

Back-to-back application of s. 95(2)(a)(ii)(B)(I) (p. 5:20)

[A]ssume that FA 1…is a parent affiliate of the kind described above….

Assume, for a particular year, that the only revenue actually received by FA 1 in its investment business consists of interest on loans (of money) used by FA 2 for the purpose of earning income in its active business. Further assume that this interest payable is deductible in computing FA 2's prescribed earnings from its active business under paragraph (a) of the definition of "earnings" in regulation 5907(1). FA l's net income from its investment business for the year is certainly "derived from" amounts deductible in computing FA 2's prescribed earnings from its active business. This should be sufficient to recharacterize what would otherwise be FA l's net income from its investment business (income from property) into income from an active business under subclause 95(2)(a)(ii)(B)(I).

Furthermore, if FA 1 has itself obtained financing in connection with its investment business from another foreign affiliate (FA 3), the foregoing could affect the tax treatment of interest income earned by FA 3. This is so whether the financing relates to shares held in the investment business or to loans held in the investment business. For instance, assume that FA 3 financed FA l's acquisition of shares held in FA l's investment business. In computing FA l's net income from this one source, FA 1 deducts interest payable to FA 3. Interest payable to FA 3 should represent an amount deducted by FA 1 in computing its net amount that is required to be recharacterized as active business income under subclause 95(2)(a)(ii)(B)(I). This, in turn, should mean that the interest income received by FA 3 is also recharacterized as active business income under subclause 95(2)(a)(ii)(B)(I), because the interest payable by FA 1 to FA 3 is deductible by FA 1 in computing its prescribed earnings from an active business under paragraph (b) of the definition of "earnings" in regulation 5907(1).

John Lorito, Trevor O'Brien, "International Finance – Cash Pooling Arrangements", 2014 Conference Report, (Canadian Tax Foundation), 20:1-33

Difficulties in establishing tracing in cash pool (p. 22)

It may be possible for interest earned by a foreign affiliate from deposits/loans made under a cash pooling arrangement to be re-characterized to be income from an active business under subparagraph 95(2)(a)(ii) where the head account holder is another foreign affiliate, however, many complexities exist. The activities carried on by the head account holder associated with the cash pooling arrangement should be treated as an investment business. The principal business purpose of the head account holder relating to the cash pool is to earn interest income by borrowing funds from some members of the cash pool and on-lending such funds to other members. As a result, any income earned by the head account holder should be income from property unless such income separately qualifies to be re-characterized to be income from an active business under subparagraph 95(2)(a)(ii).

If the head account holder is a foreign affiliate and it lends all the funds advanced to it under the cash pooling arrangement to other foreign affiliates to fund their active businesses, it should be reasonable to expect that all the interest income earned by the head account holder under the cash pooling arrangement should qualify to be re-characterized to be income from an active business, and correspondingly, all the interest paid by the head account holder to other foreign affiliates should also qualify to be re-characterized to be income from an active business of the other foreign affiliates. However, the odds of such perfect lending symmetry ever being achieved in a physical cash pooling arrangement is likely extremely low.

As deposits are made into the cash pool, there is generally no guarantee that another member in I the pool will require additional funding at that time, as a result, the head account holder may invest such deposits into short-term securities, etc. The income generated from such short term investments should be earned as part of the head account holders investment business and should be treated as income from property….

See description of cash pooling under s. 15(2.3).

Melanie Huynh, Eric Lockwood, "Foreign Accrual Property Income: A Practical Perspective", International Tax Planning, 2000 Canadian Tax Journal, Vol. 48, No. 3, p. 752.

Tasso Lagios, Arda Minassian, "Foreign Accrual Property Income: Pitfalls for the Unwary", 1999 Conference Report, c. 3.

Ahmed, "Selected Issues Relating to the 1995 Foreign Affiliate Amendments", International Tax Planning, 1997 Canadian Tax Journal, p. 2141.

Lanthier, Tobin, "Intercorporate Financing of Canadian Investment in the United States", Cross-Border Taxation Issues and Developments 1996, International Fiscal Association, p. 211.

Finance

Wallace G. Conway, "The New Foreign Affiliate Provisions: The Department of Finance's Perspective", 1995 Conference Report, c. 40, Q. 5

Discussion of the phrase "directly or indirectly":

The phrase "directly or indirectly" is meant to deal with back-to-back loans and certain fronting arrangements involving insurance.

... Subparagraph 95(2)(a)(iii) is intended to treat property income of a foreign affiliate of a taxpayer in respect of which the taxpayer has a qualifying interest as active business income only to the extent that it is derived from amounts paid or payable directly or indirectly by a qualified payer and only to the extent that the amounts paid or payable reduce the active business income of the qualified payer. The qualified payer is described in each clause of subparagraph 95(2)(a)(ii).

The objective of subparagraph 95(2)(a)(ii) is to keep whole the active business income of certain affiliated or related groups of corporations where there are payments among its members.

Clause 95(2)(a)(ii)(D)

Administrative Policy

27 January 2017 External T.I. 2013-0482351E5 - Clause 95(2)(a)(ii)(D)

s. 95(2)(a)(ii)(D) can recharacterize a loan prepayment penalty as active business income

Canco wholly-owns two controlled foreign affiliates (“FA Finco” and “FA Holdco”). Canco, FA Finco and FA Holdco have calendar year ends. FA Holdco uses funds borrowed from FA Finco under the “Loan” (which satisfies the conditions under s. 95(2)(a)(ii)(D) (“Clause D”) respecting the interest thereon) to acquire all the shares of FA Opco. The Loan has arm’s length terms including a clause that, upon FA Holdco opting to repay a portion of the principal amount before its maturity date, requires it to pay a penalty not exceeding the present value of the interest that would otherwise have been payable by it. Would Clause D recharacterize the penalty? In responding favourably, CRA itemized four requirements of Clause D, of which the following three required most of the analysis:

(2) the penalty received by FA Finco is an amount paid or payable by FA Holdco “under a legal obligation to pay interest on borrowed money;”

(3) the penalty received by FA Finco is an amount paid or payable by FA Holdco “in respect of any particular period in the year;” and

(4) the borrowed money is used for the purpose of earning income from property that is shares of a foreign affiliate.

CRA stated:

[Under] the second condition…[o]nce the penalty amount is paid, paragraph 18(9.1)(e)…will…deem the amount of the penalty to have been paid by FA Holdco and received by FA Finco as interest on the Loan.

[Respecting] the third condition…the grammatical structure of paragraph 95(2)(a)… confirms that the “year” in the phrase “in respect of any particular period in the year” in Clause D is the taxation year of FA Finco.

…The importance of the reference to a particular period is based on the requirement of Clause D that FA Holdco holds shares of a corporation that is a foreign affiliate of Canco throughout that period and that the shares are excluded property of FA Holdco throughout the same period. However, since the penalty payment occurs at a particular time (unlike interest which is accruing on a daily basis over a period of time), the relevant period during which FA Holdco must meet the above requirements for purpose of recharacterizing the penalty payment under Clause D is effectively represented by the time at which the payment is made by FA Holdco and received by FA Finco. …

[Respecting] the last condition…provided that at the time FA Finco receives the amount of penalty, FA Holdco continues to hold the shares of FA Opco that constitute a source of income for FA Holdco, the fourth condition of Clause D would be satisfied.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 18 - Subsection 18(9.1) s. 18(9.1) applied where loan prepayment penalty was equal to PV of interest thereon 174
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(2.7) loan prepayment penalty fully deducted from surplus when paid 155

24 November CTF Annual Roundtable, Q.9

CRA considers that a member of an LLC is subject to U.S. income taxation on the LLC income for purposes of s. 95(2)(a)(ii)(D)(IV)(2) even though the net inclusion in its income is reduced by interest payable to a financing foreign affiliate

S. 95(2)(a)(ii)(D) may apply to deem interest payments received by FA #1 from FA #2 (the “Second Affiliate”) in a year on money borrowed by the Second Affiliate to acquire shares of a foreign affiliate (the “Third Affiliate”) to be active business income. Among other conditions, s. 95(2)(a)(ii)(D)(IV) requires that in respect of both the Second Affiliate and Third Affiliate, either:

  1. the affiliate is subject to income taxation in a foreign country in the year; or
  2. the affiliate's shareholders are subject to income taxation in a foreign country on substantially all of the affiliate's income for the year.

CRA considers that the 2nd test above will be satisfied, in the situation where the Third Affiliate is an LLC that is treated for U.S. purposes as a partnership in which the Second Affiliate has a 95% partnership interest, if substantially all (i.e., 95% in this example) of the Third Affiliate’s income is included in the computation of the income of the Second Affiliate, even though that computed income is reduced by the interest expense payable by the Second Affiliate to FA #1 on the borrowed money that had been used to acquire the Second Affiliate. CRA stated:

[T]he requirement in sub-subclause 95(2)(a)(ii)(D)(IV)(2) that the shareholders or members of the Third Affiliate are subject to income taxation “on all or substantially all of the income” of that affiliate does not mean the Second Affiliate cannot incur expenses. Rather, it means that the requirement will not be met where, generally, more than 10% of the income of the Third Affiliate is ultimately not subject to income taxation in a country other than Canada (e.g., a 20% shareholder or member is tax-exempt or otherwise not subject to income tax in the foreign jurisdiction). Therefore, provided that the requirements in sub-subclause 95(2)(a)(ii)(D)(IV)(2) are otherwise satisfied, the fact that the Second Affiliate has incurred interest or other expenses will not cause the requirements of sub-subclause 95(2)(a)(ii)(D)(IV)(2) not to be met.

28 May 2015 IFA Roundtable Q. 6, 2015-0581601C6 - IFA 2015 Q.6: Reversal of position on 95(2)(a)(ii)(D)

note acquired for contribution to a foreign subsidiary (thereby enhancing the dividend-earning potential of its shares) was acquired for the purpose of earning income from shares

In 2013-0496841I7, CRA took the position that s. 95(2)(a)(ii)(D) did not apply to recharacterize interest on a debt ("Note 2") issued by FA2 to acquire a note ("Note 1") that was subsequently contributed to the capital of another foreign affiliate (FA3) by FA2 without the receipt of shares. CRA reversed that position in 2014-0519801I7 [also summarized under 2013-0496841I7]. Why the reversal? CRA responded:

[W]e are now of the view that the purpose test that must be met when reading subclause 95(2)(a)(ii)(D)(II) ("Subclause (II)") in conjunction with Subclause (III) being that the purpose of the acquisition of a property be the earning of income from property where the property is shares of a foreign affiliate will be met even if the property acquired (Note 1) on the issuance of Note 2, as referred to in Subclause (II), is not the same property as that referred to in Subclause (III), being the shares of FA3, as long as the property (Note 1) has been acquired for the purpose of earning income from those shares of FA3.

…[S]ince the contribution to FA3 of the property acquired (Note 1) enhanced the dividend earning capacity of FA2 with respect to the FA3 shares, we consider, notwithstanding that no new shares of FA3 were issued, that the acquisition of Note 1 by FA2 meets the purpose test, i.e. Note 1 was acquired for the purpose of gaining or producing income from property being the shares of FA3, as of the time of the contribution. Therefore…the interest paid on Note 2 by FA2 to FA1 would be recharacterized as active business income of FA1… .

21 October 2013 Internal T.I. 2013-0496841I7 - Application of clause 95(2)(a)(ii)(D) ITA

purchase debt not issued to directly acquire shares

Following preliminary transactions, Canco held all the membership interest in a U.S. LLC (NR1) as well as 99.99% ownership of a [Netherlands?] co-operative (NR2), with the other 0.01% interest in NR2 held by NR1. NR2 owned 100% of NR3 which, in turn, owned 100% of NR4, an S.R.L.

NR1 also held all the shares of NR6, which carried on an active business. (The holding company for NR6 (NR5) had recently been acquired by NR3, followed by a liquidation of NR5 into NR3, a transfer of NR6 by NR3 to Canco in repayment of a loan, and a contribution by Canco of NR6 to NR1 for NR1 units.)

NR4 acquired all the NR6 shares from NR1 at FMV in consideration for an interest-bearing note (Note1). NR2 acquired Note1 from NR1 by issuing Note2 (also interest-bearing) in the same amount, and then contributed Note1 to NR3.

The only issue raised: did s. 95(2)(a)(ii)(D) apply to the interest paid by NR2 to NR1 on Note2? Per the original memo, it did not.

S. 95(2)(a)(ii)(D)(I) did not apply as (applying McCool) "no lender-borrower relationship has been created between NR1 and NR2 [and] as a consequence, the interest paid or payable by NR2 to NR1 was not paid or payable on borrowed money." S. 95(2)(a)(ii)(D)(II) also was not available as "NR2 acquired Note1 in consideration for the issuance of Note2…[so that] the property acquired was not shares of another foreign affiliate" and, furthermore "NR2 did not acquire any property upon the contribution of Note1 to the capital of NR3."

The subsequent memo (without explanation) stated:

[W]e are no longer of the view that the interest received on Note 2 should be included in the FAPI of NR1... . Upon further consideration, we are of the view that subclause 95(2)(a)(ii)(D)(II)...applies in the circumstances... .

1 May 2009 CLHIA Roundtable Q. 12, 2009-0317191C6 - CLHIA Roundtable Question #12- 95(2)(a)(ii)(D)

"subject to income taxation"

Respecting a situation where Borrower and Subsidiary are resident in Country A and are liable to tax on a worldwide basis in Country B, CRA stated "it is our view that 'subject to income taxation' means that all the income earning activities of the corporation fall under the taxing jurisdiction of the relevant country. A corporation would be subject to income taxation notwithstanding that it does not pay any tax in a particular year because it has incurred a loss or because it has losses of other years available to us at net income that would otherwise be taxable." Furthermore, "if Borrower and Subsidiary, which are resident in Country A for tax purposes, elect to be taxed as a resident in the United States under subsection 953(d) of the IRC, and are consequently taxable on their worldwide income in United States, it would still be necessary to determine whether each corporation was subject to income taxation in Country A."

