News of Note
CRA rules on a pubco spin-off of a U.S. business using s. 86
Email this ContentCRA has ruled that a spin-off by a Canadian public corporation (Parent”) to its shareholders of a Canadian Newco indirectly holding a U.S. business qualified as a s. 86 reorg. Under the Plan of Arrangement, the articles of Parent are amended to provide that the existing common shares of Parent are changed into Class A common shares (carrying two votes per share) and, at the same time, “New Common Shares” are added to the authorized capital with identical attributes to the former common shares. There then is an exchange of the Class A common shares for Newco shares and New Common Shares.
CRA ruled that s. 86 applied to the exchange, and that the previous change of the common shares into Class A common shares was not a disposition.
Neal Armstrong. Summaries of 2016-0679281R3 under s. 86(1) and s. 248(1) – disposition.
CRA rules that USco’s use of a Canadian affiliate for substantial marketing support for web-delivered services did not constitute carrying on business in Canada
As a small part of its business, a U.S. resident who is not registered for GST/HST purposes (“USco”) supplies information services to Canadian businesses and individuals, who subscribe by credit card through a website hosted on a U.S. web server and with the information services being delivered electronically to them from that server. USco, whose personnel for the most part do not visit Canada, will now receive expanded assistance respecting marketing to its Canadian customers from its Canadian resident affiliate ("Canco"), which heretofore has only provided it with customer address and contact information and other data. The "New Services" include most of the leg work involved in marketing including strategy development, weekly “prospecting” of accounts, assistance in the preparation of term sheets and proposals for delivery to prospective clients and in the negotiation of contract terms and drafting contracts, use of the Canco website as a portal in communicating with current and prospective purchasers and attending key trade events to promote the USco information services.
The Services Agreement between Canco and USco stipulates that Canco is not acting as agent of USco; and Canco does not have contact with the customers.
There is no statutory definition of carrying on business in Canada for ETA purposes. CRA ruled that USco, following the New Services addition, is not carrying on business in Canada for GST/HST purposes – and also ruled that the supply of the New Services by Canco to USco is zero-rated pursuant to Sched. VI, Pt. V, s. 5 (arranging for, procuring or soliciting orders for supplies made outside Canada).
Neal Armstrong. Summary of 16 March 2018 Ruling 158124 under ETA s. 240(1) and Sched. VI, Pt. V, s. 5.
Complexities can arise in determining the contribution of foreign affiliates to safe income on hand
S. 55(5)(d) provides that the safe income of a foreign affiliate of a taxpayer is the lesser of its tax free surplus balance respecting the taxpayer (computed on a somewhat modified basis) and the fair market value of all its shares.
It may be possible to engage in transactions to increase a foreign affiliate’s TFSB by, for example, paying up interaffiliate dividends in order to blend the applicable excess hybrid underlying tax of one affiliate with a "low-taxed" hybrid surplus pool of another (having regard to the inclusion in TFSB of hybrid surplus of a particular foreign affiliate only if such surplus is "fully sheltered" by hybrid underlying tax.)
Reliance for safe income purposes on a computed TFSB balance may be problematic given the possibility of retroactive adjustments to surplus balances, for example, as a result of amending returns in the local jurisdiction, or as a result of retroactive adjustments to surplus pools arising from adjustments under Reg. 5907(1.1) to reduce (or increase) each group member’s surplus pools for local tax borne by (or refunded to) it.
The rule in s. 93.1(1) for looking through partnerships does not apply for purposes of s. 55(5)(d). This may not be as bad as it sounds. S. 55(2.1)(c) merely refers to the amount of the income earned or realized by any corporation, and Lamont Management concluded that the reference to “any corporation” can include a foreign non-affiliate.
Neal Armstrong. Summary of Jim Samuel, "Interaction of the Foreign Affiliate Surplus and Safe-Income Regimes: Selected Anomalies, Issues, and Planning Considerations", Canadian Tax Journal, (2018) 66:2, 269-307 under s. 55(5)(d).
