News of Note

Deans Knight – Tax Court of Canada finds that the absence of an acquisition of effective control of a Lossco also demonstrated an absence of s. 245(4) abuse

The “Tax Attributes” of a Lossco (the taxpayer) were effectively sold to arm’s length investors pursuant to transactions under which:

  • The existing shareholders of Lossco exchanged their Lossco shares for “Newco” shares under a Plan of Arrangement
  • A private company “facilitator” (Matco) acquired a debenture of the Lossco that was convertible into shares representing 79% of its equity shares but only 35% of its voting shares (this occurred before the introduction of s. 256.1). Newco also had the right to put its remaining shares of Lossco to Matco for a pre-agreed price.
  • Lossco transferred it assets to Newco for a note.
  • Matco then identified a mutual fund management company who wanted to IPO Lossco and use the IPO proceeds (of $100M) for a new bond trading business to be carried on in Lossco.
  • The IPO subscription price for the newly-issued common shares caused the securities of Lossco held by Newco and Matco to appreciate which, in the case of Matco, effectively was its fee.
  • Newco sold its remaining shares of Lossco to Matco for the pre-agreed price notwithstanding that this was at a 20% discount to the shares’ current market value.

Paris J rejected the Crown’s technical argument that the parties effectively treated Newco’s right to sell the remaining Lossco shares to Matco as a right of Matco to acquire those shares, so that s. 256(8) applied by virtue of a s. 251(5)(b) right to deny use of the Tax Attributes, stating that the Crown, contrary to Shell, was effectively seeking to recharacterize the transactions based on their economic substance.

He also found that there was no abuse of the loss-streaming rules (and, in particular, of ss. 256(8) and 251(5)(b)), stating:

I … find that the object, spirit and purpose of subsection 111(5) is to target manipulation of losses of a corporation by a new person or group of persons, through effective control over the corporation’s actions… .

[T]he circumstances referred to by the Respondent do not, in my view, indicate that Matco had effective control over the majority of the voting shares of the Appellant prior to the IPO … .

Neal Armstrong. Summaries of Deans Knight Income Corporation v. The Queen, 2019 TCC 76 under s. 251(5)(b)(i) and s. 245(4).

Income Tax Severed Letters 17 April 2019

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

CRA expands its official published positions on the replacement property rules

Folio S3-F3-C1 on the replacement property rules has largely repeated the points in (now-cancelled) IT-259R4, but has also added a few points:

  • Class 14.1 properties (e.g., farm quotas) will not be eligible as former business properties because they are not real property.
  • The s. 44 rollover can be used to reduce a capital gain that otherwise would arise after giving effect to a partial rollover under s. 85(1).
  • A building rented by a partner to a partnership for use in its business would normally be considered to be a former business property of the partner.
  • Where a partnership is wound up under s. 98(3), CRA accepts that the undivided interests received in the former partnership’s property can qualify as former business properties, so that the former partners can now exchange their undivided interests for divided interests on a rollover basis under ss. 44 and 13(4).
  • CRA has added brief comments on the extension in s. 13(4.2) of the former business property concept to limited-period franchises, concessions or licences that have been disposed of or terminated.

Various of the positions carried forward from IT-259R4 are potentially quite helpful, including an expansive interpretation of the concept of similar business.

Neal Armstrong. Summaries of Folio S3-F3-C1 dated 8 April 2019 under s. 13(4.1), s. 13(4.3), s. 44(1), s. 44(1)(e), s. 44(5)(a), s. 44(6), s. 248(1) – former business property, s. 87(2)(l.3) and s. 88(1)(e.2).

CRA comments on criteria for downward transfer-pricing adjustments, and s. 247(2)(d) adjustments process

Comments made by Alexandra MacLean (DG, ILBD) at a recent CTF transfer-pricing seminar included:

  • CRA’s focus respecting when it will consider a downward transfer-pricing adjustment under s. 247(10) to be “appropriate in the circumstances” is on whether there is good evidence that there will be a corresponding upward adjustment in the other jurisdiction (that respects the arm’s length principles), so as to not result in double non-taxation. The International Tax or Audit Division will forward the requested downward adjustment to the Competent Authority Services Division where there is a treaty country on the other side of the transactions.
  • Recharacterization under s. 247(2)(d) entails a three-step process.
    • First, audit staff make a submission to the Transfer Pricing Review Committee. If accepted, the taxpayer is notified.
    • The audit team then conducts additional research, and makes a second submission to the TPRC, and a second review by it determines whether the auditor is permitted to propose an adjustment under ss. 247(2)(b) and (d). The taxpayer is then notified and allowed to make a submission..
    • At the third stage, the TPRC meets, along with representatives from Justice, Abusive Tax Avoidance, and Finance, to make a final recommendation.
  • BP is not a complete bar to access tax accrual working papers, as indicated by Atlas. The Communiqué on “Obtaining Information for Audit Purposes” contemplates reasonableness and restraint, as the focus is on determining the facts and purpose of the transaction, with CRA then making its own determination of the transaction’s legal effects.

  • The threshold for the Audit File Resolution Committee to look at a proposed adjustment is $100 million.

Neal Armstrong. Summaries of 27 March 2019 CTF Seminar - Transfer Pricing under s. 247(10), s. 247(2)(d), s. 233.8(3) and s. 231.1(1)(a).

6 more translated CRA interpretations are available

We have published a translation of a CRA interpretation released last week and a further 5 translations of CRA interpretations released in March 2012. Their descriptors and links appear below.

These are additions to our set of 831 full-text translations of French-language Rulings, Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers the last 7 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
2019-04-10 2 April 2019 Internal T.I. 2016-0649821I7 F - Unclaimed superannuation or pension benefits Income Tax Act - Section 56 - Subsection 56(1) - Paragraph 56(1)(a) - Subparagraph 56(1)(a)(i) subsequent year’s payment of benefit to a previously-unidentified beneficiary is only income in that year as an “in lieu of” pension amount
General Concepts - Payment & Receipt amount received in Year 2 in lieu of pension benefit includes source deductions in Year 1
2012-03-30 12 March 2012 External T.I. 2011-0425361E5 F - Assistance paid by franchisor Income Tax Act - Section 9 - Exempt Receipts/Business reimbursements of business expenses increase income
Income Tax Act - Section 12 - Subsection 12(1) - Paragraph 12(1)(x) contest awards paid to franchisees includible under s. 12(1)(x) if not under s. 9
8 March 2012 External T.I. 2011-0426061E5 F - Bien agricole admissible Income Tax Act - 101-110 - Section 110.6 - Subsection 110.6(1.3) - Paragraph 110.6(1.3)(c) land that had been farmed for 5 years before being rented out to neighbouring farmer qualified, including farm house
21 March 2012 External T.I. 2011-0423141E5 F - Application du paragraphe 107(4.1) Income Tax Act - 101-110 - Section 107 - Subsection 107(4.1) - Paragraph 107(4.1)(c) s. 107(4.1) applied to distribution to settlor/beneficiary of property acquired with borrowed money
20 March 2012 External T.I. 2011-0424461E5 F - Déduction d'une rétribution à un agent immobilier Income Tax Act - Section 9 - Timing commissions paid for leasing-up a new building generally are fully and currently deductible
Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(b) - Capital Expenditure v. Expense - Improvements v. Repairs or Running Expense lease-up commissions were current expenses
16 March 2012 External T.I. 2011-0423191E5 F - Disposition d'une participation dans une SP Income Tax Act - Section 98 - Subsection 98(1) disposition of partnership interest for nil proceeds when partnership dissolved upon winding-up distribution
Income Tax Act - Section 248 - Subsection 248(1) - Disposition - Paragraph (b) - Subparagraph (b)(i) disposition of partnership interest even though no proceeds received

CRA publishes its Communiqué on examining tax accrual working papers

CRA has published its Communiqué on “Obtaining Information for Audit Purposes” including tax accrual working papers and CRA’s interpretation of BP.

It was drafted before the Cameco decision was affirmed in the FCA. CRA states that “Pending a final decision in this case, CRA officials can continue to … request that individuals be interviewed.”

CRA considers that tax accrual working papers, “particularly the list of uncertain tax positions,” can be requested “where CRA officials determine there is a higher risk of non-compliance” – and the Communiqué states that “A taxpayer with large unexplained tax reserves may be considered to be at a higher risk of non-compliance.”

CRA also states:

The taxpayer’s list of uncertain tax positions that relates to the tax reserve in their financial statements is not a privileged document. …

Provided all the relevant facts of the transactions are disclosed, including the taxpayer's purpose or purposes in undertaking a transaction or series of transactions, exclusions of their advisors’ analysis of the legal and tax effects of the transactions may be accommodated.

The CRA’s position is that taxpayers are required to disclose sufficient detail regarding their business and tax transactions for the CRA to fulfill its mandate of assessing taxes owing. Where the criteria outlined in the communiqué are met, the CRA considers that it retains the right to request tax accrual working papers, including a list of uncertain tax positions. A request for the taxpayer’s list of uncertain tax positions in these circumstances is not a request that the taxpayer self-audit.

Neal Armstrong. Summary of AD-19-02 Obtaining Information for Audit Purposes 2019-03-21 under s. 231.1(1)(a).

CRA applies Rio Tinto approach to categorization of mine design studies

CRA has published a table indicating the classification of various categories of pre-mining expenditures as Canadian exploration expense, Canadian development expense, deductible expense under s. 9, Class 41 or 41.2 (or other) depreciable property, or “eligible capital expenditure” (i.e., Class 14.1 property).

