Dear Sirs:
We are writing in response to your letter dated January 25, 1991 wherein you requested a technical interpretation on the application of subsection 129(6) of the Income Tax Act (Canada) (the "Act") to the following hypothetical situation:
Facts
1. A and B are brothers and both are residents of Canada.
2. A owns all of the issued and outstanding shares of Aco, a Canadian controlled private corporation ("CCPC"). C.C.P.C., as used here and subsequently, has the meaning assigned by paragraph 89(1)(c) of the Act.
3. B owns all of the issued and outstanding shares of Bco, a C.C.P.C.
4. Aco and Bco each own 50% of all the issued and outstanding shares of ABCO, a C.C.P.C., which carries on an active business in Canada.
5. Aco and ABCO are associated corporations within the meaning of subsection 256(1) of the Act and Bco and ABCO are associated corporations within the meaning of subsection 256(1) of the Act.
6. Each of Aco and Bco have loaned funds to ABCO and charge interest of those loans. The interest paid by ABCO is a tax deductible expense to ABCO pursuant to paragraph 20(1)(c) of the Act and is deductible in computing the income from an active business carried on in Canada by ABCO.
You are of the view that if Aco and Bco elect pursuant to subsection 256(2) of the Act not to be associated with each other for purposes of section 125 of the Act then the interest income earned by each of Aco and Bco on the funds loaned to ABCO will be deemed to be income from a specified investment business. Your view is based upon the fact that the provisions of subsection 129(6) of the Act only applies to associated corporations and Aco and Bco are not associated corporations pursuant to their election under subsection 256(2) of the Act.
We are of the view that since ABCO is associated with Aco then the interest paid by ABCO to Aco would be subject to the provisions of subsection 129(6) whereby the interest would be deemed to be active business income in the hands of Aco. Similarly, the provisions of sub section 129(6) would apply to the interest paid by ABCO to Bco. Whether Aco and Bco are associated with one another is irrelevant in the circumstances described herein since there is no amount being paid by either company to the other that would be subject to the provisions of subsection 129(6) of the Act.
Even if an amount of interest was payable by Aco to Bco or by Bco to Aco it is our opinion that an election by the recipient corporation not to be associated with the payor corporation, by virtue of subsection 256(2) of the Act, would have no effect for purposes of subsection 129(6) of the Act since such an election is valid only for the purposes of section 125 of the Act.
The foregoing comments are given in accordance with the guidelines set out in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990 .
Yours truly,
for Director Reorganizations and Non-Resident Division Rulings Directorate Legislative and Intergovernmental Affairs Branch