Section 91

Interposition of a partnership between a small stakeholder and a non-resident corp may generate FAPI (p. 10)

FAPI of a non-resident corporation may be included, in the income of a Canadian-resident person notwithstanding that the non-resident corporation may not, in fact, be a foreign affiliate or CFA of such person.

… [C]onsider a corporation resident in Canada (Canco) that has a 5 percent interest in a general partnership. The remaining partnership interest is held by an arm’s length non-resident corporation. The partnership holds all of the issued and outstanding shares of Forco, a non-resident corporation, and Forco’s income includes FAPI. For the purposes of computing its income under subsection 96(1), which includes the application of subsection 91(1), Forco is a CFA of the partnership. As a result, the FAPI of Forco must be included in the income of the partnership, and 5 percent of such FAPI must be allocated to Canco. …

77% effective tax rate on property income subject to US tax (pp. 12-13)

Suppose that Forco, a foreign corporation (characterized as such on the basis of provisions such as article IV of the Canada-US treaty…)…earns $1,000 of property income, pays foreign tax at 50 percent, and pays out the remaining $500 as a dividend.

If A (a top-bracket Ontario-resident individual) owns Forco directly, the total tax payable is $767.65 ($500 foreign tax + $0 Canadian tax on FAPI + $267.65 Canadian tax on the dividend), for a tax rate of almost 77 percent on the initial $1,000 earned…The calculations are as follows:

• A has a $1,000 FAPI inclusion… . However, the net taxable amount is $0 because this inclusion is fully offset by a $1,100 deduction for foreign accrual tax…
• A has $500 of ordinary income from Forco because the dividend does not receive the dividend gross-up and tax credit. The subsection 91(5) deduction…is computed as the lesser of the dividend ($500) and, essentially, the amount of FAPI that has been taxed in Canada ($0)….

69.7% effective tax rate if flowed through a Canco (and deferral until Canco dividend) (p. 13)

Assume that A owns 100 percent of Canco, and Canco owns 100 percent of Forco. If the funds are to be reinvested by Canco, no Canadian tax arises, and the total tax payable is $500 of foreign tax…

If the funds are to be passed on to A as a dividend for reinvestment at the personal level (instead of the corporate level), the total tax burden is $696.70[:] $500 foreign tax + $196.70 Canadian tax...calculated as 39.34 percent of the eligible dividend of $500.

Otherwise de minimis changes effectively are linked to another change not part of the series

The de minimis exception in s. 91(1.1)(b) does not apply to a large number of trivial SEP changes (e.g., where there is an employee stock option plan on the shares of the FA) if there is also a larger SEP change in the year, even if this does not occur as part of the same series of transactions.

Rule does not extend to individuals and trusts

Furthermore, the exception for situations where the acquisition or disposition resulting in a decrease in SEP for the taxpayer leads to a corresponding increase in SEP for one or more non-arm’s length taxpayers does not extend to such taxpayers who are Canadian individuals or trusts.

General potential triggering of stub year for controlled foreign affiliate (CFA) if disposition triggering change to surplus entitlement percentage (SEP) (p. 9)

[I]f there is an acquisition or disposition of shares of a foreign affiliate of the taxpayer that results in a change to the taxpayer's SEP in respect of the particular CFA, then there may be a deemed year end for the particular CFA at the "particular time" which is immediately before the acquisition or disposition….

No exclusion in s. 91(1.1)(b)(i) where different CFA’s with matching SEP changes or where increased SEP lands in NAL individual (p. 9)

[T]he first exception, under subparagraph 91(1.1)(b)(i), is where the decrease to the taxpayer's SEP in the particular CFA is matched by an increase to the SEP in the particular CFA of one or more taxpayers, each of which is a taxable Canadian corporation that does not deal at arm's length with the taxpayer immediately after the particular time. Two points[:]…First, the decrease and increase(s) must be in respect of the same particular CFA. Thus, if there is some sort of reorganization involving two particular CFAs and the taxpayer's SEP in one of them decreases but the taxpayer's (or a non-arm's length taxable Canadian corporation's) SEP in the other one increases, that does not fit within this exception even if the total amount of attributable FAPI remains unchanged. Moreover, this exception would apply only where the increased SEP lands in a non-arm's length taxable Canadian corporation - and thus would not apply where the other non-arm's length taxpayer is an individual or a trust or even a partnership, notwithstanding that the SEP decrease is to be "determined as if the taxpayer were a corporation resident in Canada"….

