News of Note

CRA rules on the use of surety bonds rather than LCs to secure SERP benefits

A Company determined that, rather than securing a non-registered supplemental employee retirement plan (“SERP”) for its senior employees using letters of credit, there would be lower fees to instead arrange for surety bonds to be delivered to the trustee for the security arrangements by insurance companies. In addition, “surety bonds will not reduce the Company’s borrowing capacity (in contrast to LOCs).”

This entails essentially following the same arrangements as where LCs are used. Every time a surety bond is required to be issued, renewed or replaced, the Company will be required to pay the surety fee to the trustee under a new trust, and the Company will make a corresponding payment to the Receiver General equal to the surety fee on account of the refundable tax payable under Part XI.3. The trustee will, in turn, pay the surety fee to the insurance company for such issuance, renewal or replacement of a surety bond.

CRA ruled that the amounts paid to the trustee by the Company and the amounts remitted to the Receiver General by the Company, will constitute contributions made to the retirement compensation arrangement, and will be deductible by the Company to the extent permitted by s. 20(1)(r) for the taxation year in which they are made.

Neal Armstrong. Summary of 2018 Ruling 2017-0720901R3 under s. 207.5(1) – refundable tax – para. (a).

Van Steenis – Tax Court of Canada finds that “return of capital” distributions by a mutual fund reduced the unitholder’s deductible interest

Graham J agreed with CRA’s position (in e.g., 2003-000082) that returns of capital received by a unitholder in a REIT or other mutual fund trust give rise to a change in the current use of the funds under the still-outstanding loan of the unitholder that had funded the units’ purchase. Thus, a taxpayer who had borrowed $300,000 to buy MFT units and received “return of capital” distributions totaling $200,000 over the following eight years (most of which were used for personal purposes) thereby lost over half of his interest deductions by the end of this period.

Graham J considered that it truly accorded with the scheme of the Act to characterize trust distributions in excess of the s. 104(13) income distributions as being returns of the unitholder’s capital, stating:

Subparagraph 53(2)(h)(i.1) reduces the unitholder’s adjusted cost base in the fund by the amount of capital distributed to him or her. … The fact that distributions of capital are not treated as income until they exceed the amount of a unitholder’s investment clearly indicates that Parliament viewed distributions of capital as being returns of the unitholder’s own investment.

The contrary viewpoint would emphasize the artificiality of treating such distributions, which are effectively deemed to be capital distributions only for capital gains computation purposes, as being truly a return of the investor’s capital (whose units might have an increasing rather than diminishing NAV.) Presumably, there would have been a different result if the borrowed funds had been used instead to invest in a public real estate company paying the same distributions (treated under s. 82(1) as 100% income), and which had not yet bothered to convert to a REIT because it was still fully sheltered (i.e., no taxable income).

Neal Armstrong. Summary of Van Steenis v. The Queen, 2018 TCC 78 under s. 20(1)(c)(i).

Income Tax Severed Letters 25 April 2018

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

DaSilva – Tax Court of Canada accepts the taxpayer’s testimony that she did not receive a notice of assessment over a CRA affidavit to the contrary

Where a taxpayer alleges that she did not receive a notice of assessment, ETA s. 335(6) provides that an affidavit of a CRA official in charge of the appropriate records and stating that “an examination of the records shows that a notice of assessment was mailed … to a person … is evidence of [such] statement… .” (ITA s. 244(5) is somewhat similar.)

Graham J found that an affidavit by such an official (Mr. Neill) that a particular “business client communications system cycle” had ran without errors did not establish very much as he had not directly confirmed that the taxpayer’s notice of assessment was in that cycle - nor had the Crown provided an affidavit of someone working for Mr. Neill, who might have confirmed this point.

As Graham J also found the taxpayer’s testimony, that she had not received a copy of the notice of assessment until over three years following the time of its alleged mailing, to be credible, he went on to effectively find that the taxpayer had objected on a timely basis.

Neal Armstrong. Summary of DaSilva v. The Queen, 2018 TCC 74 under ETA s. 335(6).

Epsilon is proposing to continue from Alberta to Delaware

Epsilon is an Alberta corporation holding, through US subsidiaries, a profitable U.S. oil and gas business. It is proposing to continue out of Canada and be "domesticated" as a Delaware corporation pursuant to the continuance “export” provisions in the ABCA and the domestication provisions in the Delaware General Corporation Law. Although this will result in a deemed disposition of all its property (s. 128.1(4)(b)) and an exit tax calculated at 5% of NAV minus PUC (s. 219.1), management does not anticipate any material Canadian income tax under these rules based on current values and Canadian tax attributes including significant loss carryforwards and (it would appear) significant paid-up capital for its shares.

U.S. shareholders holding less than 10% of its shares can elect, in lieu of recognizing gain, based on the FMV of their shares, to include in income as a deemed dividend the “all earnings and profits amount” attributable to their shares, which management estimates to be nil.

As discussed in a previous post on another transaction, the continuance of Gastar Exploration (with a U.S. natural gas business) from Alberta to Delaware was regarded from a U.S. tax perspective as entailing a transfer by Gastar of all its assets to the new Delaware corporation (Gastar Delaware), followed by a distribution by Gastar of Gastar Delaware to its shareholders. This distribution step was problematic as Gastar Delaware was a United States real property holding company for FIRPTA purposes. Notwithstanding that essentially the only properties of Epsilon are its U.S. oil and gas interests, its disclosure indicates that the domesticated Epsilon is not anticipated to be a USRPHC.

Neal Armstrong. Summary of Epsilon Energy Proxy Circular under Other - Continuances/Mergers.

14 further full-text translations of CRA interpretations are available

The table below provides descriptors and links for the Technical Interpretation released last week and for 13 of the October 2017 APFF Roundtable questions and answers released two weeks ago (Q.6 to Q.18), as fully translated by us.

These (and the other full-text translations covering the last 4 1/2 years of CRA releases) are subject to the usual (3 working weeks per month) paywall.

Bundle Date Translated severed letter Summaries under Summary descriptor
2018-04-18 24 January 2018 External T.I. 2016-0645911E5 F - Avantage imposable - Stationnement Income Tax Act - Section 6 - Subsection 6(1) - Paragraph 6(1)(a) free parking benefit scaled to comparable-spot charge/ business-use exception excludes overtime use
2018-04-11 6 October 2017 APFF Roundtable Q. 6, 2017-0709041C6 F - Services PE Treaties - Income Tax Conventions - Article 5 there can be a services PE in Canada during the tail end of a project which ends in the first few months of a calendar year
6 October 2017 APFF Roundtable Q. 7, 2017-0709051C6 F - Dédommagement-annulation d'une offre d'achat Income Tax Act - Section 54 - Capital Property damages for breach of a purchaser's covenant were proceeds of a capital property
Income Tax Act - Section 13 - Subsection 13(21) - Undepreciated Capital Cost - A if damages relate to a particular asset of a business that was not disposed of, they will reduce the asset’s cost
6 October 2017 APFF Roundtable Q. 8, 2017-0719491C6 F - Production of NR4 forms Income Tax Regulations - Regulation 202 - Regulation 202(1) CRA requires NR4 reporting of withholding-exempt amounts
6 October 2017 APFF Roundtable Q. 9, 2017-0709071C6 F - Corporate Attribution Rules Income Tax Act - Section 74.4 - Subsection 74.4(2) a second freeze transaction by a family trust could be viewed as an indirect transfer by the original freezor
Income Tax Act - Section 74.5 - Subsection 74.5(5) unborn children and spouse not designated persons re freezer trust
6 October 2017 APFF Roundtable Q. 10, 2017-0709081C6 F - Election to treat excess as separate dividend Income Tax Act - Section 184 - Subsection 184(3) elected-upon amount is retroactively deemed as income even if it is still unpaid
Income Tax Act - Section 185 - Subsection 185(3) normal reassessment period starts running from date of Pt III assessment
6 October 2017 APFF Roundtable Q. 11, 2017-0709091C6 F - Transitional rules - Class 14.1 Income Tax Act - Section 13 - Subsection 13(38) - Paragraph 13(38)(d) - Subparagraph 13(38)(d)(iii) s. 13(38)(d)(iii) transitional election is irrelevant to ECP dispositions by a calendar-year partnership
6 October 2017 APFF Roundtable Q. 12, 2017-0709111C6 F - Dépenses relatives à un congrès Income Tax Act - Section 20 - Subsection 20(10) non-capital convention expenses incurred as business expense may be deducted without refererence to s. 20(10) - but “historically” convention expenses viewed as capital expenditures
Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(b) - Capital Expenditure v. Expense - Know-How and Training convention expenses "historically" viewed as capital expenditures
6 October 2017 APFF Roundtable Q. 13, 2017-0709061C6 F - Calcul des frais pour droit d'usage Income Tax Act - Section 6 - Subsection 6(2) s. 6(2) standby charge based on leasing cost to the employer rather than the automobile’s cost to an affiliated purchaser
6 October 2017 APFF Roundtable Q. 14, 2017-0720321C6 F - GAAR & 21-year rule planning Income Tax Act - 101-110 - Section 104 - Subsection 104(4) - Paragraph 104(4)(a) Act does not contemplate any deferral beyond 21 years while property is directly in a discretionary trust or through a Canco
6 October 2017 APFF Roundtable Q. 15, 2017-0709141C6 F - Designation pursuant to paragraph 111(4)(e) Income Tax Act - Section 111 - Subsection 111(4) - Paragraph 111(4)(e) appreciated goodwill is now eligible for the s. 111(4)(e) step-up
6 October 2017 APFF Roundtable Q. 16, 2017-0709161C6 F - Résidence principale sur une terre agricole Income Tax Act - 101-110 - Section 110.6 - Subsection 110.6(1) - Interest in a Family Farm or Fishing Partnership - Paragraph (a) - Subparagraph (a)(i) a legally non-severable farm that is used both in farming and as a residence is one property for purposes of the s. 110.6 principal-use tests
Income Tax Act - Section 248 - Subsection 248(1) - Property non-severable farm is a single indivisible property
6 October 2017 APFF Roundtable Q. 17, 2017-0709171C6 F - Arm's length determination Income Tax Act - Section 251 - Subsection 251(5) - Paragraph 251(5)(b) - Subparagraph 251(5)(b)(i) "holder-by-holder" method applied to treat contingent s. 251(5)(b) rights as being exercised re all the other shareholders
6 October 2017 APFF Roundtable Q. 18, 2017-0721691C6 F - APFF 2017 - Question 18 Income Tax Act - Section 152 - Subsection 152(1) DTS update

The unitholders of a U.S. LLC (BSR) are proposing an IPO though a TSX-listed holding MFT that will be a REIT for Code purposes

A closely-held Delaware LLC with a portfolio of apartment buildings in the southern U.S. appraised at U.S.$890M (“BSR”) is proposing to effectively do an IPO in Canada. This would occur as follows:

  • a newly-formed Ontario s. 108(2)(a) unit trust (the “REIT”) will complete a relatively modest IPO in Canada (for about U.S.$135M) with a view to trading on the TSX
  • the REIT will use those proceeds to fund a newly-formed Delaware “C Corp” subsidiary of the REIT (“US Holdco”) which, in turn will fund a new wholly-owned Delaware LLC subsidiary (“MergerSub”)
  • MergerSub will be merged into BSR with BSR as the survivor
  • on the merger, US Holdco will be issued Class A units of BSR, and the existing BSR unitholders will receive Class B exchangeable units of BSR (valued at around U.S.$270M)

Although the REIT will be deemed by the U.S. anti-inversion rules in Code s. 7874 to be a U.S. corporation, it is expected to qualify as a REIT for Code purposes. The disclosure does not discuss whether it will also qualify as a REIT for ITA purposes, but states that it is not expected to be subject to SIFT tax by virtue of not holding any non-portfolio property.

