News of Note

3295036 Canada – Court of Quebec finds that the use, years later, of stepped up ACB through sales of the property was “in contemplation” of the basis step-up series

In October 1996, a Quebec-taxpayer company (“329”) acquired public company shares from its parent. The parent realized no gain because federal and Ontario s. 85(1) elections were made. However, 329 acquired the shares at full cost for Quebec purposes because no Quebec rollover election was filed. Most of the shares were sold by 329 in 2000 at a capital loss for Quebec purposes, and it claimed some of those capital losses in its 2007 and 2008 Quebec returns.

A specific Taxation Act provision (s. 529.1) effectively denied 329’s use of its stepped-up cost if its two 1996 acquisitions occurred as part of a series of transaction that ended after18 December 1996. Fournier JCQ found that the two 1996 share drop-downs were a “series of transactions” and that the subsequent sales of the shares by 329 were transactions occurring “in contemplation” of that series and, thus, were assimilated to the series by the Quebec equivalent of s. 248(10).

He also rejected 329’s submissions that the backward-looking interpretation of “in contemplation” adopted in inter alia Copthorne should be rejected because the French version had used the narrower phrase “en vue de” rather than “au vue de” and because a narrower scope should be given to a specific anti-avoidance provision than to GAAR. Accordingly, the ARQ was successful in its application of s. 529.1 to deny the use of the stepped-up basis.

S. 248(10) only assimilates a transaction to an existing series. A different result might have obtained if the 1996 drop-down had occurred in a single transaction rather than on two separate days.

Neal Armstrong. Summary of 3295036 Canada Inc. v. Agence du revenu du Québec, 2018 QCCQ 8100 under s. 248(10).

CRA indicates that it could accept Univar GAAR doctrine of looking at reasonable alternative transactions

Univar found that the result of cross-border surplus-stripping transactionscould have been equally accomplished if the non-resident indirect purchaser of Canco had instead been able to access the surplus of Canco by using a subsidiary Buyco with high paid-up capital.

Alexandra MacLean indicated that Univar signifies that, in the context of a consideration of the general anti-avoidance rule, there can be an examination of what the taxpayer could have done versus what the taxpayer did do – but CRA is examining what limitations should be placed on this approach. For example, the mooted alternative must have been commercially reasonable – something that the taxpayer could actually have done.

Neal Armstrong. Summary of Alexandra MacLean, "CRA Audits of Large Corporations - The view from ILBD" under Responses to recent adverse decisions – Univar, 27 November 27 2018 CTF Annual Conference presentation under s. 245(4).

CRA indicates that GAAR should not be applied until realization of a tax savings

Wild found that transactions that boosted the paid-up capital of shares held by the taxpayer should not be addressed by applying the general anti-avoidance rule to reduce the PUC of those shares, but that there instead could only be a GAAR abuse when such PUC was distributed to him.

After indicating that the effect of the decision is that a tax benefit has to be realized before s. 245(2) can be applied, CRA indicated that, as a result, when the GAAR Committee determines that excessive tax attributes have been created, CRA will issue a letter indicating that if a future cash tax benefit is realized through their use, GAAR will be applied at that time.

Summary of Alexandra MacLean, "CRA Audits of Large Corporations - The view from ILBD" under Responses to recent adverse decisions – Wild, 27 November 27 2018 CTF Annual Conference presentation under s. 247(2).

Cameco loss has not affected CRA’s administration of s. 247(2)

Cameco, which is under appeal, has not affected the CRA operation of its transfer pricing audit program.

Neal Armstrong. Summary of Alexandra MacLean, "CRA Audits of Large Corporations - The view from ILBD" under Responses to recent adverse decisions – Cameco, 27 November 27 2018 CTF Annual Conference presentation under s. 247(2).

The ILBD is working on reducing the number of TEBA-induced unsustainable assessments made by field auditors

CRA uses TEBA (“tax earned by audit”) to measure the performance of Tax Services Offices, and different CRA programs, and to decide where to allocate resources. Alexandra MacLean (Director General of the International Large Business Directorate) acknowledged that this has resulted in auditors making assessments that then should be reversed by Appeals. In this regard, she indicated that:

  • A priority for the International and Large Business Program is to work on making sustainable reassessments that can be defended on both the letter and spirit of the law.
  • CRA is working to better understand the reversal rate at Appeals in dollar terms and by tax issue.
  • CRA is also working on trying to provide positive performance assessments for good audit work even where non-compliance is not found.
  • Ideally, CRA would move to more of a whole-Agency approach on important tax interpretive issues (apparently, as contrasted with a divergence between positions applied at Audit, and before CRA Appeals with Headquarters input), and publishing more guidance so that taxpayers could know what they were facing at the time of filing their returns, and essentially making a choice to go to litigation if their filing position was contrary to the guidance.
  • Having said that, a lot of what CRA does relates to matters where there is substantial interpretive uncertainty. On a recent count, the Federal Court of Appeal reversed four out of eight Tax Court decisions on GAAR. CRA has good resources now for pursuing litigation.
  • Pressure on the system respecting interpretive uncertainties might be reduced with more s. 173 referrals to the Tax Court.

The ILBD has finished piloting, and has now made permanent, the Audit Files Resolution Committee, which has a mandate to try and resolve files at the audit stage. It has representation from Appeals, Justice, Headquarters, the field office involved in the audit and another field office. It considers taxpayer proposals to resolve a material file at the audit stage. The Committee will examine the proposal, and make recommendations in terms of accepting, counter-proposing, or other possible responses.

Neal Armstrong. Alexandra MacLean, "CRA Audits of Large Corporations - The view from ILBD," 27 November 27 2018, 2018 CTF Annual Conference.

Hi-Tech – Tax Court of Canada confirms that the required ITC documentary information can be spread among different supporting documents

Sommerfeldt J dealt with a situation where an audit fee paid in various payments by a GST registrant had problematic documentation. In denying an input tax credit to the registrant on various grounds, he noted that supporting documentation “may be contained collectively in multiple documents” rather than, say in a single invoice.

Respecting the distinction drawn between 3(a)(ii) of the Input Tax Credit Information (GST/HST) Regulations, which requires that where an invoice is issued, it must give the invoice date, and s. 3(a)(iii), which provides that where there is no invoice, the supporting documentation must provide the date on which the GST/HST is paid or payable, he stated (after noting a claim by the registrant that it had not received the invoice):

[I]n order to issue an invoice, not only must the invoice be created, but it must also be sent to the client or customer.

Although not needing to land on this issue, he indicated that there may have been undue delay for purposes of the rule in ETA .s 152(1)(b) (effectively deeming consideration to have become due when its invoicing is unduly delayed) even if the audit firm had “issued” the invoice, given that the invoice date was six months after the completion of the audit work – whereas normally invoices were issued much more promptly.

Neal Armstrong. Summaries of International Hi-Tech Industries Inc. v. The Queen, 2018 TCC 240 under Input Tax Credit Information (GST/HST) Regulations, s. 3(a)(ii), s. 169(1) and ETA s. 152(1)(b).

Burton – Federal Court of Australia finds that a foreign tax credit was reduced by ½ when only ½ of a capital gain was brought into income

An Australian-resident individual was taxed at the 15% long-term U.S. capital gains rate on his gains on the disposal of U.S. oil and gas drilling rights. For Australian purposes a 50% discount was applied to the capital gain before imposing tax at a rate of around 45% on it. The Australian foreign tax credit (FITO) provision provided a credit for foreign income tax “if you paid it in respect of an amount that is all or part of an amount included in your assessable income for the year.” The Commissioner successfully took the position that as only half of the U.S. gain had been included in the individual’s income, he was entitled to the FITO for only half of the U.S. tax.

Art. 22(2) of the Australia-U.S. Convention provided that U.S. tax “shall be allowed as a credit against Australian tax payable in respect of the income” but went on to provide that: “Subject to these general principles, the credit shall be in accordance with the provisions and subject to the limitations of the law of Australia as that law may be in force from time to time.”

In finding that Art. 22(2) did not help the taxpayer, McKerracher J stated:

Under Australian law, the only income forming part of the assessable income is 50% of the capital gain on which tax is paid in the US. Where Art 22(2) refers to Australian tax payable in respect of income, the income is only 50% of the capital gain.

