A taxable Canadian corporation and its wholly owned Canadian subsidiary (collectively “Canco”) have always owned 100% of a partnership (“LP”) that has always owned 100% of a non-resident corporation (“FA”), all having calendar fiscal periods. On December 31, 2016, FA had an exempt and taxable surplus balances of $3,000 and $2,000 (consisting of undistributed foreign accrual property income (“FAPI”) that was included in LP’s income) respectively in respect of Canco. In 2017 (during which it had no income or loss), FA paid a $3,000 dividend to LP, which was LP’s only income item other than $300 of deductible interest expense. This was deemed to be a $3,000 dividend paid out of the exempt surplus of FA in respect of Canco, and entitled LP to a $2,000 s. 91(5) deduction under Reg. 5900(3), resulting in income to LP of $700 (i.e., $3,000 dividend - $2,000 s. 91(5) deduction - $300 interest expense). As such, this $700 would be included in computing Canco’s income for its 2017 taxation year by virtue of paragraph 96(1)(f).
S. 93.1(2)(d)(i) limits the amount deductible by Canco under s. 113 respecting the dividend to the portion of the amount of the dividend that is included in its income pursuant to s. 96(1). Is the s. 91(5) deduction allowed to LP taken into account in determining this limitation.
CRA noted that if Canco had directly owned the FA shares, its 2017 taxable income would have been a $300 loss (i.e., $3,000 dividend - $3,000 s. 113(1) deduction - $300 interest expense).
Here, under subsection s. 96(1)(c), LP’s $2,000 s. 91(5) deduction and its $300 interest expense are both wholly applicable to its dividend income, so that $700 of the $3,000 dividend is included in Canco’s income for purposes of s. 93.1(2)(d)(i) ($3,000 dividend - $2,000 s. 91(5) deduction - $300 interest expense).
However, expenses such as interest relating to acquisitions by a partnership of foreign affiliate shares are not taken into account in applying the s. 93.1(2)(d)(i) limitation, so that only the s. 91(5) deduction is taken into account in determining that limit. Therefore, in computing its taxable income, Canco would have a loss of $300 (i.e., partnership income of $700, minus a s. 113(1)(a) deduction of $1,000 (the $3,000 dividend reduced by LP’s $2,000 s. 91(5) deduction) for a loss of $300).)
It is appropriate to reinstate $2,000 of exempt surplus of FA in respect of Canco, and to reduce its taxable surplus in respect of Canco by the same amount. That would bring the surplus accounts into line with Canco’s position.