Subsection 90(2) - Dividend from foreign affiliate

Finance indicated that given that (as stated in the Explanatory Notes) ss. 90(2) and (5) provided a comprehensive definition of what constituted a dividend (namely, a pro rata distribution on the shares of a foreign affiliate), pro rata distributions to its members by an LLLP or LLC that was a corporation for purposes of the Act would be treated as dividends, including for disclosure in a T1134 supplement.

Current structure

XX2, an indirect controlled foreign affiliate of a Canadian public corporation, is the sole limited partner of a German KG, and its indirect wholly-owned German subsidiary (FA2), is the sole general partner of KG with a 0% partnership interest. KG, FA2, and two direct wholly-owned German subsidiary of FA2 (FA3 and FA4), constitute all the shares (being of a single class) of a German corporation carrying on an active business (FA5).

Current PTAs

Each of the Transferring Entities below has entered into a profit and loss transfer agreement (“PTA”) with the Dominating Entity below for the Transferring Entity to transfer its statutory profit to the Dominating Entity and for the Dominating Entity to cover any statutory losses of the Transferring Entity:

Background on PTAs

17. …[F]or German tax purposes, in order for tax consolidation to be possible, the parties to a PTA must be a parent and a subsidiary (direct or indirect) to meet the requirement of financial integration.

18. PTAs are generally concluded in order to implement an Organschaft for German tax purposes. Once an Organschaft is implemented, the taxable income/loss (after adjustment for matters such as book to tax differences and non-deductible items, etc.) of the subsidiary is transferred to the parent.

19. The [German Stock Corporation Act] requires a PTA to provide for adequate compensation of outside shareholders with annual payments established in proportion with their shares in the share capital of the Transferring Entity. The annual amount to be provided as compensation payment must not be less than the amount which could be expected to be distributed as the average dividend for each share based on the past profitability of the corporation and on its prospective profits.

Proposed transactions

1. FA4 will be merged into FA3 with FA3 (“New FA3") as the survivor. Consequently, PTA3 will be extinguished.
2. FA2 will transfer all of its shares of FA5 to New FA3 in consideration for shares of New FA3.
3. The (ordinary) shares held by KG in FA5 will be converted into voting cumulative preferred shares.

Rulings

The payments made by FA5 to New FA3 and KG under PTA1 and by New FA3 to FA2 under PTA2 will be deemed by s. 90(3) to be dividends including for various surplus calculation purposes. Each payment made by New FA3 to FA5 under PTA1 and by FA2 to New FA3 will be treated as a contribution of capital for purposes of s. 53(1)(c) and will not be treated as earnings or loss under Reg. 5907(1).

Canco owned 100% of the preferred shares of a Barbados International Business Company (“FA”), all of whose common shares are held by a non-resident corporation that is not a foreign affiliate of Canco. FA was a controlled foreign affiliate of Canco., Prior to 19 August 2011, FA redeemed all the preferred shares (with particulars of the redemption resolution redacted). Canco made no s. 93(1) election.

Barbados law is silent about the characterization of an amount received upon the redemption of shares of a Barbadian company, but…does not prevent a corporation from treating such amount, or a part thereof, as a dividend.

CRA responded:

[Although] subsection 90(2)…may apply earlier [than August 19, 2011] if a certain election has been filed…whether… subsection 90(2) applies is likely to not matter as, if there is in fact a distribution that is separate from the redemption…[as] the determination of the treatment of the proceeds… will…depend on whether legally there is, in part, a distribution of certain funds in the form of a dividend and, in another part, proceeds from a redemption of shares. If there is only, as a matter of law, a redemption and cancellation of shares, or if there is no conclusive evidence as to whether there is, in part, a dividend, we would generally view all such amounts as having been received as proceeds from the disposition of the… Shares, and no amount as having been received as a dividend. In this event, you may want to consider whether the taxpayer may be eligible to make a late [93(1)] election… .

If there is, in part, a dividend… to the extent the purpose… is to skew exempt surplus to the Canadian shareholder…consideration [should] be given as to the potential application of subsection 95(6) and/or subsection 245(2).

A limited liability partnership (FA1) will pay a distribution proportionately to its partners who directly comprise (i) a limited partner corporation (Canco9), and (ii) a general partner which is a general partnership - whose partners on a s. 212.3(25) look-through basis are two other Canadian corporations in the same group (Canco7 and Canco8). The CRA ruling letter described the proportionate distribution as being deemed by s. 90(2) to be a dividend and ruled that the distribution will be considered to be received as a dividend in respect of a single class of shares of capital stock of FA1 by Canco7, 8 and 9 for the purposes of s. 212.3(9)(b)(ii) – A(B).

Under an “Organschaft,” a German corporation (“Parentco”) and another corporation resident in Germany (“Subco”) enter into a Profit Transfer Agreement (“PTA”) under which Subco agrees to annually transfer its entire profit determined in accordance with German (statutory) GAAP to Parentco, and Parentco agrees to compensate Subco for any loss incurred under German GAAP.

A profit transfer payment made by Subco to Parentco could be re-characterized as income from an active business of Parentco under s. 95(2)(a) to the extent that Subco had earnings from an active business before taking into account the profit transfer payment (see, e.g., 2001-0093903). However, where the statutory accounting profits of Subco included income such as dividends from underlying affiliates or capital gains from dispositions of excluded property, all or a portion of a profit transfer payment could be included in the computation of the foreign accrual property income of Parentco notwithstanding that Subco had no FAPI prior to the payment.

Would CRA consider a profit transfer payment made by Subco to Parentco under a PTA to be a dividend under that s. 90(2)?

