FA4 and FA5 Subco were US-resident indirect controlled foreign affiliates (CFAs) of Canco in which Canco had a qualifying interest. FA4 owned a 99% limited partnership interest in a US limited partnership (“LP”). Both FA4 and LP owned portfolios which were acquired about the middle of the 2013 taxation year.
The business of LP, FA4 and FA5 Subco consisted mainly of acquiring, owning and collecting portfolios of debt receivables. FA4 had more than 100 employees who managed and operated the activities of FA4, FA5 Subco and LP, and other US group entities, and with the exception of one employee of FA4, these constituted the only employees in that group. LP employed the equivalent of more than five employees full time, taking into consideration the services provided by the employees of FA4.
The Directorate indicated that FA4 appeared to have two separate businesses - a debt portfolio business, and a business of providing services to other foreign affiliates in the group – given inter alia that its services were mostly to other foreign affiliates (in contrast to the arm’s length customers of the debt portfolio business) and thus not principally services rendered to FA4’s own debt portfolio business.
Regarding the directly-related test in s. 95(2)(a)(i)(A)(I) as it applied after the middle of 2013:
[T]he activities of FA5 Subco do not appear to meet the directly related test, as it relates to FA4’s service business, since FA5 Subco can be viewed as a customer of FA4’s services whose activities are not directly related to those of its service provider. Generally, the activities of a customer are detached from the activities of a service provider and one would not necessarily view them as directly related with the active business activities of the service provider, even if the customer depends on these services in carrying on its business. …
[Furthermore] the assets of FA5 Subco are not at risk or employed in support of the service business of FA4.
However, the activities of FA5 Subco were directly related to FA4’s debt portfolio business since their respective debt portfolio activities were integrated activities that required the services of employees that had similar expertise, and they carried on the same type of debt portfolio business.
Furthermore, the prescribed active business earnings requirement in s. 95(2)(a)(i)(B) would also appear to be met, “since the income of FA5 Subco would be included in computing the amount prescribed to be the earnings or loss of FA4, from an active business carried on in a country other than Canada, if the income were earned by FA4.”
Similarly, the directly related test in s. 95(2)(a)(i)(A)(IV) (applicable to the 2014 taxation year) would appear to be satisfied by FA5 Subco in relation to the debt portfolio business of LP for essentially the same reasons – and the prescribed active business earnings requirement in s. 95(2)(a)(i)(B) also appeared to be met, also for similar reasons.
If s. 95(2)(a)(i) applied as described above, so that the services fees paid by FA5 Subco to FA4 were deductible from deemed active business income of FA5 Subco rather than foreign accrual property income, s. 95(2)(b)(i)(B) would not apply to deem such services fees to be FAPI to FA4.