2 August 1985 Income Tax Severed Letter 7-4095 - [N/A]

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.

FOREIGN & SMALL BUSINESS SECTION D. Lanos (613) 957-2125 Ref: 7-4095

Consent Dividends XXXX Foreign Affiliate Project

XXXX

This is in reply to David Purton's Round-Trip-Memorandum of July 16, 1985 (copy attached) concerning a Vancouver D.O. memorandum (Gordon Paulson) dated January 21, 1985 in respect of representations by XXXX

Mr. Burton has since requested that his references to sections 333 and 337 of the 1954 Internal Revenue Code (the "Code) and subsection 88(3) of the Income Tax Act (the "Act") be ignored as the real point of concern is whether the "consent dividend", included in XXXX gross income for United States' income tax purposes pursuant to a consent election (Form 972) under section 565 of the Code, can also be considered to be received by XXXX for purposes of section 90 of the Act.

Prior to your enquiry, our position was that it could, but as agreed in our meeting (D. Lanos, D. Burton) of July 23, 1985, with XXXX that position has now been reviewed in light of XXXX contentions that a deemed dividend for U.S. tax purposes (the consent dividend) is not "received" for purposes of the Canadian Act and that, in any event, the Canadian taxation system is not harmed by not treating such dividends as received for purposes of the Act.

The facts as we understand them from the representations made by XXXX in her letter of January 7, 1985 to Vancouver D.O. and our subsequent meeting, as well as from our additional research, are as follows:

XXXXXXXX is a "personal holding company" as defined by section 542 of the Code and is subject to an additional personal holding company tax of 50% on its undistributed personal holding company income; the latter tax may be avoided by making a consent dividend election for U.S. income tax purposes and paying tax thereon as required by section 565(e) of the Code. The "personal holding company" provisions in the scheme of the Code resemble the now defunct "personal corporation" provisions in section 67 and 68 of the pre-1972 Act.

3. For U.S. income tax purposes, a consent dividend is considered to be a distribution to a shareholder and a simultaneous contribution of capital back to the dividend-paying company by the shareholder-recipient (see section 565(c) of the Code).

XXXX

5. Section 565(e) of the Code required foreign corporations to remit with their consent dividend election the amount that would be required to be deducted and withheld of the consent dividend had been paid to the shareholder in money as a dividend. In fact, however XXXX has advised that XXXX itself withheld and remitted the U.S. consent dividend tax on behalf of its Canadian parent, XXXX

6. XXXX argues, and we agree, that the provisions of a foreign statute, such as the Code, are not relevant to a determination of whether an amount has been received in respect of a dividend for purposes of section 90 of the Act. She makes reference to two court cases (Robwaral Limited v. M.N.R., 1960 C.T.C. 16, Ex. Ct. and Albert Pichosky v. M.N.R., 64 C.T.C. Ex. Ct.), both in our view having little relevance to our consent dividend situation, but she cannot find any cases directly on point. We could not uncover any relevant cases either.

7. XXXX has been advised by XXXX that the financial statements of a U.S. company prepared in accordance with generally accepted accounting principles would not record a consent dividend as a dividend paid or received by the respective payor and payee because a consent dividend is not considered to be income distributed or received. She adds that the unaudited financial statements of XXXX for XXXX were prepared for U.S. income tax purposes only an accordingly show the income tax effect of the consent dividend (Form 1120, Schedule M-2) but otherwise are totally irrelevant for Canadian tax purposes.

Only a handritten draft of XXXX financial statements could be obtained by Vancouver D.O. (Gordon Paulson) upon D. Burton's request for financial statements. XXXX advises that it is unlikely that XXXX would prepare fiancial statements for purposes other than its U.S. income tax return. The handwritten draft did not reflect the consent dividend.

8. Unaudited financial statements prepared by XXXX for the fiscal year ended XXXX "solely for (Canadian) income tax purposes" (see Notice to Reader thereon), show a 1981 increase in the Balance Sheet asset account XXXX exactly equal to the amount of the above-noted consent dividend of XXXX for its U.S. income tax purposes. For Canadian income tax purposes, Form T2S(1) shows a deduction of that same consent dividend in computing XXXXXXXX net income, since the said consent dividend was included in the gross dividend income reported on XXXX Statement of Earnings and Retained Earnings.

Previous Position on Consent Dividends

9. Until your enquiry, we had taken the position that the making of a consent dividend election for U.S. income tax purposes would also result, for Canadian income tax purposes, in the payment of a dividend (equivalent in amount to the U.S. consent dividend) by the U.S. corporation and a receipt of his proportionate share of that same dividend by any Canadian shareholder for purposes of section 90 of the Act.