S. 91(1.1)(b)(iii) applicable if single disposition/acquisition (p. 10)

[T]he Explanatory Notes state that this exception [in s. 91(1.1)(b)(iii)] applies where the acquisition or disposition "is one of multiple in the year,…However, the statutory language does not seem to actually require multiple acquisitions or dispositions…

Thrust of new stub-period accrual rules if s. 91(1.1) exceptions do not apply (p. 8)

If the exceptions do not apply, the CFA has a deemed stub year-end in respect of the taxpayer and a corporation or a partnership that is connected to the taxpayer….This rule prevents the stub period FAPI from being included in the income of a connected person whose SEP [surplus entitlement percentage] in the CRA has increased.

Continued potential for double income inclusion (p. 9)

Because the deemed year-end extends only to connected corporations and partnerships, double income inclusion may still arise in certain cases. Assume that a Canco disposes of a CFA to a non-arm's-length Canadian individual who does not own the CFA before the transfer and who continues to own the CFA at the end of its normal year-end. In this case, the stub period FAPI is included twice: in the hands of both the Canco and the individual. Similar anomalies arise if the transferor is another individual instead of a Canco, or if the transferee is a trust, or if a partnership with non-corporate members is involved.

Previously no pick-up of FAPI if not a CFA at year end (p. 762)

One surprise in Bill C-43 is that it does not contain a substantial amendment proposed in the summer of 2013….

[F]API) of a "controlled foreign affiliate" (CFA) is attributed to the relevant Canadian resident only if there is CFA status vis-a-vis the Canadian at the end of the taxation year of the CFA….

Analogous U.S. rule (p. 762)

(The U.S. rule in converse circumstances is that pro rata portions of Subpart F income must be recognized unless the disposition occurs in the first 30 days of the CFC's taxable year and the sale is to a non-U.S. person; but for U.S. corporations that pay the same rate of the tax on capital gains and ordinary income, these effects may be neutral.) [fn 34: See Code §951(a). Where a corporation has capital losses that may only be offset against capital gains, the effects would seemingly not be neutral.]

Adoption of FAPI pick-up if disposition before year end (p.762)

An amendment proposed last summer [fn 35: Proposed §91(1.1) and §91(1.2).] would change the 38-year-old rule and adopt the U.S. approach by requiring a FAPI pick-up even if the CFA interest has been disposed of before year end. But this change should have no net effect where the disposed CFA is a U.S. corporation because the usual U.S. corporate tax rate would, pursuant to a de facto (§91(4)) foreign tax credit, eliminate any net Canadian tax on the attributed FAPI. That would preclude any upward basis adjustment (under §92 of the Act) for the Canadian shareholder and thus not affect the determination of the amount of gain upon the disposition.

But, as noted, the amendment is being reworked and is not in Bill C-43.

18 September 2017 proposals (“Current Proposals”) did not extend s. 91(1.2) to acquisition of shares of (existing) FA from NR (p. 9)

[N]o changes appear to have been made to the Current Proposals to address concerns where shares of an FA are acquired from a non-resident. As described in the example in the Joint Committee submission, a Canadian corporation that owns 10% of the shares of an FA and then acquires the other 90% of the shares of the FA from a non-resident person shortly before the last day of the FA's taxation year, will be required to include in its income 100% of the FAPI of the FA earned in the year. This result arises since neither the carve-out rule in paragraph 95(2)(f.1) would apply (since the affiliate is an FA prior to the acquisition) nor would subsection 91(1.2) be applicable (since the acquisition is from a non-resident corporation)….

