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: Various questions concerning the maintenance of the paid-up capital of a class of shares of a corporation with a US$ “elected functional currency” for various purposes under the Act, including the determination of the amount of a dividend deemed to be paid and received under subsection 84(3).
Position: General comments on how to maintain paid-up capital accounts for non-functional currency tax reporters and for functional currency tax reporters.
Reasons: See below.
2016 International Fiscal Association Conference
Question 3 – Application of subsections 84(3) & (4) to a functional currency tax reporter
Assume that a Canadian corporation (“Issuer”) with a US$ “elected functional currency” (“EFC”), within the meaning of subsection 261(1), issues for full fair market value consideration preferred shares to a shareholder (“Shareholder”) with a redemption value of US$100,000 at a time when US$1.00 = C$1.00 and that this amount is added to the stated capital of the preferred shares. Issuer then redeems the preferred shares held by Shareholder for proceeds of US$100,000 at a time when US$1.00 = C$1.25.
In the following situations, what is the CRA’s view as to how the deemed dividend paid by Issuer and received by Shareholder would be computed:
a) Shareholder is a U.S. corporation – For withholding tax purposes, would the deemed dividend be computed in US$ or C$? Assuming the deemed dividend for withholding tax purposes would be computed in C$, would there be a separate deemed dividend calculation in US$ for other purposes, such as Part VI.1 tax?
b) Shareholder is a Canadian corporation that also has a US$ EFC – Would the deemed dividend be computed in US$ or C$? Assuming both corporations are Canadian-controlled private corporations, would there be a separate calculation for purposes of determining the dividend refund to Issuer (i.e. based on US$ proceeds in which case there is no deemed dividend) and for purposes of determining the Part IV tax payable by Shareholder (i.e. based on proceeds in C$ in which case there would be a deemed dividend of C$25,000, which equals US$20,000 using the spot rate on the day of the redemption)? Would the answer change if the Issuer were not a functional currency tax reporter, i.e. where it reports its Canadian tax results in C$?
c) Would the approach to the calculations be any different if Shareholder was a Canadian corporation that had the euro (“€”) as its EFC and Issuer had a US$ EFC?
d) Would the answers to a) and b) be the same if Issuer returned capital to Shareholder in the amount of US$100,000 thereby invoking subsection 84(4), instead of redeeming the preferred shares? Does this answer, or any of the other answers, depend on the currency in which the stated capital of Issuer is maintained for legal purposes?
Before answering the specific questions posed, we would like to take this opportunity to provide our views as to some general principles to be followed, in the hopes of providing taxpayers with the tools necessary to address other specific questions that may arise. Where there is still doubt in a particular situation, including where certain anomalies appear to arise based on these principles, we would invite taxpayers to submit additional questions to us for our consideration.
Non-functional currency tax reporters
The “paid-up capital” (“PUC”) of a particular class of shares of a corporation, or of a particular share of that class, may be an “amount that is relevant in determining the amounts described in respect of the taxpayer under paragraphs (a) to (c)” of the definition “Canadian tax results” (“CTRs”) in subsection 261(1) in respect of both the issuing corporation (e.g. where subsection 18(4) is relevant) and each of its shareholders (e.g. for the application of subsection 84(3)). Consequently, in the absence of a valid functional currency election by either the issuer or a shareholder thereof, subsection 261(2) dictates that PUC must be maintained in C$.
This is so notwithstanding the currency used to maintain the legal stated capital of the class of shares. Thus, in accordance with the long-standing position of the CRA, in determining the PUC of a class of shares the legal stated capital account of which is maintained in a foreign currency, all entries to that account have to be converted to their C$ equivalent using the “relevant spot rate” (“RSR”), within the meaning of subsection 261(1), for the day on which the transaction that gives rise to the particular entry arises.
Where shares of an issuer are redeemed, subsection 84(3) deems a dividend to be paid by the issuer and received by the shareholder in an amount equal to the amount by which the amount paid by the issuer exceeds the PUC in respect of the redeemed shares immediately before the redemption. Where foreign currency amounts are paid, they must be converted to C$ at the RSR for the day on which the redemption occurs, based on paragraph 261(2)(b), and the PUC, as maintained in C$, will generally have to be used by the issuer to determine the amount of the deemed dividend for the purposes of determining its CTRs. The issuer will also have to use these C$ amounts for all other purposes of the Act, such as producing T5 information returns and determining amounts to be withheld under Part XIII.
Issuer as a functional currency tax reporter
The fact that an issuer has an EFC pursuant to a functional currency election is only relevant for the purposes of the application of the operative rules of subsection 261(5) in respect of the determination of the issuer’s own CTRs. Such an election in no way alters the general utilization of the C$ for all other purposes of the Act.
Where an issuer starts out as a Canadian currency tax reporter and then converts to the functional currency regime, paragraph 261(7)(g) requires that all amounts that were added or deducted in computing the PUC in respect of a class of shares of the issuer’s capital stock in a “Canadian currency year” (“CCY”), within the meaning of subsection 261(1), have to be converted to the issuer’s EFC using the RSR for the last day of the issuer’s last CCY. Any further entries to the Issuer’s PUC account would either have to be made by accounting for the particular amount in its original currency, if it corresponds to the issuer’s EFC, or by converting the particular entry to an amount expressed in the issuer’s EFC using the RSR for the day on which the particular amount arose, in application of paragraph 261(5)(c). In parallel with the application of these rules, the issuer will still have to maintain the PUC of its classes of shares in C$ for all purposes of the Act other than the determination of its own CTRs. In this regard, it is notable that an amount payable on behalf of another person under section 215 is specifically excluded from the definition of CTRs.
Shareholder as a functional currency tax reporter
As noted above, the PUC attributable to an issuer’s shares owned by a shareholder is also a CTR in respect of the shareholder. However, the fact that the shareholder has an EFC is only relevant for the purposes of the application of the operative rules of subsection 261(5) in respect of the shareholder’s CTRs. It does not interfere with the way the Act and its regulations apply to the issuer, either in respect of the determination of the issuer’s own CTRs, or for any other purpose.
More particularly, in respect of the PUC of shares owned by a shareholder that has an EFC, the shareholder has to maintain that PUC in its EFC in order to determine its CTRs in respect of those shares. In this respect, where the shareholder starts out as a Canadian currency tax reporter and then converts to the functional currency regime, all entries to the PUC account made in a CCY have to be converted using the RSR for the last day of the shareholder’s last CCY, based on paragraph 261(7)(h). On the same basis as mentioned above, any further entries to that account would either have to be made by accounting for the particular amount in its original currency, if it corresponds to the shareholder’s EFC, or by converting the particular entry to an amount expressed in the shareholder’s EFC using the RSR for the day on which the particular amount arises.
Thus, the determination of the amount of a deemed dividend resulting from the redemption of an issuer’s shares for the purposes of determining the CTRs of a shareholder that has an EFC does not consist simply of converting the C$ amount of the dividend reported by the issuer on the appropriate information return. Instead, the shareholder has to re-compute the deemed dividend in its EFC.
Specific responses to questions
Based on the above comments, our answers to the specific questions posed are as follows:
a) Since Part XIII withholding tax is not a CTR of Issuer but rather of Shareholder, the deemed dividend would be computed using the relevant amounts expressed in C$, resulting in C$25,000 being deemed to be paid and received.
A separate calculation would be required to be made using US$ amounts, which would result in no dividend being deemed to be paid and received for the purposes of Issuer’s CTRs, including Part VI.1 tax, assuming Issuer has a US$ EFC throughout the period in which the shares are outstanding.
b) With respect to the CTRs of Issuer and Shareholder, the deemed dividend would be determined in US$.
Thus, generally no dividend would have to be accounted for, assuming both Issuer and Shareholder have a US$ EFC throughout the period in which the shares are outstanding, whether for dividend refund/Part IV tax purposes or otherwise. However, Issuer would still be required to produce its information returns in respect of Shareholder based on calculations using C$ amounts.
If, instead, Issuer is a Canadian currency tax reporter, C$ would have to be used by it in determining its CTRs and for all other purposes of the Act. However, this would change nothing in respect of the application of the Act from the perspective of Shareholder.
c) Issuer would have to maintain its PUC in US$ for the purposes of determining its CTRs, and in C$ for all other purposes of the Act. Shareholder would have to maintain that PUC balance in € for the purposes of determining its CTRs.
d) In general, subsection 84(4) would deem a dividend to be paid by Issuer and received by Shareholder equal to the amount by which the amount paid by it on the reduction of capital exceeds the PUC reduction in respect of the class of shares owned by Shareholder. Thus, based on the above comments, the answers would generally be the same as under a) and b) if there were a return of capital instead of a redemption of shares. However, this result assumes that, as a legal matter, it is possible to return the same amount of capital as can be distributed by way of a redemption. This would only seem to be possible if stated capital for legal purposes is maintained in US$ and that balance is equal to the redemption value of US$100,000.
From a strict tax perspective, as noted in our introductory comments above, the maintenance of legal stated capital in a foreign currency does not change any of these answers as PUC is fundamentally a C$ tax concept, absent functional currency considerations.
May 26, 2016
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