This in answer to your memorandum of October 31, 1990.
The Department's position is that subsection 17(1) contemplates an annual and continuous test for purposes of calculating the interest deemed to be received be the lender corporation with respect to the loan made to a non-resident person. It is also our view that subsection 17(3) cannot be interpreted independently of subsection 17(1). Accordingly, in determining whether subsection 17(3) of the Act exempts the application of subsection 17(1) for a particular taxation year, the borrower must be a subsidiary controlled corporation when the loan is made and it is necessary to determine on an annual basis whether during the year the money that was loaned continued to be used in the subsidiary corporation's business for the purpose of gaining or producing income and whether the borrower, during the year, remained a "subsidiary controlled corporation".
In light of the above interpretation with respect to the tests to be met in subsections 17((1) and 17(3) of the Act, we offer the following comments concerning the two issues raised in your memorandum of October 31:
Issue 1
A Canadian corporation (Parentco) made an interest free loan to a second-tier U.S. subsidiary corporation (U.S.Co.2). Subsection 17(1) of the Act applied. Later U.S.Co.2 merged with the first-tier U.S. subsidiary corporation (U.S.Co.1) to form Mergco. You queried whether the lender-borrow relationship ceased between Parentco and U.S.Co. and whether one was created between Parentco and Mergco. You also asked whether after the merger the provisions of subsection 17(3) would apply to Parentco with respect to the "loan" to Mergco.
As we understand it, under most U.S. corporate statutes the assets and the liabilities of the corporation that ceases to exist on the merger are acquired by and become liabilities of the survivor corporation. If the merger is carried out under this common type of statute, U.S.Co.2 will dispose of its assets to and its liabilities will become liabilities of U.S.Co.l. Since the identity of the debtor will change when the liability becomes a liability of U.S.Co.1, the loan between Parentco and U.S.Co.2 would be extinguished and the provisions of subsection 17(1) would cease to apply. The application of subsection 17(3) would not be relevant.
Issue 2
A Canadian corporation (Parentco) had B wholly-owned Canadian subsidiary corporation (Canco) and a wholly-owned U.S. subsidiary corporation (U.S.Co). Canco made an interest free loan to U.S. Co to which subsection 17(1) applied. Parentco and Canco subsequently amalgamated to form Amalco. You asked whether the lender-borrower relationship ceased between Canco and U.S. Co and whether the exception in subsection 17(3) applied to Amalco.
Generally, Canadian corporate law, in most jurisdictions, provides for the flow through of the assets and the liabilities of the predecessor corporation to and the continuation of the predecessor corporations in Amalco. This traditional position is based on the principles set out by the Supreme Court of Canada in The Queen v. Black and Decker Manufacturing Co. Limited, (1975) 1 SRC 411 in which the Court ruled that an amalgamation neither creates a new corporation nor extinguishes an old corporation. However notwithstanding corporate law, paragraph 87(2)(a) of the Act states that the amalgamated entity is deemed for purposes of the Act to be a new corporation. In this respect the various rollover provisions in subsection 87(2) of the Act provide for the flow through of the tax attributes of the predecessor corporations to the new corporation.
With respect to the issue at hand, it would appear that pursuant to paragraph 87)2)(e), assuming that the loan to U.S. Co was capital property of Canco, Amalco would acquire the loan from Canco at Canco's ACB thereof. Based on Banister v. M.N.R. 73 DTC 42, it appears that the lender-borrower relationship between Canco and U.S. Co would be extinguished at the time of acquisition. Subsection 17(1) would therefore have no further application to Canco as of the date of amalgamation.
The foregoing result differs, however, from that obtained under corporate law. Under most Canadian corporate law, it appears that the loan and the lender-borrower relationship between Canco and U.S. Co is not extinguished but rather is continued between Amalco and U.S. Co. Additionally as the amalgamation results in U.S. Co becoming a subsidiary controlled corporation of Amalco, one would tend to look to the relieving provisions of subsection 17(3). However, absent a provision similar to subsection 87(7) to deem Amalco to have made the original loan, as U.S. Co was not a subsidiary controlled corporation at the time the loan was made, Amalco/Canco would continue to be subject to the application of subsection 17(1). 21(1)(b)
21(1)(b)
We trust that our comments will be of assistance to you.
for DirectorReorganisations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch