24 November 2015 Annual CTF Roundtable - Official Response

Presented by Randy Hewlett, Director, Financial Industries and Trusts Division, Income Tax Rulings Directorate, CRA and Stéphane Prud'Homme, Director, Reorganizations Division, Income Tax Rulings Directorate, CRA*

Question 1: T2 Late-Filing: Impact on Dividend Refund and RDTOH

Over the past few years, a number of court decisions1 have confirmed the CRA’s position that a corporation is not entitled to a dividend refund where it pays a dividend for which it would otherwise be entitled to the refund but it fails to file its applicable income tax return within the three-year period (the “Period”) required by subsection 129(1) 2.

In these cases, the position of the CRA has been that the corporation’s refundable dividend tax on hand (“RDTOH”) balance must still be reduced by the amount of the denied refund (see document no. 2012- 0436181E5).

The CRA has also required that a dividend recipient pays Part IV tax if it receives a dividend from a dividend payer that is a connected corporation that had RDTOH at the end of a particular taxation year even if the dividend payer is denied a dividend refund because its income tax return was not filed within the required Period.

Recently, in Presidential MSH Corporation v. The Queen3 and Nanica Holdings Limited v. The Queen4, the Tax Court of Canada held that a corporation’s RDTOH balance is only reduced by the amount of the dividend refund actually received by the corporation.


a) Will the CRA follow these recent court decisions that have not required the reduction of a corporation’s RDTOH balance where it was denied a dividend refund because it failed to file its applicable income tax return within the required Period?

b) Based on the decisions in Presidential MSH and Nanica Holdings will the CRA change its position regarding the payment of Part IV tax by a dividend recipient in the circumstances described above?

CRA Response

The CRA will follow these recent Tax Court of Canada decisions with respect to the computation of a corporation’s RDTOH balance. In 1057513 Ontario Inc. v. The Queen5, the Federal Court of Appeal has also recently stated, in obiter, that unclaimed dividend refunds did not reduce the corporation’s RDTOH balance.

In our view, the court’s objective was to achieve a balance between fostering compliance in the context of Canada’s self-assessment system (the denial of the dividend refund) and continuing respect of the integration principle (the non-reduction of the RDTOH balance).

As well, the CRA will consider that a dividend recipient’s Part IV tax liability with respect to a dividend received from a connected dividend payer will be determined according to the dividend refund actually received by the dividend payer.

The impact of the recent decisions in this particular context, as well as in the context of interpreting other provisions of the Income Tax Act (the “Act”) referring to the notion of “dividend refund”, will be monitored by the CRA.

1 See, among others, Tawa Developments Inc. v. The Queen, 2011 TCC 440, Ottawa Ritz Hotel Company Limited v. The Queen, 2012 TCC 166 and 1057513 Ontario Limited v. The Queen, 2014 TCC 272 (affirmed by the Federal Court of Appeal, 2015 FCA 207).

2 Unless otherwise stated, all statutory references herein are to the Income Tax Act.

3 2015 TCC 61 (“Presidential MSH”).

4 2015 TCC 85 (“Nanica Holdings”).

5 Supra note 1 at paragraph 6.

Question 2: Salary deferral arrangement rules

Amounts deferred under a salary deferral arrangement (SDA) are included in income under paragraph 6(1)(a), by virtue of subsection 6(11), in the year they are earned.

An SDA is defined in subsection 248(1) as being a plan or an arrangement under which any person has a right, in a taxation year, to receive an amount in a subsequent year where it is reasonable to consider that one of the main purposes for the creation or existence of the right is to postpone tax payable under the Act by the taxpayer in respect of an amount that is, or is on account or in lieu of, salary or wages for services rendered by him or her in the year or a preceding taxation year.

There are a number of types of plans that are expressly exempted from being an SDA, these include: a three-year bonus plan described in paragraph (k) and a prescribed plan under paragraph (l) that is a deferred share unit (DSU) plan designed to fit within the parameters of paragraph 6801(d) of the Regulations.
Paragraph (k) requires the bonus to be paid by the end of the third calendar year following the taxation year in which the services to which the bonus relates were rendered. Paragraph 6801(d) requires that payment be made only after a participant’s death, retirement or loss of office or employment.

(a) Conversion of units in a three-year bonus plan to units in a DSU plan

In the past, the CRA has provided rulings where units of a 3-year bonus plan that satisfied the conditions of paragraph (k) in the definition of SDA could be converted, without realizing tax, to units of a DSU plan that satisfied the conditions of paragraph 6801(d) of the Regulations. Why has the CRA discontinued providing such rulings?

CRA Response

When considering the conditions that must be satisfied under paragraph (k) of the definition of SDA and paragraph 6801(d), a conversion of rights under a 3-year bonus plan to rights under a DSU plan, or vice versa, will not satisfy the conditions under either paragraph (k) or 6801(d). In such circumstances, the conversion of rights under what was a 3-year bonus plan could effectively permit the payment of an amount after the third calendar year, and the conversion of rights under what was a DSU plan could result in the payment of an amount prior to death, retirement or termination of employment. Accordingly, we are of the view that the operation of these provisions does not permit the terms of a plan to provide a taxpayer with the flexibility to subsequently convert those rights under a paragraph (k) plan for rights under a paragraph 6801(d) plan or vice-versa. Therefore, the terms of a plan cannot under any circumstance provide a taxpayer with conversion rights.

(b) Interaction between Regulation 6801(d) and section 409A of the Internal Revenue Code

Where a DSU plan includes participants who are subject to income taxation in the United States, the plan must meet the requirements of section 409A of the Internal Revenue Code in addition to those of paragraph 6801(d). Can a DSU plan provide for payments to be made in accordance with the permissible distributions events in section 409A and still comply with the requirements of paragraph 6801(d)?

CRA Response

The timing of payments under section 409A can be earlier than the timing of a factual loss of office or employment required under paragraph 6801(d). For example, section 409A permits payments to be made as a result of a reduction in service to less than 20% of the previous level, a change in control of the employer or an unforeseeable emergency.

Consequently, it is our view that a DSU plan could not provide for the full range of distribution events permitted by section 409A with respect to participants who are subject to both Canadian and U.S. taxation, and still comply with paragraph 6801(d).

(c) Effective date of positions in (a) and (b)

When do these revised positions become effective?

CRA Response

Advance income tax rulings provided in respect of 3-year bonus plans and DSU plans that contained terms permitting conversions or payments described in (a) or (b) above are in the process of being revoked. The revocation will not apply to any units credited on or before the date specified in the revocation letter (including units with unexercised conversion rights on that date) or to additional units credited at any time in respect of those units, for example, dividend equivalents and proportional adjustments due to stock splits or corporate reorganizations.We understand that some taxpayers established 3-year bonus plans and DSU plans that relied on the positions reflected in these published rulings but did not themselves obtain a ruling. The CRA will continue to apply the positions in these published rulings to any units credited on or before November 24, 2015 (including units with unexercised conversion rights on that date), as well as to additional units credited at any time in respect of those units, for example, dividend equivalents and proportional adjustments due to stock splits or corporate reorganizations.

Question 3: Residency of a Trust for Provincial Income Tax Purposes

The central management and control test articulated by the Supreme Court of Canada (“SCC”) in Fundy Settlement v. Canada (“Fundy”)6 is determinative in establishing residency of a trust. There have been two recent cases involving the determination of the province of residence of a trust.

In Discovery Trust v. Canada (National Revenue)7 (“Discovery Trust”), the issue was whether beneficiaries and their advisers exercised central management and control such that the trust would be resident in Newfoundland, or whether the trustees exercised central management and control such that the trust would be resident in Alberta. In that case, the Supreme Court of Newfoundland and Labrador decided that the trust was resident in Alberta.

In Boettger c. Agence du revenu du Québec8 (“Boettger”) the issue was whether the trust was resident in Quebec or in Alberta. The Court of Québec (Civil Division) found that the Alberta trustee’s role was to passively hold the assets of the trust and follow the actions dictated by the professional advisors; accordingly, the Court determined that the trust was resident in Quebec.

Can the CRA provide its views regarding the application of the central management and control test in establishing the residency of a trust for provincial income tax purposes in light of these two decisions?

CRA Response

The CRA’s view regarding the application of the central management and control test in establishing the residence of a trust for provincial income tax purposes has not changed in light of the above decisions. The following comments from the courts are indicative of how the test applies in a trust context. In Garron Family Trust v. The Queen, Woods J. of the Tax Court of Canada concluded that management and control of both trusts was located in Canada because based on the evidence as a whole, the individuals who made the “substantive decisions respecting the trusts, either directly or indirectly through advisers that they directed”, were located in Canada. 9

At the Federal Court of Appeal (“FCA”), Sharlow J.A. provided the following guidance regarding the meaning of central management and control in a trust context: “By analogy from De Beers, supra, the task is to determine where a trust ‘keeps house and does business,’ i.e. where the power and discretion of the trustee are really being exercised.”10

The SCC affirmed the FCA decision and similarly cited De Beers, the landmark decision on corporate residence: “As with corporations, residence of a trust should be determined by the principle that a trust resides for the purposes of the Act where ‘its real business in carried on’, which is where the central management and control of the trust actually takes place.” 11

Case law on the meaning of the test in a corporate context supports that central management and control encompasses the concept of high-level, strategic decision making12 and governance rather than day to day functions such as practical business management. In our view, that fact that a trustee discharges their administrative and fiduciary obligations does not necessarily lead to the conclusion that the trustee exercises the level of substantive decision making that meets the central management and control test.
Determining the location in which the central management and control of a trust takes place continues to be a question of fact. Relevant factors may include, for example, whether the beneficial interests therein are closely held such as in a personal or family trust arrangement in which the beneficiaries or the settlor might be in a position to exercise management and control over the trust, or are widely held by members of the public such that the trustee does in fact have management and control over the trust. Paragraphs 1.5 and 1.6 of Income Tax Folio S6-F1-C1: Residence of a Trust or Estate provide additional guidance in respect of determining whether central management and control of the trust rests with someone other than the trustee.

6 Fundy Settlement v. Canada (“Fundy”), (2012 SCC 14); affirming St. Michael Trust Corp. v. Minister of National Revenue, (“St. Michael’s”), (2010 FCA 309); affirming Garron Family Trust v. The Queen, (“Garron”), (2009 TCC 450)

7 Discovery Trust v. Canada (National Revenue), (2015 NLTD(G)86

8 Boettger c. Agence du revenu du Québec JL3793, 2015 QCCQ 7517

9 Garron, supra para. 252

10 St. Michael’s, supra para. 62

11 Fundy supra para. 15 citing De Beers Consolidated Mines, Ltd. V. Howe, [1906] A.C. 455 (H.L.), at para. 458

12 This description was used in a UK decision, Laerstate BV v HM Revenue & Customs [UKFTT 09 (TC).

Question 4: GAAR Committee Decision – Planning Involving the Intentional Use of Subsection 55(2) to Generate Capital Gains

Consider the following scenario:

Mr. A is one of the shareholders of OPCO and wants to extract OPCO’s surplus allocable to his shares, but not in the form of taxable dividends.

Approximately 25% of the fair market value (“FMV”) of the OPCO shares owned by Mr. A is attributable to something other than safe income on hand (“SIOH”).

The series of transactions described below is undertaken.

1) Mr. A transfers some of his OPCO shares to a new corporation (“HOLDCO A”) on a rollover basis pursuant to subsection 85(1) in return for HOLDCO A shares.

2) OPCO redeems the OPCO shares held by HOLDCO A. Because the amount of the dividend deemed to arise on the share redemption is greater than the SIOH attributable to those shares, and because no designation is made under paragraph 55(5)(f), the entire amount of the dividend is recharacterized by subsection 55(2) as proceeds of disposition and results in a capital gain to HOLDCO A.13 Consequently, HOLDCO A adds the non-taxable portion of the capital gain to its capital dividend account (“CDA”).

