Canco (and its Canadian sub) hold LP, which received a $3,000 dividend from a wholly-owned foreign affiliate (FA). Although the dividend came out of FA’s exempt surplus of $3,000, it was deemed insofar as LP was concerned to be deductible as to $2,000 under s. 91(5) and Reg. 5900(3) respecting previously earned foreign accrual property income.
S. 93.1(2)(d)(i) limits the s. 113 deduction of Canco to the portion of the $3,000 dividend that is included in its income under s. 96(1). Taking into account $300 of interest expense on acquisition debt of LP, the income of Canco (ignoring any other sources and rounding its partnership interest up to 100%) is $700 ($3,000 dividend - $2,000 s. 91(5) deduction - $300 interest expense). However, as CRA does not take into account interest relating to acquisitions by a partnership of FA shares for 93.1(2)(d)(i) limit purposes, the s. 113(1) deduction of Canco is $1,000 rather than $700 – so that 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).
CRA considered this to be the appropriate result: there would have been the same $300 loss had Canco directly owned FA ($3,000 dividend - $3,000 s. 113(1) deduction - $300 interest expense). However, it was 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.