2014-0560811I7 FACL carryback – Surplus & PAS election

Principal Issues: 1) Do the surplus pools of a given CFA have to be adjusted as a result of a FACL carryback against the TCG portion of the FAPI inclusion reported in a previous year? 2) In a given set of facts, is the taxpayer barred from making a PAS election under paragraph 5901(2)(b) of the Regulations in respect of a dividend paid by one of its FAs in 2010? 3) If the answer to question 2) is yes, is there any other statutory or administrative discretion available to the CRA to allow the taxpayer to late-file any required election in order for a dividend paid by one of its FAs in 2010 to be treated as being paid out of PAS?

Position: 1) No. 2) Yes. 3) No.

Reasons: Application of the Act and Bill C-48.

Author: Roulier, Yannick
Section: 95(1) FAPI; 5901(2)(b), (2.1), (2.2) of the Reg.; S.79 of Bill C-48

April 21, 2015

Mr. Mark Turnbull, Team Leader                           HEADQUARTERS
International Advisory Services Section                Income Tax Rulings
International and Large Business Directorate        Directorate
                                                                               Yannick Roulier

                                                                               2014-056081

FACL carryback – Surplus implications, PAS election & application      
of Bill C-48 transitional rules

This is in reply to your correspondence of December 8, 2014, wherein you requested our assistance in respect of the surplus implications of a “foreign accrual capital loss” (“FACL”) carryback in the context of a given set of facts. Also, you raised issues concerning the availability of the “pre-acquisition surplus” (“PAS”) election provided by paragraph 5901(2)(b) of the Income Tax Regulations (“Regulations”), considering the transitional rules set out in subsection 79(2) of the Technical Tax Amendments Act, 2012 (2013, c. 34; “Bill C-48”). Unless otherwise indicated, all statutory references are to the Income Tax Act (“Act”).

Facts

The facts, as we understand them, are as follows:

1.    At all relevant times, Canco owns 100% of the issued and outstanding shares of the capital stock of CFA, a non-resident corporation that is a “controlled foreign affiliate” of Canco, as this expression is defined in subsection 95(1).

2.    On XXXXXXXXXX, and in the course of Canco’s taxation year ending on XXXXXXXXXX 2010, CFA declares and pays a dividend to Canco (“2010-Dividend”).

3.    In XXXXXXXXXX, the Canada Revenue Agency (“CRA”) initiates the audit of Canco’s 2008 to 2010 taxation years (“Current Audit”).

4.    In the course of the Current Audit, the CRA determines that CFA incurred a capital gain in its 2009 taxation year. It results in an amount of “taxable capital gain” (“TCG”) having to be included under variable B of the definition “foreign accrual property income” in subsection 95(1) (“FAPI”) in respect of CFA’s taxation year ending on XXXXXXXXXX, 2009 (“2009-FAPI-TCG”).CFA incurred a capital loss in its 2011 taxation year. It results in an amount having to be accounted for under paragraph (a) of variable E of the FAPI definition in respect of CFA’s taxation year ending on XXXXXXXXXX, 2011. It also results in a FACL of CFA, pursuant to subsection 5903.1(3) of the Regulations, for CFA’s 2011 taxation year (“2011-FACL”).

5.    In XXXXXXXXXX, Canco designated a portion of the 2011-FACL to be carried back to CFA’s taxation year ending XXXXXXXXXX, 2009.

6.    Correspondence and documents provided by Canco in the course of the Current Audit contain no reference to any election under either subsection 79(2) of Bill C-48 or under paragraph 5901(2)(b) of the Regulations. The CRA otherwise has no record of any election made by Canco or its representatives on or before June 30, 2014 under these provisions.

These facts are based on your request for an opinion, including the Memorandum from XXXXXXXXXX and phone conversations held in March 2015 between officers involved in the Current Audit and an officer from our Directorate. Note that all the facts pertaining to this particular situation are not fully repeated herein and one should refer to these documents for additional details, where necessary. No other documents were provided with the request, including any written representations or correspondence from the taxpayer or its representatives.