3) HOLDCO A then pays a capital dividend to Mr. A equal to its CDA balance.

The overall result of this series of transactions is that the amount of tax payable by Mr. A, OPCO and HOLDCO A, with respect to OPCO’s surplus distributed first to HOLDCO A and then to Mr. A, is significantly less than the amount of tax that would have been payable if OPCO had distributed the same surplus to Mr. A as taxable dividends.


Is the CRA of the opinion that the GAAR applies to this particular series of transactions taking into consideration, among others, the Tax Court of Canada decisions in Evans v. The Queen14, Gwartz v. The Queen15 and Descarries v. The Queen16 and, notably, the following comments of the court in the Descarries decision:

As stated by the appellants in their written submissions, I noted in Gwartz v. The Queen that the Act does not contain any general prohibition stating that any distribution by a company must be done in the form of a dividend. However, I also specified in that case that, although the taxpayers may arrange to distribute surpluses in the form of dividends or of capital gains, that option is not limitless. Any tax planning done for that purpose must comply with the specific anti-avoidance provisions found in sections 84.1 and 212.1 of the Act17.

CRA Response

A file with a similar series of transactions (the “Transactions”) was recently referred to the GAAR Committee for consideration.

Although the GAAR Committee considered that the Transactions circumvented the integration principle, it recommended that the GAAR not be applied. The GAAR Committee was of the view that it would be unlikely that the GAAR could be successfully applied to the Transactions given the current state of the jurisprudence.

It was also recognized that results similar to those obtained from the Transactions could be achieved in a variety of ways. For example, in a corporate structure similar to that in the Transactions, instead of using subsection 55(2), HOLDCO A could realize a capital gain by selling its OPCO shares to a new sister corporation or by transferring its OPCO shares to OPCO in exchange for new OPCO shares. The CRA is nevertheless concerned with the type of surplus stripping arrangement described above and has expressed those concerns to the Department of Finance.

The CRA will still maintain its position of applying the GAAR and/or subsection 84(2) to cases like The Queen v. Macdonald18 where a taxpayer uses losses or other tax shelter to reduce a capital gain realized as part of a surplus stripping scheme. Also, the CRA will rely on the reasoning in Descarries19 where a taxpayer seeks to extract corporate surplus in a manner contrary to the object, spirit or purpose of specific anti-avoidance provisions, such as sections 84.1 and 212.1.

13 Paragraph 55(3)(a) does not apply to prevent the application of subsection 55(2) in this case.

14 2005 TCC 684.

15 2013 TCC 86.

16 2014 TCC 75 (“Descarries”).

17 Idem, at paragraph 43.

18 2013 FCA 110.

19 Supra note 16.

Question 5: Private health services plan update20

Does the CRA have an update regarding its position on what qualifies as a private health services plan (“PHSP”)?

CRA Response

After a detailed internal review and consultation with Finance Canada and external stakeholders, the CRA has revised its position on what qualifies as a PHSP. Our previous position was that all medical expenses covered under a plan had to be eligible for the medical expense tax credit (“METC”) for the plan to qualify as a PHSP. That is, it was an all or nothing test. Effective January 1, 2015, a plan is considered a PHSP as long as the premiums paid under the plan relate “all or substantially all” to medical expenses that would otherwise qualify for METC (assuming all other conditions to be a PHSP are met).Our revised position will be posted on the CRA website shortly.

L’ARC compte-t-elle mettre à jour sa position en matière de régime privé d’assurance-maladie (RPAM)?

Réponse de l’ARC :

Après avoir effectué un examen approfondi à l’interne et consulté le ministère des Finances Canada ainsi que des parties intéressées externes, l’ARC a modifié sa position sur ce que constitue un RPAM. Selon notre position antérieure, un régime était considéré comme un RPAM si les frais médicaux que le régime couvrait étaient admissibles au crédit d’impôt pour frais médicaux (CIFM). C’est-à-dire, c’était tout ou rien. Depuis le 1er janvier 2015, un régime est considéré comme un RPAM dans la mesure où « la totalité ou presque » des primes versées aux termes du régime se rapportent à des frais médicaux qui seraient par ailleurs admissibles au CIFM (en supposant que soient remplies toutes les autres conditions d’admissibilité pour un RPAM). Notre nouvelle position sera publiée sous peu sur le site Internet de l’ARC.

