2016-0662221I7 Tax Sharing Payments made by LLCs

Principal Issues: In the context of the situation submitted, whether payments made by U.S. LLCs give rise to prescribed amounts considered to be FAT in application of paragraph (b) of the definition of that expression in subsection 95(1), and paragraph 5907(1.3)(a) of the Regulations, in respect of FAPI inclusions to Canco's income for given taxation years?

Position: Yes, but the prescribed amounts will be reduced to zero, based on the specific facts of the situation submitted.

Reasons: Certain payments made give rise to prescribed amounts under paragraph 5907(1.3)(a). However, subsection 5907(1.4) will reduce these prescribed amounts to nil, resulting in no FAT being recognized in respect of these payments until (and to the extent that) subsections 5907(1.5) and (1.6) apply in respect of one or more of Canco’s five subsequent taxation years.

Author: Roulier, Yannick
Section: 91(4), 95(1)"foreign accrual tax"; Reg. 5907(1.091), (1.092), (1.1), (1.12), (1.13), (1.3)

March 3, 2023

Rita Ziftsoglou                                                                           HEADQUARTERS
Large Files Case Manager
International and Large Business Directorate                 Income Tax Ruling                                                                                                                           Directorate
                                                                                                  Yannick Roulier
           
                                                                                                  2016-066222

Tax Sharing Payments made by LLCs – Subsection 91(4) Deduction

This is in reply to the correspondence of July 21, 2016, wherein we were asked for our views with respect to the qualification as “foreign accrual tax” of tax sharing payments made by two limited liability companies (“LLCs”). The initial request we received was subsequently complemented by information received through e-mails, and in the course of various telephone conversations.

Unless otherwise stated, all references below to statutory provisions are references to provisions of the Income Tax Act (the “Act”), and the Income Tax Regulations (the “Regulations”).

Background

We understand the relevant facts of the situation submitted to be as follows:

A. Relevant Entities

1. XXXXXXXXXX (“Pubco”) is a public corporation that is a taxable Canadian corporation, within the meaning assigned to these expressions by subsection 89(1). It is also a financial institution within the meaning assigned by subsection 142.2(1).

2. Pubco directly and indirectly owns all of the issued and outstanding shares of XXXXXXXXXX (“Canco”), which is a taxable Canadian corporation and a financial institution within the meaning assigned by subparagraph 142.2(1)(a)(iii).

3. Canco owns all of the issued and outstanding shares of XXXXXXXXXX. (“CFA1”), which is a non-resident corporation incorporated in the United States (“U.S.”) and subject to tax therein.

4. CFA1 owns 80.22% of the shares of XXXXXXXXXX (“CFA2”), which is a non-resident corporation incorporated in the U.S. and subject to tax therein. The remaining 19.78% of the shares of CFA2 are owned by third parties that are not part of Pubco’s group of entities.

5. CFA2 owns all of the issued and outstanding shares of XXXXXXXXXX. (“CFA3”), which is a non-resident corporation incorporated in the U.S. and subject to tax therein. CFA3 is the parent of a group of entities referred to as “CFA3 Group”.

6. CFA3 owns all of the issued and outstanding shares of XXXXXXXXXX. (“CFA4”), which is a non-resident corporation incorporated in the U.S. and subject to tax therein.

7. CFA3 is also a member of the following non-resident LLCs: XXXXXXXXXX (“LLC1”), XXXXXXXXXX.

8. The operating agreement of LLC1 was adopted as of XXXXXXXXXX, and was further amended and restated as of XXXXXXXXXX, by CFA3 as the sole member of LLC1 (“Operating Agreement1”).

9. LLC1 is governed by the laws of the state of XXXXXXXXXX and is carrying on a business solely in the U.S. The business of LLC1 is to provide financing for the acquisition of consumer receivable portfolios made by other affiliates within the CFA3 Group.

10. CFA4 is a member of the following non-resident LLCs: XXXXXXXXXX (“LLC2”), XXXXXXXXXX.

11. The operating agreement of LLC2 was initially adopted as of XXXXXXXXXX, and was further amended and restated as of XXXXXXXXXX, by CFA4 as the sole member of LLC2 (“Operating Agreement2”).

12. LLC2 is governed by the laws of the state of XXXXXXXXXX and is carrying on a business solely in the U.S. The business of LLC2 is to originate structured loans to unrelated debt buyers in the distressed asset market.

13. Under the laws of the state of XXXXXXXXXX, LLC1 and LLC2 are entities separate and distinct from their respective sole member. Also, their liabilities are their own, and their respective sole member has extended limitations on liabilities.

14. In addition, the Operating Agreement1 and the Operating Agreement2 (“Operating Agreements”) are similarly drafted and generally provide, among other things, that (capitalized words refer to defined terms in the relevant agreement):

a. the Sole Member may, at its sole and absolute discretion, make Additional Contributions in such amount as it deems appropriate (section 4.2);

b. all Profits or Losses of the Company shall generally be allocated entirely to the Sole Member (section 5.1);

c. an interim distributions of Distributable Cash shall be made at the sole discretion of the Sole Member (section 5.2);

d. no distributions shall generally be declared and paid unless the Fair Market Value of the assets is sufficient to cover the Company’s liabilities (section 5.4); and

e. the Sole Member shall be entitled to received distributions from the Company in the form of cash or any other property (section 5.5).

B. Tax Treatment in the U.S.

15. CFA1 is the parent of a group of corporations (“US Consolidated Group”) which is considered for U.S. federal income tax purposes to be an affiliated group of corporations under the provisions of the Internal Revenue Code (“IRC”).

16. The US Consolidated Group is comprised of CFA1 and the following corporations (collectively the “US Members”):

a. CFA2, XXXXXXXXXX, each of which are wholly-owned subsidiaries of CFA1 (referred to collectively as“CFA1 Subs”); and

b. CFA3, CFA4, XXXXXXXXXX, each of which are wholly-owned subsidiaries of CFA2 (referred to collectively as “CFA2 Subs”; and CFA2 and CFA2 Subs being collectively referred to as “CFA2 Subgroup”).

17. The US Members are residents in the U.S. for the purposes of the IRC and the Canada - U.S. Income Tax Convention, and have an October 31 taxation year end.

18. The US Members of the US Consolidated Group elected to file an annual consolidated U.S. federal income tax return under section 1501 of the IRC. This election is effective for the US Members’ taxation years 2011 and 2012. The U.S. federal income tax rate applicable is generally of 35%.

19. Subsection 1503(a) of the IRC provides that for “any case in which a consolidated return is made or is required to be made, the tax shall be determined, computed, assessed, collected, and adjusted in accordance with the regulations under section 1502”.

20. For the purposes of the application of the regulations under section 1502 of the IRC, CFA1 is the common parent for the US Consolidated Group. As such, CFA1 is generally, under U.S. Treasury Regulations § 1.1502-77, the sole agent authorized to act in its own name with respect to all matters relating to the U.S. federal income tax liability for each member of the US Consolidated Group during the relevant applicable period. Furthermore, those regulations also provide that any assessment of tax may be made in the name of CFA1, an assessment naming CFA1 would be considered as an assessment with respect to each US Member, notice and demand for payment of taxes may generally be given only to CFA1, and such notice and demand would be considered as a notice and demand to each US Member.

21. U.S. Treasury Regulations § 1.1502-6 generally provides that the common parent corporation and each subsidiary which was a member of the group during any part of the consolidated return year shall be severally liable for the tax for such year computed in accordance with the applicable regulations prescribed under section 1502 of the IRC for the filing of the consolidated return for such year. No agreement entered into by one or more members with any other member of such group or with any other person shall in any case have the effect of reducing that liability.

22. U.S. Treasury Regulations § 1.1502-2 provides that the tax liability for a group that has elected to report on a consolidated basis shall be determined by adding together a number of items, including, under paragraph (a) of that regulation, the tax imposed by section 11 of the IRC on the “consolidated taxable income” of the group.

23. In calculating the US Consolidated Group's “consolidated taxable income”, U.S. Treasury Regulations § 1.1502-12 generally provides that the “separate taxable income” of each US Member must first be calculated under the provisions of the IRC, subject to certain modifications (for example, certain items get eliminated through consolidation).

24. Based on paragraph 7701(a)(3) of the IRC and the related U.S. Treasury Regulations, an LLC is entitled to elect to be treated as a corporation subject to U.S. federal income tax, as a partnership if it has more than one member or as a disregarded entity if it only has one member. If an LLC does not file an election under the so-called “check-the-box” regulations, it will be deemed to have elected to be a partnership (if it has more than one member) or a disregarded entity (if it only has one member). In the latter case, the LLC’s activities will be treated in the same manner as a sole proprietorship, branch, or division of the member.

25. LLC1 and LLC2 are disregarded for U.S. federal income tax purposes. As such, they are not US Members of the US Consolidated Group, and are not required to compute their taxable income in accordance with the IRC. LLC1 and LLC2 both have an October 31st taxation year end.

26. Under the IRC, the taxable income of LLC1 and LLC2 for a year are respectively included in the “separate taxable income” of CFA3 and CFA4 for that given year.

27. For the taxation year ended October 31, 2011, CFA1 paid no U.S. federal income tax because the “separate taxable income” of each of CFA2 and its subsidiaries were offset by current operating losses of other US Members of the US Consolidated Group resulting in a consolidated operating loss.

28. For the taxation year ended October 31, 2012, CFA1 paid USD 1.4 million of alternative minimum tax because the “separate taxable income” of each of CFA2 and its subsidiaries were offset by current operating losses of other US Members of the US Consolidated Group and by the usage of prior year losses resulting in a taxable income of USD 0, after net operating losses.

29. For the taxation year ended October 31, 2011, LLC1 and LLC2 have respectively net income before income taxes of approximately XXXXXXXXXX United States Dollar (“USD”) and USD XXXXXXXXXX.

30. For the taxation year ended October 31, 2012, LLC1 and LLC2 have respectively net income before income taxes of approximately USD XXXXXXXXXX.

31. For the taxation year ended October 31, 2013, CFA1 used all of the prior operating losses of the US Members in calculating the US Consolidated Group's “consolidated taxable income”, and paid an amount of U.S. federal income tax of USD XXXXXXXXXX.

C. Tax Sharing Payments

32. A tax sharing agreement was entered into on December 20, 2013 by the US Members (“TSA”); no disregarded entities are part of this agreement.

33. The objective of the TSA is to ensure that each of the US Members of the US Consolidated Group pays their fair share of the tax borne by the US Consolidated Group under the IRC and the relevant applicable regulations. The TSA established a method to that end, in accordance to which each US Member’s respective share of the US Consolidated Group’s tax is generally determined as if it had filed a separate tax return. From a general perspective, the operation of the TSA relies on a division of the US Consolidated Group into the following two subgroups:

a. The CFA1 Subs, excluding CFA2, which constitute a group of corporations wholly-owned by CFA1, and

b. The CFA2 Subgroup, which includes CFA2 and a group of corporations owned at 80.22% through CFA2 by CFA1.

34. The TSA generally provides, among other things, that (capitalized words generally refer to defined terms in the TSA):

a. the procedures set forth in the Agreement in sharing the Group’s Consolidated Tax Liability, and the other terms of the Agreement, reflect the intent of the parties, such procedures were utilized for the 2012 Taxable Year (or to the extent not fully utilized, it was the intent of the parties that they be utilized), and the Group wishes to utilize such procedures for further taxable years of the Group (3rd paragraph of the recitals);

b. the parties wish to memorialize their agreement on a method for sharing the Group’s Consolidated Tax Liability (4th paragraph of the recitals);

c. payments have generally to be made between CFA2 and CFA2 Subs, and between CFA1 and CFA1 Subs, in the manner and in accordance with the terms of the Agreement (sections 2, 3 and 4);

d. the Agreement is effective for all Taxation Years of the Group beginning with the 2012 Taxation Year, and to the extent the provisions of this Agreement were not fully utilized for that Taxation Year, the parties agree to make such adjustments and take such further actions, to the extend reasonably feasible, to give effect to the Agreement in all material respects (section 10);

e. the Agreement shall be binding upon and shall inure to the benefits of each of the parties and its respective successors and assigns (section 11.2);

f. the Agreement supersedes any existing tax sharing agreement or arrangement (whether oral or written) between any of the parties (section 11.5);

g. the Agreement contains the entire understanding of the parties with respect to the subject matter it addresses (section 11.6); and

h. the Agreement is made and shall be governed by, construed, and enforced in accordance with the laws of the state of XXXXXXXXXX (section 11.8).

35. Other than the relevant facts reported herein, the auditors of the Canada Revenue Agency’s (“CRA”) XXXXXXXXXX (“TSO”) have no evidence that a previous tax sharing agreement was in place before December 20, 2013.

36. As of May 27, 2016, the TSA was the only written tax sharing agreement entered into by one or more US Members with any other member of that group, or with any other person, and as such, is the only written tax sharing agreement provided to the auditors of the CRA’s XXXXXXXXXX.

37. In June 2014, further to the issuance of a notice of payment by CFA1 to CFA2, the following payments were made:

a. LLC1 paid USD XXXXXXXXXX (“LLC1 Payment 2011”) to CFA2 for the October 31, 2011 year end, which payment represents a notional U.S. federal income tax that can reasonably be regarded as being in respect of the share of USD XXXXXXXXXX of the U.S. taxable income of the US Consolidated Group earned through LLC1 during that taxation year;

b. LLC2 paid USD XXXXXXXXXX (“LLC2 Payment 2011”) to CFA2 for the October 31, 2011 year end, which payment represents a notional U.S. federal income tax that can reasonably be regarded as being in respect of the share of USD XXXXXXXXXX of the U.S. taxable income of the US Consolidated Group earned through LLC2 during that taxation year; and

c. CFA2 paid USD XXXXXXXXXX (“CFA2 Payment 2011”) to CFA1 for the October 31, 2011 year end, which payment represents a notional U.S. federal income tax that can reasonably be regarded as being in respect of the share of the U.S. taxable income of the US Consolidated Group earned by the members of the CFA2 Subgroup, including the U.S. taxable income earned through LLC1 and LLC2 mentioned in subparagraphs a. and b. of the present paragraph.

38. In June 2014, further to the issuance of a notice of payment by CFA1 to CFA2, the following payments were made:

a. LLC1 paid USD XXXXXXXXXX(“LLC1 Payment 2012”) to CFA2 for the October 31, 2012 year end, which payment represents a notional U.S. federal income tax that can reasonably be regarded as being in respect of the share of USD XXXXXXXXXX of the U.S. taxable income of the US Consolidated Group earned through LLC1 during that taxation year;

b. LLC2 paid USD XXXXXXXXXX (“LLC2 Payment 2012”) to CFA2 for the October 31, 2012 year end, which payment represents a notional U.S. federal income tax that can reasonably be regarded as being in respect of the share of USD XXXXXXXXXX of the U.S. taxable income of the US Consolidated Group earned through LLC2 during that taxation year; and

c. CFA2 paid USD XXXXXXXXXX (“CFA2 Payment 2012”) to CFA1 for the October 31, 2012 year end, which payment represents a notional U.S. federal income tax that can reasonably be regarded as being in respect of the share of the U.S. taxable income of the US Consolidated Group earned by the members of the CFA2 Subgroup, including the U.S. taxable income earned through LLC1 and LLC2 mentioned in subparagraphs a. and b. of the present paragraph.

39. The intent of the parties is that the LLC1 Payment 2011, the LLC2 Payment 2011, the LLC1 Payment 2012 and the LLC2 Payment 2012 are payments that do not constitute loans to or indebtedness of any US Members. The quantum of each of these payments, and of the CFA2 Payment 2011 and the CFA2 Payment 2012, were determined based on the method for sharing the US Consolidated Group’s U.S. federal income tax stated in the TSA. Accounting entries to “income tax expense” and “income taxes payable”, and then to “cash” and “income taxes payable” were reported by LLC1 and LLC2 in respect of these payments.

