1 October 1997 External T.I. 9706145 - FOREIGN TAX CREDITS AND DEDUCTIONS

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:

Treatment of U.S. taxes paid by Canadian resident individual in respect of individual's share of income of S Corporation

Position:

Where S corp makes a distribution during year, all U.S. taxes paid should be included in paragraph 20(11)(a) amount.

Reasons:

All of the taxes "may reasonably be regarded as having been paid in respect of an amount that has been included in computing the taxpayer's income for the year from the property" for purposes of 20(11)(a).

Tim Kuss
XXXXXXXXXX 970614

Attention: XXXXXXXXXX

October 1, 1997

Dear Sirs:

Re: Subchapter S Corporations - Foreign Tax Issues

This is in reply to your letter dated February 25, 1997 requesting a technical interpretation regarding a number of tax issues involving U.S. citizens who are resident in Canada and are shareholders of corporations that are taxed as "S corporations" under Subchapter S of the Internal Revenue Code.

As your request appears to deal with a factual situation we are unable to provide our views with respect to the specific transactions which are the subject of your request. Further to paragraph 22 of Information Circular 70-6R3, interpretation requests relating to proposed transactions should be submitted in the form of an advance income tax ruling request, while requests for a written opinion on a completed transaction should be addressed to the appropriate Tax Services Office of Revenue Canada. Nevertheless, we are prepared to make the following general comments which may or may not apply to your situation.

Where in a particular year an S corporation has made a distribution to its Canadian resident shareholder, for purposes of computing the deduction under subsection 20(11) of the Income Tax Act, in our view, the amount determined under paragraph 20(11)(a) should be the U.S. taxes otherwise payable for that year in respect of the shareholder's share of income of the S corporation. To put another way, in a year where there has been a distribution by the S corporation and the amount of the distribution is different than the shareholder's share of income for that year, there should not be an attempt to prorate the U.S. taxes paid for the year between the amount distributed and the income retained by the S corporation. In our opinion, all of the U.S. taxes paid "may reasonably be regarded as having been paid in respect of an amount that has been included in computing the taxpayer's income for the year from the property" for purposes of paragraph 20(11)(a).

The amount deductible under subsection 20(11) will affect the amount deductible under subsection 20(12) or creditable under subsection 126(1), by virtue of its impact on the definition of "non-business-income tax" in subsection 126(7).

Where there is no distribution from the S Corporation in a particular year, subsection 20(11) would not apply in that year and all of the U.S. tax paid by the shareholder in respect of the shareholder's share of income of the S Corporation would be deductible pursuant to subsection 20(12). To the extent the tax was not deducted under subsection 20(12), the tax would be a creditable tax for purposes of subsection 126(1).

Where an individual resident in Canada disposes of shares of an S corporation, any U.S. tax paid in respect of that disposition will be a creditable tax for purposes of subsection 126(1). Such tax would not be deductible under subsections 20(11) or 20(12).

Agreements pursuant to paragraph 5 of Article XXIX of the Canada-U.S. Income Tax Convention (the "Convention") to treat the S corporation as a "controlled foreign affiliate" for Canadian tax purposes, must be concluded with the competent authority of Canada and are subject to terms and conditions satisfactory to such competent authority. While the Income Tax Rulings and Interpretations Directorate is not involved in negotiating such agreements, we would expect that the agreements would generally cover the period that the person is resident in Canada and holding the shares of the S corporation. We would not expect a taxpayer to be able to opt in and out of the provision on an annual basis. However, you should consult the competent authority for guidance as to what terms and conditions they would normally expect in such an agreement.

Where a taxpayer is subject to the rules in paragraph 5 of Article XXIX of the Convention, it is reasonable to expect that a loss incurred by the S corporation would be treated as a "deductible loss" for purposes of computing the corporation's "foreign accrual property income". However, this would need to be covered in the competent authority agreement, as the corporation could be carrying on an active business and the loss would not otherwise form part of the corporation's "deductible loss" pursuant to draft section 5903 of the Regulations.

We hope our comments are of assistance.

Yours truly,

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