News of Note

Income Tax Severed Letters 24 August 2016

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

The narrowing of “taxable Canadian property” also has narrowed s. 119 relief

S. 119 provides relief from double taxation where an individual paid income taxes under s. 128.1(4), on emigrating from Canada, on accrued gains on shares and subsequently received dividends on those shares that were subject to Part XIII tax. However, such relief is only available where the shares were taxable Canadian property.

Neal Armstrong. Summary of Henry Shew, "Section 119: Flawed Relief from Departure Tax," Canadian Tax Focus, Vol. 6, No. 2, May 2016, p.9 under s. 119.

Foreign income taxes imposed on business income which is allocated to a provincial PE generally is non-creditable

The provinces do not accord a foreign tax credit for foreign taxes imposed on business income because, from their perspective, they only impose tax on income which is allocated to provincial permanent establishments under the Reg. 400 rules. There thus is an obvious problem if in fact foreign income tax is imposed on such business income. This happens where the foreign rules for allocating business income are different from the Canadian and provincial rules.

Neal Armstrong. Summary of Kyle B. Lamothe, "The Missing Provincial Tax Credit for Foreign Business-Income Tax," Canadian Tax Focus, Vol. 6, Number 2, May 2016, p. 10 under s. 126(2).

CRA applies a pro-rating approach to money borrowed from an affiliate to return capital used to fund both exempt and non-exempt activities

Where FA1 borrows from a sister (FA3) to make a capital distribution on its Class A common shares, which had previously been issued solely to finance FA1’s active business, CRA would accept that the interest on this loan would be received as deemed active business income by FA3 under s. 95(2)(a)(ii)(B), on the basis that it was deductible in computing FA1’s earnings from an active business under Reg. 5907. This would be so even if FA1 had issued shares of another class (its Class B common shares), to finance the acquisition of shares which were not excluded property, at the same time as it issued the Class A common shares – so that even though CRA did not articulate it this way, a tracing approach evidently is accepted.

In the situation where FA1 was required to compute its income (pursuant to Reg. 5907(1) – earnings – (a)(iii)) under Part I of the Act, CRA indicated that the interest was deductible under s. 20(1)(c) “because the borrowed funds replaced capital that…had been used by FA1 for the purpose of earning income from an active business,” whereas in the situation where the earnings were computed pursuant to (a)(i) or (iii) of the earnings definition under local tax law and the interest was non-deductible under such law, CRA laconically stated that the interest would be deductible under Reg. 5907(2)(j) without explicitly indicating that it was applying the fill-the-hole approach here as well.

If instead, shares of only one class had been issued to fund the two (good and bad) uses of funds, as to 80% and 20%, respectively, CRA would consider that “the portion to which clause 95(2)(a)(ii)(B) applies should be determined on a pro-rata basis based on the current use of the capital (i.e., prior to its replacement with the borrowed funds)…[so that] 20% of the interest income of FA3 would not be recharacterize.” as active business income.

Neal Armstrong. Summary of 26 May 2016 IFA Roundtable Q. 8, 2016-0642041C6 under s. 95(2)(a)(ii)(B).

CRA has expressed concerns to Finance about products which technically skirt the LIA policy rules

CRA has identified leveraged insurance arrangements (which “technically escaping the LIA policy definition”) where products that form part of the arrangements are interdependent and would not have been otherwise issued without the others. These arrangements:

involve manipulating the terms of the products (including pricing) that form part of the arrangements and the issuance of products that would not have been otherwise issued on a stand-alone basis (including life insurance policies insuring non-insurable lives) to obtain unintended tax benefits.

In addition to potentially attacking these arrangements on the basis that interdependent products are one contract or under GAAR, CRA has brought its concerns to Finance.

Neal Armstrong. Summary of 3 May 2016 CALU Roundtable, Q. 1, 2016-0632601C6 under s. 248(1) – LIA policy.