Explanatory Notes to the Legislative Proposals and Draft Regulations Relating to Income Tax (February 2004): 4
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Appendix A

Pensions and qualified limited partnership

Information Returns - RRSPs and RRIFs

ITR
214(5)

Subsection 214(5) of the Income Tax Regulations requires issuers of registered retirement savings plans (RRSPs) to file information returns for transfers from RRSPs. It is intended that this reporting requirement apply only for transfers relating to a division of property arising on the breakdown of a marriage or common-law partnership. However, a recent amendment to subsection 214(5) inadvertently broadened the kinds of transfers to which it applies. Subsection 214(5) is amended to correct this result by replacing the reference in it to subsection 146(16) of the Income Tax Act with a reference to paragraph 146(16)(b), effective after 2002.

ITR
215(5)

Subsection 215(5) of the Regulations requires carriers of registered retirement income funds (RRIFs) to file information returns for transfers from RRIFs relating to a division of property arising on the breakdown of a marriage or common-law partnership. Subsection 215(5) is amended, effective after 2003, to replace the reference to paragraph 146.3(14)(b) of the Act with a reference to subsection 146.3(14). This amendment is strictly consequential to a restructuring of subsection 146.3(14) and does not represent a change to existing reporting requirements.

Deferred Income Plans - Qualified Investments

ITR
Part XLIX

Part XLIX of the Regulations lists a number of qualified investments for RRSPs, RRIFs, registered education savings plans (RESPs) and deferred profit sharing plans (DPSPs).

ITR
4900(1)(e)

Paragraph 4900(1)(e) of the Regulations provides that a warrant or right that gives the holder the right to acquire property is a qualified investment, provided that the underlying property is a qualified investment.

This paragraph is amended in two ways. First, it is amended to add an arm's length test. To qualify, the issuer of the warrant or right will be required, on an on-going basis, to deal at arm's length with each person who is an annuitant, a beneficiary, an employer or a subscriber under the registered plan. Second, the underlying property will be required to be a share or unit of the issuer or a share or unit of another person or partnership that, at the time of issuance, does not deal at arm's length with the issuer.

This amendment applies in respect of property acquired after Announcement Date.

ITR
4900(1)(e.01)

New paragraph 4900(1)(e.01) of the Regulations provides that an option that is listed on a stock exchange referred to in section 3200 or 3201 of the Regulations is a qualified investment, provided that the underlying property is a qualified investment and regardless of whether settlement is made by way of delivery of the underlying property or by cash payment. The effect of this change is to enable RRSPs, RRIFs, RESPs and DPSPs to acquire publicly-listed put options and cash-settled index options, in addition to call options (which were already qualified investments under former paragraph 4900(1)(e)).

This amendment applies after Announcement Date.

ITR
4900(1)(i.3)

New paragraph 4900(1)(i.3) of the Regulations provides that a debt obligation issued by a Canadian corporation or a trust resident in Canada is a qualified investment, subject to the following requirements:

• the principal purpose of the issuer is to derive income from the holding of indebtedness;

• the debt obligation derives all or substantially all of its value from the indebtedness held by the issuer;

• at least 80% of the issuer's property is indebtedness owed by Canadian residents;

• the debt obligation had an investment grade rating with a recognized rating agency when it was acquired by the plan trust; and

• the debt obligation was issued as part of single debt issue of at least $25 million.

Paragraph 4900(1)(i.3) is intended, in particular, to accommodate investments in debt obligations (commonly known as asset-backed securities) that are backed by cash flows from pools of loans and other receivables. Paragraph 4900(1)(i.3) applies after Announcement Date.

ITR
4900(1)(j)

Paragraph 4900(1)(j) of the Regulations provides that a mortgage obligation that is secured on real property situated in Canada is a qualified investment. For this purpose, paragraph 4901(3)(a) provides that a reference to a mortgage includes a charge, hypothec or similar instrument pertaining to real property, as well as an interest in a mortgage.

Paragraph 4900(1)(j) is amended to ensure that a mortgage obligation qualifies only if the amount of the mortgage obligation (together with the amount of any other indebtedness in respect of the property that is of equal or superior rank) does not exceed the fair market value of the property, except as a result of a decline in the fair market value of the real property after issuance of the mortgage obligation. This test applies on an on-going basis. This amendment is consistent with the introduction of subparagraph (g)(iii) to the definition of "foreign property" in subsection 206(1) of the Act.

Amended paragraph 4900(1)(j) applies after Announcement Date, except that it does not apply before 2005 in respect of property acquired on or before Announcement Date. This is intended to give a plan trust that holds a bona fide mortgage obligation, which fails to satisfy the new test, until the end of 2004 to either dispose of the obligation or arrange for adequate real property security.

ITR
4900(1)(n.01)

New paragraph 4900(1)(n.01) of the Regulations provides that debt of a limited partnership whose units are listed on a Canadian stock exchange referred to in section 3200 of the Regulations is a qualified investment. This amendment applies after Announcement Date.

Deferred Income Plans - Foreign Property

ITR
Part L

Part XI of the Act imposes a penalty tax on excess foreign property held by certain trusts and other tax-exempt persons governed by deferred income plans. The expression "foreign property" is defined in subsection 206(1) of the Act to include an interest in a partnership, except as otherwise prescribed by regulation. Section 5000 of the Regulations sets out those exceptions.

Qualified Limited Partnerships

ITR
5000

Subsection 5000(1.3) of the Regulations, which deals with qualified limited partnerships (QLPs), states that the specified portion of a limited unit in a QLP that is held at any time by a specified partner of the QLP is non-foreign property. "Limited unit" and "qualified limited partnership" are defined in subsection 5000(7) of the Regulations, and "specified partner" has the meaning assigned by subsection 5000(1.5) of the Regulations.

Pursuant to subsection 5000(1.4) of the Regulations, the specified portion of a limited unit of a QLP held at any time by a specified partner is the whole of the unit if the specified partner does not hold more than 30% of the limited units of the partnership (either alone or with other partners with whom the specified partner is not dealing at arm's length). Otherwise, the specified portion of the unit corresponds to the proportion of property held by the QLP that is non-foreign property. In other words, when the 30% ownership limit is exceeded, the specified portion of a limited unit of a QLP is that portion of the unit that the total cost amount to the QLP, at that time, of all its non-foreign property is of the total cost amount to it, at that time, of all its property.

According to the definition in subsection 5000(7) of the Regulations, a QLP is a limited partnership that has met the following conditions, among others, at all times since its formation:

• The QLP's general partner's share in each income and loss of the partnership, for any particular period, is identical, regardless of the source of the income or the loss. An exception is possible for the general partner's share of the income or loss generated from specified property (within the meaning of subsection 5100(1) of the Regulations), which may vary from the general partner's share from any other source (paragraph (b)).

• The general partner's share in income and losses of the partnership for any particular period is not less than the general partner's share for any previous period (paragraph (c)).

• The interests of the limited partners are described by reference to units in the partnership, which are identical in all regards (paragraph (d)).

• The partnership's investments are limited to those described in paragraph (f).

• The cost amount of foreign property held by the partnership does not exceed the allowed percentage (currently 30%) of the cost amount to it of all property held by it (paragraph (i)).

Non-compliance with any of these conditions, at any time, results in the permanent loss of QLP status and, consequently, the whole of the units held in the partnership are deemed to be foreign property pursuant to subsection 206(1) of the Act.

A number of amendments to the QLP definition and to the definition of the specified portion of a limited unit in a QLP will provide greater flexibility. In particular, holding more than 30% foreign property will no longer affect the designation of a partnership as a QLP. As a result, exceeding the 30% foreign property limit will no longer have the effect of deeming all of the partnership's units to be entirely foreign property on a permanent basis. However, when the foreign property limit is exceeded, limited units held by specified partners will qualify as non-foreign property only in proportion to the non-foreign property held by the QLP. Furthermore, at any time in the future that the QLP satisfies the foreign property limit, the whole of the limited units held by specified partners (except those exceeding the 30% ownership threshold) will qualify as non-foreign property.

The new consequences set out in the preceding paragraph are the result of the repeal of paragraph (i) of the QLP definition, which contains the condition limiting the foreign property that can be held by a QLP, and the addition of the foreign property rule to the definition of "specified portion" in subsection 5000(1.4).

In short, the modifications to the way in which a QLP is affected if the foreign property limit is exceeded result in less severe consequences by:

• allowing the non-foreign property portion of the units of the QLP to be determined on a proportional basis, rather than completely disqualifying the units from non-foreign property treatment; and

• allowing the whole of the units of the QLP to be treated as non-foreign property at any subsequent time that the QLP complies with the foreign property limit.

In addition to the modifications to the foreign property rule, the QLP definition is amended to accommodate a number of commercial practices. Specifically, the conditions in paragraphs (b) and (c), relating to the general partner's share in income and losses, are replaced by the condition in amended paragraph (b). As amended, paragraph (b) requires that the general partner's share in all income and losses of the partnership be determined on the basis of a single fixed percentage that is specified in the agreement governing the partnership and has not changed since the formation of the partnership. Nevertheless, as amended, paragraph (b) permits the general partner's share to vary from this fixed percentage in the following circumstances:

• Subparagraph (b)(i) allows the share to be less than the fixed percentage for income and losses from investments in specified properties. This replicates the exception set out in the existing paragraph (b).

• Pursuant to subparagraphs (b)(ii) and (iii), the share may be less than the fixed percentage to allow the limited partners to receive, in priority to other distributions, amounts not exceeding their contributed capital and a reasonable rate of return on that contributed capital, determined in accordance with the agreement governing the partnership.

• Pursuant to subparagraph (b)(iv), the share may be more than the fixed percentage to allow the general partner to receive amounts, in priority to other distributions, to compensate for previous reductions in the general partner's share resulting from priority distributions to limited partners as a return on their contributed capital as permitted under subparagraph (b)(ii).

The QLP definition is also amended so that the condition relating to the interests of the limited partners, currently set out in paragraph (d), will henceforth be in amended paragraph (c). As amended, this paragraph gives more flexibility by limiting the requirement that the units determining the interests of the limited partners be identical to the following characteristics: (i) the terms governing the obligations of the limited partners to contribute capital to the partnership; and (ii) the terms governing the rights of the limited partners to receive distributions from the partnership.

Paragraph (d) of the QLP definition is also amended to require that the share of the limited partners in any income or loss of the partnership be determined in accordance with rules stipulated in the agreement governing the QLP, and that the share allocated in respect of any particular income or loss be identical for all units held by limited partners. However, this paragraph allows an exception when, at any particular time, the amount of capital contributed by a particular limited partner exceeds the amount of capital required by the general partner to be contributed by all limited partners. In these circumstances, any income or loss from a particular specified property (as newly defined in subsection 5000(7)) that is attributable to the investment of the excess contributed by the particular partner may be allocated entirely to the particular partner.

Lastly, the QLP definition is amended to allow a QLP to invest, after 2002, in another QLP (referred to as "investment partnership" for the purposes of this paragraph) as a limited partner. However, under amended subsection 5000(1.4), such an investment will qualify as non-foreign property for the investing QLP only in proportion to the non-foreign property held by the investment partnership. This investment is permitted by virtue of new subparagraph (f)(iv.1) of the QLP definition. This subparagraph also provides for a grace period for situations in which a QLP has invested in an investment partnership that, subsequently, ceases to be a QLP. In such instances, the investing partnership does not lose its status as a QLP if it disposes of the investment by the end of the third month following the month in which the investment partnership ceased to be a QLP.

Section 5000 is also amended by adding a definition "specified property" to subsection (7), which replicates the properties described in the definition "specified property" in subsection 5100(1). Consequential changes are made, where the expression "specified property" is used in section 5000, to eliminate references to subsection 5100(1). Finally, the definition "limited unit" in subsection 5000(7) is amended to refer to paragraph (c), rather than paragraph (d), of the QLP definition. This amendment is purely consequential to the amendments to the QLP definition.

Most of the amendments to section 5000 apply after 2002. The amendments to the definition "qualified limited partnership" in subsection 5000(7) apply in determining if a partnership is, at any time after 2002, a QLP. This is particularly relevant for a partnership that was established before 2003, since it establishes that it is the conditions in the modified QLP definition (rather than in the existing definition) that must be satisfied at all times since the formation of the partnership, in order for the partnership to be a QLP at any time after 2002. This will enable, for example, existing partnership that did not have QLP status to qualify as a QLP provided it meets the revised definition.

Prescribed Amounts and Areas

ITR
7308(4)

Subsection 7308(4) of the Regulations applies for the purpose of determining the minimum amount that an annuitant under a RRIF is required to withdraw each year from the fund. In general, the minimum amount for a year is the fair market value of the RRIF assets at the beginning of the year, multiplied by a prescribed factor corresponding to the attained age of the RRIF annuitant (or, on election, the annuitant's spouse or common-law partner). The factors are set out in the table contained in subsection 7308(4).

Subsection 7308(4) is amended so that the factors also apply for the purpose of determining the minimum amount in connection with the new variable benefit under money purchase provisions of registered pension plans (RPPs). For details, refer to the commentary on section 8506.

This amendment applies after 2003.

Pension Adjustments, Past Service Pension Adjustments, 
Pension Adjustment Reversals and Prescribed Amounts

ITR
Part LXXXIII

Part LXXXIII of the Regulations provides rules for calculating pension adjustments, past service pension adjustments, pension adjustment reversals and other prescribed amounts. These amounts impact on the determination of an individual's RRSP deduction room.

Definitions

ITR
8300(1)

"excluded contribution"

Certain amounts transferred to an RPP are defined in subsection 8300(1) of the Regulations to be "excluded contributions". An excluded contribution is disregarded in determining pension credits under a money purchase provision or under a defined benefit provision of a specified multi-employer plan.

The definition is amended to add to the list of excluded contributions an amount that was transferred to an RPP in accordance with new subsection 146.3(14.1) of the Act. Subsection 146.3(14.1) permits the direct transfer of an amount from an annuitant's RRIF to a money purchase provision of an RPP for the benefit of the annuitant, provided the annuitant was previously a member of the RPP.

This amendment applies after 2003.

Normalized Pension

ITR
8303(5)

Section 8303 of the Regulations provides rules for determining the past service pension adjustment (PSPA) of an individual for a year. A PSPA arises when benefits are provided to an individual under a defined benefit provision of an RPP on a past service basis, such as by upgrading existing benefits or by crediting additional years of pensionable service. PSPAs reduce an individual's RRSP deduction room.

In general terms, the PSPA is the total of the additional pension credits that would have been determined for each past service year if the past service benefits had been provided to the individual on a current service basis. In recalculating the pension credits, subsection 8303(5) provides that various benefit increases are to be excluded, thus reducing the PSPA otherwise determined.

The benefit exclusion in paragraph 8303(5)(f) applies where the benefit formula includes a flat benefit component. It excludes benefits arising from an increase in the flat benefit rate to the extent of the percentage increase in the average wage from the preceding year to the current year. It applies only to the first flat benefit rate increase each year.

The most common application of the exclusion provided for in paragraph 8303(5)(f) would be with respect to members of earnings-related plans whose earnings are large enough that their benefits are capped by the defined benefit limit. The defined benefit limit, which is defined in subsection 8500(1) as the greater of $1,722.22 and 1/9 of the "money purchase limit" (as defined in subsection 147.1(1) of the Act), is scheduled to be indexed to average wage growth starting in 2006. (This is by virtue of the fact that the money purchase limit, which will prevail after 2003, is indexed to average wage growth after 2005.) By virtue of paragraph 8303(5)(f), no PSPA will be required to be reported for members whose benefits are increased annually as a result of the indexing of the defined benefit limit.

The defined benefit limit is also increased from $1,722 to $1,833 for 2004 and is scheduled to be further increased to $2,000 for 2005. (These amounts equal 1/9 of the money purchase limits of $16,500 and $18,000 for 2004 and 2005, respectively.) However, to the extent that average wage growth is less than the percentage increase in the defined benefit limit in these two years, paragraph 8303(5)(f) would not serve to fully exclude resulting benefit increases from PSPA. To avoid this result, new paragraph 8303(5)(f.1) is introduced to provide an exclusion for such flat benefit rate increases. This will ensure that no PSPA will be required to be reported for members whose benefits are increased simply as a result of the increases to the defined benefit limit in these two years.

If a plan's existing flat benefit rate is less than the defined benefit limit for a year of past service, no exclusion is provided under new paragraph 8303(5)(f.1) for that portion of the increase in the flat benefit rate that is required to bring the rate up to the defined benefit limit for that year. For example, if a plan's flat benefit rate were increased from $1,500 to $1,833 in 2004, paragraph 8303(5)(f.1) would not exclude that portion of the increase that is required to bring the rate up to the defined benefit limit for the year of past service. In other words, of the $333 benefit increase in respect of prior years, only $111 (= $1,833 - $1,722) would be excluded.

Paragraph 8303(5)(f.1) provides no relief for plans that are not amended until after 2005 to reflect the higher defined benefit limit. Furthermore, if a plan sponsor waits until 2005 to amend the plan to reflect the higher defined benefit limit, only partial relief will be provided for benefits in respect of 2004. This is illustrated in the example at the end of the commentary on this paragraph.

As with the exclusion in paragraph 8303(5)(f), paragraph 8303(5)(f.1) applies only with respect to the first flat benefit rate increase each year. Further, the exclusion applies only if a single flat benefit rate enters into the determination of the member's post-1989 lifetime retirement benefits, except as permitted in writing by the Minister of National Revenue. In the case of multiple flat benefit rates, it is expected that the Minister would generally permit the exclusion to apply as long as it would not result in a widening of the scope of the exclusion.

Pension Credits and Prescribed Amounts for Certain

Unregistered Retirement Arrangements

ITR
8308.1 to 8309

Sections 8308.1 to 8309 of the Regulations set out rules for determining pension credits and prescribed amounts for individuals who participate in foreign pension plans and other unregistered retirement arrangements. These amounts reduce the participant's RRSP deduction room.

These sections provide special transitional rules for determining pension credits from 1996 to 2003 and for determining prescribed amounts from 1997 to 2004. The intent of these rules is that, during those years in which the RRSP dollar limit was scheduled to be less than $15,500, high-income participants would lose all or part of the new RRSP deduction room that would otherwise have become available to them in those years by virtue of the $600 PA offset.

These sections are being amended so that the special rules cease to apply one year earlier than previously scheduled (that is, the rules will not apply in determining 2003 pension credits and 2004 prescribed amounts). These amendments are consequential to amendments to the Act, which provided for increases to the RRSP dollar limit earlier than previously scheduled.

Registered Pension Plans

ITR
Part LXXXV

Part LXXXV of the Regulations sets out conditions that must be satisfied in order for a pension plan to be registered under the Act.

Interpretation

ITR
8500(7)

Subsection 8500(7) of the Regulations deems the allocation of surplus and forfeited amounts to an individual under a money purchase provision of an RPP to be a contribution made on behalf of the individual for the purposes of a number of provisions in Part LXXXV that depend on whether money purchase contributions are made on behalf of an individual.

Subsection 8500(7) is amended so that the deeming provision also applies for the purpose of new paragraph 8506(2)(c.1), which prohibits money purchase contributions from being made on behalf of a member at any time after the calendar year in which the member turns 69 years of age.

This amendment applies after 2003.

Conditions for Registration

ITR
8501(1)

Subsection 8501(1) of the Regulations lists the prescribed conditions for the registration of a pension plan. The prescribed conditions include, in paragraph 8501(1)(e), a condition that enables the Minister to refuse to register a plan where it is apparent that there may, immediately or at a future date, be non-compliance with certain specified conditions that are not prescribed conditions for registration.

Paragraph 8501(1)(e) is amended to add a reference to new subsection 8506(4), which provides a minimum payment rule applicable to money purchase RPPs that offer the new RRIF-like benefit option to its members. To comply with this prescribed condition as it relates to subsection 8506(4), such a plan would have to include a term requiring that the amount of variable benefits to be paid each year in respect of a member's account not be less than the minimum amount specified for the purpose of that subsection. For more details, refer to the commentary on subsections 8506(4) to (6).

This amendment applies after 2003.

Conditions Applicable to Registered Pension Plans

ITR
8501(2)

Subsection 8501(2) of the Regulations lists conditions that apply to a pension plan that has been registered. If an RPP fails to comply with any of these conditions, it becomes a revocable plan and, pursuant to subsections 147.1(11) to (13) of the Act, its registration may be revoked.

Paragraph 8501(2)(c) is amended, effective after 2003, to add a reference to the conditions in new paragraphs 8506(2)(c.1) and (i) relating to money purchase provisions. For details, refer to the commentary on those paragraphs.

Permissible Contributions

ITR
8502(b)

Section 8502 of the Regulations lists conditions that apply for the registration of a pension plan. Paragraph 8502(b) lists the contributions that are permitted to be made to an RPP. The list includes transfers from other registered plans in accordance with any of subsections 146(16) (transfer from an RRSP), 147(19) (transfer from a DPSP) and 147.3(1) to (8) of the Act (transfer from an RPP).

Paragraph 8502(b) is amended to expand the list of permissible contributions to include transfers from a RRIF in accordance with new subsection 146.3(14.1) of the Act. Subsection 146.3(14.1) permits the direct transfer of an amount from an annuitant's RRIF to a money purchase provision of an RPP for the benefit of the annuitant, provided the annuitant was previously a member of the RPP.

This amendment applies after 2003.

Payment of Pension

ITR
8502(e)

Paragraph 8502(e) of the Regulations requires an RPP to provide that retirement benefits will begin to be paid to each member no later than the end of the year in which the member turns 69 years of age.

Paragraph 8502(e) is amended to extend the pension commencement date by one year in the case of retirement benefits provided under a money purchase provision in accordance with new paragraph 8506(1)(e.1). That paragraph allows money purchase RPPs to provide retirement benefits to members in a manner similar to that permitted under a RRIF. This amendment is intended to provide consistency with the maximum deferral permitted under the RRSP/RRIF rules. Specifically, since RRSP annuitants have until the year in which they turn 69 years of age to convert their RRSP into a RRIF and minimum withdrawals under a RRIF are required to begin only in the year following the year in which the RRIF is set up, an RRSP annuitant can effectively defer receipt of retirement income to the year in which they turn 70 years of age. Paragraph 8502(e) is also amended for greater clarity.

These amendments apply after 2003.

Money Purchase Provisions

ITR
8506

Section 8506 of the Regulations describes the benefits that may be provided under a money purchase provision of an RPP and contains conditions that apply to a plan that has a money purchase provision.

Guarantee Period

ITR
8506(1)(c)

Paragraph 8506(1)(c) of the Regulations allows retirement benefits payable under a money purchase provision of an RPP to be guaranteed for up to 15 years. The guarantee benefits must not exceed the retirement benefits that would have been payable to the member if the member were alive.

Paragraph 8506(1)(c) is amended so that any variable benefits (retirement benefits permissible under new paragraph 8506(1)(e.1)) that were payable to the member are ignored in determining the limit on the amount of guarantee benefits that may be provided. This will be relevant where a member's retirement benefits were provided partially by means of an annuity held by the plan and partially by means of the payment of variable benefits from the member's account. This amendment applies after 2003.

Post-retirement Survivor Benefits

ITR
8506(1)(d)

Paragraph 8506(1)(d) of the Regulations permits an RPP to provide for the payment of survivor benefits under a money purchase provision to a spouse or common-law partner or former spouse or common-law partner of a member who dies after beginning to receive retirement benefits. The survivor benefits, together with any benefits payable under a guarantee, must not exceed the retirement benefits that would have been payable to the member if the member were alive.

Paragraph 8506(1)(d) is amended so that any variable benefits that were payable to the member are ignored in determining the limit on the amount of survivor benefits that may be provided. This amendment is consistent with the amendment to paragraph 8506(1)(c). It applies after 2003.

Variable Benefits

ITR
8506(1)(e.1)

New paragraph 8506(1)(e.1) of the Regulations permits an RPP to provide retirement benefits (referred to as "variable benefits") to a member under a money purchase provision, and to beneficiaries of the member after the member's death, by means of payments from the member's account. This is in contrast to retirement benefits described in paragraphs 8506(1)(a) to (e), which by virtue of paragraph 8506(2)(g) must generally be provided by means of an annuity purchased from a licensed annuities provider. Paragraph 8506(1)(e.1) is intended to allow money purchase benefits to be provided in the same manner as is permitted under a RRIF.

The amount of variable benefits payable each year from the member's account must not be less than the minimum amount determined in accordance with rules set out in subsections 8506(5) and (6). The minimum amount is determined on the basis of the balance in the member's account at the beginning of each year and the attained age of either the member or the member's spouse or common-law partner. These rules are similar to the minimum withdrawal rules that apply to RRIFs. The calculation of the minimum amount is illustrated in the examples following the commentary on subsection 8506(7).

As noted, variable benefits can be provided to beneficiaries of a member after the death of the member. Where the beneficiary is a specified beneficiary of the member, the payment of variable benefits can continue until the end of the calendar year in which the specified beneficiary dies. The expression "specified beneficiary" of a member, which is defined in new subsection 8506(7), is restricted to the surviving spouse or common-law partner of the member and requires that there be a written designation of the individual as specified beneficiary. The payment of variable benefits to other beneficiaries (which can include a spouse or common-law partner who has not been designated as a specified beneficiary) must cease no later than the end of the calendar year following the year in which the member dies. Paragraphs 8506(2)(h) and (i) require that the balance in the member's account remaining after variable benefits cease to be payable be paid as soon as is practicable.

The characterization of payments from a member's money purchase account as periodic payments (and, thus, retirement benefits as defined in subsection 8500(1)) for the purposes of paragraph 8506(1)(e.1) may not always be straightforward. However, where a money purchase plan contemplates post-retirement benefits being paid from a member's account as permitted under paragraph 8506(1)(e.1) and, as such, contains terms setting out minimum amounts which must be withdrawn at least annually, payments made in accordance with those terms would be considered to be periodic in nature. Although all other payments made from a member's account would generally be considered to be lump sum, rather than periodic, there may be exceptions. For example, if a member establishes a pattern of payments in excess of the minimum required under the plan terms (by electing to receive, for example, annual payments equal to the maximum permitted under governing pension benefits legislation), any excess payments fitting this pattern would also be considered to be periodic payments.

The characterization of payments as periodic or lump sum is relevant, in particular, for purposes of the transfer provisions in section 147.3 of the Act. These provisions allow the tax-free transfer of funds between registered plans only where the amount transferred constitutes a lump sum. This is illustrated in example 3 following the commentary on subsection 8506(7). The characterization is also relevant for purposes of determining withholding tax on pension payments to non-residents. Many of Canada's income tax treaties provide for a reduced rate of withholding tax for periodic pension payments.

New paragraph 8506(1)(e.1) applies after 2003.

Payment from Account After Death

ITR
8506(1)(g)

Paragraph 8506(1)(g) of the Regulations permits an RPP to provide for the payment of lump sum amounts under a money purchase provision to beneficiaries of a member where the member dies before beginning to receive retirement benefits. These payments cannot exceed the balance in the member's account.

Paragraph 8506(1)(g) is amended to allow lump sum payments to be made from the member's account to beneficiaries of the member regardless of whether the member had begun to receive retirement benefits. This ensures the balance in the money purchase account of a deceased member who had been receiving variable benefits may be paid to the member's beneficiaries. This amendment applies after 2003.

Contributions Not Permitted

ITR
8506(2)(c.1)

New paragraph 8506(2)(c.1) of the Regulations generally prohibits a contribution or transfer to a money purchase provision of an RPP on behalf of a member at any time after the calendar year in which the member turned 69 years of age. This prohibition also applies to the allocation of amounts to a member that are attributable to forfeited amounts or surplus, since such amounts are deemed by subsection 8500(7) to be contributions for the purpose of this rule.

Exceptions to this prohibition are provided for post-age 69 transfers that are made in accordance with subsection 146.3(14.1) of the Act (transfers from a RRIF), subsection 147.3(1) of the Act (lump sum transfers from a money purchase provision) and subsection 147.3(4) of the Act (lump sum transfers from a defined benefit provision) and similar intra-plan transfers.

Paragraph 8506(2)(c.1), which applies after 2003, is added for greater certainty and does not reflect a change in policy.

Allocation of Earnings

ITR
8506(2)(e)

Paragraph 8506(2)(e) of the Regulations requires an RPP containing a money purchase provision to allocate earnings of the plan (other than earnings attributable to forfeited amounts or a surplus under the provision) on a reasonable basis and no less frequently than annually to plan members.

Paragraph 8506(2)(e) is amended to require plan earnings be allocated on a monthly basis, as a minimum. This is intended to bring the earnings allocation rule more in line with current practice. This amendment applies after the month that includes Announcement Date.

Retirement Benefits

ITR
8506(2)(g)

Paragraph 8506(2)(g) of the Regulations requires that retirement benefits payable under a money purchase provision of an RPP be provided either by means of annuities purchased from a licensed issuer of annuities or under an arrangement acceptable to the Minister.

Paragraph 8506(2)(g) is amended in three ways. First, it is amended so that it does not apply to variable benefits permissible under new paragraph 8506(1)(e.1). Variable benefits are simply provided by means of payments from a member 's account based on the account balance and the attained age of the member or the member's spouse or common-law partner.

The second amendment to paragraph 8506(2)(g) removes the discretionary authority for the Minister to accept other arrangements. However, grandfathering is provided for plans that do not provide retirement benefits by means of annuities purchased from a licensed annuities provider, if the arrangement under which retirement benefits are provided was accepted by the Minister before Announcement Date and the arrangement continues to remain acceptable.

Finally, paragraph 8506(2)(g) is amended by replacing some of the existing words in the paragraph with the expression "licensed annuities provider", which is defined in subsection 248(1) of the Act. This amendment does not represent a change in policy.

These amendments apply after 2003.

Undue Deferral of Payment

ITR
8506(2)(h)

Paragraph 8506(2)(h) of the Regulations requires that lump sums payable under a money purchase provision of an RPP after the death of a member be paid as soon as practicable after the death of the member.

Paragraph 8506(2)(h) is amended to provide an exception for lump sum payments that are payable after the death of the member's specified beneficiary, as defined in subsection 8506(7). In general, the specified beneficiary of a member is the surviving spouse or common-law partner of a deceased member to whom variable benefits (as permitted under new paragraph 8506(1)(e.1)) continue to be paid from the member's account. This amendment ensures that, after the death of the specified beneficiary, the balance in the member's account may be paid out of the plan without contravening the condition in paragraph 8506(2)(h).

This amendment applies after 2003.

ITR
8506(2)(i)

New paragraph 8506(2)(i) of the Regulations is similar to paragraph 8506(2)(h). It requires that lump sums payable under a money purchase provision of an RPP after the death of a specified beneficiary of a member be paid as soon as practicable after the death of the specified beneficiary. Paragraph 8506(2)(i) applies after 2003.

Non-payment of Minimum Amount - Plan Revocable

ITR
8506(4)

New subsection 8506(4) of the Regulations applies to RPPs containing a money purchase provision that provides for the payment of variable benefits to members and beneficiaries of members. Variable benefits are retirement benefits permissible under new paragraph 8506(1)(e.1).

Subsection 8506(4) provides that an RPP becomes a revocable plan at the beginning of a calendar year if the total amount of variable benefits paid from a member's account in the year is less than the minimum amount for the account for the year. The minimum amount is determined in accordance with rules set out in subsections 8506(5) and (6). For details, refer to the commentary on those subsections.

Subsection 8506(4) applies after 2003.

Minimum Amount

ITR
8506(5)

Subsection 8506(5) of the Regulations defines the minimum amount for a member's account under a money purchase provision of an RPP with reference to a calendar year. In general, the minimum amount for a calendar year is determined on the basis of the balance in the member's account at the beginning of the year and the attained age of the member (or the member's spouse or common-law partner). Examples 1 to 3 following the commentary on subsection 8506(7) illustrate the operation of the minimum amount rules.

The definition applies for the purposes of subsection 8506(4) and paragraph 8506(1)(e.1) in determining the minimum payout schedule for variable benefits under a member's money purchase account. This definition generally corresponds to the definition "minimum amount" in subsection 146.3(1) of the Act that applies in determining minimum withdrawals under a RRIF.

More specifically, except as noted below, the minimum amount for a member's account for a calendar year is determined by multiplying the balance in the member's account at the beginning of the year by a designated factor corresponding to the attained age of the member or, in certain circumstances, the member's spouse or common-law partner. The designated factors are set out in the table in amended subsection 7308(4) of the Regulations.

The account balance must be determined in a manner that reasonably reflects the fair market value of the property of the plan held in connection with the account. Where, in addition to variable benefits, the plan also provides for a portion of the member's retirement benefits to be provided by means of an annuity purchased from a licensed annuities provider, the value of the annuity is to be disregarded in determining the account balance. Similarly, where a portion of the member's retirement benefits are provided under a grandfathered arrangement as described in the commentary to paragraph 8506(2)(g), the property held in connection with those retirement benefits is also disregarded. In both cases, the disregard applies only to the extent that retirement benefits had begun to be paid before the beginning of the year and remain payable in the year.

For years in which the member is alive, the minimum amount can be based on the age of either the member or the member's spouse or common-law partner. In order to use the age of the member's spouse or common-law partner for a given year, the member must advise the plan administrator in writing before the beginning of the year.

Changes to the payout schedule may be made to reflect changes in family circumstances. For example, a member who marries a younger spouse after having begun to receive variable benefits may wish to change the payout schedule so that the minimum amount is based on the age of his or her spouse. Assuming the pension plan permits, the member can effect such a change simply by making a written request to the plan administrator. The revised payout schedule would apply beginning in the year following the year in which the request was made.

The payout schedule that applied while the member was alive continues to apply after the member's death with respect to any variable benefits that remain payable to a beneficiary (other than the specified beneficiary) of the member for the year of death and the following year. Where the member's surviving spouse or common-law partner is entitled to receive variable benefits as the member's specified beneficiary, the payout schedule must be revised so that the minimum amount is based on the age of the spouse or common-law partner. For further details, refer to the commentary on subsection 8506(7) and examples 1 and 2 following that subsection.

The determination of the minimum amount under new subsection 8506(5) is subject to new subsection 8506(6). Under that subsection, the minimum amount for years prior to the year in which the member (or, after the death of the member, the specified beneficiary) turns 70 years of age is defined to be nil. This is intended to provide consistency with the maximum deferral permitted under the RRSP/RRIF rules.

Subsection 8506(5) applies after 2003.

When Minimum Amount is Nil

ITR
8506(6)

To provide consistency with the maximum deferral permitted under the RRSP/RRIF rules, new subsection 8506(6) of the Regulations (in conjunction with amended subparagraph 8502(e)(i)) ensures that a member is not required to begin receiving variable benefits from their money purchase account until the year in which the member turns age 70. It does so by defining the minimum amount for a member's money purchase account for calendar years before the calendar year in which the member turns 70 years of age to be nil. Similar treatment is provided with respect to the specified beneficiary of a deceased member. The application of this subsection is illustrated in example 1 following the commentary on subsection 8506(7).

Subsection 8506(6) applies after 2003.

Specified Beneficiary

ITR
8506(7)

New subsection 8506(7) of the Regulations defines the "specified beneficiary" of a member in relation to a money purchase provision and with reference to a calendar year as the surviving spouse or common-law partner of the member. The specified beneficiary of a member is entitled to receive variable benefits from the member's account after the member's death and throughout their lifetime in accordance with paragraph 8506(1)(e.1).

To qualify as the specified beneficiary for a given year, the member or the member's legal representative must provide a written designation of the individual as the specified beneficiary to the plan administrator before the beginning of the year. Further, an individual cannot be a specified beneficiary any earlier than the year following the year in which the member dies. This condition, which applies primarily for mechanical reasons, ensures that the minimum amount for the year of the member's death is determinable at the beginning the year and does not change as a result of the member's death. It is important to note that the surviving spouse or common-law partner of a member may receive variable benefits for the remainder of the year in which the member dies and for the following year without having to qualify as the member's specified beneficiary. This is by virtue of the fact that paragraph 8506(1)(e.1) allows variable benefits to continue to be paid after the death of the member to any beneficiary of the member until the end of the year following the year of death.

The operation of the minimum amount rules is illustrated in the following examples.

Galen turns 69 years of age in 2005 and must begin receiving variable benefits starting in 2006. When Galen retired in 2004, he advised the plan administrator to use the age of his younger spouse, Carole, in determining the minimum payout schedule for his account. He also designated Carole as his specified beneficiary for years after his death so that she could continue to receive payments from the account throughout her lifetime in the event that he dies before her.

At the beginning of 2006, Carole is 66 years of age and the account balance is $320,000. The minimum amount for 2006 for Galen's account is $13,333 (= $320,000 x (1/(90- 66))). In accordance with the plan terms, the minimum amount is payable in equal monthly instalments over the course of the year.

Galen dies in October 2006. The remaining two instalments are paid to Carole. The minimum amount for 2007 is determined on the basis of Carole's age, as specified beneficiary for that year. Since Carole is less than 70 years of age, the minimum amount for 2007 is nil in accordance with subsection 8506(6).

Example 2

Anita dies in 2007 after having received variable benefits for two years. The minimum amount was based on Anita's age. When commencing to receive retirement benefits from the plan, Anita designated her spouse, Daniel (who is two years older), as her specified beneficiary, but only for years after the year following the year of her death. Thus, for the remainder of 2007 and for all of 2008, the retirement benefits payable to Daniel as beneficiary are based on the minimum payout schedule established for Anita. However, when Daniel starts receiving retirement benefits as specified beneficiary in 2009, the payout schedule is revised so that the minimum amount is based on his age.

Example 3

In September 2005, Clarke decides to transfer his money purchase funds to a RRIF. The balance at that time in Clarke's account is $180,000. The minimum amount for Clarke's account for 2005 is $15,000. Clarke has already received $10,000 from his account during the year. The maximum amount eligible for tax-free transfer under subsection 147.3(1) of the Act is $175,000 (= $180,000 - ($15,000 - $10,000)). The remaining $5,000 must be paid directly to Clarke.

PA Limits - 1996 to 2002

ITR
8509(12)

Subsection 8509(12) of the Regulations contains a special transitional rule that ensures that a defined benefit RPP providing maximum benefits to higher-income members does not become revocable only because of the fact that pension adjustments are greater than the money purchase limit. The rules apply for those calendar years (1996 to 2003) in which the money purchase limit was scheduled to be less than $15,500.

Subsection 8509(12) is amended so that it does not apply for the 2003 calendar year. This amendment is consequential to an amendment to the Act, which provided for increases to the money purchase limit earlier than previously scheduled.

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Appendix B

Insurers

ITR
Part XXIV

Part XXIV of the Income Tax Regulations sets out special rules for the computation of an insurer's income.

Subsection 138(9) of the Income Tax Act requires resident multinational life insurers and non-resident insurers to include in computing their income from an insurance business carried on in Canada their gross investment revenue for the year derived from their designated insurance property.

Section 2411 of the Regulations prescribes an amount for the purpose of subsection 138(9) of the Act, which ensures that an insurer's net investment revenue from its designated insurance property is not less than the net investment revenue that would be determined from that property if the average rate of return on its designated assets of each class were equal to the average rate of return on all its investment property of that class. This prevents an insurer from understating its Canadian business income by designating assets in respect of its Canadian insurance business that produce lower investment returns than its assets not so designated.

Regulation 2411(3) sets out the computation of the minimum amount of net investment revenue that must be reported by an insurer for a taxation year. In general terms, the minimum net investment revenue is determined by multiplying the net investment revenue earned on the insurer's designated property by the ratio that the insurer's net investment revenue on all its investment property is of the value for the year of all its investment property. That ratio represents the average yield on the insurer's investment property. Multiplying the ratio by the value of the designated insurance property produces the average yield imputed to that property.

The descriptions of B and E in the formula in subsection 2411(3) of the Regulations are amended so that the total value of property described therein is determined without reference to any property described in paragraph (i) of the definition "Canadian investment property" in subsection 2400(1) of the Regulations. The description of H in that formula is similarly amended to exclude any property described in paragraph (e) of the definition "investment property" in subsection 2400(1). As a result, due or accrued income that arises from designated insurance property and that was assumed in computing the Canadian reserve liabilities will not be taken into account in determining the average yield.

These amendments apply to taxation years that end after Announcement Date.

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Appendix C

Foreign Affiliates

ITR
5902(1)

Section 5902 of the Income Tax Regulations applies where a corporation elects to treat proceeds of disposition of a share of a foreign affiliate as a dividend under subsection 93(1) of the Income Tax Act. Subsection 5902(1) of the Regulations computes a foreign affiliate's surplus accounts and the amount of a whole dividend used in applying subsection 5901(1) for the purposes of subsection 5900(1) of the Regulations.

Subsection 5902(1) is replaced with a new subsection that changes how the exempt surplus or exempt deficit, taxable surplus or taxable deficit, underlying foreign tax and net surplus is determined for the foreign affiliate of a corporation resident in Canada whose shares are disposed of and in respect of which disposition an election under subsection 93(1) or (1.2) of the Act is made by the corporation resident in Canada.

Under proposed subsection 5902(1), the surplus balances of the foreign affiliate of the corporation resident in Canada (the "disposed foreign affiliate") are to be computed using a new consolidation approach, which will take into account the surpluses and deficits of foreign affiliates, for the disposed foreign affiliate and any other foreign affiliate of the corporation resident in Canada in which the disposed foreign affiliate has an equity percentage.

As well, under proposed subsection 5902(1), the amount of an election in respect of a disposed share will be capped at the amount of the attributed net surplus in respect of the share determined under the rules in that new subsection.

New subsection 5902(1) provides that, in respect of a corporation resident in Canada, the following rules apply if, at a particular time, one or more shares (a "disposed share") of a class (the "specified class") of a particular foreign affiliate of the corporation resident in Canada is disposed of by a particular shareholder of the particular foreign affiliate and, because of an election made under subsection 93(1) or (1.2) of the Act in respect of that disposition, a dividend is deemed under subsection 93(1) or (1.2) of the Act to have been received on a disposed share at the time (the "dividend time") that is immediately before the particular time.