Potential double-taxation of stub-period FAPI where an arm’s length individual or trust has a participating percentage (PP) increase (p. 4)

If the stub year-end deeming rule applies and a taxpayer's FA has a stub year-end at a particular time, that year-end applies to all "connected corporations" and "connected partnerships" in respect of the taxpayer. A connected partnership is one in which either the taxpayer or a connected corporation is a member directly or indirectly through one or more partnerships. A connected corporation is defined as a non-arm's-length resident company or an arm's-length resident company (if the FA is the company's FA at the particular time and the triggering event results in an increase in the company's PP in the FA). The technical notes say that the concept of connected corporation now includes non-arm's-length corporations as described above, which makes unnecessary subsection 91(1.5) in the 2016 draft. However, subsection 91(1.5) in that draft applied to all taxpayers, not just corporations. Hence, under the 2017 draft, the same stub-period FAPI is now taxed twice—in a taxpayer that has a PP decrease, and in another arm's-length non-corporate taxpayer (such as an individual or a trust) that has a PP increase.

Recognition should be based on PP rather than SEP changes

The triggering event for a stub period under s. 91(1.2) should be a change in the participating percentage rather than in the surplus entitlement percentage. For example, all the income of the FA in question might be allocable for the year to preferred shares (i.e., the preferred shareholder’s PP is 100%) so that it would not be appropriate to trigger the rule based on a change in the year of the SEP of a holder of the FA’s common shares.

Stub period for CFA applies re NAL Cdn corps (p. 10)

[T]his deemed [s. 91(1.2)] year end applies… also in respect of each corporation or partnership that is "connected" to the particular taxpayer…[including, under s. 91(1.3)] a corporation… if, at or immediately after the particular time, it is resident in Canada and does not deal at arm's length with the taxpayer; and… a partnership… if, at or immediately after the particular time, the particular taxpayer or a non-arm's length corporation resident in Canada is, directly or indirectly through one or more partnerships, a member of the partnership.

Problematic exclusion of arm’s length taxpayers where s. 95(2)(f.1) carve-out is inapplicable (p. 11)

[T]here is no "stub-period end time" with respect to arm's length taxpayers, which can be problematic if the "carve-out" rule in paragraph 95(2)(f.1) is not applicable to them, as that could result in double FAPI attribution.

Deemed year-end for CFA whose SEP increases? (p. 6)

The proposal's charging provision operates whenever – vis-à-vis a particular CFA – there is a decrease in a taxpayer's surplus entitlement percentage (SEP), calculated as if the taxpayer were a Canco. Immediately before the time of the decrease, the CFA has a deemed taxation year-end for the purposes of section 91, and thus the disposing taxpayer must pick up its share of FAPI in the stub period. The deemed year-end rule does not apply if another connected Canco has an equal and offsetting SEP increase vis-à-vis the CFA. It is not clear whether the CFA of a Canco whose SEP increases (the acquiring taxpayer) also has a deemed year-end if that Canco is not connected.

Narrowness of relieving concept of "connected" (pp. 6-7)

The relieving definition of "connected" in the proposal is a concern because it is much narrower than the relieving definition of "specified person or partnership" in the companion provision in paragraph 95(2)(f.1), which uses the concept of non-arm's length. As a result, more than 100 percent of the FAPI in a stub period may be caught in the Canadian tax net, because the disposing and acquiring taxpayers may be related but not connected (as defined for the two companion provisions). Thus, if the CFA does not have a deemed year-end vis-à-vis the acquiring taxpayer because it is related to the disposing taxpayer, the acquiring taxpayer must pick up current-year FAPI in the year of acquisition and before the SEP change (paragraph 95(2)(f.1)). If the disposing taxpayer is not connected with the acquiring taxpayer, the disposing taxpayer must also pick up the same FAPI (proposed subsection 91(1.1)).

Narrowness of connected definition (p. 1275)

[A]ssume that A is a non-resident that owns 100% of the shares of two first tier Canadian holding companies (B and C) and that B and C in turn each own 50% of the shares of another Canadian corporation (D), which owns 100% of the shares of a CFA (F). If D transfers the shares of F to B and C, the exception does not appear to apply as neither B nor C is connected with D under the current draft.

Excluded property test not appropriate

It would be preferable for the rules in ss. 91(1.4) and (1.5) to apply by default, with taxpayers being able to elect to have these rules not apply. Furthermore, it is not apparent why, where there is a disposition of the particular FA’s shares by a CFA of the taxpayer, the shares must be excluded property immediately thereafter.

