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MacDonald - Tax Court suggests that "pipeline" transactions work

MacDonald dealt with a surplus-stripping transaction.  A New Brunswick doctor, who was about to emigrate to the US, sold a cash-rich corporation to his brother-in-law for a promissory note, with his resulting capital gain being sheltered by unrelated capital losses - and with his brother-in-law extracting the corporate funds following a transfer of the corporation to a Newco of the brother-in-law, and then paying off the promissory note.  The doctor was not subject to deemed dividend treatment under s. 84(2) (because he was a creditor rather than a shareholder at the time of the corporate asset extraction) or under the general anti-avoidance rule (given, among other considerations, that it was not contrary to the scheme of the Act to accelerate the recognition of capital gains.)  Also relevant was that, in the absence of this planning, the doctor would have realized the same capital gain on emigration under s. 128.1(4)(b) (although he avoided Part XIII taxes that would have been payable on subsequent extractions of corporate surplus.)

Hershfield J. indicated that the CRA requirement that there be a one-year delay before extracting funds in a (broadly similar) post-mortem pipeline transaction (see, e.g., 2011 STEPs Roundtable, Q. 5 2011-0401861C6), was arbitrary and not justified.

Neal Armstrong.  Summary of MacDonald v. The Queen, 2012 TCC 123 under ss. 84(2), 245(1) and 245(4).

CRA accepts "royalty-free" characterization of trademark licence

Canco proposed an exclusive licence agreement with a qualifying US-resident (Pubco) to manufacture and distribute products of Pubco in Canada.  CRA accepted that Canco's payments to Pubco would be exempted from withholding tax by the Canada-US Income Tax Convention by virtue of being patent/know-how licence payments, other than payments for know-how provided under a "franchise" (a broad term - see Investors Group.)

CRA did not challenge Canco's characterization of its trademark licence from Pubco as being "royalty-free," so that the practical effect of the ruling was that the trademark could be licensed free of withholding tax.

Scott Armstrong.  Summary of Ruling 2011-0416821R3 under Treaties - Article 12.

CRA adopts 2010 OECD Transfer Pricing Guidelines

After noting some of the changes in the 2010 version of the OECD Transfer Pricing Guidelines as contrasted to the 1995 version, CRA  stated that it "endorses the application of the arm's length principle and the 2010 version of the TPG for the administration of the Income Tax Act in transfer pricing matters."

Although it would have been astonishing for CRA to reject the 2010 Guidelines, it nonetheless is useful to have this written confirmation.

Neal Armstrong.  Summary of 2011 TEI Roundtable, Q. 12 2011-0427311C6 under s. 247(2).

Denial of Canadian dollar FX losses realized by subsidiary using a different functional currency

CRA has confirmed  that where a parent with a Canadian dollar functional currency has lent in Canadian dollars to a (Canadian) subsidiary with a different functional currency, a foreign exchange loss realized by the subsidiary on repayment of the loan will be denied.

Presumably the same position would apply if the parent had lent in US dollars to its subsidiary, and it realized an FX loss (in Canadian dollars) on repayment of the loan.

Neal Armstrong.  Summary of 2011 TEI Roundtable, Q. 4 2011-0426981C6 under s. 261(20).

Supreme Court agrees that trusts have the same residency test as corporations

The Supreme Court has found that, as with a corporation, the place of residence of a trust is wherever its "central management and control" (respecting important decisions) is exercised, which is not necessarily the jurisdiction of residence of the trustee(s).

The Court also has confirmed British case law that if a shareholder exercises the central management and control of a corporation from another jurisdiction than where the board of directors meets, the corporation is resident in that other jurisdiction.

Scott Armstrong.  Summary of Fundy Settlement v. Canada, 2012 SCC 14, under ITA s. 2.

CRA maintains global grasping of employee source deductions

CRA has confirmed that a US (or other non-resident) employer is required to withhold and remit Canadian source deductions from the remuneration paid by it to its Canadian-resident employees, even if it does not carry on business in Canada directly or indirectly, the employees work only in the US and their remuneration is subject to full US source deductions.

Although the literal scope of the Regulations in question is consistent with this position (clarifying an earlier position), it appears to be oblivious to a principle of statutory interpretation (see Territorial Limits) that generally an implication should be read into a taxing provision that it does not apply to a taxpayer (in this case, a US corporation) which has no connection to the jurisdiction imposing the tax (or, in this case, a source deduction obligation.)

