10 March 1998 External T.I. 9703535 - foreign affiliates - dividend deduction

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

A) Can the income or profits tax paid by a Canadian corporation ("Canco") to the U.S. government in respect of the income of a U.S. limited liability company ("LLC") be considered as "applicable" to a dividend distribution out of such income made by such LLC to Canco for the purposes of 113(1)(c)(i)(A)?

B) Would our position be the same if the income or profits tax was paid by Canco for a previous taxation year. Would the tax still be considered as a "non-business income tax paid by the corporation applicable to" a dividend received in the current year on share a foreign affiliate?

Position:

A) Yes but the portion of the tax paid that can be considered applicable to a dividend is a question of fact.

B) Yes

Reasons:

Please see analysis in documen below.

970353
XXXXXXXXXX Olli Laurikainen
(613) 957-2116
Attention: XXXXXXXXXX

March 10, 1998

Dear Sirs:

Re: Foreign Affiliates - Deductions in Respect of Foreign Tax

This is in reply to your letter dated February 3, 1997. You request our comments in reference to whether foreign tax credits or deductions would be available to a corporation resident in Canada ("Canco") for foreign taxes paid by it in respect of the income of a U.S. limited liability company ("LLC") in which Canco is a shareholder. You describe the following hypothetical situation.

1) LLC is a corporation resident in the United States for the purposes of the Income Tax Act (the "Act") and a partnership for the purposes of U.S. IRS Code.

2) LLC is a foreign affiliate but not a controlled foreign affiliate of Canco as those terms are defined in subsection 95(1) of the Act.

3) LLC carries on an “investment business” as that term is defined in subsection 95(1) of the Act. The income from such business represents taxable surplus of LLC vis-A-vis Canco such that when distributions are made to Canco they are considered to have been out of such taxable surplus.

4) Canco pays tax in the United States in respect of a portion (i.e. Canco's share) of the income earned by LLC from its investment business.

You request our views concerning the status of the tax referred to paragraph 4 above, under sections 20, 113 and 126 of the Act.

Our Comments

In accordance with Interpretation Bulletin IT-392, the LLC is considered to have capital stock consisting of 100 issued shares and each owner of an interest in the LLC is considered to own the number of shares proportionate to its interest in the LLC. Each amount distributed on account of profits by LLC will be considered dividends for the purposes of the Act. Therefore distributions received by Canco from LLC would be included in the income of Canco under section 90 of the Act.

It is our view that the tax paid by Canco in respect of the income of LLC may reasonably be regarded as having been paid by Canco in "...respect of income from a share of the capital stock of a foreign affiliate..." of Canco for the purposes of subsections 126(1) and 20(12) of the Act regardless of whether a dividend is distributed by LLC in the taxation year in which the taxes are paid. Accordingly, no tax credit or deduction in respect of such tax is available to Canco under those provisions. Moreover, when a dividend is paid by LLC to Canco, no deduction would be available in respect of taxes paid by Canco under paragraph 113(1)(b) of the Act since as set out in the definition of "underlying foreign tax" and the definition of "underlying foreign tax applicable" in subsection 5907(1) of the Regulations to the Act, the deduction is only available in respect of taxes paid by a foreign affiliate.

The taxes paid by Canco in respect of the income of LLC from its investment business cannot "...reasonably be regarded as tax in respect of the income of (Canco) from any business carried on by (Canco) in the business country..." for the purposes of the definition of "business-income tax" in subsection 126(7) of the Act. Therefore Canco does not qualify for a foreign tax credit under the provisions of subsection 126(2) of the Act.

By virtue of subsection 113(3), the term "non-business-income tax" for the purposes of clause 113(1)(c)(i)(A) of the Act derives its meaning from the definition set out in subsection 126(7). It is our view that the tax paid by Canco qualifies as a "non-business income tax" for the purposes of the definition in subsection 126(7) and therefore clause 113(1)(c)(i)(A) of the Act. The Department considers that the foreign tax paid by Canco in respect of the profits of LLC is in respect of dividends that are derived from the shares of LLC held by it. Therefore a deduction would be available under paragraph 113(1)(c) of the Act to the extent that a portion of a particular dividend received by Canco is prescribed to have been paid out of the taxable surplus of LLC vis-A-vis Canco and Canco can establish that a foreign tax paid by Canco is applicable such portion. It is the Department's view that in order to be “applicable” to a dividend for the purposes of clause 113(1)(c)(i)(A), it is not necessary that the foreign tax be paid by Canco in the same taxation year as the dividend distribution. However, in order to qualify, it has to have been paid.

It is a question of fact what portion of the taxes that have been paid by Canco in respect of the income of LLC can be considered as applicable to a particular dividend. However, in the simple example set of facts set out above, if all of the income of LLC is from an investment business, it would all be included in computing its taxable surplus vis-A-vis Canco. Therefore all of the tax paid by Canco in respect of the income of LLC would qualify for the deduction paragraph 113(1)(c) to the extent that it could be established to be applicable to a distribution by LLC.

Since dividend distributions by a corporation generally cannot be traced to a particular source of income, the Department would expect a proportionate allocation of taxes paid by Canco in respect of the taxable surplus of LLC would be made to distributions made from that taxable surplus. For example, assume that Canco owns a 25% interest in LLC. In its first taxation year LLC had taxable surplus of $100 on which its members must pay U.S. income tax of $40. In such case Canco's share of such tax would be $10. At the beginning of its second taxation year, LLC makes an $80 distribution of dividends to its members. Canco's $20 share of such distribution would be prescribed to be a dividend from the taxable surplus of LLC. The $80 dollar distribution from the taxable surplus of LLC represents 80% of the taxable surplus of LLC vis-A-vis Canco at the time of the distribution. Therefore 80% of the $10 U.S. tax paid by Canco or $8 would be considered as applicable to the dividend for the purposes of clause 113(1)(c)(i)(A) of the Act. The remaining $2 dollars of foreign tax paid by Canco in respect of the profits of LLC would be taken into consideration for the purposes of computing any future deduction under 113(1)(c) when dividends are again distributed to Canco out of the taxable surplus by LLC.

The above example deals with a case where LLC is not a controlled foreign affiliate of Canco and accordingly there is no income inclusion by Canco under the provisions of subsection 91(1) in respect of the foreign accrual property income of LLC. However, that fact does not impact on the Department's interpretation of paragraph 113(1)(c). That is, a deduction would be available in such case as described above for the taxes paid by Canco in respect of the income of LLC that are applicable to a dividend out of taxable surplus. It is noteworthy however, that the Department takes the view that no deduction is available under subsection 91(4) of the Act for taxes paid by Canco because such tax does not qualify as "foreign accrual tax" as defined in subsection 95(1) for the reason that it is not paid by a foreign affiliate.

The views above pertain to the simple set of facts set out above. More complex structures involving tiers of foreign affiliates, would have to be assessed on their own merits.As a final comment, we note that since LLC is not a controlled foreign affiliate of Canco, in the above circumstances consideration should be given to whether Canco would be subject to the provisions of section 94.1 of the Act as a consequence of holding an interest in LLC.

The foregoing comments are given in accordance with the practice referred to in paragraph 22 of information Circular 70-6R3 and are not binding on Revenue Canada.

We trust this is the information you require.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch