15 December 1998 External T.I. 9819355 - FOREIGN AFFILIATES - FOREIGN ACCRUAL TAX

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: Where FAPI arises as a result of a disposition by a foreign affiliate but foreign tax in respect of that disposition is deferred a result of a roll-over under foreign law, may foreign tax arising as a result of a gain on the disposition of the consideration received by the foreign affiliate on the original transaction qualify as foreign accrual tax?

Position: Question of fact - the foreign tax may qualify.

Reasons: The definition of foreign accrual tax is very broad but it would be necessary to review the details of an actual case in order to make a definitive determination.

						981935
XXXXXXXXXX 					Olli Laurikainen
(613) 957-2116
Attention:  XXXXXXXXXX 

December 15, 1998

Dear Sirs:

Re: Foreign Accrual Tax

This is in reply to your letter dated July 22, 1998 requesting our views regarding the definition of “foreign accrual tax” in subsection 95(1) of the Income Tax Act (the “Act”).

You describe the following hypothetical scenario:

1) Canco is a corporation resident in Canada.

2) Canco owns 100% of the shares of Usco a corporation resident in the United States.

3) Usco owns a 50% interest in a limited partnership (the “Partnership”) which owns U.S. real estate (the “Rental Property”) which has been used by the partnership to earn income from property. The Rental Property which is comprised of a building and land has increased in value such that a disposition at fair value would result in a capital gain and recaptured capital cost allowance for both the purposes of the Act and the Internal Revenue Code of the United States (the “Code”).

4) The Partnership disposes of the Rental Property in exchange for a different property (the “Consideration Property”) and the exchange is treated as a roll-over under the Code but is treated as a fair market value disposition under the Act. Accordingly, Usco’s share of the recaptured depreciation and capital gain of the Partnership would be included in computing its foreign accrual property income (“FAPI”). Such FAPI is included in the income of Canco under subsection 91(1) of the Act.

5) In the immediately following taxation year, the Partnership disposes of the Consideration Property for proceeds of disposition equal to its fair market value and this value is equal to its adjusted cost base for the purposes of the Act. Under the Code this transaction results in a capital gain and Usco pays U.S. tax on its share of the capital gain of the Partnership. Under the Act this transaction is treated as a fair market value disposition but neither recaptured depreciation nor a capital gain arises.

You request our view whether the U.S. tax referred to in paragraph 5 above would constitute “foreign accrual tax” (“FAT”) as that term is defined in subsection 95(1) of the Act in respect of which a deduction would be available to Canco under subsection 91(4) of the Act.

Our Comments

The wording of the definition of FAT in subsection 95(1) of the Act is very broad, (i.e. “the portion of any income or profits tax that was paid...by the particular affiliate...and may reasonably be regarded as applicable to” the FAPI). It is a question of fact whether tax paid by a foreign affiliate meets this test and it would be necessary to review the facts of an actual case in order to decide the issue. However, the Department recognizes that because the FAPI of a foreign affiliate is computed pursuant to the provisions of the Act while the foreign taxes paid by a foreign affiliate are determined in accordance with foreign tax law, there may result many reconciling items and timing differences between the FAPI reported by a taxpayer and the foreign taxes paid by the particular affiliate. The Act alleviates this problem with the above broad wording defining FAT and by providing, in subsection 91(4) of the Act, for a six year period to match the foreign taxes paid with the FAPI reported.

In the above hypothetical situation it is our view that the U.S. tax paid by Usco on its share of the portion of the gain computed pursuant to the Code from the disposition of the Consideration Property by the Partnership that could reasonably be regarded as the gain and/or recaptured depreciation determined pursuant to the Code that was deferred on the disposition of the Rental Property by the Partnership would qualify as FAT. Canco would be entitled to a deduction pursuant to subsection 91(4) of the Act in respect of such portion because the FAT arose within the time limitations set out therein. However, it would be necessary to review all the relevant details that would be available in an actual case in order to make a definitive determination whether the gain on the Consideration Property could be entirely attributed to the income deferred on the original disposition.

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