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: Various issues regarding the computation of the earnings and capital gains of a foreign affiliate for the purposes of section 5907 of the Regulations
Position: Please review attached opinion
Reasons: The use of examples is necessary to demonstrate the issues.
XXXXXXXXXX 991768
Olli Laurikainen
Attention: XXXXXXXXXX
July 14, 1999
Dear Sirs:
Re: Winding-up of a Foreign Affiliate Partnership
This is in reply to your request for our views in reference to certain hypothetical transactions that may be carried out by foreign affiliates, including the winding-up of a partnership in which a foreign affiliate has an interest.
Acquisition of Partnership Interest
Consider the following example.
1) FA1 and FA2 are two foreign affiliates in which Canco a corporation resident in Canada, holds all of the shares.
2) FA1 has a 30% interest in a partnership (the "Partnership") which carries on an active business in a country other than Canada ("County x"). FA1 has held the interest in Partnership since its inception in year 1 and the value of the active business assets of Partnership have declined. The other 70% of the interests in Partnership were held by persons who deal at arm's length with Canco, FA1 and FA2.
3) In year 4, FA2 purchased the other 70% of the interests in Partnership for fair market value consideration.
It is our view that in the above circumstances, the purchase of a 70% interest in Partnership by FA2 would not have an effect on the adjusted cost base of the capital property of Partnership for the purpose of computing FA1's and FA2's share of the capital gains and losses of Partnership. Moreover, the purchase of the Partnership interest by FA2, in and by itself, will not affect computation of the income of Partnership for purposes of the "earnings" computation in respect of FA1 or FA2 under section 5907 of the Regulations to the Act unless otherwise provided for under the tax law of the relevant country.
Dissolution of Partnership
Assume that Partnership in the above example is dissolved and the property of Partnership distributed to FA1 and FA2. Assume further that the property of Partnership passes to FA1 and FA2 under the tax legislation of Country X on a rollover basis.
It is our view that subsection 98(2) would apply on the dissolution of Partnership. Therefore capital gains of Partnership and the adjusted cost base of the property transferred to FA1 and FA2 would be determined on the basis that Partnership's capital property was disposed of to FA1 and FA2 at its fair market value. The income of Partnership for the purpose of determining the "earnings" of FA1 and FA2 would be calculated under the tax legislation of Country X. As property is distributed to FA1 and FA2 on the dissolution on a rollover basis under the tax law of Country X, there would be no "earnings" created as a result of the wind-up of FA1 and FA2. Moreover it is our view that the provisions of paragraphs 5907(2)(f) and j) of the Regulations would not apply to include an amount in FA1'sor FA2's share of earnings from Partnership for the reason that any earnings or loss of Partnership not recognized on the rollover would be recognized later by FA1 or FA2. Therefore the provisions of subparagraphs 5907(2)(f)(i) and 5907(2)(j)(i) of the Regulations would prevent any adjustment to FAl 's or FA2's share of earnings from Partnership under either of paragraphs 5907(2)(f) or (j) of the Regulations.
Pursuant to subsection 5907(12) of the Regulations, any amount included in computing the exempt earnings or loss or taxable earnings or loss of either FA1 or FA2 as a result of a capital gain or loss realized by Partnership will be added or deducted from the adjusted cost base of such foreign affiliate's interest in Partnership. The fair market value of the assets received by each foreign affiliate on the dissolution of Partnership will comprise its proceeds of disposition of its interest in Partnership for the purposes of computing its capital gain or loss.
Contribution of Capital Property by Foreign Affiliate
Consider the following example.
1) Canco is a corporation resident in Canada. It holds all of the shares of a foreign affiliate FAl.
2) FAl has depreciable capital property with a fair market value of $200. The cost of the property to FAl is $100 and FAl has claimed depreciation equal to the full $100 for the purpose of computing its active business income for tax purposes in the foreign country in which it is resident and carries on active business ("Country A").
3) FAl holds all of the shares of a second foreign affiliate of Canco ("FA2") which is also resident in Country A. FAl and FA2 are required to compute income for tax purposes under the income tax law of Country A.
