2014-0550421C6 2014 TEI Liaison Meeting, Q.E6

Principal Issues: Whether the issuance of shares from treasury by Forco to a Canadian resident (whether upon incorporation or otherwise) precludes Forco from claiming the benefit of the safe harbour rule in subsection 115.2(2)?

Position: Yes, to the extent the shares remain outstanding and the shareholder remains a “Canadian investor” within the meaning assigned by subsection 115.2(1).

Reasons: By issuing shares from treasury (whether upon incorporation or otherwise), Forco would be considered to have “sold an investment in itself” as the phrase is used in clause 115.2(2)(b)(i)(B).

Author: Carruthers, Lori
Section: 115.2(2)

2014 TEI-CRA Liaison Meeting
November 18, 2014

Question E6 - Non-Resident Carrying on Business in Canada

Where a non-resident engages a Canadian investment manager, the activities of the investment manager may cause the non-resident to be carrying on business in Canada for Canadian tax purposes.  Under subsection 115.2(2), where certain conditions are met, the non-resident will not be considered to be carrying on business in Canada solely because of the activities of its Canadian investment manager. For purposes of discussion, assume that the management of a foreign company (Forco) wishes to engage a Canadian-resident corporation (CSP) to provide Forco with “designated investment services.” (All quoted terms are as defined in subsection 115.2(1)).  CSP’s provision of these services to Forco could cause Forco to be carrying on business in Canada unless the exemption in subsection 115.2(2) is available. 

The diagram below illustrates the relationships and the issue is whether the issuance of shares by Forco, from its treasury, to a Canadian resident precludes Forco from claiming the benefit of the safe harbor rule in subsection 115.2(2).

In responding to the questions and comments below, assume that:

(i)         Forco was created more than a year ago;
(ii)        100 percent of Forco’s shares were issued by Forco to, and continue to be owned by, a company resident in Canada (Canco);
(iii)       Canco is affiliated with CSP;
(iv)       Canco is a “designated entity” in respect of CSP;
(v)        Forco has not, directly or through its agents, directed promotion of investments in Forco principally at Canadian investors; and
(vi)       Forco has not, directly or through its agents, filed any document with a public authority in Canada to permit the distribution of interests in Forco to persons resident in Canada.

Would the CRA agree that by issuing shares to Canco from treasury Forco would not be considered to have “sold an investment in itself,” as the phrase is used in clause 115.2(2)(b)(i)(B)?  Does the mere issuance by Forco of treasury shares to a Canadian parent preclude the availability of the safe harbor even though Forco does not offer securities for sale to Canadians in Canada?  We invite the CRA’s comments.

CRA Response:

Forco’s issuance of shares from treasury to Canco (whether upon incorporation or otherwise), would result in Forco being considered to have “sold an investment in itself” as the phrase is used in clause 115.2(2)(b)(i)(B). As such, the issuance of treasury shares by Forco to Canco (whether upon incorporation or otherwise) would, to the extent the shares remain outstanding and Canco remains a “Canadian investor” within the meaning assigned by subsection 115.2(1), prevent Forco from benefiting from the availability of the safe harbour rule in subsection 115.2(2).

This is consistent with previous advance income tax rulings issued by the CRA and comfort letters issued by the Department of Finance. For example, in advance income tax ruling 2002-0157313 we ruled favourably on subsection 115.2(2) and a relevant aspect of the proposed transactions was that the non-resident corporation would not sell its shares to any resident of Canada by ensuring each subscription agreement (i.e., share issuances from treasury) would include a representation to the effect that the investor was not a resident of Canada.

With specific reference to the hypothetical scenario presented in this question, we would note that it represents an example of what was specifically not intended to be eligible for the safe harbour rule in subsection 115.2(2). For example, the purpose for the condition in clause 115.2(2)(b)(i)(B) that the non-resident not sell investments in itself to Canadian investors was described in the 1999 Budget Supplementary Information as follows:

“This will ensure that no incentive is created to serve Canadian investors from offshore, thereby displacing the domestic Canadian fund industry.”

Whereas, the hypothetical scenario presented in this question is, in our view, equivalent to Canco’s investment needs being serviced offshore through Forco.

As another example, in comfort letters dated June 4^th and November 20^th of 2002, the Department of Finance stated that:

“The underlying policy for the investment restrictions in subsection 115.2(2) is to ensure that a reasonable measure of independence exists between non-resident persons who benefit from section 115.2 and their service providers.”

Whereas, given that Canco is a widely held corporation, it’s affiliation with CSP indicates that Forco would be affiliated with CSP as well. Such an affiliation would not, in our view, constitute the reasonable measure of independence noted by Finance above.

Lori Carruthers
2014-055042

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