2019-0798761C6 IFA 2019 Q.9: Surplus Documentation

Principal Issues: (1) What information should a Canco maintain with respect to a deduction claimed under subsection 113(1) of the Act ("113 Deduction") in respect of a dividend paid by a FA in a taxation year? Are detailed surplus account computations essential to support the 113 Deduction? (2) In a particular set of circumstances, would the CRA accept the late filing by Canco of an election under subsections 5901(2.1) and (2.2) of the Regulations in order for the dividend to be completely sheltered by the 113 Deduction?

Position: (1) General comments, including that a taxpayer is required under 230(1) to maintain records and books of account, which may be inspected, audited, or examined, pursuant to s. 231(1)(a) of the Act. (2) General comments.

Author: Roulier, Yannick
Section: 113(1), 152(7), 230(1), 231.1(1)(a), Reg. 5900, 5901(1), 5901(2)(b), 5901(2.1), 5901(2.2)

2019 International Fiscal Association Conference
CRA Roundtable

Question 9 – Surplus Documentation

A corporation resident in Canada (“Canco”) received a dividend in a taxation year from a wholly-owned foreign affiliate (“FA”).

Canco did not prepare a detailed calculation of its exempt surplus, hybrid surplus and taxable surplus accounts, neither did it make any detailed determination of its hybrid underlying tax and underlying foreign tax accounts, in respect of FA as would have been required under Part LIX of the Income Tax Regulations (the “Regulations”).

Canco decided to claim a deduction under subsection 113(1) of the Act equal to the amount of the dividend (the “113 Deduction”) based on the application of the general ordering rules of subsections 5900(1) and 5901(1) of the Regulations for the purpose of determining its taxable income for the year.

Should a more careful review result in the amount of the dividend not being completely sheltered by the 113 Deduction, Canco was of the view that the adjusted cost based (“ACB”) of the FA shares was sufficient to prevent any further net inclusion to its taxable income for the year that might otherwise have resulted from the interplay of paragraph 53(2)(b), subsection 40(3) and subsection 92(2) of the Act.

a.    What information should Canco maintain with respect to the 113 Deduction in respect of the dividend paid by a FA in a taxation year? Are detailed surplus account computations essential to support the 113 Deduction?

b.    Would the CRA accept the late filing by Canco of an election under subsections 5901(2.1) and (2.2) of the Regulations (“PAS Election”) in order for the dividend to be completely sheltered by the 113 Deduction?

CRA Response – Question a.)

The calculation of the surplus accounts is required, amongst others, to substantiate the claim of a deduction under subsection 113(1). Detailed rules in Part LIX of the Regulations, including the definition of “exempt surplus”, “hybrid surplus” and “taxable surplus”, determine how those surplus accounts are to be computed and the amount prescribed to have been paid out of each of those accounts and the pre-acquisition surplus (“PAS”) for purposes of the different paragraphs of subsection 113(1).

The balance of those surplus accounts is also relevant in the context of the application of different other provisions of the Act, such as paragraph 55(5)(d), subsection 90(9) and the interaction between subsection 40(3) and paragraph 93(1.1)(b) of the Act.

It is the duty of taxpayers and their representatives to use due care in claiming that the amount of a dividend is deductible under subsection 113(1) of the Act and that accurate allocations are made under the related Regulations. In a self-assessing system, the onus to compute and report taxable income pursuant to provisions of the Act and to determine the amount of tax owing is on the taxpayer.  In that context, subsection 152(7) of the Act provides that the Minister is not bound by a return or information supplied by a taxpayer and may, notwithstanding a return or information so supplied, assess the tax payable under Part I of the Act.

If complete surplus computations are not provided to the CRA, the current CRA general practice is to deny the deduction under subsection 113(1) of the Act.

In addition, taxpayers are responsible for documenting their own affairs in a reasonable manner. In that respect, subsection 230(1) of the Act specifically requires taxpayers to maintain records and books of account, in such form and containing such information as will enable the determination of taxes payable under the Act. Pursuant to paragraph 231.1(1)(a) of the Act, the books and records of a taxpayer may also be inspected, audited, or examined, by an authorized person of the CRA.

An unsupported claim of a deduction under subsection 113(1) of the Act could be subject to the application of subsections 152(4), 163(2), or 163.2(2) and 239(1) of the Act, among others, depending on the circumstances.

CRA Response – Question b.)

Paragraph 5901(2)(b) of the Regulations provides that where a foreign affiliate of a corporation resident in Canada pays a dividend, the corporation resident in Canada can file a PAS Election to deem the dividend to have been paid in whole or in part out of its PAS in respect of the corporation and not out of the other surplus accounts.

Subparagraph 5901(2)(b)(i) of the Regulations specifically provides a filing deadline for a taxpayer to make a PAS Election.  In general terms, the election has to be filed with the Minister before the filing-due date for the taxation year of the corporation resident in Canada in which the whole dividend was paid (or before the earliest of the filing-due dates for the taxation years of the corporations resident in Canada described in subparagraph 5901(2)(b)(i) where a joint election has to be filed).

If the conditions in subsection 5901(2.1) are met, subsection 5901(2.2) of the Regulations provides that the Minister can exercise her discretion in order for a late-filed PAS Election to be deemed to have been filed on time.  For the sake of completeness, we note that the conditions of application in subsections 5901(2.1) and (2.2) are different from the conditions of application of subsection 220(3.2) of the Act, which governs the elections listed in section 600 of the Regulations (the PAS Election is not listed in that Regulation).

The conditions in paragraphs 5901(2.1)(a) and (b) of the Regulations require that: (i) a corporation determined not to make a PAS Election in respect of a whole dividend before the applicable filing-due date; and (ii) the corporation demonstrates that the determination was made using reasonable efforts.  As mentioned above, the CRA’s view is that relying on surplus balances to support a deduction under subsection 113(1) of the Act without a detailed computation would generally not meet the conditions for that provision to apply.  Consistently, in the situation submitted, the determination not to make a PAS Election on that basis would generally not be considered to have been made using reasonable efforts, such that Canco would generally not be considered to meet the requirement set out in paragraph 5901(2.1)(b).

In addition, subsection 5901(2.2) provides that in the opinion of the Minister, the circumstances have to be such that it would be “just and equitable” to permit a late filing of a PAS Election. In that respect, the Department of Finance Explanatory Notes to section 5901 of the Regulations (released October 24, 2012; Bill C-48) state the following:

“Provision is also made, in new subsections 5901(2.1) and (2.2), for late-filing of the pre-acquisition surplus election in paragraph 5901(2)(b). Although the ability to late file the election is subject to the discretion of the Minister, it is generally expected that the "just and equitable" standard would be met where the taxpayer's decision not to file by the normal deadline was based on reasonable expectations as to the relevant surplus balances of its foreign affiliates and those surplus balances require adjustment because of subsequent assessments made by a foreign tax authority or the Canada Revenue Agency. However, the taxpayer must have made reasonable efforts in determining not to file the election in the first place and is expected to have adequately documented those efforts at the time of that determination, i.e. before the normal deadline for filing the election.”

In our view, in the context of the Canadian self-assessment tax system, the circumstances would not be such that it would be “just and equitable” to permit the late filing of a PAS Election where Canco did not make detailed computations of its relevant surplus accounts, relying on the assumption that a late PAS Election and related reduction of the ACB to Canco of the shares of FA would result in no net inclusion to Canco’s taxable income for the year.

Yves Moreno/Yannick Roulier
2019-079876
May 15, 2019
Response prepared in collaboration with:
Marian Young, International Tax Division
International, Large Business and Investigations Branch

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