Section 90

After noting that in 2012-0439741I7 "we indicate that upon redemption of MRPS [mandatory redeemable preference shares], the redemption premium would be characterized as a dividend," CRA stated:

This statement does not reflect the views of the CRA. In the absence of an election under subsection 93(1) of the Act, redemption proceeds are treated as proceeds of disposition. Accordingly, Rulings document 2012-0439741I7 will be removed from our database.

withdrawn by CRA on 25 August 2014

Mandatory Redeemable Preferred Shares ("MRPS"): are voting; have a mandatory redemption date approximately 10 years from the allotment date, with the redemption proceeds (equal to the issue price, plus the Premium accrued to the redemption payment date) to be paid in cash on the mandatory redemption date; and have a Premium equal to the per share equivalent of (a) a fixed premium of 7.1% per annum of the issue price, compounded quarterly, plus (b) a variable premium of 5.5% of the aggregate net profit after tax less, minus any amount paid by way of dividend. The TSO position was that the MRPS were debt, consistent with their accounting treatment and their treatment for tax purposes "in other jurisdictions."

In indicating that the MRPS would be considered equity, CRA stated that "generally speaking, we will respect the form of the investment regardless of how it is accounted for or how it is treated for tax purposes in other jurisdictions," and that "payments of interest or dividends will derive their income tax consequences from the legal nature of the payment." Respecting the redemption Premium, "as it is paid on a share investment, we consider it to be a dividend."

Capital gains distributions made to Canadian-resident shareholders by U.S. non-diversified closed-ended management investment companies, comprised of "long-term capital gains" and "short-term capital gains," were dividends rather than capital gains for Canadian purposes.

The distribution of amounts out of a share premium account of a foreign corporation that could have been declared and paid as a dividend under the foreign corporate law, but was not, should be characterized as a distribution of paid-in capital and not as a dividend.

A Canadian-resident received a $10,000 dividend from a French company as reduced by French withholding tax of 15% ($1,500) and by the avoir fiscal (tax credit) withheld by the French company which, according to the correspondent, was 33 1/3 of the net dividend paid by it, or $2,833, and according to CCRA was $5,000. After noting that under the Cananda-France convention, the individual appeared to be entitled to apply to the French government for a refund of the avoir fiscal, CCRA indicated that the full $10,000 gross amount was required to be included in the individual’s income.

Publico, a Canadian public corporation, invested $1 million in its wholly-owned US affiliate which is an LLC under the American corporate law. What is the fiscal treatment of a repatriation of the initial subscription? The Department stated (TaxInterpretations translation):

In a given situation, whether an amount is paid as a reimbursement of an initial subscription in a LLC is a question of fact. However, in a case where an amount paid to Publico by the LLC could be considered a reimbursement of its initial subscription under its relevant constituting documents, the amount paid would be considered a reduction in the paid-up capital rather than a dividend for purposes of the Act.

Whether a capital distribution made to a Canadian shareholder of a U.S. corporation would be a dividend or a return of capital for Canadian tax purposes would be a question of U.S. corporate law.

It is the Department's view that a dividend can include any distribution of property by a corporation to its shareholders that is not a return of the paid-up capital of a corporation." Because under the Delaware corporate law, "it is not possible for a corporation to make any asset distribution by reducing its capital" and "cash distributions must be made from the surplus account and constitute dividends" under such law, such a distribution from a Delaware corporation's surplus account will be a dividend for purposes of s. 90(1) of the Act.

FA1, a Delaware corporation, wishes to make a cash distribution to Canco by reducing its capital. However, as under Delaware corporate law a cash distribution can only be made from a "surplus" account, FA1 must first transfer the amount from its capital account to its surplus account. CRA stated:

[T]hese payments are not distributions of corporate profits. This does not appear to have any bearing on the matter as such distributions are still regarded as dividends in Delaware. … [A] distribution as described above would be regarded as a dividend and not as a return of capital, regardless of whether the initial contribution was made to capital or to surplus, and… this tax result is attributable to the fact that Delaware corporate law does not permit any return of capital except from a surplus account.

Dividends received from a non-resident corporation, including a mutual fund, are generally included in income as dividend income for the Canadian resident (subject to the provisions of s. 95(1) for dividends received from a foreign affiliate) irrespective of the source of such distribution (as business income, property income or capital gains).

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.

