17 May 2023 IFA Roundtable

This provides the text of written questions that were posed, and abbreviated summaries of the CRA oral responses, at the CRA Roundtable held on May 15, 2023 at the International Fiscal Association (Canadian Chapter) conference in Calgary. The presenter from the Income Tax Rulings Directorate was:

Yves Moreno, Director, International Division

The questions were orally presented by Grace Chow (Cadesky) and Ken Saddington (Goodmans). We have employed our own titles.

Q.1 – Cross-border charges re stock-based compensation

  • CRA has traditionally not allowed inbound charges for stock option expenses incurred by related parties to be deducted by a Canadian taxpayer when the cost of such stock options is included in the cost of services provided by the related nonresident person
  • There are revised rules in Canada allowing, in certain situations, deductions of non-qualified stock option expenses

In this context, can CRA comment on the following:

  • Will CRA now expect that Canadian taxpayers include stock option expenses in the cost base for services charged to related non-residents, where the employees providing the services to the related non-residents received employer-deductible stock options?
  • If "Yes", will CRA provide reciprocity on inbound stock-based compensation charges if the circumstances are similar?

Preliminary Response

The answer below has three components (terminology, the transfer pricing rules, and the stock option rules) and discusses their interplay.

Regarding terminology, the question deals with inbound and outbound charges. The outbound component concerns cross-border payments for services that are provided by a Canadian resident (or a non-resident subject to tax in Canada). The inbound element is where the Canadian taxpayer is receiving property or services and paying a charge for them.

Regarding transfer pricing, whether for inbound or outbound charges, the general concept under s. 247(2) is that, in determining what is an arm length’s price and whether that principle is respected, the different relevant elements need to be taken into account.

Regarding the stock-based component of the question, the general regime is governed by s. 7(3)(b), which is a fairly broad provision denying the deduction of charges in general. More recently s. 110(1)(e) was introduced, allowing for deductions on stock-based compensation in some circumstances where the conditions are met.

Bringing all those elements together, the question asks about the interplay of the option-deduction rules (i.e. whether to deny the deduction), and s. 247(2) (i.e. the arm’s length principle). In that respect, Transfer Pricing Memorandum 15, para. 44, deals precisely with that interplay, and states:

If a charge includes non-deductible items, but the amount is an arm's length amount, the Income Tax Act does not prevent the taxpayer from paying the amount; however, it will prevent its deduction for tax purposes.

When applied to ss. 7 and 247(2), this passage indicates that there is no direct connection – whether the amount is deductible is one matter, and the role the stock-based compensation plays in the application of s. 247(2), is a separate matter. Basically, there being no deduction would not require an adjustment under s. 247(2) to be taken into account in determining the outbound or inbound charge.

On the question of the deduction itself, where a Canadian taxpayer provides services or goods and takes into account the stock-based compensation that is part of the cost that was provided, that could be a relevant element. The determination of whether it would be deductible or not would be made under s. 7(1)(b). On inbound charges, again, the stock compensation component might be a relevant consideration in following the arm’s length principle.

On deductibility, the test in s. 7(3)(b) basically says that the amount would be not be deductible if the income of the Canadian taxpayer would be less than it would have been had the benefit not been conferred on the employee. There is an interplay with s. 7 there, and that would be determined by the circumstances involved.

Another type of inbound payment could be a situation where a related non-resident bears the stock compensation costs on behalf of the Canadian taxpayer. An example of this type is where the Canadian taxpayer is part of a group that is held by a related non-resident public corporation, and the public corporation issues shares to the employees of its group, including the employees of the Canadian taxpayer. The charge would be the compensation the Canadian taxpayer pays to the other corporation and, in those circumstances, s. 7(3)(b) would generally apply and s. 110(1)(e) might allow a deduction if its conditions are met.

