News of Note

CRA rules on a pipeline involving a deferred distribution of portfolio assets from the corporation held on death

CRA labelled it a “post-mortem hybrid pipeline,” so that must have been what it was despite an unusual form.

An individual died holding shares of a portfolio investment company (“Investments”) directly and through a holding company (“Newco”), so that the estate acquired those shares with their basis stepped up under s. 70(5). Investments redeemed various shares held by the estate for a note (giving rise to deemed dividends and capital losses which were carried back under s. 164(6)), and the estate then disposed of all its shares of Investments to Newco in consideration for a further note. Investments then sold its stock market investments to the estate beneficiaries (four testamentary trusts) for four trust notes.

It was now proposed that Investments be wound-up into Newco under s. 88(1), and that the estate distribute, to its beneficiaries, most of the Newco notes owing to it by Newco, with the beneficiaries (the four trusts) then presumably using these notes as the currency to settle the trust notes owing by them to Newco. Newco would then by wound-up into the estate pursuant to s. 88(2).

Neal Armstrong. Summary of 2021 Ruling 2020-0865901R3 F under s. 84(2).

National R&D – Federal Court of Appeal confirms the need for use of the scientific method in SR&ED

Rennie JA confirmed that, as set out in Northwest Hydraulic, the scientific method was required to be followed in order for work to qualify as SR&ED. The Tax Court judge “did not take a narrow or restrictive approach to what evidence might be encompassed by the scientific method,” and she had “noted that ‘what is important’ is there be the formulation of hypothesis, testing of those hypotheses and recording of results in a systematic manner.”

In contrast, here, the taxpayer “did not conduct its work in a methodical manner and did not keep adequate records.” The denial of its investment tax credit claims was confirmed.

Neal Armstrong. Summary of National R&D Inc. v. Canada, 2022 FCA 72 under s. 248(1) - SR&ED.

CRA confirms that the CSV-valuation rule in s. 70(5.3) applies to a foreign life insurance policy of a non-resident corporation whose shares were held by an immigrating individual

At the time a non-resident individual immigrated to Canada, the individual owned shares of a non-resident corporation which was the policyholder of a foreign life insurance policy on the life of the individual. On the immigration, there was a deemed disposition and acquisition of the shares for their FMV under s. 128.1(1)(b) and (c).

CRA indicated that, by virtue of s. 70(5.3), the shares were to be valued for such purposes by treating the policy as having a value equal to its cash surrender value.

In contrast, a foreign life insurance policy (which would not be an “excluded right or interest” under s. 128.1(10) – (f)) held by a non-resident corporation when it became resident in Canada would not be subject to s. 70(5.3), and for purposes of determining its deemed cost under s. 128.1(1)(c), “would be valued in accordance with normal valuation practices taking into consideration all facts relevant to the particular case.”

Neal Armstrong. Summary of 17 February 2022 External T.I. 2021-0882401E5 under s. 70(5.3).

Income Tax Severed Letters 11 May 2022

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

CS Communication – Court of Quebec finds that that expenditures under an agreement to develop software for a 3rd party pursuant to its specifications qualified for SR&ED ITCs

A software development company (CS Canada) entered into an agreement with Pratt & Whitney for the sale to of aeronautical control system software. The ARQ accepted that various salary expenses of CS Canada (of about $0.9M per annum) were incurred on the prosecution of SR&ED, but denied investment tax credits on the basis that the contractual consideration paid by P&W constituted “contract payments” under the Quebec equivalent of the definition of that term in ITA s. 127(9), i.e., on that basis that the SR&ED was performed on behalf of P&W.

In finding that such payments were not contract payments, so that CS Canada was entitled to its claimed ITCs, Riverin JCQ noted that subject matter of the contract was a sale of system control software (required to meet the detailed specifications of P&W) and not the performance of SR&ED, and that CS Canada bore all the risk (it paid all the development costs in consideration for a largely fixed contract price), and retained ownership of the intellectual property developed by it in performing the development work (although it licensed that IP to P&W).

