10 July 2003 External T.I. 2003-0007895 - Dividend received by foreign affiliate

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 CCRA.

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

Principal Issues: I) Whether a dividend paid by one foreign affiliate to another is foreign accrual property income ("FAPI")?

II) Whether a dividend paid by one foreign affiliate of an individual to a second foreign affiliate is included in the second foreign affiliate's exempt surplus?

Position:     		I) No.
II) No.

Reasons: I) The definition of FAPI excludes dividends paid from one foreign affiliate to another.

II) The definition of "exempt surplus" does not apply in respect of an individual.

XXXXXXXXXX 								2003-000789
T. Cook
July 10, 2003

Dear XXXXXXXXXX:

Re: Foreign Accrual Property Income ("FAPI") Inquiry

We are writing in reply to your inquiry of December 10, 2002. We apologize for the delay in responding. Your inquiry requested our comments with regard to the following situation. A Canadian resident individual holds all the shares of a corporation resident in British Virgin Islands ("BVI Co"). BVI Co holds all of the shares of a corporation resident in Hong Kong ("HK Co"), which in turn holds all of the shares of a corporation resident in China ("China Co"). China Co is a manufacturer and all income earned by it is active business income. China Co pays a dividend to HK Co. HK Co then pays a dividend in the same amount to BVI Co.

Specifically, you have asked for comments on:

? whether the dividend paid from China Co to HK Co would give rise to FAPI for HK Co, resulting in an income inclusion for the Canadian resident individual under subsection 91(1) of the Income Tax Act (the "Act");

? whether the dividend paid by HK Co to BVI Co would give rise to FAPI for BVI Co, resulting in an income inclusion for the Canadian resident individual under subsection 91(1);

? whether the dividend paid by China Co to HK Co would be included in HK Co's exempt surplus; and

? whether the dividend paid by HK Co to BVI Co would be included in BVI Co's exempt surplus.

Our Comments

Your letter appears to describe a factual situation involving specific taxpayers. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on the tax consequences applicable to a specific taxpayer in respect of particular circumstances other than in the form of an advance income tax ruling. However, we are prepared to offer the following general comments, which may be of assistance.

With respect to the first part of your inquiry, paragraph (b) in A of the formula in the definition of "foreign accrual property income" in subsection 95(1) of the Act specifically excludes "a dividend from another foreign affiliate of the taxpayer" from the FAPI of a foreign affiliate. As a result, neither the dividend paid to HK Co nor the one paid to BVI Co would give rise to FAPI for the recipient. Since there would be no FAPI, neither dividend would result in an income inclusion under subsection 91(1) for the Canadian resident individual. We have not considered any FAPI implications with respect to China Co.

Regarding the second part of your inquiry, we note that when a taxpayer resident in Canada receives a dividend from a non-resident corporation, the amount received is included in the taxpayer's income pursuant to subsection 90(1) and paragraph 12(1)(k) of the Act. If the recipient of the dividend is a corporation and the payer is a foreign affiliate of the recipient, section 113 of the Act may apply to grant tax relief by way of deduction in computing the recipient's income. The various surplus accounts (i.e., exempt surplus, taxable surplus and pre-acquisition surplus) of the foreign affiliate are relevant for determining the total deduction allowed. For example, paragraph 113(1)(a) of the Act provides that the recipient may deduct the portion of the dividend that was paid out of the foreign affiliate's exempt surplus.

Section 113 does not apply to individuals. Instead, if the recipient of the dividend is an individual, any tax relief would be by way of foreign tax credit under subsection 126(1) or deduction under subsections 20(11) or 20(12) of the Act. The operation of these provisions is not dependent on whether the dividend was paid out of any particular surplus account. Consequently, the various surplus accounts of a foreign affiliate are not relevant with respect to an individual. This is confirmed by the definition of "exempt surplus" in subsection 5907(1) of the Income Tax Regulations:

"exempt surplus" of a foreign affiliate (in this definition referred to as the "subject affiliate") of a corporation in respect of the corporation is ...

A foreign affiliate may only have exempt surplus in respect of a corporation. The same is true for "taxable surplus", which is also defined in subsection 5907(1). As a result, neither dividend in your example would be paid into "exempt surplus" because neither HK Co nor BVI Co could have exempt surplus in respect of the Canadian resident individual. If BVI Co ultimately pays a dividend to the Canadian resident individual, the amount of the dividend would be included in the individual's income pursuant to subsection 90(1) and paragraph 12(1)(k), and tax relief may be available under subsections 20(11), 20(12) or 126(1).

We trust that these comments will be of assistance.

Yours truly,

Eliza Erskine
Section Manager (Acting)
for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch