13 September 1988 Income Tax Severed Letter 7-1821 - Foreign affiliates

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.

This is further to our (Anderson/Dalphy) telephone conversation of August 26, 1988 wherein you advised that the taxation years relevant to the matters presently under consideration are statute-barred and that notices of reassessment were not issued and waivers were not received.

In our view of the foregoing, this file has been closed.

N.B.: This file is not to be regarded as precedent setting.

The file was closed because the Saskatoon D.O. neither reassessed or obtained waivers before the file became statute-barred. See Corporate case file.

Foreign Accrual Property Income

Question

A Canadian corporation “Canco” acquires all of the shares of a foreign corporation “FA1” which in turn owns all of the shares of a second foreign corporation “FA2”. At the time of the acquisition the fair market value of FA2 is $100 but its historic cost to FA1 is $1. Subsequent to the acquisition the fair market value of the shares of FA2 declined to $1 but later recovered their value and are sold for $100. The shares of FA2 do not constitute excluded property. Does the Department agree that, for the purpose of calculating the foreign accrual property income of FA1, FA1 realizes a capital gain of $99 on the sale of the shares of FA2 since, under the assumed facts, all of the capital gain accrued during the period that FA1 was a foreign affiliate of Canco (see paragraph 95(2)(f))?

Department's Position

Although the wording of paragraph 95(2)(f) is open to interpretation, in our view the above interpretation achieves an inappropriate result and does not consider the object and spirit of the provisions. If we assume FA1's only asset is shares of FA2, Canco's basis in FA1 would be $100. Canco could have sold the shares of FA1 and no gain would have resulted. It is our opinion that the portion of the gain that may reasonably be considered to have accrued during the period that FA1 was not a foreign affiliate of Canco would be the unrealized gain that existed at the time FA1 became a foreign affiliate of Canco (i.e. $99). Therefore no amount would be included in FA1's foreign accrual property income in respect of the above disposition.

Issue Sheet

Re: 85(2)(a)(ii)

The principal issue is whether an amount can be included in the computation of income from an active business of a foreign affiliate, pursuant to 95(2)(a)(ii), in a year in which the “paying affiliate” has a loss from an active business carried on by it.

Analysis

From a policy perspective this is not a problem.

However there is a technical deficiency in the postamble of 95(2)(a)(ii) in that it only refers to “the amount prescribed to be its earnings”. “Earnings” in this context is defined in Regulation 5907(1)(e), while “loss” of a foreign affiliate from an active business is defined in Regulation 5907(1)(e).

The nature and complexity of the foreign affiliate regulations are such that a reasonable approach needs to be taken in many instances. As a result we decided to respond with a favourable interpretation. However in our view 95(2)(a)(ii) should be amended to read “ ... the amount prescribed to be its earnings or loss from an active business ... ”