26 April 2017 IFA Finance Roundtable - Official Response

Question 1 – Interaction between subsections 17(1) and 247(2)

Under subsection 17(1) income may, in certain circumstances, be imputed to a corporation resident in Canada in respect of an amount owing to it by a non-resident person, based on a prescribed rate. Under subsection 247(2), an amount in respect of a transaction entered into with a non-arm’s length non-resident may be adjusted to reflect arm’s length terms and conditions.

Where a corporation resident in Canada (“Canco”) makes a non-interest-bearing loan to its wholly owned non-resident subsidiary, could the CRA give us its views as to the potential application of subsection 17(1) and/or subsection 247(2) in the following two scenarios:

• the loan remains outstanding for more than one year and does not qualify for the exception in subsection 17(8); and
• the loan remains outstanding for one year or less and it would, if it had been outstanding for more than one year, have qualified for the exception in subsection 17(8)?

CRA Response

These questions build on a technical interpretation (2003-003389) issued by the CRA in 2004, which remains valid today. In that technical interpretation, the subject loan was assumed to be outstanding for less than one year and to not otherwise fit the conditions of subsection 17(8). In that context, it was concluded that subsection 247(2) could apply to adjust the interest on the loan to reflect an arm’s length rate.

Scenario 1

The CRA is generally of the view that subsection 247(2) can apply in conjunction with other provisions of the Act. Thus, once the conditions of application of subsection 247(2) are met and unless a specific exception applies, any amounts that, but for sections 247 and 245, would be determined for the purposes of the Act in respect of the taxpayer should be adjusted to the quantum or nature of the amounts that would have been determined if the parties had transacted at arm’s length.

In this scenario, the specific exception contained in subsection 247(7) would not be applicable, as the conditions of subsection 17(8) are assumed not to be met. However, the fact that subsection 17(1) could apply to impute an amount of interest does not preclude subsection 247(2) from applying, if all of its conditions are met.

We find this conclusion to be consistent with the context created by subsection 247(7). If Parliament had intended for section 17 to be a complete code for loans to non-residents, there would have been no need to enact subsection 247(7). Thus, given that the particular loan described above is not of the type contemplated by subsection 247(7) and assuming that all of subsection 247(2)’s conditions are met, it is the CRA’s view that subsection 247(2) would apply to ensure that the full arm’s length amount of interest is included in Canco’s income.

Scenario 2

In this scenario, although the loan is not outstanding for more than one year and is, thus, excluded from the ambit of subsection 17(1), the loan is of the type contemplated by subsection 247(7). Therefore, notwithstanding that the exception in subsection 17(8) could not have application to this loan, the CRA is of the view that subsection 247(2) would not apply.

Sophie Larochelle
Dave Beaulne
2017-069107
April 26, 2017

Question 2 – Application of section 247 in the computation of FAPI

Canada’s transfer pricing rules, contained in section 247, apply in a variety of circumstances in respect of transactions with non-arm’s length non-residents and can adjust amounts relevant for Canadian tax purposes to reflect arm’s length terms and conditions.

Does the CRA consider section 247 to apply in computing a foreign affiliate’s foreign accrual property income (“FAPI”) in respect of a taxpayer, in the context of a transaction between the foreign affiliate and another non-resident person?

CRA Response

It has been the CRA’s long-standing view that subsection 247(2) could, in general, apply to a transaction between a foreign affiliate and another non-resident person in computing the foreign affiliate’s FAPI in respect of a taxpayer. However, if the pricing of a transaction entered into by the foreign affiliate has been reviewed by the tax authority of the country in which the foreign affiliate is resident and has been determined to be in accordance with the transfer pricing legislation or guidelines of that country, the CRA will generally not challenge the pricing determined based on such legislation or guidelines provided that such legislation or guidelines adopt the arm’s length principle.

Information Circular IC 87-2R International Transfer Pricing, dated September 27, 1999, including the comments therein regarding the computation of FAPI, is currently under review.

