25 November 1999 External T.I. 9830545 - FOREIGN ACCRUAL TAX - UNDERLYING FOREIGN TAX

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

XXXXXXXXXX 	Tim Kuss
		983054
Attention:  XXXXXXXXXX 

November 25, 1999

Dear Sirs:

Re: Subsection 91(4) - Foreign Accrual Tax

This is in reply to your letter regarding the application of subsection 91(4) and the definition of "underlying foreign tax", found in subsection 5907(1) of the Regulations, to the following hypothetical situation.

1. Canco is a corporation resident in Canada.

2. Forco, a corporation incorporated and resident in the U.S., is a wholly owned subsidiary of Canco and therefore a "controlled foreign affiliate" of Canco as defined in subsection 95(1).

3. LLC is a limited liability company incorporated in the U.S. LLC is a corporation resident in the U.S. for purposes of the Act and is treated as a partnership for U.S. tax purposes.

4. Forco owns a 9% interest in LLC. The remaining 91% interest is held by persons unrelated to Canco. LLC is therefore not a foreign affiliate of Canco as defined in subsection 95(1).

5. Forco's only asset and only source of income is its interest in LLC.

6. Forco pays U.S. income tax in respect of its share of income earned by LLC.

Analysis and Discussion

As LLC is considered a corporation for purposes of the Act, distributions of earnings by LLC to Forco will be considered to be dividends for purposes of the Act. As LLC is not a foreign affiliate of Canco, such dividends would be included in the computation of the "foreign accrual property income" of Forco for the taxation year in which the distribution is received and would be included in Canco's income pursuant to subsection 91(1) for Canco's taxation that includes the particular taxation year of Forco.

Income tax paid by Forco in respect of its share of LLC's income would not be recognized as "foreign accrual tax", as defined in subsection 95(1), until the income to which it may reasonably be regarded as applicable has been included in Canco's income under subsection 91(1) (i.e. until the income has been distributed to Forco).

Where an amount has been included in Canco's income pursuant to subsection 91(1), Canco would be entitled to a deduction pursuant to subsection 91(4), giving regard to the foreign accrual tax applicable to the income amount included under subsection 91(1).

In the context of the hypothetical situation described above, where LLC has not distributed all of its earnings on a current basis, it is our opinion that the earnings of LLC and the taxes paid by Forco for a particular taxation year are each pooled with the respective undistributed earnings and related taxes for previous taxation years for purposes of determining the foreign accrual tax applicable to any future distribution by LLC to Forco (i.e. this would be computed on a proportionate basis of the undistributed earnings and would not be computed on a first-in first-out basis). Where LLC distributes, say, 10% of its undistributed earnings at a particular time, the foreign accrual tax applicable to that distribution would be 10% of the income and profits tax paid by Forco in respect of such undistributed earnings.

A distribution/dividend by LLC to Forco will increase Forco's "net earnings", "taxable earnings" and "taxable surplus" computed in respect of Canco. Pursuant to subparagraph ii of the description of "A" in the definition of "underlying foreign tax" found in subsection 5907(1) of the Regulations, the portion of U.S. income or profits tax paid by Forco that may reasonably be regarded as having been paid in respect of the earnings of LLC that are attributable to the distribution by LLC that has been included in the computation of Forco's "taxable earnings" for the year will be included in Forco's "underlying foreign tax" in respect of Canco and such tax will be deducted in computing Forco's "net earnings" and thus "taxable earnings" and "taxable surplus" in respect of Canco. This computation would also be on a proportionate basis and not a first-in-first-out basis.

We hope our comments are of assistance.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch