18 July 2011 Internal T.I. 2011-0394631I7 - Foreign non-business income tax

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: Is a subsection 20(12) deduction available in a particular fact scenario, involving a US partnership that is treated as a corporation for US purposes and pays tax to the US on business income, where for Canadian purposes the US partnership would only be considered to earn dividend income?

Position: No

Reasons: Subsection 20(12) requires that the foreign taxes paid be a "non-business-income tax". Since the foreign taxes paid in the hypothetical situation are a "business-income tax", the deduction is not available. Subsection 20(12) also requires that the foreign taxes paid must be paid in respect of the source of the particular business or property to which the foreign tax relates (i.e. on a business by business or property by property basis). Since the taxes paid by USLP are in respect of business income and USLP would generally only receive dividend income, USLP would not be entitled to the subsection 20(12) deduction as the foreign taxes paid are in respect of a separate source.

								July 18, 2011

	XXXXXXXXXX 						HEADQUARTERS
								Income Tax Rulings
								  Directorate
								M. Gauthier
								(613) 948-1143

	Attention: XXXXXXXXXX 				2011-039463

Deduction for foreign non-business income tax

This is in reply to your email of February 2, 2011 in which you asked whether a Canadian resident corporation would be entitled to a subsection 20(12) deduction in a hypothetical situation involving hybrid entities which resulted in foreign taxes being paid in respect of business income where the only potential source of income for Canadian purposes would be dividends.

Facts:

1. Canco is a Canadian resident corporation.

2. Cansubco is a Canadian resident corporation and is wholly owned by Canco.

3. USLP is a limited partnership formed in United States ("US"). Canco holds a 99.9% partnership interest in USLP. Cansubco holds the remaining 0.01% partnership interest in USLP. USLP is a partnership for Canadian purposes and has elected to be treated as a corporation for U.S. tax purposes.

4. USLLC is a limited liability company formed in the US. USLP holds all the shares of USLLC. USLLC would be treated as a corporation for Canadian tax purposes and has elected to be treated as a disregarded entity for US tax purposes. USLLC earns active business income.

Question:

For Canadian tax purposes, any distribution made from USLLC to USLP would generally be considered dividends. However, USLLC has not distributed any amount to USLP. As such USLP has not received any dividend income which would flow through to Canco and Cansubco as members of USLP.

For US tax purposes, USLP declares the active business income earned by USLLC because USLLC is treated as a disregarded entity and USLP is treated as a corporation.

Would Canco be entitled to a subsection 20(12) deduction where the US tax paid by USLP on business income is not in respect of the income that Canco would potentially receive as dividend income from USLLC shares held by USLP?

Our comments:

Subsection 20(12) allows a taxpayer to claim a deduction from business or property income for non-business income taxes paid in respect of that income to a government of a country other than Canada other than any tax that can reasonably be regarded as having been paid by a corporation in respect of income from a share of the capital stock of a foreign affiliate.

In the hypothetical situation provided, USLLC earns active business income. Since USLLC is a disregarded entity for US tax purposes, the income flows through to USLP and is subject to tax in the US as business income in the hands of USLP because USLP is treated as a corporation for US tax purposes. The foreign taxes paid by USLLP are "business income taxes" and would not be eligible for the subsection 20(12) deduction. Since the taxes paid are in respect of business income, they would not meet the definition of "non-business income taxes" in subsection 126(7). In the following paragraphs, we will analyze the phrase "in respect of that income" found in subsection 20(12).

For Canadian income tax purposes USLLC is treated as a corporation and therefore the active business income of USLLC is not considered to automatically flow through to USLP. Instead, from the point of view of Canada, any amounts distributed from USLLC to USLP would generally be considered paid as dividends. In the example provided, no amounts were paid out from USLLC to USLP. Thus, there would be no dividend income to USLP which would have flowed through to the partners of USLP, being Canco and Cansubco.

The phrase "in respect of that source" found in subsection 20(12) requires that the foreign taxes paid must be paid in respect of the particular business or property to which the tax relates. In other words, for the purposes of claiming the deduction in subsection 20(12), the computation of income from a business or property should be on a business-by-business and/or property-by-property basis. Therefore, in computing the income of a taxpayer from a particular property, the taxpayer could not deduct under subsection 20(12) a non-business-income tax that the taxpayer paid to a foreign government on income from another property. As such, in computing the income of Canco and Cansubco from the shares of USLLC (as partners of USLP), USLP cannot deduct, under subsection 20(12), the foreign taxes paid by it on income from business, computed under US tax law, because USLP would generally only receive income from property under Canadian tax law.

The deduction in subsection 20(12) also states that the tax cannot be paid by a corporation in respect of income from a share of the capital stock of a foreign affiliate. Subsection 93.1(1) provides that where shares of a non-resident corporation are owned by a partnership, in determining whether a non-resident corporation is a foreign affiliate of a corporation resident in Canada, each member of the partnership is deemed to own their pro-rata proportion of the shares in the non-resident corporation. In the hypothetical situation presented, Canco would be considered to hold 99.9% of the shares of USLLC that are held by USLP. Since USLP owns all the shares of USLLC, USLLC would meet the definition of a foreign affiliate of Canco in subsection 95(1). Therefore, Canco would not be entitled to a subsection 20(12) deduction in respect of the taxes on dividend income that could be received from the USLLC shares through USLP. However, the taxpayer may be entitled to a deduction in respect of dividend income received, if any, from a foreign affiliate by virtue of subsection 113(1).

We hope this information is of assistance to you.

Yours truly,

Alain Godin
Section Manager for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Canada Revenue Agency