5 September 2002 External T.I. 2000-00742 -

FA1 lends money to FA2 (a Swedish company) which uses the borrowed funds to acquire the shares of FA3 (another Swedish company) whose sole source of income is related company receivables giving rise to interest that is recharacterized as active business income under s. 95(2)(a)(ii). FA3 makes an asset transfer to FA2 which is deductible to FA3 and includable in the income of FA2 under Swedish income tax provisions providing for income transfers.

S.95(2)(a)(ii)(D) would not apply to the interest paid by FA2 to FA1 as such interest would only be relevant in computing the liability for income taxes of FA2.

2002 Ruling 2002-0138993 -

A foreign affiliate of the taxpayer ("Finco") in Country B makes a loan to a subsidiary of the taxpayer ("Holdco") in Country A. In connection with a takeover bid by Holdco for a public corporation in Country A, it uses the borrowed money to acquire (but not obtain a beneficial interest) in treasury shares of the taxpayer for the sole purpose of transferring such shares to the shareholders of Target as the consideration for acquiring their shares of the Target. The shares of Target will be considered to be "the property" for purposes of s. 95(2)(a)(ii)(D)(III). Comments on application of s. 95(2)(a)(ii)(D)(V).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 84 - Subsection 84(3) 133

5 October 2001 Comfort Letter 20011005 (See also 20010917)

Finance is prepared to recommend an amendment to s. 95(2)(a)(ii)(D)(iv) to accommodate an affiliate "where the affiliate is not subject to income taxation in its country of residence but all or substantially all of the income earned by the affiliate in all of the taxation years of the affiliate that ended in the taxpayer's taxation year is included in the income of the members or shareholders of the affiliate at the end of those years and is subject to income taxation in that country under the laws of that country."

1 November 2000 External T.I. 1999-000972 -

A wholly-owned subsidiary ("Subco B") of a U.S. operating corporation ("Opco") that was not resident in the United States and that was not part of the U.S. consolidated filing for Opco and other U.S. foreign affiliates of the taxpayer but all of whose income was included in the U.S. consolidated return by virtue of Subpart F of the Code would not be considered a member of the group for purposes of s. 95(2)(a)(ii)(D)(V) because its liability for income taxes in the United States, if any, would be unaffected by the group filing.

25 February 2000 External T.I. 99-000968 -

A wholly-owned foreign affiliate of Canco ("FA1") lends money to a wholly-owned U.K subsidiary of Canco (UK1) which, in turn, uses the borrowed funds to acquire all the shares of UK2. UK1, which has no revenue, pays interest of $10,000 in year 1 on its debt to FA1. UK2 has net income from its active business operation in year 1 of $7,000. UK1 surrenders $7,000 of its loss to UK2. Under U.K. tax law, the remaining $3,000 of loss incurred by UK1 in year 1, will be available for carryforward for use only by UK1 in future taxation years because a loss carried forward is not eligible for group relief.

The agency indicated that in these circumstances, $3,000 of the interest income received by FA1 would remain income from property after applying s. 95(2)(a)(ii)(D) and will be fapi.

14 May 1997 T.I. 960535

General discussion of s. 95(2)(a)(ii)(D)(v).

5 February 1997 T.I. 963562 (C.T.O. "Foreign Affiliates - Relevant, Liability for Tax")

Respecting s. 95(2)(a)(ii)(D), RC found that "if an amount is deductible in computing income for income tax purposes, it would generally be considered to be relevant in computing the liability for income tax notwithstanding that there may not be a reduction in the amount of taxes paid in the particular year."

10 October 1996 T.I. 9630775

An amount paid by a foreign affiliate could be considered "relevant in computing the liability for income taxes" for purposes of s. 95(2)(a)(ii)(D)(V) if a deduction is allowed under the foreign tax law resulting in an increased foreign tax credit carryover, even though the liability for income tax in the year the amount is deducted is unchanged.

Articles

Michael N. Kandev, "Putting on our Thinking Cap About 'CAP D'", International Tax (Wolters Kluwer CCH), June 2017, No. 94, p. 5

1st departure in s. 95(2)(a)(ii)(D) (”Cap D”) from general expansive thrust of s. 95(2)(a)(ii): importation of narrow s. 20(1)(c) terminology (p. 9)

[C]ap D has been drafted too narrowly in relation to its underlying policy, which is to "expand" the basic rule of subparagraph 95(2)(a)(ii), now found at Cap B of this provision, in order to accommodate the use of holding corporations by certain groups of foreign affiliates….

First, Cap D is available only in respect of amounts that are paid or payable either under a legal obligation to pay interest on borrowed money used for the purpose of earning income from property, or on an amount payable for property acquired for the purpose of gaining or producing income from property...[w]hereas Cap B applies to any amount as long as the deductibility criterion therein is met. Thus, for example, it is not clear why Cap D is not available in respect of royalties. It is possible to envision a US consolidated group owned by a Canadian MNE where the US top affiliate has licensed IP from, say, a Luxembourg IP Box affiliate, and then lets the US operating subsidiaries in the group use such IP without payment and in the absence of a formal sub-licensing arrangement.

2nd departure: throughout-the-year connection between 2nd and 3rd FA (p. 9)

Second, Cap D requires a sort of "permanent connection" between the holding affiliate, FA2, and the operating affiliate, FA3, by imposing the condition that either the income earning purpose of the borrowing or the amount payable for property acquired relate to "the property" that is, throughout the particular period, excluded property of FA2 that is shares of the capital stock of FA3….For example, if FA2 acquires from FA1 preferred shares of FA3 that is otherwise owned by FA2 in consideration for an interest-bearing note and then FA2 wishes to simplify the share capital of FA3 (now wholly-owned by it) to eliminate the preferred shares, there can be uncertainty as to the application of Cap D going forward depending upon how the preferred shares are eliminated. [fn 12: See…2015-0581601C6]

3rd departure: subject-to-tax requirement (e.g., re LLCs) (pp. 9-10)

Third, the subject to tax criterion has generally been the most problematic condition of Cap D….

[P]ursuant to an October 5, 2001, comfort letter the government relaxed the rule to accommodate US LLCs, which formerly were a block to the application of Cap D, but as becomes obvious from the questions put forward at the recent IFA seminar [2017-0691221C6], certain issues remain in this area.

Shawn D. Porter, David Bunn, "Is it Time to Simplify the Holding Company Rule?", International Tax Planning (Federated Press), Volume XIX, No. 2, 2014, p. 1304.

Broader thrust of s. 95(2)(a)(ii) (p. 1304)

[I]n general, the rules in subparagraph 95(2)(a)(ii) operate to preserve ABI characterization on inter-affiliate payments that have their source, directly or indirectly, in an active business and, in so doing, maintain an appropriate distinction between ABI and foreign accrual property income ("FAPI") as required under the Act….

Initial narrow scope of s. 95(2)(a)(ii)(D) (p. 1304)

Initially, the holding company rule was quite narrow in that it was limited to situations where the interest expense incurred by the second FA in respect of the shares of the third FA was relevant in computing the tax liability of a corporate group of which the second and third FA were members in a country in which they were resident and subject to income taxation. In essence, the holding company rule was limited to situations where the interest expense was deductible in computing the earnings or loss from an active business carried on by FAs forming part of a group for local country tax purposes, but did not qualify for deemed ABI treatment under clause 95(2)(a)(ii)(B) (referred to herein as "cap B" or the "Opco deeming rule") because the active business was carried on by a FA that was a subsidiary of the one incurring the interest expense.

Expansion of rule (p. 1304)

Over time, the requirements in the holding, company rule have been relaxed, with notable changes including the elimination of the group taxation requirement and, to accommodate U.S. LLCs, the easing of the requirement that the second and third FA be "subject to tax" in situations where the income of the second or third FA is taxed in the hands of its members or shareholders. Recently, new proposals were introduced to remove the requirement that the second and third FA be resident in the "same country" [fn 4: The July 12, 2013 draft legislation will remove the "same country" requirement from the holding company rule by deleting subclause (D)(IV) and making consequential amendments to subclause (D)(V), which will be renumbered as subclause (D)(IV)] and to include a new rule to facilitate the application of the holding company rule in circumstances where a partnership in which the second FA is a member borrows money to acquire shares of a third FA. [fn 5: Proposed subsection 93.1(4)]

Borrowing of FA2 to distribute PUC attributable to FA3 (p. 1306)

[I]ndirect tracing is available where borrowed money is used to pay a dividend from the accumulated profits of the borrower, but not where borrowed money is used to pay a dividend in excess of accumulated profits (even if, for instance, the borrower has significant paid-up capital that could have been returned to its shareholder(s) rather than paying a dividend). [f.n. 10 The Chase Manhattan Bank of Canada v. The Queen, 2000 DTC 6018 (F.C.A.).] ...

[A] Canadian corporation (Canco) owns a number of foreign affiliates, including a foreign financing company (FA Finco) and a foreign holding company (FA Holdco), which in turn owns a foreign operating company (FA Opco). FA Holdco borrows money from FA Finco in order to pay a dividend to Canco in excess of accumulated profits, with the dividend treated as a pre-acquisition surplus dividend for Canadian tax purposes…

[T]he borrowed money would not likely be considered used for the purpose of earning income from the shares of FA Opco since the direct use of the borrowed money was to pay a dividend (i.e., not to earn income from the shares of FA Opco) and the "fill the hole" rule could not be relied upon to indirectly trace the borrowed money to the shares of FA Opco since the was not paid from accumulated profits….

Moneys borrowed by FA2 used on merger with Holdco for FA3 to redeem Holdco shareholders (pp. 1306-7)

[A] Canadian corporation (Canco) is acquiring indirectly all of the shares of a foreign operating company (Target Opco), which is currently owned by a foreign holding company (Target Holdco). To facilitate the acquisition, Canco establishes a foreign acquisition company (FA Bidco), which is financed by a combination of equity from Canco and debt from a related financing company (FA Finco). To accommodate foreign practices, the acquisition is achieved by having FA Bidco merge with and into Target Holdco, with Target Holdco surviving the merger. On the merger, the cash in FA Bidco is used to redeem the shares owned by the Target Holdco shareholders.

…[I]t is not clear if the "fill hole rule" rule could be relied upon to indirectly trace the borrowed money to the shares of Target Opco, particularly if the amount paid to the Target Holdco shareholders was in excess of the accumulated profits and contributed capital of Target Holdco….

FA2 is precluded from borrowing money from FA1 to earn (indirectly) income from FA1 shares (p. 1309)

[A] Canadian corporation (Canco) owns a foreign holding company (FA Holdco), which in turn owns a foreign operating company (FA Opco). FA Opco has cash available for repatriation. Rather than distributing the funds as a dividend, the funds are loaned from FA Opco to FA Holdco, which in turn distributes the funds to Canco as a return of paid-up capital, which had originally been used by FA Holdco to acquire the shares of FA Opco….

While the direct use of the borrowed money is to return paid-up capital, the indirect use (when applying the "fill-the-hole" principle) is to earn income from shares of FA Opco, on the basis that the borrowed money was used to replace capital that had originally been used to acquire the shares of FA Opco. Nevertheless, because of the requirement in the holding company rule that precludes one FA from borrowing money from another FA in order to earn income from shares of the lender FA, the holding company rule cannot be met in these circumstances….

Suggested streamlining of rule (p. 1310)

[W]e suggest a more streamlined approach…

[T]his could be achieved by reformulating the holding company rule in a manner that is consistent with the language and approach in the Opco deeming rule [in s. 95(2)(a)(ii)(B)]. That is, income of a particular FA would be eligible for ABI characterization in circumstances where the income is derived from amounts that are paid or payable to the particular FA (or a partnership of which the particular FA is a member) by another FA of the taxpayer to the extent the amounts are deductible by the other FA in computing income from a property of the other FA that qualifies as an excluded property throughout the particular period. [fn 17: The qualifying interest threshold for each FA would be retained.]

Paul Barnicke, Melanie Huynh, "TI Denies Cap D Rule", Canadian Tax Highlights, Volume 22, Number 2, February 2014, p. 12.

NR2 acquires Note1 (owing by grandchild) for Note2, and contributes Note1 to wholly-owned NR 3 (p. 12)

A recent TI (2013-0496841I7...) said that clause 95(2)(a)(ii)(D) (the so-called Cap D rule) does not apply to interest paid on purchase debt because the debt was not issued to acquire shares.

NR2 did not acquire any property from NR3 (p. 12)

...NR 2 issued note 2 to acquire note 1 and contributed it to NR 3 without taking back any property: because NR 2 did not acquire any property on the contribution to NR 3, the TI said that the Cap D(II) conditions were not met. ... By inference, the CRA would also deny NR 2's interest expense as a FAPL... . [This contradicts] IT-533 [para. 25] ... which ... confirmed that a contribution of capital is an eligible use... .

NR2 acquired Note1 to earn income on its (excluded property) shares of NR3 (p. 12)

...We respectfully disagree with the TI's interpretation. Note 2 was issued by NR 2 to acquire a property (note 1) for the purpose of earning (indirectly) income from property, the pre-existing NR 3 shares: if NR 2 can demonstrate that it had a reasonable expectation of receiving dividends from NR 3, the Cap D(II) conditions are met.

No direct use test (pp.12-13)

We believe that when Cap D was introduced in 1995 the legislative drafter took inspiration from paragraph 20(1)(c). With one important difference, the Cap D requirements are based on, and informed by, those interest deductibility rules. The one difference is that in Cap D, the purpose behind the use of borrowed money or property acquired with purchase debt must be to earn income from property that is shares that are excluded property. Thus, it is reasonable to expect that the case law concepts developed under paragraph 20(1)(c) will be used to interpret Cap D.

