Upstream Loans Disadvantage Corporate Members of a Partnership

The upstream loan rules in subsections 90(6) through (15) effectively treat loans from a foreign affiliate in a manner equivalent to dividends. If a foreign affiliate is held through a partnership and a loan is made by the foreign affiliate to a corporate partner, an income inclusion results for each of the partners rather than just for the partner that received the loan. Depending on the situation, practitioners should consider drafting the partnership agreement so that any income with respect to an upstream loan is allocated specifically to the member that received the loan, as opposed to the general allocation of income in the partnership.

Assume that Canco 1 and Canco 2 are Canadian-resident corporations acting at arm's length, and that each holds an equal interest in a partnership. The partnership holds all of the outstanding shares of a foreign corporation (Forco). Forco makes a $1,000 loan to Canco 1, which is not repaid within two years. Forco has exempt surplus of $500, and the ACB of the shares of Forco held by the partnership is $200.

As a result of the deeming rule in subsection 93.1(1), Forco is a foreign affiliate of Canco 1 and Canco 2. Thus, for the purposes of subsection 90(6), Canco 1 is a specified debtor because it has received a loan from its foreign affiliate. Therefore, the specified amount of $1,000 should be included in computing the income of the relevant taxpayer for the year. The relevant taxpayer appears to be the partnership because (1) under subsection 96(1), a partnership is deemed to be a taxpayer for computing taxable income, and (2) the definition of "specified debtor" in subsection 90(15) refers to situations where "the taxpayer is a partnership." Assuming that the partnership agreement states that income is to be allocated on the basis of each partner's respective interest in the partnership, both Canco 1 and Canco 2 are deemed to have an income inclusion of $500 (despite Canco 2 not having received a loan from Forco).

For this purpose, the taxpayer's surplus entitlement percentage in the creditor affiliate (Forco) is determined without reference to the partnership lookthrough rule in regulation 5908(1). In the example, this prevents an income inclusion at both the partnership level and the corporate partner level.

What amounts are deductible against the $500 inclusions? In the example, subsection 90(9) allows deductions for the exempt surplus of Forco. Further, subsection 90(10) requires that the subsection 90(9) deductions be allocated to the corporate partners in a manner consistent with the determination of their share of partnership income under subsection 96(1)—here, one-half to each partner. Applying the one-half to Forco's exempt surplus of $500, Canco 1 and Canco 2 can each deduct $250. (Pursuant to paragraph 90(10)(b), the pre-acquisition surplus deduction that is otherwise available to corporations under subsection 90(9) is not available to corporate partners.) As noted above, each of Canco 1 and Canco 2 has an income inclusion of $500, so each has a net income inclusion of $250.

Note that if Forco were held directly by Canco 1 and Canco 2 rather than through a partnership, the upstream loan inclusion of $1,000 under subsection 90(6) would all go to Canco 1. Canco 1 would then be able to deduct its $250 share of Forco's exempt surplus, and $100 of pre-acquisition surplus, for a net income inclusion of $650. Canco 2 would have no corresponding income inclusion.

Michael Spinelli and Karthika Ariyakumaran
KPMG LLP, Toronto

Canadian Tax Focus
Volume 8, Number 4, November 2018
©2018, Canadian Tax Foundation