20 Question 5: Régime privé d'assurance-maladie

Question 6

Question 6(a): Section 55 – Basic Concepts – Significant Reduction of Value Purpose Test

As one of the conditions that could trigger the application of subsection 55(2), proposed clause 55(2.1)(b)(ii)(A) refers to a dividend that is received on a share that is held as capital property by the dividend recipient and one of the purposes of the payment or receipt of the dividend is to effect a significant reduction in the fair market value of any share.

In the case of a large dividend, it is fair to say that the payment of such a dividend will in fact reduce the value of the shares of a corporation. If we assume that the reduction of value is significant, can the CRA provide guidance on the application of the purpose test above? In particular, what factors will the CRA consider when deciding whether the factual reduction of value was the purpose for declaring the dividend?

Continuing with proposed clause 55(2.1)(b)(ii)(A), can the CRA describe the factors or tests they would consider in deciding whether a reduction of value is significant?

CRA Response

The determination of purpose is based on facts that are particular to the situation, including, but not limited to, the actions taken by the parties to the dividend and their motivation. In Ludco (2001 SCC 62), the Court was of the view that “in the interpretation of the Act, as in other areas of law, where purpose or intention behind actions is to be ascertained, courts should objectively determine the nature of the purpose, guided by both subjective and objective manifestations of purpose.” Although a dividend on a share would normally result in a reduction of value of the share, it’s not the result that determines the application of proposed subsection 55(2.1). It’s the purpose and the motivation behind the purpose that could be established by finding the answer to questions such as “What does the taxpayer intend to accomplish with a reduction in value? How would such reduction in value be beneficial to the taxpayer? What actions did the taxpayer take in connection with the reduction in value?” Without limiting the application of the purpose test, a dividend that is directly or indirectly instrumental in the creation of an accrued loss on any share that may be used, or has the potential to be used, to shelter a gain on some other property provides an indication that the FMV reduction purpose exists (for example, one might consider transferring a property with an accrued income or capital gain to the corporation that issued shares that have an accrued loss.) Furthermore, it is also necessary to ascertain that the purpose of the dividend is not to increase the cost of property. For example, and without limiting the application of the purpose test, the use or possibility of using an increased cost amount of properties to shelter a gain is an indication that the purpose of the dividend is to increase cost.

The technical notes to the July 31, 2015 Legislative Proposals stated: “the “one of the purpose” tests in subparagraphs (b)(i) and (ii) are to be applied separately to each dividend. For example, subparagraph (b)(ii) could apply to a dividend one of the purposes of which is to increase significantly the cost of any property even if subparagraph (i) applies (or does not apply because one of the purposes was not to reduce significantly a gain on any share).” As such, the purpose tests in proposed subparagraph 55(2.1)(b)(ii) could apply even if the dividend does not satisfy the purpose in proposed subparagraph 55(2.1)(b)(i) (i.e., there is no gain on the shares).

Whether a reduction of value is significant is a question of fact and could be measured in terms of an absolute dollar amount or on a percentage basis.

Question 6(b): Loss Consolidations and Section 55

A standard loss consolidation arrangement that has been sanctioned by the CRA in several Rulings is the “preferred share debt loop”. Section 55 can now apply where “one of the purposes” of the payment or receipt of the dividend is to effect a significant reduction in the FMV of any share OR a significant increase in the cost of property of the dividend recipient immediately after the dividend. There are good arguments that the proposed rules should not impact standard in-house loss consolidation structures. First of all, it is unlikely that the amount of the dividends paid each year will be significant. In addition, the sole purpose of the dividend is simply to accommodate the loss consolidation arrangement, so there is a strong argument that the “one of the purposes” test would not be met. Finance has also indicated that it is not the intent of the new rules to create issues for the normal cash movement of funds within Canadian corporate groups or conventional loss consolidation structures. Can the CRA confirm that standard in-house loss consolidation arrangements would not be caught by the “one of the purposes” tests?

