News of Note

The AMT changes will adversely affect charitable giving and inter vivos trusts incurring interest expense

PwC provided the following examples illustrating the impact of the harsher proposed federal AMT rules (provincial tax is not factored in):

Example 1

An individual earning ordinary income of $250,000 disposes of capital property in the year at a capital gain of $1,500,000 would compute regular federal income tax of $304,778 and federal AMT of $322,271 [the AMT inclusion rate for capital gains will increase to 100%].

Example 2

An individual earning ordinary income of $450,000 donates a capital property that is not a publicly listed security, with an ACB and FMV of $100,000 and $1,000,000 will compute regular federal income tax of $49,483 and federal AMT of $129,123 [the capital gains inclusion rate for the donated security will increase, and the donation tax credit will be limited to 50%].

Example 3

An inter-vivos trust (that is neither excluded from AMT, nor qualifies for a basic exemption amount) which borrows $1,000,000 at 1% to earn interest income at 3% and distributes the resulting net income of $20,000 to the trust beneficiaries would compute regular federal income tax of nil and federal AMT of $1,025 [50% of the interest expense deduction will be denied, an inter‑vivos trust will not generally benefit from the basic AMT exemption, and the $20,000 distribution does not fully eliminate the higher income for AMT purposes]

Neal Armstrong. Summary of PwC, “Tax Insights: Proposed changes to the alternative minimum tax ─ How will it affect individuals and trusts?” Issue 2023-31, 22 September 2023 under s. 127.52(1).

Galaxia – Court of Quebec finds that a company whose shareholder was named as a VP of its only client did not have a personal services business

For the three taxation years in issue, the ARQ assessed Galaxia on the basis that it was carrying on a personal services business. Galaxia’s shareholder was engaged, through Galaxia, by Galaxia’s sole client during those years (“SM”) to canvas her extensive network of overseas contracts to obtain contracts for SM’s business of providing security-related services. Before concluding that Galaxia was not engaged in a personal services business, Riverin JCQ found:

  • The shareholder was not under the control of SM, so that, for instance, she had no marketing plans to meet, and she did not inform SM of her travels.
  • The only revenues of Galaxia were commissions calculated and collected as a percentage of the billings received by SM from the contracts generated by Galaxia – so that its revenues were highly variable.
  • Galaxia incurred significant expenses, and thus was significantly at risk of generating losses.
  • Although the shareholder was named as a vice-president of SM with an SM email address, this was done only for marketing reasons and her title was honorific.

Neal Armstrong. Summary of Consultants Galaxia Inc. v. Agence du revenu du Québec, 2023 QCCQ 5871 under s. 125(7) - personal services business.

CRA indicates that generally only the GL rather than ancillary journals or back-up are subject to the extended corporate accounting-record retention period

The various records or books of account of a corporation described in Reg. 5800(1)(a) are to be kept until two years after its dissolution, whereas other records or books of the corporation need only by kept until six years after the taxation year to which they relate.

Regarding the scope of Reg. 5800(1)(a)(iv), which refers to “the general ledger or other book of final entry containing the summaries of the year-to-year transactions of a corporation,” CRA indicated that:

  • In general, the term “summary” refers only to the summary items posted to the general ledger (GL), so that more details, such as the names of the parties and the dates of the transactions, are not required.
  • However, in some cases, the GL may present only a total for several transactions otherwise presented individually in another book of final entry, such as a subsidiary ledger, in which case such subsidiary ledger is also subject to the longer retention period.
  • Notwithstanding some ambiguity in this regard arising under the wording of ITA s. 230(4)(a). the vouchers and accounts required to verify the information contained in the GL are only subject to the shorter (six-year) retention period.

Reg. 5800(1)(a)(v) refers to “any special contracts or agreements necessary to an understanding of the entries in the [GL]”. CRA stated:

Generally speaking, we are of the view that a special contract or agreement is one that includes particular provisions or conditions that are not generally found in a contract or agreement of a similar nature.

