News of Note

Finance is reviewing the interaction of the Class 14.1 transitional, and s. 85(1) rollover, rules

An individual transfers a directly-held pharmacy business to a wholly-owned Newco in 2017. On January 1, 2017, the cumulative eligible capital (CEC) account of $1.5 million, reflecting a previous purchase price for goodwill of $2 million, was transferred to Class 14.1 resulting in an undepreciated capital cost (UCC) balance of $1.5 million. The FMV of the goodwill at the time of the drop-down in 2017 is $2.2 million. The s. 85(1) elected amount is $1.5 million to avoid recapture. However, the shares received by the individual in exchange therefor would have a cost only of $1.5 million, whereas if the drop-down had occurred in 2016, it could still have occurred on a rollover basis with an elected amount of $2.0 million (i.e., 4/3 of the CEC balance), thereby giving rise to a cost of the same shares to the individual of $2 million.

After discussing the general policy behind the Class 14.1 transitional rules, Finance commented on this $500,000 cost discrepancy:

Subsections 13(38) and (39) and their interaction with other rules, including subsection 85(1), are the subject of a review by the Department of Finance Canada in order to ensure that the tax consequences of a rollover under subsection 85(1) are appropriate for the transferor and the transferee of property.

Neal Armstrong. Summary of 5 October 2018 Financial Strategies and Instruments Roundtable, Q.6 under s. 13(38).

CRA indicates that a dividend paid out of disability proceeds to fund purchase by survivor’s holdco might not have s. 55(2.1)(b) purpose

Opco is held equally by two unrelated individuals directly and through their respective Holdcos and, on the disability of one, Opco receives disability insurance proceeds and pays them as a special dividend to the healthy shareholder’s Holdco to fund the purchase by it of the other’s Holdco. CRA stated that there were insufficient facts to say much. However, it noted that in the circumstances described in 2015-0613821C6 it could give rulings on the application of the s. 55(2.1)(b) purpose test, and then stated:

Although in certain circumstances the dividend paid by Opco to the holding corporation of the active shareholder may not be considered to have any of the purposes described in paragraph 55(2.1)(b), that determination can only be made after a review of all the facts of a particular situation.

In commenting on the same scenario, Finance made very general comments, such as “The purpose of the payment or receipt of a dividend is determined according to the facts relating to the series of transactions or events of which the payment and receipt of the dividend is a part.”

Neal Armstrong. Summary of 5 October 2018 Financial Strategies and Instruments Roundtable, Q.5 under s. 55(2.1)(b) and of Finance response to Q.5 under s. 55(2.1)(b).

CRA finds that net rental income distributed by a spousal trust were excluded amounts given previous direct involvement of deceased husband

A spousal trust for Jocelyne (“Trust”) holds five commercial rental properties (generating $250,000 in annual rents, which had been managed by her deceased husband). Is the income generated by Trust and distributed to Jeanne subject to the tax on split income (TOSI) where the Trust investments are managed by Jocelyne’s son Julien?

CRA noted that there is a specific inclusion under s. (c)(ii)(D ) of “split income” for net rental income where a source individual (Julien) is actively engaged on a regular basis in the activities of Trust, irrespective of whether the rental income was property income or business income – but then went on to indicate that the distributed rental income likely would be excluded amounts (and, therefore, not subject to TOSI) under s. 120.4(1.1)(c)(ii) given that the deceased husband had carried on the rental operation directly rather than through a source individual, so that it could not have constituted a related business in respect of him.

CRA answered eight TOSI questions at the two 2018 APFF Roundtables. Honest, this is the last.

Next up: does s. 55(2) apply to an extraordinary dividend paid out of proceeds of an illness policy (Q.5); and why do the s. 85(1) rollover rules not work properly for Class 14.1 property transfers (Q.6)?

Neal Armstrong. Summary of 5 October 2018 APFF Financial Strategies and Instruments Roundtable, Q.4 under s. 120.4(1) – split income - (c)(ii)(D) and s. 120.4(1.1)(c)(ii).

CRA finds that stock market gains retain their excluded status for TOSI purposes when flowed through a trust

Jean on his decease left proceeds of an insurance policy and non-registered investments (which had been acquired by him out of accumulated savings) under a trust (“Trust”) for the exclusive benefit of his surviving spouse (“Jeanne,” also a Canadian resident), and with two of their children as trustees. Are the dividends and taxable capital gains generated by Trust from its investments in shares listed on a designated stock exchange, and interest on debt obligations, subject to the tax on split income (TOSI) when distributed to Jeanne qua beneficiary where the Trust investments are managed by: the two trustees; an independent third party; or a third child of Jean and Jeanne who is a stock broker?

CRA indicated that:

  • The distributed dividends and capital gains qualified for the exclusion from the “split income” definition for dividends and capital gains from shares listed on a designated stock exchange (signifying inter alia that CRA accepted that taxable capital gains designated under s. 104(21) retained their character as stock market gains).
  • As for the distributed interest income, it would of course not constitute income from a related business if Trust did not carry on a business.
  • On the other hand, if Trust did carry on business then, subject to the next point, CRA after indicating that Jeanne’s children were “source individuals” in respect of her (i.e., related by blood), stated that if in the alternative management scenarios posed “a source individual in respect of Jeanne is actively engaged on a regular basis in the activities of Trust related to earning income from the business, then the portion of the Distribution related to the Interest would come, directly or indirectly, from a related business in respect of Jeanne” – so that, subject to the next point, Jeanne would have been subject to TOSI on the distributed interest” (apparently even in the child as stock broker scenario).
  • However, even in the business income scenario, the distributed interest income would be excluded under s. 120.4(1.1)(c)(ii) because “the amount would have been an excluded amount in respect of an individual - Jean – who was, immediately before his death, Jeanne's spouse … if the amount were included in computing Jean's income for his last taxation year” (i.e., any such business would have been carried on by Jean himself rather than by a source individual).

