financing of non-residents and the rules under section 17

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)