Section 95

Forco 1 is held through three stacked Canadian partnerships (the bottom one, “CanGP 3”) by two taxable Canadian corporations (Canco 1D and Canco 1A) which, in turn, are indirect wholly-owned subsidiaries of a non-resident parent (“Parent”). Forco 1, which is unlimited liability company resident in Foreign Country 3, wholly owns Forco 2, which is resident in Country 3 and wholly-owns Forco 3, which is a limited liability company resident in Foreign Country 2. Parent wholly owns Forco 4, which is a limited liability company resident in Country 2. Forco 5 is a private limited liability company resident in the Netherlands and is directly owned by Forco 2, Forco 3 and Forco 4.

In the factual description, Forcos 1, 2 3 and 5 are described as a CFA of CanGP 3 and also as a FA of Canco 1A and Canco 1B by virtue of s. 93.1(1).

All the shares of Foreignco, which made investments in stock market shares, were held by Mr. A (apparently, non-resident). Mr. B (apparently, resident) had invested in Foreignco through his CCPC (“Canco”). However, as the governing legislation did not permit Canco to invest in Foreignco shares, the sums agreed by Canco were agreed, as an informal contractual matter, to be the consideration for “special warrants” to acquire shares of Foreignco, with such warrants being redeemable by the holder for the FMV of the corresponding Foreignco equity.

Before finding that the s. 94.1 rules applied, the Directorate indicated that Foreignco could not be a controlled foreign affiliate given that Canco did not hold any shares of Foreignco, and that s. 17 did not apply since, until such time as the redemption right was exercised, there was no debt owed by Canco.

Mr. X formed a foundation (a “sifting”) under the laws of Liechtenstein, of which he was the life beneficiary, and his wife and children were the income and capital beneficiaries upon his death. The Directorate found that the foundation was a corporation for ITA purposes given its separate legal personality and limited liability of its founder and members, and went on to find that it should be treated as a CFA of Mr. X in whose capital stock he held 100 out of the 100 outstanding shares, so that his aggregate participating percentage was 100%, stating:

[A]lthough the Foundation's title to property is not divided into "shares”, we will consider that Foundation has a share capital of 100 issued shares and that each person who owns an interest in Foundation owns a number of shares that is proportionate to that person's interest in the Foundation ... .

[G]iven that Mr. X is the sole beneficiary of the capital and income of Foundation for his lifetime and that, pursuant to paragraphs 251(1)(a), 251(2)(a) and 251(6)(a) and (b), Mr. X does not deal at arm's length with the other beneficiaries of Foundation, namely, his wife and children, we are of the view that Foundation is a "controlled foreign affiliate" of Mr. X within the meaning of subsection 95(1). … It appears to us that in the circumstances you would be justified in considering that Mr. X holds 100% of the shares of the Foundation.

Canadian-resident Parent wholly-owned Canco2 and Canco1. Two wholly-owned controlled foreign affiliates of Canco2 (“NR1” and “NR2”) established an Icelandic Sameignarfelag (“FORP”), which was viewed by CRA as a partnership. FORP used capital contributions from NR1 and NR2 to make loans within the affiliated group, with the interest thereon deemed under s. 95(2)(a)(ii) to be active business income to NR1 and NR2.

Next:

1. NR1 purchased an additional interest in FORP from NR2,
2. FORP disposed of its loans to another group company and
3. distributed the cash proceeds thereof as a return of capital,
4. NR1 made a dividend and capital distribution to Canco2
5. Canco2 sold NR1 and NR2 to a wholly-owned CFA of Canco1 (“NR3”), and a non-resident subsidiary of Parent, respectively.
6. All FORP’s remaining assets were distributed to its members
7. FORP was dissolved under Icelandic law
8. NR1 was liquidated and dissolved into NR3.

The taxpayer took the position that at the time it was disposed of the partnership interest of NR1 in FORP was not excluded property and, therefore, the capital gain or loss from the disposition was included in NR1’s foreign accrual property income (“FAPI”) in respect of CANCO1; and that as such gain was computed under s. 95(2)(f.14) in Canadian currency, therefore, the computation of the ACB of NR1’s partnership interest in FORP pursuant to s. 95(2)(j) and Reg. 5907(12) was to be computed in Canadian currency, including each capital contribution and reduction, earnings pick up, and distribution. Accordingly, NR1 computed a foreign accrual property loss (“FAPL”), which FAPL became a loss of NR3 upon the dissolution of NR1. On this basis, Canco1 has requested that this loss be applied to preceding taxation years.

After noting that the date of disposition of the FORP partnership interest was either 6 above by virtue of s. 98(2), or the dissolution date in 7 above, the Directorate stated:

[A] partnership interest held by a foreign affiliate of a taxpayer will be considered to be excluded property when the partnership would be a foreign affiliate of the taxpayer when the deeming rules in paragraphs (d) and (e) in the definition of “excluded property” are applied and if substantially all of the FMV of the property of the partnership itself satisfies the excluded property definition. …

[I]n determining whether [NR1’s] partnership interest is excluded property … any assets held by the partnership on which income was or would be recharacterized as active would qualify as excluded property under paragraph (c). Therefore, the Loans, while they were held by FORP, would have been excluded property.

The Directorate went on to find that if the partnership interest disposition date was 6, the cash held at that time did not qualify as an active business asset (noting that it “being used in a continuation of the active business activities undertaken by FORP, as it had never carried on an active business”); and that on the dissolution date no property was held – so that, either way, para. (b) of “excluded property” as modified by paras. (d) and (e) was not satisfied.

CRA ruled that a distribution of the assets of a mine held by the partnership did not give rise to foreign accrual property income provided that the assets were excluded property. The mine in question had been previously shut down, but now further reserves had been identified and there was a plan to resume operations. See summary under s. 95(1) – foreign accrual property income.

Is internally generated goodwill considered in determining whether shares of a foreign affiliate ("FA2") of a corporation resident in Canada qualify as "excluded property" of another foreign affiliate ("FA1") of the corporation?

CRA referred to the following position taken in 1988 respecting the "small business corporation" definition (after first referring to a similar position respecting s. 149(10)):

[T]he "all or substantially all" test will normally be satisfied if assets representing at least 90 percent of the fair market value of the assets of the corporation are used in an active business carried on by it. The assets of the corporation include goodwill, whether or not such goodwill has been purchased.

CRA then stated:

[I]nternally generated goodwill is property used by FA2 that should be taken into account in determining whether the shares of FA2 are "excluded property" of FA1. However, it must also be determined whether such goodwill is used by FA2 principally for the purpose of gaining or producing income from an active business carried on by FA2. This may, depending on the circumstances, require an apportionment of such use as between the active business of FA2 and the other activities of FA2

Mr. B wholly-owns Canco 3 and Canco 4, and Mr. A, who is unrelated, wholly-owns Canco 1 and Canco 2. Canco 2 and Canco 3 each holds 50% of Forco, which has a 10% LP interest in foreign LP, whose assets are all used in an active business. Canco 1 and Canco 4 each have direct 5% interest in LP – and the other partners of LP are third parties. Would Forco's partnership interest in LP be excluded property? CRA stated:

[B]y virtue of paragraphs (d) and (e) of the definition "excluded property" in subsection 95(1), LP is deemed to be a non-resident corporation having 100 shares of capital stock of which Forco owns 10%, for the purposes of the definitions "foreign affiliate" and "direct equity percentage". Consequently, the equity percentage of Canco 3 in LP is 5%, thereby satisfying the requirement in paragraph (a) of the definition "foreign affiliate" in subsection 95(1).

However… the requirement in paragraph (b) of the definition "foreign affiliate" is not met… because Canco 4's 5% interest in LP is not to be taken into account. – Forco is the only partner of LP that is deemed to hold shares of LP for the purposes of the definition "excluded property". Consequently, LP would not be considered to be a "foreign affiliate" of Canco 3 and Forco's interest in LP would not qualify as "excluded property"… .

Canco's wholly-owned subsidiary Forhold 2 has a 30% interest as general partner in LP1 which has a 15% LP interest in LP2 which, in turn, has 75% of the shares of Forco, substantially all of the asets of which are used principally for the purpose of producing income from an active business outside Canada. Cansub, which is wholly-owned by Canco, has a 25% LP interest in LP1. Forhold 1, which also is wholly-owned by Canco, directly holds 25% of Foco's shares. Would LP2 be considered to be a foreign affiliate of Canco for the purposes of the definition of "excluded property"? CRA stated:

LP1 is deemed to be a non-resident corporation under paragraph (d) of the definition of "excluded property" and paragraph (e) of the definition deems Forhold 2 to own 30% of the shares of that deemed corporation for the purposes of the definitions of "foreign affiliate and "direct equity percentage". Canco therefore has an equity percentage in LP1 of 30%, making LP1 a foreign affiliate of Canco for the purposes of the definition of "excluded property". As LP1 is deemed to be a foreign affiliate...LP2 is deemed to be a non-resident corporation under paragraph (d)...; LP1 is deemed to hold 15% of the issued shares of LP2 under paragraph (e).

…LP1 is considered to have a direct equity percentage of 15% in LP2. Accordingly, Canco has an equity percentage in LP2 that is not less than 1%, thereby fulfilling the requirement in paragraph (a) of the definition of "foreign affiliate". However… the requirement in paragraph (b) of the definition of "foreign affiliate" is not met in these circumstances and therefore LP2 cannot be considered a foreign affiliate of Canco. Paragraph (e) of the definition of "excluded property" only deems LP... [and] no other person...to hold shares in LP2... . [I]t follows that LP1 is the only holder of a direct equity percentage in LP2. ...[Respecting] if Canco is related to LP1 for the purposes of the definition of "excluded property" ... the deeming provisions in paragraphs (d) and (e) of the definition of "excluded property" do not speak to the matter of the de jure control of the "deemed corporation" and therefore do not apply to treat a partnership as a corporation for the purposes of determining if a partnership is related to a corporation. Accordingly, Canco would not be considered to be related to LP1 for the purposes of determining whether LP2 is a foreign affiliate of Canco for the purposes of the definition of "excluded property".

Having concluded that LP2 is not a foreign affiliate of Canco for the purposes of the definition of "excluded property", the shares of Forco held by LP2 are not property of a foreign affiliate of Canco and are therefore not excluded property.

