News of Note

Black – Tax Court of Canada finds that an ancillary income-earning purpose for making a loan whose terms were never finalized was sufficient to satisfy s. 20(1)(c)(i)

Conrad Black controlled both Hollinger Inc. (“Inc.”) and Hollinger International Inc. (“International”). In 2004, the Delaware Court of Chancery ordered Black and Inc. jointly to pay to International damages equalling the amount of a “non-compete” payment of U.S$16,6 million that International had paid to Inc., plus interest thereon. Black used money borrowed from a third party ("Quest") at 12.68% interest to pay all of such damages, but argued that he had advanced such funds on behalf of Inc. in satisfaction of an interest-bearing loan that he had orally agreed to make in the same amount to Inc. Although the Audit Committee of Inc. had approved the receipt of a loan from Black, the relationship between the independent directors of Inc. and Black deteriorated, and the alleged loan by him to Inc. was never formally documented – and following subsequent litigation, all of Black’s alleged rights in that regard were extinguished in a settlement in which he agreed to pay damages to Inc.

Rossiter CJ accepted Black’s position that the borrowed money had been used by Black to make a loan to Inc., so that Black was entitled to an interest deduction on his borrowed funds, stating:

… Black and Inc. reached an agreement on the essential terms of the loan and left the details to be worked out at a later date. The fact that a formal document outlining those essential terms was to be prepared later on and signed … does not alter the validity of the earlier contract. …

Since Black had an obligation to pay interest expenses on the Quest Loan, Black had to earn interest income on the loan to Inc. in order for him to be made whole. …

… While I find that this was an ancillary purpose compared to his primary purpose of helping Inc., that was a bona fide objective of his investment, which is capable of providing the requisite purpose for interest deductibility under paragraph 20(1)(c).

Neal Armstrong. Summary of Black v. The Queen, 2019 TCC 135 under s. 20(1)(c).

CRA rules that interest on borrowed money used to pay a premium on the cash redemption of convertible debentures is deductible

A Canadian public company (ACo ) will force the conversion of its outstanding convertible debentures, by issuing a notice to redeem them for their principal amount. However, upon receiving notice that the debentureholders are converting, it will then exercise a further right to redeem such debentures in cash for their value based on the market value of the underlying shares, thereby resulting in the payment by it of a substantial cash redemption premium. The redemption will be funded with borrowed money.

CRA applied the “fill the hole” concept to rule that the interest on the borrowed money used to pay the premium will be deductible under s. 20(1)(c)(i) given that the accumulated profits of ACo at the time of the redemption will exceed the premium. More routinely, it also ruled that the borrowed money used to repay the debentures’ principal will be deductible in light of s. 20(3).

Neal Armstrong. Summaries of 2018 Ruling 2018-0740931R3 F under s. 20(1)(c)(i) and s. 20(3).

CRA states that the SDA exception for SAR plans is unavailable where dividend equivalents are paid in cash

The share appreciation rights (SAR) plan of an employer corporation provides for dividend equivalents on SAR units that are satisfied by way of cash payments made annually to employee participants.

CRA indicated that if the current vesting period for a SAR unit granted under the plan was extended from three years to five years (so that the three year bonus plan safe harbour in para. (k) of the salary deferral arrangement definition no longer applied), then the plan would not be considered to come within CRA’s accommodation of SAR plans, so that the SDA rules could apply. CRA stated:

If a SAR plan provides for dividend equivalents to be paid in cash on an accelerated basis (such as annually or after each dividend payment date) without the whole of the corresponding unit being redeemed, the CRA general position will cease to apply with effect from the time that the employee becomes entitled to receive the first such dividend equivalent payment. This is because, in such a case, the units would not be considered to be solely for future services.

Neal Armstrong. Summaries of 14 May 2019 External T.I. 2017-0737571E5 under s. 248(1) - salary deferral arrangement and s. 6(14).

The expansion of the FAD rules creates tension with existing FAD rules which implicitly contemplate a real non-resident parent

The Budget proposed amendment to the foreign affiliate dumping (FAD) rules would expand them to situations where the non-resident “parent” of the CRIC is a non-resident individual or a group of non-resident persons not dealing with each other at arm’s length (a “NAL group”).

The existing “more closely connected business” (“MCCB”) exception in s. 212.3(16) is simply unworkable where the deemed “controlling” person is a trust beneficiary by virtue of s. 212.3(26). In addition, s. 212.3(26)(c) (re a discretionary beneficiary having a deemed 100% interest) could deem multiple discretionary beneficiaries to each own 100% of the shares owned by the trust, leading to multiple incidence of tax on multiple deemed dividends. Given that the core premise -- that absent tax considerations, the investment in the FA would have been made by the discretionary beneficiary is almost certainly false -- s. 212.3(26)(c) should be scrapped.

Ss. 212.3(26)(a) and (b) (providing a look-through rule to non-resident trust beneficiaries) also are unnecessary – if the CRIC is controlled by a Canadian-resident trust (albeit, with non-resident beneficiaries), the CRIC will in reality be controlled by Canadian-resident decision makers.

The addition of the concept of a NAL group is fraught since identifying such a group is a difficult question of fact which it very well might be impracticable for the CRIC to determine. In addition, why should a NAL group who have gone to the trouble to negotiate a shareholders agreement for the CRIC be regarded as the real direct investors in the FA? Furthermore, the s. 212.3(16) exception would be very difficult to apply where the deemed “parents” do not exercise control.

Neal Armstrong. Summaries of Joint Committee “Foreign Affiliate Dumping, Derivative Forward Agreement and Transfer Pricing Amendments Announced in the 2019 Federal Budget” 24 May 2019 Submission of the Joint Committee under s. 212.3(1)(b), s. 212.3(16), s. 212.3(26), s. 212.3(18), s. 12(1)(z.7), s. 248(1) – tax-indifferent investor, s. 247(1.1) and s. 152(4)(b)(iii).

Moras – Tax Court of Canada finds that s. 20.1(2)(c) allowed a taxpayer to deduct interest on personally-owed debt following a drop-down

Prior to the transfer of his accountancy practice in 2007 to his corporation, the taxpayer borrowed under a home equity line of credit to fund alleged expenses of that practice. Following the drop-down, the outstanding balance was maintained. Favreau J allowed in full the deduction by the taxpayer of his HELOC interest for two subsequent years, stating:

[P]aragraph 20.1(2)(c) specifically provides that the portion of the borrowed money outstanding when the business ceases operating shall be deemed to be used by the taxpayer at any subsequent time for the purpose of earning income from the business.

An oddity is that CRA initially had disallowed the deduction of all of the HELOC-financed expenses, and then at trial conceded that 2/3 of them were deductible – yet Favreau J allowed all of the related interest to be deducted under s. 20.1(2)(c). Although not discussed, perhaps this could be explained on the basis that the taxpayer had succeeded in “demolishing” the basis for the full interest denial by CRA, so that the onus now shifted to the Crown to demonstrate that some portion of the interest was still non-deductible on more factual grounds, which it failed to do.

The self-represented taxpayer apparently did not argue that the shares of his corporation had replaced his accountancy practice as an income-producing source.

Neal Armstrong. Summary of Moras v. The Queen, 2019 TCC 111 under s. 20.1(2)(c).

Income Tax Severed Letters 19 June 2019

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

3087-1883 Québec – Federal Court finds that a determination of CRA not to reassess a taxpayer is a reviewable decision

Two co-owners paid a portion of the expropriation proceeds received for one of their properties to their affiliated tenant of that property. However, when CRA treated that receipt in the tenant’s hands as a s. 9 receipt, rather than as a s. 12(1)(x) receipt that was eligible for the s. 13(7.4) election, the two co-owners and the tenant requested CRA (within the normal reassessment period) to amend their returns for the year of expropriation to treat the amount that had been paid to the tenant not as income to the tenant but instead as capital gains realized by the co-owners. CRA essentially refused this request. The taxpayers considered it to be unfair that CRA had not issued any reassessment that they could appeal, and applied for an order of mandamus compelling CRA to reassess in some manner.

Walker J found that the refusal of CRA to reassess was a decision that could be subject to judicial review (e.g., if the decision was unreasonable) – although, of course, the substantive question of whether the requested adjustment was correct could not be reviewed by her. However, this decision was not before her because their application had not been brought on a timely basis and the criteria for extending the 30-day period for bringing such an application had not been made out.

In any event, CRA had no legal obligation to issue a reassessment notice following the taxpayer request – that was a decision that was within its discretion (s. 152(4) used the word “may”).

Neal Armstrong. Summary of 3087-1883 Québec Inc. v. Canada (National Revenue), 2019 CF 785 under s. 152(4).

CRA publishes written answers to 15 May 2019 IFA Roundtable

Although we summarized most of the oral responses provided at the 2019 IFA CRA Roundtable a month ago, for you convenience the table below provides descriptors and links to the published version of the CRA answers.

Topic Descriptor
15 May 2019 IFA Roundtable Q. 1, 2019-0798831C6 - Thin capitalization Income Tax Act - Section 18 - Subsection 18(5) - Equity Amount - Paragraph (a) - Subparagraph (a)(ii) contributed surplus will cease to be recognized if the contributor ceases to be a specified non-resident shareholder
15 May 2019 IFA Roundtable Q. 2, 2019-0798751C6 - Shared workspaces and PE Treaties - Income Tax Conventions - Article 5 a Canadian shared-work space can readily constitute a PE
15 May 2019 IFA Roundtable Q. 3, 2019-0798741C6 - Participating Debt Interest & US Treaty Treaties - Income Tax Conventions - Article 11 contingent interest under Art. XI(6)(b) of the US Treaty does not taint contemporaneous fixed interest
15 May 2019 IFA Roundtable Q. 4, 2019-0798721C6 - 78(1)(b)(ii) deemed loan & thin capitalization Income Tax Act - Section 18 - Subsection 18(5) - Outstanding Debts to Specified Non-Residents - Paragraph (a) - Subparagraph (a)(ii) unpaid simple interest that is deemed to be a loan by s. 78(1)(b)(ii) generally is not outstanding debts to specified non-residents
Income Tax Act - Section 78 - Subsection 78(1) - Paragraph 78(1)(b) - Subparagraph 78(1)(b)(ii) deemed s. 78(1)(b)(ii) loan is not also deemed to bear interest
15 May 2019 IFA Roundtable Q. 5, 2019-0798811C6 - Functional currency Income Tax Act - Section 261 - Subsection 261(11) a functional currency reporter realizes capital gains or losses from FX fluctuations when it receives a Cdn$ tax refund for an earlier functional currency year
15 May 2019 IFA Roundtable Q. 6, 2019-0798861C6 - Non-resident filing income tax return Income Tax Act - Section 150 - Subsection 150(5) - Paragraph 150(1)(b) non-resident partners of a partnership that has disposed of TCP must file Part I returns even if a s. 116 certificate indicates that all Part I tax is paid
Income Tax Act - Section 150 - Subsection 150(1) - Paragraph 150(1)(a) "tax is payable" even if already paid
15 May 2019 IFA Roundtable Q. 7, 2019-0798821C6 - Subsection 246(1) and Non-Residents Income Tax Act - Section 246 - Subsection 246(1) - Paragraph 246(1)(a) a s. 15(1)-relevant s. 246(1)(a) benefit generally will not subject a non-resident to Part I tax
15 May 2019 IFA Roundtable Q. 8, 2019-0798841C6 - Active Trade or Business Test under the LOB Clause Treaties - Income Tax Conventions - Article 29A Art. XXIX-A(3) Canada-US LOB clause exclusion would be unavailable to income derived by a Canadian subsidiary from an offshore connected-business FA
15 May 2019 IFA Roundtable Q. 9, 2019-0798761C6 - Surplus Documentation Income Tax Regulations - Regulation 5901 - Subsection 5901(2.2) failure by Canco to prepare surplus accounts precludes late- filed Reg. 5901(2)(b) election
Income Tax Act - Section 113 - Subsection 113(1) - Paragraph 113(1)(a) CRA generally denies a s. 113(1) deduction where Canco has failed to prepare surplus accounts
15 May 2019 IFA Roundtable Q. 10, 2019-0798781C6 - Foreign Affiliate Earnings and Foreign Transfer Pricing Adjustments Income Tax Regulations - Regulation 5907 - Subsection 5907(2) - Paragraph 5907(2)(j) MAP settlement resulted in reduction in "earnings" - (a)(i) under Reg. 5907(1) but in increase under Reg. 5907(2)(j)
Income Tax Regulations - Regulation 5907 - Subsection 5907(1) - Net Earnings - Paragraph (a) MAP Settlement reduced net earnings when foreign country reassessed to implement income reduction

CRA elaborates on the surplus effects of a MAP settlement

CRA provided some further commentary on 2017-0729431R3, which helps fill in some of the redacted details.

