Computing UCC for newly-acquired LLCs

Feb 14, 2023

Key takeaways

There may be competing interpretations when computing the surplus of certain foreign affiliates.

The purpose of Regulation 5907(2.03) is to prevent taxpayers from inflating surplus accounts.

US LLCs will generally compute surplus earnings according to Canadian income tax principles.

Business tax Tax policy

If Canco acquires an LLC, should CCA – and similarly all other optional deductions under the Act – be considered to have been claimed for the years before the acquisition? There are valid arguments on both sides. Canco would prefer that these deductions would have been considered to be claimed: there would be a lower UCC at the time of the acquisition and hence, lower CCA deductions in the following period. Lower CCA deductions mean higher earnings, and therefore, potentially a higher exempt surplus pool that can be repatriated to Canada.

Subparagraphs 5907(1)(a)(iii), 5907(2.03)(a), and (b) of the Regulations and (for LLCs) CRA document 2016-0669761C6 provide that, subject to certain conditions, earnings of a foreign affiliate of a taxpayer resident in Canada from an active business for an “earnings or loss year” should be computed as if the business were carried on in Canada, the affiliate were resident in Canada, and on the basis that the affiliate claimed maximum deductions that it could have claimed.

Suppose that in the operation of its active business, US LLC first acquired and used depreciable assets in 2015. US LLC’s shares subsequently are acquired by a Canadian taxpayer (Acquireco) on January 1, 2022.

The question to be addressed is what should the starting UCC of US LLC’s assets be for the purposes of computing US LLC’s earnings post-acquisition. In particular, under Reg. 5907(2.03) should maximum CCA be considered to have been claimed for the years before the acquisition (2015 to 2021)?

The argument that maximum CCA should be considered to have been claimed is that the wording in paragraph 5907(2.03)(a) refers to the foreign affiliate’s “income or loss from the business for each taxation year”. This could mean that possible CCA deductions in a year when the foreign affiliate was not even an affiliate of Acquireco should be taken in computing the earnings or loss of an affiliate for a particular year.

On the other hand, there are other arguments that no CCA should have been considered to have been claimed in the pre-acquisition period. This approach is less favourable to the taxpayer and would reduce “earnings” computed for US LLC post-acquisition as opposed to using the tax-amortized cost of the assets.

First, prior to the acquisition of US LLC’s shares by Acquireco, US LLC was not a foreign affiliate of Acquireco, and therefore, it never claimed depreciation to compute income under the Act with respect to Acquireco. As such, the UCC of the assets could be equal to the capital cost of the property less ‘nil’ depreciation. In other words, the UCC of the assets would be equal to the capital cost of the property or the actual cost of acquiring the property which could probably refer to the historical tax cost of the assets.

Second, paragraph 5907(2.03)(a) provides that all deductions which could be claimed are treated as having been claimed for an “earnings or loss year” of the US LLC. There was no “earnings or loss year” of the US LLC in respect of Acquireco prior to the acquisition, which could refute that paragraph (2.03)(a), specifically the words “could have claimed” should be interpreted expansively.

Finally, the technical notes provided on the introduction of Reg. 5907(2.03) in 2012 suggest that its purpose is to prevent taxpayers from inflating surplus. Clearly, the assumption that CCA – and similarly all other optional deductions – have been claimed for a year when US LLC was not computing earnings or surplus in respect of Acquireco does exactly that. Thus, a purposive interpretation of the provision supports this interpretation.

RSM contributors

  • Nakul Kohli
    Senior Manager
  • Simon Townsend

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