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.
Principal Issues: Whether compensatory payment under a tax sharing agreement was foreign accrual tax pursuant to Regulation 5907(1.3) made by a US LLC which was treated as a disregarded entity under the Internal Revenue Code?
Reasons: Regulation 5907(1.3) only applies to a group where the members are otherwise taxable. The tax paid by the taxable member of the LLC qualifies as foreign accrual tax when the earnings of the LLC in respect of which the tax was paid are distributed to the member. Accordingly, had Regulation 5907(1.3) applied to the compensatory payment, this would lead to duplication.
April 8, 2004
Mara Praulins Suzanie Chua
International Tax Operations Division (613) 957-2115
344 Slater Street, Canada Building
Ottawa K1A 0L5
Atten: Tim Kuss 2003-003729
XXXXXXXXXX Group Foreign accrual tax
This is in response to your email of August 23, 2003 wherein you requested our view on whether a compensatory payment made by a foreign affiliate that is a US limited liability company under a group tax sharing arrangement can be deemed to be foreign accrual tax pursuant to subsection 5907(1.3) of the Regulations. You provide the following set of facts:
1. XXXXXXXXXX is a taxable Canadian corporation.
2. XXXXXXXXXX owns 100% of the shares of US Holdco, which is a corporation incorporated in the United States ("US") and taxable in the US. US Holdco does not carry on business.
3. US Holdco wholly-owns all of the shares of two US limited liabilities corporations, namely US LLC1 and US LLC2 (collectively, the "LLCs").
4. US LLC1 and US LLC2 are corporations for Canadian tax purposes.
5. US Holdco, US LLC1 and US LLC2 are "controlled foreign affiliates" of XXXXXXXXXX pursuant to subsection 95(1) of the Income Tax Act (the "Act").
6. Both US LLC1's and US LLC2's only activity and source of income is the carrying on of XXXXXXXXXX and income from that business is "foreign accrual property income" ("FAPI") pursuant to those definitions in subsection 95(1) of the Act.
7. US LLC1 and US LLC2 are flow-through entities for US tax purposes and as such, are not liable to income or profits taxes in the US under the Internal Revenue Code (the "Code").
8. In each taxation year, the income or loss of US LLC1 and US LLC2 is included in the income or loss for purposes of the Code of US Holdco as the sole member of US LLC1 and US LLC2 without a distribution from US LLC1 or US LLC2.
9. As a result, US Holdco pays US income tax on the income earned by US LLC1 and US LLC2 in a taxation year under the Code.
10. US LLC1, US LLC2 and US Holdco (collectively the "Group") have a tax sharing agreement wherein it is agreed that each Group member will pay their own respective tax costs as if they had filed a separate tax return. Each amount of this hypothetical tax as calculated will be distributed amongst the Group by means of inter-company payments ("compensatory payments") e.g. should an LLC be in a loss position, that LLC would receive compensatory payments from the other Group members that represents the hypothetical tax refund'.
11. XXXXXXXXXX, US Holdco, US LLC1 and US LLC2 each have a XXXXXXXXXX taxation year-end.
Your specific query is whether Regulation 5907(1.3) can apply to compensatory payments made by US Holdco, US LLC 1 and US LLC 2 in the above circumstances when any income or loss of the LLC is treated under the Code, as that of US Holdco.
The provisions of subsection 95(1) define "foreign accrual tax" ("FAT") applicable to any amount included in computing a taxpayer's income by virtue of subsection 91(1) for a taxation year in respect of a particular affiliate as:
(a) the portion of any income or profits tax that was paid by
(i) the particular affiliate, or
(ii) any other affiliate of the taxpayer in respect of a dividend received from the particular affiliate
and that may reasonably be regarded as applicable to that amount, and
(b) any amount prescribed in respect of the particular affiliate to be foreign accrual tax applicable to that amount.
The Canada Revenue Agency ("CRA") view is that all the US tax paid by US Holdco is on its own account and not that of the LLCs. Based on the Facts above, since the US tax was paid by US Holdco, such tax would not qualify as "foreign accrual tax" ("FAT") under subparagraph (a)(i) of that definition in subsection 95(1) of the Act. In order to qualify as FAT under that subparagraph, the tax must be paid by the particular affiliate. However, when the LLCs distribute income to US Holdco such distribution would be characterized as a dividend. The portion of any income or profits tax paid by US Holdco that pertains to the earnings of an LLC which are distributed to US Holdco by way of dividend would, in our view, qualify as FAT under subparagraph (a)(ii) of definition in subsection 95(1). Provided the requirements of subsection 91(4) were otherwise satisfied, XXXXXXXXXX would then be entitled to a deduction in respect of such FAT in computing its income. The deduction would generally be available in the taxation year of XXXXXXXXXX in which the taxation year of US Holdco for which the tax was paid, ends.
We now deal with the specific reasons why the compensatory payments made under the tax sharing agreement as described above would not be deemed FAT under Regulation 5907(1.3). First, paragraph (1.3)(a) of Regulation 5907 applies to situations where there are two or more corporations that "determine their liabilities for income or profits tax payable" to the government of a country on a consolidated or combined basis. In XXXXXXXXXX case, as the representative conceded, under the Code, neither US LLC1 nor US LLC2 are liable for tax but are flow through entities. As a result, neither US LLC1 nor US LLC2 has liabilities for income or profits tax payable to the US, i.e. based on the Facts, there is a disconnect between the requirement that there be "liabilities for tax" and the determination of that tax on consolidated or combined basis because the former is a requisite of paragraph 5907(1.3)(a) in reference to the tax status of US LLC1 and US LLC2 under the Code that is not satisfied. Accordingly, any compensatory payment made by US LLC1 or US LLC2 under the tax sharing agreement cannot reasonably be regarded as being in respect of income or profits tax that would otherwise have been payable by either US LLC1 or US LLC2.
As we are of the view that the US income or profits taxes paid by US Holdco can qualify as FAT under subparagraph (a)(ii) of the definition in subsection 95(1), if we accepted the compensatory payments made by the Group members under the tax sharing agreement as described were also FAT under Regulation 5907(1.3), this would lead to duplication. Such interpretation would lead to results that are anomalous and should be avoided.
Finally, we are of the view that paragraph (1.3)(b) of Regulation 5907 applies where the particular affiliate and another corporation are both subject to taxation and required to file tax returns in the same country and pursuant to the income tax laws of that country, the particular affiliate deducts an amount in respect of a loss of the other corporation in computing its income or profits subject to tax. An example of the situation described would occur in the UK system where group losses are utilized. Accordingly, paragraph 5907(1.3)(b) would not apply to the above Facts.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We trust that the foregoing will be of assistance to you. Should you have any questions, please call Suzanie Chua at (613) 957 2115.
International and Trusts Division
Income Tax Rulings Directorate
Policy & Planning Branch
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