Need not be two dispositions for s. 91(1.4) to apply, and excluded property condition may be meaningless (p. 11)

Subsection 91(1.4) is designed to address among other things, duplicative FAPI attribution in the context of a multi-tiered structure, where FAPI may arise at the level of a FAPI-earning CFA, but also at the level of a higher-tier CFA because of a disposition of the lower-tier FAPI earning CFA. The Explanatory Notes include an example [to this effect.]…

[A]lthough [this] example…refers to a subsequent disposition of a lower-tier affiliate, it is not a condition of the rule that there be two dispositions. [fn 21: It should also be noted that subparagraph 91(1.4)(b)(ii) refers to the disposed of shares not being excluded property immediately after…the time the shares are disposed of. At this time, the shares arguably would not be property of the other controlled foreign affiliate so they could not be excluded property to it at that time, which makes this condition meaningless. …]

NAL ambiguity could invalidate s. 91(1.4) election (p. 12)

…[A]mbiguity in relation to factual non-arm's length relationships could result in an invalid election.

Exclusion of arm’s length purchase from NR inappropriate if carve-out rule unavailable

The unavailability of s. 91(1.5) (allowing a purchaser to have a stub period year end) to an arm’s length purchaser from a non-resident can generate an inappropriate result where the s. 95(2)(f.1) carve-out rule is unavailable to the purchaser (in respect of whom the FA might already have been an FA).

Potential relieving effect of s. 91(1.5) (p. 12)

Subsection 91(1.5) is designed to address the interaction of subsection 91(1.2) and the "carve-out" rule in paragraph 95(2)(f.1) where the latter is not applicable (mainly) in relation to an arm's length acquisition of an interest in a particular CFA because.it is already a foreign affiliate of the taxpayer (or other relevant person). …

[I]t is not clear why this measure is elective, since it is difficult to see a circumstance where this result would not be desirable from the perspective of the particular taxpayer,…

[T]his measure may, to some extent, be helpful in non-arm's length situations involving transfers (or other acquisitions and dispositions) involving corporations and individuals or trusts. As noted above, there is no exception (or automatic application of subsection 91(1.2)) where an SEP decrease to a corporation is matched by an SEP increase to a non-arm's length individual or trust, but this measure could perhaps at least eliminate the duplication of FAPI attribution.

COVID-19 related deferral of foreign taxes may eliminate current FAT deduction (p. 5)

Assuming that an amount is not recognized as FAT until it is paid, the deferral of tax payments may give rise to unexpected surprises to Canadian corporations that are generally not paying any Canadian taxes on the FAPI incurred by its CFA. … [T]he result of deferring the payment of the foreign tax is that the FAT deduction will be reduced by four times the amount so deferred, thus potentially give rise to Canadian taxes.

LLC-related FAT issues (pp. 18:24–25)

US tax paid by a Canadian member on an LLC’s income is not FAT for the purposes of subsection 91(4)….Accordingly, Canadian members of an LLC cannot claim a subsection 91(4) deduction for an income inclusion in respect of an interest in an LLC. …

[A] Canadian taxpayer that indirectly holds an interest in an LLC through a shareholder affiliate would be entitled to a deduction under 91(4) for tax paid by the shareholder affiliate in respect of FAPI earned by the LLC.

Although resident members cannot claim FAT deductions for FAPI earned by an LLC, individual members may claim a subsection 20(11) deduction and FTC for US tax paid in respect of FAPI included in income under subsection 91(1). [fn 139: 2013-0480321C6] Any excess US taxes paid by the individual member in respect of the FAPI income (that is, not deducted under subsection 20(11) or used as an FTC) may be deducted from income pursuant to subsection 20(12).

Inclusion of FAPI in aggregate investment income ("AII") (p.1052)

[F]API, as income earned from a share, should be included in a CCPC's AII in the year earned… . [T]he general corporate income tax rate in British Columbia for 2015 is 26 percent while the corporate income tax rate applicable to AII is 45.7 percent. ...

Potential advantage of earning ordinary income as FAPI (p. 1054)

Consider a CCPC subject to tax in British Columbia ("BCco") that acquires a royalty interest. The royalty interest generates $100,000 of income in 2015. If the royalty interest is owned directly by BCco, the resulting income should be subject to the combined corporate tax rate for investment income of 45.7 percent.

...[I]f Forsub is established in a jurisdiction that levies an overall effective tax rate of 25 percent on the royalty income…[t]he FAPI inclusion to BCco should still be $100,000. But because Forsub pays $25,000 in foreign tax in respect of the royalty income, BCco should be entitled to an offsetting FAT deduction of $100,000 ($25,000 multiplied by the RTF of 4). As a result, BCco will have nil net FAPI and will not be subject to Canadian corporate tax on the royalty income despite paying only $25,000 in foreign taxes….

The FAT [foreign accrual tax] or UFT [underlying foreign tax] denied under the FTCG [foreign tax credit generator] Rules is not limited to the amount of foreign income or profits taxes paid in respect of FAPI [foreign accrual property income]. In certain circumstances, the FTCG Rules could deny credit for Canadian taxes paid. FAT and UFT include income or profits tax paid by a foreign affiliate to the government of any country, including Canada. [fn. 11: See the definitions of "foreign accrual tax" in subsection 95(1) of the Act and "underlying foreign tax" in subsection 5907(1) of the Regulations, as well as Canada Revenue Agency Documents 2000-0058637 (February 5, 2002) and Canada Revenue Agency Document 2007-0247551E5 (June 27, 2008).] For example, consider a situation in which a foreign affiliate lends money to a related Canadian resident. The interest paid to the affiliate is subject to Canadian non-resident withholding tax at a rate of 25%. Absent the FTCG Rules, this withholding tax borne by the foreign affiliate should generally be included in the affiliate's FAT and UFT. However, if the FTCG Rules apply to a taxpayer in respect of the affiliate, this withholding tax will be ignored in computing the taxpayer's FAT and UFT deductions, even though it represents actual Canadian taxes paid.

After describing the cross-chain funding rule in draft s. 91(4.1) and Reg. 5907(1.06), they provided this example:

For example, consider a taxpayer that has two foreign affiliates, FA 1 and FA 2. The taxpayer directly owns 100% of the shares of each affiliate (i.e., there is no cross-ownership between FA 1 and FA2). Assume the taxpayer's investment in FA 1 satisfies a hybrid condition. The FTCG Rules will apply to the taxpayer in respect of FA 1, as the taxpayer is a specified owner and FA 1 is a pertinent person or partnership. The rules will not apply to FA 2, because FA 1 is not a pertinent person or partnership of FA 2. However, if FA 1 made a non-interest-bearing loan to FA 2, the cross-chain funding rule would deem FA 1 to be a pertinent person or partnership of FA 2. The taxpayer's investment in FA 2 would then be caught by the FTCG Rules. The cross-chain funding rule would not apply if the loan from FA 1 to FA 2 had arm's length terms and conditions.

No relief where PPOP is the hybrid (p. 1281)

Subsection 91(4.5) does not provide relief, however, where the PPOP itself is the hybrid entity. For example, consider the situation where a taxpayer has the following structure:

1. Pubco, a Canadian corporation, owns all issued and outstanding shares of U.S. Holdco, a U.S. C corporation.
2. U.S. Holdco owns all issued and outstanding units of U.S. LLC.
3. U.S. Holdco earns FAPI in respect of which it incurs U.S. tax.

In this example, the U.S. LLC is disregarded under U.S. law and therefore, U.S. Holdco does not own the shares of U.S. LLC that it owns for purposes of Canadian law. Accordingly, and stepping through the language of the provision, subsection 91(4.1) will deny Pubco its FAT deduction since U.S. Holdco, a "specified owner" in respect of the "taxpayer" Pubco, is considered under U.S. law to own less than all of the shares of U.S. LLC, a "pertinent person" in respect of the "affiliate" U.S. Holdco, that it is considered to own for purposes of the Act….

Unlike the August 2010 Proposals, the exception for the hybrid entities in the current FTCG [foreign tax credit generator] Rules only applies to the investor entity, not to the entity which receives the investment. Thus, if an entity is treated as a corporation under Canadian tax law but is treated as an entity without share capital under the relevant foreign tax law, an investment in this entity could be considered a hybrid investment that is subject to the FTCG Rules.…When the specified owner concept was introduced in the current rules, Finance may have negledcted to extend the hybrid entity exception to cover both specified owners and the new pertinent person or partnership concept.