How is the paid-up capital of a US LLC computed for purposes of s. 90(3)? Would the paid-up capital be computed differently if the US LLC were previously not a foreign affiliate?

After stating that the paid-up capital of the US LLC in respect of its shares (as determined under s. 93.2(2)) is to be computed pursuant to the definition of "paid-up capital" in subsection 89(1), and noting that IT-463R2, para. 2 states "that paid-up capital is ‘based on the relevant corporate law rather than tax law. The amount calculated under corporate law is usually referred to as the ‘stated capital'...," CRA stated:

[T]he relevant jurisdiction's laws under which the US LLC was created and the US LLC's constating documents would be the starting point for determining the paid-up capital of the US LLC… .

To the extent [such] laws and constating documents do not provide for stated capital akin to that which is provided for under Canadian domestic corporate law but, rather, provide for an attribute that is akin to a partner's capital account, the US LLC would not…have stated capital for the purposes of subsection 89(1). As such, it would not have paid-up capital for the purposes of subsection 90(3) or paragraph 53(2)(b).

As the paid-up capital of the US LLC is computed pursuant to s. 89(1), regardless of whether it is a foreign affiliate of the unit holder, it does not matter for PUC purposes when it became a foreign affiliate.

Under what circumstances will CRA apply subsection 15(1) to distributions of share premium? CRA stated:

[T]he proper approach for determining the character of a distribution from a foreign corporation to a shareholder for Canadian tax purposes is the same two-step approach that is used for the classification of foreign entities for Canadian tax purposes as set out in ITTN #38. That is, the first step is to determine the characteristics of the distribution under foreign corporate law (not tax law), and then compare these characteristics with those of recognized categories of distributions under Canadian common law and corporate law in order to classify the distribution under one of those categories. … [A]s a practical matter…[w]here the distribution is a dividend or a return of legal capital under the foreign corporate law, that characterization will generally not be challenged by the CRA.

Conversions of corporations incorporated under the laws of Delaware and California into limited liability corporations would not result in dispositions at the shareholder or the entity level, given that the conversions would be similar to corporate continuances in Canada. Although no rulings were given on the paid-up capital of the LLCs, the description of the "Shares" of the Delaware LLC ("LLC2") to be contained in the LLC Agreement - and similarly for California - stated:

"Capital" of Shares is the aggregate of all amounts paid to LLC 2 and the monetary value at the time of contribution of property contributed to LLC 2 (in each case including amounts paid or contributed prior to USco 2's conversion to LLC 2) in consideration for the issuance of Shares together with any amounts added thereto by the Board of Managers or the Stockholders in accordance with the provisions of the LLC 2 Agreement, less the aggregate of all amounts by which such capital has been reduced by the Stockholders or the Board of Managers in accordance with the LLC 2 Agreement.

The Directorate indicated that if, under the Delaware corporate law governing a return of contributed surplus by a Delaware subsidiary of the Canadian taxpayer, “any cash distribution must be made from the surplus of the corporation and that any such distribution constitutes a dividend,” then such distribution was to be treated as a dividend rather than a capital distribution.

It is the Department's view that a dividend can include any distribution of property by a corporation to its shareholders that is not a return of the paid-up capital of a corporation." Because under the Delaware corporate law, "it is not possible for a corporation to make any asset distribution by reducing its capital" and "cash distributions must be made from the surplus account and constitute dividends" under such law, such a distribution from a Delaware corporation's surplus account will be a dividend for purposes of s. 90(1) of the Act.

FA1, a Delaware corporation, wishes to make a cash distribution to Canco by reducing its capital. However, as under Delaware corporate law a cash distribution can only be made from a "surplus" account, FA1 must first transfer the amount from its capital account to its surplus account. CRA stated:

[T]hese payments are not distributions of corporate profits. This does not appear to have any bearing on the matter as such distributions are still regarded as dividends in Delaware. … [A] distribution as described above would be regarded as a dividend and not as a return of capital, regardless of whether the initial contribution was made to capital or to surplus, and… this tax result is attributable to the fact that Delaware corporate law does not permit any return of capital except from a surplus account.

A limited partnership (LP) - whose 90% general partner is FA1 (held by Canco1) and whose 10% limited partner is FA2 (held by Canco2, which is related to Canco1) – receives a paid-up capital distribution (the “Distribution”) from its wholly-owned subsidiary (FA3). Canco1 and FA1 have November 30 taxation year ends and Canco2, FA2, FA3 and LP have calendar year ends. Is only LP required to make a s. 90(3) election respecting of the Distribution?