• New paragraph (a) deems the amount of the particular foreign affiliate's exempt surplus (the "consolidated exempt surplus"), at the time (in this subsection and also in section 5905, the "calculation time") that is immediately before the dividend time, to be the amount that would be its exempt surplus, at the calculation time, if:

• New paragraph (b) deems the amount of the particular foreign affiliate's exempt deficit (the "consolidated exempt deficit") in respect of the corporation resident in Canada, at the calculation time, to be the amount that would be its exempt deficit in respect of the corporation resident in Canada, at that time, if:

• New paragraph (c) deems the amount of the particular foreign affiliate's taxable surplus and underlying foreign tax, in respect of the corporation resident in Canada (the "consolidated taxable surplus", and "consolidated underlying foreign tax", respectively), at the calculation time, to be the amount that would be its taxable surplus, and underlying foreign tax, in respect of the corporation resident in Canada, at that time, if:

• New paragraph (d) deems the amount of the particular foreign affiliate's taxable deficit (the "consolidated taxable deficit"), in respect of the corporation resident in Canada, at the calculation time, to be the amount that would be its taxable deficit, at that time if

• New paragraph (e) provides, in applying subsection 5901(1) to subsection 5900(1), and for the purpose of paragraph (f), that,

• New paragraph (f) provides that the amount of the attributed net surplus in respect of a disposed share of the specified class in respect of the particular foreign affiliate's consolidated net surplus in respect of the corporation resident in Canada, immediately before the dividend time, is deemed to be the amount that would be received by the holder of the disposed share, in respect of the disposed share, at the dividend time, if the particular foreign affiliate paid a dividend, at that time, on all of its shares, the total of which was equal to the amount of its consolidated net surplus in respect of the corporation resident in Canada, immediately before the dividend time.

• New paragraph (g) provides, for the purposes of applying subsection 5901(1) to subsection 5900(1), that the amount of the whole dividend paid by the particular foreign affiliate, at the dividend time, on the shares of the specified class is deemed to be the amount obtained when the total of all amounts deemed by subsection 93(1) or 93(1.2) of the Act to have been received as a dividend on a disposed share of the specified class is multiplied by the greater of

• New paragraph (h) provides that the amount prescribed, for the purposes of subsection 93(1) or (1.2) of the Act, in respect of a disposition of a disposed share of the specified class may not exceed the amount of the attributed net surplus in respect of the disposed share in respect of the particular foreign affiliate's consolidated net surplus (determined under paragraph (f)), in respect of the corporation resident in Canada, immediately before the dividend time.

• New paragraph (i) provides, for the purposes of paragraphs (a) to (d), that the consolidated net surplus in respect of a corporation resident in Canada, at any time, of a particular foreign affiliate of the corporation resident in Canada, is the amount that would be determined in paragraph (e) in respect of the particular foreign affiliate if the reference in that paragraph to "immediately before the dividend time" were read as a reference to "at any time".

ITR
5902(3)

Subsection 5902(3) provides that, where an election is made under subsection 93(1) of the Act, no adjustment is to made to the foreign affiliate's exempt surplus, exempt deficit, taxable surplus, taxable deficit or underlying foreign tax in respect of the corporation as a consequence of the election except as provided in subsections 5905(2), (5) and (8). The amendment to subsection 5902(3) extends the application of the provision to elections made under new subsection 93(1.2) of the Act, and also includes subsection 5905(4) in the list of provisions that may affect these amounts.

ITR
5902(6)

Subsection 5902(6) of the Regulations applies where subsection 93(1.1) of the Act deems a corporation to have made an election under subsection 93(1) to treat proceeds of disposition of a share of a foreign affiliate as a dividend. Subsection 5902(6) deems the amount designated in the deemed election to be the lesser of the capital gain otherwise determined in respect of the disposition of the share and the amount that could reasonably be expected to have been received on the share if the affiliate had paid its net surplus in respect of the corporation as a dividend.

As announced in 2001, subsection 5902(6) is amended to ensure that the subsection will apply where subsection 93(1.3) of the Act deems a corporation resident in Canada to have made an election under proposed subsection 93(1.2) of the Act in respect of a taxable capital gain from a deemed disposition of a share of a foreign affiliate of the corporation disposed of by a partnership of which another foreign affiliate of the corporation is a member.

Subsection 5902(6) is further amended to refer, in paragraph (b), to the amount of the "attributed net surplus" (defined in new paragraph 5902(1)(f)) in respect of the share being disposed of.

ITR
5902(7)

New subsection 5902(7) of the Regulations provides that the amount designated in an election deemed by subsection 93(1.3) of the Act to have been made under subsection 93(1.2) of the Act is prescribed to be the lesser of

• the taxable capital gain, if any, otherwise determined in respect of the disposition of the share; and

• the amount that is ½ of the amount referred to in paragraph 5902(6)(b).

Example - Subsection 5902(1)

A. Facts

1. Canco is a corporation resident in Canada.

2. Canco owns 100% of FA1 and 50% of FA6, and both FA1 and FA6 are foreign affiliates of Canco.

3. FA1 owns 80 shares (80%) of FA2 and FA6 owns 20 shares (20%) of FA2.

4. FA2 owns 70% of FA3, FA3 owns 100% of FA4 and FA4 owns 100% of FA5.

5. FA1 transfers 30 of its shares in FA2 to FA6, and subsection 93(1) of the Act applies to the transfer, regarding which Canco designates $123 as the dividend received by FA1 in respect of the disposed shares.

6. At the time of the transfer, FA2 has an exempt surplus of $200, a taxable surplus of $0, an exempt deficit of $0 and an underlying foreign tax ("UFT") of $0.

7. At the time of the transfer, FA3 has an exempt surplus of $100, a taxable surplus of $75, an exempt deficit of $0 and an UFT of $10.

8. At the time of the transfer, FA4 has an exempt surplus of $0, a taxable surplus of $0, an exempt deficit of $200 and an UFT of $0.

9. At the time of the transfer, FA5 has an exempt surplus of $0, a taxable surplus of $325, an exempt deficit of $0 and an UFT of $200.

10. All the corporations have only issued 100 shares of one class.

B. Application of Subsection 5902(1)

1. Consolidated Exempt Surplus (Paragraph 5902(1)(a))

The consolidated exempt surplus of FA2 is $270.

Step 1.

Exempt surplus of FA5 is determined as the exempt surplus of FA5 ($0), otherwise determined.

Step 2

. Exempt surplus of FA4 is determined as the exempt surplus of FA4 ($0), otherwise determined, plus proportionate share of exempt surplus of FA5

where

A is the amount that would be received by FA4 if FA5 paid its entire consolidated net surplus as a dividend ($325)

B is the amount of consolidated net surplus of FA5 ($325)

C is the exempt surplus of FA5 ($0).

Step 3

. Exempt surplus of FA3 is determined as the exempt surplus of FA3 ($100), otherwise determined, plus proportionate share of exempt surplus of FA4

where

A is the amount that would be received by FA3 if FA4 paid its entire consolidated net surplus as a dividend ($125)

B is the amount of consolidated net surplus of FA4 ($125)

C is the exempt surplus of FA4 ($0).

Step 4

. Exempt surplus of FA2 is determined as the exempt surplus of FA2 ($200), otherwise determined, plus proportionate share of exempt surplus of FA3

where

A is the amount that would be received by FA2 if FA3 paid its entire consolidated net surplus as a dividend ($210)

B is the amount of consolidated net surplus of FA3 ($300)

C is the exempt surplus of FA3 ($100).

2. Consolidated Exempt Deficit (Paragraph 5902(1)(b))

The consolidated exempt deficit of FA2 is $140.

Step 1

Exempt deficit of FA5 is determined as the exempt deficit of FA5 ($0), otherwise determined.

Step 2

. Exempt deficit of FA4 is determined as the exempt surplus of FA4 ($200), otherwise determined, plus proportionate share of exempt surplus of FA5

where

A is the amount that would be received by FA4 if FA5 paid its entire consolidated net surplus as a dividend ($325)

B is the amount of consolidated net surplus of FA5 ($325)

C is the exempt deficit of FA5 ($0).

Step 3

. Exempt deficit of FA3 is determined as the exempt surplus of FA3 ($0), otherwise determined, plus proportionate share of exempt surplus of FA4

where

A is the amount that would be received by FA3 if FA4 paid its entire consolidated net surplus as a dividend ($125)

B is the amount of consolidated net surplus of FA4 ($125)

C is the exempt deficit of FA4 ($200).

Step 4

. Exempt deficit of FA2 is determined as the exempt surplus of FA2 ($0), otherwise determined, plus proportionate share of exempt surplus of FA3

where

A is the amount that would be received by FA2 if FA3 paid its entire consolidated net surplus as a dividend ($210)

B is the amount of consolidated net surplus of FA3 ($300)

C is the exempt deficit of FA3 ($200).

3. Consolidated Taxable Surplus and Underlying Foreign Tax (Paragraph 5902(1)(c))

The consolidated taxable surplus of FA2 is $280 and the UFT of FA2 is $147.

Step 1.

The taxable surplus and UFT of FA5 is determined as the taxable surplus ($320) and UFT ($200), otherwise determined.

Step 2

. The taxable surplus and UFT of FA4 is determined as the taxable surplus ($0) and UFT ($0), of FA4, otherwise determined, plus the proportionate share of the taxable surplus and UFT of FA5

where

A is the amount that would be received by FA4 if FA5 paid its entire consolidated net surplus as a dividend ($325)

B is the amount of consolidated net surplus of FA5 ($325)

C is the taxable surplus ($325) and UFT ($200) of FA5.

Step 3

. The taxable surplus and UFT of FA3 is determined as the taxable surplus ($75) and UFT ($10), of FA3, otherwise determined, plus proportionate share the taxable surplus and UFT of FA4

where

A is the amount that would be received by FA3 if FA4 paid its entire consolidated net surplus as a dividend ($125)

B is the amount of consolidated net surplus of FA4 ($125)

C is the taxable surplus ($325) and underlying foreign tax ($200) of FA4.

Step 4

. The taxable surplus and UFT of FA2 is determined as the taxable surplus ($0) and UFT ($0), of FA2, otherwise determined, plus the proportionate share of the taxable surplus and UFT of FA3

where

A is the amount that would be received by FA2 if FA3 paid its entire consolidated net surplus as a dividend ($210)

B is the amount of consolidated net surplus of FA3 ($300)

C is the taxable surplus ($400) and underlying foreign tax ($210) of FA3.

4. Consolidated Net Surplus (Paragraph 5902(1)(e))

The consolidated net surplus of FA2 is $410 and is determined as follows:

where

A is the consolidated exempt surplus of FA2 ($270)

B is the consolidated taxable surplus of FA2 ($280)

C is the consolidated exempt deficit of FA2 ($140)

D is the consolidated taxable deficit of FA2 ($0).

5. Attributed Surplus (Paragraph 5902(1)(f))

The attributed net surplus in respect of each of the disposed shares is determined as follows:

where

A is the consolidated net surplus ($410)

B is the total number of shares issued by FA3 (100).

6. The Whole Dividend (Paragraph 5902(1)(g))

Assuming that the corporation resident in Canada elected, with respect to each share disposed of, under subsection 93(1) of the Act an amount equal to the attributed net surplus in respect of the share, the amount of the whole dividend paid by the foreign affiliate on the shares of the class would be determined as

where

A is the amount elected with respect to a disposed share ($4.10)

B is the number of shares disposed of (30)

C is 410/123 = 3.33

.

Effective Dates

The amendments to section 5902 apply in respect of elections made under subsection 93(1) or (1.2) of the Income Tax Act in respect of dispositions that occur after December 20, 2002 other than dispositions made under agreements in writing made by the vendor on or before December 20, 2002.

If the taxpayer makes an election under subsection 93(1) or (1.2) of the Income Tax Act in respect of a disposition that occurs after December 20, 2002 and before Announcement Date and the taxpayer makes a valid election under subsection 133(40) of the legislative proposals relating to the Income Tax Act released contemporaneously with these draft Regulations, the amendments to section 5902 do not apply and section 5902 is to be read as if it contained a subsection (6.1) that read as set out in subparagraph 5(a)(ii) of the enacting legislation for these proposed amendments to section 5902.

The amendments to section 5902 of the Regulations do not apply to an election by the taxpayer under subsection 93(1) or (1.2) of the Income Tax Act in respect of a disposition that occurs after December 20, 2002 (other than a disposition made under an agreement in writing made by the vendor on or before December 20, 2002) and before Announcement Date if the taxpayer does not elect under subsection 133(40) of the legislative proposals relating to the Income Tax Act and none of paragraphs 88(3)(a), 95(2)(c.2), and (d) to (e.5) of the Income Tax Act applies to the disposition.

The amendments to section 5902 of the Regulations do not apply to an election by the taxpayer under subsection 93(1) or (1.2) of the Income Tax Act in respect of a disposition that occurs after Announcement Date if the disposition is made under an agreement in writing made by the vendor on or before Announcement Date and none of paragraphs 88(3)(a) and 95(2)(c.2), and (d) to (e.5) of the Act applies to the disposition.

ITR
5905

Section 5905 of the Regulations provides special rules, for the purposes of determining surpluses and deficits and underlying foreign tax balances of a foreign affiliate in respect of a corporation resident in Canada.

The rules in section 5905 are being amended to require adjustments to the surplus balances of a foreign affiliate of a corporation resident in Canada in respect of dividends and consolidations of surplus accounts arising because of elections by the corporation resident in Canada under subsection 93(1) or (1.2) of the Act in respect of a disposition of a share of a foreign affiliate of the corporation resident in Canada.

ITR
5905(1)

Subsection 5905(1) of the Regulations provides rules for computing the amount of the exempt surplus or exempt deficit, the taxable surplus or taxable deficit and the underlying foreign tax, in respect of the corporation resident in Canada, of a foreign affiliate of the corporation resident in Canada when the surplus entitlement percentage of the corporation resident in Canada in respect of a foreign affiliate of that corporation increases because of the acquisition of shares of a non-resident corporation. Subsection 5905(1) is being repealed and replaced by proposed new subsection 5905(1) that clarifies the operation of the rule.

Proposed new subsection 5905(1) of the Regulations provides that if, at any time, other than in the course of a transaction to which subsection 5905(2) or (5) applies, a corporation resident in Canada or a foreign affiliate of such a corporation acquires shares of the capital stock of another corporation that was, immediately after that time, a foreign affiliate of a corporation resident in Canada (the "acquired affiliate") and as a result of the acquisition the surplus entitlement percentage of the corporation resident in Canada in respect of the acquired affiliate or any other affiliate (the acquired affiliate and each such other affiliate referred to as a "relevant foreign affiliate") increases, the following rules apply.

• The amount of the exempt surplus or exempt deficit, the taxable surplus or taxable deficit and the underlying foreign tax, in respect of the corporation resident in Canada, of the particular relevant foreign affiliate, is to be adjusted to become the proportion of the amount determined without making this adjustment, that

• For the purposes of applying the definitions "exempt deficit", "exempt surplus", "taxable deficit", "taxable surplus" and "underlying foreign tax", in subsection 5907(1), the adjusted amounts determined above are deemed to be, in respect of the particular relevant foreign affiliate, the opening exempt deficit, opening exempt surplus, opening taxable deficit, opening taxable surplus and opening underlying foreign tax, of the particular relevant foreign affiliate in respect of the corporation.

Proposed new subsection 5905(1) of the Regulations applies to acquisitions after Announcement Date.

ITR
5905(2)

Subsection 5905(2) of the Regulations applies where shares of a foreign affiliate of a corporation resident in Canada are redeemed, acquired or cancelled (otherwise than by way of a winding-up). If the corporation has made an election under subsection 93(1) of the Act or if the corporation's surplus entitlement percentage in the affiliate changes, then the affiliate's surplus balances are adjusted to offset the change in the surplus entitlement percentage. Subsection 5905(2) is being repealed and replaced by proposed new subsection 5905(2) which adjusts surplus balances of the foreign affiliate in respect of an election under subsection 93(1) or (1.2) of the Act.

Proposed new subsection 5905(2) applies in respect of dispositions in respect of which an election was made in respect of which proposed new subsection 5902(1) applies.

Proposed new subsection 5905(2) provides that, if, at any time (in this subsection, the "disposition time") a particular foreign affiliate of the corporation resident in Canada redeems, acquires or cancels (other than a redemption, an acquisition or a cancellation in respect of which an adjustment has previously been made under this subsection or subsection (1) as it read prior to November 13, 1981) in any manner whatever (otherwise than by way of a winding-up) one or more shares (referred to in this subsection and subsections 5902(16) to (23) as "disposed shares") of any class of its capital stock, the following rules apply.

• If, because of an election made by the corporation resident in Canada under subsection 93(1) or (1.2) of the Act in respect of the disposition of the disposed shares, a dividend (in this subsection and subsections 5905(18) and (21), the "disposition dividend") is deemed to have been received on the disposed shares, by the corporation or by another foreign affiliate, for the purposes of the adjustment required by paragraph (b) of the subsection,

Example - Subsection 5905(2)

Facts

1. Canco, a corporation resident in Canada, owns 100% of FA1, which owns 100 shares (100%) of FA2.

2. FA2 owns 100% of FA3.

4. Each of FA1, FA2 and FA3 are foreign affiliates of Canco.

5. FA2 redeems 10 (10%) of its shares owned by FA1.

6. Canco elects under subsection 93(1) of the Act at a designated amount of $30.

7. At the time of the redemption, FA2 has exempt surplus of $0, exempt deficit of $150, taxable surplus of $0, taxable deficit of $200 and underlying foreign tax ("UFT") of $0.

8. At the time of the redemption, FA3 has exempt surplus of $500, exempt deficit of $0, taxable surplus of $150, taxable deficit of $0 and UFT of $0.

9. All the corporations have only issued 100 shares of one class.

Application of subsection 5905(2) to FA3

Subsection 5905(2) applies to adjust the exempt surplus, exempt deficit, taxable surplus, taxable deficit and UFT of each of FA2 and FA3.

For the calculation of consolidated exempt surplus, consolidated exempt deficit, consolidated taxable surplus, consolidated taxable deficit and consolidated underlying foreign tax, see the example in the commentary to subsection 5902(1) of the Regulations.

FA3

Since FA3 has only exempt surplus and taxable surplus, it is only those amounts that must be adjusted.

A. Exempt surplus - FA3

The exempt surplus (otherwise determined) of FA3 is reduced by each of the exempt surplus reduction, exempt deficit reduction and taxable deficit allocation, in respect of the corporation resident in Canada, of FA3 in respect of the disposed shares (see subsections 5905(16) to (22)).

The adjusted amount of the exempt surplus, in respect of the corporation resident in Canada, of FA3 that is determined under paragraph 5905(2)(a) is $500 - ($30 + $150 + $50) = $270. No adjustments are required to be made under paragraph 5905(2)(b) because there is no change in the surplus entitlement percentage of the corporation resident in Canada in respect of FA3.

1. Exempt surplus reduction - FA3

The exempt surplus reduction, in respect of the corporation resident in Canada, of FA3 in respect of the disposed shares is determined as follows

where

A is the exempt surplus in respect of the corporation resident in Canada of FA3 that was included in consolidated exempt surplus in respect of the corporation resident in Canada of FA2 determined under subsection 5902(1) ($500)

B is the consolidated exempt surplus, in respect of the corporation resident in Canada, of FA2 determined under subsection 5902(1) ($500)

C is the portion of the dividend received on the disposed shares because of the election under subsection 93(1) that is, pursuant to paragraph 5900(1)(a), prescribed to be paid out of the consolidated exempt surplus of FA2 ($300 / $300 x $30 = $30)

D is the specified adjustment factor (see subsection 5905(23)), in respect of the corporation resident in Canada, in respect of FA3, of FA1 (1).

2. Exempt deficit reduction - FA3

The exempt deficit reduction in respect of the corporation resident in Canada of FA3 in respect of the disposed shares is determined as follows

where

A is the exempt surplus, in respect of the corporation resident in Canada, of FA2 that was included in the consolidated exempt surplus, in respect of the corporation resident in Canada, of FA2 determined under subsection 5902(1) ($500)

B is the consolidated exempt surplus, in respect of the corporation resident in Canada, of FA2 determined under subsection 5902(1) ($500)

C is the consolidated exempt deficit, in respect of the corporation resident in Canada, of FA2 determined under subsection 5902(1) ($150)

D is the amount that would be the surplus entitlement percentage of FA2 in FA3 if FA2 were the corporation resident in Canada (1).

3. Taxable deficit allocation - FA3

The taxable deficit allocation is determined as follows

1 / 100% x ($200 - $150) x ($500 / $500) = $50

where

A is the amount of the consolidated taxable deficit, in respect of the corporation resident in Canada, of FA2 (determined under subsection 5902(1)) in respect of the disposition of the disposed shares ($200)

B is the amount of the consolidated taxable surplus, in respect of the corporation resident in Canada, of FA2 (determined under subsection 5902(1)) in respect of the disposition of the disposed shares ($150)

C is the exempt surplus, in respect of the corporation resident in Canada, of FA3 that was included in consolidated exempt surplus, in respect of the corporation resident in Canada, of FA2 determined under subsection 5902(1) ($500)

D is the consolidated exempt surplus, in respect of the corporation resident in Canada, of FA2 determined under subsection 5902(1) ($500)

E is the amount that would be the surplus entitlement percentage of FA2 in FA3 if FA2 were the corporation resident in Canada (100%).

B. Taxable surplus - FA3

In this example, taxable surplus is only reduced by the taxable deficit reduction.

The adjusted amount of taxable surplus in respect of the corporation resident in Canada of FA3 that is determined under paragraph 5905(2)(a) is $150 - $150 = $0. No adjustments are required to be made under paragraph 5905(2)(b) because there is no change in the surplus entitlement percentage of the corporation resident in Canada in respect of FA3.

1. Taxable deficit reduction - FA3

The taxable deficit reduction is determined as $150 since the consolidated taxable deficit of FA2 exceeds the consolidated taxable surplus of FA2 in respect of the disposition of the FA2 shares (see paragraph (b) of the definition "taxable deficit reduction" in subsection 5905(20).

Note that with respect to FA2, the amounts that have to be adjusted are its taxable deficit and exempt deficit, which are both reduced to $0. As all accounts of FA2 are $0, no paragraph 5905(2)(b) adjustment is necessary.

ITR
5905(4)

Subsection 5905(4) of the Regulations provides rules for the operation of subsection 5905(3), concerning foreign mergers.

Subsection 5905(4) is replaced by new subsection 5905(4) and adjusts surplus accounts in respect of a corporation resident in Canada of a foreign affiliate of the corporation resident in Canada in respect of elections made by the corporation resident in Canada under subsections 93(1) and (1.2) of the Act in respect of shares of the foreign affiliate that are disposed of.

Proposed new subsection 5905(4) applies in respect of dispositions in respect of which an election was made in respect of which proposed new subsection 5902(1) applies.

Proposed new subsection 5905(4) provides, for the purposes of subsection 5905(3), the following rules:

• if, at any time, a foreign affiliate of a corporation resident in Canada disposes of one or more shares (in this subsection and subsections 5905(16) to (23), the "disposed shares") of a class of the capital stock of a predecessor corporation and the foreign affiliate of the corporation resident in Canada is, because of an election made under subsection 93(1) or (1.2) of the Act, deemed to have received a dividend (in this subsection and subsections (18) and (21), the "disposition dividend") on the disposed shares, for the purposes of the adjustments required by paragraphs (b) and 5905(3)(b),

• The amount, at the balance adjustment time, of exempt surplus, exempt deficit, taxable surplus, taxable deficit and underlying foreign tax, of the particular relevant foreign affiliate is adjusted to become the proportion of that amount, determined without making this adjustment, that

ITR
5905(5), (5.1), (5.2) and (6)

Subsections 5905(5) and (6) of the Regulations apply where, as a result of specified types of transactions, all or any of the shares, of the capital stock of a particular foreign affiliate of a corporation resident in Canada, owned by a "predecessor corporation" are acquired by, or otherwise become the property of, an "acquiring corporation". These transactions are described in detail in paragraphs 5905(5)(a), (b) and (c) and can be generally described as follows:

• a transfer of shares of the capital stock of the particular affiliate by a corporation (the "predecessor corporation") resident in Canada to a taxable corporation resident in Canada (the "acquiring corporation") with which the predecessor corporation does not deal at arm's length;

• an amalgamation of two or more corporations (each corporation being referred to as a "predecessor corporation") to form a new corporation (the "acquiring corporation") if

• a winding-up of a corporation (the "predecessor corporation") into another corporation (the "acquiring corporation") if

Subsections 5905(5) and (6) provide rules for computing the "opening exempt surplus", "opening exempt deficit", "opening taxable surplus", "opening taxable deficit" and "opening underlying foreign tax" of the particular affiliate (and of each other foreign affiliate of the predecessor corporation in which the particular affiliate has an equity percentage) in respect of the acquiring corporation. These rules ensure that the appropriate amounts of surplus, deficit and underlying foreign tax balances of the particular affiliate (and of the relevant subsidiaries of the particular affiliate) in respect of the predecessor corporation are assumed by the acquiring corporation as a result of the reorganization.

Subsection 5905(5) (i.e., the portion between paragraph (c) and (d)) is amended to define the term "particular relevant foreign affiliate" as a particular foreign affiliate and each other foreign affiliate of the predecessor corporation in which the particular affiliate has an equity percentage for the purposes of the subsection and subsections 5905(16) to (23). This amendment applies in respect of dispositions in respect of which an election was made in respect of which proposed new subsection 5902(1) applies.

New subsection 5905(5.1) of the Regulations concerns vertical amalgamations of corporations resident in Canada in respect of which an amount has been designated under paragraph 88(1)(d) of the Act in respect of a share of a foreign affiliate of the parent corporation resident in Canada. This new subsection applies in respect of dispositions in respect of which an election was made in respect of which proposed new subsection 5902(1) applies.

Proposed new subsection 5905(5.1) provides that, where there has been an amalgamation described in paragraph 5905(5)(b) to which subsection 87(11) of the Act applies and, in respect of that amalgamation, an amount has been - under paragraph 88(1)(d) of the Act by the corporation (the "parent corporation") described in subsection 87(11) of the Act as the parent - designated in respect of shares of a corporation (the "particular foreign affiliate") that is, immediately before the amalgamation, a foreign affiliate of the corporation (the "subsidiary corporation") resident in Canada that is described in subsection 87(11) of the Act as the subsidiary, or designated in respect of an interest in a partnership that holds such shares, certain rules apply for the purposes of paragraphs 5905(5)(d) to (h).

• Subject to paragraph 5905(5.1)(c), the amount of the exempt surplus or exempt deficit, taxable surplus or taxable deficit and underlying foreign tax, as the case may be, of the particular foreign affiliate, in respect of the subsidiary corporation and the parent corporation is deemed to be nil, immediately before the amalgamation.

• Subject to paragraph 5905(5.1)(c), the amount of the exempt surplus or exempt deficit, taxable surplus or taxable deficit and underlying foreign tax, as the case may be, in respect of the subsidiary corporation, of each other foreign affiliate (a "lower-tier foreign affiliate") of the subsidiary corporation (other than the particular foreign affiliate) in which the particular foreign affiliate has, immediately before the amalgamation, an equity percentage, is deemed to be nil, immediately before the amalgamation.

• Proposed new paragraph 5905(5.1)(c) provides that the amount of the exempt surplus or exempt deficit, taxable surplus or taxable deficit and underlying foreign tax, as the case may be, of the particular foreign affiliate and each lower-tier foreign affiliate, in respect of the parent corporation, is deemed to be the amount that would have been determined, if

New subsection 5905(5.2) of the Regulations concerns vertical amalgamations of corporations resident in Canada in respect of which an amount has been designated under paragraph 88(1)(d) of the Act in respect of a share of a foreign affiliate of the parent corporation resident in Canada. This new subsection applies in respect of dispositions in respect of which an election was made in respect of which proposed new subsection 5902(1) applies.

New subsection 5905(5.2) provides that, where there has been a winding-up described in paragraph 5905(5)(c) and, in respect of that winding-up, an amount has been - under paragraph 88(1)(d) of the Act by the corporation (the "parent corporation") described in subsection 88(1) of the Act as the parent - designated in respect of shares of a corporation (the "particular foreign affiliate") that is, immediately before the winding-up, a foreign affiliate of the corporation (the "subsidiary corporation") resident in Canada that is described in subsection 88(1) of the Act as the subsidiary or designated in respect of an interest in a partnership that holds such shares, the following rules apply for the purposes of paragraphs 5905(5)(d) to (h):

• Subject to paragraph 5905(5.2)(c), the amount of the exempt surplus or exempt deficit, taxable surplus or taxable deficit and underlying foreign tax of the particular foreign affiliate, in respect of the subsidiary corporation and the parent corporation is deemed to be nil, immediately before the winding-up.

• Subject to paragraph 5905(5.2)(c), the amount of the exempt surplus or exempt deficit, taxable surplus or taxable deficit and underlying foreign tax, as the case may be, in respect of the subsidiary corporation, of each other foreign affiliate (a "lower-tier foreign affiliate") of the subsidiary corporation (other than the particular foreign affiliate) in which the particular foreign affiliate has, immediately before the winding-up, an equity percentage, is deemed to be nil, immediately before the winding-up.

• New paragraph 5905(5.2)(c) provides that the amount of the exempt surplus or exempt deficit, taxable surplus or taxable deficit and underlying foreign tax of the particular foreign affiliate and each lower-tier foreign affiliate, in respect of the parent corporation, is deemed to be the amount that would have been determined, if

Subsection 5905(6) of the Regulations applies when there has been a non-arm's length disposition of shares of a foreign affiliate of a corporation resident in Canada to another corporation resident in Canada. Subsection 5905(6) is being replaced with proposed subsection 5905(6) that requires adjustments of surplus accounts of the foreign affiliate in respect of elections, under subsection 93(1) of the Act, made by the corporation resident in Canada with respect to the disposition of shares of a foreign affiliate of the corporation.

Proposed new subsection 5905(6) provides that, for the purpose of subsection 5905(5), certain rules apply.

• Where paragraph 5905(5)(a) applies and the predecessor corporation referred to in that paragraph is, because of an election made under subsection 93(1) or (1.2) of the Act, deemed to have received a dividend (in this subsection and subsections 5905(18) and (21), the "disposition dividend") on one or more of the shares (each of which is referred to in this subsection and in subsections 5905(16) to (23) as a "disposed share") of the particular foreign affiliate (the "issuing foreign affiliate") disposed of, at that time, in the transaction for the purposes of the adjustment required by paragraph 5905(6)(b),

• if the amount determined, in respect of the particular relevant foreign affiliate, for either B or D in the formula is nil, the amount determined, in respect of the particular relevant foreign affiliate, by the formula is deemed to be nil,

• there is included under subparagraph (v) of the description of B in the definition "exempt surplus" in subsection 5907(1), the amount of the particular foreign affiliate's exempt surplus in respect of the corporation resident in Canada if the particular foreign affiliate has an amount of exempt surplus in respect of the corporation resident in Canada and the issuing foreign affiliate's (see subsection 5902(1)) consolidated exempt deficit equals or exceeds its consolidated exempt surplus in respect of the corporation resident in Canada, in respect of the disposition of the shares,

• there is included under subparagraph (v) of the description of B in the definition "exempt surplus" in subsection 5907(1), the relevant foreign affiliate's taxable deficit allocation in respect of the disposed shares,

• there is included under subparagraph (v) of the description of B in the definition "taxable surplus" in subsection 5907(1), the amount determined by the formula

where

• if the amount determined, in respect of the particular relevant foreign affiliate for either B or D in the formula is nil, the amount determined, in respect of the particular relevant foreign affiliate, by the formula is deemed to be nil,

• there is included under subparagraph (v) of the description of B in the definition "taxable surplus" in subsection 5907(1), the amount of the particular foreign affiliate's taxable surplus in respect of the corporation resident in Canada if the particular foreign affiliate has an amount of taxable surplus in respect of the corporation resident and the issuing corporation's (see subsection 5902(1)) consolidated taxable deficit equals or exceeds its consolidated taxable surplus in respect of the corporation resident in Canada in respect of the disposition of the shares,

• there is included in subparagraph (v) of the description of B in the definition "taxable surplus" in subsection 5907(1), an amount equal to the particular relevant foreign affiliate's exempt deficit allocation in respect of the disposed shares,

• there is included under subparagraph (iii) of the description of B in the definition "underlying foreign tax" in subsection 5907(1), an amount determined by the formula

• if the amount determined above, in respect of the particular relevant foreign affiliate, for either B or D in the formula is nil, the amount determined, in respect of the particular relevant foreign affiliate by the formula is deemed to be nil,

• there is to be included under subparagraph (iii) of the description of B in the definition "underlying foreign tax" in subsection 5907(1), an amount determined by the formula

• New paragraph 5905(6)(b) provides that the exempt surplus or the exempt deficit, the taxable surplus or the taxable deficit and the underlying foreign tax in respect of a predecessor corporation (within the meaning assigned by subsection 5905(5)) and in respect of the acquiring corporation (within the meaning assigned by subsection 5905 (5)) of a particular relevant foreign affiliate is, at the balance adjustment time, to be adjusted to the proportion of the amount of the surplus, deficit or underlying foreign tax determined without reference to this paragraph that

Example - Subsection 5905(6)

Facts

1. Canco, a corporation resident in Canada, owns 100% of Cansub, another corporation resident in Canada.

2. Canco owns 90% of FA1.

3. Cansub owns 10% of FA1.

4. FA1 owns 100% of FA2.

5. Both FA1 and FA2 are foreign affiliates of Canco and Subco.

6. Canco transfers 10% of the shares of FA1 to Cansub under section 85(1) of the Act, electing under section 93(1) of the Act at a designated amount of $10 in respect of the disposed shares.

7. At the time of the transfer, FA1 has exempt surplus of $0, exempt deficit of $400, taxable surplus of $0, taxable deficit of $0 and underlying foreign tax ("UFT") of $0.

8. At the time of the transfer, FA2 has exempt surplus of $0, exempt deficit of $0, taxable surplus of $500, taxable deficit of $0 and UFT of $300.

9. All the corporations have only issued 100 shares of one class.

Application of paragraph 5905(6)(a)

Paragraph 5905(6)(a) of the Regulations applies to adjust the exempt surplus, exempt deficit, taxable surplus, taxable deficit and UFT of each of FA2 and FA3.

For an illustration of the calculation of consolidated exempt surplus, consolidated exempt deficit, consolidated taxable surplus, consolidated taxable deficit and consolidated UFT, see the example in the commentary to subsection 5902(1) of the Regulations.

This example focuses on FA2.

Application of paragraph 5905(6)(a) to FA2

FA2 has amounts of taxable surplus and UFT and those amounts must be adjusted.

The taxable surplus, in respect of Canco, of FA2 is $500 - $100 - $400 = $0.

The UFT, in respect of Canco, of FA2 is $300-($60 + $240) = $0.

1. Taxable Surplus Reduction - 5905(6)(a)(ii)(A)

The taxable surplus reduction is the amount determined by the formula

where

A is the taxable surplus, in respect of Canco, of FA2 that was included in consolidated taxable surplus, in respect of Canco, of FA1 determined under subsection 5902(1) ($500)

B is the consolidated taxable surplus, in respect Canco, of FA1 determined under subsection 5902(1) ($500)

C is the portion of the subsection 93(1) dividend in respect of the disposition of the disposed shares that is prescribed by paragraph 5900(1)(b) of the regulations to have been paid out of taxable surplus in respect of Canco ($10)

D is the surplus entitlement percentage of Canco determined on the assumption that the disposed shares were the only shares owned by Canco (10%).

2. Exempt deficit allocation - 5905(6)(a)(ii)(D)

The amount of FA2's exempt deficit allocation is determined by the formula

where

A is the consolidated exempt deficit, in respect of Canco, of FA1 determined under subsection 5902(1) ($400)

B is the consolidated exempt surplus, in respect of Canco, of FA1 determined under subsection 5902(1) ($0)

C is the taxable surplus, in respect of Canco, of FA2 that was included in consolidated taxable surplus, in respect of Canco, of FA1 determined under subsection 5902(1) ($500)

D is the consolidated taxable surplus in respect of Canco of FA1 determined under subsection 5902(1) ($500)

E is the surplus entitlement percentage of FA1 in FA2 (100%).

UFT- FA2

1. UFT Reduction -5905(6)(a)(iii)(A)

The UFT is to be reduced by the amount determined by the formula

where

A is the UFT, in respect of Canco, of FA2 that was included in consolidated UFT, in respect of Canco, of FA1 determined under subsection 5902(1) ($300)

B is the consolidated UFT, in respect of Canco, of FA1 determined under subsection 5902(1) ($300)

C is the amount prescribed by paragraph 5900(1)(d) to be the UFT, in respect of Canco, applicable to the subsection 93(1) dividend on the disposed shares paid out of the taxable surplus of FA1 ($6)

D is the surplus entitlement percentage of Canco in FA2 on the assumption that only the disposed shares were owned by Canco (10%).

2. UFT Reduction -5905(6)(a)(iii)(C) and (D)

The UFT is to be reduced by the amount determined by the formula

where

A is the UFT, in respect of Canco, of FA2 that was included in consolidated UFT, in respect of Canco, of FA1 determined under subsection 5902(1) ($300)

B is the amount determined under clause 5905(6)(a)(ii)(C) in respect of FA2 in respect of the disposition of the disposed shares ($0)

C is the exempt deficit allocation of FA2 in respect of the disposed shares ($400)

D is the amount of taxable surplus of FA2 that was included in computing the consolidated UFT, in respect of Canco, of FA1 determined under subsection 5902(1) ($500).

ITR
5905(7) to (7.4)

Subsection 5905(7) of the Regulations applies where a foreign affiliate (the "disposing foreign affiliate") of a corporation resident in Canada dissolves in circumstances where paragraph 95(2)(e.1) of the Act applies in respect of the dissolution.

Paragraph 95(2)(e.1) of the Act provides for the rollover of capital property, of a disposing foreign affiliate, to another foreign affiliate of the corporation resident in Canada on a liquidation and a dissolution of the disposing foreign affiliate where certain conditions have been met. One of the conditions is that, immediately before the liquidation, the corporation resident in Canada's surplus entitlement percentage in respect of the disposing foreign affiliate was not less than 90%. Another is that the liquidation is not taxable in the country where the disposing foreign affiliate resides.

Subsection 5905(7) provides that each other foreign affiliate of the corporation resident in Canada that has a direct equity percentage in the disposing foreign affiliate immediately before the time of the dissolution is, for the purposes of computing its exempt surplus, taxable surplus, exempt deficit, taxable deficit and underlying foreign tax balances in respect of the corporation, deemed to have received, immediately before that time, dividends from the disposing affiliate of the amount that that other affiliate could reasonably be expected to have received if the disposing foreign affiliate had paid dividends equal to the amount of its net surplus in respect of the corporation immediately before that time.

Subsection 5905(7) is to be amended in the following ways.

First, it is proposed that subsection 5905(7) be amended to include liquidations and dissolutions to which paragraph 95(2)(e) of the Act apply, in addition to liquidations and dissolutions subject to paragraph 95(2)(e.1). This amendment applies for all portions of the amended subsection, save for the deeming of the dividend, which is not necessary in the case of a foreign affiliate holding shares in a liquidating or dissolving affiliate to which paragraph 95(2)(e) does not apply.

Second, the conditions under which subsection 5905(7) applies are proposed to be amended to refer to a "liquidation and a dissolution" to better track the language in paragraph 95(2)(e.1) of the Act.

Third, the subsection is to be amended so that, where paragraph 95(2)(e) applies to a liquidation and dissolution, the dividend deemed by that subsection to have been received is considered to have been received immediately before the "specified time". The expression "specified time" is defined in new subsection 5905(7.1) to mean the time that is the earlier of

• time at which the disposing foreign affiliate was dissolved, and

• the time of the earliest distribution of property as part of the liquidation and the dissolution of the disposing foreign affiliate.

Fourth, the subsection is to be amended to deal with the case where the disposing foreign affiliate has an exempt deficit or taxable deficit in respect of the corporation immediately before the specified time. These amendments ensure that, where paragraph 95(2)(e) or (e.1) applies to the liquidation and dissolution, of the disposing foreign affiliate

• the exempt deficit in respect of the corporation of each other foreign affiliate of the corporation that held a direct equity percentage in the disposing foreign affiliate is, immediately before the specified time, increased by the sum of that other affiliate's proportionate share of the disposing foreign affiliate's exempt deficit in respect of the corporation, immediately before that time, and the amount by which its proportionate share of the exempt deficit of the disposing foreign affiliate immediately before that time exceeds the amount of the decrease (determined under paragraph 5905(7)(d)) to the amount of its exempt surplus in respect of the corporation,

• the taxable deficit in respect of the corporation of each other foreign affiliate of the corporation that held a direct equity percentage in the disposing foreign affiliate is, immediately before the specified time, increased by the sum of that other affiliate's proportionate share of the disposing foreign affiliate's taxable deficit in respect of the corporation and the amount by which its proportionate share of the taxable deficit of the disposing foreign affiliate immediately before that time, exceeds the amount of the decrease (determined under paragraph 5905(7)(e)) to the amount of its taxable surplus in respect of the corporation,

• the exempt surplus in respect of the corporation of each other foreign affiliate of the corporation that held a direct equity percentage in the disposing foreign affiliate is, immediately before the specified time, decreased by the least of that other affiliate's proportionate share of the disposing foreign affiliate's exempt deficit in respect of the corporation and the amount of its exempt surplus in respect of the corporation, as determined under the definition "exempt surplus" in subsection 5907(1), and

• the taxable surplus in respect of the corporation of each other foreign affiliate of the corporation that held a direct equity percentage in the disposing foreign affiliate is, immediately before the specified time, decreased by the least of that other affiliate's proportionate share of the disposing foreign affiliate's taxable deficit in respect of the corporation and the amount of its taxable surplus in respect of the corporation, as determined under the definition "taxable surplus" in subsection 5907(1).

New subsection 5905(7.1) provides, for the purpose of subsection 5905(5), a definition of the expression "specified time". For more detail, see the commentary to subsection 5905(7) above.

New subsections 5905(7.2) to (7.4) provide for the following rules in relation to section 5905(7):

• For the purposes of subsection 5905(7), the exempt surplus, exempt deficit, taxable surplus, taxable deficit and underlying foreign tax of the disposing foreign affiliate in respect of the corporation at any time is to be determined on the assumption that the taxation year of the disposing foreign affiliate that would otherwise have included that time had ended immediately before that time (subsection 5905(7.2));

• For the purposes of paragraphs 5905(7)(a) and (b), a foreign affiliate's proportionate share of the exempt deficit, if any, of the disposing foreign affiliate in respect of the corporation at any time is equal to the amount it could reasonably have expected to receive if the disposing foreign affiliate had, immediately before that time, paid a dividend equal to the amount of its exempt deficit, if any, in respect of the corporation (subsection 5905(7.3)); and

• For the purposes of paragraphs 5905(7)(c) and (d), a foreign affiliate's proportionate share of the taxable deficit, if any, of the disposing foreign affiliate in respect of the corporation at any time is equal to the amount it could reasonably have expected to receive if the disposing foreign affiliate had, immediately before that time, paid a dividend equal to the amount of its taxable deficit, if any, in respect of the corporation (subsection 5905(7.4)).

New subsections 5905(7) to (7.4) ensure that the exempt deficit and the taxable deficit of the disposing foreign affiliate of a group of affiliates in respect of a taxpayer are absorbed by the other foreign affiliates in the group.

New subsections 5905(7) to (7.4) are applicable to dissolutions that occur after December 20, 2002.

ITR
5905(8)

Subsection 5905(8) of the Regulations provides rules for determining surplus balances that apply when a corporation resident in Canada elects under subsection 93(1) or (1.2) of the Act in respect of a disposition of shares of a foreign affiliate (the issuing affiliate) of the corporation to the corporation or to another corporation that was, immediately after the disposition, a foreign affiliate of the corporation and a dividend is, because of the election, deemed to be received. This subsection is replaced with new subsection 5905(8), to provide for adjustments to surplus accounts in respect of the dividends arising because of the elections under subsection 93(1) or (1.2) of the Act.

Proposed new subsection 5905(8) applies if, at any time, a dividend (referred to in this subsection and subsections 5905(18) and (21) as the "disposition dividend") is, because of an election made by a corporation resident in Canada under subsection 93(1) or (1.2) of the Act, deemed to have been received on disposed shares of a particular foreign affiliate of the corporation resident in Canada that were disposed of to the corporation resident in Canada or another corporation that was, immediately after the disposition, a foreign affiliate of the corporation resident in Canada. It provides the following rules.

• Paragraph 5905(8)(a) sets out a number of adjustments, in respect of the corporation resident in Canada, to different surplus accounts, immediately before the disposition of the shares (the "balance adjustment time"), that must be taken into account in determining the adjustment in paragraph 5905(8)(b).

- In computing the exempt surplus, in respect of the corporation resident in Canada, of the issuing foreign affiliate and each other foreign affiliate of the corporation resident in Canada in which the issuing affiliate has an equity percentage (the issuing foreign affiliate and each such other foreign affiliate referred to as the "particular relevant foreign affiliate"), immediately before the disposition (the "balance adjustment time"), there is to be included under subparagraph (v) of the description of B in the definition "exempt surplus" in subsection 5907(1), the aggregate of the exempt surplus reduction, the exempt deficit reduction, and the taxable deficit allocation of that particular relevant foreign affiliate, in respect of the disposed shares. "Exempt deficit reduction", "exempt surplus reduction" and "taxable deficit allocation" are terms defined in subsections 5905(17), (18), and (19), respectively, and are further described in the commentary to those respective subsections.

- In computing the taxable surplus in respect of the corporation resident in Canada of each particular relevant foreign affiliate, at the balance adjustment time, there is to be included under subparagraph (v) of the description of B in the definition "taxable surplus" in subsection 5907(1), the aggregate of the taxable surplus reduction, the taxable deficit reduction, and the exempt deficit allocation of that particular relevant foreign affiliate, in respect of the disposed shares. "Exempt deficit allocation", "taxable deficit reduction" and "taxable surplus reduction" are terms defined in subsections 5905(16), (20) and (21), respectively.

- In computing the underlying foreign tax of each particular relevant foreign affiliate there is to be included under subparagraph (iii) of the description of B in the definition "underlying foreign tax" in subsection 5907(1), the total of

• the amount determined by the formula

• an amount equal to the underlying foreign tax reduction in respect of the corporation resident in Canada, of the particular relevant foreign affiliate of the corporation resident in Canada, in respect of the disposition of the disposed shares.

• The amount, at the balance adjustment time, of the exempt surplus, exempt deficit, taxable surplus, taxable deficit and underlying foreign tax in respect of the corporation resident in Canada of each particular relevant foreign affiliate is to be adjusted to the proportion of the amount determined, without making this adjustment, that

• For the purposes of applying the definitions "exempt deficit", "exempt surplus", "taxable surplus", "taxable deficit" and "underlying foreign tax" in subsection 5907(1), the amounts determined under paragraph 5905(8)(b) are deemed to be the opening exempt deficit, opening exempt surplus, opening taxable surplus, opening taxable deficit and opening underlying foreign tax, respectively of the particular relevant foreign affiliate, in respect of the corporation resident in Canada.

Proposed new subsection 5905(8) is applicable to dispositions that occur after December 20, 2002.

Example - S

ubsection 5905(8)

Facts

1. Canco is a corporation resident in Canada.

2. Canco owns 100% of FA1 and 50% of FA6, and both FA1 and FA6 are foreign affiliates of Canco.

3. FA1 owns 80 shares (80%) of FA2 and FA6 owns 20 shares (20%) of FA2.

4. FA2 owns 70 shares (70%) of FA3, FA3 owns 100% of FA4 and FA4 owns 100% of FA5.

5. FA1 transfers 30 of its shares in FA2 to FA6, and subsection 93(1) of the Act applies to the transfer, regarding which Canco designates $123 as the dividend received by FA1 in respect of the disposed shares.

6. At the time of the transfer, FA2 has an exempt surplus of $200, a taxable surplus of $0, an exempt deficit of $0 and an underlying foreign tax ("UFT") of $0.

7. At the time of the transfer, FA3 has an exempt surplus of $100, a taxable surplus of $75, an exempt deficit of $0 and an UFT of $10.

8. At the time of the transfer, FA4 has an exempt surplus of $0, a taxable surplus of $0, an exempt deficit of $200 and an UFT of $0.

9. At the time of the transfer, FA5 has an exempt surplus of $0, a taxable surplus of $325, an exempt deficit of $0 and an UFT of $200.

10. All the corporations have only issued 100 shares of one class.

Application of subsection 5905(8) - FA5

I. Paragraph 5905(8)(a) -FA5

Paragraph 5905(8)(a) acts to adjust the exempt surplus, exempt deficit, taxable surplus, taxable deficit and UFT in respect of Canco of each of FA2, FA3, FA4 and FA5. This example will focus on FA5.

A. Exempt Surplus - FA5

First, the adjustment to exempt surplus, in respect of Canco, must be determined by subparagraph 5905(8)(a)(i). However, in this example, FA5 has no exempt surplus, so no calculation is necessary.

B. Taxable Surplus - FA5

Second, the adjustment to taxable surplus, in respect of Canco, of FA5 must be determined by subparagraph 5905(8)(a)(ii). The taxable surplus of FA5 will be reduced by the total of the taxable surplus reduction, taxable deficit reduction and exempt deficit allocation.

The taxable surplus of FA5 is determined as $325 - $108.3 = $216.7.

For the calculation of consolidated exempt surplus, consolidated exempt deficit, consolidated taxable surplus, consolidated taxable deficit and consolidated UFT, see the example in the commentary to subsection 5902(1) of the Regulations.

1. Taxable surplus reduction - FA5

The taxable surplus reduction, in respect of Canco, of FA5 in respect of the disposed shares is the amount determined by the formula:

$227.5 / $280 x $83.99 x 1.587 = $108.3

where

A is the portion of FA5's taxable surplus, in respect of Canco, that can reasonably be considered to have been included in the consolidated taxable surplus of FA2 ($325 x .7 = $227.5)

B is the consolidated taxable surplus, in respect of Canco, of FA2 in respect of the disposition of the FA2 shares ($280)

C is the portion of the disposition dividend received by FA1 on the disposed shares, because of the election under section 93(1) of the Act, in respect of the disposition of the disposed shares, that is prescribed by paragraph 5900(1)(b) to have been paid out of the consolidated taxable surplus of FA2 ($280 / $410 x $123 = $83.99)

D is the specified adjustment factor, in respect of Canco, in respect of FA2, of FA1 (100% / 63% = 1.587).

2.Taxable deficit reduction- FA5

There is no consolidated taxable deficit, in respect of Canco, of FA2. Consequently, there is no taxable deficit reduction, in respect of Canco, in respect of FA5.

3. Exempt deficit allocation - FA5

There is no consolidated exempt deficit in excess of consolidated exempt surplus, in respect of Canco, of FA2. Consequently, there is no exempt deficit allocation, in respect of Canco, in respect of FA5.

C. Underlying foreign tax - FA5

The adjustment to the UFT, in respect of Canco, must be determined by subparagraph 5905(8)(a)(iii). The UFT of FA5 will be reduced by the total of the UFT of FA5 related to any of the taxable surplus reduction, taxable deficit reduction and exempt deficit allocation in respect of Canco of FA5.

The underlying foreign tax in respect of Canco of FA5 is determined to be $133.35 ($200 - $66.65 = 133.35).

1. Underlying foreign tax applicable to subsection 93(1) dividend

The reduction of the underlying foreign tax of FA5 related to the taxable surplus reduction is determined by the formula:

where

A is the portion of the UFT in respect of Canco of FA5 that is included in computing the consolidated UFT in respect of Canco of FA2 ($200 x .7 = $140)

B is the consolidated UFT in respect of Canco of FA2 (($200 + $10) x .7 = $147)

C is the amount, determined pursuant to paragraph 5900(1)(d), of the consolidated underlying foreign tax applicable to the disposition dividend that relates to disposed shares that is prescribed to have been paid out of taxable surplus ($147 x $84 / $280 = $44.1)

D is the specified adjustment factor in respect of Canco in respect of FA5 of FA1 (100% / 63% = 1.587).

D. Exempt deficit reduction

The adjustment to the exempt deficit, in respect of Canco, of FA5 would be determined by subparagraph 5905(8)(a)(iv). However, as FA5 has no exempt deficit, no adjustment is necessary.

E. Taxable deficit reduction

The adjustment to the taxable deficit, in respect of Canco, of FA5 would be determined by subparagraph 5905(8)(a)(v). However, as FA5 has no taxable deficit, no adjustment is necessary.

II. Paragraph 5905(8)(b) adjustment - FA5

Paragraph 5905(8)(b) acts to adjust the exempt surplus, exempt deficit, taxable surplus, taxable deficit and UFT in respect of Canco of each of FA2, FA3, FA4 and FA5. This example will focus on FA5.

As FA5 has only taxable surplus and UFT, it is only those accounts that will be adjusted.

The taxable surplus and UFT of FA5 is adjusted to be the proportion of the amounts determined above that the surplus entitlement percentage of Canco in respect of FA5, at the balance adjustment time, (determined on the assumption that FA5 had a taxation year ending immediately before that time) is of the surplus entitlement percentage of Canco in respect of FA5, immediately after the disposition, (determined on the assumption that FA5 had a taxation year ending immediately at the time of disposition).

Thus, FA5's opening balances after the transaction are as follows:

• taxable surplus in respect of Canco is $260.04

• UFT in respect of Canco is $160.02

A.Taxable surplus

$216.7 x 63 / 52.5 = $260.04

B. Underlying foreign tax

$133.35 x 63 / 52.5 = $160.02

ITR
5905(16) to (23)

New subsections 5905(16) to (23) of the Regulations define terms used in section 5905. These new subsections apply in respect of dispositions in respect of which an election was made in respect of which proposed new subsection 5902(1) applies.

"exempt deficit allocation"

ITR
5905(16)

New subsection 5906(16) of the Regulations defines the expression "exempt deficit allocation", which sets out adjustments to a foreign affiliate's taxable surplus, in respect of the corporation resident in Canada, in respect of consolidated exempt deficit where consolidated exempt deficit exceeds consolidated exempt surplus, in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares. The subsection adopts, from subsection 5905(8) of the Regulations, the terms "particular relevant foreign affiliate", "balance adjustment time", and "disposed shares".

The exempt deficit allocation in respect of the corporation resident in Canada of the particular relevant foreign affiliate in respect of disposed shares of the foreign affiliate of the corporation resident in Canada that issued the disposed shares (the "issuing foreign affiliate") is, if the particular relevant foreign affiliate has, at the balance adjustment time, an amount of taxable surplus in respect of the corporation resident in Canada and the issuing foreign affiliate has, at that time, an amount of consolidated exempt deficit (as this amount is determined under paragraph 5902(1)(b)), in respect of the corporation resident in Canada, as a result of the disposition of the disposed shares, that exceeds the amount of its consolidated exempt surplus (as this amount is determined under paragraph 5902(1)(a)), in respect of the corporation resident in Canada, as a result of the disposition of the disposed shares,

• the amount determined by the formula:

• if the amount determined, in respect of the particular relevant foreign affiliate, for the description of either D or E in the formula above is nil, the amount determined by the formula is deemed to be nil.

"exempt deficit reduction"

ITR
5905(17)

New subsection 5905(17) of the Regulations defines the expression "exempt deficit reduction", which determines the reduction of the exempt surplus of a particular relevant foreign affiliate in respect of the consolidated exempt deficit of the issuing foreign affiliate where the issuing foreign affiliate has consolidated exempt surplus in excess of consolidated exempt deficit, in respect of the corporation resident in Canada. The subsection adopts, from subsection 5905(8) of the Regulations, the terms "particular relevant foreign affiliate", "balance adjustment time", and "disposed shares".

The exempt deficit reduction, in respect of the corporation resident in Canada, of a particular relevant foreign affiliate in respect of disposed shares is

• if the particular relevant foreign affiliate has, at the balance adjustment time, an amount of exempt surplus, in respect of the corporation resident in Canada, and the foreign affiliate of the corporation resident in Canada that issued the disposed shares (the "issuing foreign affiliate") has, at the balance adjustment time, consolidated exempt surplus (as this amount is determined under paragraph 5902(1)(a)), in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares, that exceeds the amount of its consolidated exempt deficit (as this amount is determined under paragraph 5902(1)(b)), in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares,

• where the amount determined, in respect of a particular relevant foreign affiliate, for the description of any of A, B or D in the formula is nil, the amount determined by the formula is deemed to be nil; and

• if the particular relevant foreign affiliate has, at the balance adjustment time, an amount of exempt surplus in respect of the corporation resident in Canada and the issuing foreign affiliate has an amount of consolidated exempt deficit (as this amount is determined under paragraph 5902(1)(b)), in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares that is equal to or greater than the amount of its consolidated exempt surplus (as this amount is determined under paragraph 5902(1)(a)), in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares, the amount of that particular relevant foreign affiliate's exempt surplus.

"exempt surplus reduction"

ITR
5905(18)

New subsection 5905(18) of the Regulations defines the expression "exempt surplus reduction", which determines the reduction of the exempt surplus, in respect of the corporation resident in Canada, of a particular relevant foreign affiliate in respect of the disposition dividend of the issuing foreign affiliate where the issuing foreign affiliate has consolidated exempt surplus in excess of consolidated exempt deficit in respect of the corporation resident in Canada. The subsection adopts, from subsection 5905(8) of the Regulations, the terms "particular relevant foreign affiliate", "balance adjustment time", "disposed shares" and "disposition dividend".

The exempt surplus reduction in respect of the corporation resident in Canada of a particular relevant foreign affiliate, in respect of the disposition of the disposed shares is

• the amount determined by the formula

• if either A or B of the formula is determined to be nil in respect of the particular foreign affiliate, the amount determined by the formula is deemed to be nil; and

• if an amount is determined respect of the particular relevant foreign affiliate, under paragraph (b) of subsection 5905(17) (which subsection defines the expression "exempt deficit reduction"), the amount determined by the formula is deemed to be nil.

"taxable deficit allocation"

ITR
5905(19)

New subsection 5905(19) of the Regulations defines the expression "taxable deficit allocation", which determines adjustments to a foreign affiliate's exempt surplus in respect of the corporation resident in Canada, in respect of consolidated taxable deficit, where consolidated taxable deficit exceeds consolidated taxable surplus, in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares. The subsection adopts, from subsection 5905(8) of the Regulations, the terms "particular relevant foreign affiliate", "balance adjustment time", and "disposed shares".

The taxable deficit allocation of a particular relevant foreign affiliate, in respect of disposed shares of the foreign affiliate of the corporation resident in Canada that issued the disposed shares (the "issuing foreign affiliate") is, if the particular relevant foreign affiliate has, at the balance adjustment time, an amount of exempt surplus in respect of the corporation resident in Canada and the issuing foreign affiliate has, at that time, an amount of consolidated taxable deficit (as determined under paragraph 5902(1)(d)), in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares, that is equal to or greater than the amount of the issuing foreign affiliate's consolidated taxable surplus (as this amount is determined under paragraph 5902(1)(c)), in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares,

• the amount determined by the formula

• if the amount determined, in respect of a particular relevant foreign affiliate, for the description of any of D or E in the formula is nil, the amount determined by the formula is deemed to be nil.

"taxable deficit reduction"

ITR
5905(20)

New subsection 5905(20) of the Regulations defines the expression taxable deficit reduction, which determines adjustments to a foreign affiliate's taxable surplus, in respect of the corporation resident in Canada, where consolidated taxable surplus exceeds consolidated taxable deficit, in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares. The subsection adopts, from subsection 5905(8) of the Regulations, the terms "particular relevant foreign affiliate", "balance adjustment time", and "disposed shares".

The taxable deficit reduction, in respect of the corporation resident in Canada, of a particular relevant foreign affiliate of the corporation resident in Canada, in respect of disposed shares, is

• if the particular relevant foreign affiliate has, at the balance adjustment time, an amount of taxable surplus, in respect of the corporation resident in Canada, and the particular foreign affiliate of the corporation resident in Canada that issued the disposed shares (the "issuing foreign affiliate") has, at the balance adjustment time, consolidated taxable surplus (as this amount is determined under paragraph 5902(1)(c)), in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares that exceeds the amount of the issuing foreign affiliate's consolidated taxable deficit (as this amount is determined under paragraph 5902(1)(d)), in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares, the amount determined by the formula

• if the amount determined, in respect of the particular relevant foreign affiliate, for the description of any of A, B or D in the formula is nil, the amount determined by the formula is deemed to be nil; and

• if the particular relevant foreign affiliate has, at the balance adjustment time, an amount of taxable surplus in respect of the corporation resident in Canada and the issuing foreign affiliate has, at that time, an amount of consolidated taxable deficit (as this amount is determined under paragraph 5902(1)(d)), in respect of the corporation resident in Canada, as a result of the disposition that is equal to or greater than the amount of the issuing foreign affiliate's consolidated taxable surplus (as this amount is determined under paragraph 5902(1)(d)), in respect of the corporation resident in Canada, in respect of the disposition of the disposed shares, the amount of that taxable surplus.

"taxable surplus reduction"

ITR
5905(21)

New subsection 5905(21) of the Regulations defines the expression "taxable surplus reduction", which determines the reduction of the taxable surplus, in respect of the corporation resident in Canada, of a particular relevant foreign affiliate in respect of the disposition dividend of the issuing foreign affiliate where the issuing foreign affiliate has consolidated taxable surplus in excess of consolidated taxable deficit in respect of the corporation resident in Canada. The subsection adopts, from subsection 5905(8) of the Regulations, the terms "particular relevant foreign affiliate", "balance adjustment time", "disposed shares" and "disposition dividend".

The taxable surplus reduction, in respect of the corporation resident in Canada, of a particular relevant foreign affiliate of the corporation resident in Canada, in respect of disposed shares, is

• the amount determined by the formula

• if the amount determined for either A or B of the formula is nil, the amount of determined by the formula is nil; and

• if an amount is determined in respect of the particular relevant foreign affiliate under paragraph (b) of subsection 5905(20) (which subsection defines the expression "taxable deficit reduction"), the amount determined by the formula is deemed to be nil.

"underlying foreign tax reduction"

ITR
5905(22)

New subsection 5905(22) of the Regulations defines the expression "underlying foreign tax reduction", which determines the reduction of underlying foreign tax, in respect of the corporation resident in Canada, of a particular relevant foreign affiliate that is attributable to total deductions from the taxable surplus of the particular relevant foreign affiliate as a result of a taxable deficit reduction and an exempt deficit allocation. The subsection adopts, from subsection 5905(8) of the Regulations, the terms "particular relevant foreign affiliate", "balance adjustment time", "disposed shares" and "disposition dividend".

Underlying foreign tax reduction in respect of the corporation resident in Canada, of a particular relevant foreign affiliate of the corporation resident in Canada, in respect of the disposition of the disposed shares, is the amount determined by the formula

"specified adjustment factor"

ITR
5905(23)

New subsection 5905(23) of the Regulations defines the expression "specified adjustment factor", which is used in subsection 5905(8) of the Regulations and the definitions "exempt surplus reduction" and "taxable surplus reduction" in subsections 5905(18) and (21), respectively. The subsection adopts, from subsection 5905(8) of the Regulations, the terms "particular relevant foreign affiliate" and "disposed shares".

Specified adjustment factor in respect of a corporation resident in Canada of a particular relevant foreign affiliate of that corporation resident in Canada in respect of disposed shares is the amount determined by the formula

where

A is, where the corporation resident in Canada disposed of the disposed shares, 100 per cent, and, where another foreign affiliate of the corporation resident in Canada disposed of the disposed shares, the surplus entitlement percentage of the corporation resident in Canada in respect of that other foreign affiliate, immediately before the disposition of the disposed shares, and

B is the surplus entitlement percentage of the corporation resident in Canada in respect of the particular relevant foreign affiliate, immediately before the disposition of the disposed shares.

ITR
5907

Section 5907 of the Regulations provides definitions and rules for the purposes of Part LIX of the Regulations.

ITR
5907(1)

Subsection 5907(1) of the Regulations provides definitions for the purposes of Part LIX of the Regulations.

"earnings"

The definition "earnings" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the affiliate. Paragraph (b) of the definition "earnings" in subsection 5907(1) of the Regulations ensures that "earnings" will reflect the total of all amounts by which the affiliate's income for the year from an active business is increased because of paragraph 95(2)(a) of the Act.

Consequential to the amendments made to paragraph 95(2)(a) of the Act to provide for amounts by which such income of the affiliate could be decreased, paragraph (b) of the definition "earnings" in subsection 5907(1) of the Regulations is proposed to be amended to ensure that "earnings" will reflect the total of all amounts required by paragraph 95(2)(a) to be included (either as a plus or as a minus) in computing the affiliate's income for the year from an active business. For more detail, refer to the commentary to paragraph 95(2)(a).

The amendment to paragraph (b) of the definition "earnings" in subsection 5907(1) applies to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that this amendment is included in the Global Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

"exempt deficit"

The definition "exempt deficit" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses of the foreign affiliate.

The amendment to the definition "exempt deficit" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations inserts a reference to new subparagraph (viii) of the description of A in the definition "exempt surplus" in subsection 5907(1) of the Regulations.

The proposed amendment to the definition "exempt deficit" in subsection 5907(1) of the Regulations applies to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that this amendment is included in the Global Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

"exempt earnings"

The definition "exempt earnings", of a foreign affiliate of a particular corporation for a taxation year, in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the affiliate.

The definition contains a number of provisions. Subparagraphs (d)(i) and (ii) of the definition "exempt earnings" are relevant to the understanding of the commentary below. Those particular provisions provide as follows:

• Subparagraphs (d)(i) and (ii) of the definition "exempt earnings" provide that, where a foreign affiliate of a particular corporation is resident in a designated treaty country, the affiliate's earnings for the year from an active business carried on by it in a designated treaty country and the amounts included in its income from an active business for the year under paragraph 95(2)(a) of the Act, respectively, are included in computing its "exempt earnings" for the year.

• Clause (d)(ii)(D) of the definition "exempt earnings" includes, in the exempt earnings of a foreign affiliate of a particular corporation, income derived from amounts paid or payable to the affiliate by a partnership of which a non-resident corporation to which the affiliate and the particular corporation are related throughout the year was a member (other than a "specified member" at any time in a fiscal period of a partnership that ends in the year) if that income is deemed by clause 95(2)(a)(ii)(A) of the Act to be income from an active business of the affiliate. This will be the case to the extent that the amounts paid or payable would be deductible in computing the exempt earnings or the exempt loss of the partnership if it were a foreign affiliate of a corporation.

• Clause (d)(ii)(F) of the definition "exempt earnings" includes, in the exempt earnings of a foreign affiliate of a particular corporation, income derived from amounts paid or payable to the affiliate by a partnership of which another foreign affiliate of the particular corporation in respect of which the particular corporation has a qualifying interest throughout the year was a member (other than a "specified member" at any time in a fiscal period of a partnership that ends in the year) if that income is deemed by clause 95(2)(a)(ii)(B) of the Act to be income from an active business of the affiliate. This will be the case to the extent that the amounts paid or payable would be deductible in computing the exempt earnings or the exempt loss of the partnership if it were a foreign affiliate of a corporation.

• Clause (d)(ii)(G) of the definition "exempt earnings" includes, in the exempt earnings of a foreign affiliate of a corporation, income derived from amounts paid or payable to the affiliate by a partnership of which the affiliate was a member (other than a specified member at any time in a fiscal period of a partnership that ends in the year) if that income is deemed by clause 95(2)(a)(ii)(C) of the Act to be income from an active business of the affiliate. This will be the case to the extent that the amounts paid or payable would be deductible in computing the exempt earnings or the exempt loss of the partnership if it were a foreign affiliate of a corporation.

• Clause (d)(ii)(H) of the definition "exempt earnings" includes, in the exempt earnings of a foreign affiliate of a particular corporation, income derived from amounts paid or payable to it (or to a partnership of which it is a member) by another foreign affiliate (the "second affiliate") of the particular corporation related to it and to the particular corporation throughout the year if that income is deemed by clause 95(2)(a)(ii)(D) of the Act to be the income from an active business of the affiliate. The income must be derived from amounts paid or payable in respect of interest on borrowed money used to earn income from property or on an amount payable for property. That property must consist of shares of another foreign affiliate (the "third affiliate") of the particular corporation in respect of which the particular corporation has a qualifying interest throughout the year that are excluded property of the second affiliate. The second affiliate, the third affiliate and "each other affiliate relevant for the purpose of determining whether the shares of the third affiliate are excluded property" must all be resident in, and subject to income taxation in, the same designated treaty country. (The expression "designated treaty country" is defined in subsection 5907(11).) As well, the amounts paid or payable must be relevant in determining the liability for income taxes in the designated treaty country of a group of corporations composed of the second affiliate and one or more other foreign affiliates (the shares of which are excluded property), of the particular corporation, resident in that country and in respect of which the particular corporation has a qualifying interest throughout the year. For the purposes of making these determinations, two assumptions are made. First, the definition "excluded property" in subsection 95(1) of the Act is to be read without reference to amounts receivable referred to in paragraph (c) of that definition where, if interest were payable on the amounts, the interest would not be deductible by the debtor in calculating its exempt earnings or loss. Second, shares of a foreign affiliate (a "non-qualifying affiliate") that is non-resident and subject to income taxation in a designated treaty country are to be ignored in determining whether the shares of the third affiliate are excluded property, unless the shares of the third affiliate would not be excluded property if all shares of all non-qualifying affiliates were not excluded property. For convenience of reference, this second assumption is referred to in the remainder of this commentary to the definition "exempt earnings" as the "Shares Assumption".

As noted in the commentary to new clauses 95(2)(a)(ii)(A), (B) and (C) of the Act, those clauses are amended so that the condition requiring the partnership to have a relevant person as a member of the partnership (otherwise than as a specified member of the partnership) is replaced by a requirement that the relevant person to be a "qualifying member" of the partnership throughout each period, in the fiscal period of the partnership, that ends in the year. The expression "qualifying member" is newly defined in subsection 248(1) of the Act as being a person that would at the relevant time be determined to be a qualifying member of the partnership under paragraph 95(2)(o) of the Act. For more detail, see the commentary to paragraph 95(2)(o) and subsection 248(1) of the Act.

The amendments to clauses 95(2)(a)(ii)(A), (B) and (C) of the Act, in conjunction with the new definition "qualifying member", ensure that, in applying those clauses, limited partners and limited partnerships are treated in the same manner as general partners and general partnerships. These amendments also ensure that, even if the activities of the relevant person do not meet the business activity requirements in new subparagraph 95(2)(o)(i), a partnership may qualify under clauses 95(2)(a)(ii)(A), (B) or (C) if the relevant person has an equity interest in the partnership that meets the criteria set out in new subparagraph 95(2)(o)(ii). For more detail, see the commentary to new paragraph 95(2)(o) of the Act.

The definition "exempt earnings" is to be amended in the following ways.

First, new paragraph (a.1) is added to the definition "exempt earnings" in subsection 5907(1) of the Regulations to include the untaxed portion of the gain from the sale of excluded property that is eligible capital property.

Second, subparagraph (d)(ii) of the definition "exempt earnings" in subsection 5907(1) is amended in the following ways:

• Consequential to the amendments made to paragraph 95(2)(a) of the Act, subparagraph (d)(ii) of the definition "exempt earnings" in subsection 5907(1) of the Regulations is amended to provide that, in computing the affiliate's "exempt earnings" for the year, there will be included the earnings derived from "amounts required to be included in computing" income from an active business under amended paragraph 95(2)(a) of the Act.

• Clauses (d)(ii)(D), (F) and (G) of the definition "exempt surplus" in subsection 5907(1) of the Regulations are proposed to be amended consistent with similar amendments made to clauses 95(2)(a)(ii)(A), (B) and (C) of the Act. Accordingly, amendments (referred to in this commentary as the "Qualifying Member Amendments") are made to clauses (d)(ii)(D), (F) and (G) of the definition "exempt surplus" in subsection 5907(1) of the Regulations so that the condition requiring the partnership to have a relevant person as a member of the partnership (otherwise than as a specified member of the partnership) is replaced by a requirement that the relevant person be a "qualifying member" of the partnership throughout each period, in the fiscal period of the partnership, that ends in the year. The expression "qualifying member" is newly defined in subsection 248(1) of the Act as being a person that would at the relevant time be determined to be a qualifying member of the partnership under paragraph 95(2)(o) of the Act. For more detail, see the commentary to paragraphs 95(2)(o) and (q) and subsection 248(1) of the Act.

• Consistent with the amendments to clause 95(2)(a)(ii)(D) of the Act, clause (d)(ii)(H) of the definition "exempt earnings" in subsection 5907(1) of the Regulations is proposed to be amended to modify the requirement that the second affiliate, the third affiliate and "each other affiliate relevant for the purpose of determining whether the shares of the third affiliate are excluded property" must each be resident in, and subject to income taxation in, the same designated treaty country (sub-subclause (d)(ii)(H)(I)2. of the definition). That requirement is replaced with a requirement that

• Further, clause (d)(ii)(H) of the definition "exempt earnings" in subsection 5907(1) of the Regulations is proposed to be amended to delete the Shares Assumption. The Shares Assumption is no longer relevant as that clause no longer contains a reference to "each other affiliate relevant for the purpose of determining whether the shares of the third affiliate are excluded property".

• Consequential to the introduction of new subparagraph 95(2)(a)(v) of the Act, new clause (d)(ii)(L) of the definition "exempt earnings" in subsection 5907(1) of the Regulations is proposed to be added. New clause (d)(ii)(L) ensures that income of a foreign affiliate, of a corporation, for a year that, because of new subparagraph 95(2)(a)(v) of the Act, is included in computing the affiliate's active business income for the year, is included in computing the "exempt earnings" of the affiliate. In making the determination of this income, new subparagraph 95(2)(a)(v) is to be read as if it applies to the income or loss derived from the disposition of excluded property that is not capital property if

• Consequential to the introduction of new subparagraph 95(2)(a)(vi) of the Act, new clause (d)(ii)(M) of the definition "exempt earnings" in subsection 5907(1) of the Regulations is proposed to be added. New clause (d)(ii)(M) ensures that income of a foreign affiliate, of a corporation, for a year that, because of new subparagraph 95(2)(a)(vi) of the Act, is included in computing the affiliate's active business income for the year, is included in computing the "exempt earnings" of the affiliate. This is determined by reading new subparagraph 95(2)(a)(vi) as the income or loss derived from the disposition of excluded property that is not capital property if derived by the particular foreign affiliate under or as a result of an agreement that provides for the purchase, sale or exchange of currency and that can reasonably be considered to have been made by the particular foreign affiliate to reduce its risk, of fluctuations in the value of the denominated currency, with respect to

For more detail, see the commentary to subsection 95(2) of the Act.

The amendments to paragraph (a.1), and subparagraph (d)(ii), of the definition "exempt earnings" in subsection 5907(1) apply to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that these amendments are included in the Global Section 95 Election package described in the beginning of the commentary to section 95 of the Act and that, in the event of a Global Section 95 Election, the Qualifying Member Amendments apply to taxation years, of a foreign affiliate of a taxpayer, that end after 1999.

"exempt loss"

The definition "exempt loss" of a foreign affiliate of a corporation for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the affiliate.

The definition "exempt loss" in subsection 5907(1) is proposed to be amended in the following ways.

First, consequential to the proposed amendments to paragraph (c) of that definition, the "preamble" of that definition is proposed to be amended to refer to the foreign affiliate as the "particular" foreign affiliate.

Second, amendments are proposed to be made to paragraph (c) of the definition "exempt loss" in subsection 5907(1). Under existing paragraph (c) of the definition, where a particular foreign affiliate of a particular corporation is resident in a designated treaty country, the affiliate's losses for a year from an active business carried on by it in Canada or in a designated treaty country are included in computing its "exempt loss" for the year. Consequential to the amendments made to paragraph 95(2)(a) of the Act, paragraph (c) of the definition is proposed to be amended to ensure that losses from sources in a country, other than Canada, that would otherwise be property losses but are re-characterized by paragraph 95(2)(a) to be losses from an active business, are included in computing the "exempt loss" of the affiliate. The provisions to deal with these re-characterized losses are set out in new subparagraph (c)(ii) of the definition "exempt loss" and are modelled after the analogous provisions in proposed amended subparagraph (d)(ii) of the definition "exempt income" in subsection 5907(1) of the Regulations.

Third, a "postamble" to the definition "exempt loss" in subsection 5907(1) is proposed to be added to ensure that the amount that would otherwise be the "exempt loss" of a foreign affiliate of a particular corporation is reduced by the portion of any income or profits tax refunded by the government of a country for the year to the affiliate that can reasonably be regarded as tax refunded in respect of losses referred to in new subparagraph (c)(ii) of the definition "exempt loss" in subsection 5907(1).

The amendments to the definition "exempt loss" in subsection 5907(1) apply to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that these amendments are included in the Global Section 95 Election package described at the beginning of the commentary to section 95 of the Act, and that, in the event of a Global Section 95 Election, in its application to taxation years, of a foreign affiliate of a taxpayer, that end before 2000, the Member Criteria Condition will, instead of containing the Qualifying Member Requirement, contain the requirement that the partnership have a relevant person as a member of the partnership (otherwise than as a specified member of the partnership).

The expression "specified member" is defined in existing subsection 248(1) of the Act. For more detail, see the commentary to the definition "exempt earnings" in subsection 5907(1) of the Regulations.

"exempt surplus"

The definition "exempt surplus" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the affiliate. The definition is amended in three ways.

Firstly, the Regulations are proposed to be amended by replacing, with any grammatical changes that the circumstances require, every reference to "subsection 5905(7)" with a reference to "subsections 5905(7) to (7.4)" in the following subparagraphs of the description of A in the following definitions in subsection 5907(1) of the Regulations:

• subparagraph (iii) of the description of A in the definition "exempt surplus";

• subparagraph (iii) of the description of A in the definition "taxable surplus"; and

• subparagraph (iv) of the description of A in the definition "underlying foreign tax".

This amendment to the Regulations is to be effected by way of a global provision in the amending Regulation rather than by having the amending Regulation amend, provision by provision, each specific provision in the Regulations where a reference to subsection 5905(7) appears. This amendment to the Regulations is consequential to the division of subsection 5905(7) of the Regulations into subsections 5905(7) to (7.4). For more detail, refer to the commentary to subsections 5905(7), (7.1) and (7.2) to (7.4).

Secondly, the definition "exempt surplus" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is amended to include each amount determined under subparagraph 5905(2)(a)(iv), (4)(a)(iv), (6)(a)(iv) or (8)(a)(iv) in the period and before the particular time in the description of A of the definition.

Thirdly, the definition "exempt surplus" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is amended to include each amount determined under subparagraph 5905(2)(a)(i), (4)(a)(i), (6)(a)(i) or (8)(a)(i) in the period and before the particular time, in the description of B of the definition.

"loss"

The definition "loss" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the foreign affiliate.

Consequential to the amendments to paragraph 95(2)(a) of the Act, the definition "loss" in subsection 5907(1) of the Regulations is proposed to be amended to add new paragraph (b) to ensure that losses from sources in a country other than Canada, that would otherwise be property losses but are re-characterized by paragraph 95(2)(a) of the Act to be losses from an active business, are included in computing the "loss" of the affiliate.

The amendment to the definition "loss" in subsection 5907(1) is proposed to apply to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that these amendments are included in the Global Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

"net earnings"

The definition "net earnings" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the foreign affiliate.

It is proposed to amend paragraph (d) of the definition "net earnings". The amendment is to subparagraph (d)(i) and is consequential to the amendments to the definition "foreign accrual property income" in subsection 95(1) of the Act. Those amendments to the definition "foreign accrual property income" ensure that capital gains and losses from dispositions of "excluded property" to which subsection 88(3) of the Act applies are included in computing foreign accrual property income. This amendment to the definition "net earnings" ensures that, in computing net earnings, those capital gains are not double-counted.

The proposed amendment to the definition "net earnings" in subsection 5907(1) of the Regulations applies to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that this amendment is included in the Global Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

"net loss"

The definition "net loss" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the foreign affiliate.

It is proposed to amend paragraph (d) of the definition "net loss". The amendment is to subparagraph (d)(i) of the definition "net loss". The amendment removes the reference to the words in parentheses that were previously contained in that subparagraph. They were not necessary and caused confusion.

The proposed amendment to the definition "net loss" in subsection 5907(1) of the Regulations applies to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that this amendment is included in the Global Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

"taxable deficit"

The definition "taxable deficit" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses of the foreign affiliate.

The amendment to the definition "taxable deficit" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is to insert a reference to new subparagraph (vi) of the description of A in the definition "taxable surplus" in subsection 5907(1) of the Regulations.

The proposed amendment to the definition "taxable deficit" in subsection 5907(1) of the Regulations applies to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that this amendment is included in the Global Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

"taxable earnings"

The definition "taxable earnings" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses of the foreign affiliate.

The proposed amendment of the definition "taxable earnings" in subsection 5907(1) of the Regulations is to subparagraph (b)(v) and is consequential to the amendments to the definition "foreign accrual property income" in subsection 95(1) of the Act. The amendments to the definition "foreign accrual property income" ensure that capital gains and losses from dispositions of "excluded property" to which subsection 88(3) of the Act applies are included in computing foreign accrual property income. This amendment to the definition "taxable earnings" ensures that, in computing taxable earnings, those capital gains are not double-counted.

This amendment to the definition "taxable earnings" in subsection 5907(1) of the Regulations applies to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that this amendment is included in the Global Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

"taxable loss"

The definition "taxable loss" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the foreign affiliate.

As noted in the commentary to the proposed amendments to the definition "loss" in subsection 5907(1), a property loss

re-characterized by paragraph 95(2)(a) of the Act as loss from an active business is described in new paragraph (b) of the definition "loss" and is included in computing "loss".

The amendment to the definition "taxable loss" in subsection 5907(1) of the Regulations proposes to add new subparagraph (b)(v). That subparagraph ensures that, to the extent that the loss for the year determined under paragraph (b) of the definition "loss" has not been included under existing subparagraph (b)(i) of the definition "taxable loss" or deducted in computing an amount under existing subparagraph (b)(i) of the definition "taxable earnings", that loss (minus the portion of any income or profits tax refunded by the government of a country for the year that can reasonably be regarded as tax refunded in respect of that loss) is to be included in computing "taxable loss" for the year. Note, also, that the existing "postamble" to the definition "taxable loss" ensures that "taxable loss" does not include any amount included in the affiliate's "exempt loss" for the year.

This proposed amendment to the definition "taxable loss" in subsection 5907(1) of the Regulations applies to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that this amendment is included in the Global Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

"taxable surplus"

The definition "taxable surplus" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the foreign affiliate.

The definition "taxable surplus" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1) of the Regulations is proposed to be amended in three ways.

Firstly, in the description of A in the definition of "taxable surplus" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1), there is to be included a new subparagraph (vi) which will include in the description of A of the definition each amount determined under subparagraph 5905(2)(a)(v), (4)(a)(v), (6)(a)(v) or (8)(a)(v) in the period and before that particular time.