Neal Armstrong. Summary of CS Communication v. Agence du revenu du Québec, 2022 QCCQ 1175 under s. 127(9) – contract payment - (a).

Joint Committee comments on the draft EIFEL rules

We have uploaded a copy of the 61-page submission of the Joint Committee on the draft ss. 18.2 and 18.21 “excessive interest and financing expenses limitation" rules, and hope to provide our summaries within the next few days.

We have translated 8 more CRA interpretations

We have published a further 8 translations of CRA interpretation released in January of 2005. Their descriptors and links appear below.

These are additions to our set of 2,030 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 17 1/3 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
2005-01-14 10 January 2005 External T.I. 2004-0095361E5 F - Dommages Income Tax Act - Section 3 - Paragraph 3(a) courts have preferred to tax on the basis of an identified source
Income Tax Act - Section 56 - Subsection 56(1) - Paragraph 56(1)(a) - Subparagraph 56(1)(a)(i) damages for negligence resulting in not becoming entitled to QPP would not be income under s. 56(1)(a)(i)
6 January 2005 Internal T.I. 2004-0100241I7 F - Imposition des rentes au décès Income Tax Act - Section 148 - Subsection 148(2) - Paragraph 148(2)(b) no disposition of PAC under s. 148(2)(b) – but disposition if estate elects to commute
Income Tax Act - Section 148 - Subsection 148(9) - Proceeds of Disposition - Paragraph (d) disposition gain based on accumulating fund
2005-01-07 21 December 2004 External T.I. 2004-0085481E5 F - Titres détenus par une compagnie d'assurance Income Tax Act - Section 142.2 - Subsection 142.2(1) - Mark-to-Market Property MFT units not mark-to-market property
Income Tax Act - Section 248 - Subsection 248(1) - Inventory per Friesen, securities held on income account are inventory
21 December 2004 External T.I. 2004-0091011E5 F - Déductibilité-primes d'assurance-responsabilité Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(a) - Start-Up and Liquidation Costs premiums for professional liability coverage incurred after the cessation of practice for continued coverage re that practice, are deductible
21 December 2004 External T.I. 2004-0093361E5 F - Report de l'impôt minimum de remplacement-décès Income Tax Act - Section 120.2 - Subsection 120.2(2) if the tax generated in the terminal year is insufficient to recover the AMT paid in the preceding year, the deceased individual can no longer utilize a s. 120.2(2) carryback
21 December 2004 Internal T.I. 2004-0096211I7 F - Remise de dettes Income Tax Act - Section 80.01 - Subsection 80.01(4) no need for s. 80.01(4) election if assets of sub in the amount of the debt owing to the parent are distributed on the winding up in payment of that debt
16 December 2004 Internal T.I. 2004-0100891I7 F - Prestations d'assistance sociale Income Tax Act - Section 81 - Subsection 81(1) - Paragraph 81(1)(h) government and user-funded assistance with accommodation and care while attending psychiatric day hospital was exempted
16 December 2004 Internal T.I. 2004-0098631I7 F - Déduction - Résidence des membres du clergé Income Tax Act - Section 8 - Subsection 8(1) - Paragraph 8(1)(c) based on Noseworthy, RC lay pastoral workers (in one case, authorized to baptize on occasion) were not regular ministers

Issues in a applying the s. 55(3.1)(c) butterfly exclusion include uncertainties respecting the “series” and “ordinary course” and testing FMV at any time in the series

S. 55(3.1)(c) generally precludes a butterfly where a group of companies engages in transactions for the transfer of assets from the distributing company (DC) to the transferee company (TC), with the intention, from the outset, of having the TC immediately sell those assets to an unrelated third party within the same series so that the shareholder can “cash out” or otherwise gain some sort of tax benefit.