CRA responded:

[A] subsection 90(3) election in respect of the Distribution will be valid if made only by FA1 in its capacity of the general partner on behalf of LP because there is no “connected person or partnership” in respect of LP within the meaning of subsection 90(4).

… The election has to be made by FA1 by notifying the Minister in writing on or before the filing-due date of FA2 for its taxation year ended on December 31, 2021.

After discussing the manner of making the election (by letter with various relevant particulars), CRA noted:

If a joint election is made by LP, Canco1 and Canco2, CRA would accept it as valid and would accept the required election made by FA1 on behalf of LP, Canco1 and Canco2 provided such election letter includes all the required information as outlined [above].

… If an election is made jointly by Canco1, Canco2 and LP in respect of the Distribution, it is required to be made on or before the earliest of the filing-due dates of Canco1, Canco2, FA1 and FA2 for their respective taxation years that include December 31, 2021, in accordance with [Reg.] 5911(6)(b) … .

Where a non-resident subsidiary (FA) of Canco has made a loan to a non-resident subsidiary (SisterCo) of Canco’s non-resident parent (Foreign Parent), CRA considers that it is irrelevant that FA has ceased to be a creditor affiliate of SisterCo two years later, as a result of the sale by Canco of FA to Foreign Parent, so that s. 90(6) could still apply to include the loan’s amount in Canco’ income.

As a result of a wind-up of a 2^nd tier FA following a s. 90(6) loan to Canco, there technically would be a double income inclusion to Canco under ss. 90(6) and (12). By virtue of s. 248(28)(a), only one of the two amounts would be included in Canco's income.

Where FA lent to Canco, the loan was repaid (with no s. 90(14) deduction available because this occurred as part of a series) and the money was readvanced to Canco (technically giving rise to a 2^nd s. 90(6) inclusion), CRA's policy is that s. 90(6) will not be applied to the 2^nd loan. See detailed summaries of Scenarios 6 and 7 under s. 90(9).

Canco wholly owns FA 1 which wholly-owns FA 2. Each has a calendar taxation year. On December 31, 2012, FA 2 has US$1,000 of exempt and net surplus, and FA 1 has nil net surplus. After lending the "FA2 Loan" (of US$1,000) to Canco on June 15, 2013, FA 2 liquidates into FA 1 in February 2014, so that the FA 1 now holds the FA2 Loan (renamed the "FA1 Loan") and its exempt surplus increases to US$1,000.

For its 2013 year, the Loan amount of US$1,000 is included in Canco's income under s. 90(6) and it deducts US$1,000 under s. 90(9) respecting FA 1's exempt surplus.

CRA stated:

[A]s a result of the liquidation of FA2 into FA1, Canco "becomes indebted to" FA1… . Therefore, subsection 90(6) will apply to include a "specified amount" in Canco's income in its taxation year ending on December 31, 2014 in respect of the FA1 Loan… .

…[B]y virtue of the restrictions in paragraph 90(9)(b)…[the] US$1000 exempt surplus balance can be used by Canco to claim a deduction under subsection 90(9) only in respect of either the FA1 Loan or the FA2 Loan.

...[S]ubsection 90(6) provides for duplicate inclusions in Canco's income in respect of what is essentially the same loan. … Therefore…paragraph 248(28)(a)… applies to remedy the situation and avoid double taxation of the same amount. The amount to be included in Canco's income in its taxation year ending on December 31, 2014, would be either the amount under subsection 90(6) in respect of the FA1 Loan or the amount under 90(12) of the Act in respect of the FA2 Loan, but by virtue of paragraph 248(28)(a) of the Act not both. In either case, a full deduction would be available under subsection 90(9)… .

Under a second scenario in the same Canco/FA 1/FA 2 structure described above, FA 1 lent the FA1 Loan to Canco before August 19, 2011 and then merged with FA 2 on September 1, 2013 to form Amalco, which was not a continuation of either FA 1 or FA 2. On October 3, 2013, Amalco incurred a US$1,000 payable owing to Canco (the "Canco Payable"), and this was set-off against what now was labelled as the "Amalco Loan" on December 31, 2013.

CRA stated:

[A]ll pre-August 19, 2011 loans and indebtedness are entitled to a five year repayment window, such that they are not subject to the provisions of subsection 90(6), if they are repaid before August 20, 2016. However, all post August 19, 2011 loans and indebtedness must be repaid within two years of the day the loan was made or the indebtedness incurred… .

[T]he legal set-off will constitute repayment of the Amalco Loan for purposes of paragraph 90(8)(a) of the Act.

There is no provision in the Act that provides…the FA1 Loan was repaid or settled. …[However], it is reasonable to consider that…both the FA1 Loan and the Amalco Loan are repaid on December 31, 2013. Since the FA1 Loan is repaid before the August 19, 2014 deadline set out in the coming into force provisions of the Explanatory Notes, it is not deemed to be a separate loan received by Canco on August 20, 2014. Accordingly, subsection 90(6) of the Act does not apply to require Canco to include an amount in respect of the FA1 Loan in its income… . in any taxation year. Similarly… the Amalco Loan is fully repaid within two years… .

When is the interest on a loan made by a creditor affiliate to a specified debtor treated as indebtedness for purposes of s. 90(6), for example, a loan where the interest is payable together with principal on maturity of the loan after three years? CRA stated:

[W]e would consider subsection 90(6) to apply to the full amount of the principal portion of the loan, as well as to any interest that accrued in year one. Provided the loan and accrued interest are paid in full immediately upon the maturity of the loan, the interest that accrues in years two and three would be excepted from subsection 90(6) by paragraph 90(8)(a). In any event, a deduction under subsection 90(14) would be available when the loan, including accrued interest, is finally repaid.

• On September 1, 2011 a foreign affiliate (FA) of a corporation resident in Canada (Canco) made a loan to a "specified debtor" in respect of Canco. If Canco sells the shares of the FA such that FA ceases to be a foreign affiliate of Canco, before September 1, 2013, and the loan is outstanding on September 1, 2013, will Canco be deemed to have an income inclusion pursuant to proposed s. 90(6) on September 1, 2011?
• Alternatively, if prior to August 19, 2011 FA) made a loan to a "specified debtor" in respect of Canco, and Canco sells the shares of the FA before August 19, 2014, will Canco have an income inclusion per s. 90(6) on August 20, 2014, if the loan remains outstanding on August 20, 2016?
• Alternatively, if Canco sells the shares of FA after August 20, 2014 but the loan remains outstanding on August 20, 2016, will s. 90(6) apply?

Response

: Respecting the first case, proposed s. 90(6) provides that the relationships between Canco, FA and the debtor are to be tested at the time the loan is received or the debt incurred (in this case, September 1, 2011) - so that, if the loan is not repaid by September 1, 2013 (even if FA is then no longer a FA of Canco), the exception in proposed s. 90(8)(a) will not be available so that Canco will have an income inclusion on September 1, 2011. In the other case, proposed ss. 90(6) to (15) are to be applied as if the loan was received or indebtedness was incurred on August 20, 2014. If FA is not a FA of Canco at that time (e.g., the FA shares were sold before then), proposed s. 90(6) will not apply to Canco. However, if the sale of the shares of FA takes place on or after August 20, 2014 and the loan remains outstanding on August 20, 2016, since proposed s. 90(6) provides that the relationships between Canco, FA and the debtor are to be tested at the time the loan is received or the debt incurred (in this case, August 20, 2014), it will apply, so that Canco will have an income inclusion on August 20, 2014, notwithstanding that those relationships are no longer in place on August 20, 2016. Note that Canco will get a deduction pursuant to proposed s. 90(14) when the indebtedness is repaid.

Will CRA apply IT-119R4 to give administrative relief from interest and penalties relating to the requirement to withhold tax on deemed dividends to non-residents arising from s. 90(6)?

Response

: CRA generally looks to its practices on s. 15(2) to deal with practical issues involving the application of proposed ss. 90(6) to 90(15). However, as proposed s. 90(6) only applies to include a "specified amount" in the income of a taxpayer resident in Canada, consistently with its practice respecting the application of subsection 15(2) to Canadian resident debtors, CRA will not provide administrative relief from interest and penalties in the context of the application of proposed s. 90(6). Instead, it will exercise its right of enforcement.

FA makes a loan to Canco, its wholly-owning parent. Canco then sells its interest in FA to a third party, but due to foreign tax and other regulatory concerns, Canco does not repay the loan. The loan then is forgiven. Would the forgiveness satisfy the repayment condition in ss. 90(8) and 90(14)? CRA responded:

Consistent with…2015-0610621C6 and 2016-0645521I7…there has to be an actual repayment of the loan. Therefore, a settlement or extinguishment of the loan as a result of forgiveness [is] not…a repayment… for the purposes of the upstream loan rules….