A Canadian resident individual owns 100% of a corporation ("FA") resident in the Netherlands which, in turn, has an interest in a partnership, all or substantially all of the property of which is used or held principally for the purposes of gaining or producing income from an active business carried on in Canada. FA will immigrate to Canada, resulting in a deemed disposition of the partnership interest under s. 128.1(1)(b). Is the partnership interest excluded property, and would any capital gain resulting from its disposition be disregarded in computing the FAPI of FA? CRA stated:

Pursuant to the definition of "excluded property"…a partnership interest held by a foreign affiliate of a taxpayer…will be considered to be excluded property provided that the fair market value of the partnership interest held by the foreign affiliate is not less than 10% of the fair market value of all interests in the partnership and all or substantially all of the property of the partnership is used or held by the partnership principally for the purpose of gaining or producing income from an active business. The definition does not stipulate that the active business must be carried on outside Canada. Further, a taxable capital gain realized by a foreign affiliate on the disposition of an excluded property would not, subject to certain exceptions that do not appear to be relevant…, be included in a foreign affiliate's FAPI for a taxation year.

A foreign affiliate ("Holdco") owns all the shares of a second foreign affiliate ("Subco A") which, in turn, owns all the shares of a third foreign affiliate ("Subco B"). Subco A carries on an active insurance business in a foreign jurisdiction, and some of the investments (e.g., treasury bills) that are required to meet the minimum capital requirements are held in Subco B. The removal of any portion of these investments would have a destabilizing effect on Subco A since it would not meet regulatory and licencing requirements, and on this basis Subco B's income would be deemed to be active under s. 95(2)(a)(i).

The shares of Subco B will be excluded property provided that all or substantially all its assets were used or held by it principally for the purpose of gaining and producing income which by virtue of s. 95(2)(a)(i) was income from an active business.

Where a foreign subsidiary of Canco deposits a sum with a foreign bank to secure its guarantee of a loan made by the foreign bank to another foreign company in which Canco has an indirect 25% interest, with interest on the bank loan exceeding interest on the deposit by 22.5 basis points, income from the deposit will qualify under s. 95(2)(a)(ii)(B), with the deposit qualifying as excluded property.

Where a grandchild foreign factoring subsidiary acquires substantially all its trade receivables from a foreign subsidiary of the taxpayer that itself carried on an active business, the trade receivables acquired by the factoring subsidiary would be excluded property "as those trade receivables are used principally for the purpose of gaining or producing income which is deemed to be active business income pursuant to subparagraph 95(2)(a)(ii)".

Intangible property that is capital property and that is used by a controlled foreign affiliate principally in producing deemed active business income under s. 95(2)(a)(ii) where such income is included in its exempt earnings, will qualify as excluded property.

Example A

Canco owns 100% of Forhold, which has a 90% interest in a partnership (P1), whose only assets are 25% of the shares of a foreign operating company (Forco) and a 90% interest in a second partnership (P2). Substantially all of the property of Forco and of P2 is used principally for the purposes of producing income from their active businesses. CRA stated:

Any capital gain realized by Forhold on a disposition of its 90% interest in P1 would be excluded from its foreign accrual property income ("FAPI") because the interest in P1 would be considered "excluded property" as defined in subsection 95(1)… . Furthermore, any capital gain realized by P1 on a disposition of its 25% interest in Forco or its 90% interest in P2 would be excluded from the FAPI of Forhold, since its interests in Forco and P2 would also be "excluded property".

As noted at the Round Table session of the 1992 Tax Executive Institute Conference, the definition of excluded property was amended to enable a non-resident corporation in which shares of the capital stock are held by a partnership to qualify as a foreign affiliate of a taxpayer for purposes of the excluded property rules. The Department commented as follows:

This position is consistent with the definition of "excluded property" in paragraph 95(1)(a.1) in that it was considered necessary to enact, for purposes of paragraphs 95(1)(d) and 95(4)(a) as they apply to paragraph 95(1)(a.1), the deeming provisions in subparagraphs 95(1)(a.1)(iv) and (v) in order that where a foreign affiliate had an interest in a partnership and the shares of the capital stock of a corporation in which all or substantially all the assets were used in an active business were partnership property such shares could be considered excluded property.

Example B

Canco 1 owns 100% and 65% of Canco 2 and Canco 3, respectively. Canco 2 and 3 own 100% of Forhold 2, and Forhold 3, respectively. Forhold 2 has an interest of 10% in a partnership (P1), and Canco 3 and Forhold 3 have interests of 65% and 25% respectively in P1. P1's only assets are 25% of the shares of Forco) and a 90% interest in a second partnership (P2), both of whose property is used principally for the purpose of producing income from their foreign active businesses. CRA stated:

For the purpose of the excluded property rules P1 and P2 would be considered non-resident corporations. For the same purpose, in interpreting the definition of foreign affiliate in subsection 95(1) of the Act, Canco 2 has an equity percentage of 2.5% in Forco and 9% in P2 for the purpose of paragraph (a) of that definition, and Canco 2 has an equity percentage of 0% in Forco and 0% in P2 for the purpose of paragraph (b) of that definition. However, P1 which is related to Canco 2 has an equity percentage of 25% in Forco and 90% in P2 for the purpose of paragraph (b) of the definition of foreign affiliate. Therefore, for the purpose of the excluded property definition, Forco and P2 are foreign affiliates of Canco. Accordingly, any capital gain realized by P1 on a disposition of its 25% interest in Forco or its 90% interest in P2 would be excluded from the FAPI of Forhold 2, since its interests in Forco and P2 would be excluded property pursuant to that definition in subsection 95(1) of the Act.

Current structure

Canco wholly owns Foreign Holdco, which wholly owns Foreign Subco1, the owner and operator of Mine 1 in Country X. Foreign Subco1 holds Foreign LP through two wholly owned subsidiaries: Foreign Subco3 as general partner; and Foreign Subco4 as limited partner. Foreign LP owns Mine 2, which was previously closed, but as a result of exploration and the identification of reserves, it is anticipated that further surface mining will be undertaken (and the relevant mining permits have been issued). Foreign LP also holds Foreign Corp, all or substantially all of whose assets are used in an active business, and a third-party note receivable previously received for a land sale (the "Note").

Proposed transactions

1. Foreign LP will distribute Mine 2 to Foreign Subco3 and Foreign Subco4 in proportion to their respective partnership interests.
2. Foreign Subco1 will authorize the liquidation and dissolution of Foreign Subco3 and Foreign Subco4, which will distribute all of their assets to Foreign Subco1 as liquidating distributions, and Foreign Subco1 will assume all their obligations and then be dissolved.
3. As a result of Foreign Subco1 thereby becoming the sole member of Foreign LP, Foreign LP will effectively be dissolved so that its property will be considered to be distributed to Foreign Subco1, and Foreign Subco1 will assume all the obligations of Foreign LP.

Additional Information

The above steps will be non-taxable transactions under X's tax law. Each liquidations in 2 will be a designated liquidation and dissolution.The shares of Foreign Corp, the partnership interests in Foreign LP and the Mine 2 properties will be excluded property at the relevant times. The Note is not excluded property so that the taxable capital gain from its disposition will be FAPI. The disposition of the partnership interests upon the dissolution of Foreign LP will result in a capital gain determined under s. 95(2)(f). The fair market value of each of the Mine 2 buildings and the shares of Foreign Corp does not exceed their respective adjusted cost base to Foreign LP, so that no capital gain is anticipated on their disposition by Foreign LP.

Ruling

No FAPI will result from the distribution in 1 of Foreign LP's Mine 2 properties and from the disposition of the shares of Foreign Corp upon the dissolution of Foreign LP in 3 provided these properties are excluded property.

A grandchild foreign subsidiary of Canco ("FA2") is wound-up into an immediate foreign subsidiary of Canco ("FA1") at a time that a note owing by FA2 to FA1 exceeds the asset value of FA2 net of other liabilities. The Directorate commented:

"If the fair market value of the FA1 Note at the time it is settled is less than the lesser of the principal amount of the FA1 Note and the amount for which the FA1 Note was issued, section 80 of the Act could apply if, had interest been paid or payable by FA1 to FA2 in respect of the FA1 Note, clause 95(2)(a)(ii)(D) of the Act would not apply. With respect to the application of section 80 and paragraph 95(2)(g.1) of the Act, it is our view that the FA1 Note is a 'commercial debt obligation' within the meaning assigned under subsection 80(1) of the Act unless, had interest been paid or payable in respect of the FA1 Note, such amount of interest would have been deemed to be nil for the purposes of computing foreign accrual property income ("FAPI") of FA2 under descriptions A and D of the definition of FAPI ...."

Where a foreign affiliate earns foreign accrual property income (rental income) of U.S.$50,000 throughout a year, the average exchange rate for the year is 1.5 and the exchange rate the end of the year at the time a dividend of the earnings is paid to the Canadian taxpayer is 1.3, then the "A" amount in the fapi calculation would be Cdn.$75,000, but the fapi for the year would be Cdn.$70,000 due to a capital loss of Cdn.$10,000 (and deduction under "E" of $5,000) determined under s. 39(2).

Where U.S. taxes are paid by U.S. C.-corp. (which is a foreign affiliate of the Canadian taxpayer) in respect of the investment business of a U.S. LLC in which it has a 90% interest, such taxes will not qualify as foreign accrual tax under subparagraph (a)(ii) of the definition in s. 95(1). However, when the U.S. LLC pays a dividend to the U.S. C.-corp and such dividend is attributable to the income in respect of which the U.S. tax was paid by the U.S. C.-corp., then at the time the dividend is paid the U.S. tax would qualify as foreign accrual tax under subparagraph (a)(ii) of the definition.

The interest income of a controlled foreign affiliate on a foreign currency deposit denominated in a currency which was depreciating rapidly relative to the Canadian dollar was to be measured on the basis of the average exchange rate for the year, without deduction for the accrued foreign exchange loss on the deposit, in light of the fact that s. 39(2) govern the recognition of foreign exchange losses on capital account.

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).

Is the US tax paid by a Canadian-resident taxpayer on the income (which also is foreign accrual property income) of an LLC which is owned by it (and is a controlled foreign affiliate) considered to be foreign accrual tax in respect of the LLC?

CRA noted that as the US tax paid is a tax paid by the taxpayer and not by the LLC, it would not qualify as FAT and, furthermore, that arranging for the LLC to actually makes the tax payments to the IRS would not change this result as "it is implicit that any tax paid by the affiliate is, in fact, the affiliate's tax and not simply a payment on behalf of another person… ."

