News of Note
THD – Tax Court of Canada finds that damages received for the “modification” of a supply contract were deemed to be GST-inclusive irrespective of an ITC to the purchaser
Email this ContentA trucking company (THD) had a contract with McKesson Canada for the delivery of pharmaceutical products to various locations. After McKesson eliminated various of the routes and forced a renegotiation of the rates, THD brought an action, which then was settled for a lump sum.
Favreau J found that the lump sum was deemed by ETA s. 182 to include GST (on the basis that THD had received the sum as a consequence of the “modification” of its contract with McKesson), so that it had to itself bear this GST. In response to an argument that this result could unjustly enrich McKesson, Favreau J stated that the s. 182 rule “applied irrespective whether McKesson had claimed an input tax credit respecting the damages paid.”
On a separate issue, he indicated that an input tax credit could not be claimed for GST that had been invoiced to THD, because at the time of claiming its ITC, the invoice did not satisfy the documentary requirements in the applicable Regulation (although, as it turned out, there also was the more fundamental issue that Revenu Québec had retroactively annulled the GST registration number of the supplier in question).
Neal Armstrong. Summaries of THD Inc. v. The Queen, 2018 CCI 147 under ETA s. 182 and Input Tax Credit Information (GST/HST) Regulations, s. 3(b)(i).
2078970 Ontario – Tax Court of Canada finds that CRA cannot issue a s. 152(1.4) notice of determination denying partnership losses on the basis that the partnership did not exist
CRA determined that two limited partnerships did not exist because their partners were not carrying on business in common with a view to profit, and issued notices of determination to the partnerships under s. 152(1.4) determining that losses reported by the purported partnerships were, for this reason, nil. On a Rule 58 determination, Graham J accepted the partners’ submission that once CRA has determined that a partnership does not exist, any purported notice of determination that it thereafter issued to the partnership was invalid.
S. 152(1.8) provides that when, after a s. 152(1.4) notice of determination has been made, the Minister (or the Tax Court or above) concludes that the partnership in question did not exist, the Minister has a further year without limitation by the normal reassessment period to reassess the purported partners directly. Graham J indicated obiter that s. 152(1.8) could not be utilized if the notice of determination was invalid because the Minister had already concluded before issuing it that the partnership did not exist.
Neal Armstrong. Summaries of 2078970 Ontario Inc. v. The Queen, 2018 TCC 141 under s. 152(1.4) and s. 152(1.8).
Armour Group – Federal Court of Appeal finds that a lump sum paid on the acquisition of a property subject to a ground lease to the purchaser group coupled with the ground lease surrender did not generate a lease termination deduction
An investment company (“Armour”), which was the lessee under a long-term ground lease from the Province of Nova Scotia, had constructed a building on the property and leased the building back to the Province. The Province then breached terms of the building lease and, in the subsequent settlement agreement, the parties agreed that, in addition to making a cash payment, the Province owed $2.4 million to Armour and that Armour, in consideration for $2.4 million to be paid by way of set-off, would be granted an irrevocable option to acquire the Province’s freehold interest (with the ground lease being terminated). Without the encumbrance of the ground lease, the property had a fair market value of $14 million. Accordingly, it likely would have been clear that on exercise of the option by Armour, it would have acquired a capital property with a cost of $2.4 million.
However, Armour calculated that the present value of the remaining ground lease rentals was $2.24 million. This meant that if it were able to have $2.24 million of the $2.4 million to be paid by it characterized as a fully-deductible lease termination payment, this could reduce the capital expenditure to only $0.16 million. What it did was to assign the option to an affiliate (“ADL”) along with the right to $0.16 million of the $2.4 million owing by the Province, with ADL agreeing as a condition of the assignment that it would provide a long-term ground lease of the property to Armour for nominal rents. Armour then took the view that the $2.4 million liability of the Province which was extinguished at closing on the exercise of the option should be viewed as the payment by it of a $2.24 million deductible lease termination payment, and the payment by ADL of a $0.16 million option exercise price, to the Province.
Webb JA found that these transactions did not generate the targeted $2.24 million deduction. It was difficult to see how these largely internal transactions had the effect of transforming the $2.4 million paid (by way of set-off) to the Province into a lease termination payment rather than payment of the exercise price for the option.
Neal Armstrong. Summary of Armour Group Limited v. Canada, 2018 FCA 134 under s. 18(1)(b) – capital expenditure v. expense – contract cancellation.