However, if relevant tax attributes described in subsection 90(9) exist at the time when the loan is made, Canco will be entitled to a deduction from income under subsection 90(9) to offset all or a portion of the original income inclusion under subsection 90(6) and subsequent income inclusions under subsection 90(12), provided that the tax attributes continue to be available at the relevant times for the purposes of subsection 90(9). Given that the loan in the situation described will never be repaid, it is possible for such inclusions and deductions in computing Canco’s income to continue indefinitely. …

Part A: LIFO ordering/s. 113(1)(a) deduction for actual dividends

In 2013 FA, which had exempt surplus ("ES") and net surplus ("NS") of US$100, made a US$100 loan (Loan 1) to Canco (its wholly-owning parent). In 2014 FA paid a dividend (Dividend) of US$50 at a time when it had ES and NS of US$150 (no Reg. 5901(2)(b) election is made). Loan 1 is not repaid within two years and Canco has nil adjusted cost base ("ACB") in the FA shares.

In 2014 Canco will have an income inclusion of C$63, the equivalent of the US$50 dividend. Is Canco able to claim a deduction in each of 2013 and 2014 under s. 90(9)(a)(i)(A) for the Canadian dollar equivalent (C$125) at the "lending time" of Loan 1? Will Canco be entitled to a deduction in computing its 2014 taxable income of C$63 under s. 113(1)(a)?

CRA responded:

…[I]f one were to assume that exempt surplus were reduced on a first-in, first-out basis, it may be possible to argue that the dividend paid in 2014 would "spend" some of the exempt surplus that is relied upon for purposes of the 90(9) deduction such that, in 2014, paragraph 90(9)(b) would be breached.

However…we would consider a last-in, first-out ordering approach to give an appropriate result… .

…Canco would…be entitled to a subsection 90(9) deduction in both 2013 and 2014 in respect of Loan 1. As for the second question, we would note that there is nothing in section 90 that impacts in any way the availability of a deduction under subsection 113(1) in respect of dividends from a foreign affiliate. As such, Canco would be entitled to a deduction of C$63 under that subsection for the dividend received in 2014.

Part B: Subsequent exempt loss/subsequent Reg 5901(2)(b) election

The same facts as in Part A except that FA's exempt surplus balance went down to US$60 as a result of a loss in 2013 and at the time of the Dividend in 2014 Canco's ACB in the FA shares was equal to C$63 as a result of a share subscription, in 2014 but before the dividend, by Canco for FA shares. Canco elects Reg. 5901(2)(b) so that the 2014 C$63 dividend is deemed to be paid out of pre-acquisition surplus. May Canco claim a deduction in 2013 and 2014 under s. 90(9)(a)(i)(A) of C$125? Can it claim a deduction in computing its 2014 taxable income of C$63 under s. 113(1)(d)? CRA responded:

…[A]bsent tax avoidance activity, a subsection 90(9) deduction of C$125 would be available in both 2013 and 2014, given that the reduction of surplus resulting from a loss is not an event contemplated in either paragraph 90(9)(b) or (c) and that the relevant time at which to measure surplus is the dividend time and not any time in a subsequent year in which a subsection 90(9) deduction is claimed to offset a subsection 90(12) inclusion.

…[T]he conditions for making a paragraph 5901(2)(b) election would be met…given that, again, the provisions of section 90 in no way affect the surplus balances of a foreign affiliate. In other words, the condition in the pre-amble of paragraph 5901(2)(b) that requires that "in the absence of [that] paragraph" subsection 5901(1) would deem an amount to be paid out of exempt, hybrid or taxable surplus would be met. …[A] subsection 113(1) deduction would be available by virtue of paragraph 113(1)(d).

Part C: Subsequent upstream loan utilizing Reg. 5901(2)(b) election

: The same facts as in Part A except that at the lending time in 2013 Canco's ACB in the FA shares was C$63, no new ES is generated after Loan 1 is made and, instead of FA paying the US$50 dividend in 2014, FA made a second loan (Loan 2) to Canco of US$50 (which loan is not repaid within two years) in 2014. May Canco claim a deduction in 2013 and 2014 under s. 90(9)(a)(i)(A) of C$125? Can it claim an additional deduction in 2014 of C$63 under s. 90(9)(a)(i)(D) on the basis that it could have made a Reg. 5901(2)(b) election respecting Loan 2? CRA responded:

[In] 2013-048379…we took the position that a taxpayer would be entitled to rely on clause 90(9)(a)(i)(D) if the taxpayer would have been in a position to make a paragraph 5901(2)(b) election if the notional dividend had been a real dividend.

