Tax Interpretations Judicial and CRA interpretations of Canadian tax law and transactional implications

News of Note

An amalgamation of Target rather than its winding-up may be preferable from a bump perspective if Target creditors may be prohibited persons – and bump transactions for private equity funds are fraught

Comments of Stepak and Xiao on the s. 88(1)(d) bump rules include:

  • The exclusion in s. 88(1)(c.3)(i), from substituted property, for property which “at any time after the acquisition of control” has 10% or less of its fair market value attributable to property distributed on the winding-up should in context be interpreted as being fulfilled if the relative FMV test is met during the bump series of transactions rather than being required to be satisfied during a more extended and indefinite period.
  • Although when Target is amalgamated with Bidco, there arguably might be an acquisition by creditors of Bidco (who could be prohibited persons) of debt of a new corporation which, therefore, would not fit within the specified property exclusion in s. 88(1)(c.4)(ii), “paragraph 88(4)(b), when read in context, should reasonably be considered to have the effect of deeming the securities of Amalco to be the same as the securities of the predecessor corporation [here, Target]” so that the exclusion is available. However, if Target is wound-up rather than amalgamated “the above argument with respect to paragraph 88(4)(b) would not apply to debt of [Target] assumed by parent on the winding-up because paragraph 88(4)(b) only applies to amalgamations, not windings-up.”
  • Where the 10% attributed property safe harbour will not clearly be met, the funding of Bidco by a private equity fund will be problematic, as PE funds (which potentially could have prohibited persons as investors) will be loathe to disclose their investors and because for confidentiality reasons the PE fund manager typically will not be able to approach the fund investors to inquire as to any cross-ownership in the Target until after a deal has been announced.
  • Where following the amalgamation of Bidco and Target, Amalco sells one of Target's subsidiaries (Spinco) to a third party (Spinco Buyer) which, in turn and as part of the same series of transactions, sells Spinco to a fourth party, that final sale could taint the bump if the fourth party (or perhaps its shareholders) is a prohibited person – so that it is insufficient that diligence was performed on Spinco Buyer and its shareholders to assess whether they were prohibited persons. This will be the case even if Spinco itself was not bumped.
  • In light of the foreign affiliate dumping rules, it is appropriate for bumped shares of a foreign subsidiary of Target to be distributed to their ultimate resting place beneath the new foreign parent through a PUC distribution by Amalco rather than in repayment of an intra-group loan made to Bidco.
  • Under the scheme of the Act, “significant” in s. 88(1)(c.2)(iii)(A) means 10% or more, so that a toehold in Target of less than 10% (in the context of there being an indirect third-party participant in the bid who is not a specified person) should be exempted.

Neal Armstrong. Summaries of Paul Stepak and Eric C. Xiao, "The 88(1)(d) Bump – An Update," Draft paper for 2013 Conference Report (annual CTF conference) under s. 88(1)(c.3)(i), s. 88(1)(c.4)(ii), s. 88(1)(c)(vi)(B)(II)s. 88(1)(c)(vi), s. 212.3(9) and s. 88(1)(c.2)(iii)(A).

Gariepy and Chriss – Tax Court of Canada finds that unsigned directors’ resignations were effectual

Boyle J found that written resignations of corporate directors were effective (so as to start the two-year time limitation for directors’ liability under s. 227.1 running) notwithstanding that the lawyers never provided the resignation forms to the directors for signature. (This may bear on other written instruments such as elections made on a non-prescribed form.)

He further found that where there was a reasonable belief that a director had resigned, that would constitute a due diligence defence for her failure thereafter to do anything about source deductions even if her resignation instead had been ineffectual.

Neal Armstrong. Summaries of Gariepy and Chriss v. The Queen, 2014 TCC 254 under s. 227.1(4) and s. 227.1(3).