However, any amount included under s. 91(1) in respect of the FAPI would be considered income from sources in the US for purposes of ss. 20(11) and 126(1), so that an individual taxpayer could deduct under s. 20(11) any portion of the US tax paid for the year in excess of 15% of the s. 91(1) income inclusion. "Any excess [i.e., the 1st 15%] will be eligible for a foreign tax credit under subsection 126(1) and any of the excess US tax paid that cannot be utilized by the foreign tax credit may be deducted from income pursuant to subsection 20(12)." If, the taxpayer is a corporation:

any US tax paid in respect of [its] share of the income of the LLC would not be creditable for purposes of subsection 126(1) nor deductible for purposes of subsection 20(12) because the tax would be paid by a corporation in respect of income from a share of the capital stock of a foreign affiliate of the corporation. However…a deduction under paragraph 113(1)(c) would be available in respect of the US tax paid by a corporation resident in Canada in respect of the income of an LLC where a dividend distribution out of taxable surplus is received from the LLC.

A Guatemalan-resdent foreign affiliate paid tax on gross revenue at a rate (for 2013) of 5% up to a low threshold (approx. Cdn. $3,925) and 6% above that. This tax qualified as an "income or profits tax" given that it was imposed under the same "Guatemalan Income Tax Law" which:

...allows the taxpayer to annually choose whether to pay tax on its gross revenue or to pay tax on its net income or profits. ... In this way the amount of tax that would be paid on net income or profits acts as the maximum amount of tax that would be payable in a particular year.

A wholly-owned US C-corp subsidiary (US Holdco) of a taxable Canadian corporation wholly-owned two LLCs, which earned only foreign accrual property income, with their income being included in that of US Holdco for Code purposes. Under a tax sharing agreement, each group member paid its respective tax costs as if it had filed a separate return, with the amount of this hypothetical tax distributed accordingly - e.g. should an LLC be in a loss position, that LLC would receive compensatory payments from the other group members that represented the hypothetical ‘tax refund.

As all the US tax paid by US Holdco was on its own account and not that of the LLCs (who were flow-through entities), the compensatory payments would not qualify as foreign accrual tax under s. (a)(i) of the FAT definition in s. 95(1), given the requirement that the tax be paid by the particular foreign affiliates (the LLCs). However:

[W]hen the LLCs distribute income to US Holdco such distribution would be characterized as a dividend. The portion of any income or profits tax paid by US Holdco that pertains to the earnings of an LLC which are distributed to US Holdco by way of dividend would, in our view, qualify as FAT under subparagraph (a)(ii)....

Usco (100% owned by Canco) realized FAPI on the gain from the disposition in Year 1, of a partnership in which it has a 50% interest, of a rental property. No gain was realized for Code purposes as a replacement property was acquired. In Year 2, the replacement property was sold giving rise to U.S. tax but no further FAPI. CRA stated:

[B]ecause the FAPI of a foreign affiliate is computed pursuant to the provisions of the Act while the foreign taxes paid by a foreign affiliate are determined in accordance with foreign tax law, there may result many reconciling items and timing differences between the FAPI reported by a taxpayer and the foreign taxes paid by the particular affiliate. The Act alleviates this problem with the above broad wording defining FAT and by providing, in subsection 91(4) of the Act, for a six year period to match the foreign taxes paid with the FAPI reported. …

[T]he U.S. tax paid by Usco on its share of the portion of the gain computed pursuant to the Code from the disposition of the Consideration Property by the Partnership that could reasonably be regarded as the gain and/or recaptured depreciation determined pursuant to the Code that was deferred on the disposition of the Rental Property by the Partnership would qualify as FAT. Canco would be entitled to a deduction pursuant to subsection 91(4) of the Act in respect of such portion because the FAT arose within the time limitations set out therein.

USco1 paid US tax on its share of property income of US LLC (which is a partnership for Code purposes) for 1997. Its Canadian shareholder (Canco) includes the FAPI of US LLC in its income. At the beginning of the following year (1998), US LLC distributes all its earnings to its shareholders. Would the US tax paid by USco1 qualify as foreign accrual tax? CRA responded:

[T]he FAPI included in income by Canco is in respect of US LLC. Since the U.S. tax was paid by Usco1, such tax would not qualify as FAT under subparagraph (a)(i) of the definition in subsection 95(1) of the Act. However, when US LLC distributes (i.e. pays a dividend) to Usco1 and such dividend was attributable to the income in respect of which the U.S. tax was paid by Usco1, it is our view that at the time the dividend was paid the U.S. tax would then qualify as FAT under subparagraph (a)(ii) of the definition in subsection 95(1) of the Act. Provided the requirements of subsection 91(4) were otherwise satisfied, Canco would then be entitled to a deduction in respect of such FAT in computing its income. …

[I]t is a question of fact what portion of the total U.S. income tax paid by Usco1 under the Code for its taxation year ended December 31, 1997 is attributable to its share of the income of US LLC for that year. However once such portion is determined, that portion may reasonably be regarded as applicable to the dividend received by Usco1 from US LLC on January 1, 1998 because that dividend comprises all the earnings of US LLC on which U.S. tax has been paid by Usco1.

What is the "foreign accrual tax applicable" in the following scenario?

CRA responded:

In order for a foreign income or profits tax to qualify as foreign accrual tax it must be paid. Although the tax may not be paid at the affiliate's year end, provided it is paid in due course when the affiliate's tax return is filed, the tax will be considered paid in respect of the year to which it relates. ...

[T]he foreign accrual tax for Year 1 would be $18, while the foreign accrual tax for Year 3 would be $90 ($250 x 36%). This is based on the fact that over the three year period the total Fapi is $300 and the total active business income is $320. In these circumstances, it is our view that the total tax of $223 should be allocated to the Fapi on a 300/620 ratio (300/620 x $223 = $108). As the $18 paid in Year 1 clearly relates to the Fapi, it is our opinion that $90 of the tax paid in Year 3 reasonably relates to the Fapi for that year.

"'Income or profits tax' for the purpose of the definition 'foreign accrual tax' ... may include Canadian income tax paid by a foreign affiliate of a taxpayer if the tax may reasonably be regarded as applicable to an amount included in computing the taxpayer's income by virtue of subsection 91(1)."

The Department’s view was that the limit on the amount of FAT that can be claimed in respect of a taxable capital gain included in FAPI is the amount required to eliminate Canadian tax attributable to the gain (i.e., not limited to the 50% attributable to the portion of the gain included in FAPI). The Department stated:

It is the Department's view that foreign tax paid in respect of a capital gain may reasonably be regarded [as] applicable to an amount included in computing a taxpayer's income by virtue of subsection 91(1) of the Act for the purposes of subsection 91(4) and paragraph 95(1)(c) of the Act and as having been paid in respect of taxable earnings of a foreign affiliate for the purposes of paragraph 5907(1)(1) of the Regulations to the extent that such foreign tax is required to eliminate the Canadian income tax that would otherwise be payable in respect of the gain under the FAPI rules or through the repatriation of the taxable surplus resulting from the gain.

In 1990, FA disposed of capital property giving rise to a $10,000 capital gain for ITA purposes and a gain for Code purposes of $20,000). After deduction of $8,000 under s. 40(1)(a)(iii) and a deductible loss under s. 95(1)(b)(v), FA has no FAPI in 1990. Under the Code, $15,000 of the $20,000 gain is deferred until 1991.

In computing its 1991 FAPI, FA recognizes a $6,000 taxable capital gain ("TCP") under s. 40(1)(a)(ii). Its total FAPI is $10,000 due to interest income of $6,000 less a s. 95(1)(b)(v) deductible loss of $2,000. Under the Code, FA computes taxable income of $16,000 (subject to 38% tax) comprising the $15,000 deferred gain plus the $6,000 of interest less a loss carry-forward of $5,000.

What portion of this tax can be reasonably regarded as applicable to the 1991 FAPI? CRA stated:

[F]oreign tax paid in respect of a capital gain may reasonably be regarded applicable to an amount included in computing a taxpayer's income by virtue of subsection 91(1)… to the extent that such foreign tax is required to eliminate the Canadian income tax that would otherwise be payable in respect of the gain under the FAPI rules… .

In order to determine what portion of the net FAPI was attributable to the TCG…it is necessary to allocate the deductible loss to the two types of FAPI income. In our view this should be done on a pro rata basis thereby producing a figure of $5,000 for the TCG portion of the FAPI (i.e. $6,000 - [6000/(6,000 + 6,000) x $2,000]).

The total U.S. tax paid in the year was $6080 (i.e. the taxable income for U.S. tax purposes of $16,000 multiplied by the U.S. tax rate of 38%) The portion of such amount that is applicable to the capital gain computed pursuant to Canadian tax law is in our view $2,316 (i.e. the proportion of the U.S. tax that the capital gain for Canadian tax purposes is of the U.S. taxable income before the application of the U.S. loss carry-forwards). …

The portion of the $2,316 that would need to be considered reasonably applicable to the 1991 FAPI TCG in order to eliminate Canadian tax in respect thereof would be $1,900 as this amount multiplied by the relevant tax factor for the purposes of paragraph 91(4)(a) produces a deduction equal to the 1991 FAPI TCG ($5,000). A further deduction in respect of U.S. tax paid on the balance of the capital gain reported for U.S. tax purposes may be available under subsection 91(4) of the Act if the original disposition of the property gave rise to an income inclusion under subsection 91(1) of the Act in the 5 immediately preceding years. …

The amount included in computing Canco's income in 1991 by virtue of subsection 91(1) of the Act in respect of the passive interest earned by FA after the deduction of the relevant portion of the deductible loss is $5,000 (i.e.$6,000-[6,000/(6,000 + 6,000) x $2,000]). The U.S. tax that may be reasonably regarded as applicable to such interest is $1,737 (i.e. the proportion of the U.S. tax that the interest income for Canadian tax purposes before the deduction of the deductible loss is of the U.S. taxable income before the application of U.S. loss

The T1135 form and related disclosure stated that specified foreign property “does not include … a share of the capital stock or indebtedness of a foreign affiliate,” without disclosing that the definition “foreign affiliate” for these purposes is narrower than the definition in s. 95(1). For example, if a Canadian corporation holds debt of a foreign “grandchild” subsidiaries whose shares are held by its immediate Canadian subsidiary, then (by virtue of s. 233.4(2)(a) as it applies pursuant to para. (k) of the “specified foreign property” definition in s. 233.3(1)), it will not be considered to be holding debt of a “foreign affiliate,” so that such debt will be required to be disclosed on the T1135 form.

CRA indicated that applications for cancellation of interest or penalties for taxpayers that were misled by the T1135 wording would be “entertained” by CRA, and that it also encouraged taxpayers to voluntarily correct past filing errors through submitting adjustments or applying under the voluntary disclosure program.

Husband and Wife own 51% and 49% of the shares of a non-resident corporation (ForeignCo) and 49% and 51% of the shares of CanadaCo. The two corporations are associated, but ForeignCo is not a foreign affiliate of CanadaCo.

