3 October 2000 Internal T.I. 2000-0030737 - Subpar 152(4)(b)(iii) and FAPI

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.

Principal Issues: Whether a reassessment of a taxpayer to include an amount in income under section 91 in respect of foreign accrual property income ("FAPI") of a controlled foreign affiliate can reasonably be regarded as relating to a transaction involving the taxpayer and controlled foreign affiliate.

Position: Question of fact. If the controlled foreign affiliate does not conduct any business with its Canadian shareholder, a reassessment of income computed under section 91 may reasonably be considered to be made as a consequence of the initial subscription for shares in controlled foreign affiliate by the taxpayer only if the capital is directly invested by the controlled foreign affiliate in FAPI earning property or activities.

Reasons: If the capital invested by the taxpayer is used by the controlled foreign affiliate to earn income from active business and is later used to earn FAPI, the FAPI and the capital infusion by the taxpayer may be too remotely related for the reassessment of the taxpayer for section 91 income to be considered as being made as a consequence of the investment in the foreign affiliate by the taxpayer.

			October 3, 2000

	Vancouver Tax Services Office	Income Tax Rulings Directorate
	International Audit, Section 446-34	Olli Laurikainen
(613) 957-2116
	Attention:  Rick Ford
			2000-003073

Subparagraph 152(4)(b)(iii) and Foreign Accrual Property Income ("FAPI")

This is in response to your memorandum dated June 2, 2000 wherein you request our views in reference to the application of the extended assessment/reassessment period referred to in subparagraph 152(4)(b)(iii) of the Act. You provide the following two hypothetical fact scenarios to demonstrate the issues.

A) Canco incorporates and capitalises a 100 % owned controlled foreign affiliate ("CFA") after 1995. The CFA uses all of the money invested by Canco to purchase investment property which is then used to earn income from an investment business (i.e. FAPI).

B) Canco incorporates and capitalises a 100% owned CFA in 1992 and CFA uses all of the money invested by Canco to earn income from a business which initially qualifies as an active business but which falls into the definition of "investment business" and produces FAPI in taxation years of CFA commencing after 1994. The activities of CFA in taxation years commencing prior to 1995 and taxation years commencing after 1994 are identical. The change in the characterization of the income under the foreign affiliate provisions of the Act arises purely as a result of amendments to the provisions of the Act.

You request our view whether in either of the above scenarios CFA can be reassessed after the normal reassessment period if the only transaction between Canco and CFA is its original subscription for the shares issued by CFA. More specifically, you request our view whether we can "take the position that the income from shares of a controlled affiliate owned by the Canadian taxpayer constitutes a transaction involving the Canadian taxpayer and that particular controlled foreign affiliate" for the purposes of subparagraph 152(4)(b)(iii) of the Act.

Our Comments

We do not consider the operation of section 91 of the Act (i.e. by providing for inclusion of the FAPI of CFA in the income of Canco as income from a share) as giving rise to a "transaction" between CFA and Canco for the purposes of subparagraph 152(4)(b)(iii) of the Act. We consider the term "transaction" in subparagraph 152(4)(b)(iii) to be referring to any business or investment transaction entered into between the two parties in question.

Where the only transaction between Canco and a non-arm's length non-resident person (i.e. a wholly-owned CFA) is Canco's original subscription for the shares of CFA, the crux of the matter is whether a subsequent reassessment of Canco in respect of the FAPI of the CFA "can reasonably be considered as relating to" the original subscription for the shares of CFA by Canco for the purposes of subparagraph 152(4.01)(b)(iii) of the Act. As discussed in our memorandum 2000-0002687 to which you refer in your request, subparagraph 152(4)(b)(iii) of the Act will extend the period during which a reassessment in respect of unreported section 91 income can be made if there is a direct causal connection between the FAPI earned by the CFA and the investment in the shares of CFA by Canco. We generally consider this to be the case only if the moneys raised by CFA on the issuance of its shares are invested by it directly in property or a business from which FAPI is derived. If the capital invested by Canco is initially used by CFA in an active business, the causal connection is lost notwithstanding that the invested capital is later employed in an activity from which CFA derives FAPI.

In example A above, the capital invested by Canco is injected by CFA directly into an investment business from which CFA derives FAPI. In such case, we would clearly consider there to be a direct causal connection between the FAPI and the investment in the shares of CFA by Canco. Accordingly, CCRA would be entitled to reassess Canco to include an amount under section 91 in income in respect of such FAPI within the extended reassessment period referred to in subparagraph 152(4)(b)(iii) Act. In example B, the capital invested by Canco is used by CFA in an active business. Several years subsequent to the original investment, the amendments to the foreign affiliate legislation take effect and the business activities of CFA begin to produce FAPI. In such case we feel the causal connection between the original investment in CFA and the FAPI has been eroded by the fact that the funds had been invested for several years for the purpose of earning income from active business. Moreover, much of the FAPI arising in taxation years commencing after 1994 may be considered attributable to assets that were developed in the course of the active business and/or the reinvestment of active business earnings as opposed to the original capital investment.

In sum, in reference to a potential FAPI assessment we generally consider the extended reassessment period to apply to a taxpayer where the FAPI income is derived from business conducted by the controlled foreign affiliate with the taxpayer. However, in limited circumstances where it can clearly be shown that the investment by the taxpayer in the controlled foreign affiliate is used by it directly for the purpose of earning FAPI, the taxpayer may be reassessed in respect of such FAPI during the extended reassessment period.

As indicated in our earlier memorandum, in cases where a taxpayer fails to report a significant amount of FAPI earned by a controlled foreign affiliate, it may be possible to make a reassessment in respect of such FAPI after the normal reassessment period pursuant to subparagraph 152(4)(b)(i) of the Act on the basis that the failure to report the FAPI was a misrepresentation that is attributable to neglect, carelessness, or wilful default on the part of the taxpayer.

for Director
Reorganizations and International Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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