In addition to the most obvious items, CEE includes:

  • environmental studies and community consultation
  • sampling - generally only up to decision to bring the mine into production, but also where done to expand the mineral resource (but not where done for technical feasibility purposes)
  • bulk sampling (in reasonable sizes)
  • mineralogical analysis and laboratory testing of drilling cores
  • resource estimation and deposit delineation
  • deposit modelling and determination of cut-off grade
  • testing of host rock stability, and testing of ore dilution and breakability
  • metallurgical testing if for determining whether separation of pay metals is feasible (but not for determining the optimal method of separation)

Rio Tinto found that expenditures incurred determining whether to proceed with an acquisition on capital account are currently deductible. Although not framed in those terms, CRA has essentially applied the Rio Tinto approach to finding that the costs of mine design and development studies (including those of evaluation of different technically feasible options for processing the ore) are currently deductible under s. 9 (but not as CEE) to the extent that they are incurred before the decision is made to bring the mine into production. (See also 2014-0520941E5 F.)

Neal Armstrong. Summary of 21 February 2019 Internal T.I. 2019-0796791I7 under s. 66.1(6) – CEE – para. (f).

CRA finds that a subsequent year’s payment of a pension benefit to a previously-unidentified beneficiary is only income in that year under s. 56(1)(a)(i) as an “in lieu of” pension amount

A survivor benefit under a registered pension plan (“RPP”) is paid in a taxation year to the Quebec Unclaimed Property Directorate pursuant to the Quebec Unclaimed Property Act because the person entitled thereto (the “right-holder”) has not been determined. That person, when subsequently identified, receives from the Directorate the net amount that the Directorate, in turn, had received from the RPP (i.e., the survivor benefit payable under the RPP (as reduced by income tax source deductions) is paid by the Directorate to the right-holder, as further reduced by its administration fee.

CRA indicated that the amount to be included under s. 56(1)(a)(i) in the right-holder’s income is the gross amount of the survivor benefit payable under the RPP, as indicated in the T4A slip issued by the RPP administrator, which should be included for the taxation year in which the Directorate transferred that amount to the right-holder. Its reasoning was that the amount could not be considered to be “received” as a pension benefit in the year of payment by the RPP administrator to the Directorate because the right-holder had not yet been identified – whereas in the subsequent year of payment over by the Directorate to the right-holder, that right-holder is receiving that amount under s. 56(1)(a)(i) as being “in lieu of” a superannuation or pension benefit.

CRA also indicated that where the right-holder is an estate, it should include the survivor benefit under s. 56(1)(a)(i) in computing its income for the year of receipt – but with a deduction to it and an inclusion to its beneficiaries being applicable where those amounts are distributed in accordance with the usual ss. 104(6), (13) and (24) rules. However, where the administration of the estate has been completed prior to the Directorate being in a position to pay the amount, CRA accepts that an estate beneficiary directly includes the amount under subparagraph 56(1)(a)(i) in computing his or her income.

Neal Armstrong. Summaries of 2 April 2019 Internal T.I. 2016-0649821I7 F under s. 56(1)(a)(i) and General Concepts – Payment and Receipt.

Samaroo – malicious prosecution claim against CRA founders in B.C. Court of Appeal for failure to establish absence of “reasonable and probable cause”

The Samaroos were acquitted in 2011 on all counts of tax evasion respecting their having allegedly skimmed $1.7 million in cash from the restaurant operations of their corporation. In 2018, they were awarded damages (including $750,000 in punitive damages) by the B.C. Supreme Court in an action brought by them against CRA for malicious prosecution and breaching their s. 7 Charter rights.

This decision has now been reversed by the B.C. Court of Appeal. One of the requirements for finding malicious prosecution was that “the prosecution was undertaken without reasonable and probable cause.” Although CRA had suspected that the Samaroos had failed to provide the “till tapes” for one of the daily shifts to the corporate bookkeeper, Harris JA indicated that the trial judge had erred in considering “proof of the till tape theory, a particular scheme, as essential to proving the actus reus” of the alleged s. 239(1)(d) offence - whereas, in fact:

[T]he actus reus of the offence does not depend on proof of any particular method by which taxable income is not reported. What matters is the fact that taxable income is intentionally not reported. The existence of unreported taxable income does not necessarily require proof of how it is hidden or disguised.

As the “Samaroos failed to prove an absence of reasonable and probable cause to initiate and continue the prosecution,” their appeal was dismissed.

Neal Armstrong. Summary of Samaroo v. Canada Revenue Agency, 2019 BCCA 113 under General Concepts – Malicious Prosecution.

CRA comments on determining ITCs for financial institutions

ETA s. 141.02 provides somewhat detailed guidance on the need for financial institutions to consistently apply acceptable methodologies for determining their entitlement to input tax credits for GST/HST on their inputs. Comments of CRA included that:

  • Most inputs are likely to be allocable as “exclusive” or “direct” inputs rather than being “non-attributable” inputs.
  • Direct tracking of inputs should be used where possible rather than “causal allocation,” i.e., using a systematic methodology to approximate the use of inputs.
  • Generally, the categorization and allocation of business inputs must be done on an input-by-input basis and not based on “cost pools” of business inputs. The latter “are only appropriate where the use of grouping or pooling of business inputs results in the same ITC allocation result as would be arrived at if each business input was allocated without the use of pooling.”.

Neal Armstrong. Summary of 26 September 2018 Interpretation 167875 under s. 141.02(12).