| 921411 | |
| Prepared by G. Middleton |
May 21, 1992
Vancouver Round Table
QUESTIONS - 39 and 40
Facts Relating to Questions 39 and 40
A Canadian corporation carries on business in the U.S. through a permanent establishment located in the U.S. (i.e. a U.S. Branch). The taxable income connected with the U.S. business is subject to U.S. corporate income taxes and branch profits taxes. The Canadian corporation also has Canadian business operations which generate taxable income that is subject to Canadian income taxes. The Canadian operations and the U.S. Branch operations are heavily financed with arm's length third party debt.
The following two situations may arise:
I. The Canadian operations are financed by Canadian banks and the U.S. Branch is financed directly by both U.S. and Canadian financial institutions. The Branch pays the interest on its debts and deducts such interest in computing its taxable income for U.S. tax purposes.
II. The entire amount of the debt is financed by a Canadian bank and a portion of the interest on the debt is allocated to, and deducted by, the U.S. Branch in computing its taxable income for U.S. tax purposes. The Branch did not pay any of the interest or principal on this debt. The Canadian Corporation's understanding of the application of the provisions of paragraph 884(f)(1) of the U.S. Internal Revenue Code (the "IRC") is set out below.
Subparagraph 884(f)(1)(A) of the IRC does not levy a tax on the U.S. Branch but it does provide a sourcing rule for the interest paid by the Branch. The rule is that any interest paid by a U.S. Branch will be treated as if it were paid by a domestic (U.S.) corporation. This rule affects Situations I and II above as follows:
In Situation I above, subparagraph 884(f)(1)(A) of the IRC may result in U.S. non-resident tax liabilities and withholding taxes relating to the interest paid by the U.S. Branch to the Canadian financial institutions in respect of the loans owing to those institutions. The net result is that the Canadian financial institutions may have U.S. non-resident tax liabilities and the U.S. Branch may be required to withhold U.S. taxes on the interest payments it makes to such institutions.
In Situation II above, subparagraph 884(f)(1)(A) of the IRC would not apply since the U.S. Branch did not pay any interest on the loan from the Canadian bank. The tax referred to in subparagraph 884(f)(1)(B) of the IRC is commonly called the Branch-Level Interest Tax (the "BLIT"). To the extent that a U.S. Branch has been allocated an interest deduction in excess of the interest actually paid by it in computing its taxable income for U.S. tax purposes, the Branch will be liable for BLIT on such excess interest in the same manner as if the interest was paid to the Branch (i.e. a foreign corporation) by a wholly owned domestic (U.S.) corporation. Subparagraph 884(f)(1)(B) of the IRC affects Situations I and II above as follows:
In Situation I above, there is no excess interest amount allocated to the U.S. Branch; therefore, it would not be liable for any BLIT.
In Situation II above, the entire amount of interest allocated to the U.S. Branch represents the excess referred to in subparagraph 884(f)(1)(B) of the IRC. Accordingly, the U.S. Branch would be subject to BLIT on the entire amount of interest allocated to it.
Question 39
Is the BLIT referred to in subparagraph 884(f)(1)(B) of the IRC considered to be a "business-income tax" as defined in paragraph 126(7)(a) of the Income Tax Act (the "Act") or a "non-business-income tax" as defined in paragraph 126(7)(c) of the Act?
Question 40
If the BLIT does not qualify as a "business-income tax" or a "non-business-income tax" as defined in paragraph 126(7)(a) or (c) of the Act, respectively, is it deductible in computing business income for Canadian income tax purposes?
Department's Position
It is generally not Revenue Canada's position to comment on the application of the taxation laws of other countries and accordingly, the following responses to Questions 39 and 40 are based on the assumption that the Canadian Corporation's understanding of the application of paragraph 884(f)(1) of the IRC is correct.
Question 39
No. The BLIT is not an "income or profits tax" for the purposes of paragraphs 126(7)(a) or (c) of the Act for the simple reason that the BLIT is not imposed on a U.S. Branch's income or profits. Moreover, the BLIT is imposed whether or not a Branch has any profits in a particular year.
Question 40
Yes. The BLIT is considered to be a deductible expense under paragraph 18(1)(a) of the Act on the basis that it is an outlay incurred for the purposes of gaining or producing business income. The BLIT also reduces the U.S. foreign business income for the purposes of calculating any foreign tax credits under section 126 of the Act.