CRA agreed that the payment from Subco to Parentco under the PTA could be a deemed dividend under s. 90(2). In the base case scenario, there is one class of shares wholly-owned by the parent. Any profit transfer payment made after August 19^th , 2011 under the base case scenario (where there is one class of shares wholly-owned by Parentco would be a dividend under s. 90(2) - whose effect on the surplus accounts of Subco and Parentco would be in accordance with the rules of Part LIX of the Regulations.

As most taxpayers would be able to rely on CRA’s new view, CRA proposes to restrict the ability of taxpayers to treat these payments in accordance with the previous CRA view, to profit transfer payments made before 2017.

CRA applied the two-step approach to entity classification to find that MRPS (Luxembourg hybrid instruments which were “very similar to traditional shares under Canadian business corporations statutes”) were equity. They were governed by articles of incorporation, ranked after debt in a bankruptcy, could only be redeemed from funds available for distribution under Luxembourg law or from the proceeds of a new share issuances and voted on corporate matters such as the election of directors (although being non-voting would not have established that they were not shares). CRA also stated:

The fact that the MRPS must be redeemed on or before a stipulated date does not detract from their character as shares.

underline;">: €/US$ share structure. The constating documents of FA (which is a wholly-owned subsidiary of Canco that was incorporated and is resident in Country X, and whose functional currency is the U.S. dollar) state that "the capital of the Company is €€XX and US$XX divided into XX shares of €€XX each and XX shares of US$XX each," and that "[all] dividends shall be declared and paid according to the amounts paid or credited as paid on the shares in respect whereof the dividend is paid" and "[all] dividends shall be apportioned and paid proportionately to the amounts paid or credited as paid on the shares. FA issued US$ denominated shares and maintains the corresponding US$ capital account in order to match the currency of its investments and its functional currency.

Proposed Transactions

FA will declare and pay an amount that constitutes a dividend as a matter of FA's governing corporate law on all of its issued and outstanding shares (the "FA dividend"), based on the amount paid or credited as paid on the respective shares. Given the current relative currency values, the paid in capital of the €€ shares on a per share basis is greater than the paid in capital of the US$ shares and, as a result, the €€ shares will be entitled on a per share basis to a larger proportion of the dividend. Country X corporate law counsel opined that it considers that the two groups of shares of FA form two separate classes of shares under Country X's corporate law.

Rulings

The share capital of FA will be considered to consist of two classes of shares. The distribution on FA shares will be considered to be in respect of two classes of shares of FA and will be deemed to be a dividend paid by FA and received by Canco pursuant to ss. 90(2) and (5) for the purposes of ss. 15(1), 90 and 113.

An individual shareholder immigrates to Canada, thereby becoming a Canadian resident, and then receives $1,000 from a wholly-owned non-resident corporation ("NRCo") in satisfaction of a $1,000 dividend declared before her immigration. Scenario 2 is the same except NRCo issues a $1,000 promissory note to her in satisfaction of the dividend declared before the immigration (with the note being paid after the immigration).

In Scenario 1, the dividend received by her after immigration would be a dividend to her at common law and under s. 90(2) only at that time. Since in Scenario 2, the dividend would be considered received at the time when the shareholder was still a non-resident of Canada on the presumption (applying Banner Pharmacaps) that the note was issued and delivered to the shareholder in satisfaction of the obligation to pay the dividend, ss. 114 and s 90(1) would not apply to include such dividend in her income after immigration.

CRA would be prepared to consider the application of GAAR respecting any avoidance under Scenario 2 in the context of a ruling request.

Structure

Canco, a Canadian public company, directly owns a portion of the shares of FA1. FA1 is a controlled foreign affiliate of Canco resident in "Foreign Country" and holding X% of the shares of FA2, which also is a CFA of Canco and resident in Foreign Country. The balance of the shares of FA1 are owned by Forsub2 (resident in Foreign Country2), which is a subsidiary of Forsub (also resident in Foreign Country2) which, in turn, has X% of its voting shares owned by Canco.

Proposed transactions

In order to establish Newco as a "Finco" for the group:

1) FA2 will pay a dividend of FC$X to FA1, with FA1 lending such amount under the "FA Loans" to other foreign affiliates of Canco (with interest income thereon to be included in FA1's exempt surplus).

2) FA1 will undergo a divisive reorganization (the "Division") for the division of FA1 into two legal entities (FA1 and Newco) under which:

a) Newco will be formed as limited liability corporation under the laws of Foreign Country;

b) Under the deed of formation of Newco, the shares of FA2 (and other property) and liabilities of FA1 will be retained by FA1, while the FA Loans will be assigned by FA1; the legal paid-up capital of the FA1 shares will be reduced, and that of the Newco shares will be increased, on a proportionate basis; and

c) By operation of the corporate laws of the Foreign Country, Canco and Forsub2's approval of the Division will result in Canco and Forsub2 becoming the shareholders of Newco and FA1, respectively (and with liability limited to their respective capital contributions);.

Opinions

In addition to rulings on current law (including the reduction under s. 53(2)(b)(ii) of the ACB of the shares of FA1 held by Canco and Forsub2), the following opinions were provided:

• the assignment of the FA Loans by FA1 will be a pro rata distribution in respect of the shares of FA1 and the amount of the FMV of the FA Loans will be deemed to be a dividend pursuant to proposed s. 90(2);
• the Division will not result in a reduction to the ACB of the shares of FA1, held by each of Canco and Forsub2, under proposed s. 53(2)(b); and
• the Division will not result in a shareholder benefit under proposed s. 15(1.4)(e) by virtue of the exception in that provision for dividends.