Grace Tu
Olli Laurikainen
2017-069119
April 26, 2017

Response prepared in collaboration with:

Mark Turnbull
International Tax Division
International, Large Business and Investigations Branch

Question 3 – U.S. LLPs & LLLPs

At the November 2016 Canadian Tax Foundation (the “CTF”) annual conference in Calgary, the CRA announced that it had established an internal working group to study compliance issues related to Florida and Delaware limited liability partnerships (“LLPs”) and limited liability limited partnerships (“LLLPs”) arising from its prior announcement that it would generally consider such entities to be corporations for the purposes of Canadian income tax law. As part of this announcement, the CRA indicated that it was open to a prospective approach whereby prior filings would, in certain circumstances, be allowed to stand.

Can the CRA provide us with an update on the deliberations of the working group?

CRA Response

The working group is continuing its study of compliance issues relating to Florida and Delaware LLPs and LLLPs but it has made significant progress. The working group received many submissions on these compliance issues and would like to thank the tax community for this valuable input.

After an analysis of the complexities for taxpayers and the tax administration of transitioning from partnership filings to corporate filings, the CRA has decided to build on the prospective approach referred to in the November 2016 CTF announcement by offering administrative grandfathering. In particular, the CRA will be adopting the administrative practice of allowing any such entity formed before April 26, 2017 to file as a partnership for all prior and future tax years, provided none of the following conditions applies:

• One or more members of the entity and/or the entity itself take inconsistent positions from one taxation year to another, or for the same taxation year, between partnership and corporate treatment;
• There is a significant change in the membership and/or the activities of the entity; or
• The entity is being used to facilitate abusive tax avoidance.

Where any of these conditions is met in respect of any such entities formed before April 26, 2017, the CRA may issue assessments to the members and/or the entity, for one or more taxation years, on the basis that the entity is a corporation.

For these purposes, the CRA will consider any such entity to have been formed on the day on which the appropriate governmental organization accepts the filing of the required documentation in respect of the establishment of the entity as an LLP or LLLP, as the case may. Notwithstanding the above, any such entity that has consistently filed as a corporation for Canadian income tax purposes may continue to file on that basis.

Any such entities that choose to file as corporations notwithstanding the administrative grandfathering relief will be expected to do so for all open taxation years in which the entity has existed, including filing initial corporate tax returns for past years, as necessary. In this regard, previously filed tax returns of entity members may require adjustment in order to eliminate double-counting of income or losses.

Delaware and Florida LLPs and LLLPs formed after April 25, 2017 will be assessed as corporations for all purposes of Canadian income tax law.

To the extent LLPs or LLLPs of other jurisdictions of the U.S. have similar attributes to those of Florida and Delaware and the CRA views them as corporations for the purposes of Canadian income tax law, the CRA’s administrative policy outlined above will be applied to them as well. It is also notable that the CRA is of the view that Article IV(6) of the Canada-U.S. tax treaty will apply to any such LLPs or LLLPs that are treated as non-resident corporations for Canadian tax purposes and as fiscally transparent entities for U.S. tax purposes. As such, the CRA generally intends to administer that provision vis-à-vis relevant LLPs and LLLPs in a manner similar to its published practices in respect of U.S. limited liability companies.

Dave Beaulne
Yannick Roulier
2017-069113
April 26, 2017

Response prepared in collaboration with:

Alexandra MacLean
International Tax Division
International, Large Business and Investigations Branch

Question 4 – Subsections 261(20) / (21) and foreign affiliates

If the conditions set out in subsection 261(20) are satisfied, subsection 261(21) provides that, for purposes of determining a taxpayer’s income, gain or loss in respect of a “specified transaction”, certain fluctuations in the relative values of the taxpayer’s “tax reporting currency” and the tax reporting currency of a related taxpayer are deemed not to have occurred. In general, these conditions require that the specified transaction be entered into between related taxpayers with different tax reporting currencies during the period in which the income, gain or loss accrued and that, in the absence of these provisions, it would be reasonable to consider that such a fluctuation either increased the taxpayer’s loss, reduced the taxpayer’s income or gain, or caused the taxpayer to have a loss instead of income or gain in respect of the specified transaction.

