25 March 1991 Internal T.I. 47277 F - Redemption of Shares - Foreign Tax Credit

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.

7-4727

Subject: Redemption of Shares Foreign Tax Credit 

This is in reply to your memorandum dated February 15, 1990 wherein you request our opinion as to whether the U.S. withholding tax paid on the redemption of preference shares by a U.S. subsidiary of a Canadian corporation qualifies as a non-business income tax for foreign tax credit purposes (as per a rulings opinion dated September 11, 1975).

Our opinion remains as stated in the 1975 letter that the withholding tax qualifies as a non-business foreign tax within the meaning of paragraph 126(7)(c).  We enclose a copy of a memorandum to the Winnipeg District Office dated June 11, 1986 on the same issue.  Pursuant to your further request, our reasoning in adopting this position is as follows:

It is our understanding that under U.S. income tax law all distributions of property from a U.S. corporation are considered to be dividends unless there exists certain prescribed conditions.  One of the required conditions is that the corporation has no "earnings and profits" at the time of the distribution of property.  Distributions of property would include the redemption of stock regardless of the type of stock or entitlement of the stock to the income of the corporation.

In the file under audit there were earnings and profits in the U.S. subsidiary corporation.  Consequently a withholding tax was imposed on that portion of the redemption amount which was deemed pursuant to the Internal Revenue Code to constitute a dividend.

For Canadian income tax purposes, the redemption of shares constituted a disposition of capital property.  The gain on the redemption (due to foreign exchange fluctuations) is a capital gain for Canadian purposes and is therefore not "income from property" pursuant to subsection 9(3).However, the withholding tax was imposed on an amount which, pursuant to the provisions of the Internal Revenue Code, was considered to be a dividend.  Since the withholding tax in the nature of a tax "on income", it is our view that it is an income or profits tax within the meaning of paragraph 126(7)(c) of the Act. Consequently, the withholding tax is eligible for inclusion in the calculation of the foreign tax credit and deduction pursuant to subsections 126(1) and 20(12) respectively.

The same result occurs where a U.S. corporation increases its paid-up capital (under U.S. corporate law) and then pays out the increase to a Canadian shareholder.  Subsection 9(3) will not apply to the increase in paid-up capital (since that subsection is only applicable to corporations resident in Canada) and the payment will not be income for Canadian purposes (since it is a return of capital).  However, the withholding tax on any deemed dividend pursuant to the Internal Revenue Code will qualify for the 126(1) and 20(12) calculations.

21(1)(b)

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