Cap D does not require that borrowed money or purchase debt be used directly to acquire property that is shares of another FA that are excluded property... . Moreover, the preamble ... also refers to direct or indirect use... .

Subclause 95(2)(a)(ii)(D)(IV)

Sub-subclause 95(2)(a)(ii)(D)(IV)2

Administrative Policy

26 April 2017 IFA Roundtable Q. 7, 2017-0691221C6 - Clause 95(2)(a)(ii)(D)

“income” includes “loss,” but s. 95(2)(a)(ii)(D)(IV)2 inapplicable re an LLC interest that is sold before year end

S. 95(2)(a)(ii)(D)(IV)2 requires that, for each disregarded 2nd or 3rd affiliate and for each of their relevant taxation years that end in the taxation year of the foreign affiliate making the loan, their members/shareholders at the end of such year be subject to tax in a country other than Canada on all or substantially all of their income for such year.

a) If either the 2nd (2nd LLC) or 3rd (3rd LLC) affiliate has a loss in a taxation year ending after the CFA subsidiary of the Canadian parent made the loan to 2nd LLC, and all other “Cap D” conditions are met, would interest on the loan be eligible for recharacterization under Cap D notwithstanding the reference to “income” in 95(2)(a)(ii)(D)(IV)2 thereof?

b) If the 2nd affiliate (US Holdco), which owns 40% of 3rd LLC (a partnership for Code purposes, with a 60% interest therein held by an arm’s length U.S. resident) sells its 40% interest to an arm’s length U.S. purchaser on June 1, with US Holdco being subject to U.S. tax on its share of 3rd LLC’s income for the stub period up to May 31, would the “end of year” requirement to be met notwithstanding that US Holdco is not a member of 3rd LLC at its calendar year-end?

CRA indicated that:

(a) Interest-income of the CFA making the loan to the 2nd LLC would be eligible for recharacterization (based on all the other conditions of Cap D being met) so that its interest income would still be eligible for recharacterization under Cap D, notwithstanding that either 2nd LLC or 3rd LLC, or both, had a loss in the particular year.

(b) S. 95(2)(a)(ii)(D)(IV)(2) likely would not be satisfied as the members of the 3rd LLC at the end of its taxation year likely will not be subject to U.S. income taxation on substantially all of 3rd LLC’s income, because the 40% of 3rd LLC’s income in the period of January-May that would be allocated to US Holdco. This issue has been brought to the attention of the Department of Finance.

Words and Phrases
income

Paragraph 95(2)(a.1)

Administrative Policy

14 May 2015 CLHIA Roundtable, 2015-0573801C6 - Foreign affiliates - sale of property to taxpayer

exclusion where sale to foreign branch of Cdn insurer

Canco carries on a life insurance business in Canada, and also through a foreign branch with clients in the foreign country. The income of FA, which is wholly-owned by Canco and resident in that county, from its own insurance business carried on that country is solely "income from an active business."

Would s. 95(2)(a.1) deem FA's income from the sale of property (that had been used in its business) to Canco's foreign insurance branch to be income from a business other than an active business if the particular property were subsequently sold by Canco's foreign branch to a person with whom Canco deals at arm's length, so that ss. 138(2) and (9) excluded the resultant income, gain or loss from Canco's income? CRA responded:

[I]f subsections 138(2) and (9) apply to exclude the income, gain or loss arising from the disposition of the property, previously acquired by Canco's foreign insurance branch from FA, from Canco's income from an insurance business for the purposes of Part I… the cost of such property would not be "relevant in computing the income from a business carried on by" Canco for the purposes of paragraph 95(2)(a.1). Accordingly, paragraph 95(2)(a.1) would not apply to FA's income from the sale of the property to Canco.

Articles

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 138 - Subsection 138(2) exclusion where sale to foreign branch of Cdn insurer 206

Nelson Ong, "Sale of Property and Paragraph 95(2)(a.1)", 2012 Canadian Tax Journal, Vo. 60, No. 3, p. 679

Detailed discussion. S. 95(2)(a.1) does not contain a rule similar to s. 95(2)(b) that deems the income of a foreign affiliate to be FAPI if that income is sourced to an deductible from the FAPI of another foreign affiliate. The home country requirement is problematic given the ubiquity of branch businesses. Discussion of application of "manufactured" and "processed" as interpreted under other provisions. The application of the provision is unclear where there are multiple stages of manufacturing.

Tasso Lagios and Arda Minassian, "Foreign Accrual Property Income: Pitfalls for the Unwary", 1999 Conference Report, c. 3.

Jack, "The Foreign Affiliate Rules: The 1995 Amendments", 1995 Canadian Tax Journal, Vol. 43, No. 2, p. 347.

Arnold, "An Analysis of the 1994 Amendments to the FAPI and Foreign Affiliate Rules", 1994 Canadian Tax Journal, Vol. 42, No. 4, p. 993.

Subparagraph 95(2)(a.1)(iv)

Administrative Policy

25 October 2016 Internal T.I. 2016-0658241I7 - Application of 95(2)(a.1) to a capital gain

capital gains cannot constitute s. 95(2)(a.1)(iv) income

LLC, which is wholly-owned by Canco, sell an intangible to the ultimate Canadian parent of Canco, thereby giving rise to a capital gain. Could that capital gain generate income from a business other than an active business under s. 95(2)(a.1)? The Directorate responded:

Since capital gains are also income within the meaning of section 3, you are wondering whether it might be possible to argue that this capital gain is income from, that is incident to, or that pertains to, a business other than an active business [under s. 95(2)(a.1)(iv).] …

Variable B of the FAPI definition applies specifically to capital gains, whereas income from a business other than an active business, such as income from the sale of property which meets the conditions of paragraph 95(2)(a.1), would fall under variable A of that definition. Although the FAPI definition does specifically contemplate some overlap between variables A and B, that overlap is with respect to gains on income account and not capital gains. As such, given that the capital gains rule is more specific, it is our view that capital gains of a foreign affiliate must be tested for inclusion under variable B and that they are not within the scope of variable A.

Paragraph 95(2)(a.3)

Administrative Policy

21 May 1997 T.I. 970795

Gross revenue from indebtedness, the income from which would be excluded from fapi pursuant to s. 95(2.4), will nonetheless be taken into account for purposes of determining whether the 90% gross revenue test in s. 95(2)(a.3) has been met. For these purposes, gross revenue from the sale of indebtedness would include the full proceeds of disposition rather than only the gross profit.

Paragraph 95(2)(b)

Administrative Policy

13 January 2014 External T.I. 2013-0474431E5 - Application of 95(2)(b)(ii)

"full" reimbursement for seconded employee costs does not engage s. 95(2)(b)(ii)

In 2013-0474431E5 below, CRA indicated that if Canco seconds employees to its non-resident subsidiary (FA) for use in FA's services business with arm's length customers there, CRA will not impute foreign accrual property income to Canco under s. 95(2)(b)(ii) if the employees are provided to FA at cost rather than at, say, a 25% mark-up.

In response to this follow-up question, CRA confirmed that "if the Canadian parent earns a profit, then it would be considered to provide the services of its seconded employees in the course of its own business," and clarified that a mark-up over direct salaries will not result in FAPI if there is no profit element, i.e., the mark-up covers other costs such as employment benefits – and that whether more than that level of markup would result in an offsetting deduction in computing the FAPI of FA "depends on the proper determination of the related profit to be attributed to the activities of the relevant personnel."

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(2) - Paragraph 95(2)(b) seconding of employees to CFA 339

13 January 2014 External T.I. 2013-0474431E5 - Application of 95(2)(b)(ii)

seconding of employees to CFA

underline;">: Facts. Foreign Affiliate, a wholly-owned subsidiary of Canco, which provides services to arm's length customers solely in the foreign country, provides 5% of such services through employees of Canco who have been seconded to it (and relocated to that foreign country). Canco pays their salaries and charges Foreign Affiliate a fee equal to the cost of their remuneration plus a 25% mark-up. Q. 1: What portion of the service business income of Foreign Affiliate will be recharacterized as FAPI? Q. 2: What if Canco does not charge a mark-up?

Q. 1 Response [FAPI if mark-up]

[W]here a mark-up or profit element is charged by the taxpayer (Canco), that factor is indicative of the fact that Canco is providing services in the course of its business to and on behalf of Foreign Affiliate. … [I]t may be arguable that if all the employees have comparable skills, then since 5% of the services provided by Foreign Affiliate during a particular period of time are performed by the seconded employees of Canco, only 5% of the income earned by Foreign Affiliate in respect of the services provided during that period of time will be recharacterized as FAPI pursuant to subparagraph 95(2)(b)(ii)…

Q. 2 Response [no FAPI if no actual or imputed mark-up]

If…Canco is simply reimbursed for the cost of remuneration paid to the…seconded [employees]…, provided the reimbursement represents arm's length compensation to Canco, … a seconded employee would be seen as providing services on behalf of Foreign Affiliate only…[so that]… the activities of the employees would not be seen as comprising part of the business activities of Canco. Accordingly…subparagraph 95(2)(b)(ii) will not apply to recharacterize the income of Foreign Affiliate. …However, in a case where subsection 247(2)… would apply to impute a profit element in respect of a fee for the services provided by employees of a taxpayer seconded to a foreign affiliate of the taxpayer that is in the business of providing services, it would in our view follow that the taxpayer provided services through such employees and [s.] 95(2)(b)(ii) applies.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(2) - Paragraph 95(2)(b) "full" reimbursement for seconded employee costs does not engage s. 95(2)(b)(ii) 162

2002 Tax Executives Institute Roundtable Q. 14, 2002-017395 -

applies to conduit FA subadvisor

S.95(2)(b) would apply where a Canadian subsidiary of a Canadian financial institution, which provides management services to pension funds but is not licensed to carry on an investment management business outside Canada, appoints a controlled foreign affiliate of its parent as a sub-adviser for non-Canadian securities under a bona fide subcontract, comparable to that which the foreign affiliate would enter into in providing services to arm's-length parties.

7 November T.I. 95-6331 [effect of Canadian manager on FA's billing rate]

effect of Canadian manager on FA's billing rate

A Co. ( a CCPC) employs approximately 6 to 8 full-time engineers including Mr. A (its 75% shareholder) in its business of providing engineering services in Canada. B Co., a wholly owned U.S. subsidiary, directly employs approximately 8 to 10 full-time engineers but also utilizes the services of A Co.'s staff, including Mr. A. in providing engineering services in the U.S. B Co. reimburses A Co. for the portion of A Co.'s salary expense that relates to work done by A Co.'s employees for B Co. Mr. A performs services directly for B Co.'s customers for which the customer pays B Co. an hourly fee. In addition, he performs supervisory and managerial service for B Co. for which B Co. does not directly charge its clients. CRA stated:

[S]ubparagraph 95(2)(b)(ii) clearly applies…[but] the more difficult task is the determination of the amount of B Co.'s income that is affected by such application. …[R]elevant factors to consider would include...whether Mr. A's presence, or management or supervisory services, impact on the hourly fee that can be charged B Co.'s customers.

For example if B Co.'s hourly charge to its customers is well in excess of the approximate hourly rate paid to its engineers, it is likely that a portion of the income on such jobs is attributable to services provided by Mr. A... .

Articles

Paul Dhesi, Korinna Fehrmann, "Integration Across Borders", Canadian Tax Journal, (2015) 63:4, 1049-72

Likely disadvantage of generating services income as FAPI (pp. 1055-6)

[C]onsider a Canadian company ("Canco") that sells its product directly to consumers all around the world. Canco establishes a foreign wholly owned subsidiary ("Forco") in a local jurisdiction to provide brand support and technical services in respect of Canco's product sales to that country. Forco earns an arm's-length service fee from Canco for providing these services…. .

Had the income front services rendered been earned by a Canadian corporation, the entity's business income would have been subject to the general corporate tax rate (for example, 26 percent in British Columbia for 2015, ignoring the small business deduction). Instead, the FAPI earned by Forco potentially results in an income inclusion to Canco that is characterized as All [aggregate investment income]and taxed at higher rates…

Sandra Jack, "FAPI: The Goods on Goods", Canadian Tax Highlights, Vol. 9, No. 12, 27 December 2001.

Subparagraph 95(2)(b)(i)

Clause 95(2)(b)(i)

Subclause 95(2)(b)(i)(B)

Finance

23 December 2016 Comfort Letter re s. 95(2)(b) base erosion rule

[Proposed extension of s. 95(2)(a)(ii)(D) safe harbor to inter-FA fees that are deemed FAPI under s. 95(2)(b)(i)(B)(I) ]

Holdco, Opco and Manager are all foreign affiliates of a Canadian corporation. Holdco was formed to acquire shares of Opco, carrying on an active business, and Manager provides asset management and investment advisory services respecting Opco for a fee – which is paid by Holdco, rather than Opco, because Holdco is not the sole shareholder of Opco. Since Holdco does not carry on an active business (its sole activity being the holding of shares of Opco), the services fees paid by Holdco to Manager are deductible in computing Holdco's foreign accrual property income (“FAPI”), resulting in a foreign accrual property loss. Accordingly, s. 95(2)(b)(i)(B)(I) includes the services income in Manager's FAPI. This result is inappropriate, as neither Opco nor Holdco earns FAPI, and the recipient of Manager’s services (Opco) carries on an active business.

The Tax Policy Branch will recommend to the Minister that, effective for taxation years of foreign affiliates ending after 2016, s. 95(2)(b)(i)(B)(I) not apply respecting income of a foreign affiliate (''FA1") of a taxpayer from the provision of services, to the extent that conditions generally analogous to those in s. 95(2)(a)(ii)(D) are satisfied, including:

  • The income derives from amounts paid or payable by another foreign affiliate (''FA2") of the taxpayer in consideration for the services;
  • The amounts paid or payable are for expenditures incurred by FA2 for the purpose of gaining or producing income from property;
  • The property is shares of another foreign affiliate ("FA3") that are "excluded property" of FA2 (as defined in subsection 95(1)); and
  • The Canadian taxpayer has a "qualifying interest" (as defined in paragraph 95(2)(m) of the Act) in FA1, FA2 and FA3.

