CRA rules on the application of the FAT and underlying foreign tax rules to the investment of a CFA in a US private REIT (holding LLC rental properties) through tiered US partnerships

Canco wholly-owns a US corporation (FA1), which (with third parties) holds the units of a US limited partnership (USLP1), whose only significant asset is its holding of all of the USLP2 units. USLP2 holds all the common shares of a US private REIT (FA2) which holds rental properties through subsidiary LLCs (which are disregarded for US purposes unless owned jointly with a third party) or LPs. FA2 generates FAPI for Canadian purposes.

FA1 will include in its US taxable income its share of the US taxable income of USLP1, which will include the distributions received by it from FA2. In addition to actual distributions, FA2 might declare a consent dividend, i.e., a dividend that is not actually paid but is deemed under US tax law to be distributed and then contributed back to FA2 (as additional paid-in capital).

The proportionate economic interest of FA1 directly or indirectly in USLP2 is expected to decline over time due to arm’s length investors subscribing for USLP1 or USLP2 units, so that FA2 and the underlying LLCs will eventually cease to be foreign affiliates of Canco.

CRA ruled:

• US income tax paid by FA1 on FA1’s share of the distributions paid by FA2 and on any consent dividends will be “foreign accrual tax” (as defined in s. 95(1)) applicable to amounts that are included in Canco’s income under s. 91(1) in respect of the FA1 shares, to the extent that those distributions (and any consent dividends) can reasonably be regarded as distributions of amounts that are included, directly or indirectly, in computing income of USLP2 under s. 91(1).
• Provided that, at any time in a particular taxation year, the total equity percentage in FA2 of Canco, and of persons related to Canco taking into account the rules in s. 93.1(1) is at least 10%, such US income taxes paid by FA1 will not be underlying foreign tax of FA1 in respect of Canco by reason of the application of Reg. 5907(1.03).
• Conversely, if this 10% test is not met, such US income tax will be underlying foreign tax of FA1 in respect of Canco to the extent that FA1’s share of the FA2 distributions (and of any consent dividends) can reasonably be regarded as distributions of amounts that are included, directly or indirectly, in computing income of USLP2 under s. 91(1).

Neal Armstrong. Summary of 2022 Ruling 2020-0859851R3 under s. 95(1) – foreign accrual tax.