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: Where the shares of a foreign corporation held by a partnership with a Canadian corporation as partner are transferred pursuant to subsection 85(2) to another Canadian corporation owned by the partnership, whether the deemed gain determined under subsections 92(5) and (6) results in an adjustment to the proceeds of disposition of the shares in the partnership, the cost of the shares to the recipient corporation, or the elected amount under subsection 85(1)(a).
Position: The deemed gain would not result in an adjustment to the transferor's proceeds of disposition, the transferee's cost of the transferred shares, nor the elected amount pursuant to 85(1)(a).
Reasons: 92(5) deems the amount determined under 92(6) to be a gain of the corporate partner from the disposition of the shares by the partnership, and does not affect amounts determined under 85(1)(a).
May 7, 2014
Toronto East TSO Income Tax Rulings Directorate
200 Town Centre Court International Division
Scarborough, ON Denise Basso
M1P 4Y3 905-721-5199
Attention: Iftekhar Shariff 2012-043373
Application of subsection s 92(5) and (6)
This is in reply to your email of January 19, 2012, in which you requested our views regarding the application of subsections 92(5) and (6) of the Income Tax Act ("Act"). We apologize for the delay in responding. In your request, and through subsequent correspondence, the situation that you described can be summarized as follows:
Facts
- A limited partnership ("LP") was established under the XXXXXXXXXX Limited Partnership Act and is at all times a Canadian partnership as that term is defined in subsection 248(1);
- A Canadian corporation ("Canco"), as that term is defined in subsection 89(1), owns a XXXXXXXXXX% limited partnership interest in LP;
- Another Canadian corporation ("Subco"), as that term is defined in subsection 89(1), owns a XXXXXXXXXX% general partnership interest in LP;
- LP holds all of the issued and outstanding shares of a corporation ("Forco") that was created under the laws of XXXXXXXXXX; and
- Forco is a foreign affiliate ("FA") of Canco for the purposes of sections 93 and 113 by virtue of subsection 93.1(1).
In Year 1:
- LP received a dividend ("Dividend") paid from Forco's pre-acquisition surplus; and
- Canco included its respective share of the Dividend in income for Canadian tax purposes, and claimed a corresponding deduction from income under paragraph 113(1)(d).
In Year 3:
- LP formed XXXXXXXXXXULC, an unlimited liability company incorporated under the laws of XXXXXXXXXX;
- Following its incorporation, LP and XXXXXXXXXXULC entered into an agreement under which LP transferred all of its shares in Forco to XXXXXXXXXXULC in consideration for the issuance by XXXXXXXXXXULC of shares of its capital stock in an amount equal to the fair market value ("FMV") of the Forco shares transferred from LP; and
- Pursuant to subsection 85(2), XXXXXXXXXXULC and all members of LP jointly elected to transfer the Forco shares to XXXXXXXXXXULC at an amount under paragraph 85(1)(a) equal to the adjusted cost base ("ACB") of the Forco shares to LP.
As a result of the disposition of the shares of Forco from LP to XXXXXXXXXXULC in Year 3, subsection 92(5) applied to deem Canco to have realized a gain equal to an amount determined by the formula under subsection 92(6). You have asked whether this deemed gain should result in an adjustment to the proceeds of disposition ("POD") reported by LP, ACB of the Forco shares received by XXXXXXXXXXULC, or the elected amount described under subsection 85(1)(a).
When a dividend is paid by an FA from its pre-acquisition surplus to its shareholder that is a Canadian resident corporation, or to a shareholder that is another FA of a Canadian resident corporation, the ACB of the shares of the dividend-paying FA is reduced by virtue of subsection 92(2) and paragraph 53(2)(b). However, in the situation described, the shares of the dividend-paying FA, Forco, were owned by the Canadian corporation, Canco, indirectly through the partnership, LP. As such, subsection 93.1(1) is relevant to this analysis, although only for certain specific purposes. For example, through the application of subsection 93.1(1), Canco may be considered to own its proportionate share of the Forco shares held in LP, and therefore Forco may, for certain purposes under the Act, be considered an FA of Canco. However, the provisions for which subsection 93.1(1) is relevant do not include adjustments to the ACB of the Forco shares as a result of its dividend from pre-acquisition surplus as described in subsection 92(2) and paragraph 53(2)(b). As a result, in the scenario that you described, the ACB of the Forco shares held by LP would not be reduced by the amount of the Dividend paid from Forco's pre-acquisition surplus.
Instead, as you have noted, subsections 92(5) and (6) would be relevant in this situation, as a partnership has disposed of the shares of a corporation during a fiscal period in which either a corporation resident in Canada, or an FA of a corporation resident in Canada, was a member at the end of that fiscal period of the partnership. Where applicable, subsection 92(5) would cause the corporate member of the partnership to realize a gain on the disposition of the shares by the partnership. The amount of the deemed gain is determined under subsection 92(6) to be the total of all amounts deducted by the corporate member under paragraph 113(1)(d) in respect of its portion of any dividends (net of withholding taxes) on the shares that were received by the partnership, being dividends that were paid out of pre-acquisition surplus.
In the current context, subsection 92(5) applied when LP transferred its shares of Forco to XXXXXXXXXXULC. As a result, Canco was deemed to realize a gain in Year 3, calculated in accordance with subsection 92(6), as Canco was a member of LP at the end of the fiscal period of LP in which the Forco shares were disposed. The amount determined under subsection 92(6) should equal the total of amounts deducted by Canco under paragraph 113(1)(d) in respect of Forco dividends received through LP that were paid out of Forco's pre-acquisition surplus, less any foreign tax paid in respect of Canco's share of those dividends.
It should be noted that a gain calculated under subsections 92(5) and (6) is a gain to the corporate member of the partnership, rather than an amount that would be described in either of subparagraphs 96(1)(c)(i) or (ii), such as an amount of income or a taxable capital gain of the partnership. As a result, there is no adjustment to the ACB of the member's partnership interest in LP that is expected in relation to the 92(5) deemed gain.
It should also be noted that when the Dividend from Forco was paid to LP in Year 1, Canco was required to include in income its share of the Dividend pursuant to subsection 96(1). As a result, the ACB of Canco's partnership interest in LP increased in Year 1 by the amount of this income inclusion pursuant to subparagraph 53(1)(e)(i), and a corresponding reduction in ACB of the partnership would result once the amount is ultimately distributed from LP to its members pursuant to paragraph 53(2)(c).
Further, as noted above, paragraph 85(1)(a) applies to the disposition of the Forco shares by LP as a result of the joint election under subsection 85(2). However, as opposed to subsection 92(5), which deems a gain of the member from the disposition of shares by the partnership, paragraph 85(1)(a) provides that the amount that LP and XXXXXXXXXXULC have agreed on in their 85(2) election is deemed to be both the POD of the shares to LP and the ACB of the Forco shares to XXXXXXXXXXULC.
For the reasons described above, we are of the view that the deemed gain from the disposition of shares by the partnership that is contemplated under subsection 92(5) would not result in an adjustment to LP's POD and XXXXXXXXXXULC's ACB of the transferred shares and, consequently, would not affect an "agreed amount" under subsection 85(1) by virtue of subsection 85(2).
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA'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. Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the client.
We trust that these comments will be of assistance.
Yours truly,
Robert Demeter, CPA, CGA
Section Manager
for Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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