1 April 2011 External T.I. 2008-0297541E5 - Ss. 5901(2) and the Timing of Dividends

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, when applicable, subsection 5901(2) of the Regulations affects both the timing and the character of a dividend.

Position: No, subsection 5901(2) of the Regulations only affects the characterization of the dividend; however, when ss. 5901(2) also applies to a dividend paid by the dividend recipient, the character of the dividend paid by the dividend recipient is determined as if it had been paid immediately after the recipient's taxation year end.

Reasons: Wording of ss. 5901(2).

XXXXXXXXXX
									2008-029754
									Shelley Lewis
									(613) 957-2118

April 1, 2011

Dear XXXXXXXXXX ,

Re: Subsection 5901(2) of the Income Tax Regulations and the Timing of a Dividend

We are responding to your email, wherein you inquired how the Canada Revenue Agency would apply subsection 5901(2) of the Income Tax Regulations (the "Regulations") to a series of dividends. We apologize for the delay.

You request our views in the context of the following facts ("Scenario 1"):

1. A Canadian corporation ("Canco") holds all the issued and outstanding shares of a foreign affiliate that acts as a holding company ("FA1").

2. FA1 holds all the issued and outstanding shares of another foreign affiliate ("FA2"). FA2 carries on an active business.

3. Both FA1's and FA2's year-ends are on December 31st.

4. FA1 has $100 of taxable surplus at the beginning of the day on June 1, 2008.

5. FA2 has no exempt or taxable surplus in the beginning of 2008, but will have exempt surplus in excess of $100 at the end of that year as a result of its active business activity.

6. FA2 pays a $100 dividend to FA1 on June 1, 2008 (i.e. at a time that is after 90 days after the beginning of the 2008 taxation year)("FA2 Dividend").

7. FA1, immediately after having received the FA2 Dividend, pays a $100 dividend to Canco ("FA1 Dividend").

Your views

It is your opinion that subsection 5901(2) of the Regulations affects the character of a dividend, not its timing. You noted that although it cannot be known at the time that FA2 pays the FA2 Dividend whether it will be deemed by subsection 5901(2) of the Regulations to have been paid out of FA2's exempt surplus account, this will be known as at the end of the 2008 taxation year. Once it is known that the FA2 Dividend is deemed to have been paid out of FA2's exempt surplus account, the dividend received by FA1 is included in FA1's exempt surplus account. The inclusion will be as of the time the dividend was received, and not as at the end of the year.

As such, it is your view that at the time that the FA1 Dividend is paid to Canco, that dividend is necessarily paid out of FA1's exempt surplus account.

You suggest that your view is inconsistent with document 9115295, a previous technical interpretation CRA issued in respect of the 90 day rule in subsection 5901(2) of the Regulations.

For reference, the interpretation you referred to in document 9115295 had the following facts and analysis ("Scenario 2").

Facts:

• FA1 is a foreign affiliate of Canco a corporation resident in Canada. Canco acquired 100% of the shares of FA1 in 1990.
• FA1 owns 100% of the shares of FA2 and FA3 which are two other foreign affiliates of Canco.
• FA1, FA2 and FA3 all have taxation years that end on December 31. FA1's only income consists of dividends from FA2 and FA3.
• On June 30, 1991, FA1 has no exempt or taxable surplus (or deficit) in respect of Canco.
• On July 1, 1991, FA2 pays a $100 dividend (the "FA2 Dividend") to FA1. The exempt surplus and taxable surplus (or deficit) of FA2 in respect of Canco at the time of the FA2 dividend is nil.
• On August 1, 1991, FA1 pays a $100 dividend (the "FA1 Dividend") to Canco.
• On September 1, 1991 FA3 pays a $100 dividend (the "FA3 Dividend") to FA1.
• At the time of the FA3 Dividend the exempt and taxable surplus (or deficit) of FA3 in respect of Canco is nil.
• The taxable earnings of FA2 in respect of Canco for the 1991 taxation year are $100 and FA2 has no exempt surplus or deficit in respect of Canco at the end of 1991.
• The exempt earnings of FA3 in respect of Canco for the 1991 taxation year are $100 and FA3 has no taxable surplus or deficit in respect of Canco at the end of 1991.

Analysis:

The "90 day rule" rule in subsection 5901(2) of the Regulations will apply to the FA2 dividend and the FA3 Dividend because both are paid more than 90 days after the commencement of the 1991 taxation year and would have otherwise been deemed paid entirely out of pre-acquisition surplus of the affiliates in respect of Canco. Subsection 5901(2) of the Regulations will deem the FA2 dividend to have been paid out of the taxable surplus of FA2 in respect of Canco and the FA3 dividend will be deemed to have been paid out of the exempt surplus of FA3 in respect of Canco. Both are deemed paid immediately after December 31, 1991 for the purpose of determining the amounts under paragraphs 5907(1)(d), (k) and (l) of the Regulations for FA2 and FA3.

At August 1, 1991 (the time the FA1 dividend is paid), FA1 has not been determined to have any exempt or taxable surplus in respect of Canco (while the FA2 dividend has been received by FA1 prior to that date it has not yet been determined to have been from the taxable surplus of FA2 in respect of Canco), therefore subsection 5901(2) of the Regulations will also apply to the FA1 dividend. By virtue of the application of subsection 5901(2) of the Regulations to the FA2 dividend and the FA3 dividend, it is only determined after the end of FA2's and FA3's taxation years that the dividends came out of exempt and taxable surplus. This determination does not change the timing of the receipt of those dividends by FA1 but on the other hand, it also does not change the fact that subsection 5901(2) of the Regulations has deemed the FA1 dividend to have been paid immediately after FA1's taxation year for the purpose of determining FA1's amounts under paragraphs 5907(1)(d), (k) and (l) (footnote 1) . As a result, FA1 has $100 of exempt surplus and $100 of taxable surplus out of which dividends can be paid immediately after the end of its taxation year. Accordingly, by virtue of the order of surplus distribution rules set out in subsection 5901(1) of the Regulations, the FA1 dividend will be paid entirely out of the exempt surplus of FA1 in respect of Canco.

Our Comments

We agree that in Scenario 1 the FA1 Dividend would be paid out of FA1's exempt surplus and we also agree with your analysis regarding the operation of the "90 day rule" in subsection 5901(2). However, we do not believe this is inconsistent with our views in respect of Scenario 2.

In Scenario 2, but for the application of subsection 5901(2) to the FA2 Dividend received by FA1, FA1 did not have exempt or taxable surplus before the FA1 Dividend was paid to Canco, and; therefore, the FA1 Dividend would have come out of its pre-acquisition surplus. The application of subsection 5901(2) of the Regulations to the FA2 Dividend in this way triggers the application of subsection 5901(2) of the Regulations to the FA1 Dividend. Subsection 5901(2) applies to the FA1 Dividend such that for the purpose of determining character of the FA1 Dividend it is deemed to have been paid immediately following the end of the year and not when the dividend was actually paid. By the end of the 1991 taxation year, when the characterization of the FA1 Dividend is established, both the FA2 Dividend and the FA3 Dividend have been paid to FA1. Pursuant to subsection 5901(2) of the Regulations, it was determined at the end of FA2's and FA3's taxation years that the FA2 Dividend and the FA3 Dividend came out of taxable and exempt surplus, respectively. Accordingly, by virtue of the order of surplus distribution rules set out in subsection 5901(1) of the Regulations, the FA1 Dividend will be paid entirely out of the exempt surplus of FA1 in respect of Canco.

We trust these comments are of assistance.

Sincerely,

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

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained
in the original document are shown below instead:

1 We note that this provision has changed since our analysis of Scenario 2.