Principal Issues: Whether a payment made under a "profit transfer agreement" by a German subsidiary to its German parent could be deemed to be a "dividend" under subsection 90(2)?
Position: Yes, provided the payment meets the pro rata distribution condition in subsection 90(2).
Reasons: The wording of subsection 90(2) supports this position.
2016 International Fiscal Association Conference
CRA Roundtable
Question 6 - German Organschafts
The German Corporate Income Tax Act allows the taxable income or loss of a corporation resident in Germany (“Subco”) to be included in, and taxed with, the taxable income or loss of another corporation resident in Germany (“Parentco”) through a relationship referred to as an Organschaft. In order to have an Organschaft, a number of requirements have to be met, including Parentco and Subco having entered into a valid Profit Transfer Agreement (“PTA”). Under a PTA, Subco agrees to annually transfer its entire profit determined in accordance with the German statutory accounting and reporting requirements (“German GAAP”) to Parentco, and if Subco incurs a loss as determined under German GAAP, Parentco agrees to compensate Subco for such loss.
The CRA adopted a view that a profit transfer payment made by a Subco to a Parentco under a PTA was income from property to Parentco that could be re-characterized as income from an active business of Parentco in accordance with the rules in paragraph 95(2)(a) to the extent that Subco had earnings from an active business before taking into account the profit transfer payment. However, one of the effects of this view is that all or a portion of a profit transfer payment could be included in the computation of the foreign accrual property income (“FAPI”) of Parentco notwithstanding that Subco had no FAPI prior to the payment (e.g., where the statutory accounting profits of Subco included income such as dividends from underlying affiliates or capital gains from dispositions of excluded property).
With the introduction of subsection 90(2), would the CRA consider a profit transfer payment made by a Subco to a Parentco under a PTA to be a dividend under that subsection?
CRA Response
The CRA agrees that a profit transfer payment made by a Subco to a Parentco under a PTA could be deemed to be a “dividend” under subsection 90(2) of the Act. Under this subsection, an amount is deemed to be a dividend paid or received, as the case may be, at any time on a share of a class of the capital stock of a non-resident corporation that is a foreign affiliate of a taxpayer if the amount is the share's portion of a pro rata distribution (with certain exceptions) made at that time by the corporation in respect of all the shares of that class. It would be a question of fact as to whether a particular profit transfer payment made by a Subco to a Parentco meets the pro rata distribution condition in subsection 90(2). We understand that as a matter of German corporate law a PTA can be entered into by two German resident corporations in a variety of circumstances.
Where a Subco only has one class of shares issued and outstanding and Parentco directly owns all of these shares (“Base Case”), the CRA would view the profit transfer payment made by Subco after August 19, 2011 to Parentco under a PTA as being a dividend described in subsection 90(2). If the payment is such a dividend, its effect on the surplus accounts of Subco and Parentco would be in accordance with the rules in Part LIX of the Income Tax Regulations respecting dividends received or paid, as the case may be. The earnings, income or loss of Parentco and Subco would be determined without regard to the profit transfer payment.
In the Base Case, the CRA would view a payment made under a PTA by Parentco to Subco in respect of an accounting loss of Subco as being a contribution of capital made by Parentco to Subco for purposes of paragraph 53(1)(c) of the Act. Such a payment would not be taken into account in computing the earnings, income or loss of either Subco or Parentco.
In a “non-Base Case” scenario, the CRA would be prepared to consider in the context of an advance income tax ruling request whether the profit transfer payment is an amount described in subsection 90(2), the characterization of a payment in respect of an accounting loss, and the impact, if any, of such payments on the computation of the earnings, income or loss of Parentco and Subco.
Taxpayers may continue to rely on the CRA’s previous view. However, since we expect that most taxpayers would be able to rely on the CRA’s new view, we propose to limit the ability of taxpayers to treat these payments in accordance with the CRA’s previous view to profit transfer payments made before 2017. We welcome the views from the tax community in respect of the proposal to eliminate the previous position.
John Meek
2016-064208
May 26, 2016