2014-0542281E5 Foreign affiliate - prescribed foreign accrual tax

Principal Issues: 1) When determining whether an amount paid in a particular taxation year of a foreign affiliate can reasonably be considered to be in respect of a foreign accrual property loss for the purposes of subsection 5907(1.4) of the Regulations, may future taxation years be considered? 2) When an amount is reinstated as foreign accrual tax by subsection 5907(1.5) in a particular taxation year of a taxpayer, can the subsection 91(4) deduction nevertheless be claimed in a previous taxation year of the taxpayer?

Position: 1) No 2) No

Reasons: 1) The determination of whether subsection 5907(1.4) applies has to be made based on the information available at the time it is being applied. Subsections 5907(1.5) and (1.6) provide rules that take into account later taxation years and allow for reinstatement of amounts previously denied by 5907(1.4) when intended. 2) Subsection 5907(1.5) determines the taxation year of the taxpayer to which the foreign accrual tax pertains.

Author: Laurikainen, Olli
Section: Subsections 5907(1.3) to (1.6) of the Regulations

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                                                                                                                                                     2014-054228

February 6, 2015

Dear XXXXXXXXXX:

Re:  Prescribed Foreign Accrual Tax

We are writing in response to your e-mails of August 6, 7 and 9, 2014 regarding operation of subsections 5907(1.3) to (1.6) of the Income Tax Regulations (the “Regulations”) in the context of the following hypothetical fact pattern.

1)    Canco is a corporation resident in Canada.
2)    FA1 is a direct wholly-owned “foreign affiliate”, as that term is defined in subsection 95(1) of the Income Tax Act (the “Act”), of Canco.
3)    FA2 and FA3 are foreign affiliates of Canco that are directly wholly-owned by FA1 (FA1, FA2 and FA3 together will herein be referred to as the “Group”).
4)    The taxation years of Canco, FA1, FA2 and FA3 end on December 31.
5)    Under the income tax law of the country (“Country X”) in which they are resident, FA1, FA2 and FA3 determine their liabilities for income tax to the government of that country on a consolidated basis.  FA1 is responsible for paying or claiming a refund of such tax on behalf of itself and the other members of the Group.  The income or profits tax rate in Country X is 40%.
6)    In 2014 (“year 1”), FA2 earns $100 of “foreign accrual property income” (“FAPI”) as that term is defined in subsection 95(1) of the Act, and FA3 has a $100 active business loss.  As FA1 is merely a holding company, it earns no income in year 1 or year 2.  FA2 makes a payment (the “Payment”) of $40 to FA1.  That amount may reasonably be regarded as being in respect of the income or profits tax that would otherwise have been payable by FA2 in respect of the FAPI if the tax liability of the Group had not been determined on a consolidated basis in Country X.
7)    In 2015 (“year 2”), FA2 has no FAPI or other income and FA3 has a foreign accrual property loss (“FAPL”) of $100.

You observe that in the context of the above fact pattern, the $100 of FAPI earned by FA2 in year 1 is included in the income of Canco pursuant to subsection 91(1) of the Act.  You request our view whether the portion of the Payment which would otherwise be prescribed by subsection 5907(1.3) of the Regulations to be foreign accrual tax (“FAT”) applicable to the amount included under subsection 91(1) of the Act in the income of Canco in year 1, would be reduced to nil by subsection 5907(1.4) of the Regulations.

Our Comments

Subsection 5907(1.4) of the Regulations reads in part as follows:

“If the amount prescribed under paragraph (1.3)(a) or (b), or any portion of the amount, can reasonably be considered to be in respect of a particular loss…of another corporation for a taxation year of the other corporation, then the amount so prescribed is to be reduced to the extent that it can reasonably be considered to be in respect of the portion of the particular loss…that would… not be a foreign accrual property loss…”.

In our view the determination of whether subsection 5907(1.4) of the Regulations applies, must be made based on the income and losses of the members of the Group for year 1 and, if applicable, preceding taxation years.  Accordingly, the FAPL realized by FA3 in year 2 would not be relevant to the analysis.  In year 1, it is reasonable to consider that the Payment made by FA2 is in respect of the active business loss of FA3.  Therefore, it is our view that subsection 5907(1.4) of the Regulations applies to reduce the amount otherwise prescribed by subsection 5907(1.3) of the Regulations to be the FAT applicable to the amount included in income by Canco to nil.  Our view would be the same regardless of the year in which the Payment in respect of year 1 is made by FA2.

Additional Question and Our Response

You ask us to assume the same fact pattern as set out above except that fact 7) is replaced with the following:

7)    In year 2, FA2 has no FAPI or other income and FA3 has active business income of $100.

You observe that under the revised facts (i.e. assuming no other facts relevant to subsections 5907(1.5) and (1.6) of the Regulations exist), subsection 5907(1.5) of the Regulations would apply to prescribe in year 2 an amount equal to the Payment to be FAT applicable to the amount included under subsection 91(1) of the Act in the income of Canco in year 1.  You request our view whether the deduction under subsection 91(4) of the Act would be available to Canco in year 1 or in year 2.

It is our view that the operation of subsection 5907(1.5) of the Regulations will cause the deduction under subsection 91(4) of the Act to become available to Canco in year 2.  In other words, no subsection 91(4) deduction could be claimed by Canco in year 1.

We trust that the above is of some assistance.

Yours truly,

Olli Laurikainen CPA, CA
For Director
International Division
Income Tax Rulings Directorate

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