Part A: LIFO ordering/s. 113(1)(a) deduction for actual dividends
In 2013 FA, which had exempt surplus ("ES") and net surplus ("NS") of US$100, made a US$100 loan (Loan 1) to Canco (its wholly-owning parent). In 2014 FA paid a dividend (Dividend) of US$50 at a time when it had ES and NS of US$150 (no Reg. 5901(2)(b) election is made). Loan 1 is not repaid within two years and Canco has nil adjusted cost base ("ACB") in the FA shares.
In 2014 Canco will have an income inclusion of C$63, the equivalent of the US$50 dividend. Is Canco able to claim a deduction in each of 2013 and 2014 under s. 90(9)(a)(i)(A) for the Canadian dollar equivalent (C$125) at the "lending time" of Loan 1? Will Canco be entitled to a deduction in computing its 2014 taxable income of C$63 under s. 113(1)(a)?
CRA responded:
…[I]f one were to assume that exempt surplus were reduced on a first-in, first-out basis, it may be possible to argue that the dividend paid in 2014 would "spend" some of the exempt surplus that is relied upon for purposes of the 90(9) deduction such that, in 2014, paragraph 90(9)(b) would be breached.
However…we would consider a last-in, first-out ordering approach to give an appropriate result… .
…Canco would…be entitled to a subsection 90(9) deduction in both 2013 and 2014 in respect of Loan 1. As for the second question, we would note that there is nothing in section 90 that impacts in any way the availability of a deduction under subsection 113(1) in respect of dividends from a foreign affiliate. As such, Canco would be entitled to a deduction of C$63 under that subsection for the dividend received in 2014.
Part B: Subsequent exempt loss/subsequent Reg 5901(2)(b) election
The same facts as in Part A except that FA's exempt surplus balance went down to US$60 as a result of a loss in 2013 and at the time of the Dividend in 2014 Canco's ACB in the FA shares was equal to C$63 as a result of a share subscription, in 2014 but before the dividend, by Canco for FA shares. Canco elects Reg. 5901(2)(b) so that the 2014 C$63 dividend is deemed to be paid out of pre-acquisition surplus. May Canco claim a deduction in 2013 and 2014 under s. 90(9)(a)(i)(A) of C$125? Can it claim a deduction in computing its 2014 taxable income of C$63 under s. 113(1)(d)? CRA responded:
…[A]bsent tax avoidance activity, a subsection 90(9) deduction of C$125 would be available in both 2013 and 2014, given that the reduction of surplus resulting from a loss is not an event contemplated in either paragraph 90(9)(b) or (c) and that the relevant time at which to measure surplus is the dividend time and not any time in a subsequent year in which a subsection 90(9) deduction is claimed to offset a subsection 90(12) inclusion.
…[T]he conditions for making a paragraph 5901(2)(b) election would be met…given that, again, the provisions of section 90 in no way affect the surplus balances of a foreign affiliate. In other words, the condition in the pre-amble of paragraph 5901(2)(b) that requires that "in the absence of [that] paragraph" subsection 5901(1) would deem an amount to be paid out of exempt, hybrid or taxable surplus would be met. …[A] subsection 113(1) deduction would be available by virtue of paragraph 113(1)(d).
Part C: Subsequent upstream loan utilizing Reg. 5901(2)(b) election
: The same facts as in Part A except that at the lending time in 2013 Canco's ACB in the FA shares was C$63, no new ES is generated after Loan 1 is made and, instead of FA paying the US$50 dividend in 2014, FA made a second loan (Loan 2) to Canco of US$50 (which loan is not repaid within two years) in 2014. May Canco claim a deduction in 2013 and 2014 under s. 90(9)(a)(i)(A) of C$125? Can it claim an additional deduction in 2014 of C$63 under s. 90(9)(a)(i)(D) on the basis that it could have made a Reg. 5901(2)(b) election respecting Loan 2? CRA responded:
[In] 2013-048379…we took the position that a taxpayer would be entitled to rely on clause 90(9)(a)(i)(D) if the taxpayer would have been in a position to make a paragraph 5901(2)(b) election if the notional dividend had been a real dividend.
…Thus, if the taxpayer would have been in a position to make a paragraph 5901(2)(b) election had the notional dividend relating to Loan 2 been a real dividend, it is our view that Canco would, in this example, be entitled to a deduction of C$63 under subsection 90(9) by virtue of clause 90(9)(a)(i)(D). Furthermore, the taxpayer may continue to rely on clause 90(9)(a)(i)(A) in respect of Loan 1.