7 December 1999 TEI Roundtable, 1999-0007790 - The application of subsection 17(2)

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

TEI Conference
December 7, 1999

Question XXVIII.

AMENDED SECTION 17-INTERPRETATIVE ISSUES

Section 17 was recently amended and poses a number of difficult interpretative questions and issues. We would appreciate your guidance in respect of the following questions :

A. Assume a Canadian corporation is the sole source of funding for a foreign affiliate. Is the condition in subparagraph 17(2)(b)(i) satisfied ? If the answer is yes, is the answer the same where the Canadian corporation is a major or significant source of the foreign affiliate's funding ?

B. If the answer to "A" is yes, and a Canadian corporation is the sole source of funding for a foreign affiliate that makes loans to non-affiliated third parties at commercial rates within an investment business and the income on such loans is relevant to the calculation of the amount included under subsection 91(1) of the funding corporation:

a. To the extent that the funding of the foreign affiliate making the loans is by way of equity contribution from the Canadian corporation, are the third party loans subject to subsection 17(2) ?

b. Would the answer to "a." be different if the funding is by way of a loan at a rate at least equal to the prescribed rate ?

c. If a loan as described above requires an inclusion on a deemed loan under subsection 17(2), is there any way to offset the interest taxed on the real loan ?

d. Would the interest from the third parties described in the assumption meet the test in subparagraph 17(1)(b)(iii) ?

e. Would the answer to "d." be different if there were no net inclusion under subparagraph 91(1) because of varying factors, including the underlying tax or that there is no net profit ?

C.

a. Where a foreign affiliate (i) is partly funded by the Canadian parent and partly by third-party loans, (ii) has made a deemed loan under subsection 17(2), and (iii) whose assets consist of low-interest debt obligations, commercial debt obligations, and other assets, then how is the income inclusion calculated ? Does the entire amount described in paragraph 17(2)(a) generate a deemed loan under subsection 17(2) if it is reasonable to conclude that any portion of such amount is related to a loan or transfer as described in subparagraph 17(2)(b)(i) ? If some amount less than the entire amount described in paragraph 17(2)(a) generates a deemed loan, how is the lesser amount of the deemed loan determined-by a tracing or an apportionment method ?

b. What happens if the mix of funding of the foreign affiliate changes over time ?

c. What happens if the mix of assets of the foreign affiliate changes over time ?

CCRA's Position

A) The funding provided by the Canadian corporation (Canco) to the foreign affiliate would be a loan or transfer of property under subparagraph 17(2)(b)(i), whether or not Canco was the sole source of funding of the affiliate.

B)

a)b) The issue is whether it is "reasonable to conclude" that the controlled foreign affiliate (CFA) entered into the third party loans because of the funding by Canco. Whether or not the "reasonable to conclude" test is satisfied in this case or any other particular case is a question of fact.

c)d) Assuming that subsection 17(2) applies, in this case, to deem a non-resident to owe an amount to Canco, subparagraph 17(1)(b)(iii) would be available to reduce the amount otherwise included in Canco's income under subsection 17(1), to the extent that amounts included in Canco's income under subsection 91(1) are reasonably attributable to interest earned by CFA on the above-mentioned loans made by CFA.

e) Any deductions in computing foreign accrual property income, as defined in subsection 95(1), would reduce the amount otherwise included in computing Canco's income under subsection 91(1) and, therefore, could potentially reduce the amount deductible by Canco under subparagraph 17(1)(b)(iii). For example, expenses incurred by CFA to earn the interest income and which reduce the amount of interest income (i.e., FAPI) that would otherwise be included in computing Canco's income under subsection 91(1), would generally reduce the deduction available to Canco under subparagraph 17(1)(b)(iii). However, amounts deducted by Canco under subsection 91(4) with respect to foreign accrual tax paid by CFA would not reduce the amount otherwise deductible by Canco under subparagraph 17(1)(b)(iii).

C)

a) The issue is not whether any portion of the amount owed by the non-resident person under paragraph 17(2)(a) (the "second loan") may reasonably be considered to relate to a loan or transfer of property described in subparagraph 17(2)(b)(i) (the "first loan"), but, rather, whether it is reasonable to conclude that the foreign affiliate entered into the second loan because of the first loan. Therefore, if, upon an examination of the terms of the loans and other relevant facts, it is determined that the foreign affiliate entered into a second loan of, say, $1,000 because of a first loan of, say, $800, then the non-resident person will be deemed to owe an amount equal to the second loan, viz. $1,000, to Canco. Conversely, if it is not reasonable to conclude that the second loan of $1,000 was entered into because of the first loan of $800, then no amount will be deemed to be owing to Canco under subsection 17(2).

b)c) Once it is established that a non-resident person is deemed to owe a particular amount to a resident corporation under subsection 17(2) at a particular time, the amount deemed owing does not vary depending on the amount (or mix) of funding of the particular person or partnership at various future times, but, rather, is only affected by the amount owing by the non-resident person to the particular person or partnership at such times. This is because subsection 17(2) provides that the amount deemed owing at a particular time is equal to the amount owing by the non-resident person to the particular person or partnership at that time.

Author: Brian Bloom
File: 993040
Date: November 22, 1999