Subsection 261(1) defines “tax reporting currency” to mean the currency in which a taxpayer’s “Canadian tax results” are determined, and the definition of “Canadian tax results” in that same subsection includes any amount that is relevant in computing income, taxable income, or taxable income earned in Canada of the taxpayer.

Assume the following facts:

• Parent is a Canadian-resident corporation and the parent corporation of a multinational group. Parent computes its Canadian tax results in Canadian dollars.
• Cansub is a Canadian-resident corporation and a wholly-owned subsidiary of Parent. Cansub has made a functional currency election to use U.S. dollars (“USD”) as its functional currency for Canadian income tax purposes.
• FA is a corporation resident in the U.S. and a wholly-owned subsidiary of Cansub. FA carries on an active business in the U.S. and uses USD as its “calculating currency” for purposes of the Canadian foreign affiliate rules.
• FA makes an upstream loan to Parent (“FA-Parent Loan”) denominated in USD. Parent enters into a third party hedging arrangement (“Hedge”) in order to hedge its foreign exchange exposure on the FA-Parent Loan.
• Parent realizes a foreign exchange loss (“Foreign Exchange Loss”) on the repayment of the FA-Parent Loan, and an offsetting foreign exchange gain (“Foreign Exchange Gain”) on the settlement of the Hedge.

Subsection 261(6.1) deems a foreign affiliate of a taxpayer, for purposes of computing the foreign affiliate’s foreign accrual property income (“FAPI”) in respect of that taxpayer, to have an “elected functional currency” that is the same as the elected functional currency of that taxpayer.

If Parent had realized a foreign exchange gain on the repayment of the FA-Parent Loan, that gain would have been offset by a foreign exchange loss on the settlement of the Hedge, and Parent would have achieved its purpose of hedging its foreign exchange exposure. However, if subsections 261(20) and (21) operate to deny the Foreign Exchange Loss on the repayment of the FA-Parent Loan, the purpose of the Hedge would be frustrated as the Foreign Exchange Gain on its settlement would not be offset with the Foreign Exchange Loss.

Does the CRA agree that the condition in paragraph 261(20)(b) would not be met in this example such that subsection 261(21) would not apply to deny the Foreign Exchange Loss, because FA is deemed to have an elected functional currency only for purposes of determining its FAPI, and not for purposes of applying subsection 261(21) to the Foreign Exchange Loss?

CRA Response

Subsection 261(21) applies in respect of a “specified transaction”. The determination of whether the conditions in subsection 261(20) are met must be made in that context. In this example, the specified transaction for the purposes of determining the application of subsection 261(21) is the FA-Parent Loan. Therefore, the application of the conditions in subsection 261(20) must be determined in respect of that loan. Please note that our comments assume the FA-Parent Loan is on capital account in respect of Parent and FA.

The condition in paragraph 261(20)(b) will be satisfied if Parent and FA have different tax reporting currencies at any time during which Parent’s loss in respect of the FA-Parent Loan accrued. Pursuant to its definition in subsection 261(1), the determination of a taxpayer’s tax reporting currency is made by examining the currency in which the taxpayer itself determines its Canadian tax results under the Act. Therefore, in order to determine whether the condition in paragraph 261(20)(b) is met, it must be separately determined:

1. in which currency the Act requires Parent to compute its Canadian tax results, and
2. in which currency the Act requires FA to determine its Canadian tax results.

As Parent has not made a functional currency election under subsection 261(3), subsection 261(2) requires that it determine its Canadian tax results in Canadian dollars and, thus, its tax reporting currency is Canadian dollars.

With respect to FA, subsection 261(6.1) provides that, for the purposes of determining FA’s FAPI in respect of Cansub:

• FA is deemed to have elected to determine its Canadian tax results in USD, and
• FA’s Canadian tax results are its FAPI in respect of Cansub, and any amount relevant to that determination.

Therefore, FA’s tax reporting currency under the Act in respect of any amount relevant to FA’s FAPI in respect of Cansub will be USD.

As the FA-Parent Loan is not “excluded property” (as defined in subsection 95(1)) of FA, any gain or loss realized by FA on the settlement of the loan would be relevant to the determination of FA’s FAPI in respect of Cansub. Consequently, FA’s tax reporting currency in respect of the FA-Parent Loan is USD.

As FA and Parent will have different tax reporting currencies during the period Parent’s loss in respect of the FA-Parent Loan accrued, we would consider the condition in paragraph 261(20)(b) to be met, and subsection 261(21) to be applicable.

In the CRA’s view, this result is consistent with the policy underlying subsections 261(20) and (21). In particular, it should be noted that subsection 261(21) would have applied to deny any loss of FA in respect of the FA-Parent Loan in computing its FAPI in respect of Cansub had the loan been denominated in Canadian dollars.

Jeffrey Johns
Terry Young
2017-069121
April 26, 2017

Question 5 – Foreign tax credit generator rules and Brazilian interest on equity

The foreign tax credit generator (“FTCG”) rules are meant to prevent the creation of foreign tax credits and similar deductions for foreign tax to the extent that the burden of the foreign tax is not, in fact, borne by the taxpayer. Subsections 91(4.1) through (4.7) form part of these rules and can potentially impact the availability of foreign accrual tax (“FAT”) deductions under subsection 91(4) applicable to amounts included in income under subsection 91(1) in respect of the FAPI of a particular foreign affiliate.

Subsection 91(4.1) is the main operative rule and is triggered where at any time in the taxation year of a foreign affiliate, a person or partnership referred to in the FTCG rules as a “specified owner” in respect of the taxpayer, is considered under the relevant foreign tax law to own less than all of the shares of a particular corporation – that is a “pertinent person or partnership” in respect the affiliate – that are considered to be owned by the specified owner for the purposes of the Act (the “Lesser Ownership Test”).

Subsection 91(4.7) deems, for the purposes of subsection 91(4.1), the Lesser Ownership Test to be met if, under the relevant foreign tax law, dividends or similar payments in respect of the shares of a corporation held by a specified owner are treated as interest or another form of deductible payment.

Under Brazilian law, corporations can choose to make, within certain limits, tax deductible distributions to shareholders through a so-called “interest on equity” (“IOE”) mechanism. In a simple case where a corporation resident in Canada (“Canco”) owns all the shares of a Brazilian affiliate (“Brazilco”) which in turn holds only non-share assets, under what circumstances, if any, would the CRA consider that subsection 91(4.7) could apply to cause Canco to own less than all the shares of Brazilco?

CRA Response

The Lesser Ownership Test is applied to each taxation year of a foreign affiliate independent of other taxation years. The CRA considers the conditions for the application of subsection 91(4.7) to have been met in a taxation year of a foreign affiliate if, at any time in that year, dividends paid to a specified owner are deductible by the paying corporation under Brazilian tax law by virtue of an IOE election. In the above case, the “specified owner” for the purposes of subsection 91(4.7) is Canco and the “corporation” is Brazilco. The CRA would consider the Lesser Ownership Test to have been met in respect of the shares of Brazilco in its each of its taxation years in which dividends are paid by Brazilco to Canco and are deductible by virtue of an IOE election such that subsection 91(4.1) would apply to deny all amounts that would otherwise be FAT applicable to amounts included in Canco’s income in respect of the FAPI of Brazilco for those taxation years.

