10 July 1980 Income Tax Severed Letter 5-1027 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.

Dear Sirs:

RE:     Taxable Surplus and Subparagraph 95(2)(a)(ii)of the Income Tax Act (the Act)

This is in reply to your letter of December 11, 1970 requesting our views on the application of subparagraph 95(2)(a)(ii) of the Act. You have outlined the following hypothetical situation. Canadian corporation A owns all of the shares of two foreign affiliates, B and C. B is a passive investment corporation resident in a country which is not listed in subsection 5907(11) of the Income Tax Regulations (the Regulations), C is a corporation resident in a listed country and carrying on an active business in that country. B owns a rental property located in the country of residence of C. B leases a portion of the rental property to arm's length tenants, and the balance is leased to C. B does not carry on an active business.

In this case, as pointed out by you, B's income from the rental property is made up of both FAPI and income from an active business. Your concerns are related to the allocation of administrative, financial and depreciation expenses in determining the amounts of these taxable surplus components.

We agree with your suggested method for allocating general administrative expenses.

We do not agree, however, that all of the interest expense should be allocated to reduce only the FAPI. In our view, it would seem reasonable to allocate the interest expense to a source such that both the FAPI and non FAPI components of taxable earnings are reduced proportionally.

Our view with respect to the allocation of depreciation is similar to the above. We agree that it is equitable that depreciation or capital cost allowance be allowed as a deduction in this case. However, the mechanics are, as discussed, complicated by the provisions of subsection 1102(3) of the Regulations. To produce an equitable result, our view is that a reasonable depreciation expense could be deducted in computing the earnings attributable to the paragraph 95(2)(a) amounts. Accordingly, the FAPI could be reduced by a capital cost allowance claim, specifically allowable pursuant to subsection 1102(3) of the Regulations, on that portion of the rental property that reasonably can be considered to have been used to earn the FAPI.

In this peculiar situation it seems that none of the provisions of subparagraph 5907(1)(a)(i) of the Regulations would apply to determine how to calculate the depreciation referred to above. We would consider that depreciation calculated at a rate equivalent to the CCA rate used in determining the FAPI portion, and applied to the portion of the building used to earn the active business income might be a reasonable deduction in this case.

We hope the above comments will be useful to you. Please accept our apology for the delay in responding to your letter.