Principal Issues: Would the application of paragraph 5901(2)(a) of the Regulations alter the computation of the amounts under clauses 90(9)(a)(i)(A) to (C)?
Position: No
Reasons: Paragraph 5901(2)(a) would not change the surplus accounts of the foreign affiliate at the "lending time" as that term is defined in subsection 90(9).
IFA Roundtable, May 2014 Question 3(a)
Question 3(a): Upstream loan rules - Computation of surplus
Clause 90(9)(a)(i)(A) of the Act permits a deduction in respect of an upstream loan included in a taxpayer's income pursuant to subsection 90(6) or subsection 90(12). The amount deductible is the amount that the taxpayer can demonstrate can reasonably be considered to have been deductible by the taxpayer pursuant to paragraph 113(1)(a) in respect of the exempt surplus of a foreign affiliate of the taxpayer at the lending time, assuming that the amount lent was instead paid by the creditor affiliate or partnership as a dividend. Subsection 90(11) provides that for purposes of subparagraph 90(9)(a)(i), surplus accounts are deemed to be the amounts determined under paragraph 5902(1)(a)(i) of the Regulations.
Assume that an indirectly-owned foreign affiliate ("FA1") generates substantial exempt surplus during a taxation year and uses the resulting cash flow to make upstream loans to its Canadian parent corporation ("Parent") in order to avoid a high withholding tax cost that would apply if it had paid a dividend through the ownership chain to the Canadian parent corporation. Assume further that neither FA1 nor any of the foreign affiliates through which Parent indirectly holds its interest in FA1 has a surplus account balance at its last taxation year end.
In calculating exempt surplus for the purposes of clause 90(9)(a)(i)(A) can a taxpayer rely on the 90 day rule in paragraph 5901(2)(a) of the Regulations?
The technical notes to subsection 90(9) suggest that this is intended to be the result, describing the effect of subsection 90(9) as:
"This is meant to replicate the tax attributes that would be available if an actual dividend had been paid by the creditor affiliate, followed by dividends from any other affiliates between the taxpayer and the creditor affiliate."
CRA Response
In the example provided, in computing the deduction permitted by Parent under subsection 90(9) of the Act, the amount determined under clause (a)(i)(A) would be nil. We would not consider that the application of paragraph 5901(2)(a) of the Regulations would alter this conclusion.
The time that the dividend assumed by paragraph 90(9)(a) is considered to be paid by the creditor foreign affiliate and received (either directly or indirectly) by the taxpayer, is the "lending time", which is defined in that paragraph as the time the loan or debt which gave rise to the subsection (6) or (12) income inclusion was made or incurred. Clause (a)(i)(A) of subsection 90(9) permits a deduction to a taxpayer that is a corporation to the extent that the assumed dividend would have been deductible under paragraph 113(1)(a), in respect of the exempt surplus, at the lending time, of a foreign affiliate of the corporation.
The exempt earnings of a foreign affiliate of a corporation are computed on an annual basis and are added to the affiliate's exempt surplus in respect of the corporation only at the conclusion of each of the affiliate's respective taxation years. As a result, we would not consider exempt earnings of a foreign affiliate in respect of a corporation arising in the taxation year of the affiliate in which a particular loan is made to or a debt incurred by the corporation, to form part of the exempt surplus, at the lending time, of the foreign affiliate, even where those exempt earnings are ultimately included in the affiliate's exempt surplus at the end of that taxation year.
In our view, the determination of whether a paragraph 113(1)(a) deduction resulting from the dividend or dividends assumed to be paid by paragraph 90(9) would be in respect of the exempt surplus of a foreign affiliate at the lending time requires an examination, at the lending time, of the actual surplus amounts of each affiliate assumed by subsection 90(9) to pay a dividend. In the context of the paragraph 90(9)(a) assumed dividend considered in your example, even were paragraph 5901(2)(a) applicable to a real series of dividends paid up the chain of affiliates at that time such that a deduction would be available to Parent under paragraph 113(1)(a) in respect of the real dividend received by it, we would not consider that deduction to be in respect of the exempt surplus of any foreign affiliate of Parent at the lending time.
Jeffrey Johns
2014-052672