Also to the extent that s. 95(2)(b)(i)(B)(I) does not apply respecting FA1's income from services because of the above, any FAPL of FA2 resulting from its corresponding expenditures therefor will be eliminated.

Paragraph 95(2)(c)

Administrative Policy

2016 Ruling 2015-0571441R3 - Dutch Cooperative - 93.2 & 95(2)(c)

rollover is available on the drop-down of shares into a Dutch cooperative in consideration for a credit to the membership account

Current structure

Forco 1 is held through three stacked Canadian partnerships by two taxable Canadian corporations (Canco 1D and Canco 1A) which, in turn, are indirect wholly-owned subsidiaries of a non-resident parent (“Parent”). Forco 1, which is an unlimited liability company resident in Foreign Country 3, wholly owns Forco 2, which is resident in Country 3 and wholly-owns Forco 3, which is a limited liability company resident in Foreign Country 2. Parent wholly owns Forco 4, which is a limited liability company resident in Country 2. Forco 5 is a private limited liability company resident in the Netherlands and is directly owned by Forco 2, Forco 3 and Forco 4.

Proposed transactions
  1. Forco 2, Forco 3 and Forco 4 will create DC, a Dutch cooperative under the Dutch Civil Code, without making a capital contribution. Upon the registration of the notarial deed with the commercial register, DC will be regarded as a legal entity that exists separately from its members under the Dutch Civil Code and the Netherlands domestic income tax law.
  2. The Articles will provide that each member must make capital contributions to DC as unanimously agreed upon by all members, the number of votes that a member may cast at a general meeting of members will generally be proportionate to its percentage of ownership in DC, a distribution of retained profits will only be made with the unanimous agreement of all members and such distributions will be proportional to the respective ownership percentages, and the members will not be liable for any debts or losses incurred by DC that are in excess of their required contributions to the capitalization of DC.
  3. Each of Forco 2, 3 and 4 will transfer all of its Forco 5 Shares to DC solely in consideration for a credit to its membership account in DC in the amount of the fair market value of the transferred shares.
  4. Each of Forco 3, 2 and 4 will be liquidated and dissolved in succession.
Additional Information

The Dutch Civil Code provides that “a Dutch cooperative may, by its articles of association, exclude or limit to a maximum, any liability of its members or former members to contribute to a deficit.” “DC will generally not be required to withhold any tax in Foreign Country 1 on any dividends paid to Forco 1.”

Rulings
  • DC will be treated as a corporation for the purposes of the Act, and as a non-resident corporation without share capital for purposes of s. 93.2.
  • Membership interests in DC will be deemed to be shares of a single class by s. 93.2(2).
  • Provided the transfers of Forco 5 Shares to DC described in 3 increase the fair market value of the deemed class of Shares of the capital stock of DC and no election is made under s. 93.2(3)(b), s. 95(2)(c) will apply.
  • S. 95(6)(b) will not apply to the transfers by Forco 2 and Forco 3, in 3.
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Corporation Dutch cooperative whose articles limited member liability was a corp 252
Tax Topics - Income Tax Act - Section 93.2 - Subsection 93.2(2) membership interest in Dutch cooperative ruled to be shares 90
Tax Topics - Income Tax Act - Section 95 - Subsection 95(1) - Controlled Foreign Affiliate non-resident subsidiaries CFAs of bottom-tier Cdn partnership and FAs of Canadian corporate partners 126

26 May 2016 IFA Roundtable Q. 10, 2016-0642101C6 - 93.2 & 95(2)(c)

dropdown of shares made to an LLC as a contribution of capital deemed by s. 93.2(3) to be for "share” consideration

FA1 transfers all of its shares of FA2 to another non-resident subsidiary of FA1, viz., a non-share corporation (“FA3”), as a capital contribution, i.e. no new member interests are issued by FA3. S. 93.2(3)(a) deems FA3 to have issued shares to FA1 in respect of the transfer if the fair market value of a class of its shares (i.e., the FMV of its membership interest) is increased as a result of the transfer.

CRA noted that, as a technical matter, s. 93.2(3)(a) does not appear to go quite far enough so as to permit the particulars of the rollover formula in s. 95(2)(c) to be filled in. However, CRA went on to find that despite these “textual challenges,” the s. 95(2)(c) rollover would be available provided that the fair market value of the membership interest in FA3 increased by the FMV of the contributed shares.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 93.2 - Subsection 93.2(3) s. 95(2)(c) rollover can apply on a dropdown of shares made to an LLC as a contribution of capital rather than for “share” consideration 252

Articles

Schwartz, "Tax-Free Reorganizations of Foreign Affiliates", 1984 Canadian Tax Journal, November-December 1984, p. 1039.

Paragraph 95(2)(d.1)

Articles

Geoffrey S. Turner, "June 2014 Election Deadlines for Retroactive Application of New Foreign Affiliate Reorganization Rules", CCH International Tax, No. 74, February 2014, p. 1.

2011 broadening (p. 4)

The new foreign affiliate merger rollover in paragraph 95(2)(d.1) has been amended, among other things, to eliminate the "90% surplus entitlement percentage" and "foreign non-recognition" conditions, and to broaden the deemed rollover disposition so that it applies to all property of the predecessor foreign affiliates, not just capital property.

Retroactive election (p. 4)

Bill C-48 permits a taxpayer to elect to retroactively apply new paragraph 95(2)(d.1) to all of its foreign affiliate mergers occurring after December 20, 2002. Consequently, taxpayers now have the one-time opportunity to elect to generally apply the broader rollover rule in paragraph 95(2)(d.1) retroactively to all post-December 20, 2002 foreign affiliate mergers….

Patrick Marley, "Foreign Affiliate Mergers and Liquidations - Navigating Proposed Changes", Canadian Current Tax, Vol. 16, No. 12, September 2006, p. 125.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 88 - Subsection 88(3) 0

Paragraph 95(2)(e)

Administrative Policy

24 March 2004 External T.I. 2003-0034311E5 -

process of distributing the assets and satisfying the liabilities is "liquidation"

The Agency was advised that under the corporate law of the Czech Republic, there was a distinction between a wind-up with liquidation of a subsidiary (under which an appointed liquidator sold all property of the company and settled all obligations) and a wind-up of a subsidiary into its sole member/shareholder without liquidation where the business assets were transferred to the sole member. In discussing whether either procedure would qualify as "a liquidation and a dissolution" for purposes of s. 95(2)(e.1), the Agency indicated that the question to be answered was whether these procedures corresponded to the nature of a liquidation and a dissolution under Canadian corporate law and stated:

[L]iquidation refers to the act of satisfying the creditors and distributing the remaining assets to its shareholders.

Under our law, a corporation generally has to settle its debts and allocate the property to its shareholders in order to be dissolved. Even if that stage is not referred to as a liquidation under a particular enactment, where the property of the corporation is being distributed to the shareholder and the liabilities of the corporation are discharged, it will likely be qualified as a liquidation for the purposes of the Act. [citing Dauphin Plains]

...[W]hat you refer to as a "winding-up without liquidation" may be similar to what we consider a voluntary liquidation and dissolution under section 211 of the CBCA and provided that you have described Czech law accurately, it could be qualified as "a liquidation and a dissolution" for purposes of paragraph 95(2)(e.1) of the Act.

Words and Phrases
liquidation
Locations of other summaries Wordcount
Tax Topics - Statutory Interpretation - Provincial Law 68

Articles

Geoffrey S. Turner, "June 2014 Election Deadlines for Retroactive Application of New Foreign Affiliate Reorganization Rules", CCH International Tax, No. 74, February 2014, p. 1.

2011 introduction of DLAD (p. 4)

New paragraph 95(2)(e) replaces the "90% surplus entitlement percentage" and "foreign non-recognition" conditions with a "designated liquidation and dissolution" (DLAD) requirement based on a broader range of 90% ownership tests (and without any foreign non-recognition requirement), and expands the scope of the rollover to all distributed property (not just capital property). A DLAD is defined in subsection 95(1) by reference to a foreign affiliate liquidation that meets one of three alternative "90% ownership" tests. The DLAD requirement is satisfied if either (i) the Canadian taxpayer had a 90% surplus entitlement percentage in respect of the liquidating foreign affiliate, (ii) one foreign affiliate shareholder holds shares of the liquidating foreign affiliate representing at least 90% of "votes and value", or (iii) one foreign affiliate shareholder owns at least 90% of each class of shares of the liquidating foreign affiliate.

Retroactive election (p. 5)

Taxpayers may elect to retroactively apply new paragraph 95(2)(e) to foreign affiliate liquidations beginning after December 20, 2002, with the same deadline as applies for paragraph 95(2)(d.1). [fn 8: See subsection 71(28) of Bill C-48. This election must be made in writing by the later of (i) the date that is one year after Bill C-48 received Royal Assent (June 26, 2014), and (ii) the taxpayer's tax return filing due date for its taxation year that includes the date on which Bill C-48 received Royal Assent.] However, where this election is made, a modified version of the DLAD definition, and of paragraph 95(2)(e) itself, applies for liquidations beginning after December 20, 2002 but before August 19, 2011. [fn 9: In particular, the "90% of votes and value" branch of the DLAD test is simplified to a "90% of value" test; and the modified version of paragraph 95(2)(e) provides, for a DLAD, that the shares of the liquidating foreign affiliate are in all cases deemed disposed of on a full rollover basis for proceeds of disposition equal to the shareholder foreign affiliate's adjusted cost base of those shares.] The main difference is there is no forced loss realization (and surplus grind) for excluded property shares of the liquidating foreign affiliate.

Philippe Montillaud, Grant J. Russell, "Foreign Accrual Tax and Flow-through Entities", International Tax Planning, Volume XVIII, No. 4, 2013, p. 1280

Application of s. 93(2.01) stop-loss rule to DLAD capital loss (p. 1282)

Regulation 5907(5) requires that capital gains and losses for surplus purposes are to be calculated in accordance with the rules in subsection 95(2) of the Act, which rules obviously include paragraph 95(2)(e). The reference to subsection 93(4) in the Regulation's definition of "hybrid surplus," however, makes clear that recourse should also be had to other relevant rules in the Act, including the stop loss rule in subsection 93(2). Subsection 93(2), in combination with newly introduced subsection 93(2.01), provides that any loss realized by a Canadian resident corporation or a foreign affiliate of the corporation on the disposition of a share of a foreign affiliate must be reduced by the total of any "exempt dividends" received or deemed to have been received on the share by the corporation or affiliate prior to the disposition. Accordingly, where a shareholder affiliate's capital loss on a DLAD is otherwise recognized for the purpose of calculating an affiliate's hybrid surplus, the loss is nevertheless reduced under subsections 93(2) and (2.01) by the amount of any exempt dividends previously paid on the shares of the disposing affiliate. An "exempt dividend" is defined in subsection 93(3) and generally refers to a dividend that is deductible from a Canadian-resident corporation's income under section 113 of the Act.

Example showing reduction of DLAD capital loss by exempt dividend (p. 1282)

Consider the following example:

  • FA1 owns all the shares of FA2, which shares have an adjusted cost base of $100.
  • FA2 has only one asset ("Asset"), which Asset has an adjusted cost base and fair market value of $100; the Asset is not an "excluded property" within the meaning assigned under subsection 95(1).
  • FA2 has $100 of exempt surplus.
  • FA2 distributes the Asset by way of an exempt dividend to FA1.
  • FA2 is then liquidated on a DLAD.

Save for subclause 95(2)(e)(iv)(A)(II)1, FA1 would realize a capital loss on the disposition of FA2's shares equal to their cost basis of $100. This loss is recognized for hybrid surplus purposes, but is nevertheless deemed nil because of the $100 exempt dividend paid prior to the DLAD. Accordingly, no amount in respect of the loss is included in FA1's hybrid surplus calculation.

Paul L. Barnicke, Melanie Huynh, "FA Proposals prompt History Revisit", Canadian Tax Highlights, October 2011.

Schwartz, "Tax-Free Reorganizations of Foreign Affiliates", 1984 Canadian Tax Journal, November-December 1984, p. 1039.

Paragraph 95(2)(e.1)

Administrative Policy

24 November 1999 T.I. 991296

Where the disposing affiliate is resident in a different country than the liquidating affiliate, the exception only applies where gain or loss is recognized by the disposing affiliate. It does not matter whether gain or loss is recognized by the liquidating affiliate.

15 December 1997 T.I. 970771

S.95(2)(e.1) would apply to the dissolution of a U.S. foreign affiliate into another wholly-owned U.S. foreign affiliate if the transaction resulted in no recognition of gain or loss for U.S. federal tax purposes, but it was considered a taxable transaction for U.S. state tax purposes.

Paragraph 95(2)(f)

Administrative Policy

21 November 2017 CTF Annual Conference CRA Roundtable, Q.15

an LLC resulting from a conversion from a US LLC has high inside and outside basis

Where a U.S. limited partnership (USLP) is converted into a U.S. limited liability company (LLC), CRA has commented that the USLP is considered to have disposed of its assets at fair market value (FMV) and the holder of a partnership interest is also considered to have disposed of its interest at FMV. What is the adjusted cost base (ACB) of the membership interests in the converted entity (i.e. the LLC) to the members, as well as the LLC’s ACB in its assets immediately after the conversion? CRA responded:

[W]e are of the general view that a disposition of the partnership interests in the USLP and an acquisition of the membership interests in the LLC, as well as a disposition of the assets of the USLP and an acquisition of such assets by the LLC, would occur at FMV. Thus, the total ACB immediately after the conversion of all the membership interests in the LLC to the members would generally correspond to the total FMV at the time of the conversion of all the interests in the USLP. Furthermore, the LLC’s ACB in its assets immediately after the conversion would generally correspond to the FMV of these assets at the time of the conversion.

