Upstream Loans: Limitation on the Scope of the Moneylending Business Exception

On August 9, 2022, the Department of Finance released legislative proposals that include technical amendments to specific international tax measures. One of these amendments is to the moneylending business exception in paragraph 90(8)(b) of the “upstream loan” rules, which has been narrowed so as to apply only to arm’s-length moneylending businesses.

Under the upstream loan rules, which were introduced in 2011, an upstream loan made by an FA of a Canadian taxpayer to a specified debtor must be included in the income of the relevant taxpayer to the extent that an equivalent dividend could not have been paid tax-free under the FA surplus regime. Upstream loans were broadly used by Canadian multinationals as a tool to prevent or defer the payment of Canadian tax on the repatriation of funds to Canada where insufficient underlying foreign tax was paid with respect to taxable surplus, with a view to circumventing the cost of foreign withholding tax on dividends or to sidestepping certain foreign corporate-law limitations on dividend payments.

These rules, including the exceptions to their application, are similar to the shareholder loan rules in subsection 15(2), but the two sets of rules are mutually exclusive (subsection 90(6) does not apply if subsection 15(2) applies). New paragraph 90(8)(b) is aligned with the proposed changes to subsection 15(2.3) that were introduced in the same legislative package of August 2022.

Subsection 90(8) provides four general exceptions to the application of subsection 90(6), one of which—paragraph (b)—carves out an indebtedness that arose in the ordinary course of the creditor’s business or a loan that was made in the ordinary course of the creditor’s ordinary business of lending money, if bona fide arrangements were made, at the time the indebtedness arose or the loan was made, for repayment within a reasonable time. The first item (unaffected by the proposals) generally deals with trade accounts receivable, while the latter is in respect of loans made in a business of lending money.

Submissions were made a decade ago suggesting amendments to this exception, because it was considered to be too narrow in its application and because it did not take into account situations in which the creditor acquires existing loans and receivables as opposed to originating them. (See the Joint Committee submission Re: October 24, 2012 Notice of Ways and Means Motion/Bill C-48, the Technical Amendments Act, 2012.) However, the proposals are going in the opposite direction from what these submissions recommended.

Furthermore, the amendments represent a clean break from past rulings positions issued by the CRA that confirmed, in the context of subsection 15(2.3), that this exception applied to internal financing arrangements. (See, for example, CRA document nos. 2006-0191881R3, 2007; 2007-0238971R3, 2007; and 2007-0244561R3, 2007.) The CRA generally acknowledged the application of its subsection 15(2) interpretations in relation to the upstream loan rules.

The proposals would amend paragraph 90(8)(b) to narrow the moneylending business exception to predominantly arm’s-length lenders, while the trade receivables exception would remain intact. The proposed amendment to paragraph 90(8)(b) provides that if, at any time during which the loan is outstanding, less than 90 percent of the aggregate outstanding amount of the loans of the business is owing by borrowers that deal at arm’s length with the lender/creditor, the exception does not apply and the “specified amount” in respect of the loan or indebtedness made by the FA to a “specified debtor” should fall under the general rule in subsection 90(6) and be included in the taxpayer’s income.

In the explanatory notes, Finance states that “internal or ‘captive’ ” moneylenders within a corporate group will not be able to benefit from this exception, which is intended to apply only to arm’s-length lending. Considering that the exception allows less than 10 percent of the aggregate amount of loans outstanding to be with non-arm’s-length parties, the moneylending business exception has not been completely eradicated. Its scope, however, appears to be limited: only a very small percentage of the overall loans portfolio can be made on an ongoing basis to a specified debtor without falling within the ambit of the rules.

It is noteworthy that a specific set of rules already exists to exclude from the application of subsection 90(6) upstream deposits (for example, indebtedness) that are made to eligible Canadian banks with the exception in paragraph 90(8)(d), read in combination with subsection 90(8.1). Subsection 90(6) should not apply to a loan or other form of indebtedness made by an eligible bank affiliate to an eligible Canadian bank if 90 percent of all of the upstream deposits that the eligible Canadian bank owes to the eligible affiliate does not exceed the affiliate’s excess liquidity for the year. The 2014 explanatory notes regarding this exception indicated that subsection 90(8.1) “is consistent with the policy of the excess liquidity proposals in new subsections 95(2.43) to (2.45).”

The tightening of the exception in paragraph 90(8)(b) will undoubtedly limit the structuring options for intragroup financing companies. Also, given the proposed rules, a company whose purpose is to rely on the moneylending business exception for an FA creditor will need to calculate the percentage that represents the moneylending to entities within its group, during all of the time in which the loan is outstanding. The pressure on the taxpayer to rely on such an exception appears high when significant loan portfolios are in place with arm’s-length and non-arm’s-length borrowers, and balances vary on a daily basis. This difficulty is similar to the difficulty involved in applying the upstream loan rules to certain cash-pooling arrangements. By contrast, the application of the upstream deposits rule to banks uses monthly averages.

The proposals would also add subsection 90(8.01), which is an interpretive provision applicable to partnerships to determine whether the borrower and the creditor are dealing at arm’s length.

The amendments discussed above are applicable to loans made after 2022; however, they also apply to any portion of a particular loan made before 2023 that remains outstanding on January 1, 2023 as if that portion were a separate loan that was made on January 1, 2023 in the same manner and on the same terms as the particular loan. As a result, taxpayers may be required to take remedial action in respect of pre-existing upstream loans.

Audrey Dubois
KPMG LLP, Montreal