7 November 1991 Income Tax Severed Letter - Foreign Affiliates

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.

Subject: Interpretation Issues Relating to Foreign Affiliate Regulations 5907(1.1) and 5907(2)(j)

This is in response to your memorandum dated April 22, 1991 regarding the above-referenced matter.

Compensatory Payments

You have asked for us to consider whether an amount has been "paid", for purposes of Regulation 5907(1.1)(b)(i) and (ii), when it is booked on an accrual basis through an intercompany account.

In our view where the intercompany account has been charged with a number of offsetting items it is reasonable to consider that the compensatory amount has been "paid" for purposes of Regulation 5907(1.1). Where both the primary and secondary affiliate are "going concerns" this appears to be a practical approach to the issue.

In a situation where the secondary affiliate is incurring losses, it is often the case that these losses are funded by the primary affiliate. In such a case the primary affiliate would have a net amount owing to it by the secondary affiliate. If the compensatory amount has been charged against this account the Department should consider the amount "paid".

In other instances where the issue is less clear and it is to the taxpayer's advantage not to have paid the compensatory amount the onus should be on the taxpayer to establish that the amount has not been paid.

Where a payment has been made to which Regulation 5907(1.3) applies, the payment will be reflected, for purposes of "foreign accrual tax" and Regulation 5907(1.1), in the taxation year to which the payment relates.

Regulation 5907(2)(j)

You have asked what is meant by the phrase "for the purpose of gaining or producing such earnings amount" found in the preamble of Regulation 5907(2)(j).

XXX The purpose of Regulation 5907(2)(j) is to make certain adjustments to the "earnings amount" in order that the "adjusted earnings amount" more closely reflects the surplus that is available for distribution.

Certain expenses that are clearly incurred to earn income may be denied under U.S. tax law, for example insurance fees paid to a corporation that is part of the economic group or in some instances, interest. In such circumstances Regulation 5907(2)(j) would apply to reduce the "earnings amount".

For expenses such as charitable donations, political donations and penalties it will be more difficult to establish that the purpose test in the preamble of Regulation 5907(2)(j) has been met. We think it is fair to say that such expenses were intended to be deducted under Regulation 5907(2)(j) as such deduction results in the "adjusted earnings amount" more closely reflecting the surplus available for distribution. However unless persuasive arguments can be made within the context of the specific facts of a particular case that such expenses or outlays directly or indirectly are for the purpose of gaining or producing the earnings amount, the provision will not likely be applicable.

The purpose test found in Regulation 5907(2)(j) is similar to the test in paragraph 18(1)(a) and the jurisprudence pertaining to paragraph 18(1)(a) may be helpful in determining whether Regulation 5907(2)(j) would be applicable to a particular outlay or expense. We should point out that the Department of Finance considered it necessary to enact paragraph 18(1)(n) to specifically not allow the deduction of political donations in the computation of the income from a business or property. This implies that it is at least arguable that political donations would not be caught by the general exclusion in paragraph 18(1)(a).

We hope our comments are of assistance.