3 October 1996 Internal T.I. 1996-9523657 - Capitalization rules applicable to non-res.

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.

TRANSLATION FROM FRENCH

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Document No.:	F 9523657
Author:		MSEGUI
Reference Date:	October 3, 1996
Subject:		Capitalization rules applicable to non-residents
Section Ref.:		18(4)
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October 3, 1996

Laval Tax Services Office

Section 452

Rulings and Interpretations Directorate
Reorganizations and International Division

Attention: 	Denis Fleury		M. Séguin
		Coordinator		(613) 957-8953
		Technical Services	7-952365

Request for Opinion

Clause 18(4)(a)(ii)(B) of the Income Tax Act (hereinafter "the Act")

This is in response to your letter dated September 1, 1995, in which you asked Patrick Décarie, Auditor, International Transactions, for an opinion.

The facts of the case can be summed up as follows:

• Fifty percent of shares of a Canadian corporation (Canco) are held by a Canadian corporation and 50% are held by a US corporation (Usco). The Canadian corporation and the US corporation each paid $XXXXXXXXXX to a contributed surplus.
• In 1989, Usco acquired all of the shares of the capital stock of Canco.
• In 1992, following a restructuring within the group, Usco sold the Canco shares to an affiliated company resident in Germany (Germany). Germany is the parent company of Usco.
• Germany advanced an interest-bearing loan to Canco; the interest on this loan is paid annually. Part XIII tax is withheld and remitted to the Receiver General.
• The retained earnings of Canco are negative; its paid-up capital is $XXXXXXXXXX.
• In 1993, when Germany was the sole shareholder, Canco included the contributed surplus for Canco when applying subsection 18(4) of the Act, even though the surplus came from Usco (when it was a specified non-resident shareholder).

Your question

Should an amount of the contributed surplus paid in by a former specified non-resident shareholder (Usco) be included in the computation for the purposes of subsection 18(4) of the Act, even if the specified non-resident shareholder at the time of computation is Germany?

In addition, in your letter dated May 31, 1996, you asked whether our answer would be different, in whole or in part, if the following condition applied: if half of the contributed surplus came not from a contribution paid in by a non-resident but rather from a journal entry made in 1970, at the time the Canadian corporation recorded a grant received from the Government of Canada for work in this field.

Your comments

You quote author Douglas S. Ewens (CTJ 1994, Vol. 42, No. 3, page 959) on this subject:

Surplus contributed by a person when he was a specified non-resident shareholder is included in the computation of the Canadian resident shareholder corporation's equity, even if he is no longer a specified non-resident shareholder.

Our comments

Clause 18(4)(a)(ii)(B) of the Act, in both the French and English versions, reads as follows:

le surplus d'apport de la société au début de l'année, dans la mesure où il a été fourni par un actionnaire non-résident déterminé de la société,

the corporation's contributed surplus at the commencement of the year, to the extent it was contributed by a specified non-resident shareholder of the corporation.

There is no indication in these words, in either version, that the specified non-resident shareholder who paid in a contributed surplus must still be a specified non-resident shareholder at the time the calculation is made under subsection 18(4) of the Act. XXXXXXXXXX.

We agree with Mr. Ewens's observation, which you are quoting above.

With regard to the additional facts that you have put to us, a contributed surplus such as the one you identified would not be admissible for the computation under subsection 18(4) of the Act, as it is not paid by a specified non-resident shareholder of the corporation.

Section Chief
Reorganizations and International Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch