Section 110.5 - Additions for foreign tax deductions

May the income inclusions under s. 110.5 and the resulting credit under s. 126(1) be increased to the point that no foreign tax credit is available in respect of Ontario corporate taxes? CRA stated:

Section 110.5 does not place any limits on the income inclusion by way of referencing the availability of a credit against provincial income taxes. …For example, it is possible that a corporation may increase its taxable income under section 110.5 of the Act so that the full amount of the non-business-income tax paid by the taxpayer for the year to a country other than Canada is fully offset by a credit under subsection 126(1) of the Act. In this situation there would be no available foreign tax credit under section 34 of Ontario's Taxation Act.

In "clarifying" 2013-0481151I7 (immediately below), CRA stated:

In that letter, we stated that an addition to income under section 110.5… is a permissive amount in the context of… IC84-1… .

To clarify, for the purposes of IC84-1 a permissive deduction is a deduction that is permissible in the computation of income and the amount of the deduction claimed is at the discretion of the taxpayer, but subject to a maximum amount determined by a specific provision in the Act. A permissive amount in the context of IC84-1 would not include a tax credit, such as a foreign tax credit under subsection 126(1) or 126(2), nor would it include the income inclusion provided in section 110.5 of the Act.

Respecting whether s. 152(4)(b)(iv) would allow an assessment to be issued beyond the normal reassessment period in response to the taxpayer's request to increase its taxable income under s. 110.5 in order to generate a foreign tax credit, CRA stated:

[I]t is no longer our view that the provisions of [s.] 152(4)(b)(iv) would not be applicable. As noted above, the purpose of section 110.5 is to allow a taxpayer to claim a foreign tax credit in situations where they would not otherwise be able to fully utilize the foreign income or profits taxes that were paid. Therefore, there is a causal connection between the foreign tax paid and the adjustment to claim the foreign tax credit, regardless of whether the adjustment includes an addition to income under the provisions of section 110.5.

Respecting whether an addition to income under s. 110.5 is considered a permissive amount for purposes of IC 84-1, so that the Minister may allow this adjustment beyond the period provided in s. 152(4)(b)(iv), CRA agreed that this amount is permissive. However, where such adjustment increases provincial tax payable, the adjustment would not satisfy the requirement, for the Minister to accept such request, that there be no change in the tax payable for the year.

Canco realized deductible losses on FX hedging instruments due to the strengthening of the U.S. dollar. Accordingly, it engaged in the transactions to shift taxable income from profitable subsidiaries to itself ("Project Shift"). The intended effect was to allow Canco to claim foreign tax credits, and generate losses in the subsidiaries for carry-back to prior years. However, the hedging losses turned out to be greater than the income which was transferred to it under Project Shift, so that Canco had to make a s. 110.5 election to generate enough taxable income to claim the requisite level of foreign tax credits.

After noting that Project Shift accorded with CRA's position on acceptable loss consolidation strategies (which it described in general terms), the Directorate went on to find that the transactions also did not entail an abuse of s. 110.5:

Section 110.5 of the Act was enacted to provide a corporation with the option of generating additional income so that more foreign tax credits can be utilized under subsections 126(1) and 126(2) in order to avoid wasting foreign tax credits that might otherwise expire. While the effect of adding an amount to taxable income under section 110.5 is to convert into a non-capital loss for the year foreign taxes paid that might otherwise not be creditable against Canadian taxes payable in the year or any other year, the object and purpose of section 110.5 cannot be considered to have been abused or misused for the sole reason that another plan to achieve the same goal had failed because the actual loss incurred by Canco was greater than it had anticipated. Furthermore, it is important to note that Project Shift did not provide Canco with any additional tax credits that are specifically prohibited by paragraph (b) of section 110.5 of the Act.

After the normal reassessment period for its 2005 taxation year had expired, the company submitted a request for an addition to its 2005 taxable income pursuant to s. 110.5, in order to utilize available FTCs. This proposed increase to its 2005 taxable income would result in no additional tax liability once the FTCs were utilized. Under the definition of "non-capital loss" in subsection 111(8), the proposed addition to its 2005 taxable income, would be a non-capital loss, which it requested be carried forward to its 2006 return.

Does s. 152(4)(b)(iv) extend the normal reassessment period to six years on a s. 110.5 addition to taxable income? CRA stated:

[S.] 152(4)(b)(iv) does not apply to extend the normal reassessment period on a section 110.5 addition to taxable income. A section 110.5 addition of income does not result in a payment or reimbursement of any income or profits tax to or by the government of a country other than Canada or a government of a state, province or other political subdivision of any such country.

Respecting whether such s. 110.5 increase nonetheless could be made on the basis that it was a permissive adjustment contemplated by IC 84-1, CRA stated:

An addition to income under section 110.5 is not permissive in that sense, because the taxpayer can choose only to use that section or not to use it, but cannot vary the amount of inclusion, which amount is that which absorbs the FTCs, no more or less. Furthermore, this circular deals with deductions in computing income, while section 110.5 involves an income increase with an offsetting change to a federal tax credit, so it is not neutral from the standpoint of provincial tax.

A Canadian corporation realized a gain on the sale of real property situated in the U.S. for Canadian income tax purposes in year 1 but for U.S. tax purposes only in year 10. It could not increase its taxable income under section 110.5 in year 10 in order to be considered to have U.S. source income for Canadian foreign tax credit purposes in year 10. "Section 110.5 of the Act was designed to permit a corporation to increase its taxable income in order to avoid the wastage of the foreign tax credit in a year when a loss incurred by the corporation reduces its net adjusted income (i.e., the denominator of the formula for the computation of that proportion of the tax for the year otherwise payable under Part I which is attributable to the foreign source income, whether for purposes of paragraph 126(1)(b) or for purposes of paragraph 126(2)(b) and subsection 126(2.1) of the Act, as the case may be) to an amount that is less than its foreign source income. It was not designed to produce or increase the corporation's foreign source income and specifically it was not designed to resolve the timing problem of recognizing income in Canada and in a foreign country."