10. The above position was adopted out of our concern that if section 90 was not applied to the above Canadian shareholder at the time of a U.S. consent dividend election, that Canadian shareholder might argue in a subsequent taxation year that an amount equal to the U.S. consent dividend was, at the date of the U.S. consent dividend elction, also constructively received as a dividend for Canadian income tax purposes and for the same purposes was contributed back to the U.S. corporation as capital. Thus, the Canadian shareholder would be entitled to an adjusted cost base bump on his shares of the U.S. corporation under paragraph 53(1)(c) of the Act; and depending upon the timing the Department might be statute-barred from taxing, under section 90, the dividends claimed by the Canadian shareholder to have been constructively received in the earlier year of its U.S. consent dividend election. In this regard, see 14B below.

Review of Position

XXXX

Revised Position on Consent Dividends

14. The following is a summary of our current position as it applies to XXXX

A. U.S. consent dividends are not dividends received for purposes of section 90 of the Act.

B. The filing of a consent dividend election under section 565 of the Code and the consent dividend which results therefrom for U.S. income tax purposes will not produce, or result in, a paragraph 53(1)(c) bump in the adusted cost base of shares held by a taxpayer in the subject U.S. subsidiary corporation or foreign affiliate.

C. Notwithstanding that as in the case of XXXX a Canadian parent coporation's (or a Canadian shareholder's) financial statements may reflect an increase in the "Investment in Subsidiary - Shares" (or "Investment in Foreign Affiliate - Shares") account, unless the Canadian taxpayer is prepared to acknowledge actual receipt of such dividends by including them in income pursuant to section 90 of the Act for the taxation year in which the U.S. consent election was made, we will consider that said financial statements do not accurately reflect the situtation for Canadian income tax purposes. Accordingly, the positions in A and B will apply.

D. If a U.S. corporation (foreign affiliate) does increase its paid-up capital (PUC) by the amount of a consent dividend, or in any other manner, then upon repatriation of such share capital to a Canadian shareholder, we will simply apply the law that is relevant to an extraction of funds as a return of PUC when such event occurs - subparagraph 53(2)(b)(ii) and subsection 40(3) of the Act. Since this will result in the conversion of taxable dividends to capital gains in to a provision such as subsection 84(1) of the Act to remedy the situtation, we have brought this to the attention of our Current Amendments & Regulations Division.

Other Factors Considered

15. Having adopted the position on paragraph 53(1)(c) set forth in 14B above, we do not consider that it is necessary to obtain a waiver to protect against a reversal in position by the taxpayer as discussed in 10 above, as in our view there is no dividend or contribution of capital, and if there was, the provisions of subparagraph 152(4)(a)(i) should be sufficient to enable us to reassess the dividend.

16. Since we do not consider a U.S. consent dividend to be received for purposes of section 90 of the Act, a consent dividend will not have any implications for purposes of the foreign accrual property income (FAPI) provisions.

17. With regard to 13 above, consistent but not identical with the IRS view, it is our opinion that, where a U.S. corporation withholds and remits the U.S. consent dividend tax on behalf of a Canadian shareholder, the amount of such U.S. tax so withheld would constitute a benefit conferred on the Canadian shareholder for purposes of paragraph 15(1)(c) of the Act. It is also our view that if the U.S. coporation is a foreign affiliate this paragraph 15(1)(c) income inclusion constitutes "income from a share of the capital stock of a foreign affiliate of the corporation" for purposes of subsection 20(12) and clause 126(1)(b)(i)(D) of the Act. As a result, the U.S. consent dividend tax would not be creditable under subsection 126(1) against any Canadian tax arising on the paragraph 15(1)(c) income inclusion to the Canadian shareholder; but an offsetting income deduction equivalent to the amount of paragraph 15(1)(c) income inclusion would be available under subsection 20(12) of the Act (see 18 and 19 below). Consequently, there appears to be no advantage to the fisc in assessing a paragraph 15(1)(c) benefit in this situation.

18. Further to 17 above, it is also our view that any U.S. consent dividend tax withheld and paid on behalf of a Canadian shareholder of a U.S. coporation constitutes a non-business-income tax (as defined by paragraph 126(7)(c) of the Act) paid by that Canadian shareholder.

19. For purposes of paragraph 126(1)(a) and subsection 20(12) of the Act respectively, it is our view that if the U.S. corporation is a foreign affiliate the U.S. consent dividend tax itself, which as stated above qualifies as a non-business-income tax paid as defined by paragraph 126(7)(c) of the Act, may not be reasonably regarded as having been paid by the taxpayer (the Canadian shareholder-corporation) in respect of income from a share of the capital stock of a foreign affiliate of the taxpayer (corporation).

Conclusion

We hope the above will assist you in your reply to XXXX concerns regarding section 90 of the Act as well as in any related issues raised by the District Office in relation to consent dividends.

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch