Income Tax Severed Letters - 2016-02-03

Principal Issues: Can units credited under a 3-year bonus plan (RSUs) that satisfies the conditions of paragraph (k) of the definition of "salary deferral arrangement" in subsection 248(1) be converted to units under a 6801(d) plan (DSUs) and vice-versa? Can a DSU plan provide for payments to be made in accordance with the permissible distribution events in section 409(A) of the Internal Revenue Code and still comply with the requirements of paragraph 6801(d)?

Position: No. No.

Reasons: The provisions of paragraph (k) of the definition of SDA will not be satisfied where RSUs are converted to DSUs and the provisions of 6801(d) will not be satisfied where DSUs are converted to RSUs. The timing of payments under 409(A) can be earlier than the timing of a factual loss of office or employment required under 6801(d).

Principal Issues: Taking into consideration the recent Tax Court of Canada decisions with respect to surplus stripping, is the CRA of the opinion that the GAAR would apply to a particular series of transactions the purpose of which is to rely on subsection 55(2) to convert a dividend into a capital gain.

Position: A similar series of transactions (“Transactions”) was recently considered by the GAAR Committee. Although the GAAR Committee recognized that the Transactions circumvented the integration principle, it recommended that the GAAR not be applied. The GAAR Committee was of the view that it would be unlikely that the GAAR could be successfully applied to the Transactions given the current state of the jurisprudence. It was also recognized that results similar to those obtained from the Transactions could be achieved in a variety of ways. The CRA is nevertheless concerned about this type of surplus stripping arrangement and has expressed its concerns to the Department of Finance. However, the CRA will continue applying the GAAR and/or subsection 84(2) to cases like The Queen v. Macdonald where a taxpayer uses losses or other tax shelter to reduce a capital gain realized as part of a surplus stripping scheme. Also, the CRA will rely on the reasoning in Descarries where a taxpayer seeks to extract corporate surplus in a manner contrary to the object, spirit or purpose of specific anti-avoidance provisions, such as sections 84.1 and 212.1.

Reasons: According to the jurisprudence.

Principal Issues: 1) In light of the Anson UK case, has the CRA changed its position that US-LLCs are generally considered to be corporations for the purposes of the Act? 2) Can the CRA provide an update of its deliberations on the classification of Florida LLPs and LLLPs?

Position: 1) No, the Anson UK case deals with treaty interpretation issues. 2) Deliberations are still ongoing in respect of Florida LLPs and LLLPs and have been extended to Delaware LLPs and LLLPs; interested parties are invited to provide comments.

Reasons: See below.

Principal Issues: In circumstances where the Second Affiliate and Third Affiliate are fiscally-transparent under the tax laws of a foreign jurisdiction, can sub-subclause 95(2)(a)(ii)(D)(IV)(2) be interpreted such that the condition will be met with respect to the Third Affiliate where, due to the interest expense incurred by the second affiliate as well as other expenses of that second affiliate, less than all or substantially all of the income earned by the Third Affiliate would be ultimately included in the income of the ultimate non-transparent member or shareholder?

Position: Yes

Reasons: In our view, the requirement in sub-subclause 95(2)(a)(ii)(D)(IV)(2) that the shareholders or members of the Third Affiliate are subject to income taxation “on all or substantially all of the income” of that affiliate does not mean the Second Affiliate cannot incur expenses. Rather, it means that the requirement will not be met where, generally, more than 10% of the income of the Third Affiliate is ultimately not subject to income taxation in a country other than Canada (e.g., a 20% shareholder or member is tax-exempt or otherwise not subject to income taxation in the foreign jurisdiction on the relevant income.

Principal Issues: Whether the Income Tax Rulings Directorate (“ITRD”) can rule that subsection 245(2) does not apply to a proposed series of transactions similar to those in F 2005-0134731R3.

Position: The ITRD would now recommend to the GAAR Committee that subsection 245(2) be applied to a series of transactions similar to those described in 2005-0134731R3.

Reasons: In Descarries et al. v. The Queen, the Tax Court of Canada held that a series of transactions involving avoidance transactions may constitute an abuse of subsection 84.1(1) if it allows the use of V-day value (and/or the capital gains deduction) to extract corporate surplus tax-free.

Principal Issues: Is a warm climate considered a medical service for the purpose of the medical expense tax credit?

Position: No. Medical services are diagnostic, therapeutic or rehabilitative services that are performed by a medical practitioner acting within the scope of his or her professional training.

Reasons: The clear meaning provided by 118.2(2)(a) of the Income Tax Act.

Principal Issues: Can the CRA confirm that standard in-house loss consolidation arrangements would not be caught by the "one of the purposes" tests?

Position: In-house loss consolidations designed only to move losses between related or affiliated corporations on which rulings were favourably issued in the past would not be considered to have a purpose described in proposed subsection 55(2.1). An indication that such purpose is absent is that any ACB created in the loss consolidation is eliminated on the unwind.

Reasons: See response

Principal Issues: Could one rely on the exemption under paragraph 55(3)(a) on a deemed dividend under subsection 84(3) to avoid the application of proposed subparagraph 55(2.1)(b)(ii)?

Position: No. The scheme of proposed subsection 55(2) is to counter artificial generation or manipulation of cost, as supported by proposed subsection 55(2.2) and the restriction of the application of paragraph 55(3)(a). See technical notes to the July 31, 2015 legislative proposals: "The amended exception in paragraph 55(3)(a) for related-person dividends is intended to facilitate bona fide corporate reorganizations by related persons. It is not intended to be used to accommodate the payment or receipt of dividends or transactions or events that seek to increase, manipulate, manufacture or stream cost base." The CRA will seek to apply GAAR to situations where ACB is artificially created or unduly preserved in a reorganization exempt under either paragraph 55(3)(a) or 55(3)(b).

Reasons: See response