Principal Issues: Whether the acquisition of an existing debt fits into the notion of "making a loan or advance"?
Position: No, according to jurisprudence
Reasons: The acquisition of a debt is inconsistent with the notion of "making a loan or advance." For a loan to exist there must be a lender/borrower relationship between parties. According to the definitions of "loan" that Courts have held in their decisions, -- mainly from "Words and Phrases"; Permanent Edition; Volume 25A; Page 79 -- there must be an express or implied agreement whereby one person advances or delivers money to another and the latter agreed to return at a future time a sum equivalent to that which he borrows.
The acquisition of a debt doesn't create a lender/borrower relationship but a creditor/debtor relationship as there is no money delivered by one party or any money solicited by the other party.
| January 13, 2012 Quebec Tax Services Office 165, de la Pointe aux lièvres sud, Quebec QC G1K 7L3 Attention: Josée Paquette |
Income Tax Rulings Directorate International tax planning International and Large Business Directorate Nancy Turgeon, CGA 2011-041411 |
Request for interpretation - Application of subparagraph 17(8)(a)(ii)
This is in response to your email of July 12, 2011, in which you requested our comments regarding the application of subparagraph 17(8)(a)(ii) in the situation described below.
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act (the "Act").
In your email, you briefly described a situation (the "Particular Situation") where, in a particular taxation year, a taxable Canadian corporation ("Canco 1") made an interest-free loan to a non-resident corporation ("CFA 1") which was a controlled foreign affiliate of it within the meaning of subsection 17(15). Immediately thereafter, CFA 1 used the proceeds of that loan to acquire a debt (the "Debt") of another controlled foreign affiliate, within the meaning of subsection 17(15), of Canco 1 ("CFA 2"). CFA 1 acquired the Debt from a Canadian corporation ("Canco 2") with which it does not deal at arm's length. In addition, you note that this non-arm’s length relationship also exists between all the entities involved in the Particular Situation. The Debt arose from a loan that Canco 2 had made to CFA 2, with CFA 2 having used the funds from the time the loan was made to earn income from an active business within the meaning of subsection 95(1). Finally, we understand that those transactions were carried out as part of a series of transactions to effect the withdrawal from the corporate group of one of the shareholders. It is also our understanding that all the shares of the capital stock of the corporations involved were owned directly or indirectly by individuals resident in Canada.
Our Comments
Section 17 contains the rules applicable when a non-resident person owes an amount to a corporation resident in Canada. Subsection 17(1) generally applies where the amount owing in question remains outstanding for more than one year without the corporation having included interest that would have been included in computing its income for the year in respect of the amount owing if that interest were computed at a reasonable rate. In the circumstances described in subsection 17(1), the resident corporation is deemed to have received interest on the amount, calculated at a prescribed rate, at the end of each taxation year of the corporation in which the debt is owing.
Subparagraph 17(8)(a)(ii) includes an exception from the application of subsection 17(1) for a corporation resident in Canada for its taxation year in respect of an amount that a controlled foreign affiliate owed when the amount due arose as a loan or advance made to the controlled foreign affiliate and that the controlled foreign affiliate has used throughout the entire period before the end of the taxation year in which the advance or loan was made, to make a loan or advance to another controlled foreign affiliate, provided that the other controlled foreign affiliate uses the loan or advance to earn income from an active business.
The exception in subparagraph 17(8)(a)(ii) appears to us to be very limited in application and applies only to situations where all of the conditions are met. In this case, the essential question at issue is whether CFA 1 used the sum lent by Canco 1 to make a loan or advance to CFA 2.
The terms "loan" and "advance" are not defined in the Act. However, the courts have had the opportunity to interpret those terms on various occasions. In Bradley v. R., 96 D.T.C. 2040 (T.C.C.), Morgan J. refers to the following definition of "loan" in paragraph 12 of the decision:
A "loan" is a contract by which one delivers a sum of money to another and the latter agrees to return at a future time a sum equivalent to that which he borrows.
A "loan" within the law of usury is the delivery of a sum of money to another under a contract to return at some future time an equivalent amount with or without an additional sum agree upon for its use.
To constitute a "loan", there must be an express or implied agreement whereby one person advances money to another, who agrees to repay it on such terms as to time and rate of interest, or without interest, as parties may agree.
Words and Phrases, Permanent Edition, volume 25A, page 79.
In addition, the Supreme Court of Canada confirmed in T. E. McCool Ltd v. MNR [49 DTC 700; 3 DTC 1202] that for a loan to exist, there must be a lender / borrower relationship. In several other decisions (footnote 1), the courts have concluded that the concept of loan or advance is related to the existence of a payment of money between two parties and to the presence of that relationship of lender / borrower. As opposed to the creditor / debtor relationship, the lender / borrower relationship is much narrower and requires the existence of a loan. It involves a concrete gesture on the part of both parties, being the payment and acceptance of a sum of money.
Our understanding of the Particular Situation leads us to conclude that the contractual relationship between CFA 1 and CFA 2 with respect to the Debt establishes a creditor/debtor relationship and not a lender/borrower relationship. In fact, there was no agreement, either implied or explicit, nor a payment or acceptance of money between CFA 1 and CFA 2, which could enable us to conclude that there is a lender/borrower relationship. Although CFA 1 became the creditor of CFA 2 while acquiring the Debt, it never made a loan per se.
We are therefore of the view that the exception in subparagraph 17(8)(a)(ii) does not apply in the Particular Situation.
We hope that these comments are of assistance.
Guy Goulet, CA, M.Fisc.
Manager
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 See in particular: AC Simmonds & Sons Ltd v. MNR 89 DTC 707; The Queen v. Pollock Sokoloff Holdings Corp. [76 DTC 6181; [1976] CTC 349]; Duquette v MNR [84 DTC 1820; [1984] CTC 3008].