Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: 1.Whether the dividend paid would be deemed to have been paid out of pre-acquisition surplus.
2. Whether the dividend would reduce the ACB of the shares pursuant to subsection 92(2) of the Act such that the holder of the shares would realize a deemed gain pursuant to subsection 40(3) of the Act.
3.Whether paragraph 95(2)(f.1) of the Act would apply to exclude the taxable capital gain from the FAPI of the holder of the shares.
4. Whether the capital gain would create any exempt or taxable surplus for the holder of the shares.
Position: 1. Yes
2. Yes
3. No position taken
4. Our answer would depend on whether or not the capital gain is excluded from the FAPI of the holder of the shares pursuant to paragraph 95(2)(f.1) of the Act.
Reasons: 1. Paragraphs 5900(1)(c) and 5901(1)(c) of the Regulations.
2. Wording of the Act.
3. Question of fact.
4. Subsection 5907(5) of the Regulations provides that each capital gain of a foreign affiliate from the disposition of property shall be computed in accordance with the rules set out in subsection 95(2) of the Act.
XXXXXXXXXX 2008-029035
Sylvie Labarre, CA
July 8, 2009
Dear Sir,
Re: Dividend payable by one foreign affiliate to another foreign affiliate of a Canadian taxpayer
This is in reply to your letter of August 19, 2008 in which you request our opinion concerning the above noted subject.
Hypothetical Facts
1. Canco acquires all of the shares of FAco on January 1, 2006 at a cost of $1,000,000. The FAco shares were at all times prior to Canco's acquisition, not held by a person or partnership that is a specified person or partnership for purposes of paragraph 95(2)(f.1) of the Act. Canco is a Canadian Corporation within the meaning of paragraph 89(1)(a) of the Income Tax Act (the "Act").
2. FAco owns all the shares of Subco1, which it acquired in 1998 at a cost of $1,000. FAco has owned no asset other than the shares of Subco1 from 1998 up to the present time. Subco1 has owned no asset other than the shares of Subco2 from 1998 up to the present time. Subco2 has owned no asset other than Subco3 shares from 1998 up to the present time. Subco3 has owned no asset other than the shares of UKco, IRco and USco from 1998 up to the present time. The fair market value of Subco3 was equal to $1,000,000 at the time the FAco shares were acquired by Canco and therefore, the fair market values of Subco1 and Subco2 were also equal to $1,000,000 at the time the FAco shares were acquired by Canco.
3. FAco, Subco1, Subco2, Subco3, UKco, IRco, USco are controlled foreign affiliates of Canco within the meaning of subsection 95(1) of the Act.
4. During its 2008 taxation year, Subco3 pays a dividend of $200,000 to Subco2. No income or profits tax was paid on the dividend by Subco3 to the government of a foreign country.
5. Subco3 has no exempt or taxable surplus immediately before the payment of the dividend, nor at the end of its 2008 taxation year.
6. UKco, IRco et USco do not have exempt or taxable surplus before the payment of the dividend, nor at the end of its 2008 taxation year.
Questions
The principal issues in your request are as follows:
1) Whether the dividend of $200,000 would be deemed to have been paid out of pre-acquisition surplus of Subco3 in respect of Canco pursuant to paragraphs 5900(1)(c) and 5901(1)(c) of the Income Tax Regulations (the "Regulations");
2) Whether the dividend of $200,000 would reduce the adjusted cost base of the Subco3 shares at the time the dividend is received pursuant to subsection 92(2) of the Act, such that Subco2 would realize a deemed gain pursuant to subsection 40(3) of the Act;
3) Whether a deemed gain of $199,000 would arise pursuant to subsection 40(3) of the Act, assuming that the $1,000 paid by FAco for the shares of Subco1 is also the adjusted cost base of the Subco3 shares held by Subco2;
4) Whether paragraph 95(2)(f.1) of the Act (as it is read in conjunction with each of the relevant portions of proposed paragraphs 95(2)(f) and (f.11) to (f.15)) of the Act would apply to exclude the taxable capital gain of $99,500 from the foreign accrual property income of Subco2 and therefore, no amount would be included in the income of Canco under subsection 91(1) of the Act; and
5) Whether the results flowing from paragraphs 3 and 4 above are that ,
a) pursuant to paragraph 53(1)(a) of the Act, the adjusted cost base of the Subco3 shares would be nil, and
b) by virtue of paragraph 5907(5) of the Regulations, the capital gain would not create any exempt or taxable surplus for Subco2 in respect of Canco.
Our comments
1) The dividend of $200,000 paid by Subco3 to Subco2 would be deemed to have been paid out of pre-acquisition surplus of Subco3 in respect of Canco pursuant to paragraphs 5900(1)(c) and 5901(1)(c) of the Income Tax Regulations (the "Regulations") because Subco3 has no exempt or taxable surplus immediately before the payment of the dividend, nor at the end of its 2008 taxation year.
2) No income or profits tax having been paid on the dividend by Subco3 to the government of a foreign country, the dividend of $200,000 paid by Subco3 to Subco2 would reduce the adjusted cost base of the Subco3 shares at the time the dividend is received pursuant to subsection 92(2) of the Act, such that Subco2 would realize a deemed gain pursuant to subsection 40(3) of the Act.
3) Assuming that the adjusted cost base of the Subco3 shares held by Subco2 is $1,000 and assuming that subsection 93(1.1) of the Act as it exists or as proposed does not apply, the deemed gain of Subco2 pursuant to subsection 40(3) of the Act would be equal to $199,000.
4) To answer your fourth question, we will assume that the taxation year of Subco2 began after October 2, 2007 and our comments will only deal with the new legislation considering that Bill C-10 - Budget Implementation Act, 2009 - received Royal Assent on March 12, 2009.
Paragraph 95(2)(f.1) of the Act provides that, in computing an amount described in paragraph 95(2)(f) in respect of a property or a business, there is not to be included any portion of that amount that can reasonably be considered to have accrued, in respect of the property (including for the purposes of this paragraph any property for which the property was substituted) or the business, while no person or partnership that held the property or carried on the business was a specified person or partnership in respect of the taxpayer referred to in paragraph 95(2)(f).
It is a question of fact whether the amount of the gain of Subco2 can be excluded in computing the amount described in paragraph 95(2)(f) of the Act pursuant to paragraph 95(2)(f.1) of the Act and accordingly excluded from the foreign accrual property income of Subco2. We would have to determine whether the gain on the Subco3 shares accrued while being held by a specified person or partnership in respect of Canco. We do not have enough information to reach a definitive conclusion in the particular situation submitted considering that we do not have the information relating to the three subsidiaries held by Subco3 and considering there has been a period of three years since the acquisition time. We cannot exclude the possibility of finding that the gain has accrued after the acquisition time without reviewing all the relevant information even if Subco3 does not have taxable surplus or exempt surplus.
5) The adjusted cost base of the Subco3 shares held by Subco2 would be nil pursuant to paragraph 53(1)(a) of the Act.
We cannot provide you with a definitive answer to the second part of the question because we did not reach any conclusion in the fourth question. However, we agree with you that a capital gain not included in paragraph 95(2)(f) of the Act pursuant to 95(2)(f.1) of the Act would not create any exempt or taxable surplus for a foreign affiliate pursuant to subsection 5907(5) of the Regulations.
We trust the above has been of some assistance.
Yours truly,
Alain Godin, Manager
for Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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