2015-0614241C6 2015 TEI Liaison Meeting Q.6 - Specified Right

Principal Issues: In the context of a notional cash pooling arrangement, whether the right provided to an arm's length non-resident bank by pool participants to offset overdraft balances with deposit balances or the use of deposit balances to offset overdraft balances upon the exercise of that right constitutes a specified right as defined in subsection 18(5)?

Position: Not answered.

Reasons: Notional cash pooling arrangements of the type described raise issues both in respect of the thin capitalization rules and the non-resident withholding tax rules. The concept of a “specified right”, which is the main focus of your question, is relevant in the application of the new “back-to-back loan” rules contained in section 18, in respect of thin capitalization, and in section 212, in respect of non-resident withholding tax.

Author: Chang, Jack Yu-Fan
Section: 18(5), 18(6), 212(3.1)

2015 Tax Executives Institute – Liaison Meeting 

Question 6 - Back-to-Back Loans – Notional Pooling Arrangements 

Does the following fact pattern implicate a “specified right” under Income Tax Act subsection 18(5)? 

Multinational corporate groups often enter into “cash pooling” arrangements with financial institutions to efficiently manage cash balances. Cash pooling arrangements typically fall into one of two categories: physical and notional. Under a physical cash pooling arrangement, a master or “header” account is typically held by a member of the corporate group with the financial institution. Each participant in the pooling arrangement has a subaccount linked to the master/header account. Cash balances in the subaccounts are transferred to the master/header account on a daily basis thus creating an intercompany loan owing to the participant by the master/header account holder. Balances in the master/header account are transferred to the subaccounts from time to time to meet the cash requirements of the participants. 

Under a notional cash pooling arrangement, participants have separate bank accounts with the same financial institution and retain their cash balances or incur overdraft balances directly with the financial institution, as opposed to transferring cash to a header/master account. Each participant earns deposit interest and incurs overdraft interest on its respective account balance, but the rate of overdraft interest charged to a participant is typically reduced to match the deposit interest rate to the extent the aggregate balance of the participating accounts is positive. 

Additionally under notional cash pooling arrangements, financial institutions often require participants to grant the institutions the right to formally offset overdraft balances in pool accounts against deposit balances in other pool accounts. In the absence of the ability to set-off overdraft balances in this manner, the financial institutions could be required to treat the overdraft balances as non-performing loans for regulatory purposes. 

For example, suppose that Canco, a Canadian-resident corporation, is a wholly-owned subsidiary of Parentco, a non-resident corporation that has a number of other wholly-owned subsidiaries not resident in Canada and that operate in various jurisdictions. Parentco and its other subsidiaries, including Canco, have a notional cash pooling arrangement that has been established with an arm’s-length financial institution (the “Bank”) not resident in Canada. Under the relevant pooling agreement, the Bank has the right to offset overdraft balances of any pool participants against deposit balances of other pool participants without prior notice. Canco has an overdraft balance on its pool account and has overdraft interest charges owing to the Bank. 

Does the Bank’s right to offset the deposit balances of other pool participants against Canco’s overdraft balance constitute a “specified right” within the meaning of subsection 18(5)?

CRA Response

Notional cash pooling arrangements of the type you have described raise issues both in respect of the thin capitalization rules and the non-resident withholding tax rules. The concept of a “specified right”, which is the main focus of your question, is relevant in the application of the new “back-to-back loan” rules contained in section 18, in respect of thin capitalization, and in section 212, in respect of non-resident withholding tax. 

In the circumstances you have described, it is the CRA’s view that the deposit balances of the non-resident pool participants would be considered “intermediary debts” for the purposes of subparagraphs 18(6)(c)(i) and 212(3.1)(c)(i), with the result that the back-to-back loan rules would be engaged, provided its other conditions are met. We find support for this position both in the text of the law as well as in the Department of Finance Explanatory Notes accompanying the bill that enacted these “back-to-back” loan rules, which contain an example that seems to us to be exactly on point. 

The “specified right” concept represents an alternative means of engaging the back-to-back loan rules. In light of our view that such notional cash pooling arrangements would be caught under subparagraphs 18(6)(c)(i) and 212(3.1)(c)(i), it is not necessary to consider the possible application of the specified right rules contained in subparagraphs 18(6)(c)(ii) and 212(3.1)(c)(ii).

Jack Chang
2015-061424
 

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