CRA indicates that an open-end non-listed mutual fund trust could suspend redemption rights for up to one year without ceasing to qualify as a unit trust
In order to qualify as a unit trust under s. 108(2)(a)(i), the unit conditions must include a condition “requiring the trust to accept, at the demand of the holder thereof and at prices determined and payable in accordance with the conditions, the surrender of the units.” CRA has provided a ruling on the satisfaction of this condition in the case of a unit trust whose principal asset will be an illiquid investment in the LP units of a subsidiary partnership and that intends to qualify as a mutual fund trust by distributing its units to more than 150 unitholders but will not list its units. In the event that cash redemptions (which can occur on a monthly basis) exceed $X in a month, the trust will transfer LP units to a wholly-owned unit trust (with heretofore nominal capitalization) in exchange for interest-bearing notes, and distribute those notes to the redeemed unitholder in satisfaction of the balance of the redemption price (which is the amount determined by the trustee, who also is the trust’s manager, to be the redeemed units’ fair market value).
The ruling letter states that the trustee may suspend or postpone the right to redeem trust units provided that such suspension or postponement complies with securities legislation. After providing a ruling that the terms of the redemption feature will satisfy the requirements of s. 108(2)(a)(i) for purposes of determining whether the Trust qualifies as a unit trust, CRA went on to indicate, in the form of an opinion (presumably because this was not a planned transaction) that should a postponement or suspension of the right to redeem units occur and that postponement or suspension exceeded a period of more than one year, the trust would cease to meet the requirement of s. 108(2)(a)(i).
Neal Armstrong. Summaries of 2018 Ruling 2017-0723421R3 under s. 108(2)(a) and s. 253.1.
CRA confirms the use of average monthly exchange rates in a GST/HST context
ETA s. 159 (which is quite truncated as compared to ITA s. 261) provides that the consideration for a supply expressed in a foreign currency shall be converted using the exchange rate on the day the tax became payable “or such other day as is acceptable to the Minister.” CRA has replaced P-222 by significantly more detailed commentary in Memorandum 3-6 on various FX issues.
In picking an FX rate, the registrant may use:
- the day the consideration for the supply is paid
- the day the foreign currency is acquired (as to which CRA provides a simplistic example of the day on which a money order for US$1,000 is acquired, with Canadian funds, to pay a USD invoice in that exact amount)
- an average rate of exchange for the month in which the tax becomes payable (as to which CRA provides an example in which only two USD invoices were rendered in a month, showing that this method can be used even if it would be practicable to be more precise)
CRA provides a somewhat broad list of the acceptable sources for determining the exchange rate to use:
- the source used for an actual conversion (that is, the source where the foreign currency was exchanged for Canadian dollars)
- the source the person typically uses for actual conversions (for example, if a US company regular exchanges currency with a local US bank, it can use that bank as its source of FX rates)
- a Canadian chartered bank
- the Bank of Canada
- the CBSA rate used for purposes of converting the value for duty of imported goods
An example of an unacceptable source is a commercial database service. (Bloomberg is relied on by the banks and investment dealers, but CRA presumably would not want to pay the Bloomberg fees.)
Neal Armstrong. Summary of GST/HST Memorandum 3-6 Conversion of Foreign Currency July 2018 under ETA s. 159.
CRA confirms that the split income rules do not apply to preferred beneficiary income
The definition of split income includes trust income distributions under s. 104(13) but not preferred beneficiary amounts under s. 104(14). Accordingly, where a services partnership that was set up by the partners of an accounting firm earns income from the provision of back office services to the firm, and that income is then allocated in part to a limited partner that is a trust with a preferred beneficiary, the income included in the preferred beneficiary’s income under s. 104(14) will not be subject to the tax on split income.
Neal Armstrong. Summary of 6 July 2018 External T.I. 2018-0759521E5 under s. 120.4(1) – split income – para. (c).
Income Tax Severed Letters 25 July 2018
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Canada Without Poverty – Ontario Superior Court of Justice declares that ss. 149.1(6.2)(a) and (b) are of no force and effect
A registered charity devoted most of its resources to public policy advocacy with a view to ending poverty. Although this advocacy was subordinate to its poverty-reduction purpose, it nonetheless was considered by CRA to be devoting most of its activities to (non-partisan) political activities so that it was well outside the safe harbour in ITA s. 149.1(6.2) for ancillary political activities. The charity challenged this restriction on its political activities before Morgan J.
