Principal Issues: [TaxInterpretations translation] Can a taxpayer deduct interest on a loan taken out to make interest-free advances to a non-resident subsidiary?
Position: Question of fact.
Reasons: The Agency's position on interest deductibility as presented at the 2002 annual conference of the Canadian Tax Foundation.
October 30, 2002
Quebec Tax Services Office Headquarters Income Tax Rulings Directorate Attention: Raymond St-Pierre Michel Lambert Training coordinator (613) 957-8953 Business Audit 2002-014678
Dear XXXXXXXXXX,
This is further to your memo of June 13, 2002 concerning XXXXXXXXXX
THE FACTS
1. XXXXXXXXXX is a controlled foreign affiliate (the "subsidiary") of XXXXXXXXXX (the "taxpayer") of which the taxpayer acquired all the shares in XXXXXXXXXX. The taxpayer is a taxable Canadian corporation. XXXXXXXXXX.
2. In order to provide the subsidiary with the necessary liquidity to repay its loans, the taxpayer advanced to the subsidiary, in XXXXXXXXXX, sums totalling US$XXXXXXXXXX. An amount of US$XXXXXXXXXX was advanced in XXXXXXXXXX. In XXXXXXXXXX, the taxpayer advanced the subsidiary US$XXXXXXXXXX. In XXXXXXXXXX, the advances had reached US$XXXXXXXXXX. Those advances were made without repayment terms and were non-interest bearing. They were made to the subsidiary to enable it to meet its ongoing expenses in order that it could continue its operations.
3. To partially finance those advances to the subsidiary, on XXXXXXXXXX, the taxpayer issued interest-bearing debentures in the amount of $XXXXXXXXXX to XXXXXXXXXX (the "Bank").
4. The XXXXXXXXXX fiscal period was the last in which the subsidiary was XXXXXXXXXX. The equity investment and advances in the subsidiary were written off in XXXXXXXXXX on the taxpayer's books.
YOUR QUESTIONS
5. You asked whether the taxpayer could deduct the interest payable on the debentures.
YOUR OPINION
6. You are of the opinion that the interest paid to the Bank did not satisfy the conditions of paragraph 20(1)(c) of the Income Tax Act (the "Act") since the loan was used to make interest-free advances to the subsidiary and the subsidiary was a non-resident of Canada. You point out that the conditions set out in paragraph 7 of Interpretation Bulletin IT-445 were not met.
OUR OPINION
7. At the 2002 annual conference of the Canadian Tax Foundation, the Agency released the preliminary results of its study on interest deductibility in certain situations. That study was undertaken following the Supreme Court decisions in Ludco and Singleton. With regard to borrowing to make interest-free loans, the following was stated: [TaxInterpretations translation]
In certain circumstances, the direct use of borrowed money is ineligible, since the property acquired cannot generate any income. Therefore, interest on money borrowed to acquire such property is generally not deductible. However, in certain situations, interest may be deductible under the exceptional circumstances principle. No complete guidelines can be provided, however, to establish whether a loan qualifies under this principle. However, we will generally accept the deduction of interest on borrowed money that is used to make an interest-free loan to a wholly-owned corporation (or, if there are several shareholders, where each shareholder makes an interest-free loan in proportion to its shareholding) where the funds will be used by the corporation to earn income, thereby increasing the potential for receiving dividends. Interest deductibility in other situations involving interest-free loans may also be justified depending on the particular facts involved.
8. The Agency's official position on interest deductibility will be published when a new Interpretation Bulletin is issued, which should result in, among other things, the cancellation of Interpretation Bulletin IT-445.
9. In order for a taxpayer to deduct interest under paragraph 20(1)(c), the interest must relate to a loan used to earn income from a business or property. In Ludco, the Supreme Court indicated that this condition must be established at the time the property is acquired. In our opinion, the taxpayer could deduct the interest owed to the Bank if it can demonstrate that, at the time it made the advance to the subsidiary, it had an expectation of income from the shares. If it can so demonstrate, the interest will be deductible pursuant to paragraph 20(1)(c). In addition, the provisions of subsection 20.1(1) may be applicable if there is a disposition of the shares.
10. Given that the Agency has not yet taken a definitive position on interest deductibility, we suggest that you wait for the publication of the new Interpretation Bulletin on interest deductibility before undertaking a reassessment.
ACCESS TO INFORMATION
11. For your information, a copy of this memorandum will be severed using the Access to Information Act and will be available in the Legislative Access Database (LAD) located on the mainframe of the Canada Customs and Revenue Agency. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the Legislative Access Bank version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy that has been severed in accordance with the Privacy Act will be sent to you for delivery to the client.
We hope that you find these comments of assistance.
Manager
Financing and Plans Section
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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