Arm’s Length And Back-To-Back Loans

Article by Bill Maclagan, ©2005 Blake, Cassels & Graydon LLP

This article was originally published in Blakes Bulletin on Taxation - April 2005

One of the critical elements in complying with the 5/25 exemption is that the borrower and lender must act at arm’s length at the time an interest payment is made. Whether or not parties act at arm’s length is a mixed question of law and fact. Related persons are deemed not to deal at arm’s length. It is a question of fact whether other persons deal at arm’s length.

Because a corporation and the person who controls it are related, a loan from a foreign parent to a Canadian subsidiary cannot fit within the 5/25 exemption. As a result, corporations have from time to time attempted to structure intercorporate debt so as to fit within the 5/25 exemption. Various structures have included "back-to-back" loans where cash is loaned from a foreign parent to an arm’s length foreign company that then lends to the Canadian subsidiary and loans from a