Q.2 – Ukraine/Russia reporting requirements

  • Some Canadian multinationals have subsidiaries in Ukraine or Russia that have continued operating during 2022
  • Due to the war, financial reporting from these subsidiaries may not be available for 2022
  • Will CRA grant any administrative relief in relation to the reporting requirements of Canadian multinationals covering their subsidiaries in Ukraine or Russia with respect to tax reporting covering international operations, such as country-by-country reporting, forms T1134, etc.?
  • What is the CRA’s position with respect to such cases?

Preliminary Response

CRA recognizes that some Canadian multinationals may face challenges in meeting their foreign reporting obligations where they have subsidiaries affected by the war. CRA’s practice is to determine, on a case-by-case basis, whether relief is provided under a number of provisions:

  • S. 220(2.1) gives the Minister discretion to waive the requirement to file, in prescribed form, a receipt or other document.
  • S. 220(3.1) gives the Minister discretion to waive penalties or interest.

Some provisions allow the Minister to waive certain reporting obligations. S. 233.5 provides relief for incomplete T1134 and T1141 forms regarding information that is not available to the person required to file.

S. 162(5) provides relief for penalties for failing to provide information in prescribed form, and requires that the information must be in respect of another person or partnership, and reasonable efforts have been made to obtain the information.

For forms T1134 and T1141, the due diligence exception in s. 233.5 would be available if the taxpayer provides: the available information; the circumstances making the other information unavailable; and an explanation of the steps taken to obtain the information.

The application of s. 233.5 would also relieve any potential penalties under s. 162(5).

If the taxpayer’s circumstances warrant, CRA would also consider granting relief under s. 220(2.1) from the obligation to provide prescribed information or additional documents. That could include the unconsolidated financial statements of the Ukrainian foreign affiliate that otherwise would have to be filed along with the foreign T1134.

Although CRA may provide relief in respect of the provision of prescribed information normally required in foreign reporting forms under s. 162(5), the forms must still be filed by the taxpayer on or before the respective form’s filing due date.

Any Canadian multinational wishing to request relief from the obligation to file a prescribed form or other document under s. 220(2.1) should present its request to its Tax Services Office in advance of the filing due-date of the form in respect of which the relief is requested.

Under the taxpayer relief provisions, CRA can also exercise discretion in cancelling penalties and interest under s. 220(3.1). After an information return has been filed and processed, the request for penalty or interest relief under s. 220(3.1) may be submitted. CRA will consider each request based on the circumstances of that request. The written response will include a link to a page with additional information.

CRA’s response is similar for Russian subsidiaries.

Q.3 – T1134 disclosure of dividends

Part II Section 3(A)(2) of the T1134 supplement requires disclosure of dividends paid by a foreign affiliate

Could CRA please comment on the following:

1) Is the definition of dividends based on Canadian or foreign corporate/tax principles?

  • How does the disclosure apply to a US LLLP or LLC that is a foreign affiliate – corporation for Canadian tax purposes but fiscally transparent or partnership under US tax law
    • Distributions from these entities are not considered dividends for U.S. purposes and not shown as dividends on the financial statements for US purposes
    • Subsection 90(2) of the Income Tax Act (the “Act”) deems pro-rata distributions from these entities to members as dividends

Could CRA please comment on the following:

2) If Canadian principles are to be used and the taxpayer does not have information on whether the distributions are made on a pro-rata basis, would the due diligence exception under Part IV be available?

Preliminary Response

S. 90(2) deems pro-rata distributions on the shares of a foreign affiliate to be dividends. S. 90(5) provides that no amount paid or received at any time on a share of the capital stock of a non-resident corporation is a dividend unless it is so deemed under Part I.

Finance’s notes state that ss. 90(2) and (5) together provide “an all-encompassing definition of a dividend from a foreign affiliate for the purposes of the Act.” The definition also applies for the purposes of the Regulations.

In the situation described, to the extent that the LLLP or LLC are non-resident corporations that are foreign affiliates of a reporting taxpayer for Canadian tax purposes, pro-rata distributions to members that are deemed to be dividends under s. 90(2) are to be reported as dividends in Part II, s. 3(2)(a)(ii) of the T1134 supplement.