Olli Laurikainen
Dave Beaulne
2017-069112
April 26, 2017

Question 6 – T1134 filing issues

The CRA has provided some administrative relief from duplicate or repetitive reporting for form T1134. In cases where administrative relief has been provided, the apparent intent was to reduce what would otherwise be considered an undue compliance burden for the reporting entity. Such duplicate or repetitive reporting often arises due to the requirement of a reporting entity to file a T1134 in respect of controlled foreign affiliates or foreign affiliates that are owned at any time in the reporting entity’s taxation year. Some examples of where administrative relief has been provided include reporting for dormant or inactive entities, reporting for short taxation years or fiscal periods such as where there is an acquisition of control, and reporting on the organizational structure in Section 3 of Part I of the form.

a) Assume Canco1 owns a controlled foreign affiliate (“CFA1”) and Canco2 owns a controlled foreign affiliate (“CFA2”), and all the corporations have a December 31st taxation year-end. On August 1st, Canco1 and Canco2 amalgamate to form Amalco. As a result, Canco1 and Canco2 each has a deemed taxation year-end on July 31st. Each owned its respective controlled foreign affiliate at some point in that short taxation year and, therefore, would have a requirement to file a form even though CFA1 and CFA2 do not have a taxation year end in that short taxation year that is relevant for Section 3 of Part II of the form.

Assume that Amalco will select December 31st as its new taxation year-end. It will be required to file a T1134 in respect of both CFA1 and CFA2 for their December 31st taxation year, as it also would have owned those entities at one point in its taxation year.

Accordingly, the information reported by Amalco in respect of CFA1 and CFA2 would cover the December 31st year-end of those entities. Amalco would also be required to complete Section 4B(2) of Part II of the form to indicate that it acquired the shares of the controlled foreign affiliates in its taxation year.

As the relevant information in respect of the December 31st taxation year of CFA1 and CFA2 would be reported by Amalco in Section 3 of Part II of the T1134 it files, the filing of a T1134 by Canco1 and Canco2 for their short taxation year would appear to provide little additional information that would not already be reported.

Would the CRA consider extending its administrative relief to situations such as the above where there is a deemed taxation year-end due to an amalgamation of two or more taxable Canadian corporations?

b) Where the shares of a foreign affiliate are transferred sequentially to higher or lower tier Canadian corporations, multiple reporting would be required for that foreign affiliate, even though the information reported may be minimal for the reporting entities that did not own the foreign affiliate’s shares at the end of the foreign affiliate’s tax year. As well, reporting the same organizational structure in Section 3 of Part I of the T1134 form for each reporting entity would be repetitive.

Would the CRA consider providing administrative relief in situations such as the above where multiple Canadian-resident taxpayers or partnerships in a group are required to file a T1134 for the same foreign affiliate because they owned the foreign affiliate’s shares for a moment in the year, but only one taxpayer or partnership in the group owned the foreign affiliate’s shares at the end of the foreign affiliate’s tax year?

c) For Canadian taxpayers with large foreign affiliate groups, the requirement to paper file the forms and their attachments is extremely burdensome. As well, generally, an additional paper copy of all forms is requested by CRA auditors when they commence the audit of the applicable Canadian reporting entity.

Is there an expected time frame for being able to electronically file the T1134 forms?

CRA Response

a) It is noted that Part II Section 3 and Part III Sections 1, 2, 3, and 4 of a T1134 filed by Canco1 and Canco2 for CFA1 and CFA2, respectively, in the scenario described above, would require limited to no information being reported due to there being no taxation year end of the affiliate ending in the reporting entity’s taxation year-end (i.e., July 31st).

Granting the administrative relief requested, however, would not be consistent with the purpose of the T1134 reporting requirement which is to provide the CRA with an accurate record of the history of foreign affiliates and transparency of offshore structures. In the CRA’s view, not having Canco1 and Canco2 file a T1134 for CFA1 and CFA2, respectively, could diminish the accurate record of history the reporting is designed to provide.

b) Similar to the response in a), if multiple reporting is required in the scenario described above, Part II Section 3 and Part III Sections 1, 2, 3, and 4 of perhaps all but one of the multiple T1134s filed would require limited to no information being reported due to there being no taxation year-end of the affiliate ending in the reporting entity’s taxation year-end (i.e., July 31st).