Neal Armstrong. Summaries of 5 July 2023 External T.I. 2022-0954271E5 F under Reg. 5800(1)(a)(iv) and Reg. 5800(1)(a)(v).

CRA does not consider a pilot’s aviation headset to be a “tool”

CRA considers that pilots are not entitled to the deduction under s. 8(1)(s) for tools for the cost to them of aviation headsets (which are worn so as to prevent hearing loss and to facilitate communications with Air Traffic Control). It considered that such headsets come within the exclusion in s. 8(6.1)(d), from what otherwise would qualify as an eligible “tool,” for an “electronic communication device” and also considered that the headsets did not come within its understanding of the ordinary meaning of "tool," namely, an item that is “designed to create a physical change in something or be used as an instrument of measurement or manipulation.”

CRA also indicated that a pilot could not claim the deduction under s. 8(1)(g) (“transport employee’s expenses”) for the individual’s meal expenses incurred while away from the municipality of the employer establishment where the pilot reported for work (the “home city”), because the individual would fly back to the home city on the same day, and CRA considered that s. 8(1)(g) required that the “employee must generally be away from home overnight in the performance of their employment duties.” However, such meal expenses could be deducted pursuant to s. 8(1)(h) assuming inter alia that, as required by s. 8(4), the pilot was away from the home city on each trip for at least 12 consecutive hours.

Neal Armstrong. Summaries of 26 May 2023 External T.I. 2023-0962521E5 under s. 8(1)(s), s. 8(1)(g) and s. 8(1)(h).

Standard withholding tax gross-ups do not engage the mandatory tax disclosure rules

It is suggested that the mere presence of contractual protection (CP) is not sufficient to engage the CP hallmark and that a “discernible link must exist between the CP and the avoidance transaction in question.” This is consistent with CRA’s example of an RRSP trustee receiving an indemnity regarding the RRSP acquiring non-qualified investments, as such indemnity “relates to transactions (for example, the making of non-qualified investments) that do not form part of the tax motivation that gives rise to the avoidance transaction” (establishing the RRSP).

To apply a similar approach in the context, for example, of a cross-border loan transaction with a gross-up clause, where the loan itself was not an avoidance transaction but was part of a series of transactions that included an avoidance transaction (e.g., a rollover transaction), an entirely appropriate conclusion would be that the usual indemnity and gross-up are not CP “in respect of” that avoidance transaction.

Furthermore, given that CP is defined in relation to a “tax benefit,” which, in turn, refers to a reduction, avoidance, or deferral of amounts payable under the ITA, because interest to an arm’s-length foreign lender generally is not taxable under the ITA, there is no identifiable “reduction, avoidance or deferral” that would make the existence of a tax benefit clear. A tax benefit may also be identified by referring to an alternative transaction that might reasonably have been carried out but for the existence of the tax benefit (Copthorne) - yet, in normal cross-border lending situations, no such reasonable alternative is likely to exist.

Accordingly, the absence of a tax benefit is a further potential basis for a standard gross-up and indemnity in an arm’s-length lending transaction not engaging the CP hallmark.

Neal Armstrong. Summary of Andrew Spiro and Jessica Charendoff, “Mandatory Disclosure Is Here: Now What?” Perspectives on Tax Law & Policy, Vol. 4, No. 3, September 2023, p. 1 under s. 237.3(1) – contractual protection.

Income Tax Severed Letters 20 September 2023

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

Shawn Porter suggests that the identification of hallmarks should be informed by the legislative purpose “to identify potentially abusive transactions”

Shawn Porter, who was an Associate Assistant Deputy Minister, Tax Policy Branch during the design of the more recent mandatory reportable transaction (RT) rules, has co-authored an article providing perspectives on when these rules should be engaged.

