2015-0581501C6 IFA 2015 Q.4: Upstream loans: ss. 90(9) deduction

Principal Issues: Whether a claim is available under ss. 90(9) in three different scenarios.

Position: Yes, in all three scenarios.

Reasons: Based on a textual, contextual and purposive analysis.

Author: Beaulne, Dave
Section: ITA 90(9); ITR 5901(2)(b)

2015 International Fiscal Association Conference
CRA Roundtable

Question 4 – Upstream loans: subsection 90(9) deduction

Part A

Assume the following:

*     Canco directly owns all the shares of FA, a foreign affiliate; 

*     In 2013 FA made a US$100 loan (Loan 1) to Canco;

*     FA’s currency for surplus purposes is the US$ and at the “lending time” in 2013 FA had exempt surplus and net surplus of US$100; 

*     In 2014 FA paid a dividend (Dividend) of US$50 at a time when it had exempt surplus and net surplus 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 for the Canadian dollar equivalent (assume it’s C$63) of the US$50 dividend. Is Canco able to claim a deduction in each of 2013 and 2014 under clause 90(9)(a)(i)(A) for the Canadian dollar equivalent (assume it’s 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 paragraph 113(1)(a)?

Part B

The facts are the same 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 into FA. Canco makes an election under Reg. 5901(2)(b) such that the 2014 C$63 dividend is deemed to be paid out of pre-acquisition surplus. Is Canco able to claim a deduction in each of 2013 and 2014 under clause 90(9)(a)(i)(A) of C$125?  Is Canco able to claim a deduction in computing its 2014 taxable income of C$63 under paragraph 113(1)(d)?

Part C

The facts are the same as in Part A except that at the lending time in 2013 Canco’s ACB in the FA shares was C$63, no new exempt surplus 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. Is Canco able to claim a deduction in each 2013 and 2014 under clause 90(9)(a)(i)(A) of C$125? Is Canco able to claim an additional deduction in 2014 of C$63 under clause 90(9)(a)(i)(D) on the basis that it could have made a Reg. 5901(2)(b) election in respect of Loan 2?

CRA Responses

Part A

This question gets at whether paragraph 90(9)(b) contemplates some kind of ordering rule for additions and reductions of exempt surplus from new earnings and dividends arising after making an upstream loan. For example, if 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, it is our view that it would be consistent with the object and spirit of the upstream loan rules to allow taxpayers to take a flexible approach in this regard. In this case, we would consider a last-in, first-out ordering approach to give an appropriate result, i.e. so that the limitation in paragraph 90(9)(b) would not be breached.

Thus, more specifically, it is our view that Canco would, in this scenario, 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

This question has two aspects to it. First, whether an exempt loss incurred after the time an upstream loan is made affects the ability to claim an ongoing subsection 90(9) deduction and, second, whether surplus that is “frozen” by subsection 90(9) can still be relied on to determine eligibility for a paragraph 5901(2)(b) “pre-acquisition surplus” election.

Although these facts are less sympathetic than the ones in Part A, we are of the view that, absent 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.

We are also of the view that the conditions for making a paragraph 5901(2)(b) election would be met, in these circumstances, 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. It follows that a subsection 113(1) deduction would be available by virtue of paragraph 113(1)(d).

Part C

This question builds on a similar question we addressed at the 2013 IFA conference concerning the possibility of claiming a notional 5901(2)(b) election to substantiate a claim under subsection 90(9) (see CRA document no. 2013-048379, Question 5(a)). In that context, 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.

We see no reason to adopt a different position here. 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.

Additional information:

From a compliance perspective, the CRA expects taxpayers to clearly indicate the income inclusions required by subsections 90(6) and 90(12), as well as the deductions claimed under subsections 90(9) and 90(14). This applies to all upstream loans that occur, or are deemed to occur, after August 19, 2011. 

Deductions allowable under subsections 90(9) and 90(14) are permissive in nature, subject to specific conditions laid out in those provisions. As such, the onus is on taxpayers to clearly show their intentions when claiming these deductions. 

We would also like to comment on situations where taxpayers who were anticipating repayment within two years, and thus were relying on the exception in paragraph 90(8)(a), later discover that they are unable to satisfy that requirement. In such circumstances, taxpayers would be required to refile their return of income in respect of the taxation year in which the upstream loan occurred in order to reflect the appropriate income inclusion under subsection 90(6). 

Dave Beaulne
2015-058150
May 28, 2015

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