Canadian financial institutions are permitted under the FATCA rules to open up accounts for recalcitrant account holders

Findings of Candice Turner on the application of the FATCA rules to Canadian financial institutions include:

  • The institution likely can open up an account for a recalcitrant account holder who fails to provide a U.S. tax information number (although withholding tax would be imposed on U.S.-source withholdable payments).
  • When a holder of a pre-existing individual account opens a new account with the same financial institution, there is no need to re-document the account so long as the required due diligence has been (or is being) conducted and, where a threshold has been applied to the pre-existing account, the institution's computer is able to link the new account to the pre-existing one.
  • Respecting the measurement of account threshold levels corresponding to different due diligence levels, the previous balances of closed accounts should be ignored.

Neal Armstrong.  Summaries of Candice M. Turner, "Answers to Practical FATCA Questions for Canadian Financial Institutions," Tax Management International Journal, Vol. 43, No. 8, August 8, 2014, p. 484 under FATCA IGA, Art. 4. s. 2, Annex 1, s. IV, para. A and Annex 1, s. VI, para. C.

CRA does not require the filing of amended returns if a late PLOI election is made

When a Canadian corporation (a CRIC) and a (non-resident) “subject corporation” file a late “PLOI” election to have imputed interest accrue on a loan owing to the CRIC by the subject corporation rather than having Part XIII tax apply to the loan amount, CRA will assess the additional imputed interest income for the years for which CRIC returns already have been filed on the basis of the election particulars required at Pertinent loans or indebtedness, rather than expecting the CRIC to file amended returns.

However, if the late election has not yet been filed by the technical triggering of the Part XIII tax, CRA does not consider that it can wait and see if a late election is filed within the three-year period specified in s. 15(2.12), and considers itself obligated to assess the withholding tax – and will reassess if the late election subsequently is filed.

Neal Armstrong. Summary of 6 August 2014 T.I. 2014-0519431E5 under s. 15(2.11).

Income Tax Severed Letters 27 August 2014

This morning's release of seven severed letters from the Income Tax Rulings Directorate is now available for your viewing.

Application of draft s. 93.3 is ambiguous where an LLC agreement already provides for “shares”

Draft s. 93.3 deems an LLC “that does not have capital divided into shares” to have one or more classes of shares, and 2014-0522971C6 sets out a methodology for determining the number and attributes of the deemed classes of shares.  Barnicke and Huynh suggest that where the LLC agreement has purported to divide the member interests into shares, it is unclear whether taxpayers are required to go through such methodology to potentially arrive at a deemed share structure which might depart from that set out in the agreement.

Neal Armstrong.  Summary of Paul Barnicke and Melanie Huynh, "Deemed Shares in a US LLC," Canadian Tax Highlights, Vol. 22, August 2014, p. 8 under s. 93.3.

The Art. IV(7)(b) anti-hybrid rule does not apply to interest paid by a check-the-box Delaware LP on “debt” held by Canadian partners

Reminders and observations of Carderelli and Keenan on the anti-hybrid rules in the Canada-U.S. Treaty include:

  • The “two-step” solution to the denial in Art. IV(7)(b) of reduced dividend withholding by a ULC (increase PUC and then distribute it IV(7)(b)) is not recognized by CRA as being effective where the sole shareholder of the ULC is an LLC.
  • The accepted solutions to the application of Art. IV(7)(b) to the payment of interest by a ULC on a loan from its U.S. corporate shareholder (USCo) are for: say, 10% of the shares of ULC to be held instead by a U.S. subsidiary of USCo (USSub) with which it files a consolidated return; USCo to hold all of the shares of ULC through USSub but hold the loan to ULC directly; and for the loan to be made by USSub to ULC which is held 100% by USCo.
  • The Art. IV(7)(a) rules produces a harsh result for a Canadian pension plan investing in an LLC portfolio investment company given that dividends and interest on a directly held portfolio would have been exempt.
  • The uncertainty as to whether the Art. IV(7)(a) rule applies to effectively impose U.S. branch profits tax at a 30% rather than 5% rate on the business profits of an LLC has had a “chilling effect” on Canadian corporations investing in U.S. businesses through an LLC.
  • It would appear that Art. IV(7)(b) does not apply to interest paid by a check-the-box Delaware LP on “debt” held by Canadian partners.

Neal Armstrong. Summaries of Corrado Cardarelli and Peter Keenan, “Planning around the Anti-Hybrid Rules in the Canada-US Tax Treaty,” draft paper for the 2013 Conference Report (CTF annual conference) under Treaties –Art. 4.