The article suggests:

Hallmarks are intended to identify potentially abusive transactions on the basis that such transactions often exhibit a hallmark. …

[H]allmarks do not just exist in the ether; rather, they reveal themselves in circumstances where their presence may influence or cause a party to engage in the targeted riskier behaviour by entering into the potentially aggressive transaction.

In particular, since the contractual protection (CP) hallmark must be present by the time that the avoidance transaction was completed, it follows that “[p]rotection arising after the relevant avoidance transaction is consummated—and operating for the benefit of an arm’s-length person not involved with or interested in the earlier transaction that gave rise to the tax risk—is not the target.”

Thus, the Explanatory Notes “differentiate, appropriately, between (1) a situation where a purchaser obtains protection from pre-sale liabilities (including tax) and (2) a situation where insurance is obtained to cover specific identified tax risks in relation to avoidance transactions.”

Similarly, the CRA guidance indicates that protection relating to existing pre-closing tax issues, the quantum of existing tax attributes, and pre-sale safe income dividend transactions, do not bear the CP hallmark.

However, the CP hallmark would apply if CP were received after the fact, but the taxpayer seeking the benefit knew in advance that this would occur, or if the purchaser and vendor agreed to reduce the risk of a contemporaneous avoidance transaction under the guise of standard indemnities.

Neal Armstrong. Summary of Rob Jeffery and Shawn D. Porter, “Mandatory Disclosure: A Reasonable Balance Between Timely Information and Administrative Burden,” Perspectives on Tax Law & Policy, Vol. 4, No. 3, September 2023, p. 4 under s. 237.3(1) – contractual protection.

The s. 237.5 reporting rules lack a materiality threshold

Observations on the “reportable uncertain tax treatment” (RUTT) rules in s. 237.5 include:

  • In contrast to the UK rules (which apply only if the company has UK turnover in excess of £200 million and assets on the balance sheet of more than £2 billion and only apply to uncertain tax treatments in excess of £5 million), the Canadian rules (including the penalties) apply irrespective of the materiality of the uncertain tax position, and the threshold for applying the rules is only $50 million of assets.
  • A Canadian member of the group might need to report the uncertain tax treatment in a situation where there is only a nominal impact in Canada.
  • In many situations, it might not even be aware of the uncertain tax treatment or have the requisite information to report its existence (the relevant documentation would likely be kept by other members of the group).
  • A taxpayer may make a single entry for uncertain tax treatments to account for multiple interdependent potential adjustments, e.g., the reasonableness of a royalty may be considered in light of inter-affiliate charges for tangible goods. If the taxpayer were required to report the individual uncertain tax treatment even where an offsetting adjustment nets against the liability, excessive reporting would be the result – failing which, s. 237.5(5) penalties might be assessed on each uncertain treatment that was not reported.

Neal Armstrong. Summary of Dean Landry and Colin Mowatt, “The Uncertainty Surrounding Uncertain Tax Treatments,” Perspectives on Tax Law & Policy, Vol. 4, No. 3, September 2023, p. 13 under s. 237.5(2).

We have translated 7 more CRA interpretations

We have translated a CRA interpretation released last week and a further 6 CRA interpretations released during December of 2002. Their descriptors and links appear below.

These are additions to our set of 2,584 full-text translations of French-language Technical Interpretation and Roundtable items (plus some ruling letters) of the Income Tax Rulings Directorate, which covers all of the last 20 ¾ years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).

