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: Guidance on required documentation and best practices in preparing surplus account calculations.
Position: Fact dependent.
2022 International Fiscal Association Conference
Question 5 - Surplus Account Maintenance
At the 2019 IFA Conference, the CRA commented on the requirement to prepare detailed surplus account calculations to support a deduction under subsection 113(1). It was also mentioned that in situations where calculations are not provided, it is the CRA’s general practice to deny any deduction under subsection 113(1).
Given that surplus account calculations are relevant in various situations, and in order to give better clarity to taxpayers, can the CRA provide additional guidance on the required documentation and on the best practices to adopt in respect of the preparation of surplus account calculations?
The Act provides that surplus accounts are to be calculated according to the detailed rules in Part LIX of the Income Tax Regulations (the “Regulations”), as an accumulation of year-by-year computations, starting from the later of 1972 or the beginning of the foreign affiliate’s taxation year in which it last became a foreign affiliate of the taxpayer.
When a taxpayer has one or more foreign affiliates, surplus account balances are relevant for various reasons in determining tax payable under the Act including, but not limited to:
- Determining the tax consequences of a dividend received by a Canadian corporation from a foreign affiliate where a deduction under subsection 91(5) or subsection 113(1) is claimed;
- Determining the tax consequences on the disposition of shares of a foreign affiliate by a Canadian corporation (including the application of the loss limitation rules in subsection 93(2.01), and where a subsection 93(1) election was made or was deemed to be made);
- Substantiating the claim of a deduction under subsection 90(9);
- Determining the tax-free surplus balance of a foreign affiliate that has to be included under paragraph 55(5)(d) of the Act in the safe income of a corporation;
- Where a foreign affiliate has issued more than one class of shares and where there is more than one shareholder:
o Determining a specified amount to be included under subsection 90(6) of the Act where the surplus entitlement percentage is computed under subsections 5905(10) and (11) and paragraph 5905(13)(b) of the Regulations; or
o Determining the foreign accrual property income inclusion in respect of a controlled foreign affiliate under subsection 91(1) of the Act where the participating percentage is computed under section 5904 of the Regulations.
Foreign accrual property income or loss, income or loss from an active business, capital gains or losses from the disposition of property by the foreign affiliate, and various other transactions, could affect or could be affected by the surplus account balances. Examples of such transactions include, but are not limited to:
- A transaction involving, directly or indirectly, a foreign affiliate of a taxpayer that would trigger the application of any of the provisions in section 5905 of the Regulations;
- A change in the business of the foreign affiliate that triggers the application of the fresh start rules under paragraphs 95(2)(k) and (k.2) of the Act and subsection 5907(2.9) of the Regulations; and
- The payment of a dividend between two foreign affiliates or a deemed subsection 93(1) election because of paragraph 93(1.1)(a) of the Act.
Furthermore, some of the questions on Form T1134 refer to surplus accounts and their components.
In Canada’s self-assessing system, the onus to compute and report taxable income pursuant to provisions of the Act and to determine the amount of tax owing is on taxpayers.
Therefore, where surplus account balances of a foreign affiliate are relevant in determining tax payable under the Act based on one of the elements listed above, amongst others, taxpayers are required to prepare up-to-date surplus account calculations in support of those surplus account balances. It is noteworthy that subsection 5907(6) of the Regulations indicates the currency in which such accounts are required to be maintained from year to year: “all amounts referred to in subsections (1) and (2) shall be maintained on a consistent basis from year to year in the currency of the country in which the foreign affiliate of the corporation resident in Canada is resident or any currency that the corporation resident in Canada demonstrates to be reasonable in the circumstances”.
In addition, taxpayers are responsible for documenting their affairs in a reasonable manner. In that respect, subsection 230(1) of the Act specifically requires taxpayers to maintain records and books of account, in such form and containing such information as will enable the determination of taxes payable under the Act. Pursuant to paragraph 231.1(1)(a) of the Act, the books and records of a taxpayer may also be inspected, audited or examined, by an authorized person of the CRA.
It is therefore very important to keep surplus account calculations up to date as the CRA may request and review taxpayer computations and supporting documents pertaining to the surplus account balances when auditing compliance to the provisions of the Act including the reporting of the amounts listed above.
As mentioned in information circular IC77-9R, Books, Records and Other Requirements for Taxpayers Having Foreign Affiliates (the “Circular”), taxpayers must retain records and any other relevant document with respect to their foreign affiliates beyond the mandatory retention period if they refer to transactions that may have future tax consequences, such as any amount involved in calculating surplus balances due to the cumulative nature of surplus. Records and documents that support surplus account balances must be prepared and maintained by the taxpayer until it is clearly established the surplus account balances are no longer relevant to the taxpayer. Guidance on the records and documents required can be found in paragraphs 3 to 8 of the Circular.
It is a good practice for a taxpayer to maintain surplus account calculations on a continuous basis, with supporting documentation readily available, and as part of their annual form T1134 compliance or foreign accrual property income determination. Even if the determination of tax payable by a taxpayer in a given year does not rely on surplus balances, accurate surplus account balances of a foreign affiliate with respect to a taxpayer should be prepared by the taxpayer on an annual basis, and relevant books, records, documents and information to support such surplus accounts balances should be retained. Each component of the surplus accounts must be validated by appropriate documentation and such documentation should be maintained and retained accordingly. If documentation is not available to accurately support surplus account calculations at the time surplus is utilized, any deduction claimed based on surplus account balances will be denied and other adjustments may also be required. Therefore, preparing annual surplus account calculations will facilitate supporting a future filing or the claim of a future deduction.
What constitutes appropriate documentation depends on the specific facts and circumstances, but may include:
- non-consolidated financial statements of the foreign affiliate,
- trial balance of the foreign affiliate,
- complete minute books of the foreign affiliate,
- income tax returns and all relevant supporting schedules for the income tax returns of the foreign affiliate,
- support for income tax paid by the foreign affiliate, and
- relevant supporting documentation:
o describing the business(es) of the foreign affiliate,
o related to the nature of the income earned by the foreign affiliate,
o related to transactions involving the foreign affiliate, and
o related to dividends paid or received by the foreign affiliate.
May 17, 2022
Response prepared in collaboration with:
International Tax Division
International and Large Business Directorate
Compliance Programs Branch
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