Canada: CRA Reaffirms Position On Activities Carried On Outside The Municipality

Last Updated: December 23 2011
Article by Stephen J. Fyfe and Stephanie Wong

Most Read Contributor in Canada, September 2016

The authors of this article are Stephen Fyfe and Stephanie Wong.

A recently released CRA technical interpretation provides municipal electricity utilities (MEUs) and other municipally-owned corporations (MOCs) with continuing reassurance regarding the CRA's application of the geographic source of income test in paragraphs 149(1)(d.5) and 149(1)(d.6) of the Income Tax Act (Canada) (the "Act"), and presents some interesting opportunities for expanding their business footprint. Pursuant to paragraph 149(1)(d.5), the income of a MEU or a MOC is exempt from tax under Part I of the Act for a taxation year if:

  • 90% or more of the capital of the corporation was owned by one or more municipalities in Canada; and
  • 10% or less of the corporation's income for the year was from activities carried on outside the geographical boundaries of the municipalities.

Wholly-owned subsidiaries of MEUS and MOCs that qualify under paragraph 149(1)(d.5) are in turn exempt from tax under Part I of the Act for a taxation year pursuant to paragraph 149(1)(d.6) if they satisfy the same geographic source of income test.

In CRA Document No. 2011-0395521I7, a TSO auditor asked the CRA rulings directorate how to apply the geographic source of income test in paragraph 149(1)(d.5) in a situation where a MOC's income is derived from loans to and investments in shares of taxable subsidiaries that carry on business outside the geographical boundaries of the MOC's municipality. The principal issue raised was whether the geographic source of the MOC's income should be determined by considering only the location of the MOC's investment activities, or whether the test requires a look-through to the location of the subsidiaries' activities from which the MOC's income is indirectly derived. It appears that the CRA auditor sought advice on whether a look-through approach should be used out of a concern that the MOC may be circumventing the object, spirit and purpose of paragraph 149(1)(d.5). Although not stated in the technical interpretation, it is reasonable to conclude that the subsidiary's activities were not a Crown activity as described in subsection 149(1.2) of the Act.1 The specific fact situation addressed was as follows:

  • MOC raises in the City the capital that it lends to, and invests in shares of, its subsidiaries.
  • All of MOC's activities in establishing, acquiring, financing, providing services to, exercising stewardship over, and owning the subsidiaries take place in the City.
  • Share certificates relating to MOC's investment in subsidiaries are delivered and kept in the City. MOC prepares, executes, and stores loan documentation in the City.
  • MOC exercises its powers pursuant to agreements with its subsidiaries in the City.
  • MOC's bank accounts are located in the City and all dividends and interest are received by MOC into such bank accounts, and all disbursements of funds invested by MOC in its subsidiaries as loans and share subscriptions are from such accounts.
  • All intercorporate loans are negotiated and approved by either the MOC board of directors (where required) or by MOC's officers in the City.
  • MOC authorizes and executes in the City the written agreements that relate to the provision of financial services.
  • MOC performs in the City the other activities that relate to the lending arrangements and the provision of the financial services, such as coding, recording and making deposits, calculating and recording interest amounts, etc.
  • MOC's treasury functions and reporting in respect of other investments are performed in the City.

Determining whether the geographic source of income test is satisfied is a question of fact. The CRA's response, which is consistent with both the text and purpose of paragraph 149(1)(d.5), reaffirms that it is the activities of the corporation itself and not of its taxable subsidiaries that are relevant in determining where its income is earned for the purposes of the geographic source of income test. Also, the geographic source of income test is not concerned with the situs or location of the MOC's income, but rather the location of the activities from which the MOC's income is generated. Finally, the CRA reconfirmed its position that "income" for the purposes of the geographic source of income test means net income rather than gross income.

In the fact situation at hand, since the MOC's dividend and interest income was earned from loans to, and investments in shares of, taxable subsidiaries which took place within the geographical boundaries of the City, the MOC satisfied the geographic source of income test in paragraph 149(1)(d.5). This latest technical interpretation reaffirms that a MEU or MOC may, for example, own all of the shares and debt of a taxable subsidiary that carries on business outside the municipality without jeopardizing its tax exempt status as long as it ensures that any activities relating to its equity and debt investments in the subsidiary take place within the municipality. The CRA's conclusion is consistent with its previous statements in CRA document nos. E2010-037696 and E1999-0006955.

From a business opportunity perspective, the ability of a subsidiary to reduce its taxable income by deducting interest paid on debt owed to the MEU or MOC would represent an absolute tax savings if such income could eventually be paid to a tax-exempt municipal shareholder. This is conceptually similar to the structuring used to establish early generation income trusts, but has the added complexity of requiring compliance with municipal law statutes and local thin capitalization rules. The CRA's application of the geographic source of income test based on net income rather than gross income may also provide opportunities for MEUs and MOCs to enhance income earning activities outside of the municipality provided that they can generate sufficient offsetting deductions to stay within the 10% income limit imposed by the geographic source of income test.


1. A Crown activity as described in subsection 149(1.2) refers to an activity carried on (1) under an agreement between the MOC/MEU and the federal Crown or one of the provincial Crowns, or a corporation they control; or (2) in a province as a producer or distributor of, among other things, electricity, provided that such activity is regulated by the province.

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