CRA Response

Yes, in-house loss consolidations that were only designed to move losses between related or affiliated corporations and on which we have ruled favourably in the past would not be considered to have a purpose described in proposed subsection 55(2.1). An indication that such purpose is absent in similar loss consolidations is that any ACB that is created in the loss consolidation is eliminated on the unwind of the loss consolidation structure.

This was confirmed in the opinion provided by the CRA on the non-application of proposed subsection 55(2.1) in rulings recently issued on loss consolidation transactions.

Question 6(c): Calculating Safe Income Attributable to a Share

Under the new rules, a dividend will not be subject to subsection 55(2) if the dividend does not exceed the safe income that can reasonably be considered to contribute to the capital gain that could be realized on a disposition at FMV, immediately before the dividend, of the share on which the dividend is received. Many corporations have fairly complex share structures and the existing CRA administrative positions will not cover safe income allocation issues which will emerge in future safe income calculations under the proposed rules.

For example, assume that a corporation has issued shares that are non-participating and non-voting but do allow for discretionary dividends. In addition, the corporation has issued common shares and conventional estate freeze preferred shares. As there was safe income on hand at the time of the freeze, the safe income on the original common shares is now attributable to the preferred shares and additional safe income was earned after the freeze which is attributable to the common shares. As the discretionary dividends shares likely have nominal value, there would be no capital gain and no safe income could attribute to those shares. So, if a dividend is actually paid on the discretionary dividend shares, how would this impact the allocation of safe income attributable to the other two classes of shares issued by the corporation?

CRA Response

Whether participating or non-participating shares that are entitled to discretionary dividends have a value immediately before a dividend is paid is a valuation issue.

Where non-participating discretionary shares have no accrued gain, no safe income could reasonably be considered to contribute to the capital gain that could be realized immediately before the dividend since no such capital gain exists. As such, the dividend would be subject to the purpose test in proposed subsection 55(2.1), i.e., whether a purpose of the payment of such dividend is to significantly reduce the value or the capital gain of the other shares of the payer corporation or to significantly increase the cost of properties held by the dividend recipient. As explained earlier in the response to part (a) of the question, the purpose can only be determined by a review of all the facts.

The dividend on the non-participating discretionary shares results in a reduction of the safe income that could reasonably be considered to contribute to the capital gain on the participating shares since the capital gain has been reduced by the dividend and the portion of the income that was paid out as a dividend is no longer available to support such capital gain.

However, where the dividend on the non-participating shares is found to be subject to the application of subsection 55(2), we are prepared to accept that the safe income on the participating shares is not affected by the dividend.

Where dividends are paid on participating or non-participating discretionary shares that have an accrued gain, the dividends could be considered to be safe income dividends to the extent of the safe income that could reasonably be considered to contribute to the capital gain on such shares.

Question 6(d): Use of 84(3) dividend

Proposed paragraph 55(2.1)(b) does not apply to a deemed dividend under subsection 84(3). Could one rely on a deemed dividend under subsection 84(3) to avoid the application of subsection 55(2) to the extent that the tests under paragraph 55(3)(a) are met?

CRA Response

In addition to the prevention of capital gain strip, the scheme of proposed subsection 55(2) is to counter artificial generation or manipulation of cost, or reduction of FMV of a share as the reduction could potentially result in a fabricated loss on the share. The proposed introduction of subsection 55(2.2) to prevent the use of a high-low stock dividend to reduce the value of the shares on which the stock dividend is paid (unless the stock dividend is deemed to come from safe income under proposed subsection 55(2.3)) supports that scheme. So does the restriction of the application of proposed paragraph 55(3)(a) to dividends received on a redemption, acquisition or cancellation of shares since dividends in kind that have a purpose of increasing ACB or reducing FMV cannot be exempt simply on the basis that there is no unrelated persons involved. A redemption or cancellation of shares would normally result in the elimination of the ACB of the shares that have been redeemed or cancelled, and therefore, would not normally be helpful in achieving the ACB creation or FMV reduction objective. The technical notes to the July 31, 2015 legislative proposals stated the following:

“The amended exception in paragraph 55(3)(a) for related-person dividends is intended to facilitate bona fide corporate reorganizations by related persons. It is not intended to be used to accommodate the payment or receipt of dividends or transactions or events that seek to increase, manipulate, manufacture or stream cost base.”

As such, an attempt to artificially create or unduly preserve ACB in a reorganization that would be exempt under either paragraph 55(3)(a) or 55(3)(b) would frustrate the object, spirit and purpose of the provision and the CRA would seek to apply GAAR to such situation. Examples of situations that are considered offensive include the following:

  • A note or other property (other than assets owned by the dividend payer at the beginning of the series that includes the redemption) received by a dividend recipient as consideration for a redemption of shares in a reorganization that is exempt under paragraph 55(3)(a) is used by a person to generate ACB that is significantly greater than the ACB of the shares that were redeemed.
  • ACB is streamed prior to a reorganization that is exempt under paragraph 55(3)(a) or 55(3)(b) such that the redemption only applies to low ACB shares and high ACB is preserved in shares that are not redeemed.

Question 6(e): Creditor proofing

One very common transaction that has been drawn into question is using a holding company for asset protection purposes. Assume that a corporation is worth $10 million and has safe income of $2 million. The owners of Opco (an individual and his spouse) want to protect the value that they have accumulated. Their advisors determine that a dividend of $8 million could be paid to a newly formed holding company without causing commercial and corporate law issues (they will transfer their Opco shares to Holdco under section 85 and then declare the dividend). Once the dividend is received, Holdco will loan the funds back to Opco. Some of the loan will be secured against assets. The owners have no plans to sell Opco, and even if they do sell, the sale could be structured as a sale of Holdco since it should qualify for the capital gains exemption. As there has factually been a significant reduction of value of Opco’s shares, can the CRA comment on whether proposed subsection 55(2) will apply? Will the securitization dividend and loan back have to be limited to safe income despite the apparent lack of intention to sell Opco from Holdco?

CRA Response

We understand that a creditor-proofing transaction could be achieved by having Holdco lend money to Opco either before or after the payment of the dividend. When Opco pays a “lumpy” dividend such as in this creditor-proofing transaction in order to significantly reduce the value on the Opco shares, the apparent purpose of the payment of the dividend for the application of subsection 55(2) is to reduce the value on the Opco shares. When such purpose is present, subsection 55(2) applies to the dividend. We would like to further elaborate on our response as follows:

  • The deduction under subsection 112(1) on inter-corporate dividends has the purpose of avoiding double-taxation on income earned by a corporation that has already been subject to tax. In addition to other restrictions established elsewhere, subsection 55(2) essentially establishes limits to that deduction. Hence, one cannot presume that the scheme of the Act is to exempt all payments made between corporations that could be considered to be a dividend under corporate law.
  • The scheme of the Act restricts the increase in tax-free amounts that a shareholder may derive from a corporation without any payment of tax. For example, any exchange of shares of a corporation by a shareholder is subject to tax when non-share consideration is received in excess of the ACB of the shares disposed of on the exchange.
  • The payment of a dividend that is in excess of the amount of the after-tax income of a corporation for the purpose of significantly reducing the value of the shares by essentially converting a significant amount of accrued value on a share of a corporation into full ACB debt that could be sold or repaid without any tax implication should be subject to tax under the scheme of the Act, as supported by proposed subsection 55(2).
  • The fact that the purpose of the dividend is also to achieve creditor proofing would not alter that conclusion.

Question 7: Entity Classification

a) Can the CRA outline its views concerning the implications, if any, of the United Kingdom’s Anson v. HMRC case (“Anson case”; [2015] UKSC 44, United Kingdom Supreme Court) in respect of entity classification in Canada, in particular the general classification of United States Limited Liability Companies (“LLCs”) as corporations for the purposes of the Income Tax Act (“Act”)?

b) Can the CRA also provide us with an update of its deliberations on “limited liability partnerships” (“LLPs”) and “limited liability limited partnerships” (“LLLPs”)?