A Liechtenstein anstalt did not issue shares within the meaning of s. 248(1), as there was only one beneficiary. However, a division of the capital of the anstalt into shares was unnecessary so that it was reasonable to consider that the interest of the Canadian resident beneficiary (the taxpayer) was the equivalent of a share. "For Canadian tax purposes, it should suffice that the interest is what accords him the same rights as are normally conveyed by a share."

The taxpayer, as the bearer of the founder's rights, had the power to appoint, remove and discharge the board of directors, so that the taxpayer also controlled the anstalt. Accordingly, it was eminently arguable that the anstalt was a controlled foreign affiliate of the taxpayer, so that the taxpayer could be assessed for fapi generated by the anstalt.

Ruling that a U.S. LLC would be considered a corporation, that the ownership interest of a member would be considered shares, and that distributions would be considered to be dividends.

If a Delaware limited liability company is treated as a partnership rather than a corporation for purposes of the Internal Revenue Code, with the result that the shareholders rather than the company are liable to tax under the Code on the income of the company, paragraph 3 of Article IV of the Canada-U.S. Convention will not apply, s. 250(5) of the Act will not apply, the company will not be a foreign affiliate and will be taxed under the Act as a resident of Canada.

A Wyoming limited liability corporation that indirectly was owned 50% by each of two Canadian corporations dealing at arm's length with each other would be a foreign affiliate of the Canadian corporation under consideration, with the result that s. 95(2)(a)(i) would apply to certain interest income earned by the limited liability corporation.

A CFA ("CFA1") which has been developing IP, manufacturing products for distribution by affiliates and employing more than five-full time employees will not be considered to have commenced carrying on an investment business by virtue of subcontracting out the maufacturing work to related an unrelated parties and elininating its workforce, notwithstanding its licensing of some of its IP to related persons.

When asked whether it would apply the finding in 489599 B.C. Ltd. v. The Queen, 2008 TCC 332, that the requirement for "more than five full time employees", in the definition of "personal services business" in subsection 125(7), could be satisfied with five full time employees and two part time employees, to para. (c) of the "investment business" definition, CRA stated that it will be:

applying the decision in 489599 B.C. Ltd. to the "more than five employees full time" requirement in paragraph (c)...where a foreign affiliate employs five full-time employees and one part time employee. This position supersedes the positions set out in paragraph 15 of IT-73R6 and any technical interpretation issued by the CRA prior to the decision rendered in 489599 B.C. Ltd.

A controlled foreign affiliate of the taxpayer ("USCo") has several wholly-owned subsidiaries (Landcos) resident in the United States each of which holds a parcel of land for the purposes of development and each of which has no employees. The employees of USCo provide managerial, administrative, financial, maintenance and other services to each of the Landcos.

Paragraph (b) of the exclusion to the investment business definition would only be satisfied if the taxpayer could establish that each particular Landco employed the equivalent of more than five employees full-time in the active conduct of its business throughout the period in question taking into consideration the services provided by the employees of USCo. "In this respect, it would be insufficient to demonstrate that the activities of a particular Landco required the equivalent of, for example, six employees during a short period of time and only the equivalent of two employees full-time for the remainder of the period in question."

Mr X, a Canadian-resident individual, owns all of FA1 which, in turn owns 100% of FA2. FAl carries on a US business of acquiring and developing real estate for sale to arm's length persons. FAl employs more than five employees full time in the active conduct of this business and has at the particular time two real estate development projects under way. FA2 was formed to hold a real estate development project for liability reasons, has no employees, its project is managed by FAl's employees and it reimburses FA1 for its related payroll costs.

After indicating that the question as to whether s. 95(2)(a)(i) would apply to deem income of FA2 to be from an active business would turn, in part, on whether FA1 employed the equivalent of more than five employees full time in the development of its own real estate projects, CRA stated that:

had FA1 had only six employees, the real estate development business of FA1 would have been an "investment business" as defined in subsection 95(1) of the Act for the reason that it would not have employed more than five or the equivalent more than 5 employees full time in the active conduct of that business. This is because one of its employees devotes 100% of his time to supervising or managing the development of FA2's real estate project and two other employees spend part of their time doing so and this would have left the equivalent of less than 5 employees employed full time in the active conduct of FAl's real estate development business.

In a situation where a foreign affiliate develops resource property and derives profits from the disposition of such resource properties once developed, RC stated that "if in the above case, the principal purpose of the business of the foreign affiliate was to develop resource property for sale at a profit, it is our view that the business would be an 'investment business'. If on the other hand, the principal purpose of the business was to derive income from the sale of production (e.g., oil or ore) from resource property and in the course of such business, certain resource properties were sold for profit, it is our view that the business would generally fall outside the 'investment business' definition".

An International Business Corporation incorporated in Barbados whose business consisted solely of marketing and the collection of receivables performed in connection with the sale by its U.S. parent of its products to customers residing outside the United States, including persons resident in Canada who dealt at arm's length with its Canadian grandparent would not fall within the definition of investment business in s. 95(1).

If a commissionaire through whom a foreign affiliate did business was merely an agent, the foreign affiliate would be considered to be doing business with the customers to whom the relevant products were sold and licensed, rather than with the commissionaire, for purposes of the arm's length business test in paragraph (8).

Regarding a foreign affiliate of a Canadian corporation that was in the business of buying and selling natural gas and that hedged uncovered exposure on its contracts for the purchase and the sale of natural gas through transactions in natural gas on a commodity futures exchange, RC indicated that "if an examination of the facts of a particular case showed that the hedging activities were incidental to the business of buying and selling of natural gas and thus not a separate activity, then the income from such hedging activities would be active business income".

Where a foreign affiliate is licensed under the Barbadian Off-Shore Banking Act to carry on business activities defined under that Act as 'off-shore banking', such activities will be considered "regulated" in Barbados for purposes of s. 95.

The fact that a foreign affiliate receives funding to carry on its income earning activity by way of debt or equity from a related party would have little if any relevance in the determination of whether its business is carried on with persons with whom it does not deal at arm's length ... .

The question of whether the activities carried on by a foreign affiliate constitutes a single business or two or more separate businesses is one of fact. However, the credit operations (moneylending, trade finance, financial guarantees), deposit taking, cheque clearing, cash and asset management, custodial or fiduciary services performed under contract (not as a trustee), financial product sales and the foreign exchange operations of a regulated foreign bank would generally be considered part of a single business ..."

In response to the question as to whether a particular foreign affiliate is able to include the services provided to it by its own employees in making the determination of whether it employs "the equivalent of more than 5 employees full time in the active conduct of the business" in subparagraph (b)(ii) [now (c)(ii)]of the definition in circumstances where each of its employees spends a part of his or her time performing duties relating to another business of the particular affiliate or the business of related entities and no services of employees of related entities (i.e. referred to in clauses (b)(ii)(A) and (B) of the definition) are provided to the particular affiliate, CRA responded:

Yes, the particular foreign affiliate can include the services of its own employees in such circumstances. The particular affiliate will meet the test provided that it uses the equivalent of more than 5 employees full time in the active conduct of the business for the purposes of subparagraph (b)(ii) of the definition. It does not matter that those same employees have other duties or that the particular foreign affiliate does not have services performed for it by employees of other entities.

Two foreign affiliates (Aco and Bco) each carries on the business of real estate development and employ individuals in the active conduct of that business. Ms. X works a full business day on each working day of each year subject to normal absences due to vacation and illnesses for either Aco or Bco. During a particular taxation year, she spent 80% of her time employed by Aco and 20% of her time employed by Bco in the active conduct of their respective real estate development businesses. CRA stated:

for the purposes of the employee test in paragraph (b)(ii) [now (c)(ii)] of the "investment business" definition in subsection 95(1) for the taxation year in question, Ms. X would count for a 0.8 employee equivalent in respect of the business of Aco and a 0.2 employee equivalent in respect of the business of Bco.

Canco acquired a non-resident corporation (FA2) which was engaged in a non-Canadian business of licensing intellectual property to third parties and also to a subsidiary (FA3) for use in its active business. This business was deemed to be a separate non-active business under s. 95(2)(a.3) as the IP came within the extended definition of "lease obligations." See detailed summary under s. 95(2)(k).

FA2 (which owns directly or indirectly all of the shares of the "AFAs" resident in "Foreign Country") is a controlled foreign affiliate and indirect subsidiary of a chain of Canadian unlimited liability companies, including Canco2, which in turn are indirect subsidiaries of Forco2. Prior to the sale described below, FA2 was the "head company" in a consolidated group in Foreign Country, consisting of it and the AFAs, so that it was required to file a tax return for each foreign tax year (perhaps, the calendar year) reporting all income and loss of the consolidated group for that period. FA2 also apparently had a calendar fiscal year for accounting purposes.

In order (para. 21) "to achieve consolidation for Foreign Country income tax purposes with Forco2 as the head company of a consolidated group that includes FA2 and the AFAs" (and with FA2 no longer being such consolidator), FA1 (another CFC of the Cancos) and Canco2 sold all their shares of FA2 to Forco2. Immediately before the sale, FA2 and the AFAs settled various intercompany balances among them "in order to simplify the determination of whether the shares of FA2 were excluded property" (para. 12). "FA2's foreign tax year is not deemed by the laws of Foreign Country to have ended on the sale date as a result of its shares being purchased by Forco2, and FA2 is not obligated under Foreign Country's income tax law to file any income tax return in respect of a period ending on that date" (para. 17).

The proposed transaction is that Forco2 will elect in a Foreign Country return for the year of sale to be the head office of a consolidated group comprising it, FA2 and the AFAs.

Rulings that the taxation years of FA2 and the AFAs as defined in s. 95(1) were not affected by the sale, so that such taxation years ended on XXX (presumably, December 31 of the year of sale), the same as before. In its summary, CRA stated:

...the taxation year of the foreign affiliate under the subsection 95(1) of the Act is the taxation year of the foreign affiliate under the taxation laws of its country of residence. If the foreign affiliate does not have to report its income to the foreign home jurisdiction, the taxation year will be determined based on the relevant accounting principles of its home jurisdiction and in accordance with its corporate statutes.

The taxation year of a foreign affiliate, for FAPI and surplus account computation purposes, should generally, be the same as the taxation year used for foreign income tax reporting.

A change in the statutory and taxation year end (from December 31 to June 30) used by a foreign affiliate for corporate law and foreign taxation purposes would also result in a change to its taxation year for purposes of the Act.

In light of its specific wording, s. 95(1)(g) [now, s. 95(1) - taxation year] is not overridden by s. 249(4).