On the second branch of the question, a failure to provide any information required in prescribed form may result in penalties under s. 162 or 163. Where the taxpayer does not have all the information required to fulfill the reporting requirements under Form T1134 in respect of its foreign affiliate, it should file the T1134 form on time, indicating clearly in the disclosure section of the T1134 that some information is missing.

In this scenario, the availability of the due diligence exception under s. 233.5, or the reasonable efforts exception under s. 162(5), will depend on the facts of the transaction, and give rise to the requirements to file reasonable disclosure of the unavailable information to be reported in the T1134 return.

CRA would expect the determination of the distribution made by the foreign affiliate to be based on all the information that can reasonably be obtained in a given situation.

Q.4 “Special tax benefit” exclusion under Barbados Treaty

Paragraph 3 of Article XXX (Miscellaneous Rules) of the Canada-Barbados Income Tax Convention (the “Treaty”) provides:

3. The provisions of Articles VI to XXIV of this Agreement shall not apply to any person or other entity entitled to any special tax benefit:

a) in Barbados, under the International Business Companies Act, the Exempt Insurance Act, the Insurance Act, the International Financial Services Act, the Society With Restricted Liability Act, or the International Trusts Act, or any substantially similar law subsequently enacted; or

b) in either Contracting State, under a law of that State which has been identified in an Exchange of Notes between the Contracting States.

  • Barbados has abolished its Exempt Insurance Company and Qualifying Insurance Company regimes
  • Barbados general corporate income tax rates currently are based on taxable income as follows:
    • 5.5% on the first BBD 1 million;
    • 3% on BBD 1,000,001 to BBD 20 million;
    • 2.5% on BBD 20,000,001 to BBD 30 million; and
    • 1% on amounts in excess of BBD 30 million
  • Under the Insurance Act, Cap. 310 (Barbados), a Class 2 licence entitles the company to insure third-party risks wherever situated. The corporate tax rate on all insurance companies with a Class 2 licence is 2%

Does Article XXX(3) of the Treaty exclude such an insurance company from the listed benefits of the Treaty? In other words, does the 2% rate constitute a "special tax benefit" within the meaning of Article XXX(3) of the Treaty?

Preliminary Response

CRA noted that in addition to amendments to the Barbados Income Tax Act introducing the graduated rates noted above, Barbados also changed its Insurance Act to provide for Class 1, 2, and 3 licensees, with Class 2 licensees (described in the Insurance Act as “companies that underwrite risks of third parties”) subject to a 2% rate (and 0% for Class 1 licensees, and 2% for Class 3 licensees).

The preamble to Art. XXX of the Treaty is broadly worded, making reference to “any special benefit” received by any person or other entity under the Insurance Act or any “substantially similar law.” Given that there is a tax regime in Barbados that is specific to insurance companies, a Class 2 licensee is considered to receive a special tax benefit for the purpose s of Art. XXX(3). Accordingly, Class 2 licensees would not be entitled to the benefits provided under Arts. VI to XXIV of the Tax Treaty.

Q.5 – Canadian home offices and US employers

Consider the following scenario:

  • USco was formed under the laws of the U.S. as a C-corporation that is taxed in the U.S. as a separate taxpayer on a worldwide basis
  • USco is a resident of the U.S. for purposes of the Canada-U.S. Income Tax Convention (the “Treaty”)
  • USco is entitled to benefits under the Treaty (i.e., USco is a “qualifying person” for purposes of Article XXIX-A of the Treaty)
  • 50 of the 1,000 USco employees are Canadian residents
  • The employees are allowed, but not required, to work from home for two or three days a week

Could CRA please comment on the following:

Whether USco may be considered to be

i. carrying on business in Canada for purposes of the Act, and, if so

ii. earning income through a permanent establishment (as defined for purposes of the Treaty) in Canada

Preliminary Response

Despite the increase in remote working, the general principles remain unchanged.

It must be determined if a person is carrying on business in Canada. Generally, the place where the person carries on business will be the place the profit-producing contracts are concluded, or where the profit-generating activities take place, rather than where the profits are realized. CRA has provided more specific guidance, including S5-F2-C1 (“Foreign Tax Credit”), which includes a section dealing with the source of business income.

The factors that might be relevant in this context to determine whether USco would be seen as carrying on business at the home or place from which the employee works in Canada may include the following:

  • The place of the decisions to purchase or sell property – i.e., when the individual is working at home in Canada for USco, is the individual making decisions to purchase or sell property? Depending on the business of USco, that might be a relevant factor.
  • Where goods are produced or services are performed – again, this will be affected by the nature of the individual’s activities and USco’s business will be relevant in weighing this factor.
  • Whether a reasonable person would consider the individual’s at-home work to be part of the business carried on by USco.

Mere Canadian presence is not determinative, and what is important is to examine what the employee is doing and how that fits within USco’s operations.

Another potentially relevant factor is the degree of supervision or other activity by USco in Canada, or the presence of a US representative or resident expert in Canada. That would all be relevant to determining the actual presence of USco in Canada and the activities performed through the individual, and also to whether the employee’s activities were ancillary or incidental to the predominant business activities of USco. The central question is how close the operations, performed by the at-home Canadian employee, are to the predominant business activities of USco.

Those are general guiding principles. More specific circumstances will now be examined.

If the employee is providing internal support to USco from a home in Canada three days a week on a regular basis, that might be insufficient to conclude that USco is carrying on business in Canada. For example, a Canadian accountant preparing the financial reporting for USco, might not constitute USco carrying on business in Canada, nor might a human resource professional who provides internal support to USco’s managers.

Another example of specific activities would be providing services to clients. For example, if USco is in the consulting business, and the individual working from home is providing consulting services to clients or is part of a service team of USco, that might suggest that USco is carrying on business in Canada, especially if the clients themselves are in Canada.

In another example, the employee has a product-development role. S. 253(a) deems USco to be carrying out business in Canada if it “produces, grows, mines, creates, manufactures, fabricates, improves, packs, preserves or constructs, in whole or in part, anything in Canada … .” If the individual is in a product-development role, and plays an active role within USco in the activities of producing, in whole or in part, anything in Canada, or creating, manufacturing, or making improvements, all those elements might, on their own, result in the application of 253(a), so that USco would be deemed to carry on business in Canada through its remote worker.

Another example is of the individual soliciting or offering anything for sale when working remotely. If it goes beyond advertising for USco, or mere soliciting, that could also indicate that USco is carrying on business in Canada through that employee.

If there is sufficient evidence to conclude that USco is carrying on business in Canada, it would not be subject to Canadian tax unless it had a permanent establishment in Canada. Assume that the only presence of USco in Canada is through the remote workers who, as posited, work three days a week. The question, then, is whether that would constitute a permanent establishment of USco in Canada. The answer turns on whether the activities of the individual that are performed in Canada can be viewed as being performed from a fixed place of business through which USco wholly or partly carries on business. Similar to the above discussion about carrying on business in Canada, the answer turns on the individual's activities.

Some of the elements that would be relevant in making that determination are whether USco has access to the premises where the individual works and compensates the individual for the use of that space in Canada, e.g., pays rent. More generally, is there any evidence of USco’s intention to establish a workplace in Canada?

The various presumptions under the Treaty should also be factored in. One that might be relevant in this context is Art. V(5) of the US treaty. That provision might be applicable where the individual enters into contracts in Canada while working from Canada, and it mainly turns on the level of the authority the individual has to bind USco. If so, Article V(5) would deem the activities of USco to be performed in Canada through a permanent establishment to the extent that the activities of the individual, when working from Canada, bind USco. That would be viewed as a services permanent establishment. Again, the circumstances have to be considered. If USco still has to approve the transaction or the contract, but that step is a formality, the conditions could be met.