The above comments should be considered whenever there is a conversion … to U.S. limited liability partnerships or U.S. limited liability limited partnerships… .

… The CRA remains open to … an advance income tax ruling request… .

26 April 2017 IFA Roundtable Q. 2, 2017-0691191C6 - Subsection 247(2) and FAPI

s. 247(2) applies for FAPI purposes

CRA considers that the s. 247(2) rules apply to transfer pricing between a controlled foreign affiliate and non-resident non-arm’s length persons where such transactions affect the computation of the CFA’s foreign accrual property income. However, CRA generally will not apply s. 247 to such a transaction where

  • the pricing is reviewed by the tax authority of the country in which the foreign affiliate is resident;
  • the pricing is determined to be in accordance with the transfer pricing legislation or guidelines of that country; and
  • that legislation (and guidelines) adopt the arm’s-length principle.
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 247 - New - Subsection 247(2) s. 247(2) not applied to a CFA earning FAPI if the transaction has been vetted under foreign OECD-based transfer pricing rules 100

3 December 2003 External T.I. 2003-005120 -

An operating grandchild subsidiary of Canco in the United States ("FA2") pays off a third-party U.S.-dollar borrowing the initial proceeds of which had been lent by it to Canco in U.S. dollars. On the repayment of the third-party debt, the gain to FA2 under s. 39(2) is recognized under s. 95(2)(f)(i). S.95(2)(i) is inapplicable as the borrowed money did not relate to the acquisition of excluded property.

16 August 2000 TI 1999 - 000961

Where a US foreign affiliate lends Deutschemarks to a German foreign affiliate, the appropriate currency to use for the purposes of determining the first foreign affiliate's foreign exchange gain on settlement of the loan will be US dollars, and s. 95(2)(g) will not deem that gain to be nil because the gain did not arise by virtue of a fluctuation of the Canadian dollar relative to another currency.

The Department also stated:

"Where a particular currency has become a generally accepted currency for conducting business in a country, such currency may be considered 'reasonable in the circumstances', notwithstanding that some other currency is the official currency of that county. As well, the currency that is used for income tax purposes in the foreign jurisdiction would normally be considered 'reasonable' in the circumstances. We do not envisage a situation where Canadian currency would be reasonable in the circumstances, as you have suggested."

92 C.M.TC - Q.7

Where a particular currency has become generally accepted for conducting business in a country, its use will be considered reasonable in the circumstances.

88 C.R. - Q.13

If at the time Canco acquired FA1 for $100 which in turn owned FA2, the shares of FA2 had a fair market value of $100 and a basis of $1, and the shares of FA2 decline in value to $1 and the decline subsequently is reversed, then if the shares of FA2 are sold for $100, the portion of the gain that may reasonably be considered to have accrued during the period that FA1 was not a foreign affiliate of Canco would be the unrealized gain that existed at the time that FA1 became a foreign affiliate of Canco, i.e., $99.

Articles

Geoffrey S. Turner, "The Reconsidered 95(2)(f), (f.1) and (f.2) Foreign Affiliate Income Computation in Calculating Currency Proposals", International Tax, CCH, December 2007, No. 37, p. 11.

Paragraph 95(2)(f.1)

Articles

Geoffrey S. Turner, "The New 95(2)(f.1) Carve-out Rule – Election Deadline Approaching", International Tax, CCH, 7 January 2010, No. 1974, p. 1.

"In some respects, the new "designated acquired corporation" feature of the paragraph 95(2)(f.1) carve-out rule can be conceptualized as a tax cost bump applicable to property held by a foreign affiliate at the time control of its Canadian parent corporation is acquired. This is analogous to the tax cost bump provided under paragraph 88(1)(d) for non-depreciable capital property held directly by a Canadian target corporation at the time control is acquired....

However, the analogy to the paragraph 88(1)(d) tax cost bump is not complete. For instance, the paragraph 95(2)(f.1) carve-out rule is in fact a broader "fresh start" rule because it can also exclude accrued business income treated as FAPI (i.e., the item A FAPI components) and is not limited to accrued gains on non-depreciable capital properties. The paragraph 95(2)(f.1) carve-out also applies to exclude accrued losses. Another difference is that the paragraph 95(2)(f.1) carve-out rule operates by excluding the portion of capital gain/loss or business income/loss in a foreign affiliate that can reasonably be considered to have accrued, generally, before the acquisition of control. This does not result in a permanent, fixed reset of tax cost at a designated amount as in paragraph 88(1)(d)."

Shawn D. Porter, Sandra J. Slaats, "The CARP Rule and Proposed Paragraph 95(2)(f.1)", International Tax Planning, 2009, p. 1024.

Geoffrey S. Turner, "The Reconsidered 95(2)(f), (f.1) and (f.2) Foreign Affiliate Income Computation in Calculating Currency Proposals", International Tax, CCH, December 2007, No. 37, p. 11.

Paragraph 95(2)(f.14)

Administrative Policy

9 July 2015 External T.I. 2013-0475421E5 - Section 94.2

no stated accommodation for using proxy method where data unavailable

An exempt foreign trust (the "Trust") is deemed by s. 94.2(2) to be a non-resident corporation controlled by (and therefore a CFA of) a beneficiary resident in Canada, which is a financial institution under s. 142.2(1). After finding that the Trust, as a financial institution, would be subject to the specified debt obligation and mark-to-market rules in ss. 142.2 to 142.6 in calculating its foreign accrual property income ("FAPI"), CRA was asked: In computing FAPI, could the beneficiary calculate the Trust's foreign currency gains or losses by comparing the Trust's net asset value at the beginning of the year to its net asset value at the end of the year in Canadian dollars, based on the exchange rates at those relevant times? CRA responded:

Although section 94.2 is a relatively new provision…, the question of how to compute FAPI in circumstances where complete and full information may not be accessible is not novel, as it has historically been relevant in connection with CFA status under former subparagraph 94(1)(d) (the predecessor of current section 94.2) and paragraph (b) of the definition of "controlled foreign affiliate" in subsection 95(1). As such, we will not comment on the specific proxy proposed to be used in the particular circumstances.

… [A] failure to report income as required, and false statements or omissions, in respect of prescribed reporting requirements may result in substantial penalties under section 162 or 163. However, section 233.5 may provide some relief concerning the prescribed reporting requirements where a Canadian taxpayer may not have all the information required to fulfil the reporting requirements of subsection 233.4(4)… . Additional relief in connection with reporting requirements may be available on a case-by-case basis under subsection 220(2.1).

See summary under s. 142.2(1) – financial institution.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 220 - Subsection 220(2.1) potential relief from penalties where insufficient data for computing FAPI 183
Tax Topics - Income Tax Act - Section 233.5 potential relief from penalties where insufficient data for computing FAPI 183
Tax Topics - Income Tax Act - Section 94.2 deemed CFA unit trust sub of a FI subject to mark-to-market rules 170

Paragraph 95(2)(g)

Administrative Policy

16 August 2000 TI 1999 - 000961

Where a US foreign affiliate had lent money to a German foreign affiliate that was denominated in Canadian dollars, a foreign currency loss arising on settlement of the debt would be deemed by s. 95(2)(g) to be nil.

Articles

Nikolakakis, "Foreign Exchange Fluctuations: Comprehensive Rules are Needed", Corporate Finance, Vol. V, No. 1, 1997, p. 342

Discussion of how the foreign affiliate rules interfere with legitimate hedging transactions.

Paragraph 95(2)(g.1)

Administrative Policy

30 August 2004 External T.I. 2003-000135 -

The only significant asset of FA2 is a loan receivable of $100 owing by its parent, FA1, which is a wholly-owned foreign affiliate of Canco. The $100 note would be a commercial debt obligation for s. 80 purposes.

5 December 2003 External T.I. 2002-0165195

If a portion of the debt of a controlled foreign affiliate has been used to earn FAPI, and the remainder to earn active business income, the whole debt would be a "commercial debt obligation", not just the portion that related to the earning of FAPI. However, s. 95(2)(g.1) did not apply as all of the debt was used to earn dividends from subsidiaries and interst income that was deemed active business income under s. 95(2)(a)(ii).

Articles

Mark Coleman, Daniel A. Bellefontaine, "Forgiveness, Foreign Affiliates and FAPI: a Framework", Resource Sector Taxation (Federated Press), Vol. X, No. 1, 2015, p.694

Loans subject to s. 95(2)(a)(ii)(B) or (D) not commercial debt obligations (p. 695)

[I]f interest on a loan owing by a debtor affiliate to another affiliate is recharacterized under clause 95(2)(a)(ii)(B), in most cases, the loan will not be a commercial debt obligation. That is because the interest will, in most cases, be deductible in computing the debtor affiliate's active business income, and thus will not be deductible in computing its FAPI.

[E]lements A and D of the definition of FAPI (discussed in more detail below) each deem interest payments that are subject to clause 95(2)(a)(ii)(D) to be nil for purposes of computing an affiliate's income or loss from property, from a business other than an active business or from a non-qualifying business. The result of that restriction appears to be that a loan, the I interest on which is recharacterized under clause 95(2)(a)(ii)(D) cannot be a commercial debt obligation for FAPI purposes.

Exception where gap in application of s. 95(2)(a) (pp. 695-6)

While a debt to which clause 95(2)(a)(ii)(B) or (D) applies should, in most cases, not be considered a commercial debt obligation, that may not be the case where those rules cease to apply for a period of time….

[T]he definition of commercial debt obligation as it is modified by subparagraph 95(2)(g. l)(i) refers to a debt where an amount in respect of interest was or would have been deductible in computing the debtor's FAPI. The phrase "an amount in respect of interest" appears to be broad enough to apply to a circumstance where any interest in respect of a particular debt is, or would be, deductible in computing. FAPI.

Gordon Funt, Joel A. Nitikman, "FAPI and Debt Forgiveness - Now You See It, Now You Don't", CCH Tax Topics, No. 1724, 24 March 2005.

Melanie Huynh, Eric Lockwood, "Foreign Accrual Property Income: A Practical Perspective", International Tax Planning, 2000 Canadian Tax Journal, Vol. 48, No. 3, p. 752.

Paragraph 95(2)(i)

Administrative Policy

28 May 2015 IFA Roundtable Q. 9, 2015-0581581C6 - IFA 2015 Q.9: 95(2)(i): "proceeds"

excluded property also treated as acquired with "proceeds" of assumed debt or purchase note

A controlled foreign affiliate acquires a building, for continuous use in its active business, from a third party by issuing a note (or assuming debt). Would s. 95(2)(i) apply to the subsequent settlement of the indebtedness? CRA responded:

[P]aragraph 95(2)(i) would apply if the CFA had acquired the building from a third party by issuing a note.

…[T]he phrase "a debt of the debtor all or substantially all of the proceeds from which were used to acquire property" in paragraph 95(2)(i) can be interpreted…so as to include an amount payable for property acquired to the extent that all or substantially all of the amount payable was incurred to acquire excluded property.

…[G]enerally, examples where paragraph 95(2)(i) may apply would include an amount outstanding on account of the purchase price, a note issued, or a debt assumed for the acquisition of excluded property by a foreign affiliate.

27 April 2015 Internal T.I. 2014-0546641I7 - Foreign exchange on a debt arising on reduction of capital

no "proceeds" where liability to distribute share capital/s. 95(2)(a)(ii) loans are not assets used to "carry on" active business

A U.S.-dollar denominated debt (the "Liability") owing by a Hungarian corporation ("FA") to its Canadian parent (the "Taxpayer") arose as a result of a reduction in the capital ("the Capital Decrease") of the shares of FA occurring under Hungarian corporate law. The Liability thereafter was settled by several cash payments, so that the Taxpayer sustained a capital loss. The Taxpayer's position was that the indirect use test and "filling the hole" principle should apply in the context of s. 95(2)(i), i.e., the Liability replaced the capital originally invested by Canco in the FA which had been used by the FA to make U.S. dollar denominated loans (the "US Loans" – representing substantially all FA's assets) to other foreign affiliates, the interest income on which was re-characterized as active business income pursuant to s. 95(2)(a) – so that s. 95(2)(i)(i)(B) applied to avoid gain to FA on the settlement of the Liability.

In finding that s. 95(2)(i) did not apply to the settlement of the Liability, the Directorate stated:

[T]he requirement in the preamble of 95(2)(i)(i) that there be "proceeds" from the Liability is not satisfied because the FA did not receive anything (money or other property) on the Capital Decrease which gave rise to the Liability. In addition, the requirement in clause 95(2)(i)(i)(A) is not satisfied because there was no property acquired by the FA as a consequence of the Capital Decrease. Finally, the condition in clause 95(2)(i)(i)(B) that the proceeds of the debt be used to earn income from an active business "carried on by the debtor" is not satisfied. While the interest income earned by the FA is income that is deemed to be income from an active business of the FA by the provisions of paragraph 95(2)(a), those provisions do not deem the FA to carry on an active business.

22 May 2014 May IFA Roundtable, 2014-0526771C6 - Application of paragraph 95(2)(i)

delay before application of borrowed funds or disposition of non-qualifying assets

underline;">: Q.4(a). Would earning interest on borrowed money for a short period after the borrowing and before it can be employed to acquire excluded property cause s. 95(2)(i) to be inapplicable. After affirming 95-5293 (below), CRA stated:

[A] brief period… after the receipt of borrowed funds… and [before] their deployment for a qualifying purpose or after the receipt of proceeds on disposition of excluded property and the use of those proceeds for the repayment of a related debt would not automatically prevent paragraph 95(2)(i) from applying… . However…the taxpayer should be prepared to establish that the brief delay could not practically have been avoided and was not attributable to financial considerations like a desire to earn a return from a non-qualifying investment, to avoid temporary cash flow issues or because of exchange rate considerations.

