5 April 2001 External T.I. 2000-0043615 - Taxation of Shareholder of US S-Corp

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:

General tax treatment of a Canadian resident who is a shareholder of a United States S-Corp where there is no distribution in Canada but US tax has been paid by the resident on income of the S-Corp.

Position:

Where there is no distribution, subsection 20(11) does not apply. Subsection 20(12) does apply. To the extent that the US tax paid is not deducted under subsection 20(12), it is eligible for purposes of claiming a foreign tax credit under subsection 126(1).

Reasons: Where there is no distribution, there is no "amount that has been included in computing the taxpayer's income for the year from the property" (i.e., the shares of the S-Corp). Subsection 20(12) is applicable because the US tax qualifies as "non-business-income-tax" under subsection 126(7). Subsection 126(1) would also be applicable for the same reason.

XXXXXXXXXX 	2000-004361
		Eliza Erskine
April 5, 2001

Dear XXXXXXXXXX:

Re: Taxation of a Canadian Resident Shareholder of a United States S-Corporation (an "S-Corp")

This is in reply to your letter of August 16, 2000, requesting our views regarding the Canadian tax treatment of a Canadian resident who is a shareholder of an S-Corp. In our telephone conversation with you of August 30, 2000, (Major/XXXXXXXXXX), you explained that you were specifically interested in our views on the tax treatment of such a shareholder for the 1999 taxation year, in circumstances where there was no distribution in Canada by the S-Corp and the shareholder paid income tax to the United States with respect to the income of the S-Corp (the "US Tax"). For the purposes of this letter, except in the context of our discussion (see our comments below) of paragraph 5 of Article XXIX of the Canada-U.S. Tax Convention (the "Convention"), we assume that there was no foreign accrual property income ("FAPI") included in the income of the Canadian resident shareholder in respect of the income of the S-Corp.

Our Comments

The situation outlined in your telephone conversation with us appears to relate to an actual completed transaction. We note that written confirmation of the tax implications arising from particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. We note further that your request appears to be in the nature of a tax consultation. We cannot respond to your request as such, as the Canada Customs and Revenue Agency does not provide tax planning advice. We are willing, however, to provide you with some general comments on the subject of the tax treatment of Canadian resident shareholders of S-Corps. Considering the complexity of the issues involved with respect to this subject matter, we suggest that you may wish to consult with a tax professional who specializes in the area of Canada/U.S. cross-border taxation. However, if you require additional information regarding your specific tax situation, we invite you to contact your local tax services office.

It is our opinion that the US Tax paid by a Canadian resident shareholder would generally be considered to be a tax in respect of income from the shares of the S-Corp (i.e., a tax in respect of income from a property), for purposes of subsections 20(11), 20(12) and 126(1) of the Income Tax Act (the "Act"), notwithstanding that the tax is computed with reference to the S-Corp's income.

Where there was no distribution from the S-Corp in a particular year, it is our view that subsection 20(11) of the Act would not apply in that year, as no amount would be included in computing the taxpayer's income for the year from the property (i.e., the shares of the S-Corp) for purposes of the Act. As subsection 20(11) of the Act would not apply, and the US Tax would be considered to be a tax on income from a property that is a "non-business-income-tax" for purposes of subsection 126(7) of the Act, all of the US Tax paid by the taxpayer would be an eligible tax for purposes of subsection 126(1) of the Act. This means that the taxpayer could claim a foreign tax credit for all of the US Tax, as long as he or she had income from other sources in the United States that was subject to Canadian income tax. Any of the US Tax that could not be utilized as a foreign tax credit under subsection 126(1) of the Act could be deducted pursuant to subsection 20(12) of the Act.

Where there was no distribution from the S-Corp in a year and the taxpayer had insufficient income from other sources in the United States to fully utilize the foreign tax credit in respect of the US Tax, there would be the potential for unrelieved double taxation. For example, a taxpayer is subject to U.S. tax on his or her share of the income of an S-Corp as the income is earned by the S-Corp. However, under the Act, that taxpayer would not be subject to Canadian tax on such income until the income is actually distributed to the taxpayer. Therefore, there is an unavoidable timing mismatch where there is no distribution by the S-Corp to the taxpayer in a particular year. Although the deduction under subsection 20(12) of the Act is available regardless of whether the taxpayer has income from other sources in the United States, this deduction may not be satisfactory to the taxpayer, as it will not usually entirely eliminate the double tax.

Paragraph 5 of Article XXIX of the Convention may be available to the taxpayer to resolve the timing mismatch described above. If paragraph 5 of Article XXIX of the Convention applies, then, among other rules,

(a) the S-Corp is deemed to be a controlled foreign affiliate of the taxpayer,

(b) all of the taxpayer's share of the income of the S-Corp is deemed to be FAPI to the taxpayer, and

(c) this income is expressly excluded from the application of subsection 20(11) of the Act.

The effect of paragraph 5 of Article XXIX of the Convention is to bring the taxpayer's share of the income of the S-Corp into the taxpayer's income for purposes of Canadian tax in the same year that the US Tax is paid. As subsection 20(11) of the Act would not apply, the full amount of the US Tax could be claimed as a foreign tax credit under subsection 126(1) of the Act and applied against the Canadian tax payable in respect of the deemed FAPI. Generally, where paragraph 5 of Article XXIX of the Convention applied, any distribution by the S-Corp to the taxpayer in a subsequent year would not be subject to Canadian tax, as it already would have been taxed as FAPI in the hands of the taxpayer in a preceding year.

We note that in order to have the rules under paragraph 5 of Article XXIX of the Convention apply to a Canadian resident, the Canadian resident must conclude an agreement with the competent authority of Canada, subject to terms and conditions satisfactory to such competent authority. The Income Tax Rulings Directorate is not involved in negotiating such agreements and is not a party to such agreements.

It is our view that where there is a distribution from the S-Corp in a particular year, subsection 20(11) of the Act does apply in that year. This would affect the amount of the US Tax creditable under subsection 126(1) of the Act or deductible under subsection 20(12) of the Act, by virtue of the impact of subsection 20(11) of the Act on the definition of "non-business-income-tax".

The above comments represent our general views with respect to the above-noted subject matter. These comments do not constitute an advance income tax ruling and, therefore, are not binding on the Canada Customs and Revenue Agency, as described in paragraph 22 of Information Circular 70-6R4. Furthermore, nothing in these comments should be construed as an opinion regarding the specific tax treatment of the taxpayer for the 1999 taxation year.

We trust that the above comments will be of some assistance to you.

Yours truly,

Jim Wilson
for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch