2015-0592921E5 Computation of Earnings of a Foreign Affiliate

Principal Issues: For the purposes of determining "exempt earnings", how should the earnings from an active business of a branch of a foreign affiliate be computed for a taxation year for purposes of subsection 5907(1) of the Regulations in circumstances where the income tax law of the country in which the foreign affiliate is resident does not require that income or profit to be computed until such time as the income or profit are remitted to the foreign affiliate’s country of residence.

Position: The methodology to compute "earnings" will depend on the facts. However, the “net earnings” derived by a foreign affiliate for the year from the “earnings” from its active business carried on through a branch in a country that is not a "designated treaty country" will not be included in its “exempt earnings” for the taxation year.

Reasons: To the extent that the country of residence of a foreign affiliate does not require the income or profit from the active business of a branch of that foreign affiliate carried on in another country for a taxation year to be computed in accordance with its income tax law, the earnings from the active business of the branch of the foreign affiliate for that taxation year are to be computed under either subparagraph (a)(ii) or (iii) of the definition of earnings in the Regulations, as the case may be. Moreover, in order for the “net earnings” derived by a foreign affiliate from the “earnings” from its active business carried on through a branch to be included in its “exempt earnings” for the taxation year, the foreign affiliate must be resident in a “designated treaty country” and the active business must be carried on by it in a “designated treaty country" as outlined in subparagraph (d)(i) of the definition of "exempt earnings" in subsection 5907(1).

Author: Chang, Jack Yu-Fan
Section: Definition of "earnings" in Regulation 5907(1), 5906(1)(a)

XXXXXXXXXX                                                                                                                                2015-059292
                                                                                                                                                        J. Chang
                                                                                                                                                       (416) 973-0022
August 24, 2016

Dear Mr. XXXXXXXXXX:

Re:  Computation of Earnings of a Foreign Affiliate

We are writing in response to your email dated June 5, 2015, in which you requested our views on the computation of “earnings” as defined in subsection 5907(1) of the Income Tax Regulations (the “Regulations”). We apologize for the delay in responding.

Specifically, you have asked us, for the purposes of determining “exempt earnings” of a foreign affiliate, how the “earnings” of that foreign affiliate for a taxation year from active business activities carried on in a country that is not its country of residence will be computed in circumstances where the income or profit from those active business activities are only computed according to the income tax law of the country of residence once that income or profit is remitted to the foreign affiliate’s country of residence in a subsequent taxation year.  In particular, in your email, you have described the following hypothetical situation:

*     Canco is a corporation incorporated in and resident in Canada for purposes of the Income Tax Act (the “Act”) and the Canada-Singapore Tax Convention (the “Treaty”).
*     Canco wholly owns Singco, a corporation incorporated in and resident in Singapore for purposes of the Act and Treaty.
*     Singco has a permanent establishment in country A, a “designated treaty country”, as defined in subsection 5907(11) of the Regulations, through which it carries on active business activities (“Branch 1”).
*     Under the income tax law of country A, Singco is required to compute its income or profit from its active business activities carried on through Branch A for each taxation year.
*     Singco also has a permanent establishment in country B, a country that is not a “designated treaty country”, as defined in subsection 5907(11) of the Regulations, through which it carries on active business activities (“Branch 2”).
*     Under the income tax law of country B, Singco is not required to compute its income or profit from its active business activities carried on through Branch 2.
*     The profits of Branch 1 and Branch 2 are not subject to the income tax law of Singapore until such time as those profits are remitted to Singapore.

For the purposes of our comments, we have assumed that the activities carried on in country A and country B by Branch 1 and Branch 2, respectively, would constitute active business activities for purposes of the Act, the foreign tax treatment, as described to us, is valid, the income or profit of Branch 1 and Branch 2 will be remitted to Singapore in a taxation year subsequent to the taxation year in which they arose and the branches of Singco are not corporations for purposes of the Act.

Our Comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations; however, we offer the following general comments, which may be of assistance to you.

Generally, the methodology to be used to compute the earnings of a foreign affiliate from an active business carried on by it in a country in a taxation year is outlined in paragraph (a) of the definition of “earnings” in subsection 5907(1) of the Regulations.  In particular, subparagraph (a)(i) of the definition of “earnings” provides that “earnings” for a taxation year means the income or profit from the active business for the year computed in accordance with the income tax law of the country in which the affiliate is resident, in any case where the affiliate is required by such law to compute that income. Alternatively, subparagraph (a)(ii) provides that in any case not described in subparagraph (i), “earnings” means the income or profit from the active business for the year computed in accordance with the income tax law of the country in which the business is carried on, where the affiliate is required by such law to compute that income.  Lastly, subparagraph (a)(iii) provides that, if the affiliate is not required by foreign law to compute income from the active business for the year, “earnings” means what the income of the affiliate computed in accordance with Part I of the Act would be if the business were carried on in Canada, the affiliate were resident in Canada and that the Act is read without references to certain provisions.

Moreover, “net earnings”, as defined in subsection 5907(1) of the Regulations, derived by the foreign affiliate from its “earnings” from an active business carried on by it will be included in its “exempt earnings” for the taxation year where the foreign affiliate is resident in a designated treaty country throughout the year and its active business activities for the year were carried on by it in a “designated treaty country” as outlined in subparagraph (d)(i) of the definition of “exempt earnings” in subsection 5907(1).

In the particular hypothetical situation outlined, since the income or profit of Branch 1 and Branch 2 for a taxation year is remitted to Singapore in a taxation year subsequent to the taxation year in which it is earned, the income tax law of Singapore would not require that that income or profit be computed in accordance with Singapore income tax law for the particular taxation year.  Therefore, subparagraph (a)(i) of the definition of “earnings” would not apply in computing the earnings of Singco from its branches.

In the case of Branch 1, given that country A requires the income or profit from the active business activities of Branch 1 for the year to be computed in accordance with the income tax law of country A, subparagraph (a)(ii) would apply in computing the “earnings” of Singco in connection with the income or profit from the active business activities carried on in country A by Branch 1.  As such, the “net earnings” derived by Singco for the year from the “earnings” from its active business carried on through Branch 1 in country A will be included in its “exempt earnings” for the taxation year provided that Singco is resident in Singapore throughout the year.

On the other hand, given that country B does not require the income or profit from the active business activities of Branch 2 for the year to be computed in accordance with the income tax law of country B, subparagraph (a)(ii) would not apply and the “earnings” of Singco in connection with the income or profit from the active business activities carried on in country B by Branch 2 would be computed under subparagraph (a)(iii) taking into account the rule in subsection 5907(2.03) of the Regulations.  However, unlike Branch 1, the “net earnings” derived by Singco for the year from the “earnings” from its active business carried on through Branch 2 in country B will not be included in its “exempt earnings” for the taxation year as country B is not a “designated treaty country”.  Rather, they would be included in Singco’s “taxable earnings” for the taxation year.

We trust that our comments will be of assistance.

Yours truly,

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

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