11 July 1980 Income Tax Severed Letter 7-859 F

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.

RE: Foreign Affiliates

This is in reply to your memorandum of June 17, 1980 wherein you request our comments regarding problems in interpreting the legislation pertaining to foreign affiliates.

The provisions of the Act and Regulations pertaining to foreign affiliates are very complex and there is a multitude of problems. Since it would be a monumental task to make an analysis of those problems our comments will be restricted to a few examples:

1. Active business income

The foreign accrual property income (FAPI), which is included in tax income of a taxpayer by virtue of subsection 91(1), included income from property and business other than active businesses.

IT-73R3 states that whenever a corporation carries out the activities contemplated in its articles of incorporation, there is a presumption that the profits arising from those activities are profits derived from a business. The bulletin also states that once income is established as being derived from a business source, any appreciable activity expended in the actual income generating process of that business (other than usual "housekeeping" functions such as banking and record-keeping), characterizes that income as income from an active business.

If the income of a corporation is almost invariably characterized as income from an active business, its income from property will be nil in most cases and therefore no amount will be included in FAPI except taxable capital gains if any.

2. Foreign exchange fluctuations

Capital gains and capital losses must be computed in Canadian currency but the surplus accounts must be computed in foreign currency.

Therefore a foreign affiliate could incur a loss which could be a taxable gain in Canadian dollars.

Example

A foreign affiliate resident in the Netherlands made a loan of $1,000 in U.S. currency. The equivalent values were as follows:

     Dutch     U.S.     Canadian

At the time the loan was made     1995     1000     1050

At the tire the loan was repaid     2000     1000     1095

     (95)     nil     45

One half of the capital gain of $45 would be FAPI but 1/2 of the capital loss of 95 Guilders would be deducted in computing the exempt surplus and the other 1/2 would reduce the taxable surplus.

Another problem is that all borrowings (except those exempted by paragraph 95(2)(c) would trigger a foreign exchange gain or loss upon partial or full repayment when computed in Canadian dollars.

3. Consolidated returns

Many foreign jurisdictions have tax legislation providing for the combination of defined related entities for purposes of computing the group tax liability. This creates a problem for allocating taxes payable or refundable among the relevant foreign affiliates in such situations. Anomalous results may be created where for example one affiliate makes an actual payment to another foreign affiliate for the utilization of losses of the letter.

Example

A Ltd. B LtdD. C Ltd. Total

Income from an active business $1,000 $1,000 FAPI (income) $1,000 1,000 FAPI (loss)  ($1,000) (1,000) Amount taxable at 50% on a consolidated basis $1,000

In these circumstances is the $500 tax attributable to the active business income of A Ltd. or to the FAPI (income) of B Ltd?

4.

Problems also exist in obtaining information relating to the local tax matters of foreign affiliates in certain situations, particularly where the Canadian taxpayer lacks effective control. It must be recognized that foreign affiliates are corporations organized under foreign laws, managed and controlled by foreign nationals and carrying on business in foreign countries. Does a foreign shareholder, a Canadian investor, have any right to solicit information of a nature that goes far beyond that which is given out to all shareholders in the normal course of reporting and which may not be required disclosure under the statutes of the relevant country of incorporation? Indeed, such information is not required disclosure in Canada and it is doubtful whether Canadian corporations would be willing to provide minority shareholders with information such as reconciliations of taxable income to book income, copies of tax returns, etc.

Therefore, a taxpayer could not provide the Department with information which he could not obtain.