FOREIGN AFFILIATES - U.K. ADVANCE CORPORATIONS TAX
QUESTION
The U.K. has adopted an imputation system of taxation under which a U.K. corporation pays an advance corporation tax ("ACT") at the time it pays a dividend at the rate of 1/3 of the dividend. ACT paid can be credited against a corporation's mainstream corporate income tax ("MCIT") liability, if any, subject to a limitation of 25% of the corporation's taxable profits. If the corporation has no MCIT liability, the ACT may be carried back or forward to offset the MCIT of another year or it may be surrendered by a parent corporation to a subsidiary in which it has a greater than 50% interest. U.K. shareholders in receipt of a dividend include the ACT that has been paid in respect of such dividend in income but receive an equivalent tax credit. A Canadian shareholder is also entitled to a U.K. tax credit in respect of the ACT paid by a U.K. corporation, however Article X of the Canada-U.K. Income Tax Convention (1978) provides that depending on the percentage of the voting power controlled by the Canadian shareholder, it will be entitled to either a tax credit of 1/2 of the ACT credit available to a U.K. shareholder or a full ACT credit. An ACT credit received by a Canadian shareholder is treated as a dividend for the purposes of Part I of the Income Tax Act.
Does Revenue Canada view the ACT as an "income or profits tax" for the purposes of the Regulations to the Income Tax Act (the "Regulations")?
If the ACT is surrendered by a U.K. foreign affiliate to a subsidiary under U.K. tax law, does subsection 5907(1.2) of the Regulations apply notwithstanding that the subsection refers to the deduction by the transferee of a "loss" of another taxpayer?
DEPARTMENT'S POSITION
Since it is not computed on the basis of the foreign affiliate's income or profits, the ACT is not an "income or profits tax" for the purposes of the Regulations. In our view, the ACT paid by a particular foreign affiliate and credit in respect thereof received by the affiliate should not enter into the calculation of the surplus accounts of that affiliate because the ACT is generally paid and then in some manner recovered by that affiliate. Rather the MCIT paid by an affiliate before any deduction in respect of any ACT paid by the affiliate would be viewed to be the income or profits tax in respect of the year's profits.
Subparagraph 5907(1)(d)(vi.1) of the Regulations provides for an adjustment to the exempt surplus account of a foreign affiliate in respect of an ACT credit received by it in connection with a dividend from another affiliate that is added to the exempt surplus of the recipient pursuant to subparagraph 5907(1)(d)(vi) of the Regulations and subsection 5907(7.1) of the Regulations provides for adjustments to the surplus accounts of a U.K. foreign affiliate in respect of an ACT credit received by a Canadian company in connection with a dividend paid to the Canadian company by the U.K. foreign affiliate. Outside the adjustments referred to above, neither the ACT paid or any credit in respect thereof should enter into the calculation of the surplus accounts of a foreign affiliate.
In the event the ACT is surrendered to a subsidiary company, it is our position that subsection 5907(1.2) of the Regulations would not apply because, that provision deals only with losses. However, provided the parent company is reimbursed for such surrendering of tax credits, our position would appear to produce an appropriate result because balances in both the parent's and the subsidiary's (if the subsidiary is a foreign affiliate) surplus accounts would reflect the amount they have available to pay dividends.
Prepared by: O. LaurikainenDate: January 15, 1992