Granting the administrative relief requested, however, would not be consistent with the purpose of the T1134 reporting requirement. Where multiple Canadian-resident taxpayers or partnerships in a group owned a particular foreign affiliate’s shares for a moment in the year but only one taxpayer or partnership in the group owned the foreign affiliate’s shares at the end of the foreign affiliate’s tax year, in the CRA’s view, not having each owner file a T1134 for the foreign affiliate would diminish the transparency of offshore structures the reporting is designed to provide.

c) Work is currently ongoing with a view to allowing electronic filing of the T1134 information returns (as well as the T106). As of today, it is anticipated that corporations will have the ability to electronically file these information returns in mid 2017. The ability to transmit supporting financial documentation, however, will not be available at the same time. Work will continue towards adding this functionality.

Lori M Carruthers
2017-069124
April 26, 2017

Response prepared in collaboration with:

Claudia Shalaby
International Tax Division
International, Large Business and Investigations Branch

Question 7 – Clause 95(2)(a)(ii)(D) issues regarding U.S. LLCs

Clause 95(2)(a)(ii)(D) (“Cap D”) recharacterizes, as income from an active business, income derived by a foreign affiliate (the first affiliate) of a taxpayer from amounts paid or payable by another affiliate (the second affiliate) of the taxpayer as interest on borrowed money used to acquire – or on unpaid purchase price from the acquisition of – shares of another foreign affiliate (the third affiliate) of the taxpayer, provided that certain conditions set out in Cap D are satisfied.

a) Assume a hypothetical scenario where the second affiliate, the third affiliate, or both, are disregarded U.S. LLCs and had a loss in a particular taxation year that ended after the loan was made. The members or shareholders in respect of each of the second affiliate and the third affiliate, as applicable, are residents of the U.S. and are subject to income taxation in the U.S.

In respect of such a disregarded U.S. LLC, sub-subclause 95(2)(a)(ii)(D)(IV)2. (“Sub-sub 2”) requires that the members or shareholders of the LLC be subject to income taxation in a country other than Canada on, in aggregate, all or substantially all of the income of the LLC.

Can the CRA confirm that, notwithstanding that Sub-sub 2 simply refers to “income” (as opposed to “income or loss”), the interest paid or payable in respect of the loan would still be eligible for recharacterization assuming that all other requirements of Cap D are met?

b) As a variant of the previous scenario, assume that the third affiliate (“3rd LLC”) is characterized as a partnership for U.S. tax purposes with the second affiliate (“U.S. Holdco”) owning 40% of 3rd LLC’s interests and arm’s length U.S. taxable residents owning the remaining 60%. 3rd LLC and its members have a December 31st taxation year-end. The operating agreement of 3rd LLC is such that each member is allocated its share of the income or loss of 3rd LLC for the period in a particular taxation year during which it was a member.

U.S. Holdco sells all of its ownership interests in 3rd LLC to an arm’s length U.S. taxable resident on June 1st, 2016, and the disposition does not give rise to a taxation year-end of 3rd LLC for U.S. tax purposes. U.S. Holdco is a regarded corporation and is subject to U.S. tax on its share of any income or loss of 3rd LLC for the period from January 1st to May 31st, 2016, notwithstanding that U.S. Holdco is not a member of 3rd LLC on December 31st, 2016.

Sub-sub 2 requires that the members or shareholders of 3rd LLC at the end of 3rd LLC’s taxation year (December 31st, 2016) be subject to income taxation in their taxation years (ending December 31st, 2016) on all or substantially all of the income of 3rd LLC for its taxation year ending December 31st, 2016.

