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Income Tax Severed Letters 27 February 2019

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

CRA indicates that BEPS has not substantially affected its transfer-pricing practices

CRA comments relating to the mooted BEPS impact on CRA transfer-pricing practices included:

  • BEPS Actions 8 to 10 did not effect substantial changes, i.e., the underlying principles are the same.
  • CRA hopes to have final guidance out (re BEPS changes) by November 2019 including clarifying the concepts of risk-free return and risk-adjusted return.
  • Canada has not adopted the simplification measure concerning low-value-added intragroup services – so that, rather than accepting a flat markup on intragroup service-charges because of the OECD guidance, CRA will continue to rely on IC87-2R to govern intragroup pricing until adoption of a new measure.
  • Penalties are usually imposed for failure to have accurate and complete contemporaneous documentation respecting the ss. 247(4)(a)(iv) to (vi) matters (regarding the underlying analysis).
  • CRA will audit the “story” in the underlying documentation, e.g., if the taxpayer represent that one of the parties is a low-risk distributor and CRA’s review demonstrates that it is a full-fledged distributor, penalties will probably be imposed (provided the $5 million threshold is exceeded).

Neal Armstrong. Summaries of 26 February 2019 Toronto CRA & Tax Professionals Seminar under s. 247(2) and s. 247(4)(a).

The OECD Commentaries on the PPT are helpful re treaty-benefit situations that have economic substance

Comments on Art. 7 of the MLI (containing the principal purpose test) include:

  • The OECD Commentary (whose examples are based in large part on the facts of treaty abuse cases in various jurisdictions, whose results the Commentary may consider to be inapplicable under the PPT test) suggest that the PPT may apply mostly in situations where there is very little real economic substance to the transactions.
  • Because the PPT states that a benefit under a covered tax treaty (“CTA”) "shall not be granted” where the provision applies, the application of this provision could make taxpayers worse off than under a reasonable alternative transaction, e.g., a taxpayer who has sought to lower the dividend withholding tax rate from 10% to 5% could be subject to a 25% withholding rate under this complete-denial approach.
  • In interpreting a similar one-of-the-principal purposes test, UK courts have held that a principal purpose "has a connotation of importance” (Travel Document Services) and that a principal purpose of a transaction may be to obtain a tax advantage even if the transaction had a commercial objective at least as important as the tax advantage (Lloyds TSB Equipment Leasing). [See also the Groupe Honco line of cases.] Accordingly, the threshold for the PPT may be lower than in most domestic general anti-avoidance rules.
  • Since the PPT applies where it is "reasonable to conclude" that one of the principal purposes of an arrangement or transaction was to obtain a benefit under the CTA, it also imposes a relatively low burden on the tax authority, effectively requiring taxpayers to argue that it would be unreasonable to conclude that obtaining the benefit was a principal purpose of the arrangement or transaction.
  • The remedial benefits rule in Art. 7(4) has only been adopted by 28 jurisdictions (not including Canada) and is poorly drafted.

Neal Armstrong. Summaries of David G. Duff, “Tax Treaty Abuse and the Principal Purpose Test – Part 2,” Canadian Tax Journal, (2018) 66:4, 947-1011 under Treaties - MLI – Art. 7(1) and Art. 7(4).

Escape Trailer – Federal Court of Canada suggests that imposing HST on goods earmarked for immediate export fails to apply s. 142 purposively

When a B.C.-based company (the “applicant”) sold an RV to a U.S. customer, it could have avoided the requirement to charge HST on the sale price by delivering the RV to the customer in the U.S. (so that under ETA s. 142 the place of supply would have been outside Canada) or by shipping the RV to the customer in the U.S. on a common carrier (thereby engaging zero-rating). Both options were cumbersome or inconvenient, and what it did instead was to deliver the RV to the customer in a parking lot just north of the border, with the customer then driving the RV across the border as the importer of record. When CRA assessed the applicant for failure to charge HST on the sales (on the basis that they were taxable under s. 142), the applicant paid the tax but then requested that CRA recommend a remission order under s. 23(2) of the Financial Administration Act. The requested grounds were three of the criteria set out in the CRA Remission Guide, namely, financial setback coupled with extenuating factors, incorrect CRA advice and “unintended results of the legislation.”

After finding that CRA had reasonably rejected the first two grounds, Manson J went on to find that CRA had not been unreasonable in choosing “to follow the express language of section 142 over the broader purpose of the ETA to tax the consumption of goods or services in Canada,” noting that this was “consistent with past jurisprudence of this Court which has preferred the strict language of the ETA over its broader purpose.” However, he went on to state, obiter:

[I]f I had [instead] applied the correctness standard to this issue, I may have come to the opposite conclusion.