D. FAPI Regime

40. For the purposes of the Act, all the US Members (including more specifically CFA1, CFA2, CFA3 and CFA4), LLC1 and LLC2 are foreign affiliates (“FAs”) and controlled foreign affiliates (“CFAs”) of Canco, as these terms are defined in subsection 95(1).

41. For the 2011 taxation year, the CRA is of the view that LLC1 has foreign accrual property income, within the meaning assigned by subsection 95(1) (“FAPI”), for an amount of approximately 5.4 million Canadian Dollars (“CAD”).

42. For the 2012 taxation year, the CRA is of the view that LLC1 has FAPI for an amount of approximately CAD XXXXXXXXXX.

43. The remaining income of LLC1 for its 2011 and 2012 taxation year is income from an active business pursuant to clause 95(2)(a)(ii)(B) for the financing of active business within the CFA2 Subgroup.

44. For Canco’s 2011 and 2012 taxation years, CRA is of the view that the amounts of FAPI in respect of LLC1 to be included in Canco’s income under subsection 91(1) are respectively of CAD XXXXXXXXXX and CAD XXXXXXXXXX.

45. If there was to be any FAPI inclusion to Canco’s income for its 2011 and 2012 taxation years, as mentioned in the preceding paragraph, the question arises as to whether Canco could claim a corresponding deduction in respect of foreign taxes under subsection 91(4) for each of these taxation years.

46. For the 2011 taxation year, the CRA is of the view that LLC2 has FAPI for an amount of approximately CAD 2.7 million.

47. For the 2012 taxation year, the CRA is of the view that LLC2 has no FAPI.

48. For Canco’s 2011 taxation years, CRA is of the view that the amounts of FAPI in respect of LLC2 to be included in Canco’s income under subsection 91(1) is of CAD XXXXXXXXXX.

49. If there was to be any FAPI inclusion to Canco’s income for its 2011 taxation year, as mentioned in the preceding paragraph, the question arises as to whether Canco could claim a corresponding deduction in respect of foreign taxes under subsection 91(4) for that taxation year.

50. The income of LLC1 and LLC2 that gave rise to FAPI inclusions in Canco’s income for its 2011 and 2012 taxation years were offset by operating losses of US Members of the US Consolidated Group (other than CFA2) incurred in the course of the carrying on of active businesses, within the meaning assigned to this expression by subsection 95(1).

51. Canco did not make an election under subsection 88(30) of the Economic Action Plan 2014 Act, No. 2 (2014, c. 39; commonly referred to as “Bill C-43”) in respect of all its foreign affiliates. As a result, the amendments to subsection 5907(1.3) of the Regulations apply in respect of taxation years of a FA of Canco that end after 2010, rather than only in respect of taxation years of all its FAs that end on or after July 12, 2013.

These facts are based on your request for an opinion, including a document summarizing the facts and providing the taxpayer’s comments dated July 14, 2016, the TSA, the other documents attached to the request, the Operative Agreements, and conversations involving XXXXXXXXXX and Rita Ziftsoglou in dealing with your request. Also, the taxpayer provided further documents and representations that were transferred to our attention by e-mails dated February 14, 2017 and March 21, 2017. Finally, additional representations were prepared by the taxpayer’s representative dated May 19, 2017, and attached to an e-mail sent to our attention on May 23, 2017. 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.

Issues

The deduction in respect of foreign taxes available under 91(4) is generally determined with reference to the foreign accrual tax, within the meaning assigned by subsection 95(1) (“FAT”), applicable to an amount included under subsection 91(1) in computing a taxpayer’s income for a taxation year of the taxpayer in respect of a particular FA of the taxpayer, and the relevant tax factor, within the meaning assigned by subsection 95(1).

In this context, you are asking for our views on whether any payment made in the context of the situation submitted could give rise to prescribed amounts under paragraph 5907(1.3)(a) of the Regulations for the purposes of paragraph (b) of the FAT definition, in respect of Canco’s 2011 and 2012 taxation years. You are also specifically requesting comments about the following issues:

* Based on the fact that the TSA was entered into on December 20, 2013, can this agreement apply to 2011 and 2012 taxation years?

* Whether the TSA is binding on LLC1 and LLC2?

You did not request that we make any comments on the amounts of FAPI that have to be included in Canco’s income for its 2011 and 2012 taxation years, neither that we review specifically the computation method adopted to determine the quantum of the payments made.

Comments

We are of the general view that certain payments made give rise to prescribed amounts under paragraph 5907(1.3)(a) of the Regulations for the purposes of paragraph (b) of the definition of FAT, in respect of Canco’s 2011 and 2012 taxation years, as more extensively explained below. However, the “FAT blocker rules” of subsection 5907(1.4) of the Regulations will reduce these prescribed amounts to nil, resulting in no FAT being recognized in respect of these payments until (and to the extent that) the “FAT reinstatement rules” of subsections 5907(1.5) and (1.6) of the Regulations apply in respect of one or more of Canco’s five subsequent taxation years.

In order to properly address the issues that you have raised, we will review the application of paragraph 5907(1.3)(a) of the Regulations, as well as the definition of FAT, in respect of the tax sharing payments considered to have been made in the situation submitted, and further comment on the application of subsections 5907(1.4), (1.5) and (1.6) of the Regulations.

1. Context of the tax sharing payments

Before analyzing the technical application of any relevant provisions of the Act and the Regulations, one must first determine the relevant transactions or events to be considered.

In this instance, we are of the view that the payments made by LLC1 and LLC2 can reasonably be described as directed payments made on behalf of their respective sole members. Thus, each payment made by LLC1 and LLC2 consists in substance in a payment from the relevant LLC to its sole member, effected as a payment on behalf of that sole member to CFA2.

Based on the U.S. corporate consolidation rules under the IRC, it is the US Members that bear severally the liability to pay the US Consolidated Group’s U.S. federal income tax; no tax liability results for LLC1 and LLC2.

It is clear from the facts submitted that the TSA is only effective between the US Members in respect of their 2012 taxation year, and that it is not binding on LLC1 and LLC2. However the payments to CFA2 in question were payments on behalf of the members of the LLCs. Then CFA2 determined the net amount to be paid to CFA1 on behalf of those parties and other US Members subsidiary to CFA2. The TSA exists to create enforceable apportioning indemnifying rights and liabilities between US Members. As such, the TSA can only be relied on to substantiate apportioning payments. In respect of the apportioning payments concerning the 2011 taxation year, although no definitive conclusion has to be reached in this respect for the purpose of the present request, we considered reasonable, based on the context and the fact that they have effectively been made, to treat these amounts as the fulfillment of the terms of an indemnifying contract between the US Members, although not a written one.

Concerning the payments made by LLC1 and LLC2 in respect of their 2011 and 2012 taxation years, the taxpayer acknowledged that they were not loans. As these payments were made pursuant to the direction of the sole members, whether written or otherwise, with the intent that the funds so distributed satisfy the US Member’s liability under the TSA and the notice of payment issued by CFA1 to CFA2, these directed payments should be viewed as payment made by the directing party.

In this context, our understanding of the payments made by LLC1 and LLC2 to CFA2 in respect of their 2011 and 2012 taxation years is that LLC1 and LLC2 should be treated as having essentially acted as agent payers for their respective sole members. As such, they have in fact funded the apportioning payments that their sole member had reasons to make, based on US consolidated return regime. It is our view that the amounts paid may reasonably be considered to represent the amount which the particular US Member would have paid in respect of its separate income tax liability.

Given the structure of the US Consolidated Group, we understand that subsidiaries of CFA2 are first required to make payments to that entity and then CFA2 is required to pay a net amount to CFA1. This is because the CFA2 group has minority shareholders so reimbursements for the use of tax losses are made first within this sub-group of US Members. This indirect routing of payments does not alter in our view the determination that the amounts can reasonably be considered to be in respect of the particular US Member’s separate income tax liability nor that the amounts are paid to the member of the US Consolidated Group responsible for paying the group’s aggregate tax liability.

2. FAT & FAPI Rules

Considering that no actual U.S. federal income tax has been paid by any US Member for the 2011 and 2012 taxation years, the only way an amount of FAT can be recognized in the context of the situation submitted is in application of paragraph 5907(1.3)(a) of the Regulations and paragraph (b) of the definition of FAT.

