Principal Issues: (1) What information should a Canco maintain with respect to a deduction claimed under subsection 113(1) of the Act ("113 Deduction") in respect of a dividend paid by a FA in a taxation year? Are detailed surplus account computations essential to support the 113 Deduction? (2) In a particular set of circumstances, would the CRA accept the late filing by Canco of an election under subsections 5901(2.1) and (2.2) of the Regulations in order for the dividend to be completely sheltered by the 113 Deduction?
Position: (1) General comments, including that a taxpayer is required under 230(1) to maintain records and books of account, which may be inspected, audited, or examined, pursuant to paragraph 231(1)(a) of the Act. (2) General comments.
FEDERAL TAX ROUNDTABLE OCTOBER 7, 2019
2019 APFF CONFERENCE
Question 8
Surplus documentation
A foreign affiliate ("FA") pays a dividend to its sole shareholder, a corporation resident in Canada ("Canco").
Canco has not performed a detailed calculation of its exempt surplus, hybrid surplus and taxable surplus accounts nor a detailed determination of the hybrid underlying tax and underlying foreign tax accounts in respect of FA, which it was required to do pursuant to Part LIX of the Income Tax Regulations (ITR). [f.n. 10 C.R.C. c. 945 (“C.R.C.”).
Canco claims a deduction under subsection 113(1) equal to the amount of the dividend determined in accordance with the general ordering rules in subsections 5900(1) and 5901(1) for the purpose of determining its taxable income for the year.
Should it be determined, upon closer examination, that the deduction under section 113 did not cover the entire dividend, Canco is of the view that the ACB of its shares in FA would be sufficient to preclude any net increase in its taxable income for the year that would otherwise result from the interaction of paragraph 53(2)(b) and subsections 40(3) and 92(2).
Questions to the CRA
(a) In this context, what information should Canco retain regarding the deduction under section 113 in respect of the dividend paid by FA in a taxation year? Is a detailed calculation of surplus accounts essential to support the deduction under section 113?
(b) Would the CRA accept Canco's late filing of a subsection 5901(2.1) and 5901(2.2) election ("Pre-Acquisition Surplus Election") so that the deduction under section 113 would cover the entire dividend?
CRA Response to question 8 (a)
The calculation of surplus accounts is required inter alia to substantiate a deduction claimed under subsection 113(1). The detailed rules in Part LIX of the Income Tax Regulations, including the definitions of "exempt surplus", "hybrid surplus" and "taxable surplus", establish the manner of calculating these surplus accounts, as well as the amounts deemed to have been paid on each of these accounts and pre-acquisition surplus for the purposes of the various paragraphs of subsection 113(1).
The balance of those accounts is also relevant to the application of other provisions of the Income Tax Act, including paragraph 55(5)(d), subsection 90(9) and the interaction between subsection 40(3) and paragraph 93(1.1)(b).
Taxpayers and their representatives must exercise due care in claiming the deduction of a dividend amount under subsection 113(1) and must ensure adequate allocations are made pursuant to the relevant provisions of the Income Tax Regulations. Under a self-assessing system, the taxpayer is responsible for computing the taxpayer’s taxable income, declaring it and determining the taxpayer’s tax payable pursuant to the provisions of the Income Tax Act. In that context, subsection 152(7) provides that the Minister is not bound by a return or information supplied by or on behalf of a taxpayer and may, notwithstanding a return or information so supplied, assess the tax payable under Part I of the Income Tax Act.
If a taxpayer does not submit complete computations of surplus to the CRA, the general practice of the CRA is to refuse the deduction claimed under subsection 113(1).
Furthermore, taxpayers are also responsible for documenting their own affairs in a reasonable manner. In that regard, subsection 230(1) expressly provides that they must keep records and books of account in such form and containing such information as will enable the taxes payable under the Income Tax Act to be determined. Pursuant to paragraph 231.1(1)(a), an authorized person of the CRA may inspect, audit or examine the books and records of a taxpayer.
Finally, an unsupported claim for a deduction under subsection 113(1) may be subject, depending on the circumstances, to the application of subsections 152(4), 163(2), 163.2(2) and 239(1).
CRA Response to question 8(b)
In general, paragraph 5901(2)(b)ITR provides that where a foreign affiliate of a corporation resident in Canada pays a whole dividend, the corporation resident in Canada can file an election regarding pre-acquisition surplus so that the dividend is deemed to have been paid in whole or in part out of the pre-acquisition surplus in respect of the corporation and not out of other surplus accounts.
ITR subparagraph 5901(2)(b)(i) ITR establishes the filing deadline by which a taxpayer can make an election regarding pre-acquisition surplus. The election must generally be filed with the Minister by the filing-due date for the corporation resident in Canada for its taxation year in which the whole dividend was paid (or, if a joint election is to be made by corporations resident in Canada referred to in ITR subparagraph 5901(2)(b)(i), not later than the earliest of the filing-due dates for their taxation years).
If the conditions in ITR subsection 5901(2.1) are satisfied, ITR subsection 5901(2.2) provides that the Minister may exercise her discretion so that a late pre-acquisition surplus election is deemed to have been filed within the required time. It should be noted that the conditions of application of ITR subsections 5901(2.1) ITR and 5901(2.2) differ from those of subsection 220(3.2), which governs the elections enumerated in ITR section 600. (Note that the election regarding pre-acquisition surplus is not enumerated).
The conditions set out in ITR paragraphs 5901(2.1)(a) and 5901(2.1)(b) require in particular that (i) the corporation resident in Canada has determined not to make the pre-acquisition surplus election in respect of the whole dividend before the applicable filing-due date and (ii) the corporation demonstrates that the determination was made using reasonable efforts. As noted above, the CRA is of the view that a deduction claimed under subsection 113(1) based on surplus balances without a detailed computation would not meet the conditions for the application of that subsection. Consequently, in the situation submitted, the determination not to make an election regarding pre-acquisition surpluses on that basis will generally not be considered to have been made as a result of reasonable efforts, so that it would not generally be considered that Canco satisfied the requirements set out in ITR 5901(2.1)(b).
Furthermore, ITR subsection 5901(2.2) provides that, in the opinion of the Minister, the circumstances must be such that it would be "just and equitable" to permit the late filing of a pre-acquisition surplus election. In that regard, the following statement is found in the Department of Finance's Explanatory Notes to ITR section 5901 (released October 24, 2012, Bill C-48):
“Provision is also made, in new subsection 5901(2.1) and (2.2), for late-filing of the pre-acquisition surplus election in paragraph 5901(2)(b). Although the ability to late file the election is subject to the discretion of the Minister, it is generally expected that the "just and equitable" standard would be met where the taxpayer's decision not to file by the normal deadline was based on reasonable expectations as to the relevant surplus balances of its foreign affiliates and those surplus balances require adjustment because of subsequent assessments made by a foreign tax authority or the Canada Revenue Agency. However, the taxpayer must have made reasonable efforts in determining not to file the election in the first place and is expected to have adequately documented those efforts at the time of that determination, i.e. before the normal deadline for filing the election.”
The CRA is of the view that, in the context of Canada's self-assessment tax system, the circumstances would not be such that it would be "just and equitable" to permit the late filing of a pre-acquisition surplus election where Canco did not make a detailed computation of the surplus accounts, relying on the assumption that the late filing of the election and the related reduction in the calculation of the ACB to Canco of the FA shares would not result in no net inclusion to Canco’s taxable income for the year.
Marie-Claude Routhier
(613) 670-8921
October 11, 2019
2019-082131
Response prepared in collaboration with:
Venetia Putureanu and Marian Young, International Tax Division
International, Large Business and Investigations Branch