…The Officer’s literal interpretation tends to frustrate both a purposive construction of section 142 and the intent of the ETA to tax consumption of goods in Canada … [and] appears to lead to a result which is at odds with the equitable underpinnings of subsection 23(2) of the FAA.

Neal Armstrong. Summaries of Escape Trailer Industries Ltd v. Canada (Attorney General), 2019 FC 31 under Financial Administration Act, s. 23(2), ETA s. 142(1)(a) and Statutory Interpretation – Ordinary meaning.

6 further full-text translations of CRA interpretations are available

We have published a further 6 translations of interpretations released in July and June 2012. Their descriptors and links appear below.

These are additions to our set of 789 full-text translations of French-language Rulings, Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers the last 6 ¾ years of releases by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall. Next week is the “open” week for March.

Bundle Date Translated severed letter Summaries under Summary descriptor
2012-07-06 26 June 2012 Internal T.I. 2012-0436381I7 F - Nature d’un revenu - Indemnité d’assurance Income Tax Act - Section 129 - Subsection 129(6) insurance proceeds in lieu of rents from associated corp did not qualify under s. 129(6)
Income Tax Act - Section 9 - Compensation Payments life insurance proceeds for rental property did not have the character of rents from an associated corp
2012-06-29 14 June 2012 External T.I. 2011-0428341E5 F - Crédit activités physiques, activités artistiques Income Tax Act - Section 63 - Subsection 63(3) - Child Care Expense expenses that qualified for the child fitness or children's arts tax credit potentially could qualify as child care expenses
2012-06-22 5 June 2012 External T.I. 2011-0417971E5 F - Sociétés associées - CII Income Tax Act - Section 127 - Subsection 127(10.2) computation of expenditure limit where one CCPC acquires another
15 June 2012 External T.I. 2012-0434761E5 F - Dons liés à une police d'assurance-vie Income Tax Act - Section 118.1 - Subsection 118.1(1) - Total Charitable Gifts gift if pay policy premiums following assignment of policy to charity, but not by virtue of designating charity as policy beneficiary
Income Tax Act - Section 248 - Subsection 248(31) donated life insurance policy to be valued on ordinary principles
General Concepts - Fair Market Value - Other 7 factors to be considered in valuing a donated life insurance policy
13 June 2012 External T.I. 2011-0416781E5 F - Entente contractuelle particulière Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) - Subparagraph 20(1)(c)(i) intragroup charges to reflect use of each other’s capital under cash pooling arrangement are non-deductible
13 June 2012 Internal T.I. 2012-0435351I7 F - SEPE - chèques en circulation Income Tax Act - Section 248 - Subsection 248(1) - Small Business Corporation outstanding and uncashed cheques did not reduce cash
General Concepts - Payment & Receipt in Quebec, payment by cheque does not occur until debiting of bank account

Fono – Court of Quebec finds that a taxpayer gradually shifting his ties to Ottawa continued to reside in Quebec while he had secondary and personal ties there

A Quebec taxpayer, who got a job in Ottawa in 2007 along with an apartment there, was found to have continued to be resident in Quebec for his 2009 and 2010 years given that he maintained significant ties with Quebec including a significant other who stayed in Quebec and gave birth there to a child in 2010 and with the taxpayer visiting Quebec on a weekly basis. Furthermore, the taxpayer maintained various secondary Quebec ties such as bank accounts, car registration, Quebec rental properties and membership in the Quebec CPA order. Somewhat curiously, Pokomàndy JCQ found that the taxpayer did not become resident in Ontario until 2011 at the very earliest notwithstanding that the taxpayer and his significant other purchased a permanent home in Ottawa which the taxpayer, at the least, moved into in November 2010. (The provincial residency tests are based on status on December 31 of each year.)

Neal Armstrong. Summary of Fono v. Agence du revenu du Québec, 2018 QCCQ 10534 under s. 2(1).

CRA rules that a foreign collective investment vehicle is fiscally transparent rather than a unit trust

Investors subscribe for units of a “Fund”, both situated in and governed by the laws of a redacted non-resident jurisdiction. The units are described as representing proportionate interests in the property of a particular Subfund (holding a particular managed portfolio) but with an entitlement to exchange their co-ownership interest in that Subfund’s property for that in another Subfund.

Investors with different tax profiles are required to invest in separate Classes of units so that there is no pooling of withholding tax rates applicable to the securities in a Subfund’s portfolio.

