27 March 2018 Internal T.I. 2015-0592551I7 - Excluded property status of partnership interest -- summary under Excluded Property

Canadian-resident Parent wholly-owned Canco2 and Canco1. Two wholly-owned controlled foreign affiliates of Canco2 (“NR1” and “NR2”) established an Icelandic Sameignarfelag (“FORP”), which was viewed by CRA as a partnership. FORP used capital contributions from NR1 and NR2 to make loans within the affiliated group, with the interest thereon deemed under s. 95(2)(a)(ii) to be active business income to NR1 and NR2.

Next:

1. NR1 purchased an additional interest in FORP from NR2,
2. FORP disposed of its loans to another group company and
3. distributed the cash proceeds thereof as a return of capital,
4. NR1 made a dividend and capital distribution to Canco2
5. Canco2 sold NR1 and NR2 to a wholly-owned CFA of Canco1 (“NR3”), and a non-resident subsidiary of Parent, respectively.
6. All FORP’s remaining assets were distributed to its members
7. FORP was dissolved under Icelandic law
8. NR1 was liquidated and dissolved into NR3.

The taxpayer took the position that at the time it was disposed of the partnership interest of NR1 in FORP was not excluded property and, therefore, the capital gain or loss from the disposition was included in NR1’s foreign accrual property income (“FAPI”) in respect of CANCO1; and that as such gain was computed under s. 95(2)(f.14) in Canadian currency, therefore, the computation of the ACB of NR1’s partnership interest in FORP pursuant to s. 95(2)(j) and Reg. 5907(12) was to be computed in Canadian currency, including each capital contribution and reduction, earnings pick up, and distribution. Accordingly, NR1 computed a foreign accrual property loss (“FAPL”), which FAPL became a loss of NR3 upon the dissolution of NR1. On this basis, Canco1 has requested that this loss be applied to preceding taxation years.

After noting that the date of disposition of the FORP partnership interest was either 6 above by virtue of s. 98(2), or the dissolution date in 7 above, the Directorate stated:

[A] partnership interest held by a foreign affiliate of a taxpayer will be considered to be excluded property when the partnership would be a foreign affiliate of the taxpayer when the deeming rules in paragraphs (d) and (e) in the definition of “excluded property” are applied and if substantially all of the FMV of the property of the partnership itself satisfies the excluded property definition. …

[I]n determining whether [NR1’s] partnership interest is excluded property … any assets held by the partnership on which income was or would be recharacterized as active would qualify as excluded property under paragraph (c). Therefore, the Loans, while they were held by FORP, would have been excluded property.

The Directorate went on to find that if the partnership interest disposition date was 6, the cash held at that time did not qualify as an active business asset (noting that it “being used in a continuation of the active business activities undertaken by FORP, as it had never carried on an active business”); and that on the dissolution date no property was held – so that, either way, para. (b) of “excluded property” as modified by paras. (d) and (e) was not satisfied.