Technical issues as to the application of s. 55(3.1)(c)include:

  • Regarding the connecting factor in s. 55(3.1)(c)(i) that (to taint the transactions) requires that the property be acquired from TC by a non-related person in the same series of transactions or events as the butterfly, s. 248(10) “is broad enough to catch any transactions that have some connection, however remote, with the butterfly” so “that a very conservative interpretation could preclude the TC from ever disposing of property received in the butterfly to a non-related person because the series seemingly continues in perpetuity.”
  • A carve-out from the above rule for dispositions of property to unrelated persons in the ordinary course of business creates difficulties of interpretation, for example, where “the taxpayer’s ‘ordinary business’ involves transactions that are large and relatively few in number.”
  • Respecting the accessing of a further carve-out (which applies inter alia where the property that is disposed of to unrelated persons as part of the series constitutes less than 10% of the FMV of all of the butterflied property - ignoring for these purposes, money and indebtedness), the property so disposed of cannot exceed 10% of the total value of the butterflied property at any time after the butterfly and prior to the end of the series – so that even if the FMV of certain property constituted, for example, 7% of the total FMV on the disposition date, it might exceed 10% of the total FMV at some point between the butterfly date and the disposition date, so as to put the butterfly offside.

Neal Armstrong. Summary of David Carolin and Manu Kakkar, “Problematic Post-Butterfly Transferee Corporation Dispositions Involving Paragraph 55(3.1)(c): Part I,” Tax for the Owner-Manager, Vol. 22, No. 2, April 2022, p. 3 under s. 55(3.1)(c).

Enterprise Rent-A-Car – Ontario Court of Appeal finds that amounts labelled on invoices as “HST” should be treated as having been collected as HST, not RST

Although both the taxpayer (Enterprise) and the Ontario Minister of Finance agreed that Enterprise (which had been collecting amounts labelled on its invoices for sales of its insurance products as “HST” and remitting those amounts to CRA) should have been collecting RST and not HST on those sales, they also was agreed that the Minister’s assessments of Enterprise could only be sustained under s. 18 of the RSTA, which permits assessments of the “tax collected”. The Court concluded, principally on the basis of the above labelling:

The “tax collected” by Enterprise was not RST but HST. The Minister therefore had no basis to assess the “tax collected” by Enterprise.

Before so concluding, the Court stated:

Enterprise’s practices are consistent with CRA policy in its GST/HST Policy Statement P-131R that: “Generally, a person will be considered to have collected an amount as or on account of tax where the person issues an invoice for the supply to the customer indicating the amount of GST/HST payable and subsequently collects the amount.”

Neal Armstrong. Summary of Enterprise Rent-A-Car Canada Company v. Ontario (Finance), 2022 ONCA 327 under ETA s. 225(1) – A(a).

CRA indicates that a Canadian sub can voluntarily adopt IFRS to increase its retained earnings for thin cap purposes if its parent needs IFRS (in addition to, say, US GAAP) financials

After noting “that a taxpayer may be been able to significantly increase the reported retained earnings by adopting IFRS,” CRA indicated that a Canadian subsidiary within a multinational group could compute its retained earnings using IFRS, even if its adoption of IFRS was voluntary rather than mandatory, subject to the general qualification that the accounting method followed is expected to be consistent with the method followed for preparing financial statements for presentation to its shareholders.

CRA further indicated that this requirement would not be violated for instance where there was a dual-listed parent that was required to prepare financial statements both under IFRS and US GAAP. It stated:

A multinational entity … may be required to prepare financial statements using different accounting methods in order to be compliant with the GAAP for each particular country in which financial statements are required to be prepared. As such, it is feasible that a Canadian taxpayer which is part of a multi-national group of companies, who prepares financial statements for income tax purposes under Canadian GAAP (IFRS or ASPE), will also prepare financial statements using another accounting method for purposes of consolidation by a parent entity located in another country, which has a different GAAP. Absent objectionable tax planning or abusive tax avoidance, this may be acceptable, but each particular situation would need to be considered on a case-by-case basis.

Neal Armstrong. Summary of 29 October 2018 Internal T.I. 2018-0746351I7 under s. 18(5) – equity amount – (a).