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2002 December Report of the Auditor General of Canada

December 2002 Report—Chapter 11

Exhibit 11.3—Double-dip financing structures

A company can significantly reduce its effective rate of borrowing with a type of arrangement referred to as a double-dip financing structure. These structures allow taxpayers to obtain at least two interest deductions on the amount of money borrowed.

Example of a transaction

Company A, which is Canadian, borrows $275 million. The interest on the $275 million reduces Canada's tax base because "A" writes this expense off against its Canadian income before taxes. This is the first interest deduction.

Company A then invests the $275 million in shares of its Barbados and Netherlands subsidiaries. These subsidiaries then loan the $275 million to a United States subsidiary of "A." The U.S. subsidiary deducts the interest it pays to the Barbados and Netherlands subsidiaries from its U.S. income. This is the second interest deduction. Even though the Barbados and Netherlands subsidiaries receive interest income from the U.S. subsidiary, they will pay little or no tax on that income because of low tax rates in Barbados and the Netherlands.

Under Canadian tax law, the interest income, which is passive income that the Barbados and Netherlands subsidiaries receive from the U.S. subsidiary, is redefined as active business income. Because it is considered active business income it can be received in Canada as a tax-free dividend (paragraphs 11.79, 11.80, 11.81).

Source: Canada Customs and Revenue Agency