The refreeze of a non-SBC may result in imputed income on a fictional amount
Mr. X effects an estate freeze on a non-small business corporation as a result of which he is subject to imputed income under s. 74.4(2) on the “outstanding amount,” being essentially under s. 74.4(3) the redemption amount of the preferred shares that he received on the freeze of, say, $15 million. If the corporation declines in value and he does a “refreeze” so that he now holds preferred shares with a redemption value of $3 million, the outstanding amount will remain at $15 million – or only be reduced to $12 million if those preferred shares are redeemed in full for cash.
Neal Armstrong. Summary of Manu Kakkar, Alex Ghani and Boris Volvofsky, “Corporate Attribution: Refreeze May Cause Unsolvable Corporate Attribution Problem,” Tax for the Owner-Manager, Vol. 18, No. 3, July 2018, p.6 under s. 74.4(3).
Moorthy – Court of Appeal of England and Wales finds that non-taxable receipts of an employee for “injury” included damages received for hurt feelings
The U.K. statute essentially deemed employment income to include any amount received as a consequence of a person’s employment – but had a specific exclusion for a payment provided "on account of injury to… an employee." After being terminated, an executive brought an action for damages on grounds that included unlawful age discrimination - and then settled his action for £200,000. Counsel to HMRC agreed that £30,000 was allocable to his age discrimination claim, if it could properly be termed "on account of injury.”
Underhill LJ held that it “would accord with the natural meaning of the language” to find that this exclusion applied to an amount received as compensation for the taxpayer’s injured feelings for having been terminated on the basis of his age - so that the taxpayer received the £30,000 tax free.
Neal Armstrong. Summary of Moorthy v Revenue and Customs, [2018] EWCA Civ 847 under s. 248(1) – retiring allowance.
2137691 Ontario v. Park – Ontario Superior Court finds that the residential complex HST exemption applied to the sale of a portion of a large home
The land for a large home in Oakville was divided by a corporation into three lots, so that the middle lot contained a pool house and hallway structure that connected to the rest of the home on the other two lots. The corporation then sold this middle lot to an individual purchaser coupled with a covenant that it would demolish this structure – which, however, it did not do until 45 days after closing. The sales contract provided that any HST was in addition to the sales price of $2.8M, but the vendor (the corporation) provided a statutory declaration that the property qualified for exemption as being used residential accommodation, so that no HST was collected on closing. A year later, it then brought a motion to recover HST from the purchaser.
After making the questionable statement that “the time of the supply is the time that the deal closes” (ETA s. 133 was not to be taken literally), Coats J found that the sale was exempt, stating:
[A]t the time of closing, the residence and pool structure were a complete structure which were suitable for living in. … It was clearly an appurtenance to the detached home.
… There is no requirement in ETA that the residential complex/residential unit exemption involve the transfer of an entire residential unit or a complete residency unit. This would be contrary to the “part thereof” language in section 123(1) … .
She went on to indicate that even if the sale had been subject to HST, ETA s. 194 would preclude the vendor from now charging such HST to the purchaser, as the purchaser’s reliance on the exemption certificate was not unreasonable.
Neal Armstrong. Summary of 2137691 Ontario Limited. v. Lucia Pessoa Park, 2018 ONSC 4218 under ETA s. 123(1) – residential complex, s. 194 and s. 224.
CRA finds that Canadian royalties received exempt of U.K. tax by a non-domiciled U.K. resident were ineligible for Treaty-reduced rate
A former Canadian author, who now was resident but not domiciled in the UK, was not subject to UK tax on royalties he received from a Canadian publisher because the royalties were not remitted to the UK. Art. 27(2) of the Canada-UK Convention effectively provides that where under the Convention “any income is relieved from tax in” Canada and that income is subject to tax in the UK only on a remittance basis, then “relief to be allowed under this Convention in [Canada] shall apply only to so much of the income as is taxed in” the UK.
CRA interpreted these words as indicating that the royalties that he thus received free of UK income tax were subject to Canadian withholding tax at 25% rather than the Treaty-reduced rate of 10%. CRA was not asked what would happen if that income was then taxed in the UK as a result of its subsequent remittance to the UK.
Neal Armstrong. Summary of 1 June 2018 External T.I. 2017-0723051E5 under Treaties – Income Tax Conventions – Art. 29.
Income Tax Severed Letters 1 August 2018
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Medallion – Tax Court of Canada finds that a property management agreement with a rental property’s sole owner qualified as a joint venture for GST/HST purposes
A corporation (MC) acted as a property manager for the rental properties of 10 corporations (the “Owners”) with which it did not deal at arm’s length in consideration for a percentage of the rents (which apparently included exempt residential rents) and other gross revenues that it collected. In addition to some of the more usual features of a property management agreement (which in this case were labelled “Joint Venture Agreements”), most significant decisions respecting their “joint venture” was required to be approved unanimously by a management committee consisting of a representative of each of MC and the Owner. MC took the view that its share of the gross revenues was not consideration for a taxable supply made by it to the Owners (so that effectively GST, on a mangement fee, that would not have been eligible for an input tax credit was being avoided). The Crown took the view that there was no joint venture on the four grounds (taken from its Westcan listing of JV criteria) noted below (with Russell J’s finding noted after each):
MC did not have a joint property interest in the subject matter of the venture:
- Its right to a share of the revenues was a property interest in the venture.
MC had no right of mutual control or management of the enterprise:
- This was present in the joint management committee. Sales (as contrasted to leasing) were outside of the purview of the JV so that it did not matter that MC had no say on sales.
MC had no expectation of profit (or of “adventure”):
- It was entitled to a percentage of the rents and other gross income.
MC had no right to participate in the profits:
- Again, it was entitled to a percentage of the gross operating revenues, and the fact that it would not share in any gain on sale did not matter as “any sale of a Property simply was beyond the scope of the JVs as asserted in this case.”
Accordingly, the property management relationship qualified as a JV, and there was no requirement on MC to collect GST/HST on its share of the revenues.
Neal Armstrong. Summary of Medallion Corporation v. The Queen, 2018 TCC 157 under ETA s. 273(1).
St-Pierre – Federal Court of Appeal effectively treats a retroactive judgment of a Superior Court as only having prospective effect for ITA purposes
A private corporation that sold eligible capital property in 2008 declared a capital dividend in the year in an amount which included the untaxed portion of this sale receipt. This was a mistake, as the addition to the capital dividend account for this amount does not occur until the beginning of the following year. When CRA discovered this mistake a number of years later, it indicated that it would not assess the corporation for Part III tax provided that the mistake was rectified through an order of the Quebec Superior Court.
Only a small portion of the dividend made payable in 2008 was actually paid in 2008, so that the CDA addition from the sale was not needed to cover that dividend payment. Accordingly, all that was necessary to fix the problem was to get the court order to declare the payable date for most of the dividend to be on or after January 1, 2009.
What the corporation instead sought and obtained was a court order dated January 6, 2014 that retroactively annulled the dividend and ordered the individual shareholder to repay the dividend, which he then did in 2015 and with a fresh capital dividend then being declared and paid. When CRA found out that annulment rather than rectification had been requested, and while this annulment order was still being awaited (and the period for making a s. 15(2) assessment was about to run out), it assessed the individual under s. 15(2) on the basis that, as the dividends would be annulled, the payments to the individual instead represented advances (i.e., amounts which he was required to repay, as retaining them would have given rise to unjust enrichment).
Boivin JA found that the s. 15(2) assessment was without foundation, essentially on the basis of his not treating the judgement of the Superior Court as having retroactive effect for ITA purposes. He stated:
[I]f restitution was not possible before the date of the declaratory judgment of the Superior Court, it necessarily follows that there was no debt (in this context, an unjustified enrichment), before that date. The appellant could not at the same time be indebted to the Corporation and be legally incapable of repaying that debt to it.
Thus, the CRA assessment could not take an annulling judgment, which had not yet been given, into account. Furthermore, the “enrichment” of the individual taxpayer resulting from the Superior Court judgment was merely “theoretical” given his obligation to make restitution to the corporation, which he did.
Neal Armstrong Summary of St-Pierre v. Canada, 2018 CAF 144 under s. 15(2).