Questions

You are asking for our views with regard to the following questions:

1)    Do CFA’s surplus pools have to be retroactively adjusted as a result of the 2011-FACL carryback against the 2009-FAPI-TCG?

2)    Is the taxpayer barred from making a PAS election under paragraph 5901(2)(b) of the Regulations in respect of the 2010-Dividend?

3)    If the answer to question 2) is yes, is there any other statutory or administrative discretion available to the CRA to allow the taxpayer to late-file any required election in order for the 2010-Dividend to be treated as being paid out of PAS?

Comments

As a preliminary comment, it is appropriate to note that there is some uncertainty with respect to the application of the Act and the Regulations to the carryback of a FACL incurred by a foreign affiliate in a taxation year that ends after August 19, 2011 to one of its taxation years that end before August 20, 2011. In this respect, the Department of Finance Explanatory Notes to section 5903.1 of the Regulations (released October 24, 2012; Bill C-48) state the following:

This new section applies in respect of capital losses of a foreign affiliate that are incurred in taxation years of the foreign affiliate that end after August 19, 2011. Along with the changes to section 5903, this means that, for example, a capital loss from a disposition of non-excluded property in 2011 by a calendar year foreign affiliate will be a FACL, whereas a similar disposition made in 2010 by the affiliate will be a FAPL for the purposes of computing FAPI for 2010, 2011 and all future years to which the FAPL can be carried forward. Conversely, a FACL incurred in 2011 by that affiliate will only be deductible against FAPI earned in 2008, 2009 or 2010 (i.e., under the 3-year carryback provision) to the extent the FAPI includes capital gains.

Based on the above, it is the CRA’s current practice to generally not challenge FACL carrybacks that straddle August 19, 2011, provided there is no double use of any such loss.

1) In respect of your first question, we are of the view that CFA’s surplus pools are not to be retroactively adjusted as a result of the 2011-FACL carryback against the 2009-FAPI-TCG. As it is pointed out in the Memo, paragraph (b) of the definition of “net earnings” in subsection 5907(1) of the Regulations is clear in this respect. It generally provides, among other things, that for surplus purposes an amount of FAPI is to be determined without reference to variable F.1 of the FAPI definition, i.e. without regard to any loss carryback. A loss in respect of FAPI is, correspondingly, accounted for under paragraph (b) of the definition of “net loss” in subsection 5907(1) of the Regulations and is taken into account only in the taxation year of the affiliate in which the loss is incurred.

2) In respect of your second question, we are generally of the view that the taxpayer is barred from making a PAS election under paragraph 5901(2)(b) of the Regulations in respect of the 2010-Dividend. In arriving at this conclusion in the context of the facts submitted, we considered the application of paragraph 5901(2)(b) and subsections 5901(2.1) and (2.2) of the Regulations, taking into account the coming-into-force and transitional rules set out in subsection 79(2) of Bill C-48.

The PAS election rules set out in paragraph 5901(2)(b) and subsections 5901(2.1) and (2.2) of the Regulations were introduced by subsection 79(1) of Bill C-48. Paragraph 5901(2)(b) generally allows taxpayers to elect to sidestep the normal ordering rules in subsection 5901(1) of the Regulations such that a whole dividend will be deemed to have been paid first out of PAS. The election is required to be made in writing in respect of a dividend paid by a foreign affiliate of a corporation resident in Canada, and has to be filed with the Minister of National Revenue (“Minister”) on or before the corporation’s filing-due date for the taxation year in which the dividend is paid.

Paragraph 5901(2)(b) of the Regulations is complemented by subsections 5901(2.1) and (2.2), which allow for late-filing of the PAS election in certain circumstances. Subsection 5901(2.1) sets out the conditions for subsection 5901(2.2) to be applicable. The latter provision allows the Minister to exercise its discretion in order for an election to be deemed to have been filed on time. Under its paragraph (a), subsection 5901(2.1) requires that a corporation determined not to make a PAS election in respect of a whole dividend before the applicable filing-due date.