Secondly, in subparagraph (v) of the description of B in the definition "taxable surplus" of a foreign affiliate of a taxpayer resident in Canada for a taxation year in subsection 5907(1), the reference to "paragraph 5902(4)(b) or subparagraph 5905(2)(a)(ii), (6)(a)(ii) or (8)(a)(ii)" is replaced by a reference to "subparagraph 5905(2)(a)(ii), (4)(a)(ii), (6)(a)(ii) or (8)(a)(ii)".

For details on the third amendment, refer to the commentary to the definition "exempt surplus" in subsection 5907(1).

These proposed amendments to the definition "taxable surplus" in subsection 5907(1) of the Regulations apply in respect of dispositions in respect of an election in respect of which proposed new subsection 5902(1) applies.

"underlying foreign tax"

The definition "underlying foreign tax" of a foreign affiliate of a corporation resident in Canada, in respect of a corporation, in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the foreign affiliate.

Subparagraph (iii) of the description of B of the definition "underlying foreign tax" has been amended to remove the reference to paragraph 5902(4)(c), and to add a reference to subparagraph 5905(4)(a)(iii).

This proposed amendment to the definition "underlying foreign tax" in subsection 5907(1) of the Regulations applies in respect of dispositions in respect of which an election was made in respect of which proposed new subsection 5902(1) applies.

"whole dividend"

The definition "whole dividend" paid at any time on the shares of a class of the capital stock of a foreign affiliate of a taxpayer resident in Canada in subsection 5907(1) of the Regulations is relevant for the purposes of computing the surpluses and deficits of the foreign affiliate.

The proposed amendment to paragraph (b) of the definition "whole dividend" in subsection 5907(1) replaces a reference to "5902(1)(c)" with a reference to "5902(1)(g)".

This proposed amendment to the definition "underlying foreign tax" in subsection 5907(1) of the Regulations applies in respect of dispositions in respect of which an election was made in respect of which proposed new subsection 5902(1) applies.

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5907(1.1)

Subsection 5907(1.1) of the Regulations contains rules for the calculation of the surpluses and deficits of a foreign affiliate of a corporation resident in Canada where the affiliate is a member of a group (the "consolidated group") of foreign affiliates of the corporation that files a consolidated or combined return in a foreign country such as the United States and one of the affiliates (the "primary affiliate") in the group is responsible, on behalf of the group, for paying, or claiming a refund of, the tax payable in that country by the primary affiliate and the other members of the group (those other members being referred to as the "secondary affiliates").

Subparagraph 5907(1.1)(b)(ii) applies where a secondary affiliate has a loss and the primary affiliate pays an amount to a secondary affiliate in respect of a reduction or refund, by virtue of the loss of the secondary affiliate, of the tax that would otherwise have been payable in the country by the primary affiliate for the year on behalf of the consolidated group. In general terms, that subparagraph results in a reduction of the primary affiliate's surplus balances, and an increase of the secondary affiliate's surplus balances, by the amount of the payment.

The proposed amendments to subparagraph 5907(1.1)(b)(ii) deal with the case where a secondary affiliate has a tax credit and the primary affiliate pays an amount to the secondary affiliate in respect of a reduction or refund, by virtue of the tax credit of the secondary affiliate, of the tax that would otherwise have been payable in the country by the primary affiliate for the year on behalf of the consolidated group. In general terms, the amendments ensure that the primary affiliate's surplus balances are reduced, and the secondary affiliate's surplus balances are increased, by the amount of the payment.

The amendments to subparagraph 5907(1.1)(b)(ii) apply to payments made after December 20, 2002.

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5907(2)(f)

Subsection 5907(2) of the Regulations provides special rules for computing earnings of a foreign affiliate from an active business carried on by it in a country. It is proposed to amend paragraph 5907(2)(f) to delete subparagraph (ii) consequential to the introduction of the rules in paragraphs 95(2)(c.2) to (c.6), and 95(2) (f.3) to (f.8) of the Act.

The amendment to paragraph 5907(2)(f) applies in respect of dispositions by a foreign affiliate after December 20, 2002, other than a disposition made after December 20, 2002 under a written agreement made by the foreign affiliate before December 20, 2002.

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5907(2.01)

New subsection 5907(2.01) of the Regulations provides that, notwithstanding any other provision of the Regulations, in determining the earnings of a foreign affiliate of a corporation resident in Canada, the cost of a property that was acquired by a particular person or partnership from another person or partnership (the "vendor") in respect of which any of paragraphs 5907(2)(c.2), (d), (e), (e.3) to (e.5) and (f.4) of the Regulations applied to the vendor in respect of the disposition of the property to the particular person or partnership, is to be determined using the rules in those paragraphs.

New subsection 5907(2.01) of the Regulations applies in respect of dispositions made by a foreign affiliate after December 20, 2002, other than a disposition made after December 20, 2002 under a written agreement made by the foreign affiliate before December 20, 2002.

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5907(2.7)

In general terms, subsection 5907(2.7) of the Regulations provides that, where amounts are included by subparagraph 95(2)(a)(i) or (ii) of the Act in computing the income or loss from an active business of a particular foreign affiliate of a taxpayer and these amounts are in respect of amounts paid or payable to the particular affiliate by another non-resident corporation or partnership in the group, the amounts paid or payable to the particular affiliate by the other non-resident corporation or partnership are required to be deducted in computing the other non-resident corporation's or partnership's earnings or loss from an active business (unless they have already been deducted under paragraph 5907(2)(j) of the Regulations) for the earliest taxation year in which the amounts were paid or payable.

Subsection 5907(2.7) of the Regulations is proposed to be amended so that it applies to amounts included in computing the income or loss from an active business of the particular affiliate under paragraph 95(2)(a) of the Act, rather than just under subparagraph 95(2)(a)(i) or (ii).

The proposed amendments to subsection 5907(2.7) of the Regulations apply to taxation years, of a foreign affiliate of a taxpayer, that begin on or after December 20, 2002. Note that these amendments are included in the Global Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

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5907(2.8) to (2.83)

Under clause 95(2)(a)(ii)(D) of the Act, the income of a foreign affiliate of a corporation resident in Canada (the "first affiliate") that is derived from amounts paid or payable to it by another foreign affiliate of the corporation or a non-resident corporation to which the first affiliate and the corporation resident in Canada are related (referred to in subsections 5907(2.8) to (2.83) of the Regulations as the "second affiliate") is included in the active business income of the first affiliate.

The amounts paid or payable by the second affiliate must be in respect of interest on borrowed money used for the purpose of earning income from property or on an amount payable for property where the property consists of shares of another foreign affiliate of the corporation in respect of which the corporation has a qualifying interest throughout the year (in subsections 5907(2.8) to (2.83), the "third affiliate") that are excluded property of the second affiliate within the meaning assigned by section 95 of the Act in the country in which the second affiliate is resident and subject to income taxation.

It is proposed that existing subsection 5907(2.8) of the Regulations be replaced by proposed new subsections 5907(2.8) to (2.83) because of the proposed amendments to clause 95(2)(a)(ii)(D) of the Act. These are essentially rules for reducing exempt surplus of foreign affiliates of a taxpayer resident in Canada in respect of interest referred to in 95(2)(a)(ii)(D) of the Act. The proposed new subsections apply to taxation year, of foreign affiliate of a taxpayer, to which proposed new clauses 95(2)(a)(ii)(D)(III) to (V) of the Act apply.

Proposed subsection 5907(2.8) of the Regulations sets out, in respect of a particular amount of interest referred to in 95(2)(a)(ii)(D) of the Act, the requirements for new subsection 5907(2.81) to apply.

Proposed subsection 5907(2.8) provides that subsection 5907(2.81) applies to the specified foreign affiliates of a corporation resident in Canada, if

• an amount in respect of the particular amount of interest is included, under clause 95(2)(a)(ii)(D) of the Act, in computing the income or loss for a particular taxation year from an active business of a particular foreign affiliate of the corporation resident in Canada or a person related to the corporation resident in Canada, and

• the particular amount of interest is an amount of interest paid or payable to the particular foreign affiliate, by the second affiliate, under a legal obligation to pay interest on borrowed money used for the purpose of earning income from property, or on an amount payable for property acquired for the purpose of gaining or producing income from property, if

If subsection 5907(2.81) of the Regulations applies, in respect of the particular amount of interest referred to in subsection 5907(2.8), to the specified foreign affiliates of the corporation resident in Canada, the following rules apply:

• Where the specified foreign affiliate is the second affiliate referred to in subsection 5907(2.8), the particular amount of interest is to be deducted in computing the specified foreign affiliate's exempt surplus at the end of the applicable taxation year of the specified foreign affiliate, to the extent of the specified foreign affiliate's available exempt surplus amount in respect of the applicable taxation year of the specified foreign affiliate.

• Where the specified foreign affiliate is the third affiliate referred to in subsection 5907(2.8), there shall be deducted in computing the specified foreign affiliate's exempt surplus at the end of the applicable taxation year of the specified foreign affiliate, the lesser of the specified foreign affiliate's available exempt surplus amount in respect of the applicable taxation year of the specified foreign affiliate and the amount determined by the formula

• Where the specified foreign affiliate is a group foreign affiliate (defined in subsection referred to in subsection 5907(2.84)), there shall be deducted in computing the specified foreign affiliate's exempt surplus in respect of the corporation resident in Canada at the end of the applicable taxation year of the specified foreign affiliate, the lesser of the specified foreign affiliate's available exempt surplus (defined in subsection referred to in subsection 5907(2.83)) in respect of its applicable taxation year and the amount determined by the formula

• Amounts in respect of the particular amount of interest must be deducted under paragraph 5907(2.81)(a) to (c) that subsection in computing the exempt surplus in respect of the corporation resident in Canada of the specified foreign affiliates of the corporation resident in Canada at the end of each of their applicable taxation years to the extent of the total of all amounts each of which is the available exempt surplus amount of a specified foreign affiliate of the corporation resident in Canada in respect of the applicable taxation year of that specified foreign affiliate.

• An exempt surplus reduction is to be applied against the second affiliate before it is applied against the third affiliate and is to be applied against the third affiliate before it is applied against a group foreign affiliate of the corporation resident in Canada.

• There is to be added in computing the exempt deficit in respect of the corporation resident in Canada of the second affiliate the amount determined by the formula:

Proposed subsection 5907(2.82) of the Regulations provides that, in computing the second affiliate's income or loss for a taxation year from any source, no amount is to be deducted in respect of an amount paid or payable by it that is referred to in paragraph 5907(2.81)(a).

Proposed subsection 5907(2.83) of the Regulations sets out certain definitions used in subsections 5907(2.8) to (2.83).

"applicable taxation year"

"Applicable taxation year" of a specified foreign affiliate of the corporation resident in Canada, in subsection 5907(2.83) of the Regulations, is the last taxation year of the specified foreign affiliate that ends in the particular taxation year of the particular foreign affiliate referred to in paragraph 5907(2.8)(a).

"available exempt surplus amount"

"Available exempt surplus amount" of a specified foreign affiliate of the corporation resident in Canada, in subsection 5907(2.83) of the Regulations in respect of the applicable taxation year of the specified foreign affiliate is the amount determined by the formula

where

A is the total of all amounts of which is this portion the specified foreign affiliate's income, for its applicable taxation year, from an active business that is included in computing the exempt earnings in respect of the corporation resident in Canada of the specified foreign affiliate,

B is the specified foreign affiliate's exempt surplus in respect of the corporation resident in Canada at the end of the specified foreign affiliate's taxation year that immediately precedes its applicable taxation year,

C is the total of all amounts each of which is the portion of any dividend received in the applicable taxation year, by the specified foreign affiliate from another foreign affiliate of the corporation resident in Canada, that is prescribed by paragraph 5900(1)(a) to have been paid out of that other affiliate's exempt surplus,

D is the total of all amounts each of which is the portion of the specified foreign affiliate's loss, for its applicable taxation year, from an active business that is included in computing the exempt loss in respect of the corporation resident in Canada of the specified foreign affiliate,

E is the specified foreign affiliate's exempt deficit in respect of the corporation resident in Canada at the end of the specified foreign affiliate's taxation year that immediately precedes its applicable taxation year,

F is the specified foreign affiliate's taxable deficit in respect of the corporation resident in Canada at the end of the specified foreign affiliate's taxation year that immediately precedes its applicable taxation year, and

G is the total of all amounts each of which is the portion of any dividend paid in the applicable taxation year by the specified foreign affiliate that is prescribed by paragraph 5900(1)(a) to have been paid out of its exempt surplus.

"group foreign affiliate"

"Group foreign affiliate", at any time, of a corporation resident in Canada, in subsection 5907(2.83) of the Regulations, is any of its foreign affiliates (other than the second affiliate and the third affiliate) in which the second affiliate has, at that time, an equity percentage.

"specified adjustment factor"

"Specified adjustment factor", in respect of the corporation resident in Canada, in subsection 5907(2.83) of the Regulations, in respect of a specified foreign affiliate of the corporation resident in Canada, in respect of the applicable taxation year of the second affiliate, is the amount determined by the formula

where

A is the surplus entitlement percentage of the corporation resident in Canada in respect of the second affiliate, immediately before the end of the applicable taxation year of the second affiliate, and

B is the surplus entitlement percentage of the corporation resident in Canada in respect of the specified foreign affiliate, immediately before the end of the applicable taxation year of the second affiliate.

"specified foreign affiliate"

"Specified foreign affiliate" of the corporation resident in Canada, in subsection 5907(2.83), is any foreign affiliate of the corporation resident in Canada that, at the end of the particular taxation year referred to in paragraph 5907(2.8)(a) of the Regulations, is

• the second affiliate,

• the third affiliate, or

• another corporation that is

ITR
5907(2.9)

Subsection 5907(2.9) of the Regulations applies where the fresh start rules in paragraph 95(2)(k) of the Act apply to a foreign affiliate of a corporation resident in Canada in respect of a "foreign business". Subsection 5907(2.9) ensures that appropriate adjustments are made to the surplus accounts of the affiliate.

In general terms, subsection 5907(2.9) provides that there is to be added to the affiliate's "earnings" (as defined in subsection 5907(1) of the Regulations), for the last taxation year of the affiliate before the fresh start year, the total of the following amounts:

• the amount by which the actual reserves claimed exceed the maximum reserve allowed under paragraph 95(2)(k) of the Act for that last taxation year;

• where, because of paragraphs 95(2)(k) and 138(11.91)(e) of the Act, there is a deemed disposition of depreciable property that was used or held by the affiliate in the course of carrying on the foreign business, the amount by which the lesser of the fair market value and the cost to the affiliate of the property exceeds the undepreciated capital cost (or an analogous concept under the relevant foreign tax law) of the property at the end of that last taxation year; and

• where, because of paragraphs 95(2)(k) and 138(11.91)(e) of the Act, there is a deemed disposition of property (other than capital property) that was used or held by the affiliate in the course of carrying on the foreign business, the amount by which the fair market value of the property exceeds the cost of the property to the affiliate at the end of that last taxation year.

These additions to "earnings" result in corresponding increases in the balance of the affiliate's relevant surplus account.

In general terms, subsection 5907(2.9) provides that there is to be deducted from "earnings" for the last taxation year of the affiliate before the fresh start year the total of the following amounts:

• the maximum reserve allowed under paragraph 95(2)(k) of the Act minus the actual reserve claimed at the end of that last taxation year;

• where, because of paragraphs 95(2)(k) and 138(11.91)(e) of the Act, there is a deemed disposition of depreciable property that was used or held by the affiliate in the course of carrying on the foreign business, the amount by which the undepreciated capital cost of the property exceeds the lesser of fair market value and cost to the affiliate of the property at the end of that last taxation year; and

• where, because of paragraphs 95(2)(k) and 138(11.91)(e) of the Act, there is a deemed disposition of property (other than capital property) that was used or held by the affiliate in the course of carrying on the foreign business, the amount by which the cost of the property to the affiliate exceeds the fair market value of the property at the end of that last taxation year.

These decreases to "earnings" result in corresponding decreases in the balance of the affiliate's relevant surplus account.

Subsection 5907(2.9) of the Regulations is proposed to be amended to reflect the amendments to the Act which are set out in amended paragraph 95(2)(k), new paragraph 95(2)(k.1) and amended subsection 138(11.91) of the Act. In particular, subsection 5907(2.9) is proposed to be amended in the following ways.

First, subsection 5907(2.9) of the Regulations is proposed to be amended to reflect the proposed splitting of paragraph 95(2)(k) of the Act into paragraphs 95(2)(k) and (k.1).

Second, consistent with paragraphs 95(2)(k) and (k.1) of the Act, the proposed amendments to subsection 5907(2.9) of the Regulations ensure that the fresh start rules will apply where the foreign business is carried on by a partnership of which a foreign affiliate of a taxpayer is a member. These amendments to subsection 5907(2.9) ensure, in the case of partnerships, that the fresh start rules will work on the basis of fiscal periods of the partnership and that these rules will therefore be relevant in the computation of the affiliate's foreign accrual property income for the affiliate's taxation year that includes the end of a fiscal period to which the fresh start rules apply. The expression "operator" refers to the affiliate (in the case where the affiliate directly carries on the foreign business) or to the partnership (in the case where the partnership carries on the foreign business). The amounts added by subsection 5907(2.9) to "earnings" or "loss" are used in computing the earnings or loss from the foreign business (when it was an active business) of the affiliate in the preceding taxation year or fiscal period referred to in paragraph 95(2)(k), as the case may be, (which preceding taxation year or preceding fiscal period is referred to as the "preceding taxation year") in which the affiliate is deemed to have disposed of property.

Third, the proposed amendments to subsection 5907(2.9) modify the manner in which any necessary decreases are made to the affiliate's relevant surplus account. As noted above, existing subsection 5907(2.9) provides for the decreases to surplus to be made by way of decreases to "earnings". Amended subsection 5907(2.9) provides, instead, for those amounts to be placed in the "loss" (as defined in subsection 5907(1)) of the affiliate, which result in corresponding decreases in the balance of the surplus account.

Fourth, amended subsection 5907(2.9) contains new rules in respect of eligible capital property and resource property to deal more appropriately with these types of property. As mentioned above, existing subsection 5907(2.9) ensures that where, because of paragraphs 95(2)(k) and 138(11.91)(e) of the Act, there is a deemed disposition of property that was used or held by the affiliate in the course of carrying on the foreign business, the affiliate's "earnings" are increased by the total of all amounts each of which is the amount by which the fair market value of the property (other than capital property) to the affiliate exceeds the cost of the property. (There is a corresponding rule in existing subsection 5907(2.9) that provides for a decrease of "earnings" if the cost of the property to the affiliate exceeds the fair market value of the property.)

As proposed to be amended, subsection 5907(2.9) ensures that where, because of paragraphs 95(2)(k) and 138(11.91)(e) of the Act, there is a deemed disposition of eligible capital property, the affiliate's "earnings" are increased by the amount, if any, required by subsection 14(1) of the Act to be included in computing the operator's income for that preceding taxation year from the foreign business. Conversely, amended subsection 5907(2.9) also ensures that, if the operator was, because of paragraphs 95(2)(k.1) and 138(11.91)(e) of the Act, deemed to have, at the end of that preceding taxation year, disposed of eligible capital property, the affiliate's "loss" is increased by the amount, if any, that would be permitted by paragraph 24(1)(a) of the Act to be deducted in computing the operator's income for that year from the foreign business if the operator had, immediately before the end of that year, ceased to carry on the foreign business.

For more detail about the treatment of the untaxed portion of the gain or loss from the sale of excluded property that is eligible capital property, refer to the commentaries on new paragraph (a.1) of the definition "exempt earnings", and new paragraph (a.1) of the definition "exempt loss", respectively, in subsection 5907(1) of the Regulations.

Amended subsection 5907(2.9) ensures that where, because of paragraphs 95(2)(k) and 138(11.91)(e) of the Act, there is a deemed disposition of resource property, the affiliate's "earnings" are increased by the amount, if any, by which

• the total of all amounts included by subsection 59(1) or paragraph 59(3.2)(c) or (c.1) of the Act in computing the operator's income for that preceding taxation year from the active business

exceeds

• the total of all amounts that were deductible under section 66, 66.1, 66.2, 66.21 or 66.4 of the Act in computing the operator's income for that year from the active business.

Note that there is a corresponding rule in amended subsection 5907(2.9) for an inclusion in "loss" in the converse situation.

Fifth, proposed amendments to subsection 5907(2.9) provide a rule for the determination, where the operator is the partnership, of the amounts required by that subsection to be added to the affiliate's "earnings" or "loss", as the case may be, for the preceding taxation year. The amount of the increase to the affiliate's "earnings" or "loss" is essentially the amount of the increase to the "earnings" or "loss" for the partnership multiplied by the fraction the numerator of which is the affiliate's share of the income or loss of the partnership for that year and the denominator of which is the income or loss of the partnership for that year. For the purpose of this calculation, where both the income and the loss of the partnership for that preceding year are nil, the partnership is assumed to have an income of $1 million for that year.

