| 921655 | |
| 24(1) | D. Patrick |
| (613) 957-2125 |
Attention: 19(1)
December 3, 1992
Dear Sirs:
Re: Technical interpretation on agreement of factoring accounts receivable
This is in reply to your letter of May 28, 1992 wherein you requested our interpretation in the situation where a taxable Canadian corporation (Canco) "sells" its trade accounts receivable to a U.S. corporation (USco) which is Canco's wholly-owned subsidiary. The two corporations are deemed not to deal at arm's length for purposes of the Income Tax Act, but it is assumed that the transactions that are carried on under the factoring agreement are conducted on an arm's length basis.
Under the factoring agreement, the accounts receivable are "sold" to USco. Receivables which are considered by Canco to be doubtful at the time of a "sale" are not "sold" to USco. Canco makes representation that the accounts sold meet the definition of "eligible receivables".
You have indicated that "Eligible receivables" (which are apparently a defined term under the agreement) are "sold" for their outstanding value, less a factoring fee determined at the date of transfer and agreed upon by the parties. You also advise that the factoring fee is established on an arm's length basis taking into account the quality of the receivables, the interest rate and an estimated collection period. The receivables that are then transferred from Canco to USco are paid by that corporation on the day of the sale or in the immediately following days.
Canco and USco enter into an agreement, whereby Canco agrees to collect the receivables and remit amounts collected to USco. Canco's customers are not advised that their accounts have been sold to another non resident corporation. Under the agreement USco has no recourse, directly or indirectly, against Canco in respect of the receivables, however from the information you have provided, it appears that you intend to make "adjustments" to the face amount of the receivables if they subsequently are determined not to be "Eligible receivables" as defined in the agreement.
Given the above factual scenario you have requested our interpretation of the following two questions:
l. What is Revenue Canada's interpretation in respect of the "sale" of accounts receivable to the non-resident corporation and the applicability of the withholding tax under Part XIII of the Income Tax Act.
2. What are Revenue Canada's comments on the adjustment of the purchase price that could occur under a factoring agreement. In this respect you note that there may be instances where "eligible receivables" subsequently turn out not to meet the definition of "eligible receivables" under the factoring agreement. You point out that sale price adjustments aim at correcting mistakes that were made on the invoices originally sent to the customers, since, otherwise, these accounts would not meet the representations made by the seller relating to the "enforceability" against the debtor. You also state that such a provision would not however cover adjustments that relate to the credit worthiness or the solvency of the debtor nor to other circumstances where, subsequent to its sale to the purchaser, the receivable becomes uncollectible.
The question you have raised based on the above recitation of facts is whether what you have described would be a "sale transaction" as opposed to a "loan transaction". You have argued that since there is an agreement to transfer property between the parties, and the purchaser corporation does not have any recourse for the accounts it purchases, that it would be characterized as a sale rather than a loan. You further argue that since there would not be a lender-borrower relationship, and no interest calculated on a daily basis on an outstanding balance, that the withholding tax under Part XIII of the Income Tax Act would not apply.
Our Comments
Without the benefit of the actual agreements in question your request for an opinion does not contain sufficient facts to enable us to give you a definitive response to your inquiry, however, we wish to give you our general comments on the issue raised in your query.
In our opinion in addition to the question you have posed we would also have to consider whether the foreign subsidiary would be a controlled foreign affiliate of a Canadian taxpayer which is providing financial services, to the Canadian company (which services were deductible in computing the income from the business income of the Canadian company) with the result that any income of the foreign subsidiary would be FAPI income subject to being included in the Canadian Companies income pursuant to paragraph 95(2)(b). In addition it is not certain whether or not the USco would be earning income from an active business or earning income from property, or a business other than an active business.
In determining whether the transaction is a "loan" with the "discount" being considered to be "interest" payable under a loan from the subsidiary to the parent, as opposed to a "sale" of a capital asset will be a question of fact in each case. The true nature of a discount and the reason for giving the discount must be ascertained from all the circumstances of each particular case.
The purpose behind the contractual arrangements, and the relationship between the parties (i.e. a non arms length situation) will be of paramount importance in this determination.
A number of facts may compel the conclusion that the arrangements between the parties is a "loan" as opposed to a "sale", for example, where the amount of the discount is not at the normal rate or terms for discounting of similar types of accounts receivable in similar types of businesses, or for similar types of risks, it may be seen as a loan (or even as a service) of the subsidiary for the benefit of the parent corporation.
Also where the terms of the discounting arrangement suggest that title to the accounts receivable may not in fact have passed (i.e. in situations where the risk factor is reduced or eliminated by the terms of the agreement itself) the so called "sale of the accounts receivable" may in fact be determined to be a "loan secured by a partial assignment of the accounts receivable". Similarity the fact that the Canadian company continues to collect the accounts receivable without notifying the various debtors would tend to indicate that a transfer of title has not actually taken place. Another factor which would tend to point to a transaction being a "loan" as opposed to a "sale" would be the amount of the "eees" earned by the Canadian Company for its services of the collecting the accounts receivable.
The deductibility of the discount to the Canadian Taxpayer, would be subject to the considerations listed in IT Bulletin 188R and must meet the provisions of section 67 and section 69 of the Act.
Furthermore, it is arguable that paragraph 16(1)(a) applies so that the discount is deemed to be interest on a debt obligation held by the non-resident subsidiary and as such is subject to withholding tax pursuant to paragraph 212(1)(b).
Yours truly,
for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch