financing of non-residents and the rules under section 17
TRANSCRIPT
Financing of Non-Residents
and the Rules Under
Section 17
May 29, 2010 – June 4, 2010
Evelyn (Evy) MoskowitzMoskowitz & Meredith LLP,
an affiliate of KPMG LLP
Introduction
• Relevant to cross-border financings
where lender/creditor is a Canadian
resident corporation
• Rules result in deemed interest
inclusion to lender/creditor
• Application
• Purpose
• The Rules
- The Old Rules
- The Current Rules
• Anomalies
Introduction
Application of the Rules
Apply to both:
• Direct Loans or Debts
• Indirect Loans or Debts
Application of the Rules
• Direct loan or debt rules apply if:
1 a non-resident person owes an amount to a Canco;
2 the amount owing has been outstanding for more than one year; and
3 interest on the amount owing, computed at a reasonable rate, has not been included in Canco’s income
Application of the Rules
• Indirect loan or debt rules are complex
• Apply to back-to-back type of
transactions
Purpose of the Rules
• To prevent Canco from employing its
capital outside Canada by way of
non-interest bearing loans or low
interest loans
• Otherwise Canco able to avoid
Canadian tax on all or part of income
derived from such capital
Section 17 Rules
Direct Loan or
Debt Rules
Section 17 Rules
Direct Loan or
Debt RulesIndirect Loan
or Debt Rules
Section 17 Rules
Direct Loan or
Debt Rules
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
Part XIII
Exception
ss. 17(7)
ss. 17(2)*
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
Part XIII
Exception
ss. 17(7)
ss. 17(2)*
Trade
Receivables
Exception
ss. 17(9)
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
Part XIII
Exception
ss. 17(7)
ss. 17(2)*
Trade
Receivables
Exception
ss. 17(9)
SCC
Exception
ss. 17(3)*
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
Part XIII
Exception
ss. 17(7)
ss. 17(2)*
Trade
Receivables
Exception
ss. 17(9)
SCC
Exception
ss. 17(3)*
CFA
Exception
ss. 17(8)
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
Part XIII
Exception
ss. 17(2)*
ss. 17(7)
Trade
Receivables
Exception
ss. 17(9)
SCC
Exception
ss. 17(3)*
CFA
Exception
ss. 17(8)
Section 17 Rules
Charging
Provision
ss.17(1)
Direct Loan or
Debt Rules
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
• Amount Subject to s. 17
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
• Amount Subject to s. 17
• The Lender
Section 17 Rules
Direct Loan or
Debt Rules• Amount Subject to s. 17
• The Lender
• The Borrower
Charging
Provision
ss.17(1)
Section 17 Rules
Charging
Provision
ss.17(1)
• Amount Subject to s. 17
• The Lender
• The Borrower
• The Imputed Amount
Direct Loan or
Debt Rules
Section 17 Rules
Direct Loan or
Debt Rules
Indirect Loan
or Debt Rules
Section 17 Rules
Indirect Loan
or Debt Rules
Section 17 Rules
Indirect Loan
or Debt Rules
Charging
Provision
ss. 17(2)
Section 17 Rules
Indirect Loan
or Debt Rules
Charging
Provision
ss. 17(2)
CFA
Exception
p. 17(3)(a)
Section 17 Rules
Indirect Loan
or Debt Rules
Charging
Provision
ss. 17(2)
CFA
Exception
p. 17(3)(a)
Exempt
Loan or
Transfer
Exception
ss. 17(2) &
17(15)
Section 17 Rules
Indirect Loan
or Debt Rules
Charging
Provision
ss. 17(2)
CFA
Exception
p. 17(3)(a)
Exempt
Loan or
Transfer
Exception
ss. 17(2) &
17(15)
Arm’s
Length
Indebtedness
Exception
p. 17(3)(b)
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
• Amount Subject to s. 17
• The Lender
• The Borrower
• The Imputed Amount
Amount Subject to Section 17
Old Rules:
• Only applied to loans
• Not all indebtedness is a loan
Loan versus Debt
• A purchases property from B
• A issues note to B for portion of purchase price
• Amount owing by A to B is not a loan. It is a debt.
Loan versus Debt
• A makes loan to B
• A assigns loan to C
• Amount owing by B to C is not a loan. It is a debt.
Amount Subject to Section 17
Current Rules:
• Apply to all amounts owing
• Therefore all indebtedness, whether in the form of loan or debt, caught
• Relationship between non-resident and Canco can be either borrower/lender or debtor/creditor
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
• Amount Subject to s. 17
• The Lender
• The Borrower
• The Imputed Amount
The Lender
Old Rules:
• Only applied where lender was a
Canadian resident corporation
• Did not apply if lender was an
individual, a partnership or a trust
Current Rules:
• Also only apply where lender/creditor
is a Canadian resident corporation
BUT
• Look-through rules for partnerships
and trusts
[ss. 17(4) & 17(5)]
The Lender
• Each partner or beneficiary deemed
to have lent, or to be owed, a
proportionate amount of loan or debt
• Proportion deemed to be owing on
same terms as apply to full amount
owing
Look-Through Rules Partnerships and Non-Discretionary Trusts
• Proportion is:FMV of partner’s/beneficiary’s interest
FMV of all interests
• Section 17 only applies to that proportion of the loan or debt that is deemed made by, or owing to, a partner or beneficiary that is a Canadian resident corporation
Continued:
Look-Through Rules Partnerships and Non-Discretionary Trusts
Continued:
• If trust is a discretionary trust,
different look-through rules apply
Look-Through Rules Discretionary Trusts
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
• Amount Subject to s. 17
• The Lender
• The Borrower
• The Imputed Amount
Old Rules:
• Could have been any non-resident
“person”
• Did not include a partnership
The Borrower
The Borrower
Current Rules:
• Look-through rule for borrower partnerships [ss.17(6)]
• Similar to look-through rule for lender partnerships
The Borrower
• Proportion deemed to be owing on same terms as full amount owing
• Section 17 only applies to proportion deemed owing by a non-resident partner
Continued:
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
• Amount Subject to s. 17
• The Lender
• The Borrower
• The Imputed Amount
The Imputed Amount
Old Rules:
• Interest at prescribed rate
• No credit for interest actually received
• Retroactive application
Current Rules:
• No retroactive application
• Credit for actual interest received
• Credit for trust amounts
The Imputed Amount
The Imputed Amount
Individual
Individual Canco
Non-Discretionary Trust
The Imputed Amount
Individual
Individual Canco
Non-Discretionary Trust Non-Resident
$30 of interest
$3,000 loan at 1%Assumptions:
• Reasonable rate is 6%
• Prescribed rate is 6%
• Beneficiaries share equally
The Imputed Amount
$30 of interest
$3,000 loan at 1%
Non-Resident
$1000
Deemed Loan
Section 17
inclusion of $60
Assumptions:
• Reasonable rate is 6%
• Prescribed rate is 6%
• Beneficiaries share equally
Individual
Individual Canco
Non-Discretionary Trust
The Imputed Amount
Current Rules:
• No retroactive application
• Credit for actual interest received
• Credit for trust amounts
The Imputed Amount
Current Rules:
• No retroactive application
• Credit for actual interest received
• Credit for trust amounts
• Credit for FAPI
