News of Note

[Corrected title] CBS – Federal Court of Appeal finds that Galway did not permit the Crown to resile from a settlement agreement negotiated in good faith

The Justice Department entered into a settlement agreement with the taxpayer in which it agreed to permit the taxpayer to carryforward an agreed portion of a $23.4M non-capital loss – and then promptly sought to repudiate the agreement on the basis that CRA had discovered that the non-capital loss in question did not exist, so that implementing the settlement would be contrary to law, which Galway said was bad. In affirming the decision below that the Crown was bound by the settlement agreement, Woods JA stated:

Galway does not address the circumstances in which one party seeks to resile from an agreement.

Second, the parties in this case intended to enter into an agreement that applied the law to the facts. The agreement was not intended to be a compromise settlement of the type considered in Galway.

Third, the Crown does not suggest that the defect within the settlement agreement is self-evident to the Court as it was in Galway. …

The general rule is that parties should be bound by the agreements that they make.

She also found that a Tax Court order implementing a provision in the settlement agreement that tax was to be increased in a subsequent year did not violate the Last principle that the Crown was not permitted to appeal its own reassessment.

Neal Armstrong. Summaries of CBS Canada Holdings Co., 2020 FCA 4 under s. 169(3) and s. 171(1)(b).

Krumm – Tax Court of Canada applies the tax shelter rules on a private purchase of property described as Class 12 available-for-use property

The taxpayer acquired a 50% interest in software after being provided with a valuation report that indicated that the software was Class 12 property and qualified as being available for use. Visser J found that this was sufficiently tantamount to representing that the cost of the software could be written off over two years and found that there thus was an unregistered tax shelter, resulting in the CCA claims being denied under s. 237.1(6). He also rejected a submission that “the tax shelter rules are intended to apply only to publicly marketed tax shelters and not to private transactions between two parties.”

Neal Armstrong. Summary of Krumm v. The Queen, 2020 TCC 7 under s. 237(1) – tax shelter – (b).

CRA indicates that a grandfathered LLLP cannot treat itself prospectively as a corporation without losing grandfathering

2017-0691131C6 stated that one of the conditions for allowing Delaware or Florida LLLPs formed before April 26, 2017 to file as a partnership was that “no member of the entity and/or the entity itself takes inconsistent positions from one taxation year to another … between partnership and corporate treatment.” Two LLLPs (held by Canadian resident corporations) that had filed as partnerships for Canadian tax purposes since the time of their formation proposed to now treat themselves as corporations on a prospective basis. CRA found that this would violate such condition (“the change by the LLLPs from partnership to corporate treatment constitutes taking an inconsistent position from one taxation year to the next”) and added:

As stated at IFA 2017, where any of these conditions is not met in respect of any such entities formed before April 26, 2017, the CRA may issue assessments or reassessments to the members and/or the entity, for one or more taxation years, on the basis that the entity was always a corporation.

The LLLPs will not be viewed as corporations for Canadian tax purposes on a solely prospective basis.

Neal Armstrong. Summary of 1 August 2019 External T.I. 2018-0768561E5 under s. 96.

Income Tax Severed Letters 22 January 2020

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

A Starlight LP realized and distributed gains on US rental properties through use of partnerships

The Starlight U.S. Multi-Family (No. 1) Value-Add Fund is an Ontario LP established in June 2017 that was targeted to stay in existence for three years, during which time it was to acquire US rental apartment buildings, undertake “high return, light value-add capital expenditures” and then sell the buildings for a price reflecting the resulting increased rents. That now has occurred.

In order to avoid the realization of foreign accrual property income gains, and instead realize (non-FAPI) capital gains that could be integrated with capital gains treatment to the Fund unitholders, the gains were not realized within the corporate subsidiary (a US private REIT) and instead were realized on internal transfers by subsidiary LPs. In order to get the proper basis adjustments for the distribution of such capital gains, various tiers of partnerships were wound-up on a bottom-up basis as a part of the distribution of proceeds, and with the net sales proceeds ultimately distributed in redemption of the Fund units.

FIRPTA of course was recognized on the gains on the sales.

Neal Armstrong. Summary of Starlight U.S. Multi-Family (No. 1) Value-Add Fund Circular under Other – Asset Purchases.

CRA’s position that s. 84.1 dividends can be capital dividends and generate dividend refunds raises tax-deferral possibilities

11 October 2019 APFF Roundtable, Q.1 and 3 December 2019 CTF Roundtable, Q.4 confirmed that a s. 84.1 deemed dividend can benefit from both the s. 129(l)(a) dividend refund and the capital dividend account (CDA) mechanism. This might facilitate share sale planning.

For example, Bob would realize a capital gain of $999,999 and around $240,000 of capital gains tax if he sold all the shares of Opco to a third-party purchaser for $1 million.

He could instead transfer ½ of his Opco shares on a rollover basis to newly-formed Holdco, with Holdco then realizing a $500,000 capital gain on those shares on an internal transfer, so that Holdco is subject to $127,000 of corporate tax, has a $250,000 addition to its CDA and generates $77,000 of non-eligible RDTOH. He then transfers his remaining Opco shares to Holdco in two tranches for two $250,000 notes, resulting in the receipt of a $250,000 capital dividend and in a second $250,000 (taxable) dividend that generates a full refund of the $77,000 of NERDTOH to Opco.

The result (leaving aside ss. 245(2) and 129(1.2)) is that Bob pays $102,500 in personal tax and Holdco bears net corporate tax of $50,000. The total of $152,500 is less than $240,000, because tax is deferred until further dividends are paid by Holdco.

