28 February 2008 Internal T.I. 2008-0266181I7 - Reduction of PUC

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 subsection 84(4) of the Act apply in situation where a corporation paid an amount in excess of the paid up capital ("PUC") of its shares, in error, during a reduction of capital to it sole shareholder

Position: Technically yes; however, an administrative remedy may apply in the case of an honest error.

Reasons: On its words subsection 84(4) applies to deem a dividend to be paid by a corporation resident in Canada when on a reduction of paid up capital the corporation pays a shareholder an amount greater than the amount of the reduction to paid up capital. However, the administrative policy to treat the excess as an advance under subsection 15(2) in the transfer pricing context may be applied in a situation where there was an honest error. However when the "advance" remains outstanding for more than a year subsection 17(1) will apply to the "lender".

									February 28, 2008
	Toronto West TSO Aggressive Tax Planning
									HEADQUARTERS
									Income Tax Rulings
	Attention:  Charmaine Goel			  	Directorate
									Shelley Lewis
(613) 957-2118

									2008-026618
	Reduction of PUC 

This is in response to your email of January 23rd, 2008, where you inquired whether subsection 84(4) of the Income Tax Act (the "Act") applied in a situation where a corporation paid an amount in excess of the paid up capital ("PUC") of its shares on a reduction of capital to its sole shareholder who was a non-resident of Canada. You further inquired if in the event that the excess payments were made in error the amount could be considered a repayable advance of funds to a shareholder as contemplated in subsection 15(2) of the Act.

We have the following understanding of the facts:

XXXXXXXXXX ("Parentco") is a non-resident of Canada and the sole shareholder of XXXXXXXXXX ("Holdco"). Holdco is resident in Canada. In a resolution dated XXXXXXXXXX , Holdco returned "paid up capital" in the amount of CAN$XXXXXXXXXX . That same day Parentco acknowledged its receipt of a return of PUC from Holdco in the amount of CAN$XXXXXXXXXX (satisfied by the transfer of US$XXXXXXXXXX ).

During a Canada Revenue Agency (CRA) audit it was discovered that in an earlier transaction affecting the computation of PUC an incorrect foreign exchange rate had been used and as a result on the return of PUC on XXXXXXXXXX Holdco transferred CAN$XXXXXXXXXX more than the actual PUC of its shares.

In a letter dated November 1, 2007, counsel for Holdco first submitted that the amount Holdco paid Parentco in excess of its PUC was paid in error. Counsel submitted that an administrative practice that the CRA uses in secondary adjustments on treaty transfer pricing matters and in the mutual agreement procedure should be applicable to similar excess cross-border payments such as amounts paid in error. To that end, counsel submits the excess CAN$XXXXXXXXXX should be treated as a shareholder advance under subsection 15(2) of the Act which would thus give rise to a deemed divided pursuant to subsection 214(3) of the Act. Relying on subsection 227(6.1) of the Act counsel suggests that the obligation to remit the tax should be set off against the taxpayer's entitlement to a refund of the tax and that no penalties should be assessed for failure to deduct or withhold under subsection 227(8) of the Act.

Our Comments

Subsection 84(4) of the Act deems a dividend to have been paid by a corporation resident in Canada when on a reduction of PUC the corporation pays a shareholder an amount greater than the amount of the reduction of the PUC. Although subsection 84(4) of the Act specifically applies to the transaction at issue, if the miscalculation and the overpayment were an honest error, and the taxpayer was acting in good faith, it is our view that the administrative position in respect of secondary adjustments in transfer pricing cases may be applied. This position is set out in Transfer Pricing Memo TPM-02 entitled Repatriation of funds by Non-residents - Part XIII Assessment, and paragraphs 211-213 of Information Circular IC-87R2 entitled International Transfer Pricing.

It is our view, that if there were an honest error and the taxpayer was acting in good faith, the excess amount paid by Holdco to Parentco could be treated as an interest-free loan to Parentco pursuant to the administrative position. Interest would be charged on the assessment but no penalty for failure to deduct or withhold under subsection 227(8) of the Act would be applied. In addition, subsection 17(1) of the Act would apply to include in Holdco's income, for each relevant year, interest calculated at the prescribed rate on the balance for the period during the year in which the amount was outstanding.

Alternatively, if the facts indicated that there was wilful blindness, actual intent, or a manipulative desire to characterize the payment after the fact as an error when the overpayment was subsequently discovered, we would consider this an abusive transaction and no relief should be granted.

We trust that these comments will be of assistance.

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 Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

Olli Laurikainen
For Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch