Canco owns 100% of the shares of a foreign affiliate (FA1"), FA1 owns 100% of the shares of a second foreign affiliate ("FA2"), and FA2 owns 100% of the shares of a third foreign affiliate ("FA3"). FA1, the immediate subsidiary of Canco, and its 100% subsidiary, FA2 merge under a "foreign merger" (s. 87(8.1) under which FA2 ceases to exist and all its property (being all the shares of FA3) become property of FA1 ("Merged FA"). Immediately prior to the merger, the relevant surplus balances are: FA1: exempt surplus of $200, FA2: exempt deficit of $125, FA3: exempt surplus of $150. Will the deficit of FA2 would reduce not only the opening exempt surplus of Merged FA but the exempt surplus of FA3 as well? CRA responded:
[I]t was intended there should be symmetry with the "adjustments" required as a result of paragraphs 5905(7.2)(a) and (b)…[so that] it was intended that the adjustment to the deficit of FA2 under paragraph 5905(7.2)(b) should have effect before the operation of subsection 5905(3)… . [T]herefore…for purposes of determining the amount in the description of A of the formula in paragraph 5905(3)(b)… the amount of FA2's exempt deficit immediately before the merger is reduced by the amount otherwise determined in respect of FA2 under paragraph 5905(7.2)(b) of the Regulations. On this basis, while the exempt surplus of FA3 would be reduced to $25, … Merged FA's opening exempt surplus is $200. The Department of Finance concurs… .