CRA indicated that where a loan from one controlled foreign affiliate (FA Finco) of Canco to a second CFA of Canco (FA Holdco) meets the conditions in s. 95(2)(a)(ii)(D), a prepayment penalty paid by FA Holdco to FA Finco also can be recharacterized as active business income by s. 95(2)(a)(ii)(D) if the penalty is first recharacterized as interest under s. 18(9.1)(e). CRA then stated:
[E]ven though subsection 18(9.1)… generally defer the deduction by the payer of the penalty of a portion of the amount of such penalty to a future year, [Reg.] 5907(2.7)…ensures that…the entire amount of penalty is deducted from the payer’s earnings or loss from an active business in the year in which the amount is paid. Therefore…the possible increase of FA Finco’s surplus balance will be accompanied by the corresponding reduction of FA Holdco’s surplus balance in the year the amount is paid.