An Alberta trust company that offers services to the public as executor, administrator, trustee, bailee etc. and is not authorized to carry on a deposit-taking business would qualify as a trust company for purposes of s. 95(2)(1) given that the definition is an inclusive one.

Canco carries on a life insurance business in Canada, and also through a foreign branch with clients in the foreign country. The income of FA, which is wholly-owned by Canco and resident in that county, from its own insurance business carried on that country is solely "income from an active business."

Would s. 95(2)(a.1) deem FA's income from the sale of property (that had been used in its business) to Canco's foreign insurance branch to be income from a business other than an active business if the particular property were subsequently sold by Canco's foreign branch to a person with whom Canco deals at arm's length, so that ss. 138(2) and (9) excluded the resultant income, gain or loss from Canco's income? CRA responded:

[I]f subsections 138(2) and (9) apply to exclude the income, gain or loss arising from the disposition of the property, previously acquired by Canco's foreign insurance branch from FA, from Canco's income from an insurance business for the purposes of Part I… the cost of such property would not be "relevant in computing the income from a business carried on by" Canco for the purposes of paragraph 95(2)(a.1). Accordingly, paragraph 95(2)(a.1) would not apply to FA's income from the sale of the property to Canco.

Articles

Gross revenue from indebtedness, the income from which would be excluded from fapi pursuant to s. 95(2.4), will nonetheless be taken into account for purposes of determining whether the 90% gross revenue test in s. 95(2)(a.3) has been met. For these purposes, gross revenue from the sale of indebtedness would include the full proceeds of disposition rather than only the gross profit.

CRA found that the s. 95(3)(b) exclusion was unavailable where the foreign subsidiary was providing marketing services to Canco respecting the sale of Canadian residential condominiums by Canco in the course of its Canadian business, given its conclusions that real estate inventory did not qualify as “goods.”

In 2013-0474431E5 below, CRA indicated that if Canco seconds employees to its non-resident subsidiary (FA) for use in FA's services business with arm's length customers there, CRA will not impute foreign accrual property income to Canco under s. 95(2)(b)(ii) if the employees are provided to FA at cost rather than at, say, a 25% mark-up.

In response to this follow-up question, CRA confirmed that "if the Canadian parent earns a profit, then it would be considered to provide the services of its seconded employees in the course of its own business," and clarified that a mark-up over direct salaries will not result in FAPI if there is no profit element, i.e., the mark-up covers other costs such as employment benefits – and that whether more than that level of markup would result in an offsetting deduction in computing the FAPI of FA "depends on the proper determination of the related profit to be attributed to the activities of the relevant personnel."

underline;">: Facts. Foreign Affiliate, a wholly-owned subsidiary of Canco, which provides services to arm's length customers solely in the foreign country, provides 5% of such services through employees of Canco who have been seconded to it (and relocated to that foreign country). Canco pays their salaries and charges Foreign Affiliate a fee equal to the cost of their remuneration plus a 25% mark-up. Q. 1: What portion of the service business income of Foreign Affiliate will be recharacterized as FAPI? Q. 2: What if Canco does not charge a mark-up?

Q. 1 Response [FAPI if mark-up]

[W]here a mark-up or profit element is charged by the taxpayer (Canco), that factor is indicative of the fact that Canco is providing services in the course of its business to and on behalf of Foreign Affiliate. … [I]t may be arguable that if all the employees have comparable skills, then since 5% of the services provided by Foreign Affiliate during a particular period of time are performed by the seconded employees of Canco, only 5% of the income earned by Foreign Affiliate in respect of the services provided during that period of time will be recharacterized as FAPI pursuant to subparagraph 95(2)(b)(ii)…

Q. 2 Response [no FAPI if no actual or imputed mark-up]

If…Canco is simply reimbursed for the cost of remuneration paid to the…seconded [employees]…, provided the reimbursement represents arm's length compensation to Canco, … a seconded employee would be seen as providing services on behalf of Foreign Affiliate only…[so that]… the activities of the employees would not be seen as comprising part of the business activities of Canco. Accordingly…subparagraph 95(2)(b)(ii) will not apply to recharacterize the income of Foreign Affiliate. …However, in a case where subsection 247(2)… would apply to impute a profit element in respect of a fee for the services provided by employees of a taxpayer seconded to a foreign affiliate of the taxpayer that is in the business of providing services, it would in our view follow that the taxpayer provided services through such employees and [s.] 95(2)(b)(ii) applies.

S.95(2)(b) would apply where a Canadian subsidiary of a Canadian financial institution, which provides management services to pension funds but is not licensed to carry on an investment management business outside Canada, appoints a controlled foreign affiliate of its parent as a sub-adviser for non-Canadian securities under a bona fide subcontract, comparable to that which the foreign affiliate would enter into in providing services to arm's-length parties.

A Co. ( a CCPC) employs approximately 6 to 8 full-time engineers including Mr. A (its 75% shareholder) in its business of providing engineering services in Canada. B Co., a wholly owned U.S. subsidiary, directly employs approximately 8 to 10 full-time engineers but also utilizes the services of A Co.'s staff, including Mr. A. in providing engineering services in the U.S. B Co. reimburses A Co. for the portion of A Co.'s salary expense that relates to work done by A Co.'s employees for B Co. Mr. A performs services directly for B Co.'s customers for which the customer pays B Co. an hourly fee. In addition, he performs supervisory and managerial service for B Co. for which B Co. does not directly charge its clients. CRA stated:

[S]ubparagraph 95(2)(b)(ii) clearly applies…[but] the more difficult task is the determination of the amount of B Co.'s income that is affected by such application. …[R]elevant factors to consider would include...whether Mr. A's presence, or management or supervisory services, impact on the hourly fee that can be charged B Co.'s customers.

For example if B Co.'s hourly charge to its customers is well in excess of the approximate hourly rate paid to its engineers, it is likely that a portion of the income on such jobs is attributable to services provided by Mr. A... .

Current structure

Forco 1 is held through three stacked Canadian partnerships by two taxable Canadian corporations (Canco 1D and Canco 1A) which, in turn, are indirect wholly-owned subsidiaries of a non-resident parent (“Parent”). Forco 1, which is an unlimited liability company resident in Foreign Country 3, wholly owns Forco 2, which is resident in Country 3 and wholly-owns Forco 3, which is a limited liability company resident in Foreign Country 2. Parent wholly owns Forco 4, which is a limited liability company resident in Country 2. Forco 5 is a private limited liability company resident in the Netherlands whose shares are held directly by Forco 2, Forco 3 and Forco 4.

Proposed transactions

1. Forco 2, Forco 3 and Forco 4 will create DC, a Dutch cooperative under the Dutch Civil Code, without making a capital contribution. Upon the registration of the notarial deed with the commercial register, DC will be regarded as a legal entity that exists separately from its members under the Dutch Civil Code and the Netherlands domestic income tax law.
2. The Articles will provide that each member must make capital contributions to DC as unanimously agreed upon by all members, the number of votes that a member may cast at a general meeting of members will generally be proportionate to its percentage of ownership in DC, a distribution of retained profits will only be made with the unanimous agreement of all members and such distributions will be proportional to the respective ownership percentages, and the members will not be liable for any debts or losses incurred by DC that are in excess of their required contributions to the capitalization of DC.
3. Each of Forco 2, 3 and 4 will transfer all of its Forco 5 Shares to DC solely in consideration for a credit to its membership account in DC in the amount of the fair market value of the transferred shares.
4. Each of Forco 3, 2 and 4 will be liquidated and dissolved in succession.

Additional Information

The Dutch Civil Code provides that “a Dutch cooperative may, by its articles of association, exclude or limit to a maximum, any liability of its members or former members to contribute to a deficit.” “DC will generally not be required to withhold any tax in Foreign Country 1 on any dividends paid to Forco 1.”

Rulings

• DC will be treated as a corporation for the purposes of the Act, and as a non-resident corporation without share capital for purposes of s. 93.2.
• Membership interests in DC will be deemed to be shares of a single class by s. 93.2(2).
• Provided the transfers of Forco 5 Shares to DC described in 3 increase the fair market value of the deemed class of Shares of the capital stock of DC and no election is made under s. 93.2(3)(b), s. 95(2)(c) will apply.
• S. 95(6)(b) will not apply to the transfers by Forco 2 and Forco 3, in 3.

FA1 (wholly-owned by Canco) transfers all of the shares of FA2 to another non-resident subsidiary of FA1, viz., a non-share corporation (“FA3”), as a capital contribution, i.e., no new member interests are issued by FA3. S. 93.2(3)(a) deems FA3 to have issued shares to FA1 in respect of the transfer if the fair market value of a class of its shares (i.e., the FMV of its membership interest) is increased as a result of the transfer.

CRA noted that, as a technical matter, s. 93.2(3)(a) does not appear to go quite far enough so as to permit the particulars of the rollover formula in s. 95(2)(c) to be filled in. However, CRA went on to find that despite these “textual challenges,” the s. 95(2)(c) rollover would be available provided that the fair market value of the membership interest in FA3 increased by the FMV of the contributed shares.

Canco realized a suspended loss when it contributed its shares of a controlled foreign affiliate (CCo) to another CFA (BCo). CRA found that such loss was not de-suspended when CCo was then liquidated into BCo, on the basis that s. 40(3.5)(c)(i) applied to the liquidation, which was viewed by CRA as a "merger" that resulted in the "formation" of BCo (notwithstanding that BCo as a corporate entity had already been in existence prior to the merger).

The Agency was advised that under the corporate law of the Czech Republic, there was a distinction between a wind-up with liquidation of a subsidiary (under which an appointed liquidator sold all property of the company and settled all obligations) and a wind-up of a subsidiary into its sole member/shareholder without liquidation where the business assets were transferred to the sole member. In discussing whether either procedure would qualify as "a liquidation and a dissolution" for purposes of s. 95(2)(e.1), the Agency indicated that the question to be answered was whether these procedures corresponded to the nature of a liquidation and a dissolution under Canadian corporate law and stated:

[L]iquidation refers to the act of satisfying the creditors and distributing the remaining assets to its shareholders.

Under our law, a corporation generally has to settle its debts and allocate the property to its shareholders in order to be dissolved. Even if that stage is not referred to as a liquidation under a particular enactment, where the property of the corporation is being distributed to the shareholder and the liabilities of the corporation are discharged, it will likely be qualified as a liquidation for the purposes of the Act. [citing Dauphin Plains]

...[W]hat you refer to as a "winding-up without liquidation" may be similar to what we consider a voluntary liquidation and dissolution under section 211 of the CBCA and provided that you have described Czech law accurately, it could be qualified as "a liquidation and a dissolution" for purposes of paragraph 95(2)(e.1) of the Act.