Would the CRA consider that the “end of the year” requirement in Sub-sub 2 is met notwithstanding that U.S. Holdco is not a member of 3rd LLC on that date and (due to the timing of the disposition occurring in mid-year) the members of 3rd LLC at the end of its taxation year may not be subject to tax on “all or substantially all” of the income of 3rd LLC for that year?

CRA Response

a) The CRA previously addressed a similar question at the 2015 CTF round table (Q.9). The situation considered involved the second and the third affiliates being fiscally transparent under the tax law of a foreign jurisdiction and the second affiliate incurring interest and other expenses, which reduced the income ultimately included in the income of the indirect member or shareholder of the third affiliate. The question was whether, in respect of the third affiliate, the requirement of Sub-sub 2 that the member or shareholder of that affiliate be subject to income taxation in a country other than Canada on, in aggregate, all or substantially all of the income of that affiliate was met.

The CRA stated that the member or shareholder would still be considered to be subject to income taxation on all or substantially all of the income earned by the third affiliate, notwithstanding that the member or shareholder does not pay any tax in a particular year because the second affiliate incurred interest or other expenses in the year. The CRA expressed the view that the “subject to income taxation… on all or substantially of the income” requirement does not preclude the second affiliate from incurring expenses, but rather, this requirement will not be met where, generally, more than 10% of the income of the third affiliate is ultimately not subject to income taxation in a country other than Canada (e.g., a 20% shareholder or member is tax-exempt or otherwise not subject to income tax in the foreign jurisdiction).

The CRA continues to be of this view. Accordingly, in the situation described above, interest income of the first affiliate will still be eligible for recharacterization under Cap D, notwithstanding that either the second or the third affiliate or both had a loss in a particular taxation year.

b) In the CRA’s view, the words of Sub-sub 2 do not support such an interpretation. U.S. Holdco is not a member of 3rd LLC on December 31st, 2016. As a result, the portion of 3rd LLC’s income that would be subject to taxation in the hands of the entities that were members on December 31st would likely not be sufficient to meet the “all or substantially all” requirement in Sub-sub 2 because of the significant portion of income allocated to U.S. Holdco.

The CRA recognizes that this result may not be consistent with the underlying tax policy and has brought this matter to the attention of the Department of Finance.

Julia Belova
Terry Young
2017-069122
April 26, 2017

Question 8 – NR4 reporting for non-taxable amounts

In prior years, CRA Guide T4061, NR4 – Non-Resident Tax Withholding, Remitting, and Reporting commented that an information return is required with respect to amounts paid or credited under Part XIII that are subject to withholding under Part XIII. However, more recent versions of this publication appear to suggest that an information return is required with respect to amounts paid or credited by a resident of Canada to a non-resident person and identified in subsection 202(1) of the Income Tax Regulations (the “Regulations”), regardless of whether the payment was subject to Part XIII withholding.

Can the CRA clarify the reporting obligations with respect to amounts paid or credited by a person resident in Canada to a non-resident person? For example, is a person resident in Canada required to file an information return with respect to interest paid or credited by that person to an arm’s length non-resident person if the interest is not subject to Part XIII tax?

CRA Response

The reporting requirement under subsection 202(1) of the Regulations is independent from the withholding and remitting requirements under Parts XIII and XIII.2. Where a person resident in Canada pays or credits, or is deemed under Part I, XIII or XIII.2 to pay or credit, to a nonresident person on account or in lieu of payment of, or in satisfaction of, any of the amounts described in paragraphs 202(1)(a) to (h) of the Regulations, it is the CRA’s view that there is a requirement to file an information return (i.e. NR4) even if the amount paid was not subject to tax under Part XIII or XIII.2 of the Act. Accordingly, in the example described above, there is a reporting obligation with respect to an amount paid or credited on account of interest by a resident of Canada to an arm’s length non-resident person, regardless of the fact that the interest was not subject to Part XIII withholding. In the CRA’s view, similar reasoning would apply to other similar payments referred to in section 202 of the Regulations.

It is important to note that the filing requirements under section 202 of the Regulations have not been waived by the Minister under subsection 220(2.1) of the Act.

