Principal Issues: [TaxInterpretations translation] 1. Does subsection 94.1(3), as proposed in the July 18, 2005 Legislative Proposals Relating to the Income Tax Act, apply to a corporation resident in Canada where the non-resident entity is a controlled foreign affiliate of the corporation?
2. Could the imputed income rules in proposed subsection 94.1(4) apply to a corporation resident in Canada even if the non-resident entity is a controlled foreign affiliate of the corporation?
Position: 1. Section 94.1(3), as proposed, would not apply.
2. The Canadian resident corporation may be subject to subsection 94.1(4) if subsection 94.2(9) applies unless the resident corporation satisfies the conditions in subsection 94.2(3).
Reasons: 1. The share held by the Canadian resident corporation in the capital stock of the non-resident entity is an exempt interest.
2. Text of the Act.
XXXXXXXXXX Sylvie Labarre, CA 2004-009703 July 26, 2005
Dear Sir,
Subject: Foreign investment entities
This is further to your letter of October 1, 2004, requesting our views on section 94.1, as proposed in the Legislative Proposals Relating to the Income Tax Act of July 18, 2005 (the "Proposals"). We apologize for the delay in responding to your request.
Facts
Individuals, who are Canadian residents for tax purposes, form a Canadian corporation, Canco. They subscribe for common shares of Canco for $1,000,000. Canco invests that amount by subscribing for common shares in the capital stock of a non-resident corporation, Barbadosco.
Canco has authorized capital permitting the issuance of multiple classes of preferred shares. One hundred Canadian investors subscribe $1,000,000 each for Canco's preferred shares, with Canco issuing a separate class of preferred shares to each investor. The preferred shares are non-voting and non-participating and are redeemable at the option of the holder based on the value of the same class of shares of the non-resident corporation, Barbadosco.
Canco invests the $100,000,000 received from the issuance of the preferred shares by subscribing for preferred shares of one hundred separate classes of shares in the capital stock of Barbadosco. Barbadosco uses the $100,000,000 in connection with its securities investment business.
Each class of Barbadosco Preferred Shares constitutes an hermetic cell that corresponds to an investment management account of a Canco preferred shareholder. The Barbadosco preferred shares are non-voting and non-participating and are redeemable at the option of the holder. The redemption value of each class of Barbadosco preference shares is 98% of the value of the shareholder's after-tax investment management account.
Canco owns all of the common and preferred shares of Barbadosco. Barbadosco is a controlled foreign affiliate of Canco as defined in subsection 95(1) of the Income Tax Act (the "Act").
Question
You wish to know whether section 94.1, as proposed in the Proposals, would apply to this situation.
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (the "CRA") not to issue a written opinion regarding proposed transactions otherwise than by advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that we hope may be helpful to you. These comments may not, however, apply to your particular situation in certain circumstances.
Unless otherwise indicated herein, the provisions discussed and referred to in this letter are those proposed in the Proposals.
The Proposals require amounts to be included in the income of a taxpayer resident in Canada pursuant to subsection 94.1(4) where one of subsections 94.1(3) or 94.2(9) applies to the taxpayer in respect of a participating interest and subsections 94.2(3) and 94.3(3) do not apply.
As you stated, the only Canadian resident taxpayer with a participating interest in a non-resident entity is Canco, as the other Canadian investors only have shares in a resident entity. Consequently, it is necessary to consider whether Canco is subject to subsection 94.1(4) with respect to each of its shares in Barbadosco.
Subsection 94.1(3) does not apply if Canco's participating interest in Barbadosco is an exempt interest, as defined in subsection 94.1(1). In this situation, this will be the case if Barbadosco is a controlled foreign affiliate of Canco, throughout the period, in its taxation year including that time, that Canco held the particular interest, by virtue of subparagraph (a)(i) of the definition "exempt interest". Based on the facts you have given us, Barbadosco would be a "controlled foreign affiliate" of Canco as defined in subsection 95(1). Consequently, subsection 94.1(3) would not apply in this case.
However, even if subsection 94.1(3) does not apply, an amount may be required to be included in Canco's income pursuant to subsection 94.1(4) if subsection 94.2(9) applies.
In determining whether subsection 94.2(9) applies in respect of a particular participating interest, it is necessary to determine, inter alia, whether Barbadosco is a tracking entity, as defined in subsection 94.2(1), in respect of the particular participating interest. In addition, it must be determined whether the amount of any payment arising from the right to receive (whether immediate or future, absolute or contingent, or subject to the exercise of discretion by an entity or individual), in any manner from any entity, amounts in respect of the particular participating interest or identical participating interests, or the value of that right to receive, is directly or indirectly determined primarily by reference to one or more of the criteria set out in subparagraphs 94.2(9)(d)(i) to (iii) in respect of one or more properties referred to as tracked properties.
We cannot reach a definitive conclusion on the application of subsection 94.2(9) to a situation such as the one you have presented to us without examining all the facts of that situation. However, after reviewing the facts of a particular situation, we may conclude that subsection 94.2(9) applies in respect of each share of a particular class of preferred shares.
These comments are not advance income tax rulings and do not bind the CRA in any particular situation.
Best regards,
Alain Godin
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Directorate General for Policy and Planning