A further relevant deeming rule in the US Treaty is Art. V(9). That deals with circumstances where the individual is working on a single project for a Canadian-resident customer, or a permanent establishment in Canada of a non-resident. If all of the individual’s time is spent on the single project, or on a project that is connected to that project, then the number of days must be tracked, with 183 days being the cutoff. If the individual is really working on a specific project for a single Canadian client, then the presumption might apply to deem USco to have a permanent establishment and carry on business in Canada through that establishment.

Another Article of potential interest is Art. V(6). It suggests that activities that are preparatory or auxiliary might not be sufficient to create a permanent establishment in Canada.

Other considerations would have to be considered if USco has Canadian employees or employees working in Canada. In particular, USco would be required to withhold in respect of them. If the employees are also taxed in the US, then the employee might be able to claim a foreign tax credit, but a letter of authorization could be requested of CRA to reduce withholdings depending on the circumstances.

Q.6 - Art. IV(6) hybrid rule

Consider the following Scenario, depicted on the following slide:

  • A U.S. resident corporation has elected to be classified as a “real estate investment trust” (“REIT”) under the U.S. Internal Revenue Code (the “Code”), and is a regarded entity for U.S. income tax purposes. REIT is a U.S. resident and a “qualifying person” for purposes of the Canada-U.S. Income Tax Convention (the “Treaty”)
  • REIT owns US LLC 1, a disregarded entity for U.S. income tax purposes
  • US LLC 1 owns US LLC 2, which is also a disregarded entity for U.S. income tax purposes and a section 216 taxpayer for Canadian income tax purposes
  • Neither US LLC 1 nor US LLC 2 is a resident of Canada for the purposes of the Treaty
  • US LLC 1 makes an interest-bearing loan to US LLC 2. The loan is incurred in connection with US LLC 2’s real estate operations in Canada, which constitutes its permanent establishment in Canada. Interest on the loan is borne by the permanent establishment
  • Interest on the loan is subject to Canadian Part XIII withholding tax (either as a result of the application of paragraph 212(13)(f) or proposed paragraph 212(13.2)(b))
  • The CRA has previously stated that where a ULC makes payments to a U.S. LLC and both are disregarded for US tax purposes, Article IV(6) of the Treaty would not apply to treat a particular amount of Canadian source income, profit or gain as being derived by the U.S. member(s) of the LLC where that amount is “disregarded” under the taxation laws of the U.S. (Technical Interpretation 2012-0434311E5)
  • The same conclusion would apply in the given example, such that interest payments from US LLC 2 would not be eligible for relief under the Treaty
  • Can the CRA comment on the applicability of the Treaty to relieve interest payments by US LLC 2 from Part XIII withholding tax in the scenarios described below?

Scenario 1 - Creating a Regarded Interest Recipient

  • REIT incorporates a new corporation (“US TRS”) with nominal share capital. REIT and US TRS jointly elect to treat US TRS as a taxable REIT subsidiary under the Code. US TRS is a taxable corporation (and is regarded) for U.S. income tax purposes
  • US TRS is a U.S. resident and a “qualifying person” for purposes of the Treaty
  • Neither REIT nor US TRS carries on business in Canada through a permanent establishment
  • US LLC 1 and US TRS form US LP, a limited partnership formed under the laws of the US. US TRS holds a 0.1% general partner interest, and US LLC 1 holds a 99.9% limited partner interest in US LP
  • US LP is considered a flow-through entity for U.S. income tax purposes, but is not disregarded
  • US LP, rather than US LLC 1, makes an interest-bearing loan to US LLC 2
  • For U.S. income tax purposes, interest paid by US LLC 2 to US LP is viewed as interest paid by REIT to US LP and is not disregarded
  • On an annual basis REIT and US TRS are allocated interest income received by US LP in proportion to their partnership interests and include it in computing their taxable income for U.S. income tax purposes

