Regulation 5901 - Order of Surplus Distributions

Subsection 5901(1)

Administrative Policy

27 September 1991 T.I. (Tax Window, No. 11, p. 13, ¶1513)

Unless some part of the international shipping business of the foreign affiliate is actually carried on in the country in which the foreign affiliate is resident, its business will not be considered to be carried on through a permanent establishment in that country; and the mere maintenance of registered office will not by itself constitute a permanent establishment in respect of its international shipping business.

2 July 1991 T.I. (Tax Window, No. 5, p. 15, ¶1326)

Where a non-resident subsidiary of a Canadian corporation which owns or charters vessels to engage in international traffic and maintains a permanent establishment in Canada rather than abroad, it will earn exempt income which is not attributed to any country and therefore will be included in its pre-acquisition surplus.

Subsection 5901(1.1)

Administrative Policy

30 October 2014 External T.I. 2013-0488881E5 - Upstream Loan

notional Reg. 5901(1.1) election

The Reg. 5901(1.1) election is treated as being applicable for a s. 90(9)(a) notional dividend received by Canco. See detailed summary of Scenario 4 under s. 90(9).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(28) no double inclusion following FA creditor wind-up 54
Tax Topics - Income Tax Act - Section 40 - Subsection 40(3) notional s. 40(3) gain does not generate surplus 59
Tax Topics - Income Tax Act - Section 90 - Subsection 90(6) no double inclusion following FA creditor wind-up or for 2nd loan in series 105
Tax Topics - Income Tax Act - Section 90 - Subsection 90(9) notional election and double taxation issues 1108
Tax Topics - Income Tax Regulations - Regulation 5901 - Subsection 5901(2) - Paragraph 5901(2)(a) 90-day rule unavailable 22
Tax Topics - Income Tax Regulations - Regulation 5901 - Subsection 5901(2) - Paragraph 5901(2)(b) notional Reg. 5901(2)(b) election 25
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(1) - Underlying Foreign Tax notional UFT disproportionate election 31

Subsection 5901(2)

Paragraph 5901(2)(a)

Administrative Policy

30 October 2014 External T.I. 2013-0488881E5 - Upstream Loan

90-day rule unavailable

The "90-day" rule does not apply to a s. 90(9)(a) notional dividend received by Canco. See detailed summary of Scenario 1 under s. 90(9).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(28) no double inclusion following FA creditor wind-up 54
Tax Topics - Income Tax Act - Section 40 - Subsection 40(3) notional s. 40(3) gain does not generate surplus 59
Tax Topics - Income Tax Act - Section 90 - Subsection 90(6) no double inclusion following FA creditor wind-up or for 2nd loan in series 105
Tax Topics - Income Tax Act - Section 90 - Subsection 90(9) notional election and double taxation issues 1108
Tax Topics - Income Tax Regulations - Regulation 5901 - Subsection 5901(1.1) notional Reg. 5901(1.1) election 24
Tax Topics - Income Tax Regulations - Regulation 5901 - Subsection 5901(2) - Paragraph 5901(2)(b) notional Reg. 5901(2)(b) election 25
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(1) - Underlying Foreign Tax notional UFT disproportionate election 31

1 April 2011 External T.I. 2008-0297541E5 - Ss. 5901(2) and the Timing of Dividends

FA2, which had no exempt or taxable surplus at the beginning of 2008 but will have exempt surplus of $100 at the end of 2008, is wholly owned by FA1, which had taxable surplus of $100 at the beginning of June 1, 2008. FA2 pays a $100 dividend (the "FA2 dividend") to FA2 on June 1, 2008, and FA1 then immediately pays a $100 dividend (the "FA1 dividend") to its Canadian parent ("Canco").

The FA2 dividend is deemed by Reg. 5902(2) to be paid out of exempt surplus of FA2. Accordingly, the FA1 dividend also would be considered to be paid out of exempt surplus of FA1. (All surplus amounts referred to above are in respect of Canco.)

