News of Note

CRA finds that the new ETA s. 179(9) drop shipment rule does not affect whether a non-resident lessor is carrying on business in Canada

Example 1 in Policy Statement P-051R2 indicates that a non-resident lessor (with a leasing business outside Canada) is considered to be carrying on business in Canada by virtue of a sale-leaseback transaction under which it purchases a conveyance from a resident registrant, with delivery under the sale agreement and under the lease-back to the resident (who will use the conveyance partly in Canada) occurring in Canada, notwithstanding no other significant connecting factors to Canada.

ETA s. 179(9), which took effect in 2017, appears to deem this transaction to be subject to the drop-shipment rules, so that the resident is deemed to have sold the conveyance to the non-resident outside Canada, if the non-resident is not registered (so that such supply is not subject to GST/HST), and is deemed to have provided a drop-shipment certificate to the non-resident (so that the resident is subject to tax if it does not use the conveyance in commercial activity). When asked about the impact of s. 179(9), CRA stated that it “reviewed the leasing examples in P-051R2 and has determined that the introduction of new subsection 179(9) … does not impact the rationale or carrying on business conclusions in those examples.”

Although CRA did not discuss this response, there seems to be an element of circularity involved. If CRA indeed considers that the non-resident was carrying on business in Canada, it should have been registered (and, if not, CRA would register it retroactively.) Since the s. 179(9) drop shipment rule only applies where the non-resident is not registered, therefore, it does not apply. If CRA instead started with the proposition that s. 179(9) deemed the non-resident to no longer have any significant transactional connection with Canada, then it could have reached the opposite conclusion.

When also asked about a variation on this example where the equipment is purchased by the non-resident from a third party (rather than the Canadian company) and is leased by the non-resident to the Canadian company, which exports the conveyance immediately after taking possession under the lease in Canada, CRA stated that this also did not change its conclusion that the non-resident is carrying on business in Canada.

Neal Armstrong. Summaries of 27 February 2020 CBA Roundtable, Q.24 under ETA s. 240(1) and s. 179(9).

Kam-Press – Federal Court of Appeal confirms requirement for use of the scientific method in SR&ED

A taxpayer acknowledged that the work performed by it for which it claimed investment tax credits did not follow the scientific method as described in Northwest Hydraulics, but argued that “there was no reference to ‘scientific method’ in the text of the definition [of SR&ED].” Webb JA rejected this submission, noting that the tests in Northwest Hydraulics had been endorsed in the Court of Appeal.

Neal Armstrong. Summary of Kam-Press Metal Products Ltd. v. Canada 2021 FCA 88 under s. 248(1) - SR&ED.

Flash crypto loans generate unusual tax issues

In flash loans of cryptocurrency (which may occur in order for the borrower to arbitrage between different cryptocurrencies), the loan and its repayment occur at exactly the same time. This is because the loan advance of the cryptocurrency is contingent on the repayment occurring in the same block. Since either all of the steps are to be competed (i.e., added to the blockchain) or none, the loan and repayment simultaneously occur on such completion.

Thus, there is an issue as to whether compensation payable to the lender is deductible to the borrower under s. 20(1)(c) (if it is considered to have received the loan on capital account), given that there is no period of time over which interest could accrue.

Ian Caines, “Very-Short-Term Crypto Loans,” Canadian Tax Focus, Vol. 11, No. 2, May 2021, p.3 under s. 20(1)(c)(i).

Income Tax Severed Letters 12 May 2021

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

CRA indicates that s. 90(9)(b) does not preclude annual s. 90(9) deductions for an upstream loan from CFA based on its ES followed by using that ES to repay the upstream loan

Canco received a loan from a controlled foreign affiliate (“CFA”) that remained outstanding at the end of years 1, 2 and 3, and was then repaid in year 4 by means of a dividend distributed out of CFA's exempt surplus. In years 1 to 3, Canco included the loan amount under s. 90(6) (in year 1) or s. 90(12) (in years 2 and 3), and claimed a new deduction under s. 90(9) in each of those years, based on CFA having sufficient exempt surplus when the loan was made.

Did the stipulation in s. 90(9)(b), that the CFA exempt surplus must be “not relevant in applying this subsection in respect of ... any deduction under subsection ... 113(1) in respect of a dividend paid, during the period in which the particular loan … is outstanding” signify that Canco could not access the s. 90(9) deductions in years 1 to 3, because the loan was still outstanding in year 4 at the time that the dividend was paid out of exempt surplus?

