27 November 1998 External T.I. 9822835 - FOREIGN AFFILIATES - FOREIGN ACCRUAL 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.

Principal Issues: Whether US taxes paid by a US C-corp. which is a foreign affiliate, qualify as foreign accrual tax and underlying foreign tax if paid in respect of the income of a US LLC which is also a foreign affiliate.

Position: The taxes may qualify depending upon the circumstances.

Reasons: The definitions of foreign accrual tax and underlying foreign tax are very broad.

		982283
XXXXXXXXXX 	Olli Laurikainen
(613) 957-2116
Attention:  XXXXXXXXXX 

November 27, 1998

Dear Sirs:

Re: United States Limited Liability Companies

This is in reply to your letter requesting our views in connection with a hypothetical foreign affiliate structure involving a United States Limited Liability Company (“LLC”).

You describe the following hypothetical scenario:

1) US LLC is a corporation resident in the United States for the purposes of the Income Tax Act (the “Act”) which is treated as a partnership for the purposes of the Internal Revenue Code (the “Code”) of the United States.

2) Usco1 is a corporation resident in the United States which owns 90% of the issued and outstanding shares of US LLC.

3) Canco is a corporation resident in Canada which owns all the issued and outstanding shares of Usco1.

4) Usco1 and US LLC have taxation years ending December 31. Canco’s taxation year ends on January 31.

5) US LLC was incorporated and commenced business on January 1, 1997. Its only activity and source of income is the carrying on of an “investment business” as that term is defined in subsection 95(1) of the Act. The income from that business is foreign accrual property income (“FAPI”).

6) Usco1 pays U.S. income tax on its share of the income of US LLC.

7) US LLC pays a dividend on January 1, 1998 to its shareholders (i.e. including Usco1) equal to all of its earnings from the investment business for the year ended December 31, 1997.

8) Pursuant to subsection 91(1) of the Act, Canco will include the FAPI of US LLC for the year ended December 31, 1997 in its income for tax purposes to the extent of the participating percentage of the shares of Usco1 in respect of US LLC. Such FAPI is included in the taxable surplus of US LLC in respect of Canco.

You request our view whether the U.S. tax paid by Usco1 in respect of the FAPI of US LLC would qualify as “foreign accrual tax” as that term is defined in subsection 95(1) of the Act and as “underlying foreign tax” as that term is defined under subsection 5907(1) of the Regulations.

Our Comments

Foreign Accrual Tax

The provisions of subsection 95(1) define “foreign accrual tax” (FAT) applicable to any amount included in computing a taxpayer’s income by virtue of subsection 91(1) for a taxation year in respect of a particular affiliate of the taxpayer as:

(a) the portion of any income or profits tax that was paid by

(i) the particular affiliate, or

(ii) any other foreign affiliate of the taxpayer in respect of a dividend received from the particular affiliate

and that may reasonably be regarded as applicable to that amount...”.

In the above scenario, the FAPI included in income by Canco is in respect of US LLC. Since the U.S. tax was paid by Usco1, such tax would not qualify as FAT under subparagraph (a)(i) of the definition in subsection 95(1) of the Act. However, when US LLC distributes (i.e. pays a dividend) to Usco1 and such dividend was attributable to the income in respect of which the U.S. tax was paid by Usco1, it is our view that at the time the dividend was paid the U.S. tax would then qualify as FAT under subparagraph (a)(ii) of the definition in subsection 95(1) of the Act. Provided the requirements of subsection 91(4) were otherwise satisfied, Canco would then be entitled to a deduction in respect of such FAT in computing its income.

Underlying Foreign Tax

The relevant portion of the definition of “underlying foreign tax” (“UFT”) in subsection 5907(1) of the Act is subparagraph (iii) of the description of A. That subparagraph refers to income or profits tax referred to in subparagraph (iii) of the description of B in the definition of “taxable surplus” which reads as follows:

“the portion of any income or profits tax paid to the government of a country by the subject affiliate that can reasonably be regarded as having been paid in respect of that portion of a dividend referred to in subparagraph (iii) of the description of A”

Subparagraph (iii) of the description of A of the definition of taxable surplus refers to dividends received by the affiliate from another foreign affiliate that were prescribed to have been paid out of the taxable surplus of the payer affiliate.

The U.S. tax paid by Usco1 in respect of its share of the income of US LLC would not qualify as UFT until such time as the income in respect of which the tax was paid was distributed (i.e. a dividend was paid) to Usco1. When such dividend was paid to Usco1, it is our view that the tax paid by Usco1 then “can reasonably be regarded as having been paid in respect of the dividend” for the purposes of subparagraph (iii) of the description of B of the definition of “taxable surplus” in subsection 5907(1) of the Regulations. Accordingly such tax qualifies as UFT under subparagraph (iii) of the description of A in the UFT definition and is deducted in computing the taxable surplus of Usco1. Canco may subsequently then qualify for a deduction pursuant to paragraph 113(1)(b) of the Act in respect of the U.S. tax paid by Usco1 when taxable surplus dividends are received from Usco1 by Canco. A further deduction may be available under subsection 91(5) of the Act. However, the total deducted in respect of the dividend under the two provisions may not exceed the amount of the dividend.

Summary

In the above case, it is a question of fact what portion of the total U.S. income tax paid by Usco1 under the Code for its taxation year ended December 31, 1997 is attributable to its share of the income of US LLC for that year. However once such portion is determined, that portion may reasonably be regarded as applicable to the dividend received by Usco1 from US LLC on January 1, 1998 because that dividend comprises all the earnings of US LLC on which U.S. tax has been paid by Usco1. In other situations, this determination may be much more complex. For example, one may have to take into account the results of operations of earlier and subsequent taxation years of both Usco1 and US LLC, different sources of income and losses, as well as refunds of tax and the application of tax credits under the Code. For example, where there may be basis for claiming a deduction under subsection 91(4) of the Act in one taxation year, such claim may no longer be justified if the foreign tax is subsequently refunded due to a refund claimed by Usco1 as a result of a net operating loss that is carried back under the provisions of the Code. In such case Canco would be expected to refile the tax return in which the subsection 91(4) deduction was claimed. In sum, this is an area where a great deal of caution should be exercised and the determinations must be made based on the facts and circumstances of the particular case.

The foregoing comments are given in accordance with the practice referred to in paragraph 22 of information Circular 70-6R3 and are not binding on Revenue Canada.

We trust this is the information you require.

Yours truly,

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