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: Does the reference to the taxation year beginning after November 1999 in the coming-into-force provision in respect of Regulation 5907(1.4) apply to the taxation year for which the affiliate would have paid foreign taxes or the taxation year in which the compensatory payment was made.
Position: It refers to the taxation year of the affiliate for which income or profits tax would have been payable by the affiliate had its tax liability not been computed on a consolidated or combined basis.
Reasons: Consistent with position on subsection 91(4) in respect of actual foreign tax paid.
August 20, 2007
Montreal Tax Service Office HEADQUARTERS
Income Tax Rulings
Attention: Mary Seccareccia Shelley Lewis
This is in response to your correspondence of June 4, 2007, regarding the application of the coming into force provision in subsection 5907(1.4) of the Income Tax Regulations (the "Regulations"). This letter also reflects our subsequent communications (Lewis/Seccareccia).
We have the following understanding of the facts:
XXXXXXXXXX (the "FA") is a foreign affiliate of XXXXXXXXXX, a Canadian corporation, (the "Taxpayer"). The FA is a member of a group of foreign affiliates of the Taxpayer (the "Group") who file their foreign tax return on a consolidated basis. The FA has XXXXXXXXXX fiscal year-end.
In XXXXXXXXXX, the FA, inter alia, entered into a tax allocation agreement wherein the FA would pay another member of the Group compensatory payments in respect of income or profits tax that would otherwise have been payable by the FA.
In XXXXXXXXXX and XXXXXXXXXX the FA received significant interest income from another member of the Group. Although such interest was included in computing the FA's foreign accrual property income ("FAPI"), when the Taxpayer's XXXXXXXXXX and XXXXXXXXXX Canadian tax returns were filed no amount in respect of the FA's interest income was included in computing the Taxpayer's income under subsection 91(1).
In XXXXXXXXXX the FA made the compensatory payments in respect of what is assumed to be FAPI for the FA's XXXXXXXXXX and XXXXXXXXXX taxation years (the "Compensation Payments"). The Compensation Payments made by the FA in XXXXXXXXXX can, in part, reasonably be considered to be in respect of a loss of another corporation and such loss is not a foreign accrual property loss.
Assuming the Taxpayer is reassessed in respect of the unreported FAPI, the issue is whether the full amount of the Compensation Payments can be included in determining the foreign accrual tax ("FAT") available to the Taxpayer pursuant to Regulation 5907(1.3) or whether a portion of such amounts are precluded due to proposed Regulation 5907(1.4).
In general terms, FAT is the portion of any income or profits tax that has been paid by a particular affiliate and that may reasonably be regarded as applicable to an amount included in income under subsection 91(1) of the Act in respect of the particular affiliate. It also includes the portion of any income or profits tax that was paid by any other affiliate in respect of a dividend received from the particular affiliate and that may reasonably be regarded as applicable to an amount included in income under subsection 91(1) of the Act in respect of the particular affiliate. FAT also includes any amount prescribed in respect of the particular affiliate to be FAT. Regulation 5907(1.3), which is subject to draft Regulation 5907(1.4), prescribes such amounts.
In any event, an amount is not recognized as FAT until it is paid. However, once a payment qualifies as FAT, the issue becomes when and to what extent is a deduction under subsection 91(4) of the Act available.
In our view, the deduction under subsection 91(4) of the Act is available in the taxation year of the taxpayer in which the taxation year of the affiliate for which the amount in respect of foreign tax is paid [or for which an income or profits tax would have been payable in the circumstances described in Regulation 5907(1.3)], ends. The amount must be paid for the year of the affiliate for which the FAPI is included in the taxpayer's income under 91(1) of the Act, or the 5 immediately succeeding years. In those rare situations where the amount pertains to a taxation year preceding the year in which the FAPI is reported (this could be due to timing differences in how FAPI is computed under Canadian rules versus how the income is computed under the foreign law), the deduction may be made in the taxation year of the taxpayer in which the FAPI is reported.
Prescribed Amounts: Regulations 5907(1.3) and 5907(1.4)
These Regulations relate to compensatory payments that are made by a foreign affiliate that is part of a group of affiliates that file their tax returns in the foreign jurisdiction on a consolidated basis. To satisfy Regulation 5907(1.3) compensatory payments must be paid and reasonably be regarded as being in respect of income or profits tax that would have been payable by the particular affiliate in respect of an amount included in income under subsection 91(1) of the Act had the tax liability of the particular affiliate and the other corporations not been determined on a consolidated basis. There is no requirement that the tax be paid in the taxation year, or be applicable to the taxation year, in which the FAPI was earned.
Additionally, draft Regulation 5907(1.4) stipulates that such compensatory payments are not prescribed to be FAT under Regulation 5907(1.3) if the amount paid can reasonably be considered to be in respect of a loss of any other corporation and such a loss would not be a "foreign accrual property loss" of the other corporation. At issue is the application of the coming-into-force provision of Regulation 5907(1.4). Under the coming-into-force as it presently reads, Regulation 5907(1.4) will be applicable to taxation years that begin after November 1999.
As Regulation 5907(1.4) ties into Regulation 5907(1.3), there was some controversy whether the taxation year referred to in the coming-into-force provision is the taxation year of the foreign affiliate for which the particular amount is paid, the taxation year of the affiliate for which an amount is included in the income of the taxpayer under subsection 91(1) of the Act or the taxation year in which the compensatory payment was made.
It is our view that Regulation 5907(1.4) will apply to compensatory payments made by a foreign affiliate at any time for a taxation year of the foreign affiliate beginning after November 1999. The Compensation Payments described above relate to a taxation year of the FA that began prior to December 1999 and consequently, provided they otherwise meet the requirements of Regulation 5907(1.3), will be considered FAT regardless of when they are paid.
We trust that these comments will be of assistance.
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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