Principal Issues: Would capital gains from the disposition of excluded property by a foreign affiliate subsidiary in a German Organschaft arrangement be excluded in computing FAPI of the foreign affiliate parent?
Position: No.
Reasons: The amount of the transfer that represents the capital gains is income from property to the recipient and is not deductible in computing the amount that is prescribed to be the earnings from an active business (other than an active business carried on in Canada) of the payer.
2009 TEI Question
Question #5
German Fiscal Unity
Under the German Corporate Income Tax Act, the fiscal unity provision ("Organschaft") permits a German controlled foreign affiliate (CFA2) of a Canadian corporation (Canco) to transfer its profit or loss to a German parent company (CFA1) which is also a controlled foreign affiliate of Canco and which owns 100% of CFA2. For German income tax purposes, the transfer payment is deductible by CFA2 and taxable in CFA1.
When CFA2 earns income from an active business, the income derived by CFA1 from the income transfer payment received from CFA2 is generally deemed to be from an active business under clause 95(2)(a)(ii)(B) of the Act. Under the definition of "earnings" in subsection 5907(1) of the Regulations, such income is included in CFA1's "earnings" from an active business.
A capital gain realized by CFA2 on the disposition of excluded property is not included in its Foreign Accrual Property Income (FAPI) under paragraph 95(1). Clause 95(2)(a)(ii)(B), however, would seemingly not apply to re-characterize the transfer payment in respect of such gain received by CFA1 from CFA2 as income from an active business because the transfer of such income from CFA2 must be considered deductible in computing CFA2's active business income. TEI does not believe that the income transfer payment should be treated as FAPI where it is deductible from income that is not otherwise treated as FAPI. Would CRA confirm that the income transfer payment to CFA1 (income in CFA1) under the fiscal unity regime will not be treated as FAPI and thus not included in the income of Canco?
CRA Response
The CRA is of the view that an income transfer payment received by CFA1 from CFA2 is income from property to CFA1. The portion of such amount transferred by CFA2 to CFA1 that represents the amount of a capital gain realized by CFA2 from the disposition of its excluded property would be included in the FAPI of CFA1 because that amount is not deductible by CFA2 in computing the amount that is prescribed to be its earnings from an active business (other than an active business carried on in Canada) and the provisions of paragraph 95(2)(a) do not apply. In our view an amendment to the legislation would be required in order to produce a different outcome.
Prepared by Simon Leung
November 25, 2009