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 a subsection 91(5) deduction allowed to a partnership is taken into account in determining the amount referred to in subparagraph 93.1(2)(d)(i)?
Reasons: Interpretation of 96(1)(f).
IFA 2018 International Tax Conference
Canada Revenue Agency Roundtable
Question 3 – Interaction of subsection 91(5) and subparagraph 93.1(2)(d)(i)
Subsection 93.1(1) of the Income Tax Act (the “Act”) allows some of the foreign affiliate rules, including the rules in section 113 of the Act, to apply to corporate structures that include partnerships. Subparagraph 93.1(2)(d)(i) of the Act limits the amount deductible by a corporation resident in Canada (Cco) under section 113 of the Act in respect of a dividend received by a partnership, of which the Cco is a member, from a non-resident corporation that is deemed to be a foreign affiliate of Cco for purposes of section 113. In this case, the maximum amount deductible under section 113 of the Act shall not exceed the portion of the amount of the dividend that is included in Cco’s income pursuant to subsection 96(1) of the Act.
At the 2000 Conference Round Table of the Association de planification fiscale et financière (“APFF”), the Department of Finance (“Finance”) was asked the following question:
“…Consequently, the income attributed to a member under subsection 96(1) of the Act is a net amount, that is to say, an amount obtained after subtracting the expenses related to this source of income. When the partnership receives a dividend from a foreign corporation and incurs certain allowable expenses regarding the share in respect of which the dividend was received, is the Department of Finance of the view that the limitation in subparagraph 93.1(2)(d)(i) is equal to the gross amount of the dividend received or to the net amount (after subtraction of the allowable expenses)?”.
Finance’s response was: “The limitation in subparagraph 93.1(2)(d)(i) is the gross amount of dividends included for the purposes of determining the partner’s income.”
Assume the following hypothetical facts:
- A taxable Canadian corporation and its wholly owned Canadian subsidiary (collectively “Canco”) have always owned 100% of a partnership (“LP”).
- LP has always owned 100% of a non-resident corporation (“FA1”).
- Canco, LP and FA1 have a December 31 fiscal year end.
- At December 31, 2016, FA1 had an exempt surplus balance of $3,000 and a taxable surplus balance of $2,000 in respect of Canco, as those terms are defined in subsection 5907(1) of the Income Tax Regulations (the “Regulations”).
- The taxable surplus balance consists of undistributed foreign accrual property income (“FAPI”) that was included in LP’s income, and there is no underlying foreign tax.
- In its 2017 taxation year, FA1 had no FAPI or any other income or loss.
- In 2017 FA1 paid a $3,000 dividend to LP.
- LP’s income/loss for its 2017 fiscal year consisted solely of the $3,000 dividend received from FA1 (the “partnership dividend”), and interest expense of $300 on a borrowing used to acquire the FA1 shares (in addition to the subsection 91(5) deduction discussed below).
- In its 2017 taxation year, Canco had no income or loss other than the amount of LP’s income or loss that Canco was required to include in its income or loss under paragraph 96(1)(f) of the Act.
- The $3,000 dividend paid by FA1 to LP in 2017 is, under subsection 5901(1) of the Regulations, deemed to be a $3,000 dividend paid out of the exempt surplus of FA1 in respect of Canco.
In computing its income for 2017, LP would be entitled to a subsection 91(5) deduction of $2,000 as a result of subsection 5900(3) of the Regulations, resulting in LP having net income of $700 (i.e. $3,000 dividend - $2,000 s. 91(5) deduction - $300 interest expense). As such, this $700 would be included in computing Canco’s income for its 2017 taxation year by virtue of paragraph 96(1)(f).
In addition, subject to the limitation set out in subparagraph 93.1(2)(d)(i), Canco would be entitled to a subsection 113(1) deduction in computing its taxable income in respect of the dividend paid by FA1 to LP.
In the hypothetical facts, is the subsection 91(5) deduction allowed to LP taken into account in determining the amount referred to in subparagraph 93.1(2)(d)(i)?
As a preliminary comment, we note that if Canco, in the hypothetical facts above, had always directly owned the FA1 shares, and had directly incurred the interest expense of $300, Canco’s taxable income or loss for 2017 would have been a loss of $300 (i.e. $3,000 dividend - $3,000 s. 113(1) deduction - $300 interest expense).
Under paragraph 96(1)(c), the Act requires a partnership to compute its income on a source by source basis, and, under paragraph 96(1)(f), the partnership income retains its source when attributed to the partners. Income from a source is required, under section 4 of the Act, to be computed on a net basis (i.e. net of allowable deductions with respect to that source).
In the hypothetical facts, LP’s subsection 91(5) deduction of $2,000, as well as its $300 interest expense, are wholly applicable to LP’s dividend income of $3,000. In our view, the portion of the partnership dividend received by LP that is included in Canco’s income pursuant to subsection 96(1) is, for purposes of subparagraph 93.1(2)(d)(i), $700.
However, it has been the CRA’s long-standing position that interest expenses relating to acquisitions by a partnership of foreign affiliate shares are not to be taken into account in applying the limitation in subparagraph 93.1(2)(d)(i) (see for example 2007-0247551E5). As such, in our view it would be appropriate to consider that only the subsection 91(5) deduction (and not the interest expense) reduces the dividend income for the purpose of applying subparagraph 93.1(2)(d)(i). Therefore, Canco’s taxable income or loss for the year would be computed as follows:
Income from LP $700
s. 113(1)(a) deduction as modified
by s. 93.1(2)(d)(i) ($3000 - $2000) (1,000)
Taxable income (loss) ($300)
This would give a result that is consistent with the results that would be obtained if Canco had held the shares of FA1 directly.
It is also our view that it would be appropriate in the circumstances of the hypothetical facts above to reinstate the exempt surplus of FA1 in respect of Canco that is denied recognition by the operation of subparagraph 93.1(2)(d)(i) (i.e. $2,000, which is the subsection 91(5) deduction allowed to the partnership) and to reduce the taxable surplus of FA1 in respect of Canco by the same amount.
John Meek / Sherry Thomson
May 16, 2018
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2018
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2018