15 January 1992 T.I. 9115295

FA1's only source of income in 1991 is the FA2 and FA3 dividends, described below, received from its wholly-owned subsidiaries, FA2 and FA3, and on June 30 FA1 has no exempt or taxable surplus (or deficit). On July 1, 1991, at a time that it has no exempt or taxable surplus (or deficit), FA2 pays the FA2 dividend of $100 to FA1. On August 1, 1991, FA1 pays a $100 dividend (the "FA1 dividend") to its wholly-owning Canadian parent ("Canco"). On September 1, 1991, at a time that it has no exempt or taxable surplus (or deficit), FA3 pays the FA3 dividend of $100 to FA1. The relevant earnings etc. for 1991 are that FA2 has taxable earnings of $100 and FA3 has exempt earnings of $100.

Reg. 5901(2) deems the FA2 dividend to have been paid out of taxable surplus of FA2 and the FA3 dividend to have been paid out of exempt surplus of FA3 of $100. As a result, FA1 has $100 of both taxable and exempt surplus out of which dividends can be paid immediately after the end of its 1991 taxation year (the time at which the FA1 dividend is deemed to be paid for purposes of Reg. 5901(2)). Accordingly, by order of the surplus distribution rules set out in Reg. 5901(1), the FA1 dividend is paid entirely out of exempt surplus. (All surplus amounts referred to above are in respect of Canco.)

Articles

Susan McKilligan, "The 90-Day Rule and Mergers or Liquidations of Foreign Affiliates", International Tax (Wolters Kluwer CCH), October 2017, No. 96, p. 10

Survivor merger or liquidation of CFA after generating exempt earnings in current year (p. 10)

A foreign affiliate (Parent) owns all of the outstanding shares of another foreign affiliate (Sub). Sub pays a dividend to Parent more than 90 days after Sub's taxation year begins. Sub generates exempt surplus in excess of the dividend amount in the same year the dividend is paid. In the absence of Regulation 5901(2), the dividend paid by Sub would be paid out of pre-acquisition surplus. Later in the same year Sub is liquidated or merged into Parent. Parent survives the merger under the relevant corporate law.

Deemed year end for Reg. 5901(2) purposes before merger/liquidation (p. 10)

Under either Regulation 5907(8) or (9) Sub is deemed to have a year end at a time prior to the merger or liquidation… Since the deeming rule in Regulation 5901(2) affects an affiliate's exempt, hybrid, and/or taxable surplus, the deemed year end arguably applies for the purposes of the year-end deeming rule in Regulation 5901(2).

Shareholder may hold the CFA at the moment after its deemed taxation year (p. 10)

In the event that the deemed year end applies for the purposes of Regulation 5901(2), the question is whether the 90-day rule will apply to deem the distribution to be paid from Sub's exempt surplus. The CRA has held [1991-55] that the 90-day rule does not apply to a dividend paid by a foreign affiliate in a taxation year if the shareholder does not hold the shares of the foreign affiliate immediately after the end of that taxation year. However, because the tax year end is deemed under Regulation 5907 to take place prior to the foreign merger or liquidation, Sub arguably continues to exist for at least a moment after the deemed year end….

Exempt dividend amount included in Parent's ES (on receipt) but not subtracted from Sub's ES until after deemed year end (p. 11)

If the deemed year end…applies…and the 90-day rule applies to the dividend paid by Sub…:

  • Under…Regulation 5907(1)(c)(A)(v) the exempt surplus dividend paid by Sub to Parent is included in Parent's surplus at the date Parent receives the dividend.
  • Under Regulation 5901(2), Sub is deemed to pay the dividend to Parent immediately following the end of the year. As a result, Sub's exempt surplus balance immediately before the tax year end (and before the merger or liquidation time) includes the exempt surplus distributed from Sub to Parent earlier in the year.

On this basis, double-counting of sub’s distributed exempt surplus (p. 11)

The surplus paid out through Sub's dividend to Parent is double-counted in the exempt surplus balance after the merger or liquidation. First, under Regulation 5905 the opening surplus balances combines the surplus and deficit balances of Sub and Parent immediately before the merger time or deems a dividend equal to the net surplus of the Sub immediately before the liquidation to have been paid to Parent. Next, the 90-day rule in Regulation 5901(2) deems Sub to pay the dividend to Parent immediately following the end of the year. As a result of this timing, Sub's surplus balance before the merger or liquidation time includes the surplus previously paid out and already included in Parent's surplus as a result of the dividend.

