2019-0798831C6 IFA 2019 Q.1-Thin Capitalization

Principal Issues: Whether the positions adopted in document 9521415 still represent the CRA’s views. More specifically, (a) whether the definition of "specified shareholder" in subsection 18(5) of the Act requires a person to own shares of the corporation; and (b) whether an amount of contributed surplus contributed by a person that was a specified non-resident shareholder at the time of the contribution may be included in the calculation of the average referred to in the definition of “equity amount” in subparagraph 18(5)(a)(ii) of the Act where the person is no longer a specified non resident shareholder at the time that the calculation in subsection 18(4) of the Act is made.

Position: Document 9521415 still represents the CRA’s position. 1(a) Yes. 1(b) No.

Reasons: Consistent with CRA’s previous positions provided in document 9521415.

Author: Dion, Jean-Bernard
Section: 18(4), 18(5)

2019 International Fiscal Association Conference
CRA Roundtable

Question 1 – Thin Capitalization and Specified Shareholder

The thin capitalization rules set out in subsection 18(4) of the Income Tax Act (the “Act”) limit the deductibility of interest paid or payable on outstanding debts to specified non-residents, such that, in general terms, a corporation may not deduct interest based on the proportion of such debts over and above 1.5 times the “equity amount” of the corporation. In turn, “equity amount” is defined to include, among other things, contributed surplus that has been contributed by a specified non-resident shareholder of the corporation.

Does document 9521415 still represent the CRA’s position? More specifically,

(a)   Does the definition of "specified shareholder" in subsection 18(5) of the Act require a person to own shares of the corporation?

(b)   Is an amount of contributed surplus contributed by a person that was a specified non‑resident shareholder at the time of the contribution included in the calculation of the average referred to in the definition of “equity amount” in subparagraph 18(5)(a)(ii) of the Act where the person is no longer a specified non‑resident shareholder at the time that the calculation in subsection 18(4) of the Act is made?

CRA Response

The position adopted in document 9521415 was based on a previous version of existing subparagraph 18(5)(a)(ii) of the definition of “equity amount”, which was then found in old clause 18(4)(a)(ii)(B) of the Act. Under the current definition of “equity amount” in subparagraph 18(5)(a)(ii) of the Act, the amount of a corporation’s contributed surplus attributed to a specified non-resident shareholder is an average of amounts determined at the beginning of each month that ends in a taxation year.

In general terms, subsection 18(5) of the Act provides that a “specified shareholder” of a corporation is a person who, “either alone or together with persons with whom that person is not dealing at arm’s length, owns shares” of the corporation that give the holders thereof 25% or more of the voting rights, or shares having a fair market value of 25% or more of the fair market value of all issued and outstanding shares of the corporation.

Consistent with the position adopted in document 9521415, it remains our view that a person must own at least one share of a corporation in order to be a specified shareholder of such corporation. Furthermore, in order to be included in the computation of the average referred to in the definition of “equity amount” in subparagraph 18(5)(a)(ii) of the Act, we are still of the view that an amount of a corporation’s contributed surplus must have been contributed by a person that is a specified non-resident shareholder of the corporation at the time the calculation in subsection 18(4) of the Act is made, that is, at the end of a taxation year.

Considering the amendments to the method for calculating the debt-equity ratio of a corporation for thin capitalization rule purposes since the release of document 9521415, it is also our view that, in order to be included in the computation of the average referred to in the definition of “equity amount” in subparagraph 18(5)(a)(ii) of the Act, an amount of a corporation’s contributed surplus must have been contributed by a person that was a specified non-resident shareholder of the corporation at the beginning of the month for which the amount is determined.

Jean-Bernard Dion/Marie-Claude Routhier
2019-079883
May 15, 2019

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