This related to a situation where CRA had assessed a Canadian subsidiary (Canco) in a Canadian multinational group under s. 247(2) on the basis that the fees earned by a CFA (resident in Country A) of Canco’s Canadian parent from management services were too high from a transfer-pricing perspective and the fees earned by Canco itself from providing management services to group companies were too low. After negotiations between the competent authorities, it was agreed (under the “MAP Settlement”) that the income of CFA (which was from an active business) would be reduced by assessment by the Country A taxing authority, thereby generating income tax refunds for the affected years, and that there would be no adjustment to the actual fees charged by CFA (to which it was entitled under the Country A domestic law) and that there also would be no secondary adjustments.

CRA in its discussion indicated that, as a result:

  • The “earnings” of CFA, under Reg. 5907(1)(a)(i), were reduced by the income adjustment under the MAP Settlement as reassessed by Country A.
  • Upon receipt of such Country A reassessments reducing CFA’s income to reflect the MAP Settlement adjustments, the “net earnings” of CFA, under Reg. 5907(1), were increased by the amount of income taxes that had been paid to Country A but, in fact, were not payable after giving effect to the MAP Settlement and consequential Country A reassessment.
  • The amount of the MAP Settlement adjustment (reassessed by Country A) that was excluded from the computation of income or profit from an active business pursuant to the income tax law of Country A for each of the reassessed taxation years was added to the earnings of CFA pursuant to Reg. 5907(2)(f) given that the amount of such adjustment constituted “revenue, income or profit” of CFA for purposes of Reg. 5907(2)(f).

Neal Armstrong. Summary of 15 May 2019 IFA Roundtable Q. 10, 2019-0798781C6 under Reg. 5907(2)(j).

6 more translated CRA interpretations are available

We have published a further 6 translations of CRA interpretations released in December 2011 (including 3 questions from the October 2011 APFF Roundtable). Their descriptors and links appear below.

These are additions to our set of 885 full-text translations of French-language Rulings, Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers the last 7 1/2 years of releases 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
2011-12-23 15 December 2011 Internal T.I. 2011-0413891I7 F - Récupération d'amortissement-Recapture CCA Income Tax Act - Section 129 - Subsection 129(4) - Income or Loss reasonable to pro-rate recapture of depreciation between active business income and property income based on relative periods of use
Income Tax Act - Section 13 - Subsection 13(1) successive business and property income use of rental property reflected in apportionment of source of ensuing recapture
6 December 2011 External T.I. 2011-0423181E5 F - Safe Income Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) where Shareholder with high SIOH Class F shares converts its low SIOH Class A shares on rollover basis into Class F shares, there is downward averaging of SIOH per share
12 December 2011 External T.I. 2011-0416801E5 F - Safe Income on Hand - Stub Period Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) safe income generally prorated in stub period
7 October 2011 Roundtable, 2011-0411971C6 F - Appraisal Fees Deductibility Income Tax Act - Section 53 - Subsection 53(1) - Paragraph 53(1)(n) appraisal fees for valuing capital property for the purpose of its acquisition or disposition are an ACB addition
Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(b) - Capital Expenditure v. Expense - Improvements v. Repairs or Running Expense deductible appraisal fees to revalue fixed assets in accordance with IFRS
7 October 2011 APFF Roundtable Q. 4, 2011-0412071C6 F - Modifying a Capital Dividend Election General Concepts - Effective Date originally declared dividend not altered by subsequent resolution
Income Tax Act - Section 184 - Subsection 184(3) short-cut method for direct assessment of shareholders for excess amount
7 October 2011 APFF Roundtable Q. 29, 2011-0412131C6 F - Subsection 55(2) and Capital Dividend Account Income Tax Act - Section 89 - Subsection 89(1) - Capital Dividend Account - Paragraph (a) - Subparagraph (a)(i) - Clause (a)(i)A) CDA addition from application of s. 55(2)(c) is only available in the following years
Income Tax Act - Section 55 - Subsection 55(2) - Paragraph 55(2)(c) dividend paid in contemplation of subsequent arm’s length share sale is part of proceeds of that sale