Paragraph 5901(2)(b)

Administrative Policy

2016 Ruling 2016-0630761R3 - Transfer of Shares

stated capital distribution from FA treated as pre-acq dividend
Quite similar transactions for the same group and with expanded rulings were ruled upon in 2017-0693751R3

A foreign affiliate (New FA) of a Canadian corporation (ACo) transferred all the shares of FA1 to a Canadian-resident subsidiary (BCo) of ACo in consideration for a note of BCo whose amount equalled the sum of the relevant cost base of the FA1 shares and the net surplus (being exempt surplus) of FA1 (such sum, the “Transfer Amount”). BCo then used share subscription proceeds received by it from ACo to repay the note, with New FA then distributing that cash to ACo and with ACo electing under Reg. 5901(2)(b) for the distributions to come out of New FA’s pre-acquisition surplus. CRA ruled inter alia as to the application of s. 93(1.11) to effectively convert part or all of the capital gain of New FA otherwise realized on its disposition of its FA1 shares into an exempt surplus dividend.

CRA further ruled that the distribution by New FA would be deemed by s. 90(2) to be a dividend, and that such distribution would be treated as a dividend under the ss. 113(1)(d), 53(2)(b)(i) and 97(2) rules except to the extent of any excess described in s. 40(3).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 93 - Subsection 93(1.11) transfer of an FA with exempt earnings by FA Holdco to Can Subco required to occur at less than the shares’ FMV 488
Tax Topics - Income Tax Act - Section 15 - Subsection 15(1) no conferral of benefit where CRA required sideways transfer to occur at less than FMV 211

21 April 2015 Internal T.I. 2014-0560811I7 - FACL carryback – Surplus & PAS election

no relief for late-filed Reg. 5901(2)(b) election

In 2010, CFA paid the "2010 Dividend" to its 100% parent ("Canco"). On audit, CRA identified that CFA had realized a capital gain (giving rise to foreign accrual property income). Canco did not make an election under s. 79(2) of Bill C-48 or under Reg. 5901(2)(b). Is Canco barred from making a "PAS election" under Reg. 5901(2)(b) respecting the 2010 dividend (and, if yes, is administrative relief available)?

After a detailed review of the relevant transitional provisions and of the late-filing rules in Regs. 5901(2.1) and (2.2), CRA concluded that no PAS election had been made on a timely basis, and then stated:

…[C]onsidering…that subsection 220(3.2) of the Act and section 600 of the Regulations provide no discretion to the Minister to extend the time for making an election under paragraph 5901(2)(b)… there is no other statutory or administrative discretion available to the CRA to allow the taxpayer to late-file any required election in the present case in order for the 2010-Dividend to be treated as being paid out of PAS.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 220 - Subsection 220(3.2) no relief for late-filed Reg. 5901(2)(b) election 50
Tax Topics - Income Tax Regulations - Regulation 5903.1 - Subsection 5903.1(1) FACL carryback from transitional year 140
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(1) - Net Earnings surplus pools are not to be retroactively adjusted for a FACL carryback 153
Tax Topics - Income Tax Regulations - Regulation 600 no relief for late-filed Reg. 5901(2)(b) election 50

30 October 2014 External T.I. 2013-0488881E5 - Upstream Loan

notional Reg. 5901(2)(b) election

The Reg. 5901(2)(b) election is treated as being applicable for a s. 90(9)(a) notional dividend received by Canco. See detailed summary of Scenario 3 under s. 90(9).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(28) no double inclusion following FA creditor wind-up 54
Tax Topics - Income Tax Act - Section 40 - Subsection 40(3) notional s. 40(3) gain does not generate surplus 59
Tax Topics - Income Tax Act - Section 90 - Subsection 90(6) no double inclusion following FA creditor wind-up or for 2nd loan in series 105
Tax Topics - Income Tax Act - Section 90 - Subsection 90(9) notional election and double taxation issues 1108
Tax Topics - Income Tax Regulations - Regulation 5901 - Subsection 5901(1.1) notional Reg. 5901(1.1) election 24
Tax Topics - Income Tax Regulations - Regulation 5901 - Subsection 5901(2) - Paragraph 5901(2)(a) 90-day rule unavailable 22
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(1) - Underlying Foreign Tax notional UFT disproportionate election 31

Articles

Clara Pham, "Paying FA Dividends When Surplus Balances are Unclear", Canadian Tax Focus, Vol. 7, No. 1, February 2017, p. 2

Greater flexibility for subsequent surplus ascertainment if multiple dividends paid (p. 2)

Up-to-date figures on an FA's surplus pools may not be available at the time that a dividend is to be paid….