CRA has expanded its GST/HST Memorandum on zero-rated goods

CRA has revised its GST/HST Memorandum on zero-rating for goods and cognate matters. Added points include:

  • The barter rule (deeming nil consideration) in ETA s. 153(6) for provision of “make-up” gas in exchange for natural gas liquids which are consumed at a natural gas straddle plant can apply more than once in the same transaction, for example, where the natural gas owner provides rights to the natural gas to a third party who is obligated to return make-up gas, and the third party is supplied the make-up gas by the straddle plant operator for on-supply to the owner.
  • The (not so new) rule in Sched. VI, Pt. V, s. 15.1 permits zero-rating where an unregistered non-resident purchaser in Canada of a “continuous transmission commodity” (e.g., crude oil transported by pipeline) does not actually export the oil but instead delivers it in Canada to a registered Canadian in exchange for the delivery to it of equivalent crude outside Canada.
  • Where a Canadian registrant does not charge GST or HST on the supply of a continuous transmission commodity to a registrant who certifies that the commodity will be promptly exported, and that purchaser does not do so (or do a swap as described immediately above), the vendor generally will have no liability – and the purchaser instead will be subject to an imputed interest charge under s. 236.1 “which reflects the cash flow benefit obtained by [it]” (plus the avoided GST or HST itself if it did not acquire the commodity exclusively in the course of commercial activities).

Neal Armstrong. Summaries of GST/HST Memorandum 4.5.2 “Exports – Tangible Personal Property” under ETA s. 153(6), s. 236.1, and Sched. VI, Pt. V, s. 15.1, s. 15.2, s. 1, s. 2, and s. 6.1.

CRA accepts that shares can be disposed of on liquidation rather than dissolution

If an individual disposes of his shares of Opco at a loss to his personal Holdco and Opco then is wound-up into Holdco within 30 days (but articles of dissolution are not filed until beyond the 30-day period), will his capital loss be denied under the superficial loss rule?

CRA indicated that first one must assess whether his shares of Holdco are substituted property for (i.e., identical property to) his shares of Opco, and quoted IT-387R2 to the effect that this would be the case if a prospective purchaser would be equally happy with either. (The Bulletin deserves its archiving.  Securities of different persons are not identical.)

If the Holdco shares were not substituted property, then the Opco shares would be considered to be disposed of within the 30-day period if the IT-126R2 criteria were satisfied (e.g., “there is substantial evidence that the corporation will be dissolved within a short period of time.”)

There was insufficient information for a GAAR analysis.  (CRA would not like the recognition of the loss notwithstanding that Opco effectively continued as Holdco.)

Neal Armstrong.  Summary of 7 July 2014 T.I. 2014-0518561E5 F under s. 54 – superficial loss.

Bekesinski – Tax Court of Canada finds that a director who likely backdated his resignation should prevail – in part, because the Crown did not plead the backdating

Campbell J granted the taxpayer’s appeal from a director’s liability assessment under s. 227.1 on the basis that he had resigned more than two years previously, notwithstanding that, “in all likelihood, the Appellant backdated the Resignation.”  Part of the Crown’s problem was that its pleadings had only alleged that the appellant had continued as a director rather than that the resignation had been backdated.  Accordingly, mildly plausible oral explanations of the appellant were sufficient to “demolish” this diffuse assumption.  It also did not help that the Crown’s forensic evidence of backdating was disallowed for technical reasons.

Neal Armstrong.  Summary of Bekesinski v. The Queen, 2014 TCC 245 under General Concepts – Onus and s. 227.1(4).

What's Currently in Progress

  • Commentaries for the Income Tax Act provisions for which there are numerous judicial interpretations have to date been posted up to section 9 (with a cleaning-up of related summaries of judicial decisions). Commentaries on other provisions are being added on an ad hoc basis.
  • Income tax severed letters released after 1 October 2012 have been uploaded.
  • We are behind in summarizing HST/GST interpretations; accordingly, Excise Tax Act materials are not up to date.

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