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
Part XIII
Exception
ss. 17(7)
ss. 17(2)*
Trade
Receivables
Exception
ss. 17(9)
SCC
Exception
ss. 17(3)*
CFA
Exception
ss. 17(8)
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
Part XIII
Exception
ss. 17(7)
ss. 17(2)*
Trade
Receivables
Exception
ss. 17(9)
SCC
Exception
ss. 17(3)*
CFA
Exception
ss. 17(8)
CFA Exception
Direct Loan or
Debt Rules
CFA
Exception
ss. 17(8)
CFA Exception
Direct Loan or
Debt Rules
CFA
Exception
ss. 17(8)
CFA Status
CFA Exception
Direct Loan or
Debt Rules
CFA
Exception
ss. 17(8)
CFA Status Use Test
CFA Exception
Direct Loan or
Debt Rules
CFA
Exception
ss. 17(8)
CFA Status Use Test
CFA Exception Controlled Foreign Affiliate Status
Two Tests
CFA Exception Controlled Foreign Affiliate Status
Two Tests
Foreign Affiliate Test
CFA Exception Controlled Foreign Affiliate Status
Two Tests
Foreign Affiliate Test Control Test
CFA Exception Controlled Foreign Affiliate Status
Two Tests
Foreign Affiliate Test Control Test
CFA Exception Controlled Foreign Affiliate Status
Two Tests
Foreign Affiliate Test Control Test
CFA Exception Controlled Foreign Affiliate Status
Two Tests
Foreign Affiliate Test Control Test
1% Threshold
CFA Exception Controlled Foreign Affiliate Status
Two Tests
Foreign Affiliate Test Control Test
1% Threshold
10% Threshold
Foreign Affiliate Examples
Canco
NRC
10% Class A
Example 1:
Foreign Affiliate Examples
Canco Related
Person(s)
NRC
1%
Class A9%
Class B
Example 2:
Foreign Affiliate Examples
Canco
Holdco
NRC
50%
20%
Example 3:
Two Tests
Foreign Affiliate Test Control Test
1% Threshold
10% Threshold
CFA Exception Controlled Foreign Affiliate Status
Two Tests
Foreign Affiliate Test Control Test
1% Threshold
10% Threshold
Actual Control by Canco alone
Deemed Control by
Canco if aggregate all
shares owned by:
CFA Exception Controlled Foreign Affiliate Status
1. Canco 2. Persons NAL to Canco
3. Four or fewer Cdns (other than 1 or 2)
4. Persons NAL with any person in 3
Two Tests
Foreign Affiliate Test Control Test
1% Threshold
10% Threshold
Actual Control by Canco alone
Deemed Control by
Canco if aggregate all
shares owned by:
CFA Exception Controlled Foreign Affiliate Status
1. Canco 2. Persons NAL to Canco
3. Four or fewer Cdns (other than 1 or 2)
4. Persons NAL with any person in 3
• Four modifications to CFA concept for section 17 purposes:
1 Must be Canadian- controlled
2 Related Controlled Foreign Affiliate Rule [ss. 17(13)]
3 Look-Through Rules [ss. 17(10) to 17(12)]
4 Anti-Avoidance Rules [ss. 17(14)]
CFA Exception Controlled Foreign Affiliate Status
• Four modifications to CFA concept for section 17 purposes:
1 Must be Canadian- controlled
2 Related Controlled Foreign Affiliate Rule [ss. 17(13)]
3 Look-Through Rules [ss. 17(10) to 17(12)]
4 Anti-Avoidance Rules [ss. 17(14)]
CFA Exception Controlled Foreign Affiliate Status
• Four modifications to CFA concept for section 17 purposes:
1 Must be Canadian- controlled
2 Related Controlled Foreign Affiliate Rule [ss. 17(13)]
3 Look-Through Rules [ss. 17(10) to 17(12)]
4 Anti-Avoidance Rules [ss. 17(14)]
CFA Exception Controlled Foreign Affiliate Status
• Four modifications to CFA concept for section 17 purposes:
1 Must be Canadian- controlled
2 Related Controlled Foreign Affiliate Rule [ss. 17(13)]
3 Look-Through Rules [ss. 17(10) to 17(12)]
4 Anti-Avoidance Rules [ss. 17(14)]
CFA Exception Controlled Foreign Affiliate Status
• Four modifications to CFA concept for section 17 purposes:
1 Must be Canadian- controlled
2 Related Controlled Foreign Affiliate Rule [ss. 17(13)]
3 Look-Through Rules [ss. 17(10) to 17(12)]
4 Anti-Avoidance Rules [ss. 17(14)]
CFA Exception Controlled Foreign Affiliate Status
CFA Modifications Related Controlled Foreign Affiliate Rule
• A CFA of a Canadian corporation
related to Canco will also be a CFA
of Canco
CFA Modifications Related Controlled Foreign Affiliate Rule
Parent
Canco 1 Canco 2
CFA 1 CFA 2
Section 17 Rules
Direct Loan or
Debt Rules
Charging
Provision
ss.17(1)
Part XIII
Exception
ss. 17(7)
ss. 17(2)*
Trade
Receivables
Exception
ss. 17(9)
SCC
Exception
ss. 17(3)*
CFA
Exception
ss. 17(8)
CFA Exception
Direct Loan or
Debt Rules
CFA
Exception
ss. 17(8)
CFA Status Use Test
CFA Exception
Direct Loan or
Debt Rules
CFA
Exception
ss. 17(8)
CFA Status Use Test
CFA ExceptionUse Test
• CFA must use loan/debt proceeds in its
active business
• Active business defined in ss. 95(1)
• Does not include an investment business
• If not used in its own business, CFA may generally on-lend or pay over funds to another non-resident corporation (or, possibly, a partnership)
• Other non-resident corporation must be a foreign affiliate of Canco in which Canco has a qualifying interest (or a partnership of which such foreign affiliate, or the CFA, is a “qualifying member”)
CFA ExceptionUse Test
• Loan to second-tier borrower may be
interest-bearing or interest-free
depending on the circumstances
• Relationship of second-tier borrower
to Canco will also differ depending on
the circumstances
CFA ExceptionUse Test
Continued:
CFA ExceptionUse Test
Continued:
• Use Test far more complicated than it
appears on its face
• Incorporates by reference many of
the requirements of the foreign
affiliate regime
Section 17 Rules
Indirect Loan
or Debt Rules
Section 17 Rules
Indirect Loan
or Debt Rules
Charging
Provision
ss. 17(2)
CFA
Exception
p. 17(3)(a)
Exempt
Loan or
Transfer
Exception
ss. 17(2) &
17(15)
Arm’s
Length
Indebtedness
Exception
p. 17(3)(b)
Indirect Loan or Debt Rules Charging Provisions
Need at least 3 parties:
• A Canco
• An Intermediary (can’t be a Canco)
• A Non-Resident Borrower/Debtor
Indirect Loan or Debt Rules Charging Provisions
Then 2 conditions:
1 Non-Resident Borrower/Debtor (the
“Second-Tier Borrower”) must owe an
amount to the Intermediary
AND
Indirect Loan or Debt Rules Charging Provisions
2 Must be reasonable to conclude thatamount became owing because aCanco transferred or loanedproperty to any person
Continued:
i.e., must be causal link (cash flow or
otherwise) between Canco’s transfer or
loan and the amount owing by the Second-
Tier Borrower
Indirect Loan or Debt Rules Charging Provision
• This deemed loan or debt is the indirect loan or debt
• Indirect loan or debt now must be analyzed as a direct loan or debt under ss. 17(1)
• If these conditions satisfied Second-
Tier Borrower deemed to owe to
Canco an amount equal to amount
owed to the Intermediary
loan
USco
Canco
100% 100%
100%
CFA US Opco
shares
Subsection 17(2) Example
