Principal Issues: [TaxInterpretations translation] The client wishes to know whether subsection 15(2) may apply to a partnership given the definition of "person … connected with a shareholder of a particular corporation", as provided in subsection 15(2.1) of the Act as well as the scope of various other provisions.
Position: We are still maintaining our position regarding our interpretation 2003-0045851E5 and our comment F2004-0088411C6. We continue to believe that the term "person … connected with a shareholder of a particular corporation" as provided in subsection 15(2.1) of the Act may include a partnership.
Reasons: The CRA did not succeed in the Tax Court of Canada (see Gillette v. The Queen, 2003 DTC 5078) which concluded that if a person could be connected to a shareholder of a corporation pursuant to subsection 15(2.1), it was not the same for a partnership. The Federal Court of Appeal also agreed with the taxpayer, but for different reasons.
June 7, 2011
XXXXXXXXXX Tax Services Office
Income Tax Rulings Directorate Attention: XXXXXXXXXX Nancy Turgeon, CGA
2011-039792
Inter-company financing
This is in response to your April 4, 2011 email regarding the above subject. We also acknowledge receipt of additional information submitted on April 18 and May 31. You wish to know whether subsection 15(2) can apply to a partnership taking into account the definition of "person … connected with a shareholder of a particular corporation" provided in subsection 15(2.1) of the Act, as well as the scope of various other provisions.
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act (the “Act").
The Facts
1. ParentCo, a XXXXXXXXXX U.S. corporation, is the sole shareholder of a U.S. corporation (USCo) and a corporation XXXXXXXXXX.
2. USCo is the general partner (GP) and XXXXXXXXXX is the limited partner (LP) of a XXXXXXXXXX partnership (XXXXXXXXXX Partnership) formed in XXXXXXXXXX in order to carry on a money lending business for the group entities.
3. XXXXXXXXXX Partnership borrows money in Canadian or U.S. dollars from various Canadian entities at the LIBOR (footnote 1) rate and lends in non-Canadian currencies to other entities in the group that are not affiliated with Canadian entities.
4. XXXXXXXXXX Partnership states that its permanent establishment is situated in XXXXXXXXXX.
5. In the partnership agreement forming XXXXXXXXXX Partnership, the following information is disclosed:
i. Head office: XXXXXXXXXX
ii. Principal Office: General Partner's Office at XXXXXXXXXX
iii. The General Partner has the exclusive power and authority to manage, control, administer and carry on the business and affairs of XXXXXXXXXX Partnership including opening, closing, administering and managing bank accounts outside Canada
iv. The General Partner has the exclusive authority and power to file any information returns or tax returns required by any governments
v. The General Partner agrees to conduct the affairs of the corporation through its agents named XXXXXXXXXX
vi. The General Partner maintains all books and records at his principal office at XXXXXXXXXX
vii. Meetings must be held at a convenient time at a place outside of Canada.
6. ParentCo is the sole shareholder of CanHoldCo 1.
7. CanHoldCo 1 in turn holds XXXXXXXXXX% of the shares of CanHoldco 2.
8. CanHoldCo 2 holds XXXXXXXXXX% of the units of a Canadian partnership (CanP). The remaining XXXXXXXXXX% is held by XXXXXXXXXX, the latter being owned solely by CanHoldCo 2.
9. CanP is the sole holder of all the shares of Canco.
10. Canco, a Canadian corporation, lends money to XXXXXXXXXX Partnership (over XXXXXXXXXX) at the LIBOR rate in XXXXXXXXXX. That loan will be fully repaid in XXXXXXXXXX.
11. Subsections 15(2.2) to 15(2.6) do not apply to the loans in question.
Your Opinion
In your view, subsection 15(2) could apply to the partnership since CanCo made a loan to XXXXXXXXXX Partnership, a partnership connected with a shareholder of the corporation that made the loan, namely Canco.
The opinion of the Representative
The representative maintains in writing that the structure put in place exempts XXXXXXXXXX Partnership from any taxation in Canada because it does not carry on any business there. The representative is also of the view that, since the courts rendered a favourable judgment in favour of the taxpayer in the Gillette case, the term "person … connected with a shareholder of a particular corporation" in subsection 15(2.1) cannot apply to a partnership and thus subsection 15(2) cannot apply to XXXXXXXXXX Partnership.
Your Questions and Our Comments
Question 1
In this case, can we apply subsection 15(2) to the partnership by considering that the term "person … connected with a shareholder of a particular corporation" in subsection 15(2.1) can include a partnership as expressed in documents 2004-0088411C6 and 2003-0045851E5?
Briefly, subsection 15(2) provides that a person or a partnership which is a shareholder of a particular corporation, connected with a shareholder of a particular corporation, or a member of a partnership, or a beneficiary of a trust, that is a shareholder of a particular corporation and the person or partnership has in a taxation year received a loan from or has become indebted to the particular corporation, in computing the income for the year of the person or partnership, shall include that amount in its income for the year unless it falls within the exceptions provided for in subsections 15(2.2) to (2.6).
In order for the partnership to be connected to a shareholder of the lender corporation, there must be a non-arm's length relationship between the partnership and a shareholder of the corporation. The question of whether a partnership is not dealing at arm's length with a shareholder of the corporation is a question of fact. Interpretation Bulletin IT-419R2, Meaning of Arm's Length, June 8, 2004, outlines the criteria used to determine whether or not persons are dealing at arm's length with each other. Since, in your case, XXXXXXXXXX Partnership and Canco are ultimately controlled by the same corporation (ParentCo), there is a non-arm's length relationship between the Canco shareholder and the partnership that received the loan.
