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An Unpaid Amount Could Be an Upstream Loan
Assume that Canco owns a foreign affiliate (FA). Both Canco and FA have
calendar taxation years. On January 1, 2015, FA provides services to
Canco in consideration for a fee. Canco accrues an expense in respect of
the fee and deducts the amount from its taxable income in 2015. If the
expense remains unpaid for years, both subsection 78(1) and subsection
90(6) could potentially apply, subjecting the fee to Canadian tax twice.
Subsection 78(1) generally applies if a deductible expense (interest,
fees, etc.) is not paid by the end of the taxpayer’s second taxation
year following the year in which the expense was incurred, and results
in an income inclusion in the taxpayer’s third taxation year. This
inclusion can be avoided if the taxpayer and the creditor file an
agreement under paragraph 78(1)(b).
The upstream loan rules are designed to prevent Canadian taxpayers from
repatriating funds in an FA group by making long-term loans (which would
not be taxable in Canada) instead of distributions that would be
subject to Canadian tax. The upstream loan rules require an income
inclusion of a “specified amount” in Canada when an FA of a Canadian
taxpayer makes a loan to a person that is a “specified debtor” (which
includes the Canadian taxpayer) and the loan remains outstanding for
more than two years from the day that the loan was advanced or the
indebtedness arose. (Certain surplus and basis offsets may be available
to wholly or partially offset the amount of the inclusion in Canada, but
assume that for the purposes of this example such offsets are not
available.)
On January 2, 2017, if Canco has not settled its account payable, the
upstream loan rules could apply to include the amount of the accrued fee
in Canco’s 2015 income (unless the indebtedness is considered to have
arisen in the ordinary course of the lender’s business). In 2018, if no
paragraph 78(1)(b) agreement is filed and the payable is still
outstanding, Canco may also be required to add the expense back into
income under subsection 78(1). (The CRA’s administrative position that
accrual-basis taxpayers are not subject to subsection 78(1), set out in Interpretation Bulletin
IT-109R2, “Unpaid Amounts,” April 23, 1993, paragraph 15(a), should be
considered.) The fee could then be subject to tax under both subsections
90(6) and 78(1), albeit at different times.
It may be possible to prevent such a double inclusion of the fee—for
example, pursuant to subsection 248(28). Relief under that provision is
permitted “unless a contrary intention is evident.” The fact that
subsections 78(1) and 90(6) have different objectives (namely,
preventing the deductibility of accrued expenses that are not paid
within a reasonable time, and preventing tax-free distributions in
excess of tax attributes) might be evidence of such a contrary intention
and therefore that double taxation is intended. However, the FCA in Holder v. Canada (2004 FCA 188)
seems to stand for the opposite conclusion: the starting point, prima
facie, is no double taxation, and different objectives do not
automatically displace that presumption. In summary, double taxation
does not seem probable, but it remains a risk.
Another way to avoid the double inclusion is to file a paragraph
78(1)(b) agreement. However, it is not clear whether and how subsection
90(6) will apply to the loan that is then deemed to be made to the
taxpayer (Canco) by the creditor (FA) on the first day of the taxpayer’s
third taxation year.
Thus, until the interaction between subsections 78(1) and 90(6) is
clarified, taxpayers and their FAs in situations like the one described
above can avoid uncertainty and complexity by ensuring that unpaid
amounts owing to an FA are settled in a timely manner.
Clara Pham
KPMG LLP, Toronto
claratpham@kpmg.ca
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