Principal Issues: Whether an assessment in respect of foreign accrual property income (FAPI) can be considered, pursuant to subparagraph 152(4)(b)(iii), to be made as a consequence of a transaction involving the taxpayer and a non-resident person with whom the taxpayer was not dealing at arm's length whereby the taxpayer transferred its marketable securities to the said non-resident person in exchange for the issuance of shares and a loan.
Position: Yes.
Reasons: In such a case, the capital invested by the taxpayer (marketable securities) was used by the foreign affiliate to earn FAPI such that there is a direct causal connection between the transaction of investing in the foreign affiliate and the FAPI income of the foreign affiliate pursuant to subparagraphs 152(4)(b)(iii) and 152(4.01)(b)(iii).
August 13, 2018
XXXXXXXXXX Headquarters International and Large Business Auditor Income Tax Rulings Directorate Canada Revenue Agency Sophie Larochelle XXXXXXXXXX (514) 283-2309
2018-076361
Subparagraph 152(4)(b)(iii) and Ho v. The Queen, 2010 TCC 325
XXXXXXXXXX,
This is in response to your email of June 6, 2018 in which you asked us to confirm our position, as set out in Technical Interpretation 2000-000268, that an assessment attributing foreign accrual property income ("FAPI" ) may be made before the day that is three years after the end of the normal reassessment period applicable to the taxpayer, pursuant to subparagraphs 152(4)(b)(iii) and 152(4.01)(b)(iii) of the Income Tax Act (the "Act"), where there is a causal link between the FAPI earned by a foreign affiliate ("FA") and the taxpayer's investment in the shares of that FA. In addition, you wish to know the impact of the decision of the Tax Court of Canada in Ho v. The Queen, TCC 325 on our stated position.
Unless otherwise indicated, all statutory references herein are to the provisions of the Act.
Submitted Facts
Our understanding of the relevant facts can be summarized as follows:
- The taxpayer ("Holdco" or "Taxpayer") is a taxable Canadian corporation which qualifies as a Canadian-controlled private corporation that was incorporated on XXXXXXXXXX under the Canada Business Corporations Act;
- Holdco's taxation year-end is XXXXXXXXXX;
- Holdco was the sole shareholder of a controlled foreign affiliate ("ForeignCo") formed under the laws of XXXXXXXXXX, until its dissolution on XXXXXXXXXX; ForeignCo was incorporated as "XXXXXXXXXX" under XXXXXXXXXX;
- On XXXXXXXXXX, ForeignCo issued common shares to Holdco in exchange for Cdn.$XXXXXXXXXX;
- On XXXXXXXXXX, Holdco transferred to ForeignCo marketable securities (the "Marketable Securities") valued at Cdn.$XXXXXXXXXX in exchange for common shares and a note;
- On XXXXXXXXXX, the note was exchanged for redeemable preferred shares ("Preferred Shares");
- ForeignCo did not pay any dividends before XXXXXXXXXX;
- On XXXXXXXXXX, ForeignCo exchanged a portion of its Preferred Shares for common shares;
- Towards the end of the XXXXXXXXXX year, ForeignCo received a loan from XXXXXXXXXX of Cdn.$XXXXXXXXXX which was fully repaid in XXXXXXXXXX;
- On XXXXXXXXXX, ForeignCo redeemed Preferred Shares for Cdn.$XXXXXXXXXX.
- ForeignCo's activities were principally the management of the Marketable Securities transferred to it by Holdco on capital account;
- ForeignCo's income earned from XXXXXXXXXX to XXXXXXXXXX was derived from investments and all funds used in its operations were derived from its capital.
Question
You wish to know if the Minister may, despite the expiration of the normal assessment period and by virtue of subparagraphs 152(4)(b)(iii) and 152(4.01)(b)(iii), reassess the Taxpayer for its taxation years ending on XXXXXXXXXX, in order to include the income earned by ForeignCo as FAPI.
Our Comments
Subparagraph 152(4)(b)(iii) permits adding an additional three years to the normal reassessment period respecting a taxation year for assessments or reassessments made as a consequence of a transaction involving the taxpayer and a non-resident person with whom the taxpayer was not dealing at arm’s length. Subparagraph 152(4.01)(b)(iii) specifies the circumstances in which the Minister may make such an assessment beyond the normal reassessment period, being where such assessment can reasonably be regarded as relating to a transaction referred to in subparagraph 152(4)(b)(iii). In that regard, there must be a causal link between the transaction in question and the adjustment effected by the assessment or reassessment for the year in question. Thus, whether it is reasonable to consider that an assessment for FAPI relates to a transaction between the taxpayer and a non-resident person with whom it was not dealing at arm's length is a question of fact.
We consider that the term "transaction" in subparagraph 152(4)(b)(iii) refers to any business or investment transaction between the taxpayer and the non-resident. By the same token, we are of the same opinion as the Tax Court of Canada in Ho v. The Queen, 2010 TCC 325 ("Ho") that the term "transaction" for purposes of subparagraph 152(4)(b)(iii) cannot refer to an attribution of income arising from certain provisions of the Act, such as section 91, which attributes FAPI as income earned by a non-resident corporation, since no business activity is carried on in relation to the application of that provision. However, the issue in Ho was limited to that of whether the FAPI attribution was a transaction between the taxpayer and a related non-resident corporation for the purposes of subparagraph 152(4)(b)(iii). We are of the view that the fact that a FAPI attribution by virtue of the Act does not constitute a "transaction" does not preclude a transaction from reasonably giving rise to an assessment under which FAPI is attributed.
Indeed, our position, as set out in Technical Interpretations 2000-000268 and 2000-0030737, remains to the effect that where there is a causal link between the FAPI earned by an FA and the taxpayer's investment in the capital stock of that FA, and where the shares have been acquired by the taxpayer directly from the FA, the adjustment attributable to FAPI arising from the assessment or reassessment can reasonably be considered to have been made as a result of a transaction (the investment in the FA) between the taxpayer and a related non-resident corporation (the FA). That position is, moreover, accepted by analogy in the case of Labow v. The Queen, 2011 FCA 305 where the Federal Court of Appeal recognized that contributions made by a taxpayer to a non-resident trust were in themselves transactions from which arose the income earned in the trust giving rise to the reassessments, thereby permitting the application of subparagraph 152(4)(b)(iii).
Based on the particular facts set out above, the reassessments would be attributable to FAPI arising directly from the contribution by the Taxpayer of the Marketable Securities to ForeignCo which, in our view, would be a "transaction" between Holdco and ForeignCo referred to in subparagraph 152(4)(b)(iii) that it would be reasonable to consider as relating to the reassessments for purposes of subparagraph 152(4.01)(b)(iii).
Finally, it should be noted that the 2018 federal budget proposes to clarify the scope of subparagraph 152(4)(b)(iii) by expanding the situations where the three-year extended reassessment period for income earned in respect of a FA of a taxpayer may apply, by removing the need for a causal link between the transaction and the assessment. That measure, once proposed and adopted, will apply to a taxpayer's taxation years beginning on or after February 27, 2018.
Unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the taxpayer. The taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca. A copy will be sent to you for delivery to the taxpayer.
We hope that the above comments will be of assistance.
Best regards,
Nicolas Bilodeau
for the Director of the International Operations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch