Transactions
Canco (a Canadian-resident subsidiary of a Canadian public company) wholly-owns a US corporation (FA1), which owns some of the limited partnership units of a US limited partnership (USLP1) (with other LP units held by arm’s-length and non-arm’s length investors). Essentially, the only asset of USLP1 is its holding of all of the limited partnership interest in USLP2. USLP2 holds all the common shares of FA2, which is a US private REIT (wholly owned by USLP2 other than a small quantity of preferred shares held by third parties) which fully distributes its taxable income for US tax purposes (“US taxable income”). FA2 invests directly or through intermediate LPs in LPs or LLCs (the “Property Owners”) investing directly in rental properties. Third parties will acquire shares or units in various of the Property Owners.
US taxable income
Where a Property Owner is an LLC (a “Property FA”), it will be disregarded for US tax purposes if wholly owned by an intermediate LP or FA2 or as a partnership if there are also third-party owners. Each directly-owned Property FA of USLP2, or of an intermediate LP, will be a CFA of that partnership. FA1, FA2 and each Property FA carry on an investment business. FA1 will include in its US taxable income its share of the US taxable income of USLP1, which will include the distributions received by it from FA2 (which will distribute all of its US taxable income). In addition to actually distributing US taxable income, FA2 might declare a consent dividend, i.e., a dividend that is not actually paid but is deemed under US tax law to be distributed to shareholders on the last day of the given taxation year and then deemed to be contributed to FA2 (as additional paid-in capital) on the same day.
Dilution of interests in USLP2
The proportionate economic interest of FA1 directly or indirectly in USLP2 is expected to decline over time due to arm’s length investors subscribing for USLP1 or USLP2 units, so that FA2 and the Property FAs will eventually cease to be foreign affiliates of Canco for the purposes of the “specified provisions” described in s. 93.1(1.1). FA2 will remain a foreign affiliate of USLP2.
Rulings
- US income tax paid by FA1 on FA1’s share of the distributions paid by FA2 and on any consent dividends will be “foreign accrual tax” (as defined in s. 95(1)) applicable to amounts that are included in Canco’s income under s. 91(1) in respect of the FA1 shares, to the extent that those distributions and the consent dividends can reasonably be regarded as distributions of amounts that are included, directly or indirectly, in computing income of USLP2 under s. 91(1).
- Provided that, at any time in a particular taxation year, the total equity percentage in FA2 of Canco, and of persons related to Canco taking into account the rules in s. 93.1(1) is at least 10%, such US income taxes paid by FA1 will not be underlying foreign tax of FA1 in respect of Canco by reason of the application of Reg. 5907(1.03).
- Conversely, if this 10% test is not met, such US income tax will be underlying foreign tax of FA1 in respect of Canco to the extent that FA1’s share of the FA2 distributions and of any consent dividends can reasonably be regarded as distributions of amounts that are included, directly or indirectly, in computing income of USLP2 under s. 91(1).