3 April 2013 External T.I. 2012-0460671E5 - Disproportionate UFT election

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: If Canco receives a taxable surplus dividend in Year 2 from FA1 which had received a taxable surplus dividend in Year 1 from FA2, may Canco make a disproportionate UFT election in its return for Year 2 with respect to the dividend received by FA1 from FA2 in Year 1?

Position: Yes - in limited circumstances

Reasons: Canco must generally make any claim it wishes to make in respect of the FA2 dividend paid to FA1 in its return of income under Part I of the Act for Year 1. However, under limited circumstances, the CRA is prepared to accept a claim in Canco's return for Year 2 to the extent the claim is limited to the UFT of FA2 in respect of Canco that existed immediately after the FA2 dividend was paid subject to the proviso that it continued to exist in respect of Canco immediately before the FA1 dividend was paid (i.e., before the claim).

XXXXXXXXXX 2012-046067
L. Carruthers, CA

April 3, 2013

Dear XXXXXXXXXX:

Re: Disproportionate UFT Election

This is in reply to your email dated August 2, 2012, in which you inquired in what year a corporation resident in Canada should file a disproportionate underlying foreign tax ("UFT") claim pursuant to paragraph (b) of the definition of "underlying foreign tax applicable" in subsection 5907(1) of the Income Tax Regulations (the "Regulations") in the following scenario:

• A corporation resident in Canada ("Canco") owns 100% of the issued and outstanding shares of a foreign affiliate ("FA1") which owns 100% of the issued and outstanding shares of a second foreign affiliate ("FA2");
• Each of Canco, FA1 and FA2 have a December 31, taxation year end;
• The exempt surplus, taxable surplus, and UFT accounts of FA1 and FA2 in respect of Canco in Year 1 prior to the payment of any dividend are as follows:

in Year 1 FA2 pays a $100 dividend to FA1 all of which is deemed to have been paid out of FA2's taxable surplus resulting in FA1 having a taxable

• surplus and UFT account in respect of Canco of $100 and $12.50, respectively; and
• in Year 2 FA1 pays a $100 dividend to Canco all of which is deemed to have been paid out of FA1's taxable surplus.

Specifically, you enquired whether Canco could file a disproportionate UFT claim in its return for Year 2 in respect of the FA2 dividend paid to FA1 in Year 1.

Your View

In your email you indicated that, in your view, it is arguable that the claim is only relevant when the dividend is ultimately paid to Canco so the return of income for the relevant year in which to file the claim is Year 2 and not Year 1.

Our Comments

In our view, the relevant return of income under Part I of the Act in which Canco should file a disproportionate UFT claim in respect of the FA2 dividend is its return for Year 1. At a time when the disproportionate UFT claim was provided for by former subparagraph 5907(1)(m)(ii) of the Regulations, we addressed the following question in our file 901185:

May Canco make a "claim" in its return of income under Part I of the Act in year 1 pursuant to subparagraph 5907(1)(m)(ii) of the Regulations in respect of the $100 dividend paid by FA2 to FA1 in year 1 in order to optimize the foreign tax applicable to the dividend paid by FA1 to Canco in year 2?

and we concluded that:

Under the foregoing assumptions, it is our opinion that a "claim" can be made by Canco pursuant to 5907(1)(m)(ii) with respect to the $100 dividend paid from FA2 to FA1 in year 1 in its Part I tax return for year 1 as there is nothing in 5907(1)(m)(ii) that would restrict its application to dividends from top tier affiliates. The amount of the "claim" could be up to a maximum of the total underlying foreign tax account of FA2 (subject to the amount of the dividend and the balances in exempt and taxable surplus).

We continue to be of the view that the "return of income under Part I of the Act in respect of the whole dividend" referred to in paragraph (b) of the definition of "underlying foreign tax applicable" in subsection 5907(1) of the Regulations, in which any claim must be made, is the return of Canco that includes the time when the whole dividend which is the subject of the claim is paid. However, if Canco had not filed a disproportionate UFT claim in respect of the FA2 dividend in its return for Year 1, the Canada Revenue Agency (the "CRA") is prepared, in limited circumstances, to accept a disproportionate UFT claim from Canco in respect of the FA2 dividend in its return for Year 2 (i.e., in Canco's return for the year that includes the time it received the FA1 dividend).

Those limited circumstances are that for each of FA1 and FA2 (i.e., for each foreign affiliate relevant in determining the surplus entitlement percentage (the "SEP") of Canco in respect of FA1 or FA2) one of the following must have been met throughout the period that commenced on the first day of FA2's year in which the FA2 dividend was paid and ended on the day the FA1 dividend was paid:

(i) no more than one class of shares of the capital stock of the affiliate was issued and outstanding,

(ii) the SEP of Canco in respect of the affiliate was 100 per cent, or

(iii) not more than one shareholder owned shares of the capital stock of the affiliate.

Further to the above limitations, the amount of the claim would have to be limited to the maximum amount which could have been claimed by Canco in respect of the FA2 dividend in its return for Year 1 and in some circumstances would have to be less than that which could have been claimed in Year 1. For example, the CRA would not accept a claim to the extent it included any portion of FA2's Year 1 UFT balance in respect of Canco that existed immediately after the FA2 dividend was paid but which balance (determined without reference to any adjustment under the provisions of section 5905 of the Regulations subsequent to the payment of the FA2 dividend) no longer existed immediately before the FA1 dividend was paid as a result of, inter alia, a refund of tax to FA2 (e.g., as the result of a loss carryback to Year 1 or a preceding year) or a dividend paid by FA2 subsequent to the FA2 dividend.

We trust these comments are of assistance.

Olli Laurikainen, CA
for Director
International Section II
International Division
Income Tax Rulings Directorate