2013-0499121E5 upstream loan

Principal Issues: 1. Whether there is any relief available to Canco in respect of multiple income inclusions where an outstanding loan from a foreign affiliate (FA2) to Canco is transferred to another foreign affiliate (FA1) as a result of the liquidation of FA2 into FA1? 2. Whether Canco is required to include any amount in its income where an outstanding loan from a foreign affiliate is transferred within a foreign affiliate group as a result of the amalgamation of two foreign affiliates ("Amalco Loan") and the Amalco Loan is legally offset with a payable due by Amalco to Canco?

Position: 1. Yes 2. No

Reasons: 1. Paragraph 248(28)(a) should apply to avoid double taxation. 2. Since the FA1 Loan is repaid before the August 19, 2014 deadline set out in the coming into force provisions of the Explanatory Notes it is not deemed to be a separate loan received by Canco on August 20, 2014. Accordingly, subsection 90(6) of the Act does not apply to require Canco to include an amount in respect of the FA1 Loan in its income in any taxation year. Pursuant to paragraph 90(8)(a), subsection 90(6) does not apply to the Amalco Loan since it was repaid (by legal set off) within two years of the day the indebtedness arose.

Author: Argento, Angelina
Section: 90(6), 90(8)(a), 90(9), 90(14)

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                                                                                                                                                                  2013-049912
                                                                                                                                                                   Angelina Argento

November 14, 2013

Dear XXXXXXXXXX:

Re:   Foreign Affiliate Upstream Loans

We are writing to you in response to your emails of July 30, 2013 and July 31, 2013 requesting an interpretation of paragraph 90(8)(a) and subsections 90(9) and 90(14) of the Income Tax Act (the “Act”) and the coming into force provisions in clause 66(3) to Part 5 of the Explanatory Notes released with the October 24, 2012 Notice of Ways and Means Motion (“Explanatory Notes”) in the context of the following hypothetical facts:

*     Canco is a corporation resident in Canada for the purposes of the Act;
*     FA1 is a corporation which is not resident in Canada for purposes of the Act;
*     Canco owns all of the share capital of FA1;
*     FA2 is a corporation which is not resident in Canada for purposes of the Act;
*     FA1 owns all of the share capital of FA2;
*     Canco, FA1 and FA2 each have a December 31st taxation year end;
*     On December 31, 2012, FA1 has a nil “net surplus” balance as that term is defined in subsection 5907(1) of the Regulations;
*     On December 31, 2012, FA2 has an “exempt surplus” and “net surplus” balances as those terms are defined in subsection 5907(1) of the Regulations of US$1000;
*     Neither FA1 nor FA2 will carry out any transactions aside from those described below that will affect their surplus balances during the relevant period; and
*     The Canadian and US dollars are, and remain, at par throughout the periods covered below in Situation 1 and Situation 2.

Situation 1: Liquidation of FA2

Additional facts:

*     On June 15, 2013, FA2 loaned US$1000 to Canco (“FA2 Loan”);
*     The FA2 Loan will have a term of 10 years and no portion thereof will be repaid before the end of the term;
*     In February 2014, FA2 liquidates into FA1; and
*     Aside from the application of subsection 5905(7) of the Regulations, the liquidation results in no change to the surplus accounts of FA1 and FA2.

You note that as a result of the liquidation of FA2, although Canco has not received a loan from FA1, Canco becomes indebted to FA1 (“FA1 Loan”).  Therefore, assuming that pursuant to subsection 90(9), Canco deducted US$1000 from its income in its taxation year ending on December 31, 2013 to offset the 90(6) income inclusion (in respect of the FA2 Loan), for its taxation year ending on December 31, 2014, Canco will be required by subsection 90(12) to include US$1000 in its income (in respect of the FA2 Loan) and by subsection 90(6) of the Act, to include US$1000 in its income (in respect of the FA1 Loan).

You ask whether any relief is available to Canco in respect of the multiple income inclusions resulting from what is effectively one outstanding loan amount in these circumstances.

Situation 2: Amalgamation of FA1 and FA2

Additional facts:

*     FA1 loaned US$1000 to Canco before August 19, 2011 (“FA1 Loan”);
*     On August 19, 2011, the FA1 Loan remained outstanding;
*     On September 1, 2013 FA1 and FA2 amalgamated to form a new corporation (“Amalco”);
*     Under the foreign corporate law governing the amalgamation of FA1 and FA2, Amalco is not a continuation of FA1 or FA2;
*     As a result of the amalgamation of FA1 and FA2, on September 1, 2013, Canco “became indebted” to Amalco in the amount of US$1000 (“Amalco Loan”);
*     On October 3, 2013, Amalco incurred a payable owing to Canco in the amount of US$1000 (“Canco Payable”); and
*     Under the applicable commercial law, on December 31, 2013, the Amalco Loan is legally offset against the Canco Payable, such that there is a legal discharge of both the Amalco Loan and the Canco Payable on December 31, 2013.  

The coming into force provisions in the Explanatory Notes state that subsections 90(6) to 90(15) of the Act also “apply in respect of any portion of a particular loan received or a particular indebtedness incurred on or before August 19, 2011 that remains outstanding on August 19, 2014”.  You ask whether it is reasonable to conclude that subsection 90(6) did not apply to either the FA1 Loan or the Amalco Loan, since neither of these amounts is outstanding on August 19, 2014.

Our Comments

Written confirmation of the tax implications inherent in a particular transaction is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002.  This Information Circular and other Canada Revenue Agency (“CRA”) publications can be accessed on the internet at http://www.cra-arc.gc.ca/formspubs/menu-e.html.  Where a particular transaction has already been completed, a review of the relevant facts and circumstances surrounding the situation would be required.  Such review would normally be conducted by the applicable Tax Services Office (“TSO”) during the course of an income tax audit, which, if undertaken, would be carried out after the particular taxpayer has prepared and filed its income tax return for the year.

Notwithstanding the foregoing, we are prepared to provide the following general comments that may be of assistance.

Subsection 90(6) of the Act generally applies to include an amount in the income of a corporation resident in Canada where a specified debtor (footnote 1) receives a loan or becomes indebted to a foreign affiliate of Canco and none of the exceptions in subsection 90(8) apply. 

In particular, subsection 90(6) of the Act states, in part, as follows:

“Except where subsection 15(2) applies, if a person …receives at any time a loan from, or becomes at that time indebted to, a creditor that is at that time a foreign affiliate (referred to in subsections (9), (11) and (15) as the "creditor affiliate") of a taxpayer resident in Canada …. then the specified amount in respect of the loan or indebtedness is to be included in computing the income of the taxpayer for the taxpayer's taxation year that includes that time.” (Emphasis Added).

Paragraph 90(8)(a) of the Act provides that subsection 90(6) “does not apply to a loan or indebtedness that is repaid, other than as part of a series of loans or other transactions and repayments, within two years of the day the loan was made or the indebtedness arose”. 

Subsection 90(9) of the Act provides for a deduction on an annual basis for the period during which the loan or indebtedness is outstanding.  However, pursuant to paragraph 90(9)(b) of the Act, taxpayers cannot use the same amounts of surplus or adjusted cost base during the period in which a loan is outstanding (or an indebtedness is incurred) to compute a deduction under subsection 90(9) in respect of any other loan or indebtedness, or under subsection 91(5) or 113(1) for any actual (or deemed) dividends paid. 

Subsection 90(12) of the Act provides for the inclusion in computing the income of a taxpayer for the current taxation year of an amount deducted under subsection 90(9) in computing the taxpayer's income for the immediately preceding taxation year. This inclusion can then be offset by a new deduction under subsection 90(9) if the conditions of that subsection continue to be met.  In addition, subsection 90(14) of the Act provides for a deduction from a taxpayer's income to the extent that a loan or indebtedness that was subject to subsection 90(6) is repaid in a subsequent taxation year. 

Thus, in order to avoid the income inclusion in subsection 90(6) (pursuant to paragraph 90(8)(a)) or to obtain a deduction (pursuant to subsection 90(14)) for a previous income inclusion, the loan must be repaid.

Situation 1: Liquidation of FA2

There is no provision in the Act that provides that in the above-mentioned hypothetical facts, as a result of the liquidation of FA2 into FA1, the FA2 Loan was repaid or settled.  Therefore, in Canco’s taxation year ending on December 31, 2014, the conditions in subsection 90(14) do not apply to allow Canco to claim a deduction in respect of the FA2 Loan.   As a result, pursuant to subsection 90(12) of the Act, the amount deducted by Canco pursuant to subsection 90(9) in its taxation year ending on December 31, 2013 (in respect of the FA2 Loan) must be included in Canco’s income in its taxation year ending December 31, 2014 and this income inclusion could be offset by a deduction under subsection 90(9) if all the conditions specified therein are satisfied. 

As well, as you pointed out, as a result of the liquidation of FA2 into FA1, Canco “becomes indebted to” FA1 (which is a creditor that is at that time a foreign affiliate of Canco).  Therefore, subsection 90(6) will apply to include a “specified amount” in Canco’s income in its taxation year ending on December 31, 2014 in respect of the FA1 Loan where none of the exceptions in subsection 90(8) apply (for example, where the FA1 Loan is not repaid within two years of the day the loan was made). 

At the time FA2 made the FA2 Loan to Canco, FA2 had an exempt surplus balance of US $1000.  Pursuant to subsection 5905(7) of the Regulations, FA2’s US$1000 exempt surplus balance moves from FA2 to FA1 as a result of the liquidation of FA2 and therefore comprises FA1’s exempt surplus balance at the time Canco becomes indebted to FA1 (i.e. the FA1 Loan).  However, by virtue of the restrictions in paragraph 90(9)(b) of the Act, that US$1000 exempt surplus balance can be used by Canco to claim a deduction under subsection 90(9) only in respect of either the FA1 Loan or the FA2 Loan.

Under the hypothetical facts above, subsection 90(6) provides for duplicate inclusions in Canco’s income in respect of what is essentially the same loan.  It is not evident that this was the intended result under the legislation.  Therefore, it is our view that paragraph 248(28)(a) of the Act applies to remedy the situation and avoid double taxation of the same amount.  The amount to be included in Canco’s income in its taxation year ending on December 31, 2014, would be either the amount under subsection 90(6) in respect of the FA1 Loan or the amount under 90(12) of the Act in respect of the FA2 Loan, but by virtue of paragraph 248(28)(a) of the Act not both. In either case, a full deduction would be available under subsection 90(9) of the Act.

We will bring this to the attention of the Department of Finance.

Situation 2: Amalgamation of FA1 and FA2

Subsections 90(6) to 90(15) of the Act generally apply in respect of loans received and indebtedness incurred after August 19, 2011.  However, in accordance with their coming into force provisions they also apply in respect of a particular loan received or indebtedness incurred on or before August 19, 2011 that remains outstanding on August 19, 2014 as if it was received or incurred on August 20, 2014.

As noted previously, paragraph 90(8)(a) provides an exception from the income inclusion which would otherwise occur (pursuant to subsection 90(6)) where the loan is repaid, other than as part of a series of loans or other transactions and repayments, within two years of the day the loan was made or the indebtedness arose. 

Pursuant to clause 66(3) of the Explanatory Notes, subsections 90(6) to 90(15) apply after August 19, 2011.  However, any portion of any particular loans or indebtedness incurred on or before August 19, 2011 that remains outstanding on August 19, 2014 is deemed to be a separate loan or indebtedness that was received or incurred on August 20, 2014.  Accordingly, all pre-August 19, 2011 loans and indebtedness are entitled to a five year repayment window, such that they are not subject to the provisions of subsection 90(6), if they are repaid before August 20, 2016.  However, all post August 19, 2011 loans and indebtedness must be repaid within two years of the day the loan was made or the indebtedness incurred in order to avoid the income inclusion in subsection 90(6).

In the above-mentioned hypothetical facts, the FA1 Loan was made before August 19, 2011.  Therefore, in accordance with the coming into force provisions, any part of the FA1 Loan which remains outstanding on August 19, 2014, is deemed to be a separate loan received on August 20, 2014.  As a result, the FA1 Loan will not be subject to the provisions of subsection 90(6) to 90(15) of the Act if it is repaid in full prior to August 19, 2014.  Canco became indebted in respect of the Amalco Loan on September 1, 2013.  Pursuant to paragraph 90(8)(a) of the Act, subsection 90(6) will generally not apply to the Amalco Loan if it is repaid within two years of the date the indebtedness was incurred (i.e. by September 1, 2015).

It is our view that based on the jurisprudence and our previous positions on subsection 15(2) of the Act, provided that under the applicable commercial law, the set-off of the Amalco Loan and the Canco Payable represents a legal discharge of the full amount of the debts, the legal set-off will constitute repayment of the Amalco Loan for purposes of paragraph 90(8)(a) of the Act.

There is no provision in the Act that provides that in the above-mentioned hypothetical facts, as a result of the amalgamation of FA1 and FA2, the FA1 Loan was repaid or settled.  As noted previously, as a result of the amalgamation, Canco becomes indebted to Amalco.  Despite Canco having arguably become indebted to two different persons at two different times there is never more than one loan amount outstanding in these circumstances.  It is our view that a loan can be repaid as a result of the legal set-off of the Amalco Loan with the Canco Payable, therefore, it is reasonable to consider that for the purposes of the coming into force rules and paragraph 90(8)(a) of the Act, both the FA1 Loan and the Amalco Loan are repaid on December 31, 2013.  Since the FA1 Loan is repaid before the August 19, 2014 deadline set out in the coming into force provisions of the Explanatory Notes, it is not deemed to be a separate loan received by Canco on August 20, 2014.   Accordingly, subsection 90(6) of the Act does not apply to require Canco to include an amount in respect of the FA1 Loan in its income in any taxation year.    Similarly, since the Amalco Loan is fully repaid within two years of the day in which the Amalco Loan arose, pursuant to paragraph 90(8)(a), subsection 90(6) does not apply to require Canco to include an amount in respect of the Amalco Loan in its income in any taxation year.

We trust these comments to be of assistance.

Yours truly,

Olli Laurikainen, CPA, CA
For Director
International Division
Income Tax Rulings Directorate|
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 As that term is defined in subsection 90(15) of the Act.

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