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
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
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.
6 March 2015 Memorandum 2014-0549761I7 - Internally generated goodwill & excluded property
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
15 January 2015 T.I. 2014-0546581E5 - Partnership interest excluded property
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 T.I. 2006-0168571E5
Canco's wholly-owned subsidiary Forhold 2 has a 30% interest as general partner in LP1 which has a 15% LP interest in LP2. Cansub, which is wholly-owned by Canco, has a 25% LP interest in LP1. 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 [as]… LP1 is the only holder of a direct equity percentage in LP2. …[P]aragraphs (d) and (e)… do not apply to treat a partnership as a corporation for the purposes of determining if a partnership is related to a corporation. …
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 T.I. 2007-0251651E5
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 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.
Foreign Accrual Property Income
See Also
A.G. Canada v. Le Groupe Jean Coutu (PJC) Inc., 2015 QCCA 838, leave granted, SCC docket 36505
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.
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
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
- Foreign LP will distribute Mine 2 to Foreign Subco3 and Foreign Subco4 in proportion to their respective partnership interests.
- 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.
- 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.
30 August 2004 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 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.
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
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.
Foreign Accrual Tax
Administrative Policy
11 June 2013 STEP Roundtable Q. , 2013-0480321C6
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.
5 September 2013 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 Memorandum 2003-0037291I7 - US LLC and Regulation 5907(1.3)
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)....
25 March 2004 Memorandum 2002-013420
Discussion of "may reasonably be regarded as applicable" requirement including a numerical example.
Respecting whether an amount is considered "paid" for purposes of the definition of foreign accrual tax, the Agency noted that "where the companies are going concerns and the entry is made to an inter-company account that has many offsetting entries, it may be reasonable to consider payment made at the time of the entry."
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)."
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
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 Fingers of FAT: An Analysis of Foreign Accrual Tax", International Tax Planning, 2003 Canadian Tax Journal, No. 3
Foreign Affiliate
Administrative Policy
18 February 2013 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 Memorandum 2010-0388621I7
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.
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.
Income from Property
Articles
John Lorito, Trevor O'Brien, "International Finance – Cash Pooling Arrangements", draft version of paper for CTF 2014 Conference Report.
Cash risked in active business (p.22)
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)
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.
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).
Administrative Policy
2009 Ruling 2009-0308961R3
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 Memorandum 2008-0299161I7
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 Memorandum 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
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 TCC 274
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.
Leasing Obligation
Administrative Policy
31 July 2014 Memorandum 2014-0536581I7 - Foreign affiliate fresh start rules
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 T.I. 2005-0165131E5
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 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 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
30 September 2013 Memorandum 2012-0439661I7 - Income earmarked for future use & 95(2)(a)(i)
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… .
2007 May 16, CLHIA Roundtable Q. 19, 2007-0229841C6
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 T.I. 1999-001140
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 Memorandum 2000-0044387
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]
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]
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]
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
28 May 2015 IFA Roundtable Q. 11, 2015-0581571C6
"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.
31 July 2014 Memorandum 2014-0536581I7 - Foreign affiliate fresh start rules
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).
29 June 2012 Memorandum 2012-0441601I7 -
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 Memorandum 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 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 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
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", draft version of paper for CTF 2014 Conference Report.
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
28 May 2015 IFA Roundtable Q. 6, 2015-0581601C6
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 Memorandum 2013-0496841I7 - Application of clause 95(2)(a)(ii)(D) ITA
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... .
2009 CLHIA Roundtable Q. 12, 2009-0317191C6
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 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).
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 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 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
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... .
Paragraph 95(2)(a.1)
Administrative Policy
14 May 2015 CLHIA Roundtable Q. , 2015-0573801C6
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
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.
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 T.I. 2013-0474431E5 - Application of 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."
13 January 2014 T.I. 2013-0474431E5 - Application of 95(2)(b)(ii)
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.
2002 Tax Executives Institute Roundtable Q. 14, 2002-017395
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]
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
Sandra Jack, "FAPI: The Goods on Goods", Canadian Tax Highlights, Vol. 9, No. 12, 27 December 2001.
Paragraph 95(2)(c)
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.
Paragraph 95(2)(e)
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 March 2004 T.I. 2003-003431 -
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:
"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 purposes of the Act. See Dauphin Plains Credit Union Ltd. v. Xyloid Industries Ltd., [1980] 1 S.C.R. 1182 (SCC)."
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
3 December 2003 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)(Ff1) 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 T.I. 2013-0475421E5 - Section 94.2
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.
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 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 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 o earn dividends from subsidiaries and interst income that was deemed activie buisnes income nder s. 95(2)(a)(ii).
Articles
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
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 Memorandum 2014-0546641I7 - Foreign exchange on a debt arising on reduction of capital
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 Q. , 2014-0526771C6
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
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).
30 March 1988 T.I. 95-5293 [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
31 July 2014 Memorandum 2014-0536581I7 - Foreign affiliate fresh start rules
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 feesin computing the foreign accrual property income (FAPI) of FA2.
In computing the FAPI derived from the remainder of the license fees received by FA2, Caco 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
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?"
Paragraph 95(2)(m)
Administrative Policy
12 July 2013 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 Memorandum 2013-0497361I7 F - Services performed by a foreign affiliate
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 services related to the sale of goods per se.
See also summary under s. 95(3)(d).
Paragraph 95(3)(d)
Administrative Policy
13 January 2015 Memorandum 2013-0497361I7 F - Services performed by a foreign affiliate
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).
Subsection 95(3.1) - Designated property — subparagraph (2)(a.1)(i)
Subsection 95(4) - Definitions
Direct Equity Percentage
Administrative Policy
2010 Ruling 2010-037380
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).
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
Lehigh Cement Ltd. v. The Queen, 2014 DTC 5058 [at 6849], 2014 FCA 103, aff'g 2013 DTC 1139 [at 740], 2013 TCC 176
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," Stratas JA 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).
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
2 December 2014 CTF Roundtable, Q. 9
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 Q. , 2014-0526761C6
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 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).
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.