Where the disposing affiliate is resident in a different country than the liquidating affiliate, the exception only applies where gain or loss is recognized by the disposing affiliate. It does not matter whether gain or loss is recognized by the liquidating affiliate.

S.95(2)(e.1) would apply to the dissolution of a U.S. foreign affiliate into another wholly-owned U.S. foreign affiliate if the transaction resulted in no recognition of gain or loss for U.S. federal tax purposes, but it was considered a taxable transaction for U.S. state tax purposes.

FA1 which is wholly-owned by Canco is formed to acquire all the shares of FA2 (which carries on an active business in a designated treaty country) using $100 borrowed from an arm’s length bank. In a subsequent year FA2 pays an exempt surplus dividend of $75 to FA1. FA1 uses $10 from the dividend to pay interest to the Bank, and pays an exempt surplus dividend of $65 to Canco.

Would the interest paid by FA1 to the Bank be deductible in computing its foreign accrual property income, thereby resulting in a net loss in respect of FAPI (a “FAPL”)? May Canco may choose to forgo the interest deduction in computing the FAPI/FAPL in respect of FA1? CRA responded:

Paragraph … 95(2)(f.11) would not have any impact on the computation of FA1’s FAPI/FAPL. Therefore, the interest deductibility provision in paragraph 20(1)(c) would apply to provide an interest deduction in the computation of FA1’s FAPI/FAPL, provided that all the conditions of that paragraph were met. Further … clause 95(2)(a)(ii)(D) would not apply to the interest paid or payable by FA1 to the Bank. Therefore, if FA1 does not have any other amounts to be included in the computation of FAPI, the interest deduction for the interest paid or payable to the Bank would result in a FAPL in respect of FA1.

… Canco is not required to deduct the interest expense paid or payable by FA1 to the Bank when computing FAPI of FA1, since paragraph 20(1)(c) is a discretionary deduction … . However, if Canco does not deduct an amount of interest in computing FA1’s FAPI/FAPL for the year in which that interest is paid or payable, that interest may not be deducted in computing FA1’s FAPI/FAPL for any subsequent year.

… Since FA1 does not carry on an active business or earn income that is deemed to be from an active business ... Regulation 5907(2.03) would not apply to require that Canco deduct the interest expense paid or payable by FA1 to the Bank in computing FA1’s income/loss from property.

Regulation 5907(2.7), which otherwise requires a foreign affiliate to claim deductions in the earliest year in which an amount is paid or payable and deems the affiliate to be carrying on an active business, also would not apply to FA1 as the Bank is not a foreign affiliate of Canco.

Where a U.S. limited partnership (USLP) is converted into a U.S. limited liability company (LLC), CRA has commented that the USLP is considered to have disposed of its assets at fair market value (FMV) and the holder of a partnership interest is also considered to have disposed of its interest at FMV. What is the adjusted cost base (ACB) of the membership interests in the converted entity (i.e. the LLC) to the members, as well as the LLC’s ACB in its assets immediately after the conversion? CRA responded:

[W]e are of the general view that a disposition of the partnership interests in the USLP and an acquisition of the membership interests in the LLC, as well as a disposition of the assets of the USLP and an acquisition of such assets by the LLC, would occur at FMV. Thus, the total ACB immediately after the conversion of all the membership interests in the LLC to the members would generally correspond to the total FMV at the time of the conversion of all the interests in the USLP. Furthermore, the LLC’s ACB in its assets immediately after the conversion would generally correspond to the FMV of these assets at the time of the conversion.

The above comments should be considered whenever there is a conversion … to U.S. limited liability partnerships or U.S. limited liability limited partnerships… .

… The CRA remains open to … an advance income tax ruling request… .

CRA considers that the s. 247(2) rules apply to transfer pricing between a controlled foreign affiliate and non-resident non-arm’s length persons where such transactions affect the computation of the CFA’s foreign accrual property income. However, CRA generally will not apply s. 247 to such a transaction where

• the pricing is reviewed by the tax authority of the country in which the foreign affiliate is resident;
• the pricing is determined to be in accordance with the transfer pricing legislation or guidelines of that country; and
• that legislation (and guidelines) adopt the arm’s-length principle.

An operating grandchild subsidiary of Canco in the United States ("FA2") pays off a third-party U.S.-dollar borrowing the initial proceeds of which had been lent by it to Canco in U.S. dollars. On the repayment of the third-party debt, the gain to FA2 under s. 39(2) is recognized under s. 95(2)(f)(i). S.95(2)(i) is inapplicable as the borrowed money did not relate to the acquisition of excluded property.

Where a US foreign affiliate lends Deutschemarks to a German foreign affiliate, the appropriate currency to use for the purposes of determining the first foreign affiliate's foreign exchange gain on settlement of the loan will be US dollars, and s. 95(2)(g) will not deem that gain to be nil because the gain did not arise by virtue of a fluctuation of the Canadian dollar relative to another currency.

The Department also stated:

"Where a particular currency has become a generally accepted currency for conducting business in a country, such currency may be considered 'reasonable in the circumstances', notwithstanding that some other currency is the official currency of that county. As well, the currency that is used for income tax purposes in the foreign jurisdiction would normally be considered 'reasonable' in the circumstances. We do not envisage a situation where Canadian currency would be reasonable in the circumstances, as you have suggested."

An grandchild FA subsidiary of the taxpayer (FA2), which carried on both an investment business, generated royalties from licensing its IP (which had been stepped up under s. 95(2)(k.1) both to its wholly-owned subsidiary engaged in an active business (which was deemed in FA2’s hands under s. 95(2)(a)(ii)(B)(I) to be active business income) and to third parties (which was FAPI).

The Directorate found that the s. 20(1)(b) and other applicable deductions would be made first before determining the allocation of FA2's business income which was recharacterized under s. 95(2)(a)(ii) and that portion which remained as FAPI - so that in effect, only a portion of the s. 20(1)(b) deduction sheltered the FAPI. Furthermore, the portion of the income of FA2 which otherwise would be FAPI and that reasonably related to the portion of the year of FA2 prior to the acquisition of FA1 by Canco was to be excluded fom the FAPI attributed to Canco.

An Iceland “Sameignarfelag” (viewed by CRA as a partnership), which had been serving as a Finco to foreign affiliates in a Canadian multinational group, was wound up into its non-resident partners (NR1 and NR2, wholly-owned by Canco2). The interaffiliate loans had been giving rise to active business income to NR1 and NR2 under s. 95(2)(a)(ii)(B) and, thus, were excluded property. However, by the time of the disposition by NR1 and NR2 of their partnership interests on the winding-up, the partnership interests at that time no longer qualified as excluded property.

Accordingly, their ACB was to be computed in Canadian dollars under Reg. 5908(10), i.e., essentially it became irrelevant that for most of its life, the Icelandic partnership held excluded property for which the calculating currency of its partners was to be used. This, in turn, meant that NR1 and NR2 realized a capital loss for FAPI purposes on the partnership wind-up. In this regard, and after noting that amounts relevant to determining NR1’s exempt earnings would have been computed in relating to the loans in NR1’s calculating currency rather than Canadian dollars, CRA stated:

[A]djustments to ACB that may be the result of amounts that arose at a time while the property was excluded property will still need to be computed in Canadian currency, and if denominated in another currency, converted to Canadian currency at the relevant spot rate for the day the amount arose.

An exempt foreign trust (the "Trust") is deemed by s. 94.2(2) to be a non-resident corporation controlled by (and therefore a CFA of) a beneficiary resident in Canada, which is a financial institution under s. 142.2(1). After finding that the Trust, as a financial institution, would be subject to the specified debt obligation and mark-to-market rules in ss. 142.2 to 142.6 in calculating its foreign accrual property income ("FAPI"), CRA was asked: In computing FAPI, could the beneficiary calculate the Trust's foreign currency gains or losses by comparing the Trust's net asset value at the beginning of the year to its net asset value at the end of the year in Canadian dollars, based on the exchange rates at those relevant times? CRA responded:

Although section 94.2 is a relatively new provision…, the question of how to compute FAPI in circumstances where complete and full information may not be accessible is not novel, as it has historically been relevant in connection with CFA status under former subparagraph 94(1)(d) (the predecessor of current section 94.2) and paragraph (b) of the definition of "controlled foreign affiliate" in subsection 95(1). As such, we will not comment on the specific proxy proposed to be used in the particular circumstances.

… [A] failure to report income as required, and false statements or omissions, in respect of prescribed reporting requirements may result in substantial penalties under section 162 or 163. However, section 233.5 may provide some relief concerning the prescribed reporting requirements where a Canadian taxpayer may not have all the information required to fulfil the reporting requirements of subsection 233.4(4)… . Additional relief in connection with reporting requirements may be available on a case-by-case basis under subsection 220(2.1).

See summary under s. 142.2(1) – financial institution.

Where a US foreign affiliate had lent money to a German foreign affiliate that was denominated in Canadian dollars, a foreign currency loss arising on settlement of the debt would be deemed by s. 95(2)(g) to be nil.

The only significant asset of FA2 is a loan receivable of $100 owing by its parent, FA1, which is a wholly-owned foreign affiliate of Canco. The $100 note would be a commercial debt obligation for s. 80 purposes.

If a portion of the debt of a controlled foreign affiliate has been used to earn FAPI, and the remainder to earn active business income, the whole debt would be a "commercial debt obligation", not just the portion that related to the earning of FAPI. However, s. 95(2)(g.1) did not apply as all of the debt was used to earn dividends from subsidiaries and interst income that was deemed active business income under s. 95(2)(a)(ii).

A controlled foreign affiliate acquires a building, for continuous use in its active business, from a third party by issuing a note (or assuming debt). Would s. 95(2)(i) apply to the subsequent settlement of the indebtedness? CRA responded:

[P]aragraph 95(2)(i) would apply if the CFA had acquired the building from a third party by issuing a note.

…[T]he phrase "a debt of the debtor all or substantially all of the proceeds from which were used to acquire property" in paragraph 95(2)(i) can be interpreted…so as to include an amount payable for property acquired to the extent that all or substantially all of the amount payable was incurred to acquire excluded property.

…[G]enerally, examples where paragraph 95(2)(i) may apply would include an amount outstanding on account of the purchase price, a note issued, or a debt assumed for the acquisition of excluded property by a foreign affiliate.