The CRA did not succeed in the Tax Court of Canada (see Gillette v. The Queen, 2003 DTC 5078) which concluded that while a person could be connected to a shareholder of a corporation pursuant to subsection 15(2.1), it was not the same for a partnership. The Federal Court of Appeal also agreed with the taxpayer, but for different reasons. That is why we are still maintaining our position in our Interpretation 2003-0045851E5 and our comment in F2004-008411C6. We continue to believe that the term "person … connected with a shareholder of a particular corporation" as provided in subsection 15(2.1) may include a partnership.
Question 2
If subsection 214(3) were to apply to this situation, what would the applicable Part XIII withholding tax rate be?
Under paragraph 214(3)(a), where section 15 or subsection 56(2) would, if Part I were applicable, require an amount to be included in computing a taxpayer’s income, that amount shall be deemed to have been paid to the taxpayer as a dividend from a corporation resident in Canada. Such an amount, deemed to be paid as a dividend, would come within subsection 212(2) and would be subject to Part XIII tax.
In addition, the Tax Convention between Canada and the United States provides that if the beneficial owner is a company which owns at least 10% of the voting stock of the company paying the dividends, the withholding tax rate may not be exceed 5%. In all other cases, that rate increases to 15%. Due to the absence of any direct holding of voting rights between the parties, the withholding tax rate under Part XIII, pursuant to paragraph 2 of Article X of the Canada-U.S. tax treaty, cannot exceed 15%.
Furthermore, the tax treaty between Canada and XXXXXXXXXX provides in Article XXXXXXXXXX a withholding rate of not more than 15% in respect of dividends so paid.
Question 3
On the other hand, if a refund of the amounts included by virtue of subsection 214(3) occurs, what happens to the Part XIII tax previously paid on them?
If the borrower is a non-resident, paragraph 214(3)(a) deems, for the purposes of Part XIII, that the amounts that would be included in income by virtue of subsection 15(2), if Part I applied, are paid to the non-resident as a dividend by a corporation resident in Canada (unless the lender is also a non-resident in which case subsection 15 (2.2) applies). The dividend paid by a corporation resident in Canada to a non-resident is subject to income tax by virtue of subsection 212(2) and must be paid to the Receiver General for Canada.
Subsection 227(6.1), however, provides for repayment of Part XIII tax paid on a loan deemed to be a dividend by virtue of paragraph 214(3)(a) if the borrower, in whose name the tax was paid, repays the loan after December 21, 1992 and the repayment was not made as part of a series of loans or other transactions and repayments. The repayment is limited to the lesser of the Part XIII tax initially paid on the portion of the loan repaid, or the Part XIII tax that would be payable if, at the time of repayment, a dividend within the meaning of paragraph 212(2)(a), equal in amount to the repayment, were paid to the borrower. To obtain the repayment, it must be requested within two years of the end of the calendar year in which the amount was paid.
Question 4
How do subsections 15(2) and 80.4(2) interact in this case?
Subsection 80.4(2) deals with benefits from loans made or debts incurred because of the shareholder status of a taxpayer. More specifically, under that subsection, a benefit is deemed to have been received in the following circumstances:
(2) Where a person (other than a corporation resident in Canada) or a partnership (other than a partnership each member of which is a corporation resident in Canada) was
(a) a shareholder of a corporation,
(b) connected with a shareholder of a corporation, or
(c) a member of a partnership, or a beneficiary of a trust, that was a shareholder of a corporation,
and by virtue of that shareholding that person or partnership received a loan from, or otherwise incurred a debt to, that corporation, any other corporation related thereto or a partnership of which that corporation or any corporation related thereto was a member, the person or partnership shall be deemed to have received a benefit in a taxation year equal to the amount, if any, by which
(d) all interest on all such loans and debts computed at the prescribed rate on each such loan and debt for the period in the year during which it was outstanding
exceeds
(e) the amount of interest for the year paid on all such loans and debts not later than 30 days after the later of the end of the year and December 31, 1982.
However, paragraph 80.4(3)(b) provides that subsection 80.4(2) does not apply if the loan or debt is included in the debtor's income under another provision of Part I of the Income Tax Act. That would be the case if the loan or debt had already been included in the taxpayer's income under subsection 15(2). However, an assessment under subsection 15(2) is not precluded even if the taxpayer has voluntarily declared a benefit under section 80.4, as subsection 15(2) has priority over section 80.4, as stated in paragraph 10 of Interpretation Bulletin IT-421R2 Benefits to Individuals, Corporations and Shareholders from Loans or Debt.
In this case, if it should be the case that you include the loan in the taxpayer's income by virtue of subsection 15(2), then section 80.4 would not apply unless the loan is subject to repayment by virtue of subsection 227(6.1).
Question 5
Finally, is the LIBOR rate used between the corporations on the loans reasonable for the purpose of subsection 17(1)?
As stated in our Interpretation E9127055, it is a question of fact as to whether the interest rate (LIBOR) used between the parties can be considered reasonable for the purposes of subsection 17(1). Several economic and financial factors must be taken into consideration. It is not the responsibility of the Income Tax Rulings Directorate to establish reasonableness. We suggest that you refer to the International Advisory Services Section of the International and Large Business Branch.
We hope that these comments are of assistance.
Alain Godin, Manager
for the Director
International Operations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 London Inter-Bank Offered Rate