2017-0697901C6 2017 STEP – Q9 - S-corporation agreements

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether a qualified subchapter S Corporation subsidiary (QSSS) must enter into a separate Competent Authority Agreement under paragraph 5 of Article XXIX of the Canada-U.S. Tax Convention in a situation where the parent United States S Corporation has already entered into such an agreement.

Position: No.

Reasons: The income of the parent United States S Corporation as computed under the Internal Revenue Code and which is deemed to be FAPI pursuant to a “Paragraph 5 Article XXIX Competent Authority Agreement” includes the income of the QSSS.

Author: Laurikainen, Olli

Section: Paragraph 5 of Article XXIX of the Canada-U.S. Tax Convention

STEP CRA Roundtable – June 13, 2017

QUESTION 9.  Paragraph 5 of Article XXIX – procedures for Qualified Subchapter S Corporation Subsidiary

Under paragraph 5 of Article XXIX of the Canada-US Tax Convention (the “Convention”), the Competent Authority of Canada may agree to allow a Canadian-resident shareholder of a United States S Corporation to apply the following rules for Canadian tax purposes with respect to the period during which the agreement is effective:

a) the corporation shall be deemed to be a controlled foreign affiliate of the person;
b) all the income of the corporation shall be deemed to be foreign accrual property income;
c) for the purposes of subsection 20(11) of the Income Tax Act, the amount of the corporation’s income that is included in the person’s income shall be deemed not to be income from a property; and
d) each dividend paid to the person on a share of the capital stock of the corporation shall be excluded from the person’s income and shall be deducted in computing the adjusted cost base to the person of the share.

The cumulative effect of these rules synchronizes the recognition of income in Canada with that of the US and allows the shareholder to claim a foreign tax credit in respect of the amount of US tax paid on his or her share of the S Corporation’s income. However, paragraph 5 of Article XXIX of the Convention does not apply automatically. It only applies to a shareholder of an S Corporation who requests and enters into an S Corporation Agreement with the Canadian Competent Authority.  Additionally, if the shareholder has an interest in more than one S Corporation, a separate S Corporation Agreement is required for each corporation. This was recently confirmed by the CRA at the 2015 STEP CRA Roundtable.

Can the CRA comment on the situation of an S Corporation that holds the shares of a qualified subchapter S Corporation subsidiary (“QSSS”).  A QSSS is a wholly-owned subsidiary of an S Corporation for which a separate U.S. tax election is made to treat it as a pass-through entity.  In such situation, is the Canadian-resident shareholder of the S Corporation required to enter into two separate S Corporation Agreements: one with respect to the parent S Corporation and the other with respect to the QSSS?  Or would the S Corporation Agreement for the parent S Corporation automatically cover the QSSS?

CRA Response

It is our understanding that when an S Corporation elects under the Internal Revenue Code (the “Code”) of the United States to treat one of its subsidiaries as a QSSS, the QSSS is no longer treated as a separate corporation under the Code and the items of income and deduction of the QSSS are treated as those of the S-Corporation.  The template S Corporation Agreement used by the Canadian Competent Authority provides that the income of an S Corporation that is deemed to be foreign accrual property income as described in paragraph (b) above is to be determined in accordance with the Code.  On that basis, if the shareholder of an S-Corporation in the circumstances described above has entered into an S Corporation Agreement with the Canadian Competent Authority, the income of the S-Corporation as computed under the Code, which will include the income of its QSSS, is deemed to be foreign accrual property income.  If that is the case, there is no need for the Canadian shareholder to enter into a separate S-Corporation agreement with respect to the QSSS.


Olli Laurikainen

Response prepared in collaboration with:
Daryl Boychuk
Competent Authority Services Division
International, Large Business and Investigations Branch

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