The non-resident Depositary deals at arm’s length with the non-resident manager, and the Canadian securities are held by a Canadian-resident custodial subsidiary of the Depositary.

CRA ruled that the funds were fiscally transparent, so that non-resident investors holding units in a Subfund that, in turn, held Canadian equities, would be treated for Canadian withholding tax purposes and s. 116 purposes in the same manner as if they received a pro rata distribution on or proceeds of the Canadian securities.

This arrangement is somewhat similar to that in a 2014 ruling on an Irish contractual fund (2013-0496831R3 – see also 2015-0606141R3, 2009-0345011R3 and 2006-0199741R3), whose descriptions also looked somewhat similar to a unit trust, and was ruled upon to be a co-ownership arrangement. It is also is more dissimilar with (but still broadly similar to) that in a recent ruling on a Luxembourg investment mutual fund (2015-0605161R3).

Neal Armstrong. Summary of 2018 Ruling 2017-0738041R3 under s. 104(1).

CRA indicates that a health and welfare trust can administer a plan that is funded only with union or employee contributes where it also has employer-funded plans

CRA indicated that a health and welfare trust (“HWT”) which is jointly established by a union and multiple employers, can provide benefit coverage to non-unionized employees of participating employers, retired employees, and individuals who are not employees (i.e., dependants or survivors of current or retired employees where the underlying plan (i.e., a group sickness or accident insurance plan (“GSAIP”), a private health services plan (“PHSP”), or a group term life insurance policy (“GTLIP”)) allows for the provision of benefit coverage to such individuals – although a GTLIP may only provide benefit coverage to current and former (including retired) employees.

Although Folio S2-F1-C1 indicates that a trust funded only with contributions made by employees or an employee union would not qualify as a HWT, there is no explicit requirement that an employer be legally obligated to make contributions in respect of each plan or policy administered by a HWT. Accordingly:

[W]here is it established that retired employees may be provided benefit coverage through a GSAIP, PHSP, or GTLIP, and none of the participating employers have a legal obligation to pay any premiums or contributions in respect of the particular plan or policy, it would appear permissible for a HWT to administer such a plan or policy provided that the trust also administers other employer-funded plans or policies.

A HWT may administer a plan that offers drug and alcohol rehabilitation services, provided the plan qualifies as a PHSP, which entails a requirement inter alia that substantially all of the premiums paid under the plan relate to the coverage of medical expenses that are eligible for the medical expense tax credit.

Neal Armstrong. Summary of 22 January 2019 External T.I. 2016-0645581E5 under s. 6(1)(a)(i).

CRA indicates that a transfer structured as a sales agreement for nominal consideration may qualify as a gift

A parent gifted property to a child. A correspondent seemed to assume that this gift was legally required to be effected through an agreement specifying nominal consideration (of $1), with such nominal consideration actually being paid, rather than the gift being effected through a deed of gift. Would this be respected as a gift so that s. 69(1)(c) applied? CRA responded that it:

may be willing to accept that the transfer of property between non-arm’s length parties for the nominal amount of $1 could be considered a gift. For example, if the agreement governing the transfer provides for consideration of $1 merely to ensure that the agreement is legally binding, the CRA may consider the transfer to be a gift.

… If it is determined that the transfer of property was a sale for inadequate consideration rather than a gift, paragraph 69(1)(c) would not apply.

Neal Armstrong, Summary of 24 January 2019 External T.I. 2018-0773301E5 under s. 69(1)(c).

Dickinson – Court of Appeal of England and Wales states that Revenue must not let the application of its internal policies preclude the exercise of its statutory discretion

In the course of considering whether a determination by HMRC to issue advance payment notices to taxpayers before their appeals of tax assessments were heard amounted to an unlawful abuse of power (it did not), McCombe LJ discussed the tension between the desirability of HMRC developing and applying policies consistently while at the same time being mindful of the need to exercise its discretion. In this regard, he quoted with approval an earlier statement that

One aspect of the duty of fairness is that, in general, a decision- maker may not fetter his discretion. However, it is well established in public law that a decision- maker may formulate a policy to enable him to exercise a discretion consistently provided that it is not applied so rigidly that it precludes the proper exercise of discretion in each case.

And then stated:

The simple rule is, as Arden LJ said, the internal policy must not preclude a proper exercise of the statutory discretion in each case.

Neal Armstrong. Summary of Dickinson & Ors v Revenue and Customs [2018] EWCA Civ 2798 under ETA s. 315(3).