loan
USco
Canco
100% 100%
100%
CFA US Opco
shares
Subsection 17(2) Example
loan
USco
Canco
100% 100%
100%
CFA US Opco
shares
Subsection 17(2) Example
loan
USco
Canco
100% 100%
100%
CFA US Opco
shares
deemed loan
Subsection 17(2) Example
Indirect Loan or Debt Rules Charging Provision
• Does not deem amount owing by Second-Tier Borrower to Intermediary to instead be owing to Canco
• Indirect Loan or Debt Rules override look-through rules in ss. 17(4) & 17(5)
$30 of interest
$3,000 loan at 1%
Non-Resident
$1000
Deemed Loan
Section 17
inclusion of $60
Individual
Individual Canco
Non-Discretionary Trust
Indirect Loan or Debt Rules Charging Provision
loan
USco
Canco
100% 100%
100%
CFA US Opco
shares
Subsection 17(2) Example
Section 17 Rules
Indirect Loan
or Debt Rules
Charging
Provision
ss. 17(2)
CFA
Exception
p. 17(3)(a)
Exempt
Loan or
Transfer
Exception
ss. 17(2) &
17(15)
Arm’s
Length
Indebtedness
Exception
p. 17(3)(b)
Section 17 Rules
Indirect Loan
or Debt Rules
Charging
Provision
ss. 17(2)
CFA
Exception
p. 17(3)(a)
Exempt
Loan or
Transfer
Exception
ss. 17(2) &
17(15)
Arm’s
Length
Indebtedness
Exception
p. 17(3)(b)
Indirect Loan or Debt Rules CFA Exception
• Not to be confused with CFA
exception in ss. 17(8)
• Requires that both the Intermediary
and Second-Tier Borrower be CFA’s
of Canco
• Found in p. 17(3)(a)
Section 17 Rules
Indirect Loan
or Debt Rules
Charging
Provision
ss. 17(2)
CFA
Exception
p. 17(3)(a)
Exempt
Loan or
Transfer
Exception
ss. 17(2) &
17(15)
Arm’s
Length
Indebtedness
Exception
p. 17(3)(b)
Indirect Loan or Debt RulesExempt of Loan or Transfer Exception
• Focuses on relationship between Canco and Person A
USco
Canco
100% 100%
100%
CFA US Opcoloan
shares
Indirect Loan or Debt RulesExempt of Loan or Transfer Exception
Indirect Loan or Debt RulesExempt of Loan or Transfer Exception
• Loan with arm’s length rate of interest
• Transfer of property or payment of
amount if on arm’s length terms (does
not apply to transfers for shares of a FA)
• Payment of a dividend
• Return of paid-up capital
USco
Canco
100% 100%
100%
CFA US Opcoloan
Exempt
Loan or
Transfer
shares
Indirect Loan or Debt RulesExempt of Loan or Transfer Exception
Section 17 Rules
Indirect Loan
or Debt Rules
Charging
Provision
ss. 17(2)
CFA
Exception
p. 17(3)(a)
Exempt
Loan or
Transfer
Exception
ss. 17(2) &
17(15)
Arm’s
Length
Indebtedness
Exception
p. 17(3)(b)
• Found in p. 17(3)(b)
• Focuses on transaction between the
Non-Resident Borrower/Debtor and the
Intermediary
Indirect Loan or Debt RulesArm’s Length Indebtedness Exception
USco
Canco
100% 100%
100%
CFAloan
shares
Arm’s Length Indebtedness
Exception
US Opco
Indirect Loan or Debt RulesArm’s Length Indebtedness Exception
• Requires that:
- parties be unrelated
- terms of the indebtedness be arm’s
length
- interest on the indebtedness, if it
were payable, would not be FAPI of
an FA of Canco
Indirect Loan or Debt RulesArm’s Length Indebtedness Exception
Double Taxation
CancoRelated Non-
Resident
NRC “A”
NRC “B”
100%
5% 95%
$100
Loan 1
(interest-
free)
$100
Loan 2
(interest-
free)
Multiple Taxation/Multiple Cancos
Canco 1
Canco 2
Related Non-
Resident100%
$100
Loan 1A
(interest-
free)
NRC “A”5% 95%
$100
Loan 1B
(interest-
free)
NRC “B”
100%$100
Loan 2
(interest-
free)