Q.4(b)

Would s. 95(2)(i) inapplicable if the borrowed money is used to acquire property such as shares that does not qualify as excluded property for a very short period of time, but the taxpayer takes immediate steps to ensure that the shares qualify, for example, by disposing of non-qualifying assets? CRA stated:

[S]teps can be undertaken to restructure or dispose of non-qualifying assets as part of the pre-acquisition structuring or immediately after the acquisition [from the third party]. If the taxpayer takes steps to ensure that the shares qualify as excluded property immediately after the acquisition, for example by disposing of non-qualifying assets, and such shares qualify as excluded property within the same day they are acquired and the related debt has been incurred, we would consider paragraph 95(2)(i) to apply.

2012 Ruling 2010-0386201R3 - Tower structure capitalized by interest-free loans

non-interest-bearing loans is made for income producing purposes: generating dividends

Existing structure

Canco, which is a privately-owned taxable Canadian corporation, holds a US limited liability limited partnership ("LLLP") directly and through the wholly-owned GP (Cansub). LLLP borrowed U.S. dollars under interest-bearing "Term Advances" from arm's length "Senior Lenders," and on-lent those proceeds on a non-interest bearing basis to a wholly-owned special-purpose ULC under the LLLP-ULC Loans. ULC, in turn, on-lent those U.S. dollar proceeds on a non-interest-bearing basis to its special-purpose LLC subsidiary under the ULC-LLC Loans. LLC on-lent such proceeds on an interest-bearing basis under the LLC-FA Subco Loans to a grandchild U.S. subsidiary of Canco (FA Subco). FA Subco used those proceeds to on-lend them on an interest-bearing basis to its U.S. operating subsidiary (FA Opco) under the FA Subco - FA Opco Loans or to subscribe for common shares of FA Opco. FA Opco used such share subscription proceeds or borrowed money in its U.S. operating business, as described in the unredacted ruling.

Proposed transactions

LLC will pay a U.S. dollar dividend to ULC who, in turn will pay a U.S. dollar dividend to LLLP. The ULC-LLC Loans, the LLC-FA Subco Loans, the LLLP-ULC Loan and the Term Advances (owing by LLLP) will be settled in accordance with their terms – with the accrued interest owing by FA Opco, FA Subco and LLLP being paid.

Rulings

A. The income of FA Opco from carrying on its business operations…will be regarded as "income from an active business" carried on by FA Opco in the [U.S.], within the meaning of that definition in subsection 95(1) and for the purposes of Part LIX…..

B. Income derived by FA Subco from the interest payments [on the FA Subco FA Opco Loans] will be included in computing the income from an active business of FA Subco, for its taxation year in which the payment will be received, in accordance with subclause 95(2)(a)(ii)(B)(I) and in computing the "earnings" from an active business of FA Subco and its "exempt earnings" in accordance with the definitions in Part LIX of the Regulations.

C. Income derived by LLC from the interest payments [on the LLC-FA Subco Loans] will be included in computing the income from an active business of LLC, for its taxation year in which the payment will be received, in accordance with the following provisions:

(1) subclause 95(2)(a)(ii)(B)(I) to the extent of the portion of the interest paid or payable by FA Subco in respect of the portion of the proceeds from LLC – FA Subco Loans that were used by FA Subco in the relevant period to earn income from the [FA Subco FA Opco Loans], and

(2) clause 95(2)(a)(ii)(D) to the extent of the portion of the interest paid or payable by FA Subco in respect of the portion of the proceeds from LLC – FA Subco Loans that were used by FA Subco in the relevant period to subscribed for additional common shares of FA Opco… provided that the FA Subco common shares continue to be Excluded Property and FA Subco and FA Opco continue to meet the conditions in that clause with respect to their residence and being subject to taxation in the Foreign Country, and such interest will be included in computing the "earnings" from an active business of LLC and its "exempt earnings" in accordance with the definitions in Part LIX….

D. Provided that the [LLC-FA Subco Loans] continue to constitute Excluded Property to LLC, paragraph 95(2)(i) will apply to deem any gain or loss realized by LLC on the settlement of [such loans] to be a gain or loss from the disposition of Excluded Property.

E. Provided that the [FA Subco FA Opco Loans], and the shares of FA Opco, continue to constitute Excluded Property to FA Subco, paragraph 95(2)(i) will apply to deem any gain or loss realized by FA Subco on the settlement of the [LLC-FA Subco Loans] to be a gain or loss from the disposition of Excluded Property.

F. The following gain or loss will be accounted for under subsection 39(1) or (2), as the case may be:

(1) provided that ULC continues to hold the [ULC-LLC Loans] as capital property, any gain or loss realized by ULC on the settlement of those loans….;

(2) any loss or gain realized by ULC on the settlement of the [LLLP-ULC Loans];

(3) provided that LLLP continues to hold the [LLLP-ULC Loans] as capital property, any gain or loss realized by LLLP on the settlement of those loans…;

(4) any loss or gain realized by LLLP on the settlement of the [Term Advances].

G. Subparagraph 40(2)(g)(ii) will not apply to deny any loss that may be realized by LLLP on the settlement of the [LLLP-ULC Loans], nor to deny any loss that may be realized by ULC on the settlement of the [ULC - LLC Loans].

Further rulings re s. 17 not applying based on s. 17(3) or 17(8)(a)(i), s. 113(1)(a) deduction to ULC, s. 20(1)(c) deduction to LLLP, and re ss. 247(2) and 245(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 40 - Subsection 40(2) - Paragraph 40(2)(g) - Subparagraph 40(2)(g)(ii) unwinding of tower where LLC and ULC funded with non-interest bearing U.S. dollar loans - Byram applied 832

30 March 1988 T.I. 95-5293 [proceeds of sale must be applied with due dispatch]

proceeds of sale must be applied with due dispatch

After a foreign affiliate incurred a liability and used the proceeds to acquire an excluded property, it disposed of the property and deposited the proceeds into a bank account - before it made arrangements to repay its liability and realized an exchange gain. CRA stated:

Provided there is clear evidence, at the time of the disposition of the excluded property, that arrangements are being made for the repayment (with due dispatch) of the "related debt"...the fact that the actual repayment of the debt occurs after the disposition of the excluded property would not, in and by itself, result in the debt not being considered "... related at all times ... ". However if it was determined that other factors (such as cash flow problems, or unfavourable prevailing interest or exchange rates) contributed to the delay in repayment, it is likely that the provisions of paragraph 95(2)(i) would not apply on the repayment of the debt.

Paragraph 95(2)(k)

Administrative Policy

5 November 2015 Internal T.I. 2015-0585381I7 - Paragraph 95(2)(k) - Fresh Start Rules

fresh start rule can apply to a newly-acquired foreign affiliate notwithstanding Standard Life

2014-0536581I7 found that the fresh start rule can apply to bump the tax basis of the assets of a foreign corporation which is acquired by Canco and thereby becomes a foreign affiliate of Canco which is carrying on an investment business, even though s. 95(2)(k)(ii)(A) references a requirement that the “foreign affiliate” have also carried on that business in the preceding taxation year. CRA considered that this was merely a convenient way of referring to the corporation which had now become a foreign affiliate of Canco rather than implying that there was a requirement that it also have been a foreign affiliate of Canco in the preceding year. Standard Life took essentially the opposite approach to the interpretation of a similar requirement under s. 138(11.3) – so that it was necessary for the taxpayer to qualify as an "insurer" in the preceding taxation year rather than only in the current year, in order for an asset bump to be available.

When this point was raised with the Rulings Directorate, it stated:

[I]n accordance with the textual, contextual and purposive approach…we are of the view that there are substantial differences in interpreting the provisions of subsection 138(11.3) and paragraph 95(2)(k)… as applicable to the relevant facts in the Standard Life case and document 2014-053658. As a result, our conclusions previously reached in document 2014-053658 remain unchanged.

31 July 2014 Internal T.I. 2014-0536581I7 - Foreign affiliate fresh start rules

extends to arm's length acquisition/deemed ECE respecting licensed IP

Canco acquired the shares of FA1 (which carried on an active business and held FA2) from an arm's length vendor. FA2, in turn, held FA3 as well as carrying on a non-Canadian "investment business", as defined in s. 95(1), which entailed licensing intellectual property of FA2 solely to XX, its subsidiary (FA3) and an arm's length Canadian resident.

The license fees paid by FA3 to FA2 are deducted by it in computing the amount prescribed to be its earnings or loss for a taxation year from an active business (other than an active business carried on in Canada), so that Canco excluded those fees in computing the foreign accrual property income (FAPI) of FA2.

In computing the FAPI derived from the remainder of the licence fees received by FA2, Canco took a deduction under s. 20(1)(b) based on FA2 having made a deemed eligible capital expenditure ("ECE") under the fresh start rule in respect of the intellectual property at the beginning of the taxation year of FA2 in which it became a foreign affiliate of Canco. Was this correct?

After first giving an affirmative conclusion (that "as a result of the operation of subparagraph 95(2)(k.1)(iii) and paragraph 138(11.91)(e)… FA2 is deemed to have disposed of its intellectual property immediately before the beginning of its [acquisition] taxation year"), CRA noted that the requirement in s. 95(2)(k)(ii)(C) was satisfied as:

the business of FA2 is an investment business in FA2's [preceding] taxation year…and its activities included activities that are deemed by paragraph 95(2)(a.3) of the Act to be a separate business, other than an active business, carried on by FA2. However, in its immediately preceding taxation year, the definition of "investment business" in subsection 95(1)… did not apply to FA2 with reference to Canco because that definition only applies with reference to a "a foreign affiliate of a taxpayer". Similarly, paragraph 95(2)(a.3) had no application to FA2 with reference to Canco in that year.

Respecting the requirement in s. 95(2)(k)(ii)(A) that the "affiliate" or partnership have carried on the business, or the activities deemed to be a separate business, in the preceding year, should be considered to have been satisfied notwithstanding that FA2 was not an affiliate in the preceding year.

After noting that the wording of s. 138(11.91)(e) "does not mesh well with the definition of ECE" in s. 14(5) given that such definition requires an "outlay or expense made or incurred…as a result of a transaction,". CRA nonetheless concluded that the wording of s. 138(11.91)(e) of the Act was "sufficient to cause FA2 to be considered to have made an ECE at the relevant time."

The s. 20(1)(b) and other applicable deductions would be made first before determining the allocation of FA2's business income which was recharacterized under s. 95(2)(a)(ii) and that portion which remained as FAPI.

After noting that the cost of property used to earn income from property rather than from a business would "not be similarly bumped when a foreign corporation becomes an FA," CRA noted that "the threshold amount of activity that is required to cause any corporation (including a FA) to be considered to be carrying on business is extremely low," so that "it would be generally be difficult for the CRA to challenge the taxpayer's position" that it was carrying on a business.

Articles

Grant Russell, Philippe Montillaud, "'Fresh Start' Rules – on Becoming an Affiliate", , International Tax Planning (Federated Press), Vol. XX, No.2, 2015, p. 1392

Stub period income inclusion under s. 95(2)(k.1)(i) (pp. 1392-3)

[A] passive business [in this article] is an "investment business" and a "non-qualifying business," as defined in subsection 95(1), activities that are deemed by any of paragraphs 95(2)(a.l) to (b) to be a separate business other than an active business, and a business described in paragraph 95(2)(l)….[A]s per subparagraph 95(2)(k.l)(i), the affiliate is deemed to carry on the passive business in Canada at the beginning of the specified taxation year and throughout each subsequent year in which the affiliate carries on the business….

[T]hat the affiliate is deemed to carry on the business at the start of the specified taxation year instead of at the transition time, however, means that any income earned during the stub period between the year's commencement and the business' transition is deemed to be passive business income and is vulnerable to inclusion in the affiliate's FAPI….

Accrued gains not excluded (p. 1393)

[T]he affiliate's fresh start under this rule can be premature since the deemed disposition and reacquisition is deemed to take place immediately before the beginning of the specified taxation year and not at the business' transition time. As a result, any gain accrued during this interim period is not excluded from the affiliate's FAPI on a future disposition of the asset….

Carve-out rule can apply without contradicting fresh start rule (pp. 1394-5)

That the carve-out rule in paragraph 95(2)(f.1) can apply in conjunction with paragraph 95(2)(k.l), however, is not readily apparent from a casual read of the two provisions: one appears to require an income inclusion for the stub period while the other appears to mandate its exclusion. That said, subparagraph 95(2)(k.l)(i) provides that, for the purposes of computing the affiliate's gain or loss from its passive business, the affiliate is deemed to have carried on that business in Canada from the beginning of the specified taxation year. This is not the same as deeming the affiliate to have been an affiliate from the beginning of the year. Indeed, the FAPI and surplus accounts of an affiliate are generally computed under the Act for the affiliate's entire taxation year regardless of whether the corporation was factually an affiliate from the beginning of that year. Accordingly, paragraph 95(2)(f.l) can apply to exclude from income gains or losses that arose prior to the corporation becoming an affiliate without contradicting the rule in subparagraph 95(2)(k.l)(i)….

No cost reset under s. 95(2)(f.1)

[P]aragraph 95(2)(f.l) does not provide for a fixed reset of cost the way the deemed disposition and reacquisition under subparagraph 95(2)(k.l)(iii) does. Where the value of a property with a significant gain declines post-acquisition, for example, paragraph 95(2)(f.l) may permit any gain realized on a subsequent sale of the property to be eliminated, but no loss can be realized since the amount carved out is only that portion of the gain that accrued prior to the affiliate's acquisition….

Paul Barnicke, Melanie Huynh, "Fresh-Start FA Rules", Canadian Tax Highlights, Vol. 22, No., 12, December 2014, p. 7.