Neal Armstrong. Summary of Aasim Hirji and Kenneth Keung, “Planning Possibilities Resulting from CRA Policy Reversal on Section 84.1,” Tax for the Owner-Manager, Vol. 20, No. 1, January 2020, p.9 under s. 129(1).

Planning for intercorporate dividends can now be more fraught

There is increased complexity associated with the payment of dividends by private corporations.

Where a subsidiary corporation has non-eligible refundable dividend tax on hand (NERDTOH), ERDTOH, or GRIP balances, attention is needed to ensure that dividends from the subsidiary result in additions to the same pools in the parent company. Eligible dividends may add to the parent company's GRIP and ERDTOH, but will not recover NERDTOH in the subsidiary. Non-eligible dividends can increase the parent company's ERDTOH, but not its GRIP.

In addition, the usual Pt IV tax considerations should be addressed including that shares held by a trust will not qualify for the votes and value test in s. 186(4)(b). Staggered year-ends create planning challenges.

Neal Armstrong. Summary of A.G. (Sandy) Stedman, “Intercorporate Dividend Planning: More Complexity,” Tax for the Owner-Manager, Vol. 20, No. 1, January 2020, p. 7 under s. 129(1).

5 more translated CRA interpretations are available

We have published a further 5 translations of CRA interpretations released in March, 2011. Their descriptors and links appear below.

These are additions to our set of 1,068 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 8 ¾ years of releases of Interpretations by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall.

Bundle Date Translated severed letter Summaries under Summary descriptor
2011-03-04 8 October 2010 Roundtable, 2010-0373311C6 F - Oeuvres d'artistes étrangers Income Tax Regulations - Regulation 1102 - Subsection 1102(1) - Paragraph 1102(1)(e) foreign art work decorating corporate offices is non-depreciable
Income Tax Act - Section 15 - Subsection 15(1) art used to decorate the office of a shareholder-employee generally does not generate a s. 15(1) benefit
Income Tax Act - Section 54 - Listed Personal Property art work in corporate boardroom is not personal use property, perhaps also where decorates office
8 October 2010 Roundtable, 2010-0373251C6 F - Immeuble détenu par une société Income Tax Act - Section 15 - Subsection 15(1) determining the "normal rate of return" used in computing imputed rent
8 October 2010 Roundtable, 2010-0373691C6 F - T4A et T5018 - Honoraires Income Tax Regulations - Regulation 238 - Subsection 238(2) unlike T4A, amounts paid include GST/HST
Income Tax Regulations - Regulation 200 - Subsection 200(1) GST/HST excluded from services payments
8 October 2010 Roundtable, 2010-0373431C6 F - Montants payés ou payables par une fiducie Income Tax Act - 101-110 - Section 104 - Subsection 104(24) requirements for distributing income in the year pursuant to issuance of unconditional promissory note
8 October 2010 Roundtable, 2010-0373541C6 F - Mise à part de l'argent après Lipson Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) - Subparagraph 20(1)(c)(i) cash damming still respected following Lipson

Morris – Court of Quebec finds that disclosure of part of a legal opinion in an audit report was not a waiver of privilege

The taxpayer, who faced tax evasion charges, argued that there had been waiver of the privilege attached to a legal opinion prepared by a notary working for the ARQ when part of that opinion was included in an audit report that had been provided to him. He claimed that this represented waiver of such privilege.

In finding that there had been no such waiver, so that the opinion continued to be protected by the privilege, Asselin JCQ stated:

Only the client can waive it. …

[T]he disclosure of part of the legal opinion does not constitute an implied waiver of the right to legal professional privilege. … [T]here is no evidence that the auditor … was authorized, in the course of her duties, to disclose it in whole or in part.

However, the taxpayer was successful in his claim that it was contrary to his Charter rights for his file to be disclosed to him on a USB key without the benefit of a search engine or electronic disclosure management system that would permit him to readily search the file, and the prosecution was ordered to provide this to him.

Neal Armstrong. Summaries of R. v. Morris, 2019 QCCQ 7635 under s. 232(1) – solicitor-client privilege and Charter – s. 7.

The 2017 OECD transfer-pricing guidelines mandate an “accurate-delineation approach” that is contrary to s. 247(2)

The approach taken in the 2017 OECD Guidelines of “accurately delineating” a transaction is, in fact, an approach of departing from the contracts and characterizing the cross-border transaction in accordance with its economic substance. This can be seen, for instance, in the example in para. 1.48 of the 2017 Guidelines respecting a parent which licenses IP to a subsidiary (Company S) but, under the OECD’s accurate-delineation approach, it is found that it “in fact controls the business risk and output of Company S such that it has not transferred risk and function consistent with a licensing agreement, and acts not as the licensor but the principal” so that the “actual transaction” differs from the written contract. It is suggested that:

In contrast, section 247 of the Act was never intended to permit transactions to be characterized or recharacterized on the basis of economic substance. As a result, the accurate-delineation approach under the 2017 guidelines is not permitted under Canadian law where it characterizes or recharacterizes transactions on the basis of economic substance. Nevertheless, the Canadian government has repeatedly stated that it has adopted the 2017 guidelines and that those guidelines merely clarify, and do not significantly change, the arm’s-length principle.

It would be problematic if CRA thus sought to apply an accurate-delineation approach to cross-border transactions with the U.S. For example, in the above example, it is understood that:

the United States would respect the licence and price it accordingly. If Canada treated the entire arrangement as an agency, the dispute would be difficult to resolve through competent authorities.

Neal Armstrong. Summary of Christopher J. Montes and Siobhan A.M. Goguen, “Recharacterization of Transactions Under Section 247: Still an Exceptional Approach,” 2018 Conference Report (Canadian Tax Foundation), 21:1-25 under s. 247(2).