4) FAl contributes the property to FA2 as capital contribution for which no additional shares were issued to FA1. The property transfer receives rollover treatment under the tax legislation of Country A.
In our view the adjusted cost base of the shares of FA2 held by FAl would be increased by an amount equal to the fair market value of the property transferred to FA2 (i.e. $200) pursuant to paragraph 53(1)(c) of the Act. For the purposes of computing the surplus accounts of FAl, no capital gain would be realized on the transaction by virtue of subsection 5907(5.1) of the Regulations. Moreover no amount in respect of recaptured depreciation on the property would be included in "earnings" of FAl as defined in subsection 5907(1) of the Regulations determined under the tax law of County A for the reason that the transaction receives rollover treatment under such tax law. Subparagraph 5907(2)(f)(ii) of the Regulations would deny an adjustment to "earnings" under paragraph 5907(2)(f) of the Regulations.
Foreign Currency - Adjusted Cost Base
Consider the following hypothetical scenario.
1. Canuckco is a corporation resident in Canada.
2. FAl and FA2 are two wholly-owned foreign affiliates of Canucko resident in Mexico.
3. FA3 is a foreign affiliate of Canucko and a wholly-owned subsidiary of FA2 also resident in Mexico.
4. The shares of FA3 were acquired by FA2 in 1990 for 100 million Mexican pesos ("MP") at a time when CAN$1 = MP2.
5. In 1994 FAl and FA2 amalgamate in a transaction that qualifies as a foreign merger as defined in subsection 87(8.1) of the Act to form FA12 at a time when CAN$1 = MP4. The combination of FAl and FA2 qualifies as a non-recognition transaction under Mexican tax law.
6. In 1996 FA12 makes a cash capital contribution to FA3 of MP5O million when CAN$1 =MP5.
7. In 1999 FA12 is wound-up pursuant to subsection 88(3) of the Act when CAN$1 = MP6. FA12 has no other property other than the shares of FA3 and it has no liabilities. Canucko does not claim a greater amount under paragraph 88(3)(a) of the Act. The shares of FAl2 and FA3 are excluded property.
In the above example, the proceeds of disposition to FA12 of its shares in FA3 and Canucko of its shares in FA12 as determined under subsection 88(3) of the Act will be equal to the adjusted cost base to FA12 of the shares of FA3. Paragraph 95(2)(f)(i) provides that a capital gain or loss of controlled foreign affiliate from a disposition of property to which paragraph 88(3)(a) applies will be computed in Canadian currency. Therefore the adjusted cost base to FA12 of its shares in FA3 will be computed in Canadian currency.
In our view the ACB of the shares of FAl2 will be equal to the Canadian dollar equivalent in 1990 of the original purchase price of MPlOO million or CAN$50 million paid by FA2 plus the Canadian dollar equivalent in 1996 of the capital contribution of MP5O million or CAN$10 million by FA12 for a total of CAN$60 million. The merger of FAl and FA2 is governed by paragraph 95(2)(d. 1) of the Act and subparagraph (ii) of that provision provides that FA12 shall with respect to any disposition by it of any capital property owned by FA2 at the time of the merger to be the same corporation and a continuation of FA2. Therefore it is our view that the original Canadian dollar adjusted cost base of the shares of FA3 would flow through to FA12 under 95(2)(d. 1). The Canadian dollar value of the capital contribution by FA12 in 1996 would be added to the ACB of the shares of FA3 pursuant to paragraph 53(1)(c) of the Act.
General Anti-Avoidance Rule
Nothing in this letter should be construed as implying that the provisions of section 245 of the Act could not apply to any of the above hypothetical transactions. The application of section 245 of the Act is dependent on a determination, inter alia, that a particular transaction is an avoidance transaction as that term is defined in subsection 245(3) that results in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole, and in order to make such determination, it would be necessary to have access to all of the facts that would be available in an actual case.
The foregoing comments are given in accordance with the practice referred to in paragraph 22 of Information Circular 7O-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
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