1993 CANADIAN PETROLEUM TAX SOCIETY
LOANS TO NON-RESIDENTS
QUESTION 4
Paragraph 17(3) of the Income Tax Act provides an exception to Paragraph 17(1) if the loan is made to a subsidiary controlled corporation that uses the funds in its business for the purpose of gaining or producing income. Consider the following situation:
ParentCo is a taxable Canadian corporation that holds a 100% interest in a United States subsidiary corporation, ("US HoldCo"). US HoldCo in turn holds a 100% interest in another United States corporation ("US OpCo"), a corporation with no activities or assets other than those related to the conduct by it of an active business in the United States. ParentCo makes a non-interest bearing loan to US HoldCo. which then uses the funds to make a second loan to US OPCO, which second loan bears interest at commercial rates. US HoldCo's only sources of income are interest and dividend payments received from US OpCO.
(a) Would Paragraph 17(3) apply to the loan between ParentCo and US Hold Co?
(b) Would the answer be different if US HoldCo and US OpCO filed consolidated returns?
(c) If US HoldCo used the funds to invest in more shares of US OpCo (instead of making a loan to US OpCo) would Paragraph 17(3) apply to the loan between ParentCo and US HoldCo?
DEPARTMENT'S POSITION
The answer to the above three questions is no. These queries are similar to question 10 of the Revenue Canada Round Table in the 1988 Conference Report of the Canadian Tax Foundation and our position remains the same.
a) It has been the Department's position not to look to the end user of the funds in determining whether the money was used in a business for the purposes of Paragraph 17(3) of the Act. (i.e. US HoldCo must use the money in its business for the purpose of producing income to be exempt from the provisions of Paragraph 17(1) of the Act.) Whether the principal activity of US HoldCo can be construed as a business is normally a question of fact to be determined at the particular time.
b) In our opinion the ability to file consolidated returns in a foreign jurisdiction does not alter the use made of the borrowed money by the borrower. Paragraph 17(3) of the Act makes an exception to the application of 17(1) when "the money that was loaned was used in the subsidiary corporation's business"...
c) When a subsidiary controlled corporation (US HoldCo) uses money that is borrowed from its parent to invest in shares of its subsidiary (US Opco) for the purpose of receiving dividends, the department would not consider such investment to be part of the business of US HoldCo.