A U.S.-dollar denominated debt (the "Liability") owing by a Hungarian corporation ("FA") to its Canadian parent (the "Taxpayer") arose as a result of a reduction in the capital ("the Capital Decrease") of the shares of FA occurring under Hungarian corporate law. The Liability thereafter was settled by several cash payments, so that the Taxpayer sustained a capital loss. The Taxpayer's position was that the indirect use test and "filling the hole" principle should apply in the context of s. 95(2)(i), i.e., the Liability replaced the capital originally invested by Canco in the FA which had been used by the FA to make U.S. dollar denominated loans (the "US Loans" – representing substantially all FA's assets) to other foreign affiliates, the interest income on which was re-characterized as active business income pursuant to s. 95(2)(a) – so that s. 95(2)(i)(i)(B) applied to avoid gain to FA on the settlement of the Liability.

In finding that s. 95(2)(i) did not apply to the settlement of the Liability, the Directorate stated:

[T]he requirement in the preamble of 95(2)(i)(i) that there be "proceeds" from the Liability is not satisfied because the FA did not receive anything (money or other property) on the Capital Decrease which gave rise to the Liability. In addition, the requirement in clause 95(2)(i)(i)(A) is not satisfied because there was no property acquired by the FA as a consequence of the Capital Decrease. Finally, the condition in clause 95(2)(i)(i)(B) that the proceeds of the debt be used to earn income from an active business "carried on by the debtor" is not satisfied. While the interest income earned by the FA is income that is deemed to be income from an active business of the FA by the provisions of paragraph 95(2)(a), those provisions do not deem the FA to carry on an active business.

underline;">: Q.4(a). Would earning interest on borrowed money for a short period after the borrowing and before it can be employed to acquire excluded property cause s. 95(2)(i) to be inapplicable. After affirming 95-5293 (below), CRA stated:

[A] brief period… after the receipt of borrowed funds… and [before] their deployment for a qualifying purpose or after the receipt of proceeds on disposition of excluded property and the use of those proceeds for the repayment of a related debt would not automatically prevent paragraph 95(2)(i) from applying… . However…the taxpayer should be prepared to establish that the brief delay could not practically have been avoided and was not attributable to financial considerations like a desire to earn a return from a non-qualifying investment, to avoid temporary cash flow issues or because of exchange rate considerations.

Q.4(b)

Would s. 95(2)(i) inapplicable if the borrowed money is used to acquire property such as shares that does not qualify as excluded property for a very short period of time, but the taxpayer takes immediate steps to ensure that the shares qualify, for example, by disposing of non-qualifying assets? CRA stated:

[S]teps can be undertaken to restructure or dispose of non-qualifying assets as part of the pre-acquisition structuring or immediately after the acquisition [from the third party]. If the taxpayer takes steps to ensure that the shares qualify as excluded property immediately after the acquisition, for example by disposing of non-qualifying assets, and such shares qualify as excluded property within the same day they are acquired and the related debt has been incurred, we would consider paragraph 95(2)(i) to apply.

Existing structure

Canco, which is a privately-owned taxable Canadian corporation, holds a US limited liability limited partnership ("LLLP") directly and through the wholly-owned GP (Cansub). LLLP borrowed U.S. dollars under interest-bearing "Term Advances" from arm's length "Senior Lenders," and on-lent those proceeds on a non-interest bearing basis to a wholly-owned special-purpose ULC under the LLLP-ULC Loans. ULC, in turn, on-lent those U.S. dollar proceeds on a non-interest-bearing basis to its special-purpose LLC subsidiary under the ULC-LLC Loans. LLC on-lent such proceeds on an interest-bearing basis under the LLC-FA Subco Loans to a grandchild U.S. subsidiary of Canco (FA Subco). FA Subco used those proceeds to on-lend them on an interest-bearing basis to its U.S. operating subsidiary (FA Opco) under the FA Subco - FA Opco Loans or to subscribe for common shares of FA Opco. FA Opco used such share subscription proceeds or borrowed money in its U.S. operating business, as described in the unredacted ruling.

Proposed transactions

LLC will pay a U.S. dollar dividend to ULC who, in turn will pay a U.S. dollar dividend to LLLP. The ULC-LLC Loans, the LLC-FA Subco Loans, the LLLP-ULC Loan and the Term Advances (owing by LLLP) will be settled in accordance with their terms – with the accrued interest owing by FA Opco, FA Subco and LLLP being paid.

Rulings

A. The income of FA Opco from carrying on its business operations…will be regarded as "income from an active business" carried on by FA Opco in the [U.S.], within the meaning of that definition in subsection 95(1) and for the purposes of Part LIX…..

B. Income derived by FA Subco from the interest payments [on the FA Subco FA Opco Loans] will be included in computing the income from an active business of FA Subco, for its taxation year in which the payment will be received, in accordance with subclause 95(2)(a)(ii)(B)(I) and in computing the "earnings" from an active business of FA Subco and its "exempt earnings" in accordance with the definitions in Part LIX of the Regulations.

C. Income derived by LLC from the interest payments [on the LLC-FA Subco Loans] will be included in computing the income from an active business of LLC, for its taxation year in which the payment will be received, in accordance with the following provisions:

(1) subclause 95(2)(a)(ii)(B)(I) to the extent of the portion of the interest paid or payable by FA Subco in respect of the portion of the proceeds from LLC – FA Subco Loans that were used by FA Subco in the relevant period to earn income from the [FA Subco FA Opco Loans], and

(2) clause 95(2)(a)(ii)(D) to the extent of the portion of the interest paid or payable by FA Subco in respect of the portion of the proceeds from LLC – FA Subco Loans that were used by FA Subco in the relevant period to subscribed for additional common shares of FA Opco… provided that the FA Subco common shares continue to be Excluded Property and FA Subco and FA Opco continue to meet the conditions in that clause with respect to their residence and being subject to taxation in the Foreign Country, and such interest will be included in computing the "earnings" from an active business of LLC and its "exempt earnings" in accordance with the definitions in Part LIX….

D. Provided that the [LLC-FA Subco Loans] continue to constitute Excluded Property to LLC, paragraph 95(2)(i) will apply to deem any gain or loss realized by LLC on the settlement of [such loans] to be a gain or loss from the disposition of Excluded Property.

E. Provided that the [FA Subco FA Opco Loans], and the shares of FA Opco, continue to constitute Excluded Property to FA Subco, paragraph 95(2)(i) will apply to deem any gain or loss realized by FA Subco on the settlement of the [LLC-FA Subco Loans] to be a gain or loss from the disposition of Excluded Property.

F. The following gain or loss will be accounted for under subsection 39(1) or (2), as the case may be:

(1) provided that ULC continues to hold the [ULC-LLC Loans] as capital property, any gain or loss realized by ULC on the settlement of those loans….;

(2) any loss or gain realized by ULC on the settlement of the [LLLP-ULC Loans];

(3) provided that LLLP continues to hold the [LLLP-ULC Loans] as capital property, any gain or loss realized by LLLP on the settlement of those loans…;

(4) any loss or gain realized by LLLP on the settlement of the [Term Advances].

G. Subparagraph 40(2)(g)(ii) will not apply to deny any loss that may be realized by LLLP on the settlement of the [LLLP-ULC Loans], nor to deny any loss that may be realized by ULC on the settlement of the [ULC - LLC Loans].

Further rulings re s. 17 not applying based on s. 17(3) or 17(8)(a)(i), s. 113(1)(a) deduction to ULC, s. 20(1)(c) deduction to LLLP, and re ss. 247(2) and 245(2).

After a foreign affiliate incurred a liability and used the proceeds to acquire an excluded property, it disposed of the property and deposited the proceeds into a bank account - before it made arrangements to repay its liability and realized an exchange gain. CRA stated:

Provided there is clear evidence, at the time of the disposition of the excluded property, that arrangements are being made for the repayment (with due dispatch) of the "related debt"...the fact that the actual repayment of the debt occurs after the disposition of the excluded property would not, in and by itself, result in the debt not being considered "... related at all times ... ". However if it was determined that other factors (such as cash flow problems, or unfavourable prevailing interest or exchange rates) contributed to the delay in repayment, it is likely that the provisions of paragraph 95(2)(i) would not apply on the repayment of the debt.

2014-0536581I7 found that the fresh start rule can apply to bump the tax basis of the assets of a foreign corporation which is acquired by Canco and thereby becomes a foreign affiliate of Canco which is carrying on an investment business, even though s. 95(2)(k)(ii)(A) references a requirement that the “foreign affiliate” have also carried on that business in the preceding taxation year. CRA considered that this was merely a convenient way of referring to the corporation which had now become a foreign affiliate of Canco rather than implying that there was a requirement that it also have been a foreign affiliate of Canco in the preceding year. Standard Life took essentially the opposite approach to the interpretation of a similar requirement under s. 138(11.3) – so that it was necessary for the taxpayer to qualify as an "insurer" in the preceding taxation year rather than only in the current year, in order for an asset bump to be available.

When this point was raised with the Rulings Directorate, it stated:

[I]n accordance with the textual, contextual and purposive approach…we are of the view that there are substantial differences in interpreting the provisions of subsection 138(11.3) and paragraph 95(2)(k)… as applicable to the relevant facts in the Standard Life case and document 2014-053658. As a result, our conclusions previously reached in document 2014-053658 remain unchanged.

Canco acquired the shares of FA1 (which carried on an active business and held FA2) from an arm's length vendor. FA2, in turn, held FA3 as well as carrying on a non-Canadian "investment business", as defined in s. 95(1), which entailed licensing intellectual property of FA2 solely to XX, its subsidiary (FA3) and an arm's length Canadian resident.

The licence fees paid by FA3 to FA2 are deducted by it in computing the amount prescribed to be its earnings or loss for a taxation year from an active business (other than an active business carried on in Canada), so that Canco excluded those fees in computing the foreign accrual property income (FAPI) of FA2.

In computing the FAPI derived from the remainder of the licence fees received by FA2, Canco took a deduction under s. 20(1)(b) based on FA2 having made a deemed eligible capital expenditure ("ECE") under the fresh start rule in respect of the intellectual property at the beginning of the taxation year of FA2 in which it became a foreign affiliate of Canco. Was this correct?

After first giving an affirmative conclusion (that "as a result of the operation of subparagraph 95(2)(k.1)(iii) and paragraph 138(11.91)(e)… FA2 is deemed to have disposed of its intellectual property immediately before the beginning of its [acquisition] taxation year"), CRA noted that the requirement in s. 95(2)(k)(ii)(C) was satisfied as:

the business of FA2 is an investment business in FA2's [preceding] taxation year…and its activities included activities that are deemed by paragraph 95(2)(a.3) of the Act to be a separate business, other than an active business, carried on by FA2. However, in its immediately preceding taxation year, the definition of "investment business" in subsection 95(1) … did not apply to FA2 with reference to Canco because that definition only applies with reference to a "a foreign affiliate of a taxpayer". Similarly, paragraph 95(2)(a.3) had no application to FA2 with reference to Canco in that year.

The requirement in s. 95(2)(k)(ii)(A) that the "affiliate" or partnership have carried on the business, or the activities deemed to be a separate business, in the preceding year, should be considered to have been satisfied notwithstanding that FA2 was not an affiliate in the preceding year given that if the buisness had instead been carried on through a partnership, there would have been no requirement for its partners to have been FAs in the preceding year.

After noting that the wording of s. 138(11.91)(e) "does not mesh well with the definition of ECE" in s. 14(5) given that such definition requires an "outlay or expense made or incurred … as a result of a transaction," CRA nonetheless concluded that the wording of s. 138(11.91)(e) of the Act was "sufficient to cause FA2 to be considered to have made an ECE at the relevant time."

The s. 20(1)(b) and other applicable deductions would be made first before determining the allocation of FA2's business income which was recharacterized under s. 95(2)(a)(ii) and that portion which remained as FAPI - so that in effect, only a portion of the s. 20(1)(b) deduction sheltered the FAPI.

After noting that the cost of property used to earn income from property rather than from a business would "not be similarly bumped when a foreign corporation becomes an FA," CRA noted that "the threshold amount of activity that is required to cause any corporation (including a FA) to be considered to be carrying on business is extremely low," so that "it would be generally be difficult for the CRA to challenge the taxpayer's position" that it was carrying on a business.

CRA noted that the then current version of the s. 95(2)(k) rules:

do not apply for the purpose of computing a capital gain or loss, as that would not be income from an investment business or the separate business. As a result, there is no "bump" to the adjusted cost base at the time of the coming into force of the fresh start rules for the purpose of computing any capital gain or loss from the property. Under current law, the full gain or loss would be included at the time of subsequent disposition as income from property under the usual rules.

Howver, amendments were anticipated that would address this definciency.

Canco has a 51% interest in a partnership ("Partnership") holding all the shares of Forco1 which, in turn, owns all the shares of Forco2. Forco1 makes an interest bearing loan to Forco2.

Query

: For purposes of applying s. 95(2)(a) in determining whether Canco has FAPI, does s. 95(2)(y) prevent Partnership from having a qualifying interest in Forco1 and Forco2?

FAPI is to be determined at the partnership level (s. 96(1)). Partnership would have a qualifying interest in respect of Forco1 and (having regard to the look-through rule in s. 95(2)(m)(iii)) in respect of the shares of Forco2 owned by Forco1, if the usual conditions were satisfied.

This would be the case notwithstanding the deeming rule of paragraph 95(2)(y) that…would deem each member of Partnership to own the Forco1's shares based on their proportionate interest in the Partnership for the purposes of determining whether a non-resident corporation is, at any time, a Foreign affiliate of a member of the Partnership in respect of which it has a qualifying interest.

An interest rate swap would be a "similar agreement".

A deposit made by a foreign affiliate will qualify as a specified deposit if the foreign affiliate does not carry on an active business, even if s. 95(2)(a)(i) deems income earned by it to be from an active business.

A wholly-owned foreign affiliate (“FA”) of a corporation resident in Canada (“Canco”) provides marketing services for FMV fees to Canco respecting the sale of Canadian residential condominiums by Canco in the course of its Canadian business. Does real estate inventory, such as the Canco condos, held for sale in the regular course of business qualify as “goods” for purposes of s. 95(3)(b) so that, in this case, s. 95(3)(b) would oust the application of s. 95(2)(b) to the services income of FA?

CRA referred to the statement in Canadian Wirevision that “goods … is used in the common parlance of merchandise or wares, or, to put it in legal jargon, tangible moveable property” and to various dictionary definitions generally referencing “all tangible, moveable, personal property intended for sale,” Furthermore, CRA’s view that residential condominiums, being real estate, are not “goods” under s. 95(3)(b) was consistent with the balance of the wording of s. 95(3) – for instance s. 95(3)(a) excluded the transportation of goods.

Accordingly, if no other exclusions are met, s. 95(2)(b) would apply to services provided in connection with the sale of real estate inventory, including residential condominiums.

Four U.S.-resident controlled foreign affiliates of a Canadian public corporation (“Canco”), namely, CFA1 (wholly-owned by Canco), and CFA2, CFA3 and CFA4 (wholly-owned by CFA1) performed, as their only activity, research and development services (“R&D Services”) for the benefit of Canco, and with the fees paid therefor by Canco being their only revenue.

After finding that s. 95(2)(b) applied to the R&D Services provided to Canco, the Directorate rejected Canco’s argument that the R&D Services provided to Canco should be considered to be services performed in connection with the sale of goods under s. 95(3)(b), stating:

[T]he phrase “services performed in connection with the (...) sale of goods” is limited to services that are directly related to the sales function … .[T]he structure of the phrase refers to activities that are immediately linked or related to the process of selling goods and transferring ownership in the goods from the seller to the purchaser, requiring that the services be directly performed in the actual sale or negotiation process. … [T]he R&D Services … would generally not be immediately linked or related to the process of selling goods and transferring ownership in the goods from the seller to the purchaser.

A foreign affiliate ("FA1") of a Canadian manufacturer (the "Taxpayer") provides testing services to the Taxpayer on products (namely, prototypes) manufactured by the Taxpayer in Canada or abroad and which are owned by the Taxpayer. The tests on the prototypes help validate the manufacturing processes developed in Canada by the Taxpayer and resolve problems. Although the prototypes themselves are not sold, the information generated from the testing thus ameliorates issues on subsequent production for sale as a result of corrective adjustments being made. Taxpayer employees are involved in oversight of the testing.

Did s. 95(3)(b) apply so that the testing services were not services for purposes of s. 95(2)(b)? In responding negatively, the Directorate stated (TaxInterpretation translation):

Our long-standing position respecting the expression services performed in connection with the sale of goods is that only services directly related to such sales so qualify.

…[T]hese activities fall under scientific research and experimental development…and not under services related to the sale of goods, per se.

See also summary under s. 95(3)(d).

Four U.S.-resident controlled foreign affiliates of a Canadian public corporation (“Canco”), namely, CFA1 (wholly-owned by Canco), and CFA2, CFA3 and CFA4 (wholly-owned by CFA1) performed, as their only activity, research and development services (“R&D Services”) for the benefit of Canco, and with the fees paid therefor by Canco being their only revenue.

After finding that s. 95(2)(b) applied to the R&D Services provided to Canco, the Directorate rejected Canco’s argument that the R&D Services provided to Canco should be considered to be services performed as part of the manufacturing or processing of property, and as such subject to the exception provided in s. 95(2)(d), stating:

[T]he R&D Services would not qualify as manufacturing or processing activities. We note that for purposes of the manufacturing and processing profits deductions set out in subsection 125.1(1), the expression qualifying activities (as defined in section 5202 of the Regulations) includes scientific research and experimental development (as defined in section 2900 of the Regulations) carried on in Canada. … [N]o such extended meaning applies for the purposes of paragraph 95(3)(d).

A foreign affiliate of a Canadian manufacturing company (the taxpayer) provided services to the taxpayer of testing prototypes (manufactured by the taxpayer) of goods that would subsequently be manufactured and sold by the taxpayer. In finding that the testing activities, viewed as scientific research and experimental development, did not qualify as manufacturing or processing notwithstanding the inclusion of such activities in the definition of "qualified activities" in Reg. 5202, the Directorate noted that as "it required a positive act of the legislator, namely their inclusion in the ITR" for such activities to be included in manufacturing or processing, this implied that the unadorned expression in s. 95(3)(d) did not include SR&ED. See summary under s. 95(3)(b).

A foreign cooperative, treated as a corporation under the foreign nation's law, is deemed to have "shares" for the purposes of determining "direct equity percentage" under s. 95(4), for disposition of shares of a foreign affiliate under s. 85.1(3), and for exchanges of shares under s. 86(1).

In the case of a Delaware LLC whose capital was divided into two classes: Class 1 interests representing the common equity; and Class 2 interests representing the preferred equity; RC will apply its administrative position in IT-392 that where the ownership of a foreign business entity is not divided into units entitled "shares", RC will consider the foreign business entity as if it had capital stock of 100 issued shares, with each owner of the beneficial interest being considered to own a number of shares proportionate to the owner's beneficial interest in the foreign business entity.

Canco held the preferred, but not the common, shares of a Barbados International Business Company (“FA”), and its preferred shares were redeemed. Although the facts are mostly redacted, it would appear that the resolution pursuant to which FA redeemed the shares provided that a portion of the proceeds paid on the redemption were a dividend, and Canco apparently relied on this wording rather than making a s. 93(1) election. After discussing whether such treatment could give rise to a dividend to Canco, the Directorate went on to state:

If there is, in part, a dividend… to the extent the purpose of issuing the...Shares is to skew exempt surplus to the Canadian shareholder…consideration [should] be given as to the potential application of subsection 95(6) and/or subsection 245(2).

Over the 2010-2013 period a total of 19 cases were considered by the s. 95(6) Committee, which recommended in seven cases that s. 95(6)(b) be applied. Two s. 95(6)(b) cases are before the courts.

Canco is wholly-owned by MNC, a non-resident multi-national corporation. All the treasury functions for the group are carried out by Canco, which lends to non-resident subsidiaries of MNC (Foreign Subs). Before starting to make these loans, Canco subscribes for common shares of the Foreign Subs so that it holds 1% (or, in another scenario, 10%) of the shares of each.

After noting that the loans might not be exempted by s. 15(2.3) in the absence of the cross-shareholdings, CRA stated:

We may consider the possible application of paragraph 95(6)(b) of the Act in those situations such that the acquisition of the shares of the Foreign Subs by Canco would be deemed to not have occurred. We note that that subsection 95(6) applies only for the purposes of subdivision i of Division B of the Act (other than section 90). Subdivision i in part deals with the definition of "foreign affiliate" and the share acquisition has a direct impact on whether the Foreign Subs are foreign affiliates of Canco. We are of the view that paragraph 95(6)(b) of the Act could be applied to those situations with consequences to the application of subsection 15(2.1).

Discussion of the application of the "directly or indirectly" test where a loan made by a foreign affiliate of Canco ("FA") to a related non-resident corporation that is not a foreign affiliate uses the funds solely to acquire intellectual property which it licenses to NR2, which also is a related, but unaffiliated, corporation.