The amendments to subsection 5907(2.9) of the Regulations are proposed to apply to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that these amendments are included in the Fresh Start Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

ITR
5907(2.91)

Proposed new subsection 5907(2.91) of the Regulations is consequential to the introduction of new paragraphs 95(2)(k.1) and (k.3) of the Act. New subsection 5907(2.91) provides that, for the purposes of section 5907 of the Regulations, any property of a foreign affiliate of a corporation resident in Canada, or of a partnership of which a foreign affiliate of a corporation resident in Canada is a member, that is, for the purposes of subdivision i of Division B of Part I of the Act, deemed because of either paragraph 95(2)(k.1) or (k.3), and paragraph 138(11.91)(e), of the Act to have been disposed of and reacquired by the affiliate or the partnership, as the case may be, is, for the purpose of section 5907 of the Regulations, deemed to have been disposed of and reacquired by the affiliate or the partnership, as the case may be, in the same manner and for the same amounts as if those provisions applied for the purpose of section 5907 of the Regulations.

Subsection 5907(2.91) ensures that the deemed disposition and reacquisition are taken into account when calculating a foreign affiliate's surplus accounts.

New subsection 5907(2.91) of the Regulations is proposed to apply to taxation years, of a foreign affiliate of a taxpayer, that begin after December 20, 2002. Note that this amendment is included in the Fresh Start Section 95 Election package described at the beginning of the commentary to section 95 of the Act.

ITR
5907(5.1)

Subsection 5907(5.1) of the Regulations is repealed because of the introduction of the rules in paragraphs 95(2)(c.2) to (c.6) and paragraphs 95(2)(f.3) to (f.8) of the Act. See the commentary for those proposed new paragraphs.

ITR
5907(9) and (9.1)

Where a foreign affiliate of a taxpayer resident in Canada has been dissolved, subject to the rules in paragraph 95(2)(e.1) of the Act, subsection 5907(9) of the Regulations provides that certain rules apply for the purposes of computing the various amounts referred to in section 5907 of the Regulations.

It is proposed that subsection 5907(9) of the Regulations be amended so that the rules will be subject to the rules in proposed new paragraphs 95(2)(e) and (e.1) and subsection 88(3). See the commentary for the proposed new paragraphs and subsection.

It is also proposed that subsection 5907(9) of the Regulations be amended so that the rules do not apply to dissolutions of a foreign affiliate because of a foreign merger within the meaning assigned by subsection 87(8.1) of the Act.

Proposed new subsection 5907(9.1) of the Regulations provides rules similar to those contained in proposed amended subsection 5907(9) of the Regulations that apply on transfers of property by a foreign affiliate of a taxpayer resident in Canada as a payment of a dividend or as a distribution of property to a shareholder of the foreign affiliate.

This amendment is proposed to apply to dissolutions, payments of dividends and distributions made after the after December 20, 2002.

ITR
5907(13) and (14)

Subsection 5907(13) of the Regulations adds a prescribed amount to the foreign accrual property income (FAPI) of a foreign affiliate that immigrates to Canada. The starting-point for the determination of this amount is paragraph 5907(13)(a), which refers to the affiliate's taxable surplus for the taxation year that is deemed under section 128.1 of the Act to have ended before immigration (excluding net earnings in respect of FAPI).

Under section 128.1 of the Act, one of the tax consequences of immigration to Canada is a deemed disposition of most kinds of property. That deemed disposition will often cause an increase in the taxable surplus of an immigrating foreign affiliate. To ensure the appropriate measurement of such an increase, paragraph 5907(13)(a) of the Regulations is amended to exclude, from the taxable surplus amount it describes, any amount that would have been added to the affiliate's underlying foreign tax if the deemed disposition had been an actual disposition. This amendment generally applies after 1992. The sole exception is that if the affiliate continued into Canada before 1993 and elected, under paragraph 111(4)(a) of S.C. 1994, c. 21, to have subsection 250(5.1) of the Act apply in respect of the continuation, this amendment will apply to the affiliate from the time of that continuation.

In some instances, the gains that an immigrating affiliate would realize if it had actually disposed of its property would not in fact be subject to any foreign tax. New subsection 5907(14) of the Regulations ensures that in such a case, subsection 5907(13) does not recognize any addition to the affiliate's underlying foreign tax. This new subsection applies after 1992, except that its application is confined to paragraph 5907(13)(a) in respect of dispositions that occur on or before Announcement Date.

ITR
5911(1) and (2)

Proposed new subsections 5911(1) and (2) of the Regulations set out the rules for determining the additions to and the deductions from the adjusted cost base of a share of a foreign affiliate of a corporation resident in Canada required under paragraphs 92(1.3)(a) and (b) of the Act when there has been a specified section 93 election in respect of a relevant share. Refer to the commentary for proposed new subsections 92(1.1) to (1.4) of the Act for the definitions "election time", "relevant share", "relevant foreign affiliate" and "specified section 93 election", the adjusted cost base adjustment requirements and the purposes for which the adjustments to the cost base of shares are to be made.

Proposed new subsections 5911(1) and (2) of the Regulations apply after December 20, 2002.

New subsection 5911(1) of the Regulations determines the required addition to the adjusted cost base of a relevant share in respect of a specified section 93 election.

The amount prescribed, for the purpose of paragraph 92(1.3)(a) of the Act, in respect of the relevant share referred to in that paragraph, in respect of a specified section 93 election related to the relevant share, is the lesser of

• the amount, if any, by which the fair market value exceeds the adjusted cost base to the holder, at the election time, of the relevant share, and

• the amount determined by the formula

Proposed subsection 5911(2) of the Regulations determines the required deduction to the adjusted cost base of a relevant share in respect of a specified section 93 election.

The amount prescribed, for the purpose of paragraph 92(1.3)(b) of the Act, in respect of the relevant share referred to in that paragraph, in respect of a specified section 93 election related to the relevant share, is the lesser of

• the amount, if any, by which the adjusted cost base to the holder exceeds the fair market value, at the election time, of the relevant share, and

• the amount determined by the formula

Proposed new subsection 5911(3) of the Regulations determines the required addition to the adjusted cost base of a relevant share in respect of a specified section 93 election amount determined in the formulas in subsections 5911(1) and (2) in respect of the relevant share referred to in paragraph 92(1.3)(a) is nil.

If the amount determined in each of the formulas in paragraphs 5911(1)(b) and 5911(2)(b) in respect of the relevant share referred to in paragraph 92(1.3)(a) of the Act is nil, the amount determined for B in the formula in paragraph 5911(1)(b) in respect of the relevant affiliate is greater than nil and the amount determined for C in the formula in paragraph 5911(2)(b) in respect of the relevant affiliate is greater than nil, the amount prescribed for the purpose of paragraph 92(1.3)(a) of the Act, in respect of the relevant share referred to in that paragraph, in respect of a specified section 93 election related to the relevant share, is the lesser of

• the amount, if any, by which the fair market value of the relevant share, at the election time, exceeds the adjusted cost base, at the time of the disposition, of the relevant share to the holder, and

• the amount that would, if the relevant share was the disposed share and the relevant affiliate was the disposed affiliate in respect of the specified section 93 election, be determined under paragraph 5902(1)(f) to be the attributed net surplus in respect of the relevant share if the consolidated net surplus of the relevant foreign affiliate were the amount determined for B in the formula in paragraph 5911(1)(b).

Example

Facts

1. Canco, a corporation resident in Canada, owns 100% of the issued shares of FA1 (which owns 80% of the issued shares of FA2) and 50% of the issued shares of FA6 (which owns 20% of the issued shares of FA2).

2. FA2 owns 70% of the issued shares of FA3, which owns 100% of the issued shares of FA4 (which owns 100% of the issued shares of FA5).

3. FA1 sells 30 issued shares of FA2 to FA6 and Canco elects under subsection 93(1) of the Act ($123 of sale proceeds to be treated as dividends on the 30 disposed shares of FA2).

4. At the time of the sale, FA2 has an exempt surplus of $200, a taxable surplus of $0, an exempt deficit of $0 and an underlying foreign tax of $0.

5. At the time of the sale, FA3 has an exempt surplus of $100, a taxable surplus of $75, an exempt deficit of $0 and an underlying foreign tax of $10.

6. At the time of the sale, FA4 has an exempt surplus of $0, a taxable surplus of $0, an exempt deficit of $200 and an underlying foreign tax of $0.

7. At the time of the sale, FA5 has an exempt surplus of $0, a taxable surplus of $325, an exempt deficit of $0 and an underlying foreign tax of $200.

8. All the corporations have 100 issued shares of one class of shares.

Application of Sections 5902, 5905 and 5911

For the application of subsection 5902(1) - see the example in the commentary for that subsection.

For the application of subsection 5905(8) - see the example in the commentary for that subsection.

For the application of subsections 5911(1) and (3) - see the calculation below.

Application of Section 5911 of the Regulations

Subsection 5911 of the Regulations provides for adjustments to the cost base to the holder of the share of the relevant foreign affiliate in respect of the adjustments to the surplus balances under section 5905 of the Regulations in respect of a specified section 93 election related to the relevant share.

The calculation is being performed only for the shares of FA4 and FA5 in this example.

Subsection 5911(1) - Additions to the ACB of Shares

For the purposes of the calculations below, it is assumed that the fair market value exceeded the adjusted cost base to the holder of shares of the relevant foreign affiliates.

Calculation - FA5

Under subsection 5911(1), the required addition to the adjusted cost base of a share of FA5, for example, is $0.65 determined by the formula

where

A is the amount that would be determined to be the attributed surplus in respect of a share of FA5 if the share of FA5 and FA5 were the "disposed share" and the "disposed foreign affiliate" referred to in subsection 5902(1) in respect of the specified section 93 election ($325/100 = $3.25),

B is the amount that would be determined to be the consolidated net surplus (after the application, in respect of the specified section 93 election, of subsection 5905(8) to FA5) under 5902(1) in respect of FA5 if the share of FA5 and FA5 were the disposed share and the disposed foreign affiliate referred to in subsection 5902(1) in respect of a disposition, immediately after the disposition to which the specified section 93 election applies, of the FA5 share in respect of which an election was made by Canco under subsection 93(1) ($260), and

C is the amount that would be determined to be consolidated net surplus of FA5, in respect of the specified section 93 election, under 5902(1) in respect of FA5 if the share of FA5 and FA5 were the disposed share and the disposed foreign affiliate referred to in subsection 5902(1) ($325).

Calculation - FA4

Under subsection 5911(3), the required addition to the adjusted cost base of a share of FA4, for example, is $2.60. This amount is determined as the amount that would, if the share of FA4 was the disposed share and FA4 was the disposed affiliate, be determined under paragraph 5902(1)(f) to be the attributed net surplus in respect of the FA4 share ($260/100 shares) if the consolidated net surplus of the FA4 were the amount determined in respect of FA4 for B in the formula in subsection 5911(1) ($260).

The amount determined for B in the formula in subsection 5911(1) is the amount that would be determined to be the consolidated net surplus (after the application, in respect of the specified section 93 election, of subsection 5905(8) to FA4) under subsection 5902(1) in respect of FA4 if the share of FA4 and FA4 were the disposed share and the disposed foreign affiliate referred to in subsection 5902(1) in respect of a disposition, immediately after the disposition to which the specified section 93 election applies, of the FA4 share in respect of which an election was made by Canco under subsection 93(1) ($260).

ITR
5912

Proposed new subsection 5912 of the Regulations determines the amount to be included as the adjusted suspended gain and the adjusted allocable tax in respect of the specified share, of the relevant foreign affiliate (referred to in new paragraph 95(2)(c.3) of the Act), at the earlier of the first times (which earlier time is referred to as the "recognition time"), after the original disposition time, that is described by new paragraph 95(2)(c.3) of the Act.

Proposed new subsection 5912 of the Regulations applies after December 20, 2002.

New subsection 5912(1) provides the rules for the calculation of the adjusted suspended gain in respect of the specified share, of the relevant foreign affiliate (referred to in new paragraph 95(2)(c.3) of the Act), at the recognition time. This amount is determined by the formula

where

A is the amount of the unadjusted suspended gain in respect of a specified share of the relevant foreign affiliate at the original disposition time,

B is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the original disposition time determined assuming that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time, and

C is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the recognition time determined assuming that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time.

New subsection 5912(2) provides for the calculation of the adjusted allocable tax in respect of the adjusted suspended gain, in respect of the specified share, of the relevant foreign affiliate (referred to in new paragraph 95(2)(c.3)) at the recognition time. This amount is determined by the formula

where

A is any income or profits tax paid to the government of a country by the relevant foreign affiliate that can reasonably be regarded as tax in respect of the unadjusted suspended gain in respect of the specified share,

B is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the original disposition time determined on the assumption that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time, and

C is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the recognition time determined on the assumption that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time.

ITR
5913

New section 5913 of the Regulations determines the amount to be included as the adjusted suspended income or gain in respect of the specified property, of the relevant foreign affiliate (referred to in new paragraph 95(2)(f.5) of the Act), at the earlier of the first times (which earlier time is referred to as the "recognition time"), after the original disposition time (referred to in new paragraph 95(2)(f.5) of the Act), that is described by new paragraph 95(2)(f.5) of the Act.

Proposed new subsection 5913 of the Regulations applies after December 20, 2002.

New subsection 5913(1) provides rules for the calculation of the adjusted suspended income or gain in respect of the specified property, of the relevant foreign affiliate (referred to in new paragraph 95(2)(f.5)), at the recognition time. This amount is determined by the formula

where

A is the amount of the unadjusted suspended income or gain in respect of a specified property of the relevant foreign affiliate at the original disposition time,

B is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the original disposition time determined assuming that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time, and

C is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the recognition time determined assuming that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time.

New subsection 5913(2) provides for the calculation of the adjusted allocable tax in respect of the adjusted suspended income or gain, in respect of the specified property, of the relevant foreign affiliate (referred to in new paragraph 95(2)(f.5)) at the recognition time. This amount is determined by the formula

where

A is any income or profits tax paid to the government of a country by the relevant foreign affiliate that can reasonably be regarded as tax in respect of the unadjusted suspended income or gain in respect of the specified property,

B is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the original disposition time determined on the assumption that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time, and

C is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the recognition time determined on the assumption that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time.

ITR
5914

New section 5914 of the Regulations determines the amount to be included as the adjusted suspended loss or capital loss in respect of the specified property, of the relevant foreign affiliate (referred to in new paragraph 95(2)(h.3) of the Act), at the earlier of the first times (which earlier time is referred to as the "recognition time"), after the original disposition time (referred to in new paragraph 95(2)(h.3) of the Act), that is described by new paragraph 95(2)(h.3) of the Act.

Proposed new subsection 5914 of the Regulations applies after December 20, 2002.

New subsection 5914(1) provides for the calculation of the adjusted suspended loss or capital loss in respect of the specified property, of the relevant foreign affiliate (referred to in new paragraph 95(2)(h.2)), at the recognition time. This amount is determined by the formula

where

A is the amount of the unadjusted suspended loss or capital loss in respect of a specified property of the relevant foreign affiliate at the original disposition time,

B is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the original disposition time determined assuming that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time, and

C is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the recognition time determined on the assumption that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time.

New subsection 5914(2) provides for the calculation of the adjusted allocable tax refund in respect of the adjusted suspended loss or capital loss, in respect of the specified property, of the relevant foreign affiliate (referred to in new paragraph 95(2)(h.2)) at the recognition time. This amount is determined by the formula

where

A is any income or profits tax refunded by the government of a country to the relevant foreign affiliate that can reasonably be regarded as tax refunded in respect of the unadjusted suspended loss or capital loss in respect of the specified property,

B is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the original disposition time determined on the assumption that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time, and

C is the surplus entitlement percentage of the corporation resident in Canada in respect of the relevant foreign affiliate immediately before the recognition time determined on the assumption that the taxation year of the relevant foreign affiliate that otherwise would have included that time had ended immediately before that time.

ITR
5915

Proposed section 5915 of the Regulations sets out the requirements for an election by a corporation resident in Canada under proposed paragraph 95(2)(c.2) of the Act.

Proposed new subsection 5915 of the Regulations applies after December 20, 2002.

Generally, the new section requires the election to be made by filing the prescribed form with the Minister of National Revenue on or before

• if a foreign affiliate of the corporation resident in Canada was the vendor that disposed of the specified share, the filing-due date of the corporation resident in Canada for its taxation year that includes the last day of the foreign affiliate's taxation year in which the disposition was made; and

• if a foreign affiliate of the corporation resident in Canada is a member of a partnership that was the vendor that disposed of the specified share, the filing-due date of the corporation resident in Canada for its taxation year that includes the last day of the taxation year of the foreign affiliate that includes the last day of the partnership's fiscal period in which the disposition was made by the partnership.

ITR
5916

Proposed section 5916 of the Regulations sets out the requirements for an election by a corporation resident in Canada under subsection 88(3) or clause 95(2)(d)(iii)(A), (e)(v)(B), (e.3)(iv)(B), (e.4)(v)(B) or (e.5)(v)(B) of the Act.

Proposed new subsection 5916 of the Regulations applies after December 20, 2002.

Generally, the section requires the election to be made by filing the prescribed form with the Minister of National Revenue on or before

• if a foreign affiliate of the corporation resident in Canada made the disposition, the filing-due date of the corporation resident in Canada for its taxation year that includes the last day of the foreign affiliate's taxation year in which the disposition was made; and

• if a foreign affiliate of the corporation resident in Canada is a member of a partnership and that partnership made the disposition, the filing-due date of the corporation resident in Canada for its taxation year that includes the last day of the taxation year of the foreign affiliate that includes the last day of the partnership's fiscal period in which the disposition was made by the partnership.

ITR
5917

Proposed section 5917 of the Regulations sets out the requirements for an election by a corporation resident in Canada under paragraph 95(2)(f.4) of the Act.

Proposed subsection 5917 of the Regulations applies after December 20, 2002.

Generally, the section requires the election to be made by filing the prescribed form with the Minister of National Revenue on or before

• if a foreign affiliate of the corporation resident in Canada was the vendor that disposed of the specified property, the filing-due date of the corporation resident in Canada for its taxation year that includes the last day of the foreign affiliate's taxation year in which the disposition was made; and

• if a foreign affiliate of the corporation resident in Canada is a member of a partnership that was the vendor that disposed of the specified property, the filing-due date of the corporation resident in Canada for its taxation year that includes the last day of the taxation year of the foreign affiliate that includes the last day of the partnership's fiscal period in which the disposition was made by the partnership.

ITR
5918

Proposed section 5918 of the Regulations sets out the requirements for an election by a corporation resident in Canada under new subparagraph 95(2)(k.3)(iii) of the Act. For further detail, see the commentary to paragraph 95(2)(k.3) of the Act.

Proposed new subsection 5918 of the Regulations applies after December 20, 2002.

Generally, the section requires the election to be made by filing the prescribed form with the Minister of National Revenue on or before

• if a foreign affiliate of the taxpayer was the operator, the taxpayer's filing-due date for its taxation year that includes the last day of the foreign affiliate's taxation year that is the specified taxation year; and

• if a partnership - of which a foreign affiliate of the taxpayer was, or was deemed by new paragraph 95(2)(k.7) of the Act to be, a member - was the operator, the taxpayer's filing-due date for its taxation year that includes the last day of the taxation year of the foreign affiliate that includes the last day of the partnership's fiscal period that is the specified taxation year.

ITR
5919

New section 5919 of the Regulations sets out the requirements for an election, under paragraph 88(3)(a) of the Act, by a corporation resident in Canada in respect of the disposition of shares in the capital of one of the foreign affiliates of the corporation resident in Canada by another of the foreign affiliates of the corporation resident in Canada. The proposed section states that an election under paragraph 88(3)(a) of the Act shall be made by filing the prescribed form with the Minister of National Revenue, on or before the filing-due date of the taxation year of the corporation resident in Canada that includes the last day of the other foreign affiliate's taxation year in which the other foreign affiliate made the disposition.

Proposed new subsection 5919 of the Regulations applies after December 20, 2002.

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Appendix D

Prescribed Properties and Permanent Establishments

Part LXXXII of the Income Tax Regulations prescribes property, and defines the expression "permanent establishment", for various purposes of the Income Tax Act.

The Regulations are being amended to add new section 8202.

New subsection 8202(1) of the Regulations defines the term "permanent establishment" of a person or partnership for the purposes of the definition "investment business" in subsection 95(1) of the Act, paragraph 95(2)(l)(iii) of the Act, and paragraphs 95(2.3)(b) and (2.4)(a) of the Act to mean

- a fixed place of business of a person or partnership, including an office, a branch, a mine, an oil well, a farm, a timberland, a factory, a workshop or a warehouse, or

- where the person or partnership does not have any fixed place of business, the principal place at which the business of the person or partnership is conducted.

New subsection 8202(2) of the Regulations provides that the definition of permanent establishment in a tax treaty that Canada has with a foreign country takes precedence over subsection 8202(1) if the person or partnership is resident in that foreign country.

New subsection 8202(3) of the Regulations provides other rules for the purposes of determining if a fixed place of business exists for the purposes of subsection 8202(1).

New section 8202 applies to the 1999 and subsequent taxation years. However, where the taxpayer has made a valid Global Section 95 Election, new subsection 8202 applies to 1994 and subsequent taxation years. For information about the Global Section 95 Election, see the beginning of the commentary to section 95 of the Act.

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