Neal Armstrong. Summaries of 5 October 2018 APFF Financial Strategies and Instruments Roundtable, Q.3 under s. 120.4(1) – split income – (e)(ii)(C), related business – (a)(ii) and s. 120.4(1.1)(c)(ii).

CRA indicates that shares of a rental property company potentially may qualify as excluded shares for TOSI purposes

2018 STEP Roundtable Q.7 indicated that the shares of a corporation that did not generate business income (e.g., a corporation that generated rents that, given the level of activity, constituted income from property ) cannot qualify as excluded shares, whereas Examples 10 of CRA’s “Guidance on the application of the split income rules for adults” found that dividends received by siblings (now, over 25) following a sale of one of Real Estateco’s rental properties at a gain were from excluded shares, and Example 12 found that Spouse A, aged 65 who owned 95% of the shares of Investco, whose active business was actively managed by Spouse A (with no involvement of Spouse B) before it became a portfolio company, held that 95% bloc as excluded shares. When asked to reconcile Q.7 with the latter two examples, CRA stated:

[T]o demonstrate that the various exclusions were applicable not only to entities that earn income from an active business, such as a manufacturing corporation, but also to entities that carry on a business of earning income from property, such as a property rental business (in Example 10) or an investment management business (in Example 12), we had assumed that these corporations had a sufficient level of activity such that their income could be considered as derived from a business.

This response is essentially the same as that provided at 5 October 2018 APFF Roundtable, Q.9(a), except that some further comments were provided on Example 12 (regarding relief for spouses of business owners who turned 64 before the end of the year.)

Neal Armstrong. Summary of 5 October 2018 APFF Financial Strategies and Instruments Roundtable, Q.2 under s. 120.4(1) - excluded shares - (a)(i).

CRA indicates that more gain will be realized if an appreciated life insurance policy is distributed as redemption proceeds rather than a dividend-in-kind

2017-0690331C6 found that a dividend-in-kind by a subsidiary to its parent of a life insurance policy would result in proceeds of disposition to it equal to the greater of the policy’s cash surrender value (CSV) and its adjusted cost basis (ACB), rather than equaling the policy’s higher fair market value (FMV), given that the dividend would not result in consideration being given for the policy. CRA indicated that if the same policy had been transferred in payment of the redemption price for shares, its proceeds would equal the (higher) redemption price.

CRA went on to note that this difference in treatment may reflect an anomalous treatment for a dividend-in-kind, which has been brought to Finance’s attention.

Neal Armstrong. Summary of 5 October 2018 APFF Financial Strategies and Instruments Roundtable, Q.1 under s. 148(7).

CRA indicates that payment of one’s home office expenses by a spouse could give rise to s. 9 or 80 inclusions

Respecting the situation where the taxpayer, an independent contractor, incurred home office or automobile expense and another person (who might be a spouse) paid such expenses, CRA stated that the fact of the payment of the expenses by another need not detract from their having been incurred by the taxpayer – but found that the payment by the other might give rise to an inclusion under s. 9 (or s. 80).

All the answers at the (regular) October 2018 APFF Roundtable have now been uploaded in fully translated form. Next week we will start publishing translated CRA responses at the October 2018 Financial Strategies and Instruments Roundtable on a piecemeal basis.

Neal Armstrong. Summaries of 5 October 2018 APFF Roundtable, Q.16 under s. 18(1)(a) – incurring of expense, s. 9 – nature of income, and s. 13(21) – undepreciated capital cost - A and s. 13(21) – depreciable property.

National Money Mart – Ontario Court of Appeal finds that a supplier can issue an invoice after being assessed for the HST on the supply

A supplier failed to charge HST on sales of unrefined gold. When CRA discovered this, the supplier issued invoices to the purchaser showing the sale particulars and the applicable amount of HST as being unpaid, and following being assessed for this tax by CRA and paying it, sued the purchaser for its payment.

The purchaser relied on the requirement in ETA s. 224 for compliance with the disclosure requirement in s. 223(1) in order for the supplier to have the right to sue the purchaser for unpaid HST. In finding that the post-sale invoices satisfied this requirement, Brown JA stated:

Section 223(1) is silent on when a registrant must give disclosure of the tax payable to a recipient. The overwhelming weight of the jurisprudence, the CRA’s Policy Statement P-116, and the professional commentary have interpreted that statutory silence to mean that a registrant supplier can comply with the s. 223(1) disclosure obligations by delivering an invoice or receipt containing the prescribed information after the supply transaction.

Neal Armstrong. Summary of National Money Mart Co. v 24 Gold Group Ltd, 2018 ONCA 812 under ETA s. 223(1).

CRA declines to find that a CCPC with too many employees to have a specified investment business must have an active business

Following decisions such as Supreme Theatres that corporations with very little in the way of activity nonetheless qualified as carrying on an active business, s. 125 was amended to define “active business” to include any “business” other than a specified investment business or personal services business. CRA was essentially asked to confirm the proposition that a Canadian-controlled private corporation that employed six full-time employees in its rental operations (so that it thus did not carry on a specified investment business) will therefore qualify as carrying on an active business for purposes of s. 125(1) rather than being considered to earn income from property. CRA declined to give comfort on this point (stating that it was a question of fact) and not referring to any of the above history), but stated that the concept of “business” is “accorded an expanded meaning by subsection 248(1) by being defined in particular as including an undertaking of any kind whatever” (essentially, “activities” of any kind whatever in French).

Neal Armstrong. Summary of 5 October 2018 APFF Roundtable, Q.17 under s. 125(1) - “active business carried on by a corporation”.

Income Tax Severed Letters 17 October 2018

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