…Thus, if the taxpayer would have been in a position to make a paragraph 5901(2)(b) election had the notional dividend relating to Loan 2 been a real dividend, it is our view that Canco would, in this example, be entitled to a deduction of C$63 under subsection 90(9) by virtue of clause 90(9)(a)(i)(D). Furthermore, the taxpayer may continue to rely on clause 90(9)(a)(i)(A) in respect of Loan 1.

Scenario 1 [90-day rule unavailable]

On December 31, 2012, FA has a nil "net surplus" balance and no relevant deficits. In its 2013 (calendar) taxation year, it earns $1500 of "exempt earnings" and on June 30, 2013, it makes a loan of $1500 to Canco (which wholly-owns it). This "Loan" will not be repaid by June 30, 2015. In determining the amount deductible by Canco pursuant to s. 90(9), does the "90-day" rule in Reg. 5901(2)(a) apply to the s. 90(9)(a) notional dividend so that Canco can deduct $1,500 for 2013? In responding negatively, CRA stated:

Although Canco would have been in a position to have paragraph 5901(2)(a)… apply to deem an actual dividend to be paid out of FA's current year exempt surplus… it would be contrary to the words "exempt surplus at the lending time in respect of the corporation" in clause 90(9)(a)(i)(A) to consider the application of paragraph 5901(2)(a)… in determining the amount deductible under subsection 90(9).

Scenario 2 [notional UFT disproportionate election]

The facts are similar except that on 31 December 31 2012, FA has taxable surplus ("TS") and underlying foreign tax ("UFT") balances of $3000 and $500, respectively. In determining the amount deductible by Canco under s. 90(9), can Canco be considered to have filed a disproportionate election under s. (b) of the UFT definition in Reg. 5907(1) so that Canco can deduct $1500 for 2013? In responding affirmatively, CRA noted that absent a disproportionate election, the notional s. 90(9)(a) dividend would have been characterized as having been paid from FA's TS, thereby allowing Canco a $750 deduction under s. 113(1)(b), and stated:

However…Canco could be considered, hypothetically, to have taken all the necessary steps to make the Disproportionate Election, such that…a $1500 deduction would be available to Canco under subsection 90(9) by virtue of clause 90(9)(a)(i)(C).

Scenario 3 [notional Reg. 5901(2)(b) election]

Canco1 and Canco2, which are related, own 60% and 40% of the shares of FA1 having ACBs of $900 and $600, respectively. FA has hybrid surplus ("HS") and net surplus balances of $1,500 and nil hybrid underlying tax ("HUT") respecting both Cancos. On 30 June 2013 FA lent $1,500 to Canco1, and this loan was not repaid by 30 June 2015. Accordingly, $900 and $600 is included in their respective incomes for their years ending 31 December 2013, based on their respective surplus entitlement percentages. Can Canco1 and Canco2 be treated as having made the election under Reg. 5901(2)(b) so that the notional dividend under s. 90(9)(a) would deemed to be paid from FA's pre-acquisition surplus? CRA stated:

Since…Canco1 and Canco2 have an ACB of $900 and $600, respectively, in the shares of FA, and Canco1 and Canco2 would each have been in a position to jointly make an election under paragraph 5901(2)(b)… to deem an actual dividend paid by FA to be out of FA's pre-acquisition surplus, …[therefore] for the purposes of subsection 90(9) Canco 1 and Canco 2 would be in position to demonstrate that $900 and $600 may "reasonably be considered to have been deductible" by them… .

Scenario 4 [notional Reg. 5901(1.1) election]

Similar facts to Scenario 1, except that FA has HS and HUT balances of $1500 and nil, and TS and UFT balances of $1500 and $500. Can Canco be treated as if it had made the Reg. 5901(1.1) election to have the s. 90(9)(a) notional dividend deemed to be paid from FA's TS? CRA responded:

Since Canco would have been in a position to make an election under subsection 5901(1.1)… to deem the full amount of an actual $1500 dividend paid by FA to be paid out of FA's TS …[therefore] an amount may "reasonably be considered to have been deductible" in respect of the dividend under paragraph 113(1)(b)…[so that] Canco would be in a position to deduct $1500 from its income pursuant to clause 90(9)(a)(i)(C).