We agree with the taxpayer’s representations that the Act and the Regulations do not require that the tax sharing payments be paid pursuant to a written agreement in order to give rise to a prescribed amount that can be considered to be FAT. As such, it suffices that the amount be paid and have the character described in the provision. Also, the fact that the tax sharing payments have been paid in June 2014 does not prevent paragraph 5907(1.3)(a) of the Regulations from applying to these amounts for the purposes of Canco’s 2011 and 2012 taxation years. In our view, the deduction under subsection 91(4) is available in the taxation year of the taxpayer in which the taxation year of the FA, for which an income or profits tax would have been payable in the circumstances described in subsection 5907(1.3) of the Regulations, ends. This is consistent with our current position in that regard and with our general position on the timing of foreign tax credits (in this respect, see technical interpretation 2002-0134201I7, and Income Tax Folio S5-F2-C1, Foreign Tax Credit, paragraphs 1.32 and 1.33).

The amounts constructively paid by CFA3 and CFA4 were determined in a manner that, in our view, supports that they can reasonably be regarded as being in respect of the income tax that these foreign affiliates would have paid in respect of FAPI earned by their disregarded subsidiaries (LLC1 and LLC2 respectively) if the tax liabilities of CFA3 and CFA4 had those amounts not been determined as members of the US Consolidated Group but rather had been determined separately. Accordingly these amounts should give rise to a prescribed amount under paragraph 5907(1.3)(a) of the Regulations.

To the extent that the particular US Member’s separate tax liability is determined in part by the income of the LLC, and that income is FAPI, the appropriate portion of the payment of the US Member’s separate tax liability is then deemed to be FAT that is relevant for purposes of subsection 91(4).

However, subsection 5907(1.4) of the Regulations generally reduce a prescribed amount determined under subsection 5907(1.3) to the extent that it can reasonably be considered to be in respect of the portion of the particular loss or capital loss, as the case may be, that would generally not be a foreign accrual property loss (within the meaning assigned by subsection 5903(3)), or a foreign accrual capital loss (within the meaning assigned by subsection 5903.1(3)), as the case might be, of another CFA of the taxpayer that meets certain conditions.

Based on the facts submitted (i.e., several US Members of the US Consolidated Group have reported operating losses from their active businesses), subsection 5907(1.4) of the Regulations will reduce each of the prescribed amounts recognized for Canco’s 2011 and 2012 taxation years to nil, resulting in no FAT being recognized in respect of the relevant tax sharing payments considered until (and to the extent that) subsections 5907(1.5) and (1.6) of the Regulations apply in respect of one or more of Canco’s five subsequent taxation years.

This has been preliminarily discussed with the auditors of the CRA’s Montreal TSO, the taxpayer and its representatives. We understand that limited work has been done in this respect in the course of the current CRA audit of the taxpayer’s 2011 and 2012 taxation years, and that this issue will be handled as applicable in the context of the coming audit of the taxpayer’s following taxation years.

3. Surplus Computation Rules

You did not request our views on the application of the surplus computation rules in respect of the various tax sharing payments identified above.

Subsections 5907(1.1) to (1.13) of the Regulations provide rules for the computation of surplus balances in situations in which foreign affiliates are members of a group filing a consolidated income tax return in their jurisdiction of residence in circumstances such that one member of the group pays income tax or receives a refund on behalf of the group as a whole. These are supplemented by subsections 5907(1.091) and (1.092) where one or more of the members are the shareholders of fiscally transparent entities. Although there are no specific provisions governing the interaction of these sets of regulations, it is our view that the consolidated return provisions should generally be applied first and the fiscally transparent entity provisions applied afterward. We invite you to contact us in respect of any interpretative issue you may encounter in applying these rules in order to achieve results consistent with the intended policy.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA’s electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day 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 taxpayer identity. Requests for this latter version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca. 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,

Nicolas Bilodeau
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© His Majesty the King in Right of Canada, 2023

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté le Roi du Chef du Canada, 2023