2 March 1999 External T.I. 9903585 - F/A - ELECT DIVIDEND T/S NOT E/S

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: Whether election under 5900(2) can be made in respect of real dividends on a share of a foreign affiliate if a 93(1) election has been, or is in the future, made on the share.

Position: Yes. The election is only denied in respect of a subsection 93(1) deemed dividend.

Reasons: Other interpretations lead to results that are anomalous.

		990358
XXXXXXXXXX 	Olli Laurikainen
(613) 957-2116
Attention: XXXXXXXXXX 

March 2, 1999

Dear Sirs:

Re: Foreign Affiliates - Subsections 5900(2) and 5907(1) of the Regulations
Subsection 5900(2) of the Regulations to the Income Tax Act (“Act”)

Subsection 5900(2) of the Regulations provides that a corporation resident in Canada which is in receipt of a dividend on a share of the capital stock of a foreign affiliate may designate that a portion not exceeding the amount of the dividend that would otherwise be prescribed to have been paid out of the affiliate’s exempt surplus in respect of the corporation, to have been paid out of the affiliate’s taxable surplus in respect of the corporation. However, subsection 5900(2) of the Regulations contains an exception that provides that it does not apply to a “share in respect of which an election is made under subsection 93(1) of the Act”. The issue is whether a subsection 93(1) election made in respect of a share of the capital stock of a foreign affiliate of a corporation would taint that share, vis-à-vis all dividends ever paid on the share (i.e. including those paid prior to and subsequent to the election) such that a subsection 5900(2) designation would not be effective in respect of those dividends.

Our Comments

It is our view that the exception in subsection 5900(2) of the Regulations applies only in respect of a designated amount that is deemed to have been received as a dividend on the share of a foreign affiliate pursuant to an election under subsection 93(1) of the Act. Therefore a Canadian corporation would not be prevented from making the subsection 5900(2) designation in respect of actual dividends received by it on such share either before or after a dividend is deemed to have been received on such share pursuant to subsection 93(1) of the Act.

Subsection 5907(1) of the Regulations - Underlying Foreign Tax

Assume the following hypothetical facts:

1) Canco is a corporation resident in Canada.

2) Canco owns 100% of the shares of a foreign affiliate of Canco (“Holdco”).

3) Holdco owns 100% of the shares of another foreign affiliate of Canco (“Opco”) resident and carrying on active business in a designated treaty country for the purposes of section 5907 of the Regulations. The adjusted cost base of the shares of Opco to Holdco were nil. The shares of Opco were excluded property.

4) Holdco has disposed of all of the shares of Opco to an arm’s length third party for a $1000. At the time of the sale, Opco had net surplus vis-à-vis Canco of $600 made up of $400 exempt surplus and $200 taxable surplus.

5) The disposition of shares of Opco by Holdco gave rise to a $1000 gain for foreign income tax purposes and Holdco paid foreign tax of $400 on that gain.

6) For the purposes of the Act, the gain is only $400 by virtue of the application of subsection 93(1.1) of the Act which would provide that $600 of the $1000 of the total proceeds of disposition would be deemed a dividend from Opco to Holdco. The dividend would be comprised of $400 exempt surplus and $200 taxable surplus.

In the above circumstances, the question is how the $400 of foreign tax would be allocated between the exempt and taxable surplus accounts of Holdco.

Our Comments

It is our position that in allocating the foreign taxes applicable to a capital gain of a foreign affiliate between exempt surplus and taxable surplus, the portion of such tax up to the amount necessary to enable the taxpayer to obtain a paragraph 113(1)(b) deduction equal to the dividend from taxable surplus on the repatriation of the taxable surplus reasonably attributable to the gain may be allocated to taxable surplus and be considered underlying foreign tax. This amount is generally equal to the lesser of the amount of the foreign tax and 38% (i.e. Canadian corporate tax rate) of the taxable surplus arising on the gain. In this case the disposition of the shares of Opco gave rise to taxable surplus of $300 (i.e. $400 X 75%) before the allocation of foreign taxes applicable to this taxable surplus. If $114 of foreign tax (i.e. 38% of $300) is applied to the taxable surplus attributable to the gain, the net taxable surplus would be $186. The amount of underlying foreign tax necessary to obtain a 113(1)(b) deduction equal to this net surplus is $114 (i.e. [1/.38-1] X $114] = $186). Therefore it is appropriate to allocate $114 of the foreign tax to the $300 of taxable surplus arising on the disposition of the shares of Opco.

This leaves $286 of foreign tax to be allocated amongst the exempt surplus arising on the gain and the net surplus moving from Opco to Holdco pursuant to the application of 93(1.1). The exempt surplus arising on the gain was $100 and, of the $600 subsection 93(1.1) deemed dividend paid by Opco to Holdco, $400 was from exempt surplus, $200 was from taxable surplus. Therefore it is our view that $204 (i.e. 500/700 X $286) of the remaining $286 of foreign tax would be allocated to exempt surplus and the remainder $82 (200/700 X $286) would be allocated to the taxable surplus and added to the underlying foreign tax of Holdco in respect of Canco.

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.

Yours truly,

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