An individual who was a Canadian resident and a US citizen and who owned voting shares of an S Corporation paid US taxes on its income. During the period that he and the Canadian Competent Authority had an Agreement under Art. XXIX(5) of the Canada-US Treaty in effect (apparently, for 2017), he included his share of the S Corporation’s income as FAPI, claimed a credit under s. 126 for the US taxes, and added such FAPI to the ACB of his shares. He did not receive any distribution in 2017. The Canadian Resident then revoked S Corporation’s status as a fiscally transparent entity for US tax purposes, so that the Agreement thereupon ceased to be effective.
S Corporation then made a distribution (the “dividend”) of income that previously had been included in his income as FAPI and that now was included in his income under s. 90(1).
The Directorate indicated that where S Corporation was a CFA of the Canadian resident at all times, he could take a s. 91(5) deduction of the dividend paid after the Agreement invalidation, with a corresponding reduction to the ACB of his shares.
However, where S Corporation was not a FA at the time the dividend was paid, no s. 91(5) deduction would be available (with no corresponding ACB reduction) because in such absence of FA status, Reg. 5900(3) would not deem the dividend to come out of taxable surplus.
The Directorate noted that it could be argued that s. 248(28) would apply to exclude the dividend from his income given that “both the dividend and FAPI arise from the same source, namely the shares of S Corporation .” However, the Directorate stated:
[T]he better view … is that the dividend income and FAPI inclusion are not the same amount …
[T]he dividend income is a cash distribution on the shares of S Corporation while the FAPI is a notional allocation of the income of S Corporation deemed to be FAPI on its shares of S Corporation … [so that] the dividend income and FAPI are separate amounts of a different nature … [which] would preclude the application of subsection 248(28).