Principal Issues: What is the requisite degree of linkage, between a debt owing by the taxpayer to a creditor and a secondary obligation existing between that creditor (or someone not dealing at arm's length with that creditor) and certain non-residents, sufficient to potentially engage subsection 18(6.1) and 212(3.2), respectively?
Position: It is a question of fact, which can only be determined after a review of all of the facts and circumstances applicable to the particular situation. However, the "Clause B causality test" in subsections 18(6) and 212(3.1) should, in our view, be interpreted broadly enough to fulfill the policy intent of the new back-to-back loan rules as described in the 2014 Budget Plan.
Reasons: A textual, contextual and purposive approach should be used to determine the meaning of words in the Income Tax Act. Furthermore, there is similarity between the language in subsections 17(2), 18(6) and 212(3.1)
2015 International Fiscal Association Conference
CRA Roundtable
Question 5 - Back-to-back loans: Interpretation of "because" test
The new back-to-back loan rules in subsections 18(6) and 212(3.1) of the Income Tax Act ("the Act") include a "because" test as the requisite degree of linkage, between a debt owing by the taxpayer to a creditor and a secondary obligation existing between that creditor (or someone not dealing at arm's length with that creditor) and certain non-residents, sufficient to potentially engage subsections 18(6.1) and 212(3.2), respectively. Can the CRA comment on how it interprets the "because" test?
CRA Response
The 2014 Budget Plan described the policy intent of the new "back-to-back loan" rules in subsections 18(6) and 212(3.1) as being specific anti-avoidance rules intended to curtail taxpayers from avoiding, through the use of so-called "back-to-back loan" arrangements, either or both the thin capitalization rules (including the then existing anti-avoidance provision in those rules) and Part XIII withholding tax on interest. The so-called "back-to-back loan" arrangements were described as generally involving the interposition of a third party (e.g., a foreign bank) between two related taxpayers (such as a foreign parent corporation and its Canadian subsidiary) in an attempt to avoid the application of rules that would apply if a loan were made, and interest paid on the loan, directly between the two taxpayers.
With regard to your question, clause (B) of each of subparagraphs 18(6)(c)(i), 18(6)(c)(ii), 212(3.1)(c)(i) and 212(3.1)(c)(ii) describes the degree of linkage between a debt and a secondary obligation (or a specified right as the case may be) sufficient to potentially engage subsection 18(6.1) or subsection 212(3.2) (herein the "Clause B causality tests").
In any particular situation, the determination of whether a Clause B causality test is met would be a question of fact, which can only be determined after a review of all of the facts and circumstances applicable to the particular situation.
That being said, the Department of Finance expressed, in the October 2014 Explanatory Notes to subsection 212(3.1), that the conditions listed in paragraph 212(3.1)(c) closely mirror those in paragraph 18(6)(c) and that for examples as to the application of 212(3.1)(c), one should see the commentary on paragraph 18(6)(c). As such, the CRA will interpret the Clause B causality tests in both of these provisions in the same manner and broadly enough to fulfill the policy intent of the new back-to-back loan rules as described in the 2014 Budget Plan. We would anticipate that, generally, in a case where a third party intermediary is interposed between two related taxpayers principally for the purpose of avoiding the application of subsection 18(4) or Part XIII tax on interest, that on an examination of the facts, we would find that there is sufficient linkage between the two debt instruments involved to engage the new rules.
We observe that subsection 17(2) dealing with indirect loan arrangements sufficient to engage subsection 17(1) contains a causality test much like the Clause B causality tests. Although the Income Tax Rulings Directorate has not previously opined on this test in subsection 17(2), we are not aware of any reason why it should be interpreted differently than the Clause B causality tests.
Judy Ho
2015-058153
May 28, 2015