Secondly, the word ‘all’ does not appear before the words ‘United States tax paid’ in the first line of Art 22(2). The Article does not suggest that a credit is allowed against Australian tax payable for the whole amount of the US tax paid. … It does not prescribe how much is to be allowed as a credit. The credit is subject to the provisions and limitations of Australian law.

The same issue could arise in Canada but has not given the CRA approach of allowing the U.S. tax on 100% of the gain to be taken into account in computing the Canadian foreign tax credit on the Canadian taxable capital gain (see. e.g., Folio S5-F2-C1, para. 1.89).

Neal Armstrong. Summaries of Burton v Commissioner of Taxation [2018] FCA 1857 under s. 126(1) and Treaties – Income Tax Conventions – Art. 24.

Income Tax Severed Letter 5 December 2018

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

Ryanair – European Court of Justice finds that takeover expenses incurred in order to earn management fees from the target would generate VAT deductions

Ryanair sought to deduct VAT incurred on its expense incurred in a takeover bid on the basis that it intended to earn management fees from the target – even though this intention was not realized since, for competition law reasons, it ultimately was permitted to acquire only a portion of the target’s shares. Article 17(2)(a) of the Sixth Directive provided a deduction for VAT paid respecting goods and services used for the purposes of the taxable person’s taxable transactions.

The ECJ concluded that the claim should be allowed if the exclusive reason for the expenses was in the intended management activity (and that “In the event that the expenditure is attributed in part also to an exempt or non-economic activity, VAT paid on that expenditure may only be deducted in part.”) Before so concluding, the Court stated:

[T]he right to deduct, once it has arisen, is retained even if the intended economic activity was not carried out and, therefore, did not give rise to taxed transactions … . Any other interpretation would be contrary to the principle that VAT should be neutral as regards the tax burden on a business. It would be liable to create, as regards the tax treatment of the same investment activities, unjustified differences between businesses already carrying out taxable transactions and other businesses seeking by investment to commence activities which will in future be a source of taxable transactions.

Neal Armstrong. Summary of Ryanair Ltd. v. Revenue Commissioners, [2018] EUECJ C-249/17 (First Chamber) under ETA s. 141.01(2).

Fowler – English Court of Appeal finds that a domestic provision deeming employment income to be from trade rendered it business profits for Treaty purposes

A U.K. domestic income tax provision deemed the diving activities of a South African resident in the North Sea to be the carrying on of a U.K trade, notwithstanding that in fact he was an employee. The majority of the Court of Appeal of England and Wales found that this meant that his earnings were business profits for purposes of Art. 7 of the U.K-South Africa Treaty (rather than employment income under Art. 14) so that they escaped U.K. taxation (as he had no U.K. permanent establishment.)

Both Lord Justices in the majority treated the domestic deeming provision (which merely deemed the underlying activity to be a trading activity rather than explicitly deeming the resulting income to be “profits” of an enterprise) as having effect for Treaty purposes. However, each of the three Lord Justices had a different view of the scope of Art. 3(2) of the Treaty (which, in the standard OECD form, provided that any term not defined in the Treaty “shall, unless the context otherwise requires, have the meaning that it has …under the law of [the U.K.]”).

Baker LJ in his concurring reasons stated:

The term "employment" is not defined in the treaty and, under article 3(2), is ascribed the meaning that it has under UK tax law. Under that law … Mr Fowler is deemed not to be in employment but rather carrying on a trade.

Henderson LJ (also in the majority) stated:

My approach does not depend to any significant extent on the provisions of article 3(2) … however, I would accept … that the purpose of article 3(2) is to anchor the provisions of the treaty … to the domestic tax law of the Contracting State which is applying the treaty.

In the course of his dissenting reasons, Lewison LJ stated that Art. 3(2) permitted reference to the common law of England to determine the meaning of “employment,” and further stated:

I cannot extract from [a South African] case the general proposition that a word used in a double tax treaty to describe a particular source of income or gain necessarily encompasses a domestic deeming provision, particularly where the word in question is defined in domestic tax law … .

Neal Armstrong. Summary of Fowler v HM Revenue and Customs [2018] EWCA Civ 2544 under Treaties – Income Tax Conventions – Art. 3(2).