12 April 1995 External T.I. 9237145 F - Foreign Tax Credits - Consolidated Foreign Returns

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.

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Attention:  XXXXXXXXXX

Dear Sirs:

Re:  Subsection 20(12) of the Income Tax Act (the "Act")

This is in reply to your letter concerning the application of subsection 20(12) of the Act in circumstances where foreign tax is payable by a Canadian corporation as a consequence of its membership in an "affiliated group" which files a consolidated tax return for U.S. tax purposes.

Our understanding is that under certain circumstances the I.R.S. Code permits that a corporation resident in Canada may, at the option of its U.S. parent corporation, be included as a member of an "affiliated group" for the purpose of filing a consolidated group tax return in the United States.  You indicate that where an affiliated group elects to file a consolidated tax return in the United States, the income of the affiliated group for these purposes is adjusted to eliminate inter-company transactions and one of the corporations becomes an agent for the members of the affiliated group for the purposes of filing the return and paying the related tax liability.  You also indicated that frequently, where the parent corporation is responsible for paying the tax liability, the affiliated group will enter into a "tax allocation agreement" to provide for "compensatory payments" which are intended to ensure that each member of the affiliated group pays its share of the group's tax liability or is compensated for the tax attributes (e.g. losses) that are contributed to the consolidated group.

The hypothetical situation you describe involves a corporation resident in Canada which derives all of its income from Canadian sources.  Assuming the affiliated group was made up of only two corporations, the Canadian corporation and its U.S. parent, you inquire about the Canadian tax consequences where:

A)      The Canadian corporation is profitable but due to losses incurred by the parent, the affiliated group is not liable for tax in the United States.  The Canadian corporation is nevertheless required to make a compensatory payment to the parent under the tax allocation agreement in respect of the use of the parent's U.S. tax loss.

B)      The Canadian corporation and its parent are both profitable and the Canadian corporation makes a payment to the parent for the U.S. tax paid by the parent in respect of its share of the consolidated income of the group.

C)      The Canadian corporation incurs a loss and receives a "compensatory payment" from the parent under the "tax allocation agreement" because the parent is able to use the loss to offset its income.

In order to qualify for deduction under subsection 20(12) of the Act a foreign tax must generally meet the definition of "non-business-income tax".  Subsection 126(7) of the Act defines a "non-business-income tax" as "such portion of income or profits tax paid ... for the year to the government of that country...".  In scenario A, no foreign tax is paid to the government of a foreign country and therefore it is clear that the compensatory payment made by the Canadian corporation cannot fall within the above definition of "non-business-income tax".

In Scenario B, a tax is paid to the U.S. government, however, it is our view that any payment the Canadian corporation makes to its U.S. parent in respect of such U.S. tax paid would not qualify as an income or profits tax for the purposes of the definition of "non-business-income tax". In the absence of the voluntary election to include the Canadian corporation in the affiliated group for U.S. tax purposes the Canadian corporation has no tax liability in respect of its Canadian source income under the I.R.S. Code. Furthermore, the Canadian source income of a corporation resident in Canada is generally exempt from tax in the United States under the Canada-U.S. Income Tax Convention (1980).  Under these circumstances, where corporation resident in Canada nevertheless pays an amount in respect of United States tax, it is our view such amount would not be considered an income of profits tax under the Act.

Since we do not recognize the Canadian corporation to be liable for U.S. tax and because the compensatory payments referred to in A) and B) above, are not made for the purpose of earning income, they would not be deductible for the purpose of computing income under the Act.

The issue of whether an amount received by a taxpayer in respect of another taxpayer's use of its tax account should be included in income is presently under study by the Department.  We are therefore unable to comment at this time whether a payment received by a Canadian corporation in the circumstances described in C) above would be included in its income for the purposes of the Act.

We trust the above will be of assistance to you.

for DirectorReorganizations and Foreign DivisionIncome Tax Rulings and Interpretations DirectoratePolicy and Legislation Branch