23 February 1996 External T.I. 9523075 - SAFE INCOME - FOREIGN AFFILIATES

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Tim Kuss
XXXXXXXXXX 952307

Attention: XXXXXXXXXX

February 23, 1996

Dear Sirs/Madams:

Re: Income Earned or Realized - Foreign Affiliates

This is in reply to your letter dated August 24, 1995 regarding the computation of "income earned or realized" of a foreign affiliate for purposes of subsection 55(2). We apologize for the delay in responding. Your specific enquiry relates to "stub period" accounting and the impact of a loss in a stub period on income earned or realized.

We provide the following general comments.

Subsection 55(2) applies to a dividend that reduces the gain that is attributable to something other than income earned or realized. Therefore, to determine whether subsection 55(2) applies to a particular dividend it is necessary to determine what part of the gain that is reduced is attributable to income earned or realized and what part is attributable to something else. The provisions of paragraphs 55(5)(b), (c) and (d) provide for the computation of income earned or realized. These provisions do not provide that the amount computed under those provisions represents an amount of income earned or realized that could reasonably be considered to attribute to the capital gain. If the income earned or realized is on hand at the time the dividend in question is paid the Department has taken a position that this income attributes to the value of a share on a dollar for dollar basis. If the income earned or realized is not on hand, subsection 55(2) will apply if the dividend paid reduces the portion of the capital gain that is attributable to something other than safe income.

It is recognized that the computation of an amount in accordance with paragraph 55(5)(d) does not necessarily include accumulated losses (deficits) of other foreign affiliates of the particular corporation in which the foreign affiliate has a direct or indirect interest.

However, that paragraph does not establish that amounts computed in accordance with its provisions attribute to the gain in the shares of the particular corporation. For example, as well as possibly not including deficits incurred during the holding period of a shareholder of the particular corporation such an amount could possibly reflect incomes and losses which were not realized during such holding period. With respect to deficits incurred in such holding period, while they may not be included in the amount computed in accordance with paragraph 55(5)(d), they are required to be included in the computation of safe income for the purposes of subsection 55(2). Should the computation of safe income not take into account such deficits, the payment of a dividend by the particular corporation in the amount of safe income so computed will reduce the portion of capital gain in the shares of the particular corporation attributable to something other than safe income.

Regarding the treatment of stub period earnings of a foreign affiliate of a corporation, it is our view that such earnings, to the extent they accrued during the relevant holding period, should be included in the income earned or realized by that corporation for purposes of subsection 55(2). This includes both the stub period commencing immediately after acquisition of the subject shares and the stub period ending immediately prior to the particular time. Any exempt loss accruing in the first taxation year ending after the corporation became a foreign affiliate but prior to the acquisition of the foreign affiliate would not reduce the safe income on hand. Any losses accruing during the holding period would affect the safe income on hand. For example, any loss incurred after the end of the last taxation year of the affiliate but before the particular time would reduce safe income on hand. Conversely, any exempt earnings that accrued before the particular time, but for a taxation year ending after the particular time, would be included in the income earned or realized on hand. It is a question of fact as to what portion of an affiliate's income or loss for a taxation year has accrued at a particular time during that year.

In our opinion the purpose of paragraph 55(5)(d) is to ensure that taxable surplus of a foreign affiliate that has not been subject to tax in the foreign jurisdiction will not be considered income earned or realized. Income earned or realized would therefore not include stub period earnings that, if included in the surplus accounts and paid out as dividends, could not be deducted under paragraphs 113(1)(a) or (b).

We hope our comments are of assistance.

Yours truly,

for Director
Reorganizations and Foreign Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch