Principal Issues: Would a transfer pricing adjustment be made under subsection 247(2) in respect of an interest-free loan made by an individual to a foreign corporation with whom the individual does not deal at arm’s length?
Position: Yes, if all the conditions of application of subsection 247(2) are met.
Reasons: The interest-free loan is entered into between persons not dealing at arm's length.
FEDERAL TAX ROUNDTABLE OCTOBER 7, 2020
APFF CONFERENCE 2020
10. Interest-free loan from an individual to a foreign company - interaction between sections 247 and 17 ITA
The Income Tax Act includes a provision to provide for the inclusion of an amount in the income of a corporation resident in Canada where the corporation makes a loan to a non-resident person and the rate of interest charged by the corporation is less than the rate prescribed in the Income Tax Act. This inclusion is provided for in section 17.
In the March 19, 2019 Federal Budget, the Department of Finance Canada introduced certain clarifications to determine the priority between the rules in Part XVI.1 and other provisions of the Income Tax Act. Under proposed subsection 247(2.1), adjustments under the transfer pricing rules would now be made before the application of any other provision of the Income Tax Act.
An individual who makes an interest-free loan to a non-arm's length foreign corporation is not subject to the rules in section 17 and generally does not have to include an amount in computing income under that provision.
Question to the CRA
Is the CRA of the view that, in the case of an interest-free loan from an individual to a non-resident corporation with which the individual does not deal at arm's length, the individual will be required to include in income an amount equal to the interest that the individual would have received if an arm's length rate had applied in accordance with the provisions of Part XVI.1 of the ITA?
CRA Response
The CRA does not generally comment on proposed legislation. Accordingly, our comments will be limited to the provisions of the Income Tax Act that are currently in force.
Subsection 17(1) generally applies where a non-resident person owes an amount that has been or remains outstanding for more than a year to a related corporation resident in Canada, pursuant to paragraphs 17(1.1)(a) and 17(1.1)(b). For subsection 17(1) to apply, paragraph 17(1.1)(c) further requires the Canadian corporation to include, in computing its income for the year, on account of or in satisfaction of all or part of the interest on the debt, an amount less than the amount of interest that would be included in its income if that interest were computed at a reasonable rate for the period in the year during which the amount was outstanding.
Except in situations of indirect arrangements or loans referred to in subsection 17(2), section 17 generally does not apply to an amount that is owed to an individual.
However, where a taxpayer (including an individual) and a non-resident person with whom the taxpayer does not deal at arm's length enter into a transaction and the terms and conditions between the parties differ from those that would have been entered into between arm's length persons, subsection 247(2) could apply. In such a case, the amounts that would be determined for the purposes of the Income Tax Act in respect of the taxpayer will generally be adjusted to reflect the value or nature of the amounts that would have been determined if the terms and conditions of the transaction had been those that would have been entered into between arm's length persons.
In the scenario presented, we believe that subsection 247(2) would apply and that the individual would be required to include in income an amount of interest equivalent to the adjustment described above, regardless of the proposed addition of subsection 247(2.1).
Yves Grondin
Marie-Claude Routhier
October 7, 2020
2020-085222