Scenario 5 [notional s. 40(3) gain does not generate surplus]

Canco owns nil ACB shares of FA1, which had HS and ES balances of $750 each, and nil HUT and ES. FA1 held all the shares of FA2 which had nil ACB and were excluded property. FA2 had nil net surplus. On 30 June 2013 FA1 lent $1,500 to Canco, and this loan was not repaid by 30 June 2015. An actual $1500 dividend paid by FA2 to FA1 would have given rise to a s. 40(3) capital gain to FA1. Would a notional $1,500 s. 90(9) dividend from FA2 to FA1 increase the HS of FA1 for purposes of computing the s. 90(9) deduction to Canco? CRA responded:

[O]nly the actual ES, HS, HUT, TS, UFT and ACB amounts at the lending time..[are] relevant in the determination of the deduction …under [s. 90(9)]. Therefore…. the deemed gain to FA1 that would arise…if, as contemplated by paragraph 90(9)(a), FA2 were to pay a $1500 dividend to FA1 (and FA1 were to pay a $1500 dividend to Canco) would not be included when computing the HS balance of FA1 and the deduction available to Canco under subsection 90(9) in the above scenario.

Scenario 6 [no double inclusion following FA creditor wind-up]

Canco owns all the shares of FA1, which had nil net surplus and net earnings. FA1 held FA2, which had ES and net surplus of $1,500, and nil net earnings. On 20 June 2013 FA2 made the $1,500 "FA2 Loan" to Canco for 10 years – but FA2 was wound-up into FA1 on 20 February 2014. As a result of the liquidation, Canco becomes indebted to FA1 ("FA1 Loan"), resulting in a s. 90(6) income inclusion for 2014. Furthermore, as Canco deducted $1,500 under s. 90(9) in computing its 2013 income to offset the 90(6) income inclusion in respect of the FA2 Loan, that amount will fall into its 2014 income pursuant to s. 90(12). Is any relief available respecting this double income inclusion? CRA responded:

[B]y virtue of paragraph 248(28)(a), either the amount determined under subsection 90(6) in respect of the FA1 Loan or the amount determined under subsection 90(12) in respect of the FA2 Loan, not both, is required to be included in the income of Canco for its taxation year ending on December 31, 2014.

Scenario 7 [no s. 90(6) inclusion for 2nd loan in series]

Canco owns nil ACB shares of FA, which had no relevant surplus or net earnings amounts. On 20 June 2013 FA made a loan of $1,500 to Canco with a term of one year, and this loan was repaid and readvanced on 6 February 2014. $1,500 would be included in Canco's income for 2013 under s. 90(6), with no deduction under s. 90(9), and with no s. 90(14) deduction on repayment because the repayment would be considered to be part of a series of loans or other transactions and repayments. Would the amount of the new loan also be included in its income under s. 90(6)? CRA responded:

[W]here subsection 90(6) has applied to a loan or indebtedness that is a part of a series of loans or other transactions and repayments, it will not apply again to the same amount of another loan or indebtedness in that series. Therefore…subsection 90(6) would not apply to include the amount of the New Loan in Canco's income.

An indirectly-owned foreign affiliate ("FA1") generates substantial exempt surplus during a taxation year and uses the resulting cash flow to make upstream loans to (Canadian) "Parent." Neither FA1 nor any other intervening FA has a surplus account balance at its last taxation year end. Does the 90-day rule in Reg. 5901(2)(a) apply in calculating exempt surplus for purposes of s. 90(9)(a)(i)(A)? CRA stated:

The exempt earnings of a foreign affiliate of a corporation are computed on an annual basis and are added to the affiliate's exempt surplus in respect of the corporation only at the conclusion of each of the affiliate's respective taxation years. As a result, we would not consider exempt earnings of a foreign affiliate in respect of a corporation arising in the taxation year of the affiliate in which a particular loan is made to…the corporation, to form part of the exempt surplus, at the lending time, of the foreign affiliate… .

[W]ere paragraph 5901(2)(a) applicable to a real series of dividends paid up the chain of affiliates at that time such that a deduction would be available to Parent under paragraph 113(1)(a) in respect of the real dividend received by it, we would not consider that deduction to be in respect of the exempt surplus of any foreign affiliate of Parent at the lending time.

