In 2012-0461651I7, the CRA said that the general anti-avoidance rule (s. 245) did not apply to a legally-effective plan to transfer income from subsidiaries (each, a Subco) into their parent corporation which had losses (Parent), even though the same result could have been obtained by Parent electing under s. 110.5.
- In the case considered, Parent had profitable foreign branch operations in respect of which Parent was paying foreign tax. Parent also anticipated ordinary losses from certain hedging activities. The effect of these losses would be to reduce Parent’s total income to an amount that was less than its foreign-source income. In such circumstances, Parent’s “Canadian tax otherwise payable” would be less than its foreign taxes paid, which meant that Parent would not be able to claim a full foreign tax credit (under s. 126). This latter circumstance is sometimes referred to as “foreign tax credit wastage attributable to a loss” (see the Department of Finance’s Technical Notes to s. 110.5).
- The rule in s. 110.5 was specifically enacted to allow a corporation (such as Parent) to elect to increase its taxable income in order to avoid this wastage. The additional income under s. 110.5 is treated as non-capital loss (s. 111(8)). The effect is to allow the use of the full foreign tax credit, and to essentially change the current year loss into a non-capital loss available for carryover to other taxation years.
- In the case considered, rather than make a full s. 110.5 election, Parent undertook an in-house loss utilization plan with each Subco that had the effect of generating (interest) income in Parent to be used against Parent’s (hedging) losses, and generating an offsetting interest expense in the Subcos. The intended result was to allow Parent to claim a full foreign tax credit. As it turned out, Parent in fact had to make a (smaller) election under s. 110.5, as the interest income from the Subcos did not fully offset Parent’s (hedging) losses.
- Citing the Department of Finance’s Technical Notes to s. 245, the CRA confirmed that the in-house loss utilization plan was not abusive because the provisions of the Act “clearly permit such transactions between related corporations”. The CRA further said that s. 110.5 cannot be considered to have been abused simply because Parent chose to implement transactions (the in-house loss utilization) that were designed to have the same effect (in Parent) as an election under s. 110.5.