Application of fresh start rule on acquisition of FA carrying on an investment business where carve-out rule otherwise would have applied (p. 8)

[T]he reset in the fresh-start rules uses the FMV at the beginning of the year in which a non-resident becomes an FA, but the carve-out rule in paragraph 95(2)(f.l) is based in part on the FMV at the time when the non-resident is acquired. Assume that a non-resident acquired a property for $10 in year 1; the property had an FMV of $100 at the beginning of year 3; a taxpayer acquired the non-resident in year 3 when its property had an FMV of $50; and the FA sold the property for $400 in year 5. If the fresh-start rules do not apply, the gain in year 5 is initially calculated as $390 ($400 - $10) and is reduced by $40 ($50 - $10) to $350 under paragraph 95(2)(f.l). If the fresh-start rules apply, the gain is calculated as $300 ($400 - $ 100), and on the facts no further adjustment is made under paragraph 95(2)(f.l), because no part of the gain is considered to have accrued before the taxpayer acquired the non-resident. Depending on the property's excluded property status, the taxpayer in this example may wish to consider whether its FA carried on a business and thus whether its acquisition of the FA triggered the fresh-start rules.

Supplanting of carve-out rule? (pp. 8-9)

The scope of the fresh-start rules seems to have broadened significantly [by 2014-0536581I7, above] and may be taking over the role of the carve-out rule in paragraph 95(2)(f.l). Given the CRA's comment on the threshold level before an FA is considered to have a business, do the fresh-start rules now extend to an FA holdco and bump the basis in lower-tier Fas? Where does one draw the line?

Jerry Mahnger, Susan McKilligan, "The Foreign Affiliate Fresh Start Rules", 2009 Canadian Tax Journal, No. 2

Discussion of s. 95(2)(k) to 95(2)(k.6) including detailed examples.

Melanie Huynh, Eric Lockwood, "Foreign Accrual Property Income: A Practical Perspective", International Tax Planning, 2000 Canadian Tax Journal, Vol. 48, No. 3, p. 752.

Atlas, "Transitional Issues still Cloud Application of New Fapi Rules", Tax Topics, May 8, 1997, No. 1313, p. 1

Because s. 95(2)(k) is limited to the computation of income rather than capital gains, it does not have the effect of grandfathering gains that accrued before an active business became an investment business.

Paragraph 95(2)(l)

Articles

Chapman, "Foreign Affiliate Amendments: Three Strikes and you are Done", 1995 Canadian Tax Journal, Vol. 43, No. 2, p. 433.

Jack, "The Foreign Affiliate Rules: The 1995 Amendments", 1995 Canadian Tax Journal, Vol. 43, No. 2, p. 347

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(6) 6

Finance

Jayme Yeung, , 'Trading or Dealing in Indebtedness Offshore: Paragraph 95(2)(l) Revisited", 2011 Canadian Tax Journal, Vol 59, p. 843

General discussion including of "business principally carried on," "regulated" activities and "similar authority" tests.

Wallace G. Conway, "The New Foreign Affiliate Provisions: The Department of Finance's Perspective", 1995 Conference Report, c. 40, Q. 1

Response to question "what types of income is paragraph 95(2)(l) directed at?"

Subparagraph 95(2)(l)(iii)

See Also

CIT Group Securities (Canada) Inc. v. The Queen, 2016 TCC 163, 2017 TCC 86

regulated Barbados subsidiary which invested in corporate debt qualified under the s. 95(2)(l) exclusion for foreign banks

The taxpayer held a Barbados subsidiary (“CCG”) through nine (mostly wholly-owned) Barbados international business corporations (the “IBCs”). The main business activity of CCG was to borrow money from the IBCs and use those funds primarily to for project or corporate finance purposes, either by lending the funds to arm’s length borrowers or acquiring debt obligations of arm’s length third parties and, in both cases, holding those debt obligations to maturity. Thes activities required the taxpayer to be licensed as a trust and finance company under Part III of the Financial Intermediaries Regulatory Act (Barbados), subsequently the Financial Institutions Act (Barbados) (the "FIA").

The taxpayer treated the income of CCG as active business income, so that the interest income earned by the IBCs was treated as active business income under s. 95(2)(a)(ii). The Crown viewed the interest income of CCG as deemed property income under s. 95(2)(l) (thereby giving rise to foreign accrual property income), but conceded that CCG did not have an investment business.

In rejecting the argument of the taxpayer (at para. 80) that the phrase “which for the purpose of this paragraph includes the earning of interest on indebtedness” merely “expands or confirms the type of income from the business of trading or dealing in indebtedness that is included in income from property, but it does not modify the word ‘business’ or expand the meaning of the words ‘trading or dealing in indebtedness,” Owen J concluded (at para. 120) that, having regard to the text and syntax (and contrasts with other provisions), that “the parenthetical modifies the phrase "'trading or dealing in indebtedness’.” Accordingly, the interest income of CCG qualified under the preamble of s. 95(2)(l) as income from trading or dealing in indebtedness (para. 136).

However, the Crown had conceded that CCG came within s. 95(2)(2)(l)(iv), and Owen J went on to find that CCG also came within the exception in s. 95(2)(2)(l)(iii). This partly turned on whether CCG was a "foreign bank," whose Bank Act definition included a foreign-incorporated company that:

(c) engages, directly or indirectly, in the business of providing financial services and employs, to identify or describe its business, a name that includes the word “bank”… [or]

(e) engages, directly or indirectly, in the business of providing financial services and is affiliated with another foreign bank.

As the business of a corporation (CIT Bank, or "CTIB") which was a U.S. subsidiary of the indirect U.S. parent of the taxpayer:

…included the taking of deposits and the provision of credit, this is sufficient to conclude that CITB was using the word bank to identify or describe its business. … (para 147)

Respecting the “financial services requirement in para. (c), he stated (at paras. 149-150):

“[F]inancial services” include services in respect of the management of money, the provision of credit, banking and investment, or any combination of these activities.

… CITB engaged directly or indirectly in the business of providing financial services in the form of the provision of credit and the taking of deposits. Accordingly...CITB was a foreign bank...under paragraph (c)… .

In finding that para. (e) applied to CCG as CITB’s affiliate, Owen J stated (at paras. 153, 156):

…CCG was engaged directly or indirectly in the business of providing financial services in the form of the provision of credit to arm’s length third parties.

… [P]aragraph (e) of the definition of “foreign bank” in the Bank Act does not require CCG to be licensed as a bank under the laws of the foreign country, nor does it require CCG to carry on a banking business as such. …

In finding that the business of CCG as a foreign bank also was “regulated,” as required by s. 95(2)(2)(l)(iii), Owen J stated (at paras. 162, 165):

… [T]he employees of CCG filed monthly and quarterly reports with the Central Bank and regularly met with officials of the Central Bank. As well, CCG was subjected to two audits by the Central Bank and paid an annual fee to the Central Bank to maintain its licence under Part III of the FIA. …

… [T]he regulatory requirements in the FIA were both enforced and satisfied.

Accordingly, the FAPI assessments of the taxpayer should be reversed.

Words and Phrases
financial service
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(1) - Foreign Bank no requirement to be regulated as a bank 239
Tax Topics - General Concepts - Evidence hearsay evidence could support expert opinion 114

Paragraph 95(2)(m)

Administrative Policy

12 July 2013 External T.I. 2011-0415911E5 - FA held through partnership -– 95(2)(m) & 95(2)(y)

Canco has a 51% interest in a partnership ("Partnership") holding all the shares of Forco1 which, in turn, owns all the shares of Forco2. Forco1 makes an interest bearing loan to Forco2.

Query

: For purposes of applying s. 95(2)(a) in determining whether Canco has FAPI, does s. 95(2)(y) prevent Partnership from having a qualifying interest in Forco1 and Forco2?

FAPI is to be determined at the partnership level (s. 96(1)). Partnership would have a qualifying interest in respect of Forco1 and (having regard to the look-through rule in s. 95(2)(m)(iii)) in respect of the shares of Forco2 owned by Forco1, if the usual conditions were satisfied.

This would be the case notwithstanding the deeming rule of paragraph 95(2)(y) that…would deem each member of Partnership to own the Forco1's shares based on their proportionate interest in the Partnership for the purposes of determining whether a non-resident corporation is, at any time, a Foreign affiliate of a member of the Partnership in respect of which it has a qualifying interest.

Paragraph 95(2)(n)

Articles

Angelo Nikolakakis, "Lehigh Cement Limited v. The Queen – A Bridge Too FAAAR", International Tax Planning, Volume XIX, No. 1, 2013, p. 1284

In the course of a submission that it was contrary to the scheme of the Act to apply s. 95(6)(b) to attack indirect loans to a non-resident parent, he stated:

Purposes of s. 95(2)(n) (pp.1289-1290)

During the taxation years in question, there was no requirement that the relevant taxpayer (i.e., the Finco owning taxpayer) must have held a "qualifying interest" (as defined in paragraph 95(2)(m))), or any economic interest at all, in the borrower Opco. It was sufficient for the borrower Opco to be a related non-resident corporation, at least insofar as subdivision i is concerned. There is still no such requirement. When the rules were changed as announced under the 2007 federal budget to eliminate clause 95(2)(a)(ii)(A), which provided for recharacterization in respect of a borrower Opco that is merely a related non-resident corporation, paragraph 95(2)(n) was introduced for the purpose of deeming the Finco owning taxpayer to have the requisite qualifying interest provided that such an interest was held by a related corporation resident in Canada. These changes were intended to block the establishment of a Finco to make an "indirect loan" to a borrower Opco that was held by a non-resident ultimate parent corporation but only where not even 10% of its votes and value were held by the taxpayer or a related corporation resident in Canada, and a transitional period was provided for in the sense that these changes only had application for taxation years that end after 1999. It cannot be that these changes were unnecessary, or that the transitional rule was ineffective, because the structure was already defeated by paragraph 95(6)(b).

Paragraph 95(2)(c.1)

Articles

Firoz Ahmed, Patrick Marley, "Proposed Amendments to Foreign Affiliate Rules", Canadian Current Tax, Vol. 14, No. 8, May 2004, p. 81.

Subsection 95(2.5) - Definitions for paragraph (2)(a.3)

Excluded Income

Administrative Policy

Edward A. Heakes, "Another Wave of Foreign Affiliate Proposals", International Tax Planning, Volume XVIII, No. 4, 2013, p. 1275

Narrowing of excluded income/revenue (p.1278)

"Excluded income" and "excluded revenue" are both defined in subsection 95(2.5). The July 12 Proposals would narrow the definitions to restrict them to income derived from leases with arm's length residents of Canada related to property used in carrying on a business through a permanent establishment outside of Canada. The change in the definition of excluded revenue is intended to cure an existing anomaly (acknowledged in a previous comfort letter by the Department of Finance) by clarifying that revenues from leases with arm's length non-residents are not part of excluded revenue. Therefore, such revenues can potentially count as "good" revenue for the purposes of the 90% de minimis test. The change of the definition of excluded income would appear to very slightly broaden the net of the basic provision in fairly limited circumstances.

Extension to s. 95(2)(a)(ii) income (p.1278)

The other proposed change to the two definitions is that any payment that is deemed to be active business income under subparagraph 95(2)(a)(ii) would be treated as excluded income and excluded revenue. The change to the definition of excluded income is a welcome change that clarifies that the favourable rule in subparagraph 95(2)(a)(ii) trumps the unfavourable rule in subparagraph 95(2)(b.3). the change to the definition of excluded revenue is somewhat puzzling as this would prevent such items from counting as "good" revenue for the purposes of the 90% de minimus test.

Indebtedness

Administrative Policy

20 January 1997 T.I. 963269

An interest rate swap would be a "similar agreement".

Specified Deposit

Administrative Policy

5 July 1995 T.I. 951478 (C.T.O. "6363-1 Foreign Affiliates - Specified Deposit")

A deposit made by a foreign affiliate will qualify as a specified deposit if the foreign affiliate does not carry on an active business, even if s. 95(2)(a)(i) deems income earned by it to be from an active business.

Subsection 95(3)

Administrative Policy

14 September 2001 Comfort Letter

In light of the principle that there is no erosion of the tax base or diversion of income from Canada if the services in question are required by their nature to be performed outside Canada, Finance will recommend that s. 95(3)(a) be amended "to ensure that the transmission of electronic signals or electricity along a transmission system located outside Canada be excluded from being "services" for the purposes of s. 95(2)(b)."

26 June 1991 T.I. (Tax Window, No. 4, p. 4, ¶1318)

Discussion of what constitutes "Canadian risk".

Paragraph 95(3)(b)

Administrative Policy

13 January 2015 Internal T.I. 2013-0497361I7 F - Services performed by a foreign affiliate

prototype testing services not directly related to sales of improved product

A foreign affiliate ("FA1") of a Canadian manufacturer (the "Taxpayer") provides testing services to the Taxpayer on products (namely, prototypes) manufactured by the Taxpayer in Canada or abroad and which are owned by the Taxpayer. The tests on the prototypes help validate the manufacturing processes developed in Canada by the Taxpayer and resolve problems. Although the prototypes themselves are not sold, the information generated from the testing thus ameliorates issues on subsequent production for sale as a result of corrective adjustments being made. Taxpayer employees are involved in oversight of the testing.

Did s. 95(3)(b) apply so that the testing services were not services for purposes of s. 95(2)(b)? In responding negatively, the Directorate stated (TaxInterpretation translation):

Our long-standing position respecting the expression services performed in connection with the sale of goods is that only services directly related to such sales so qualify.

…[T]hese activities fall under scientific research and experimental development…and not under services related to the sale of goods, per se.

See also summary under s. 95(3)(d).

