Principal Issues: In what circumstances would the CRA consider the foreign tax credit generator rules to apply in a scenario where a Brazilian foreign affiliate is eligible to make tax deductible dividend payments under Brazil’s interest on equity provisions?
Position: The foreign tax credit generator rules apply in any taxation year of the foreign affiliate in which it pays dividends to a specified owner that are deductible by virtue of an interest on equity election.
Reasons: The test is applied to each taxation year of a foreign affiliate independent of other taxation years.
2017 International Fiscal Association Conference
CRA Roundtable
Question 5 – Foreign tax credit generator rules and Brazilian interest on equity
The foreign tax credit generator (“FTCG”) rules are meant to prevent the creation of foreign tax credits and similar deductions for foreign tax to the extent that the burden of the foreign tax is not, in fact, borne by the taxpayer. Subsections 91(4.1) through (4.7) form part of these rules and can potentially impact the availability of foreign accrual tax (“FAT”) deductions under subsection 91(4) applicable to amounts included in income under subsection 91(1) in respect of the FAPI of a particular foreign affiliate.
Subsection 91(4.1) is the main operative rule and is triggered where at any time in the taxation year of a foreign affiliate, a person or partnership referred to in the FTCG rules as a “specified owner” in respect of the taxpayer, is considered under the relevant foreign tax law to own less than all of the shares of a particular corporation – that is a “pertinent person or partnership” in respect the affiliate – that are considered to be owned by the specified owner for the purposes of the Act (the “Lesser Ownership Test”).
Subsection 91(4.7) deems, for the purposes of subsection 91(4.1), the Lesser Ownership Test to be met if, under the relevant foreign tax law, dividends or similar payments in respect of the shares of a corporation held by a specified owner are treated as interest or another form of deductible payment.
Under Brazilian law, corporations can choose to make, within certain limits, tax deductible distributions to shareholders through a so-called “interest on equity” (“IOE”) mechanism. In a simple case where a corporation resident in Canada (“Canco”) owns all the shares of a Brazilian affiliate (“Brazilco”) which in turn holds only non-share assets, under what circumstances, if any, would the CRA consider that subsection 91(4.7) could apply to cause Canco to own less than all the shares of Brazilco?
CRA Response
The Lesser Ownership Test is applied to each taxation year of a foreign affiliate independent of other taxation years. The CRA considers the conditions for the application of subsection 91(4.7) to have been met in a taxation year of a foreign affiliate if, at any time in that year, dividends paid to a specified owner are deductible by the paying corporation under Brazilian tax law by virtue of an IOE election. In the above case, the “specified owner” for the purposes of subsection 91(4.7) is Canco and the “corporation” is Brazilco. The CRA would consider the Lesser Ownership Test to have been met in respect of the shares of Brazilco in each of its taxation years in which dividends are paid by Brazilco to Canco and are deductible by virtue of an IOE election such that subsection 91(4.1) would apply to deny all amounts that would otherwise be FAT applicable to amounts included in Canco’s income in respect of the FAPI of Brazilco for those taxation years.
Olli Laurikainen
Dave Beaulne
2017-069112
April 26, 2017