CRA indicated that it considers this stipulation to be targeted at the years in which the s. 90(9) deduction is claimed so that, if in one of those years the surplus was relevant to taking a s. 90(9) deduction regarding another loan or to a s. 113(1) deduction for a dividend paid in the year, the s. 90(9) deduction would thereupon cease to be available. Since the s. 90(9)(b) condition was met during the years (1 to 3) for which the s. 90(9) deductions were claimed, such deductions were permitted for those years, and s. 90(9)(b) only applied during year 4 to prohibit a s. 90(9) deduction in that year.

Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.8 under s. 90(9)(b).

CRA states that a non-interest-bearing loan from a CFA to a NR sister of the Canadian taxpayer generated double tax (FAPI and Pt. XIII tax)

A wholly-owned foreign subsidiary (FS) of CanCo uses funds generated from its operations to make a non-interest bearing loan to a foreign borrower (FB), which is wholly owned by the foreign parent (FP) of CanCo. The loan is repaid within 2 years so that the upstream loan rules in s. 90(6) do not apply.

CRA stated its “long-standing view” that s. 247(2) can generally apply to transactions between a foreign affiliate and another non-resident in computing the FA’s FAPI. Here, it would apply s. 247(2) to impute interest income to FS and, thus, FAPI to CanCo.

CRA went on to find that this application of s. 247(2) to generate imputed interest to FS did not preclude imputing a s. 80.4(2) benefit to FB. In its view, the s. 80.4(2) benefit would be deemed by s. 15(9) to be a benefit conferred on “a” shareholder (FB), with s. 214(3)(a) deeming this benefit to be paid “to the taxpayer [FB] as a dividend from a corporation resident in Canada.” Thus, in addition to generating FAPI, the interest-free benefit would be subject Part XIII tax, which FS would be required to withhold and remit. As in 2015-0622751I7 , there is no mention of Oceanspan or principles of territoriality.

Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.7 under s. 214(3)(a).

We have published 10 more CRA translations

We have published a further 10 translations of CRA interpretation released in the period going back to April, 2008. Their descriptors and links appear below.

These are additions to our set of 1,526 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 13 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
2008-06-20 27 May 2008 External T.I. 2008-0269441E5 F - Withdrawn Ruling Request Income Tax Act - Section 84 - Subsection 84(2) the 2005-0134731R3 transactions, accommodating “an intergenerational transfer of a family business,” would be abusive surplus stripping if applied to inter-sibling transfer
Income Tax Act - Section 245 - Subsection 245(4) GAAR applied to use of outside basis, created with the capital gains exemption, for an inter-sibling transfer
13 June 2008 Internal T.I. 2008-0280121I7 F - Crédit d'impôt pour condition physique des enfant Income Tax Regulations - Regulation 9400 - Subsection 9400(1) - Physical Activity initial swimming lesson program for preschoolers qualified notwithstanding that did not contribute initially to cardio-respiratory endurance
2008-06-06 29 May 2008 External T.I. 2007-0262591E5 F - Remboursement de sommes versées par erreur Income Tax Act - Section 8 - Subsection 8(1) - Paragraph 8(1)(n) s. 8(1)(n) could extend to reimbursements of disability benefits to an employer-arranged insurer
26 May 2008 External T.I. 2007-0263001E5 F - 2006 GRIP Addition Income Tax Act - Section 89 - Subsection 89(7) illustration of circular calculations for GRIP additions where cross-redemption in 2004
2008-05-09 25 April 2008 External T.I. 2008-0274401E5 F - Crédit d'impôt pour enfant Income Tax Act - Section 118 - Subsection 118(1) - Paragraph 118(1)(b.1) meaning of "ordinarily reside" and "throughout the … year"
2008-04-18 8 April 2008 Internal T.I. 2008-0267811I7 F - Article 44.1 - Désignation tardive Income Tax Act - Section 44 - Subsection 44(1) - Replacement Share late designation permitted if resulted from bona fide error and not prompted by retroactive tax planning
9 April 2008 Internal T.I. 2008-0268881I7 F - Crédit d'impôt pour apprentis Income Tax Act - Section 127 - Subsection 127(9) - Eligible Apprentice $2,000 limit not required to be allocated to one employer where unrelated employers
10 April 2008 Internal T.I. 2008-0271801I7 F - Frais juridiques liés à amende ou pénalité Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(a) - Income-Producing Purpose deductibility of legal fees is subject to the 65302 principles including that the defended conduct not be egregious or repugnant
2008-04-11 1 April 2008 External T.I. 2008-0269311E5 F - Ajustements salariaux rétroactifs Income Tax Act - 101-110 - Section 110.2 - Subsection 110.2(1) - Qualifying Amount negotiated payment of retroactive salary adjustments were not qualifying amounts
2008-04-04 27 March 2008 External T.I. 2006-0197601E5 F - Crédit équivalent pour personne à charge Income Tax Act - Section 118 - Subsection 118(1) - Paragraph 118(1)(b) - Subparagraph 118(1)(b)(ii) - Clause 118(1)(b)(ii)(B) having legal custody of the child is relevant, but not a sine qua non

CRA indicates that a s. 17(8) exception for a loan by a partnership of two related Cancos to an FA does not imply a s. 247(7) exclusion of s. 247(2)

A limited partnership (LP) between two resident related corporations (ACo and BCo) made a non-interest bearing loan to FA, which was wholly-owned by ACo. FA used the loan proceeds for the purpose of earning income from an active business, so that there was no imputed income to the partners under s. 17(1) by virtue of ss. 17(4), (8), and (13). However, s. 247(7), which generally avoids the imputation under s. 247(2) of interest on indebtedness that is covered by s. 17(8), is only stated to apply to amounts owing to a resident corporation, and not to a Canadian partnership.

CRA stated that it was “not prepared to take an administrative position to consider that subsection 247(7) would apply in respect of the loan between the FA and LP … .” In this regard, it indicated that:

  • Ss. 17 and 247 “each have a distinct and separate role,” so that “the exception from application of one of these sections” does not generally establish “an intention to preclude the application of the other section.”
  • Further, “adopting the requested administrative position could potentially facilitate the use of structures using hybrid entities to achieve a tax benefit.”

Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.5 under s. 247(7).

CRA acknowledges that Cameco may limit the use of s. 247(2)(d) recharacterization – and that s. 247(2)(c) must take into account the parties’ relationship

Regarding the CRA response to the TCC and FCA decisions in Cameco , CRA stated “that these decisions may limit situations where the re-characterization provision in paragraphs 247(2)(b) and (d) could be applied … [h]owever, the CRA will continue to consider the application of the re-characterization provision where appropriate.”

CRA further stated:

The CRA will continue to administer … 247(2)(a) and (c) in a manner consistent with the guidance … [in] General Electric [para. 54]:

“…The task in any given case is to ascertain the price that would have been paid in the same circumstances if the parties had been dealing at arm’s length. This involves taking into account all the circumstances which bear on the price whether they arise from the relationship or otherwise.”

CRA also noted the consultation process that commenced with the 2021 Budget.

Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.4 under s. 247(2)(a).

CRA finds that the C$5M threshold in s. 247(3)(b)(ii) is to be translated into a functional currency on the basis that it is not “in respect of a penalty”

A Canadian corporation (“Canco”) with an elected functional currency is subject to transfer pricing income adjustments respecting a functional currency year. What is the relevant spot rate to be used in converting the C$5,000,000 threshold in s. 247(3)(b)(ii) into the elected functional currency? S. 261(5)(b) generally requires that the relevant spot rate for the first day of the particular taxation year in issue be used in a converting a dollar amount, except where that amount is “in respect of a penalty or fine.”

CRA found that, in light of the quoted exclusion, the threshold amount was to be converted using the relevant spot rate for the first day of Canco’s particular taxation year in respect of which the transfer pricing income adjustments are made. In this regard, CRA noted that the C$5M threshold amount in s. 247(3)(b)(ii) was only one of the two components for establishing the threshold above which a penalty might be assessed, and that the penalty itself is equal to 10% of the amount determined under s. 247(3)(a), and does not take into account s. 247(3)(b). Thus, the C$5M threshold was in respect of determining whether a penalty might apply, but was not in respect of the penalty itself.

Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.3 under s. 261(5)(b).