Bundle Date Translated severed letter Summaries under Summary descriptor
2023-09-13 11 September 2017 External T.I. 2017-0706851E5 F - Changement partiel d'usage - Immeuble locatif Income Tax Act - Section 45 - Subsection 45(1) - Paragraph 45(1)(c) - Subparagraph 45(1)(c)(i) partial change-of-use rules applied when a non-resident with a s. 216 rental triplex immigrates to Canada and moves into one of the units
Income Tax Act - Section 216 - Subsection 216(1) previous s. 216 use of property taken into account, following immigration to Canada, under ss. 13(7)(d)(ii) and 45(1)(c)(i)
2002-12-20 23 December 2002 Internal T.I. 2002-0176087 F - LIMITE APPLICABLE TRANSFER DANS REER Income Tax Act - Section 146.3 - Subsection 146.3(6.1) deemed benefit under s. 146.3(6.1) included in amount referred to in s. 146.3(5)
Income Tax Act - Section 146.3 - Subsection 146.3(6.11) - Paragraph 146.3(6.11)(b) - Variable C Variable C included the deemed benefit under s. 146.3(6.1)
12 December 2002 External T.I. 2002-0146175 F - Losses Incurred by a Taxpayer ect...... Income Tax Act - Section 39 - Subsection 39(1) - Paragraph 39(1)(c) - Subparagraph 39(1)(c)(iii) usual s. 50(1)(b)(i) and SBC qualification rules applied to shares of a cooperative corporation that became bankrupt
11 December 2002 Internal T.I. 2002-0173007 F - Observation aux commentaires (OCDE) Treaties - Income Tax Conventions - Article 12 Canada’s withdrawal of its observation on Art. 12 on March 28, 2002 was prospective, and did not affect its right to impose withholding tax on payments for use of a secret process prior to that date
2002-12-06 16 December 2002 External T.I. 2002-0138195 F - ALLOCATION POUR FRAIS DE DEPLACEMENT Income Tax Act - Section 6 - Subsection 6(1) - Paragraph 6(1)(b) - Subparagraph 6(1)(b)(vii.1) travel allowance for travel 40% of the employment days between home and a more remote employer situs was for personal travel
Income Tax Act - Section 81 - Subsection 81(3.1) amalgamation of 2 part-time employers ended the s. 81(3.1) exclusion so that travel allowance was for personal travel
17 December 2002 External T.I. 2002-0158165 F - REPAS DE FETE OFFERTS PAR L'EMPLOYEUR Income Tax Act - Section 67.1 - Subsection 67.1(2) - Paragraph 67.1(2)(f) monthly restaurant event for only those employees whose birthday month it was would not qualify/ restaurant implicitly the employer’s place of business
20 December 2002 External T.I. 2002-0159365 F - REMUNERATION NON MONETAIRE Income Tax Act - Section 153 - Subsection 153(1) - Paragraph 153(1)(a) no source deduction or remittance obligations where all remuneration is non-monetary

The mandatory-disclosure rules do not comply with the constitutional requirement to place a disclosure obligation on lawyers only when “absolutely necessary”

Chambre des notaires found that a limitation imposed on solicitor-client privilege (SCP) that wasnot absolutely necessary to achieve the purposes of the ITAthereby infringing on s. 8 of the Charter, and further found that there it wasnot absolutely necessary … to rely on notaries or lawyers rather than on alternative sources in order to obtain the information or documents being sought.”

Considering the number of parties simultaneously subject to the MDR disclosure obligations, and considering that subjecting lawyers to an MDR disclosure obligation creates a high-risk situation for the clients to whom the SCP belongs, it does not seem “absolutely necessary” to rely on lawyers “rather than on alternative sources in order to obtain the information or documents being sought.”

Other jurisdictions instead place the primary disclosure obligation on the promoter.

Relying (as contemplated under ss. 237.3(17) and 237.4(18)) on lawyers to raise SCP would place an “inappropriate burden” on them (see Chambre des notaires, at para. 44) and, in particular, they would be caught between their duty to assert SCP and the potentially severe sanctions for failing to report all relevant information, thereby putting them in a position of direct conflict with their clients’ interests.

Neal Armstrong. Summary of Élisabeth Robichaud and Marie-Emmanuelle Vaillancourt, “An Avoidable Threat to the Protection of Solicitor-Client Privilege,” Perspectives on Tax Law & Policy, Vol. 4, No. 3, September 2023, p. 11 under s. 237.4(18).