Scenario 2 - Creating a Regarded Interest Payor

  • US LLC 1 incorporates a new corporation (“US TRS”) with a nominal share capital. US LLC 1 and US TRS jointly elect to treat US TRS as a taxable REIT subsidiary under the Code. US TRS is a taxable corporation (and is regarded) for U.S. income tax purposes
  • US TRS is a U.S. resident and a “qualifying person” for purposes of the Treaty
  • Neither REIT nor US TRS carries on business in Canada through a permanent establishment
  • US TRS subscribes for a 0.1% membership interest in US LLC 2, while US LLC 1 holds a 99.9% membership interest
  • US LLC 2 is treated as a partnership for U.S. income tax purposes, which is a flow-through entity, but is not disregarded for U.S. income tax purposes
  • US LLC 1 makes an interest-bearing loan to US LLC 2
  • For U.S. income tax purposes, interest paid by US LLC 2 to US LLC 1 is viewed as interest paid by US LLC 2 to REIT and it is not disregarded
  • REIT includes the amount of interest received as interest income from US LLC 2 through US LLC 1 in computing its taxable income for U.S. income tax purposes

Preliminary Response

Base Scenario

Here, the interest is paid by LLC 2 is deemed to arise in Canada because it is borne by the LLC 2 in Canada, and Art. XI(1) accords exclusive taxing rights to the US only if the interest is beneficially owned by a US resident – whereas, here, LLC 1, is disregarded for US purposes and, on that basis, cannot be a US-resident beneficial owner.

Turning to Art. IV(6), it provides Treaty benefits where: the interest be received through an entity that is fiscally transparent in the US; that fiscally transparent entity does not reside in Canada; and that the tax-treatment of the payment from the disregarded entity would be the same under the tax laws of the US if it had been derived directly by the person.

In the base scenario, CRA would conclude, consistent with its prior positions, that such conditions are not met (the amount is disregarded) and, therefore, Art. IV(6) would not be applicable.

Scenario 1

This scenario goes from the interest being received by a fiscally transparent entity to being received by a partnership. CRA’s longstanding position is that, when determining treaty benefits on distributions from a partnership, it has regard to the members of the partnership. In this scenario, the two partners are US TRS, and the REIT (through US LLC 1, which is disregarded for US purposes).

Regarding the first leg of this distribution to US TRS, US TRS would be entitled to the benefits of the Treaty on its share of interest payments made by US LLC 2. Under Art. XI(1), only the US could tax that distribution of interest to US TRS.

Regarding the second leg of the distribution to the fiscally disregarded US LLC 1, the REIT would be considered to meet the conditions of Art. IV(6): the payment is received through an entity that is fiscally disregarded in the US (i.e., US LLC 1); the interest is taxed in the US in the hands of the REIT; and the tax treatment in the US is the same as if the REIT had received the interest directly. Accordingly, the conditions of IV(6) are met and Art. X(1) accords full taxing rights to the US.

Scenario 2

In this case Art. IV(6) would apply as well.

Q.7 - HK Treaty main purpose test/ MLI PPT

Article 10 paragraph 2 of the Hong Kong-Canada Income Tax Agreement (Agreement) provides that the Canadian withholding tax on a dividend paid by a Canadian resident company to a Hong Kong tax resident will be reduced to either:

a) 5% of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) that controls directly or indirectly at least 10% of the voting power in the company paying the dividends (Article 10(2)(a)); and

b) 15% of the gross amount of the dividends, in all other cases (Article 10(2)(b))

Paragraph 7 of Article 10 (Article 10(7)) of the Agreement contains a main purpose test which states as follows:

“A resident of a Party shall not be entitled to any benefits provided under this Article in respect of a dividend if one of the main purposes of any person concerned with an assignment or transfer of the dividend, or with the creation, assignment, acquisition or transfer of the shares or other rights in respect of which the dividend is paid, or with the establishment acquisition or maintenance of the person that is the beneficial owner of the dividend, is for that resident to obtain the benefits of this Article.” (Emphasis Added)

Consider the following example:

  • Mr. A and his spouse (Taxpayers) have been residents of Hong Kong since prior to 2013 and have been resident there since
  • The Taxpayers are equal shareholders of a Canadian resident corporation (Canco)
  • The Taxpayers plan to incorporate a new Hong Kong company (HKCo) and will each transfer their shares of Canco to HKCo
  • HKCo will own 100% of Canco after the transfer

Canco Current Structure Mr. A. Mrs. A. 50% 50% Structure After Transfer Mr. A. Mrs. A. Canco HKCo 50% 50% 100%

1) Will dividends paid by Canco to HKCo be eligible for the 5% reduced treaty rate in Article 10(2)(a)?

2) Will the anti-avoidance rule under Article 10(7) of the Agreement apply to deny the benefit of Article 10(2)?

3) If yes, will the withholding tax rate be 15% as available prior to the transactions or 25% as provided without the benefit of a tax treaty?

4) Will the Multilateral Instrument (MLI) have any implications to the withholding tax rate applicable under the Agreement?

Preliminary Response

Moreno: Our answer assumes that one of the main purposes of the taxpayers or any of the persons concerned with the acquisition by taxpayers of the shares of Canco did not include obtaining the benefits of Art. 10 of the Treaty, and that HKCo had the same purposes when acquiring the Canco shares.

In the situation described in the question, in the absence of any main purpose to gain access to Art. 10 of the Treaty, Art. 10(7) will generally not apply to deny the benefits of the Treaty to such dividends. Had Article 10(7) applied, the withholding rate would have been 25%.

Chow: What are the implications of Canada and Hong Kong signing onto the MLI?

Moreno: The test under the MLI is slightly different. The test is whether the result is consistent with the object and purpose of the relevant provisions of the agreement, and the conclusion here would be that Article 7(1) of the MLI would generally not apply to deny the benefits of 10(2)(a) of the Treaty to the dividends here, where the individuals transfer their shares to a holding corporation.

Q.8 – Computing TFSB on s. 88(1)(d) bump

At the 2011 IFA Conference CRA Roundtable, the CRA indicated that it would not challenge a paragraph 88(1)(d) bump in respect of the shares of a foreign affiliate (FA) by raising an issue with an FA’s tax-free surplus balance (TFSB) calculation or lack thereof where:

  • absent clause 88(1)(d)(ii)(C), the shares of FA could be bumped to fair market value such that there would be no gain on a subsequent distribution of the FA shares to a foreign parent;
  • no dividends were paid or were deemed to be paid on the FA shares following the acquisition of control; and
  • the FA shares were distributed to the foreign parent within a reasonable amount of time.

(CRA document 2011-0404521C6)

Given the CRA’s more recent statements on the necessity of computing surplus to support deductions under section 113, can the CRA confirm its prior position regarding tax-free surplus balance and the bump?

Preliminary Response

The more recent reiterations by CRA of the requirement to support deductions under s. 113 with supporting information and computations were based on the application of s. 230(1), requires that records and books support the reporting.

The 2011 position effectively does not require that the taxpayer provide such computations where Forco acquired, through an acquisition company in Canada (Holdco), control of a Canco, which owns a foreign affiliate (FA) and, shortly after the wind-up of Canco and the bump in the ACB of the foreign affiliate shares that were now with the acquisition company, it then distributed them out of Canada to the foreign parent so that the surplus becomes irrelevant for Canadian purposes.

The waiving of the requirement to provide supporting computations really turns on the conditions that neither Canco nor Holdco receive, or are deemed to receive, any dividend after the acquisition of control of Canco; and the shares of the FA are transferred within a reasonable time after the takeover of Canco; and there is no prospect that the surplus of the FA would be relevant after the acquisition of control of Canco. Where those conditions are met, the bump can be made without a computation of the tax-free surplus balance that s. 88(1)(d) would otherwise require.

That administrative position is reconcilable with more recent CRA statements on the basis that the surplus is not relevant in Canada. Future circumstances may dictate that revisions are necessary, but CRA continues to apply the 2011 administrative position, provided the conditions are met.