2023-0964561C6 Tax-free Surplus Balance and Paragraph 88(1)(d)

Principal Issues: For purposes of a paragraph 88(1)(d) bump to the ACB of a foreign affiliate's shares, whether CRA will raise an issue with a foreign affiliate's tax-free surplus calculations, or lack thereof, in a specific situation.

Position: No, provided the conditions as outlined in CRA's previous 2011 administrative position are met in a particular situation as described in that 2011 position, CRA will not raise an issue with a foreign affiliate's tax-free surplus balance calculations, or lack thereof, in computing the bump to the ACB of the foreign affiliate shares.

Reasons: In the particular situation outlined, and provided the conditions are met, the surplus balances of the particular foreign affiliate will cease to be relevant following the sale of the foreign affiliate out from under Canada. As any tax-free surplus grind to the bump would result in a gain on disposition which would be eliminated with a 93(1) election, the requirement for tax-free surplus calculations would be a redundant exercise since surplus available for a 93(1) election would generally equal the tax-free surplus balance.

Author: Kippen, Ann
Section: 88(1)(d)(ii); Reg 5905(5.4), (5.5)

2023 IFA Annual Conference
CRA Roundtable

Question 8 – Tax-free Surplus Balance Calculation and Paragraph 88(1)(d) “Bump”

At the 2011 IFA Conference CRA Roundtable (CRA document 2011-0404521C6), the CRA indicated that it would not challenge a paragraph 88(1)(d) bump in respect of the shares of a foreign affiliate (FA) by raising an issue with an FA’s tax-free surplus balance (TFSB) calculation or lack thereof in circumstances where, absent clause 88(1)(d)(ii)(C), the shares of FA could be bumped to fair market value such that there would be no gain on a subsequent distribution of the FA shares to a foreign parent, provided that no dividends were paid or were deemed to be paid on the FA shares following the acquisition of control and the FA shares were distributed to the foreign parent within a reasonable amount of time. Given the CRA’s more recent statements on the necessity of computing surplus to support deductions under section 113, can the CRA confirm its prior position regarding tax-free surplus balance and the bump?

CRA Response

The CRA response to the question posed at the 2011 IFA Conference CRA Roundtable (CRA document 2011-0404521C6) was in connection with the specific situation in which a foreign corporation (Forco) incorporated a Canadian corporation (Holdco) to acquire the shares of a Canadian corporation (Canco) which owned all the shares of an FA, and shortly thereafter Canco wound up into Holdco with Holdco then disposing of the FA shares to Forco. Following the disposition of FA to Forco, the surplus of FA would no longer be relevant in determining the Canadian tax implications to a taxpayer.

In this situation, the CRA indicated that it would not challenge the designation made under paragraph 88(1)(d) (the “ACB bump”) in respect of the FA shares by raising an issue with FA’s TFSB calculation or lack thereof, provided that the FA shares were transferred to Forco by Holdco within a reasonable period of time after the takeover of Canco and provided that neither Canco nor Holdco received, or was deemed to receive, any dividends from FA after the takeover of Canco (the “2011 administrative position”). Any other circumstance in which relevant surplus balances are used in the year to reduce Canadian income tax will also be disqualifying. The 2011 administrative position eliminates the need for TFSB calculations by a taxpayer in the scenario described in the question posed at the 2011 IFA Conference.

The 2011 administrative position is conditional on the sale of FA by Holdco to Forco occurring within a reasonable period of time following the acquisition of Canco. What will be considered to be a “reasonable” period of time is a question of fact and will depend upon the particular circumstances.

The CRA has over the past several years emphasized that taxpayers are required to compute and maintain foreign affiliate surplus calculations to support deductions under subsection 113(1) and in numerous other situations where an FA’s surplus balances are relevant in determining tax payable under the Income Tax Act (the “Act”) (2019 and 2022 IFA Conferences, CRA documents 2019-0798761C6 and 2022-0928101C6 respectively). This requirement is legislative and not administrative, being based on subsection 230(1) of the Act which specifically requires taxpayers to maintain records and books of account in such form and containing such information that will enable determination of taxes payable under the Act.

To be applicable, the 2011 administrative position requires that neither Canco nor Holdco received a dividend from FA subsequent to the takeover of Canco (nor otherwise were required to use available surplus balances). It is also premised on the transfer of the FA shares to Forco within a reasonable period of time after the takeover of Canco, making its surplus balances irrelevant for Canadian tax purposes upon that transfer. Consequently, the 2011 administrative position is not inconsistent with our understanding of the policy partially underlying subsection 230(1) requiring that surplus balances of a foreign affiliate be computed and provided to support deductions under subsection 113(1) and in numerous other situations where a foreign affiliate’s surplus balances are relevant in determining tax payable under the Act.

Accordingly while, as with any other administrative policy, circumstances in the future may dictate that revisions are necessary, the CRA continues to apply the 2011 administrative position provided the conditions are met.

Ann Kippen and Charles Taylor
2023-096456
May 17, 2023

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