Neal Armstrong. Summary of BSR REIT preliminary prospectus under Offerings – REIT and LP Offerings - Cross-Border REITs.

CRA states that the FMV of a free parking spot is a taxable benefit unless there is “regular” business use

CRA accepts that there is no taxable benefit to an employee from a free parking spot where it is provided for business purposes, i.e., the employee’s car must be used “regularly” in performing the employment duties. CRA does “not consider that parking offered to facilitate working irregular or extended hours is parking for business purposes.”

Any taxable benefit is computed based on the FMV of the spot, “i.e., the market price for a similar space in the surrounding area having the same conditions of use as for the space provided by the employer.”

Neal Armstrong Summary of 24 January 2018 External T.I. 2016-0645911E5 F under s. 6(1)(a).

Markou – Tax Court of Canada indicates that donative intent no longer is required for split gifts

The Ontario and Quebec appellants had engaged in the same leveraged donation program as to which the Federal Court of Appeal in Maréchaux had confirmed that none of the donations (even the cash portion) qualified as a “gift” for charitable credit purposes. In the Markou case, Paris J found thatdonative intent in civil law, as in common law, is always an essential element of a gift, even a partial gift,” whereas here “there was just one interconnected transaction and no part of it can be considered a gift that was given in expectation of no return.”

One of the taxpayers’ arguments was that consent judgments had been issued, respecting donations made after the subsequent introduction of the split-gifting rule in s. 248(30), that accorded a credit for the cash portion of donations made under a leveraged donation program. In rejecting the proposition that this entailed an implicit recognition that there was “donative intent” for such cash components, Paris J stated:

[I]t appears that where the 80% threshold [in s. 248(30)] is not crossed, the lack of donative intent is no longer a bar to allowing charitable donation tax credits for transfers to qualified donees.

Neal Armstrong. Summaries of Markou v. The Queen, 2018 TCC 66 under s. 118.1(1) – total charitable gift and s. 248(30).

Travel Document Service – Court of Appeal of England and Wales finds that an anti-avoidance provision based on “one of the main purposes” for holding a loan applied to a deemed loan

A British taxpayer (TDS) used a total return swap to cause its share investment in a subsidiary (LGI) to be deemed to be a loan. However, its hoped-for tax benefit was denied by an anti-avoidance provision that applied if “one of the main purposes” for being a party to a loan relationship was to secure relief from tax. In rejecting TDS’s submission that the anti-avoidance provision should only be applied to actual loans and not deemed loans, Lord Justice Newey referred to the dictum in Marshall v. Kerr (repeated in many subsequent cases) that “because one must treat as real that which is only deemed to be so, one must treat as real the consequences and incidents inevitably flowing from or accompanying that deemed state of affairs, unless prohibited from doing so.” This then meant that what was to be evaluated under the anti-avoidance rule was the purposes for which TDS held its shares of LGI.

In this regard, TDS emphasized that it had held its TDS shares long before entering into the swap and a related novation contract. In rejecting this contention, Lord Justice Newey stated:

Had the tax advantage in view been small, there might have been scope for argument as to whether an intention to use the shares to achieve it implied that obtaining the advantage was now a main purpose of holding the shares. In fact, however, the hoped-for gain was large both in absolute terms (more than £70 million) and relative to the apparent value of TDS (some £280 million).

He also rejected HMRC’s submission that "’main’ … means ‘more than trivial’," stating:

A purpose can be "more than trivial" without being a "main" purpose. "Main" has a connotation of importance.

Neal Armstrong. Summaries of Travel Document Service & Ladbroke Group International v Revenue & Customs (Rev 1) [2018] EWCA Civ 549 under Statutory Interpretation – Interpretation Provisions and s. 83(2.1).