Neal Armstrong.  A summary of Memorandum 2012-0436311I7 appears under Regulation 102.

BC Supreme Court gives taxpayers a second shot at rectifying a deficient trust deed

The BC Supreme Court granted a rectification order to cleanse a trust deed of deficiencies that had caused CRA to assess on the basis that s. 75(2) applied to attribute a substantial capital gain realized by the trust to the settlor (the father).  However, on receiving this rectification order, CRA confirmed its reassessments on the basis that it had discovered further deficiencies in the trust deed that caused s. 75(2) to continue to apply!  The solution?  The taxpayers went back to Court (in a contested motion) to get a further rectification order to correct the further alleged deficiencies.  Dorgan J reasoned that as tax planning (i.e., multiplying the capital gains exemption) was a major purpose of the trust from its inception, rectification relief gave effect the the parties' specific intentions.

Neal Armstrong.  Summary of McPeake v. Canada, 2012 BCSC 132, under Rectification.

Tax Court disallows all of the fraudulent loss suffered by a lawyer

A Calgary lawyer suffered a loss of nearly $400,000 in a classic "419 scheme." (i.e., paying "processing" fees to recover large sums on behalf of knaves posing as clients).

Webb J. found that, because it was wholly unreasonable to be duped by the scheme, it was unreasonable to spend any amount to recover the sums - therefore, the entire loss was denied under s. 67.

Scott Armstrong.  Summaries of Ruff v. The Queen, 2012 TCC 105, appear under s. 67 and  s. 4(1)(a).

CRA rules that movies that are sublicensed through a Canadian distributor for use in Canadian homes are exempt under the US Treaty from Canadian withholding tax

While iTunes and Amazon continue to be the most prominent online content sales platforms, with their direct-to-home-users sales model, other content sellers work through intermediaries.  In an advance ruling, CRA considered a situation where a U.S. corporate group focused on the infrastructure side - obtaining permission from copyright holders, and setting up the back-end parts of an online sales platform - billing systems, content servers, etc.  The group's Canadian distributors handled the front-end - storefront, branding, and marketing - and sold the content to home users.  The relevant group member (a limited liability company with a qualifying US-resident member) received rulings that monthly fees collected through its billing system directly from the  Canadian home users were exempt from Part XIII withholding tax by virtue of the exemption for copyright royalties in Article XII of the Canada-US Income Tax Convention.

Two interesting points.

First, CRA accepted the taxpayer's representation (in the description of facts) that the LLC was the beneficial owner of the payments received from the Canadian individuals notwithstanding that all the LLC had to license was limited home-use distribution rights that it, in turn, had been licensed by the third-party holders of the copyright.  (This is consistent with the Velcro decision, where a licensee of IP from a related party was found to be the beneficial owner of royalties paid to it by a related sub-licensee.)  Furthermore, this representation was accepted notwithstanding that the individuals contracted directly with the Canadian distributors rather than with the LLC.  (There is no statement to the effect that the distributors contracted with the individual users as agent for the LLC.)

Second, no mention was made of the exclusion, from the exemption in Article XII for copyright royalties, where the royalties are "in respect of motion pictures" (or of the similar exclusion in s. 212(5)(a) of the Act from the copyright royalty exemption in s. 212(1)(d)(vi)), notwithstanding that the licensed "Digital Content" included movies. This likely reflects that CRA accepts that royalties paid for the home use of movies are exempt under the Convention - see 2011-0374421E5.   The LLC qualified for this exemption under Art. IV, para. 6 of the Convention because its sole member was a qualifying US resident.

Scott Armstrong.  See summaries of Ruling 2011-0416891R3 under Treaties - Article XII and ITA s. 212(4).

Japanese absorptive merger triggered a taxable disposition of shares of Canadian subsidiary

CRA has found that a Japanese absorptive merger - in which only one of the merging  corporations survived and the others were considered under the Japanese Commercial Code to have been dissolved - resulted in gain being triggered on the taxable Canadian property held by the dissolved Japanese corporations, in this case, shares of Canadian subsidiaries.  This is consistent with previous CRA positions (see, for example, 2000-002395, a ruling respecting a US absorptive merger.)

Foreign mergers of this type can be problematic.  The foreign advisors, who know that there is a rollover under the foreign tax law, may not realize that they give rise to a disposition under the Act.

Neal Armstrong.  See summary of 8 March 2012 Memorandum 2010-0387961I7 under ITA s. 248(1) - "Disposition".

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