Words and Phrases
in connection with
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(3) - Paragraph 95(3)(d) prototype testing services not manufacturing 116

Paragraph 95(3)(d)

Administrative Policy

13 January 2015 Internal T.I. 2013-0497361I7 F - Services performed by a foreign affiliate

prototype testing services not manufacturing

A foreign affiliate of a Canadian manufacturing company (the taxpayer) provided services to the taxpayer of testing prototypes (manufactured by the taxpayer) of goods that would subsequently be manufactured and sold by the taxpayer. In finding that the testing activities, viewed as scientific research and experimental development, did not qualify as manufacturing or processing notwithstanding the inclusion of such activities in the definition of "qualified activities" in Reg. 5202, the Directorate noted that as "it required a positive act of the legislator, namely their inclusion in the ITR" for such activities to be included in manufacturing or processing, this implied that the unadorned expression in s. 95(3)(d) did not include SR&ED. See summary under s. 95(3)(b).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 95 - Subsection 95(3) - Paragraph 95(3)(b) prototype testing services not directly related to sales of improved product 171

Subsection 95(3.1) - Designated property — subparagraph (2)(a.1)(i)

Subsection 95(4) - Definitions

Direct Equity Percentage

Administrative Policy

2010 Ruling 2010-0373801R3 - Conversion from a BV to a DC

A foreign cooperative, treated as a corporation under the foreign nation's law, is deemed to have "shares" for the purposes of determining "direct equity percentage" under s. 95(4), for disposition of shares of a foreign affiliate under s. 85.1(3), and for exchanges of shares under s. 86(1).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 85.1 - Subsection 85.1(3) 44
Tax Topics - Income Tax Act - Section 86 - Subsection 86(1) exchange of shares in Netherlands BV for membership interests in Dutch coop qualified under s. 86 139
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Share membership interest in Dutch coop a share 131
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Disposition conversion of Netherlands BV to Dutch co-op 89

25 November 1998 T.I. 981001

In the case of a Delaware LLC whose capital was divided into two classes: Class 1 interests representing the common equity; and Class 2 interests representing the preferred equity; RC will apply its administrative position in IT-392 that where the ownership of a foreign business entity is not divided into units entitled "shares", RC will consider the foreign business entity as if it had capital stock of 100 issued shares, with each owner of the beneficial interest being considered to own a number of shares proportionate to the owner's beneficial interest in the foreign business entity.

Subsection 95(6) - Where rights or shares issued, acquired or disposed of to avoid tax

Administrative Policy

Income Tax Technical News, No. 36 "Paragraph 95(6)(b)"

18 March 1999 T.I. 990312

S.95(6) applies with respect to provisions of the Act not contained in subdivision (i), including s. 122.3(1). It is not necessary that the preamble in s. 95(6)(b) state that it applies for purposes of the Act.

Articles

Jack, "The Foreign Affiliate Rules: The 1995 Amendments", 1995 Canadian Tax Journal, Vol. 43, No. 2, p. 347

Discussion of s. 95(6) at pp. 350-353.

Paragraph 95(6)(b)

Cases

Canada v. Lehigh Cement Limited, 2014 DTC 5058 [at 6849], 2014 FCA 103, aff'g 2013 DTC 1139 [at 740], 2013 TCC 176

restricted to status-manipulating acquisitions or dispositions

The taxpayer ("CBR Canada") directly (as to 99%) and indirectly (through a wholly-owned Alberta subsidiary as to 1%) used $US 100 million borrowed from two arm's length non-resident banks (with the principal but not the interest obligation under the first loan then being assigned by the first bank to a Belgian subsidiary of the taxpayer's ultimate Belgian parent – "CBR SA") by making capital contributions to a US LLC, which used those funds to make interest-bearing loans to a U.S. sister corporation ("CBR US") of CBR Canada. CBR US used those funds to repay interest-bearing intercompany loans (in the case of the proceeds indirectly derived from the first loan to the taxpayer) or to pay a dividend to its U.S. parent (in the case of the second loan).

CBR Canada deducted the interest on the two bank loans to it, and claimed the s. 113(1)(a) deduction respecting the payment to it of dividends from the LLC derived from the interest on the loans owing by CBR US; with CBR US deducting such interest under the Code (as well as withholding U.S. withholding tax of 10%). The Minister denied the s. 113(1)(a) deduction under s. 95(6)(b).

Stratas JA found that s. 95(6)(b) did not apply. After noting (at para. 46) that s. 95(6)(b) "requires us to focus on the principal purpose for the acquisition or disposition of the shares, not the principal purpose of the series of transactions of which the acquisition or disposition forms a part," and (at para. 56) that the tax avoidance specifically addressed is "the manipulation of share ownership of the non-resident corporation," he stated (at para. 68):

[P]aragraph 95(6)(b) is targeted at those whose principal purpose for acquiring or disposing of shares in a non-resident corporation is to meet or fail the relevant tests for foreign affiliate, controlled foreign affiliate or related-corporation status in subdivision i... .

Here, there was no such manipulation of status (para. 72), and the Tax Court instead had found that the purpose of the LLC was to achieve US tax savings (para. 71).

Locations of other summaries Wordcount
Tax Topics - Statutory Interpretation - Consistency restricting of anti-avoidance rule to avoid arbitrary application 152
Tax Topics - Statutory Interpretation - Headings provision not in Tax Avoidance Part of Act 137

See Also

Univar Canada Ltd. v. The Queen, 2005 DTC 1478, 2005 TCC 723

The taxpayer incorporated a Barbados subsidiary ("BarbadosCo") using borrowed money to subscribe for the shares of BarbadosCo, and BarbadosCo used the proceeds to purchase from the American parent of the taxpayer ("UC") an interest-bearing note owing to UC by a wholly-owned European subsidiary of UC ("UE"). Bell J. accepted evidence of the taxpayer's officers that there was never any intent for the taxpayer to itself acquire the note. Accordingly, there was no tax avoided through the incorporation of BarbadosCo and the receipt of tax-free dividends by the taxpayer from BarbadosCo funded out of the interest payments made on the note.

Administrative Policy

11 April 2017 Internal T.I. 2016-0670541I7 - Foreign affiliate share redemption

skewing exempt surplus to Canco could engage s. 95(6)

Canco held the preferred, but not the common, shares of a Barbados International Business Company (“FA”), and its preferred shares were redeemed. Although the facts are mostly redacted, it would appear that the resolution pursuant to which FA redeemed the shares provided that a portion of the proceeds paid on the redemption were a dividend, and Canco apparently relied on this wording rather than making a s. 93(1) election. After discussing whether such treatment could give rise to a dividend to Canco, the Directorate went on to state:

If there is, in part, a dividend… to the extent the purpose of issuing the...Shares is to skew exempt surplus to the Canadian shareholder…consideration [should] be given as to the potential application of subsection 95(6) and/or subsection 245(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 90 - Subsection 90(2) portion of proceeds paid on a redemption might be respected as a dividend (subject to s. 95(6)) if this is clearly indicated in accordance with Barbados law 289
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Dividend redemption proceeds might in part be a dividend under Barbados law 131

2 December 2014 CTF Roundtable, Q. 9

may extend to transitory FA positions

After being asked to comment on Lehigh, CRA responded:

The CRA accepts the decision in the Lehigh Cement case that paragraph 95(6)(b) is generally targeted at acquisitions and dispositions of shares in non-resident corporations that are carried out for the principal purpose of manipulating status of the non-resident corporation for the purposes of subdivision i of Division B of Part I of the Act with a view to avoiding, reducing or deferring Canadian tax. However, … paragraph 95(6)(b) could still apply in other contexts such as… the manipulation of a taxpayer's participating percentage in a controlled foreign affiliate.

…[T]he CRA's 95(6)(b) Committee intends to review cases and assess whether they include a share investment or divestment in a foreign affiliate that could be considered to have been for the principal purpose of manipulating share ownership in the affiliate in order to secure a tax benefit, such as for example, a subsection 113(1) deduction for a stream of dividends. This may be the case where it could be considered that the share ownership in the foreign affiliate is transitory on the basis that it is reasonable to conclude that a subsequent disposition was contemplated at the outset.

22 May 2014 May IFA Roundtable, 2014-0526761C6 - Foreign affiliate share acquisition or disposition

s. 95(6) Committee stats

Over the 2010-2013 period a total of 19 cases were considered by the s. 95(6) Committee, which recommended in seven cases that s. 95(6)(b) be applied. Two s. 95(6)(b) cases are before the courts.

8 February 2006 External T.I. 2004-0064811E5 -

Canco is wholly-owned by MNC, a non-resident multi-national corporation. All the treasury functions for the group are carried out by Canco, which lends to non-resident subsidiaries of MNC (Foreign Subs). Before starting to make these loans, Canco subscribes for common shares of the Foreign Subs so that it holds 1% (or, in another scenario, 10%) of the shares of each.

After noting that the loans might not be exempted by s. 15(2.3) in the absence of the cross-shareholdings, CRA stated:

We may consider the possible application of paragraph 95(6)(b) of the Act in those situations such that the acquisition of the shares of the Foreign Subs by Canco would be deemed to not have occurred. We note that that subsection 95(6) applies only for the purposes of subdivision i of Division B of the Act (other than section 90). Subdivision i in part deals with the definition of "foreign affiliate" and the share acquisition has a direct impact on whether the Foreign Subs are foreign affiliates of Canco. We are of the view that paragraph 95(6)(b) of the Act could be applied to those situations with consequences to the application of subsection 15(2.1).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 15 - Subsection 15(2.3) debt does not include a loan 255

Income Tax Technical News, No. 36, 27 July 2007.

21 May 1996 T.I. 9526865

Discussion of the application of the "directly or indirectly" test where a loan made by a foreign affiliate of Canco ("FA") to a related non-resident corporation that is not a foreign affiliate uses the funds solely to acquire intellectual property which it licenses to NR2, which also is a related, but unaffiliated, corporation.

Articles

Angelo Nikolakakis, "Lehigh Cement Limited v. The Queen – A Bridge Too FAAAR", International Tax Planning, Volume XIX, No. 1, 2013, p. 1284

Essentially an indirect loan (p.1284)

[I]n essence, the decision involves the potential application of paragraph 95(6)(b) to a taxpayer's acquisition of the shares of a non-resident corporation as part of what is commonly referred to as an "indirect loan" financing arrangement….

No comparison with alternative transactions (pp. 1287)

In brief, it is submitted that the "purpose tests" under paragraph 95(6)(b) and subsection 245(3) involve the "why" (i.e., why was the actual transaction done?), not the "how" (i.e., why was the actual transaction done that way or instead of doing it another way or doing an alternative transaction?). This would mean that, as Bonner J. put it in Canadian Pacific, the word "primarily" is intended to preserve the right of the taxpayer to structure a business driven transaction in a tax-effective manner, not to test whether it was structured in a tax-efficient manner primarily in order to obtain a tax benefit – which of course would generally be the case.

Use of indirect loans by Canadian and foreign multinationals (p.1290)

There is no doubt that the Canada Revenue Agency ("CRA") and the Department of Finance have struggled for many years to find the right balance between facilitating the establishment of a Finco for the purpose of making an "indirect loan" in relation to Canadian multinationals, while curtailing this in relation to foreign multinationals, but that struggle has not played out through efforts to revise the purpose or effect of paragraph 95(6)(b). Paragraph 95(6)(b) does not provided for any distinction – and none should be read in – between a Finco owning taxpayer that is part of a Canadian multinational group rather than a foreign multinational group. Interestingly, even in the context of a Finco owning taxpayer that is part of a foreign multinational group, the structure is facilitated under subsection 212.3(24) of the foreign affiliate dumping provisions, provided that certain conditions are satisfied.

Nathan Boidman, "The Troubling Effects for Canadian MNEs of the Decision in Lehigh", Tax Notes International, 17 June 2013, p. 1211

(Similar comments on the purpose of s. 95(6) are made by him at Tax Notes International, 12 May 2014 at p. 528 before indicating at p. 529 that the FCA confirmed that the provision is "a precise instrument for very precise issues, namely, attempts to create FA status where none would otherwise exist and de-control what would otherwise be CFAs.")

Nat Boidman suggests that the interpretation given to s. 95(6) in Lehigh by the Tax Court is significantly broader than the tax community's understanding (summarized at p. 121 and reproduced below) of the provision's historical purpose and scope:

But notwithstanding its broad language the tax community has long thought that the rule has been enacted for only two reasons. First, it is contended that the rule was initially adopted to protect the integrity of a separate set of rules [the FAPI rules in s. 91] that attribute, to a relevant Canadian MNE, the passive income of those foreign affiliates that are controlled, in specified ways, by Canadians or affiliated parties or a combination thereof (that is a "controlled foreign affiliate" (CFA)). Second it is contended that certain amendments to the rule some years later was to protect the integrity of a another set of rules, under section 95(2)(a)(ii), that recharacterize certain inter-foreign group financing and licensing income as active business income so as to not be subject to attribution as passive income.

In the first case it was thought that section 95(6) was intended to prevent decontrolling CFAs by issuing or selling voting shares to friendly foreign parties. That would serve to make the attribution rule in section 91 inapplicable.

In the second case it was thought that section 95(6) was intended to prevent artificially creating FA status by having say preferred shares issued by non-resident corporations that were not otherwise FAs of Canadian parties and to whom there would be loans or licensing of property. The purpose of that would be to render the income recharacterization rule of section 95(2)(a)(ii) applicable to income derived from such loans or licences, and avoid passive income attribution.

Elizabeth J. Johnson, "CRA's Latest Views on Paragraph 95(6)(b) Foreign Affiliate Anti-Avoidance Rule: Reflections", International Tax, CCH, October 2007, No. 36, p. 6.

Elizabeth J. Johnson, Geneviève C. Lille, James R. Wilson, "A Recent Response to the CRA's View on the Scope and Interpretation of Paragraph 95(6)(b)", 2006 Canadian Tax Journal, Vol. 54, No. 3, p. 571.