In response to the Attorney General’s argument that “the Applicant has a right to free speech, not to subsidized speech” through the ability to issue charitable receipts, Morgan J stated:
[T]he evidence is that the Applicant cannot function – or will have difficulty in functioning – in the absence of registered charitable status.
After concluding that s. 149.1(6.2) “violates s. 2(b) of the Charter in that it burdens the Applicant’s pursuit of public policy advocacy,” he found that the Attorney General had failed to justify this infringement under s. 1 of the Charter through failure to answer the question “why Parliament has limited political speech acts done in furtherance of accepted charitable purposes.”
He went on to make a declaration that “that ss. 149.1(6.2)(a) and (b) are of no force and effect pursuant to s. 52(1) of the Constitution Act, 1982.” However, he did not really mean this (which would have the effect of eliminating any safe harbour for even minor political activity) as he earlier made a declaration “that the phrase 'charitable activities' used in s. 149.1(6.2) be read to include political activities, without quantum limitation, in furtherance of the organization’s charitable purposes.” He also stated that the exclusion for partisan “charitable activities” in s. 149.1(6.2)(c) remained. Even before this, the Government was thinking about removing or amending ss. 149.1(6.2)(a) and (b),
He did not discuss jurisdictional issues. How are non-Ontario charities affected by his declaration? In reviewing any proposed revocation of registration of this or another charity by CRA, would the Federal Court of Appeal feel obliged to apply his modification of their Act?
Neal Armstrong. Summary of Canada Without Poverty v. AG Canada, 2018 ONSC 4147 under s. 149.1(6.2).
Straessle – Tax Court of Canada finds that the beneficiary of an estate that had been wound up could appeal an assessment of the estate
The definition of a “person” indicates that such word “includes … the heirs, executors … or other legal representatives of such a person.” Lafleur J found that this definition indicated that the heir of an estate (i.e., the daughter receiving as the beneficiary of the estate of her mother), who had never been an executor or other legal representative of the estate, could object to and then appeal an assessment of the person and taxpayer in question, being the estate (which had since been wound up). She rejected the Crown’s argument that, in order to have this ability, the heir was required by the quoted wording to have been an heir who was also a legal representative, stating:
Parliament cannot have intended that an assessment be immune to a judicial challenge.
It is unclear whether there are non-procedural contexts in which a reference to taxpayer that is an estate will include an heir.
Neal Armstrong, Summary of Estate of Winifred Straessle v. The Queen, 2018 TCC 144 under s. 165(1).
Landbouwbedrijf Backx – Tax Court of Canada finds that the central management and control of a B.V. with a sole Dutch director was in Canada
When a Netherlands couple (the Backxes) immigrated to Canada in 1998 to acquire a dairy farm here, they created a structure under which the farm was held in a partnership which was held by them directly as to 51% and as to 49% through a Netherlands holding company (“B.V.”) of which the wife’s sister (a Netherlands resident) was the sole director. On a subsequent disposition by B.V. of the partnership interest, they took the position that B.V.’s gain was exempt from tax under the Canada-Netherlands Treaty, as being from the disposition of a substantial interest in a partnership holding a property (the farm) in which its business was carried on.
Smith J found that B.V. instead was subject to capital gains tax as a Canadian resident, as its central management and control was in Canada, stating:
[I]t was the Backxes who assumed effective and independent control of [B.V.] In most if not all instances, [the sister] was not even copied with the correspondence. This quite clearly suggests that she was a mere nominee who carried out clerical and administrative functions on behalf of the Backxes.
Furthermore, B.V. was resident in Canada for Treaty purposes as its effective management and control was in Canada - and if it was resident in both countries, this was a matter for the competent authorities to address and not the Tax Court. (The Treaty provided that a dual-resident corporation was not a Treaty resident in the absence of competent-authority agreement.)
He also found that there had not been any previous step-up in the adjusted cost base of the partnership interest of B.V. under s. 128.1(1)(c), as its central management and control had been in Canada from the time of the partnership’s formation.
Neal Armstrong. Summaries of Landbouwbedrijf Backx B.V. v. The Queen, 2018 TCC 142 under s. 2(1), s. 128.1(1)(c) and Treaties - Income Tax Conventions - Art. 4.