Gillian Godson
Bob Naufal
2017-069114
April 26, 2017

Response prepared in collaboration with:

Phil Kerwin
Collections and Verification Branch
Daryl Rutz
Assessment, Benefit, and Service Branch

Question 9 – Computation of earnings for a disregarded U.S. LLC

At the November 2016 Canadian Tax Foundation annual conference in Calgary (“2016 Annual Conference”), in its response to Question 11, the CRA stated it had changed its position regarding the computation of earnings of a disregarded U.S. limited liability company (“LLC”) that carries on an active business. The CRA’s previous position (“2009 Position”), which was reaffirmed in its response to Question 9 at the 2011 IFA Conference, was that such an LLC should compute its earnings in accordance with subparagraph (a)(i) of the definition of “earnings” (“Earnings Definition”) in subsection 5907(1) of the Income Tax Regulations (“Regulations”). The CRA’s revised position, expressed at the 2016 Annual Conference (“2016 Position”), is that in light of the introduction of subsection 5907(2.03) of the Regulations, such an LLC should compute its earnings in accordance with subparagraph (a)(iii) of the Earnings Definition. The CRA stated that this change in position applies retroactively to the LLC’s first taxation year ending after August 19, 2011, which is the effective date of subsection 5907(2.03) of the Regulations.

The change in the CRA’s position described above can have a material retroactive impact on the computation of a foreign affiliate’s earnings for surplus purposes. Over the past few years, up until the 2016 Position was announced, many transactions have taken place that have affected, or have relied on, such computations, including distributions, liquidations, upstream loans, and sales or acquisitions of shares.

Given the potentially adverse consequences associated with the change in the CRA’s administrative position for the computation of an LLC’s earnings, would the CRA be willing to consider the following:

a) For taxation years of the LLC beginning prior to November 29, 2016, the taxpayer may choose whether to compute the LLC’s earnings in accordance with either the 2009 Position or the 2016 Position.

b) To the extent of any dividends received by a Canadian taxpayer on or before November 29, 2016, or any other transactions completed prior to November 29, 2016 that relied on the computation of the LLC’s earnings based on the 2009 Position, the computation of the LLC’s earnings may be based on the 2009 Position.

CRA Response

Since the 2016 Position was published, the CRA has listened to taxpayers’ concerns regarding the retroactive effect of the change in position with respect to the calculation of earnings of disregarded U.S. LLCs. The CRA appreciates that where taxpayers have completed certain transactions and relied on the computation of earnings in accordance with the 2009 Position, the retroactive effect of the 2016 Position may result in adverse tax consequences that could not have been foreseen by the taxpayers. We also appreciate that some taxpayers may have incurred compliance costs in relation to the calculations of earnings and surplus of disregarded U.S. LLCs based on the 2009 Position, prior to the announcement of the 2016 Position.

For these reasons, if a taxpayer uses the 2009 Position to calculate the earnings of a foreign affiliate that is a disregarded U.S. LLC for the LLC’s taxation years ended on or before November 29, 2016 (i.e. prior to the announcement of the 2016 Position), the CRA is prepared to accept that calculation, provided that the taxpayer and all taxpayers related to the taxpayer use the 2009 Position to calculate the earnings of all of their foreign affiliates that are disregarded U.S. LLCs for all taxation years of these LLCs that ended on or before November 29, 2016. Alternatively, such taxpayers can choose to compute the earnings of all of their foreign affiliates that are disregarded U.S. LLCs in accordance with the 2016 Position for all taxation years of these LLCs that ended after August 19, 2011.

The CRA is of the view that the earnings of a disregarded U.S. LLC for any taxation year that ends after November 29, 2016 should be computed in accordance with the 2016 Position.

Grace Tu
Olli Laurikainen
2017-069120
April 26, 2017

Response prepared in collaboration with:

Mark Turnbull
International Tax Division
International, Large Business and Investigations Branch