News of Note

Fink – Federal Court of Appeal considers it reasonable for CRA to not recommend FAA relief for s. 7 stock option benefits, as contrasted to s. 7 stock purchase plan benefits

The taxpayer realized s. 7 stock option benefits, and requested relief under the Financial Administration Act after having disposed of the shares in a subsequent year at a capital loss, with no ability to carry back that loss to offset any s. 7 benefit. On his appeal to the Federal Court of CRA’s refusal to recommend remission, he argued that he should be treated the same as employees of SDL Optics, who had been granted remission orders respecting their inability to offset capital losses against s. 7 income realized under a stock purchase plan.

Dawson JA agreed with the view of Roussel J below that it was reasonable for CRA to consider that the taxpayer’s stock option benefits were categorically different from the s. 7 benefits at issue in the SDL case, stating:

In the case of SDL Optics, employees who purchased shares through a stock option plan, as opposed to a stock payment plan, were not entitled to remission. This reflects the fact that a stock option plan provides greater flexibility to employees. The appellant had the option to purchase, or not purchase, shares at a designated price for a specified period of time regardless of shifts in market value during that period.

Incidentally, the Federal Court reasons (2018 FC 936) reveal that the taxpayer had got CRA to agree to a reduction pursuant to a Tax Court consent judgment to the quantum of his stock option benefits based on discounting the shares' value from their TSX trading price by 30%. Thus he had been largely successful in his argument that: "since the shares acquired were subject to numerous blackout periods and he was considered an insider of [the employer] for the purposes of the TSX and relevant shares legislation and regulations, the assessed value of the shares should not be more than 60% of the trading price on the date of purchase."

Neal Armstrong. Summaries of Fink v. Canada (Attorney General), 2019 FCA 276 under Financial Administration Act, s. 23(2) and ITA s. 7(1)(a).

CRA indicates that s. 104(13.4)(b) cannot be used to redirect only a targeted portion of a trust’s income

Any income arising from the application of the deemed disposition rules in s. 104(4) on the death of the relevant beneficiary, is subject to taxation in the trust unless a valid joint election is made under s. 104(13.4)(b.1) for that income to fall into the terminal return of the deceased. CRA is of the view that this election operates on all of the trust’s income.

Therefore, in the situation where the surviving spouse beneficiary of a spousal trust died in 2017 and all the s. 104(13.4)(b.1) conditions for making the joint s. 104(13.4)(b) were met, it nonetheless would not be possible to elect on only a portion of the capital gains deemed to be realized on the death of the surviving spouse respecting the trust’s portfolio of marketable securities. Thus, it would not be possible for only this amount to be included in the terminal return (where it would be subject to graduated rates), with the remaining portion of the deemed capital gains being retained at the trust level in order to use up trust capital loss carryforwards.

However, CRA noted that s. 104(13.1) or (13.2) designations generally are available to soak up trust losses.

Neal Armstrong. Summary of 16 August 2019 External T.I. 2018-0742431E5 under s. 104(13.4)(b).

CRA indicates that it has no specific policy for providing interest relief where its Registry falsely indicates that a registration number is valid

CRA indicated, respecting the GST/HST Registry for confirming GST/HST registration numbers, that “they have resolved the issue of false positives that occurred in some instances.” CRA went on to indicate that the “CRA does not currently have a specific policy to waive penalty and interest in cases where a supplier of real property relied on the GST/HST registry to verify a recipient’s GST/HST registration status and the GST/HST registry gave a false positive.”

Neal Armstrong. Summary of 28 February 2019 CBA Roundtable, Q.26 under ETA s. 221(2).

CRA confirms that the GST/HST test of an investment limited partnership is not a day-by-day numerical test

The ETA definition of an “investment limited partnership” (ILP) includes a test as to whether the “primary purpose” of the limited partnership was to “invest funds in property consisting primarily of financial instruments.” CRA confirmed its position in Notice 308 that this encompassed situations where the purpose of the LP was to invest in real estate through subsidiary LPs. CRA indicated that this was a primary purpose test which “would generally reflect its main or fundamental purpose at the time it was established – and may be reassessed later on.” Thus, the application of this test would not be affected solely by short-term changes in the value of investments due to market shifts.

Respecting this scenario:

On day one, LP uses 40% of the capital raised to acquire interests in other limited partnerships which invest in commercial and residential real property; and on day two, it uses the remaining 60% to invest directly in real property. On day 180, due to market shifts, the interests LP owns in the limited partnerships are now worth $1,200,000, while the direct investments in real property (acquired with 60% of the original capital) are now worth $800,000.

CRA stated that “we would likely conclude that the LP is not an ILP and further information would be required to determine if the LP … is considered an ILP at a later time."

Neal Armstrong. Summary of 28 February 2019 CBA Roundtable, Q.25 under ETA s. 123(1) - investment limited partnership.

Diamond Stacking – B.C. Supreme Court finds that a purchaser could not rely on a vendor’s GST exemption certificate where he knew of the property’s commercial use

ETA s. 194 provides that where a supplier has incorrectly certified that a sale of real estate was of exempt residential real estate, then the sale price is deemed to have been inclusive of the applicable GST/HST (so that it is that supplier rather than the purchaser who bears that GST/HST) – except where the purchaser “knows or ought to know that the supply is not an exempt supply.”

A vendor certified that an 18-acre property was an exempt residential property and, when it was assessed by CRA for failure to charge GST on the 16-acre portion of the property that was used as a blueberry farm, sued the purchaser for the GST thereon, plus interest. Saunders J found that the purchaser knew of the property’s use as a blueberry farm, and stated that the purchaser thus “possessed knowledge of fact which, through taking the appropriate advice a reasonable person would seek on those facts, would have indicated that GST would apply to the sale.” Accordingly, since the contract was silent on GST, the vendor was entitled under ETA s. 224 to recover its GST assessment from the purchaser – but had no entitlement to recover interest that CRA has assessed against it.

Neal Armstrong. Summaries of Diamond Stacking Co. Ltd. v Zuo, 2019 BCSC 1849 under ETA s. 194 and s. 224.

Income Tax Severed Letters 13 November 2019

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

Addy – Federal Court of Australia finds that the imposition of flat tax on UK working-holiday visa holders contravened the Treaty non-discrimination Article

The taxpayer, who was a British citizen aged 23, came to Australia on a “working visa” for a 20-month stint, during which period she was found by Logan J to be resident in Australia on ordinary principles. A citizen and resident of Australia would have largely escaped income taxation on her modest income as a waiter due to the right to deduct a “tax-free threshold.” However, the “backpacker tax” provisions of the Australian Rates Act provided that a “working holiday worker” (defined to include the holder of a working visa), was subject to 15% tax on her income.

The taxpayer, although an Australian resident, was by virtue of her citizenship a UK national and not an Australian national under the definition in the Australia-U.K. Treaty. That Treaty's non-discrimination clause (also found in many of the Canadian treaties) read:

Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances, in particular with respect to residence, are or may be subjected.

Logan found that this 15% tax contravened this clause given that “Only non-citizens can hold the types of visa that constitute a “working holiday visa.” He stated:

[T]he discrimination between resident derived income from the same source in Australia is based on nationality. It is disguised by the reference to “working holiday maker” but the definition of that term makes it plain that what the disguise covers is nationality. A resident “national” of Australia undertaking the same work as did Ms Addy … would have the benefit of the tax free threshold.

This decision potentially also is of corporate interest given that “nationals” can include companies deriving their status from the domestic law.

Neal Armstrong. Summaries of Addy v Commissioner of Taxation [2019] FCA 1768 under Treaties – Income Tax Conventions – Art. 25 and ITA s. 2(1).

S. 125(5.1)(b) passive income grind can be avoided by winding-up subs

The passive income grind to the small business deduction under s. 125(5.1)(b) potentially can be avoided by promptly winding-up an associated corporation that has realized a passive gain. For example , if Holdco holds Opco and Realtyco, and Realtyco realized a capital gain from selling its land in Year 1, and Realtyco is wound-up before the end of Year 1, then that passive gain will neither affect Opco’s ability to claim the SBD in Year 1 (because s. 125(5.1)(b) operates on a lagged basis) nor in Year 2 (because in Year 2, Realtyco no longer is associated with Opco).

If the passive asset with the accrued gain instead is held by Holdco, Holdco could drop-down that asset to a Newco sub under s. 85(1), with Newco then selling the asset and being promptly wound-up. However, in “this situation…GAAR must be considered” (see e.g., Iberville re using s. 85 to avoid rather than defer tax).

Neal Armstrong. Summary of Martin Lee and Thanusan Raveendran, “Possible Anomaly in the Passive Income SBD Grind?,” Canadian Tax Focus, Vol. 9, No. 4, November 2019, p.1 under s. 125(5.1)(b).

CRA reiterates that the ETA s. 167 is unavailable where a newly-formed Amalco immediately transfers its assets

Two registrants amalgamate to form AmalCo, which immediately thereafter sells all its assets to a registered third party. In finding that no ETA s. 167 election could be made for this sale, CRA indicated that the supplier (AmalCo) did not satisfy the s. 167 requirement that it have “established” the business (this was done by its predecessors, who were deemed separate persons) and by assumption it also did not satisfy the s. 167 requirement that it have “carried on” the business.

Neal Armstrong. Summary of 28 February 2019 CBA Roundtable, Q.24 under ETA s. 167(1).

CRA is reviewing the Medallion decision

In Medallion, a corporation that acted as a property manager for the rental properties of 10 non-arm’s length owner-corporations in consideration for a percentage of the rents, was found to qualify as the participant in a joint venture, notwithstanding that it had no ownership interest in the properties, so that it had validly elected to be the JV operator. In response to a question as to whether a participant in a joint venture includes a person who contributes solely property management services to the joint venture pursuant to a written joint venture agreement, CRA responded:

We are currently reviewing the extent to which the Medallion decision would affect our position with respect to the issue of who can be considered to be a participant in a joint venture for purposes of section 273 …, and this includes taking into consideration the issue described in the question.

Neal Armstrong. Summary of 28 February 2019 CBA Roundtable, Q.23 under ETA s. 273(1).