…FAT denial does not arise in situations where the specified owner does not own the same number of FA shares in the PPOP [pertinent person or partnership] solely because it is disregarded for foreign (such as US) tax purposes. However, the FTCG proposals deny all FAT in an FA chain if the PPOP is the hybrid entity. Assume, for example, that USco wholly owns a US pass through LLC. Under US tax law, the LLC does not exist, and therefore USco does not own all of the shares that it owns for Canadian tax purposes. Thus, all FAT in this FA ownership chain is denied. (Finance is aware of this anomaly and may be sympathetic to a legislative amendment.) An additional concern arises for an entity (tested as a PPOP) that under foreign tax law does not issue shares (such as a company limited by guarantee) and other non-share entities (such as a limitada or a GmbH that has percentage ownerships or quotas in lieu of actual shares). [emphasis added]

After referring to the expansion of the income test in s. 91(4.1)(a) by virtue of the deductible dividend test in s. 91(4.7), they stated:

… On this basis, the income test could apply to investments that may not be considered hybrid instruments in the conventional sense. For example, dividends paid on certain Australian preferred shares are deductible by the payer, but are still considered dividends for some Australian tax purposes. These types of investments appear to be the subject of the income test addition to the FTCG Rules.

The income test refers to dividends or similar amounts that are treated as "interest or another form of deductible payment" under the relevant foreign tax law. It is not clear whether this rule applies only when amounts are actually paid and deducted, or if it applies whenever an entity has the ability to make deductible distributions in respect of shares.…

For example, Brazilian law allows incorporated companies to pay pro rata distributions referred to as "interest on equity." These distributions generally are deductible under Brazilian tax law, up to a maximum amount based on the company's "equity" and certain prescribed interest rates. These payments are deductible when declared, but a company can choose not to claim the deduction. Based on the words, the income test could apply when a Brazilian company makes an interest on equity payment, even if it chooses not to deduct this payment.

Under some foreign tax laws, dividends or similar amounts in respect of an FA are either tax-deductible interest payments or other deductible payments; in that case, the specified owner of those shares is deemed to own less than all of the shares of that PPOP [pertinent person or partnership]. This situation may occur, for example, if a taxpayer or an FA in an FA chain owns redeemable preferred shares of an Australian corporation; those shares may be treated like debt under Australian tax law. The perceived mischief may arise because the dividend paid is tax-deductible in Australia but a receipt is exempt surplus for Canadian tax purposes. Unfortunately, this same provision may catch most commercial conduit entities that are FAs, such as US REITs, REMICs, RICs, and co-ops. Brazilian interest-on-equity shares and UK LLPs may also be adversely affected. Belgian and Italian notional interest deduction regimes are generally considered not to be vulnerable.

Current s. 91(5) deduction for FAPI included in individual LLC member’s income as the dividend payment (p. 18:27)

When an LLC pays a dividend to an individual member, the member will be entitled to a deduction under subsection 91(5) for FAPI included in computing the member’s income on a “share” of the LLC. Although there is arguably a timing issue with respect to taking a subsection 91(5) deduction for FAPI included in the member’s income in the same taxation year as the dividend, the CRA’s longstanding administrative practice is to permit the deduction. [fn 142: 59693] Because an individual member can take deductions and credits for US tax paid in respect of FAPI allocated from an LLC, the individual member is entitled to partial credit for US tax in the year of the FAPI inclusion, and to a full deduction when the FAPI is repatriated. …

Double taxation for corporate LLC members until dividend (p. 18:27)

[U]nlike individual members, corporate members are effectively subject to double taxation on FAPI inclusions until the income is repatriated. In some situations, this could result in permanent double taxation if the corporate member cannot use both the subsection 91(5) and paragraph 113(1)(c) deductions in the same year, or otherwise use the resulting NOL.

Deficiencies in s. 91(5) (pp. 43:7-43:8):

• No recognition is provided for FAPI that was taxed in respect of a share while the share was owned by a related Canadian resident
• If shares of a foreign affiliate are exchanged in the course of a tax rollover transaction (for example, a subsection 85.1(3) share exchange or a subsection 87(8) foreign merger), there is no "substituted property" rule whereby recognition for the previously taxed FAPI can be transferred to the new shares acquired on the exchange.