Assume that Canco owns all the shares of FA. FA has $100 of taxable surplus ("TS"), no exempt surplus and no underlying foreign tax (UFT) balances. The TS is attributable to foreign accrual property income ("FAPI") of FA and has been fully included in the income of Canco and the ACB of FA's shares. Assume that FA makes a $100 loan to Canco and the "specified amount" in respect of the loan is included in Canco's income pursuant to proposed s. 90(6). Will a reserve be available to Canco pursuant to the provisions of proposed s. 90(9)?

Response

In this scenario, no amount is included in the reserve under proposed s. 90(9)(a)(ii) in respect of previously taxed FAPI, because the specified debtor is Canco (which is not a person described in proposed s. 90(9)(a)(i)(D)(I) or (II)). Furthermore, no deduction could be made under s. 90(9)(a)(i)(C) because FA has no UFT, and no deduction could be made under s. 90(9)(a)(i)(D) because no portion of the notional dividend was out of FA's pre-acquisition surplus. However, the ACB of Canco's shares of FA is increased as a result of the inclusion in respect of the FAPI of FA; and the suppression election in proposed Reg. 5901(2)(b) allows a taxpayer to have the whole dividend deemed to be paid out of pre-acquisition surplus. Since Canco would have been in a position to make the suppression election to deem the dividend to be paid out of pre-acquisition surplus, it is CRA's view that:

for the purposes of proposed subsection 90(9) an amount may "reasonably be considered to have been deductible" in respect of the dividend under paragraph 113(1)(d). Therefore an amount would be included in the subsection 90(9) reserve under proposed clause 90(9)(a)(i)(D).

An LLC subsidiary of a Canadian subsidiary (Canco3 - that was lower down in a corporate group controlled by a U.S. Pubco) received the repayment of a loan that it had made to a non-resident affiliated corporation (Forco2, which was not a foreign affiliate of Canco3), and used the repayment proceeds to purchase note receivables from group companies within the Forco2 silo and also to pay a dividend to Canco3 – which then lent some of this money “back” to Forco2 and also repaid loans owing to Canadian affiliates held in a separate silo from the Canco3 or Forco 2 silos.

CRA ruled that the repayment by Forco2 of its loan from the LLC would not be considered to be made “as part of a series of loans or other transactions and repayments” for the purpose of s. 90(8)(a) or 90(14).

When an upstream loan to Canco from its wholly owned CFA is forgiven following a sale of the CFA, this will not qualify as a repayment of the loan for purposes of the upstream loan rules so that, at best, reserves will need to be claimed under s. 90(9) throughout the indefinite lifetime of Canco.

In 2013, FA, which is wholly-owned by Canco, makes a loan to SisterCo., which is wholly-owned by the non-resident parent of Canco (“Foreign Parent”). Before the expiration of the two-year s. 90(8)(a) limit, Canco sells its shares of FA to Foreign Parent for cash consideration. The loan remains outstanding for more than two years. Would there be a s. 90(6) income inclusion to Canco? CRA responded:

[T]he sale of FA by Canco in this fact pattern would not give rise to a repayment of the loan it made to SisterCo and, since the loan remains outstanding for more than two years, subsection 90(6) would apply. The fact that FA is no longer a “creditor affiliate” of Canco at the two year time limit is not relevant as the legislation tests the status of the lender as a “creditor affiliate” only at the time the loan is made. On the other hand, the deduction available under subsection 90(14) is not dependent on FA being a “creditor affiliate” at the time of repayment. Thus, in our view, when the loan is finally repaid a deduction will be available to Canco in the taxation year of repayment, provided the repayment is not made as part of a series of loans or other transactions and repayments.

CRA has not yet developed any specific positions on the application of the upstream loan rules to cash pooling arrangements and would welcome a detailed submission from industry.

A non-resident subsidiary (ForeignHoldco) of a taxable Canadian corporation (Parent) will eliminate a non-interest-bearing loan previously made by it to Parent by declaring a dividend, paying the dividend by issuing a demand promissory note and then receiving the note from Parent in payment of the loan. CRA was only asked to rule to the effect that dividends (including a liquidating dividend) previously received by ForeignHoldco from a Malaysian-resident subsidiary qualified as an addition to ForeignHoldco's exempt surplus in respect of that subsidiary.

See detailed summary under Reg. 5907(11.2).