[T]he FA [could] pay multiple smaller dividends totalling the desired distribution amount

In this way, there is more flexibility to elect under regulation 5901(2)(b) as needed in respect of each whole, smaller dividend at a later time when surplus and basis computations are clearer or more complete. … Any dividend on which an election is not made will first come out of exempt surplus….

Geoffrey S. Turner, "June 2014 Election Deadlines for Retroactive Application of New Foreign Affiliate Reorganization Rules", CCH International Tax, No. 74, February 2014, p. 1.

Retroactive election (p. 3)

… Bill C-48 permits taxpayers to electively apply Regulation 5901(2)(b) (together as a package with subsections 90(2) and 93(1.11)) retroactively to foreign affiliate distributions made after December 20, 2002.

Choice between surplus and basis grind (p. 3)

By electing to apply Regulation 5901(2)(b) retroactively, and by thereby electing to apply subsection 90(2) retroactively to deem each post-December 20, 2002 foreign affiliate distribution to be a dividend (regardless whether it was in fact paid as a dividend or a capital distribution), taxpayers can either (i) choose to treat the particular distribution as a dividend that accessed the relevant surplus balances of the distributing foreign affiliate (by not further electing to apply Regulation 5901(2)(b) to that particular dividend or deemed dividend), or (ii) choose to treat the particular distribution as a pre-acquisition surplus dividend that accessed the basis of the foreign affiliate before potentially dipping into the relevant surplus balances of the distributing foreign affiliate (by further electing to apply Regulation 5901(2)(b) to that particular dividend or deemed dividend).

E.g., resolving divided/capital character or surplus balances or using subsequently-ground exempt surplus (p. 3),

For example, consider an historic foreign affiliate distribution, paid for foreign corporate law purposes out of share premium, contributed surplus, or similar equity-type account where the Canadian tax treatment (as a dividend or capital distribution) might have been unclear. Or consider an historic dividend where the surplus balances might have been uncertain and there was a risk of elevating taxable surplus with insufficient underlying tax. Alternatively, consider an historic capital distribution paid by a foreign affiliate with exempt surplus that might have subsequently been eroded by exempt losses. In each of these cases, the Canadian parent now has the time-limited opportunity to reconsider the originally intended surplus and basis consequences of the distribution….

Geoffrey S. Turner, "New Foreign Affiliate Capital Distribution Elections: QROCs and Reg. 5901(2)(b) Dividends", CCH International Tax, No. 67, p. 1

From a group structure perspective, taxpayers may also wish to capitalize on the enhanced superiority of basis over surplus, by reorganizing their foreign affiliate groups to consolidate basis in one or more holding company foreign affiliates....The effect is to aggregate and consolidate the basis in those transferred top-tier foreign affiliate shares, into the basis of the newly issued top-tier foreign affiliate holding company shares held directly by the Canadian parent corporation. Future distributions sourced from the various underlying chains could then ultimately be paid to the Canadian parent by the top-tier foreign affiliate "basis consolidator" as dividends electively deemed by Regulation 5901(2)(b) to be pre-acquisition surplus dividends. In this manner, the potential adverse consequences from elevating possible "bad" hybrid surplus or taxable surplus from the underlying foreign affiliates could be deferred to the greatest extent. Moreover, by strategically electing under Regulation 5901(2)(b) in respect of those lower-tier foreign affiliate distributions, it may be possible to defer the elevation of any such "bad" hybrid surplus or taxable surplus up the chain.

Geoffrey S. Turner, "Upending the Surplus Ordering Rules: Implications of the New Regulation 5901(2)(b) Election", CCH Tax Topics, No. 2079, p. 1, 12 January 2012

Taxpayers may now hold their foreign affiliate groups under a "basis and surplus mixer" foreign affiliate holding company, and routinely use the Reg. 5901(2)(b) election for top-tier foreign affiliate distributions.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 90 - Subsection 90(2) 0

Elaine Buzzell, "Distributions of Share Premium by Foreign Affiliates", Corporate Finance, Vol. XVII, No. 2, 2011, p. 1962

Includes comparison with previous comfort letter proposals.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 90 - Subsection 90(2) 25

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