Although the PAS election rules generally apply to dividends paid by a foreign affiliate after August 19, 2011, subsection 79(2) of Bill C-48 provides for an election, along with various transitional rules, to have the PAS election rules apply to dividends paid after December 20, 2002. The relevant part of paragraph 79(2)(a) of Bill C-48 reads as follows, as modified to incorporate the relevant deadlines that would be applicable in the context of the facts submitted (see text underlined):

(…) if the corporation (…) elect in writing under this paragraph in respect of all of their respective foreign affiliates and file the election with the Minister of National Revenue on or before the day that is the later of (…) the filing-due dates for their taxation years that include the day on which this Act receives royal assent [June 30, 2014] and the day that is one year after the day on which this Act receives royal assent [June 26, 2014], subsections 5901(2) to (2.2) of the Regulations, as enacted by subsection (1), apply to dividends paid after December 20, 2002 by all the respective foreign affiliates of the elector corporations (…)

In the context of the present case, the election for the PAS election rules to apply to the 2010-Dividend would have to have been made on or before June 30, 2014. Based on our understanding of the facts submitted, this requirement does not appear to have been met.

Furthermore, the election to make the PAS election rules applicable to dividends paid after December 20, 2002 does not alleviate the taxpayer’s responsibility to file the PAS election itself. In this respect, paragraph 79(2)(b) of Bill C-48 reads as follows, as modified to incorporate the relevant deadlines that would be applicable in the context of the facts submitted (see text underlined):

(b) any election referred to in subparagraph 5901(2)(b)(i) of the Regulations, as enacted by subsection (1), that would otherwise be required to be filed with the Minister of National Revenue before the day that is 120 days after the day on which this Act receives royal assent [October 24, 2013] is deemed to have been filed with the Minister on a timely basis if it is filed with the Minister within 365 days after the day on which this Act receives royal assent [June 26, 2014] (…)
Hence, in the context of the present case, the PAS election under paragraph 5901(2)(b) of the Regulations in respect of the 2010-Dividend would have to have been made on or before June 26, 2014. Based on our understanding of the facts submitted, this requirement also does not appear to have been met.

Finally, in respect of the late-filing rules provided in subsections 5901(2.1) and (2.2) of the Regulations, the determination required to be made under paragraph 5901(2.1)(a) is subject to a transitional reading set out in paragraph 79(2)(c) of Bill C-48. This provision reads as follows, as modified to incorporate the relevant deadlines that would be applicable in the context of the facts submitted (see text underlined):

(c) any determination referred to in paragraph 5901(2.1)(a) of the Regulations, as enacted by subsection (1), that would otherwise be required to be made before the day that is 120 days after the day on which this Act receives royal assent [October 24, 2013] is deemed to have been made on a timely basis if it is made within 365 days after the day on which this Act receives royal assent [June 26, 2014]. Considering that we previously concluded that the PAS election rules, including subsections 5901(2.1) and (2.2) of the Regulations, were not applicable in this instance because it appears that the taxpayer failed to properly elect under paragraph 79(2)(a) of Bill C-48, it is not necessary to determine if all the conditions of subsection 5901(2.1) are met in the present case. Nevertheless, if the PAS election rules were applicable, we would be of the view that the facts submitted would not support the conclusion that any such determination would have been made by the taxpayer before June 26, 2014.

3) Further to the conclusions reached in respect of your second question, and considering also that subsection 220(3.2) of the Act and section 600 of the Regulations provide no discretion to the Minister to extend the time for making an election under paragraph 5901(2)(b) of the Regulations, it is our view that there is no other statutory or administrative discretion available to the CRA to allow the taxpayer to late-file any required election in the present case in order for the 2010-Dividend to be treated as being paid out of PAS.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library.  A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases.  The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer.  Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove the taxpayer’s identity.  Requests for the latter version should be e-mailed to: LPRA-PLAR ITR-DDI Access Team-Équipe d'Accès.   In such cases, a copy will be sent to you for delivery to the taxpayer.

We trust that these comments will be of assistance, and thank you for your enquiry.

Yours truly,

Dave Beaulne, CPA, CA
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

c.c. XXXXXXXXXX TSO

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