9 August 1991 External T.I. 901185 - Regulation 5907(1)(m)(ii)

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.

Re: Regulation 5907(1)(m)(ii)

As discussed with you on july 31, 1991 (Kauppinen/Kreuger) we are forwarding to you comments regarding a letter dated January 10, 1990  from      19(1)          regarding subparagraph  5907(1) (m)(ii) of the Regulations (copy attached).  We have written to    and advised him that you will be responding directly to him regarding query.

We have taken the liberty of simplifying 19(1)  hypothetical  example since the essence of his query is whether a disproportionate claim under subparagraph 5907(1)(m)(ii) of the Regulations can be made by a Canadian resident corporation in respect of a dividend received by its first tier foreign affiliate from a second tier foreign affiliate.

For this purpose we have made the following assumptions:

1.     A Canadian resident corporation ("Canco") owns 100% of the shares of a foreign affiliate ("FAl").

2.     FA1 owns 100% of the shares of another foreign affiliate of Canco ("FA2").

3.     In year 1, FA2 pays a dividend of $100 to FA1.  No dividend is paid in year 1 from FA1 to Canco.

4.     In year 2, FA1 pays a dividend of $100 to Canco.  No dividend is  paid in year 2 from FA2 to FA1.

5.     It is assumed that the exempt surplus account of FA1 and FA2 in  respect of Canco is nil at all times during years 1 and 2.

6.     The taxable surplus and underlying foreign tax accounts of FA1 and FA2 in year 1 prior to the payment of the dividend, are assumed to be the following: 

               Taxable Surplus          Underlying Foreign Tax

FA1                           0                                          0FA2                        1000                                      100

After payment of the dividend from FA2 to FAl the taxable surplus and underlying foreign tax accounts of FAl and FA2 at the end of year 1 are as follows (assuming subparagraph 5907(1)(m)(ii) of the Regulations is not applicable):

                   Taxable Surplus     Underlying foreign tax

FAl                      100                      10(1)FA2                      900                      90(2)

(1)     Subparagraph 5907(1)(1)(vii)

(2)       Subparagraph 5907(1)(1)(ix)

The payment of the dividend from FAl to Canco in year 2 would have the following income tax consequences to Canco:

Dividend income                           100.0:Less: 113(1)(b)(i) deduction          16.3             (1)Taxable income                      83.7 

(1)      Assume "relevant tax factor" is 100/38.  Therefore deduction is (100/38 - 1) X 10.

Issue to be Addressed

May Canco make a "claim" in its return of income under Part I of the Act in year 1 pursuant to subparagraph 5907(1)(m)(ii) of the Regulations in respect of the $100 dividend paid by FA2 to FA1 in year 1 in order to optimize the foreign tax applicable to the dividend paid by FA1 to Canco in year 2?

Our Opinion

We would firstly note that a "claim" under subparagraph 5907(1)(m)(ii) of the Regulations is not an amount which can be deducted from income pursuant to paragraph 113(1)(b) of the Act. The paragraph 5907(1)(m)(ii) "claim" is an element of "underlying foreign tax applicable" to a whole dividend paid by the affiliate which in turn is used, pursuant to paragraph 5900(1)(d) of the Regulations, in computing the "foreign tax applicable" to the portion of the dividend paid out of the taxable surplus of the foreign affiliate.

Under the foregoing assumptions, it is our opinion that a "claim" can be made by Canco pursuant to 5907(1)(m)(ii) with respect to the $100 dividend paid from FA2 to FA1 in year 1 in its Part I tax return for year 1 as there is nothing in 5907(1)(m)(ii) that would restrict its application to dividends from top tier affiliates.  The amount of the "claim" could be up to a maximum of the total underlying foreign tax account of FA2 (subject to the amount of the dividend and the balances in exempt and taxable surplus).

The tax consequence of the claim in year 1 would be that the "underlying foreign tax" of FA1 would be increased by the amount under 5907(1)(m) of the Regulations (including the amount "claimed" under subparagraph 5907(1)(m)(ii)) pursuant to subparagraph 5907(1)(1)(vii) of the Regulations.  The "underlying foreign tax" account of FA2 would be reduced by the same amount pursuant to subparagraph 5907(1)(1)(ix) of the Regulations.

In our example assume that the amount "claimed" by Canco pursuant to subparagraph 5907(1)(m)(ii) of the Regulations in year 1 with respect to the $100 dividend paid by FA2 to FAl is $51.

As a result the surplus accounts of FA1 and FA2 at the end of year 1 would be:

                Taxable surplus               Underlying foreign tax

FA1                     100                           61 (1)FA2                      1000                         39 (2)

(1)      10 (5907(1)(m)(i)) plus a 5907(1)(m)(ii) "claim" of 51 (2) (100 - 61) (5907(1)(1)(ix))

As FA1 pays out 100% of its taxable surplus to Canco as a dividend in year 2 it is not necessary to make a claim under Regulation 5907(1)(m)(ii) in respect that dividend.  The income tax consequences to Canco in year 2 are therefore as follows:

Dividend Income                   100113(1)(b) deduction               100              (1) Taxable income                     0   

(1)      (61) (100/38 - 1) (assuming a relevant tax factor of 100/38)(Therefore, at the end of year 2 the taxable surplus account and underlying foreign tax account of FA1 are both zero).

It should be noted that it prior to the above dividend from FA1 its taxable surplus was in excess of $100 and its underlying foreign tax remained 61%, it would have been necessary for Canco to make a claim in year 2 under 5907(1)(m)(ii) of the Regulations in respect of the $100 dividend from FA1 in order for Canco to obtain a $100 deduction pursuant to paragraph 113(1)(b) of the Act.  In the foregoing we have assumed for the sake of illustration that the two dividends were paid in separate years and the optimal claim, pursuant to subparagraph 59(1)(m)(ii) of the Regulations was made in year 1 in order to reduce Canco's taxable income to zero in year

However, because the computation of "underlying foreign tax" pursuant to paragraph 5907(1)(1) of the Regulations is "at a particular time", it is our view that the two dividends could be paid in the same taxation year of Canco (i.e. one from FA2 to FA1 and then another from FA1 to Canco) with the same result being achieved.  The underlying foreign tax of FA2 could be utilized to increase the deduction available to Canco pursuant to paragraph 113(1)(b) of the Act by making a disproportionate claim on Canco's Part I return.  This would be accomplished by notifying the Department by letter attached to Canco's Part I return identifying the dividend from FA2 to FAl and the amount of the disproportionate "claim" pursuant to subparagraph 5907(1)(m)(ii) of the Regulations for that dividend.  The additional amount so claimed would reduce the underlying foreign tax account of FA2 pursuant to subparagraph 5907(1)(1)(ix) of the Regulations and increase the underlying foreign tax of FA1 pursuant to subparagraph 5907(1)(1)(vii) of the Regulations.

A separate disproportionate claim could then be made, if necessary, for the dividend paid from FA1 to Canco pursuant to subparagraph 5907(1)(m)(ii) of the Regulations.  Any such claim would reduce the underlying foreign tax account of FA1 pursuant to subparagraph 5907(1)(1)(ix) of the Regulations and increase the deduction available to Canco pursuant to paragraph 113(1) (b) of the Act. However, as previously mentioned, if all of FA1's taxable surplus was paid out as a dividend a second claim under Regulation 5907(1) (m)(ii) would not be necessary since the "proportion of the underlying foreign tax" of FA1 referred to in subparagraph 5907(1) (m)(i) would be lOO%.

We would appreciate receiving a copy of your response to 19(1) regarding this issue.

for DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch