FOREIGN AFFILIATE REGULATIONS - "90 DAY RULE
QUESTION
FA1 is a foreign affiliate of Canco a corporation resident in Canada. Canco acquired 100% of the shares of FA1 in 1990. FA1 owns 100% of the shares of FA2 and FA3 which are two other foreign affiliates of Canco. FA1, FA2 and FA3 all have taxation years that end on December 31. FA1's only income consists of dividends from FA2 and FA3. On June 30, 1991, FA1 has no exempt or taxable surplus (or deficit) in respect of Canco. On July 1, 1991, FA2 pays a $100 dividend (the "FA2 dividend") to FA1. The exempt surplus and taxable surplus (or deficit) of FA2 in respect of Canco at the time of the FA2 dividend is nil. On August 1, 1991, FA1 pays a $100 dividend (the "FA1 dividend") to Canco. On September 1, 1991 FA3 pays a $100 dividend (the "FA3 dividend") to FA1. At the time of the FA3 dividend the exempt and taxable surplus (or deficit) of FA3 in respect of Canco is nil. The taxable earnings of FA2 in respect of Canco for the 1991 taxation year are $100 and FA2 has no exempt surplus or deficit in respect of Canco at the end of 1991. The exempt earnings of FA3 in respect of Canco for the 1991 taxation year are $100 and FA3 has no taxable surplus or deficit in respect of Canco at the end of 1991. How will subsection 5901(2) of the Regulations to the Act (the "Regulations") apply in these circumstances?
DEPARTMENT'S POSITION
The "90 day rule" rule in subsection 5901(2) of the Regulations will apply to the FA2 dividend and the FA3 dividend because both are paid more than 90 days after the commencement of the 1991 taxation year and would have otherwise been deemed paid entirely out of pre-acquisition surplus of the affiliates in respect of Canco. Subsection 5901(2) of the Regulations will deem the FA2 dividend to have been paid out of the taxable surplus of FA2 in respect of Canco and the FA3 dividend will be deemed to have been paid out of the exempt surplus of FA3 in respect of Canco. Both are deemed paid immediately after December 31, 1991 for the purpose of determining the amounts under paragraphs 5907(1)(d), (k) and (l) of the Regulations for FA2 and FA3.
At August 1, 1991 (the time the FA1 dividend is paid), FA1 has not been determined to have any exempt or taxable surplus in respect of Canco (while the FA2 dividend has been received by FA1 prior to that date it has not yet been determined to have been from the taxable surplus of FA2 in respect of Canco), therefore subsection 5901(2) of the Regulations will also apply to the FA1 dividend. By virtue of the application of subsection 5901(2) of the Regulations to the FA2 dividend and the FA3 dividend, it is only determined after the end of FA2's and FA3's taxation years that the dividends came out of exempt and taxable surplus. This determination does not change the timing of the receipt of those dividends by FA1 but on the other hand, it also does not change the fact that subsection 5901(2) of the Regulations has deemed the FA1 dividend to have been paid immediately after FA1's taxation year for the purpose of determining FA1's amounts under paragraphs 5907(1)(d), (k) and (l). As a result, FA1 has $100 of exempt surplus and $100 of taxable surplus out of which dividends can be paid immediately after the end of its taxation year. Accordingly, by virtue of the order of surplus distribution rules set out in subsection 5901(1) of the Regulations, the FA1 dividend will be paid entirely out of the exempt surplus of FA1 in respect of Canco.
Prepared by: O. LaurikainenDate: January 15, 1992