CRA Response

a) Although foreign countries’ court cases generally have no precedential value under Canadian law, we do consider them, especially when our laws are rooted in similar legal systems. With the Anson case, we find both the reasons in the United Kingdom Supreme Court case as well as the Court of Appeal case to be of value. However, it is our view that those cases essentially deal with treaty interpretation issues in the application of the United Kingdom – United States Tax Convention and that their overall conclusions are not relevant for entity classification in Canada. Thus, we are maintaining our position that LLCs would generally be considered to be corporations for the purposes of the Act, based on the application of our usual “two-step approach”. We say “generally” because we haven’t analyzed every state’s LLC statute and have not updated very many of our opinions for any possible changes to the statutes we have previously considered.

b) As for the status of our deliberations in respect of the classification of LLPs and LLLPs governed by the laws of the State of Florida, we have not yet concluded our analysis but we are heavily leaning towards treating them as corporations for the purposes of the Act. We have received one very good submission thus far, but would like hear from others as well. Thus, we will hold off concluding for a few more weeks in the hopes of receiving additional submissions.

We have more recently been asked to consider the treatment of similar entities governed by Delaware law. Our preliminary views in this regard are that they are virtually identical to their Florida counterparts. We will similarly hold off concluding on these Delaware entities in the hopes of receiving submissions on them.

Question 8: Liquidation of a foreign affiliate and upstream loans

If a foreign affiliate (the creditor affiliate) has made a loan to its Canadian shareholder (Canco), and the loan is not repaid within two years, the loan would be subject to the upstream loan rules such that the amount of the loan is included in Canco’s income pursuant to subsection 90(6) of the Income Tax Act. Would the loan from the creditor affiliate to Canco be considered to be repaid for the purposes of the upstream loan rules when the creditor affiliate is liquidated and the upstream loan is not repaid prior to or as part of the liquidation?

CRA Response

We would not consider the loan to have been repaid for purposes of the upstream rules as a result of the liquidation in the described situation. Therefore, Canco would not be entitled to a deduction under subsection 90(14).

This and other issues with the upstream loan rules were brought to the attention of the Department of Finance by the CPA-CBA Joint Committee in their submission dated August 7, 2013. We anticipate that this issue will likely be resolved eventually through legislative amendment.

Question 9: Sub-subclause 95(2)(a)(ii)(D)(IV)(2): Fiscally Transparent Entities

One of the exceptions from treating interest income earned by a foreign affiliate of a Canadian taxpayer as FAPI is found in clause 95(2)(a)(ii)(D) of the ITA. In general terms, this provision applies when the interest is payable to the foreign affiliate by another foreign affiliate of the taxpayer (the “Second Affiliate”) on amounts borrowed by the Second Affiliate to acquire shares of another corporation (the “Third Affiliate”) where the acquired shares constitute excluded property and a number of other conditions are met. One of those conditions is that both the Second Affiliate and the Third Affiliate must be subject to taxation in a country other than Canada or their direct or indirect members or shareholders must be subject to taxation in a country other than Canada in respect of all or substantially all of the particular affiliate’s income for the relevant taxation year. This latter provision is to enable limited liability companies and other similar fiscally transparent entities to meet the conditions. However, an issue arises where both the Second Affiliate and the Third Affiliate are fiscally transparent. Due to the interest expense incurred by the Second Affiliate as well as other expenses that the Second

Affiliate may incur, it is possible that less than 90% of the income earned by the Third Affiliate will be included in the income of the ultimate non-transparent member.

Can the CRA confirm that it will interpret sub-subclause 95(2)(a)(ii)(D)(IV)(2) such that the condition will be met with respect to the Third Affiliate provided that all or substantially all of the Third Affiliate’s net income is included in the income of Second Affiliate and the Second Affiliate meets the requirements of sub-subclause 95(2)(a)(ii)(D)(IV)(2)?

CRA Response

In general, for the purpose of subsection 95(2) of the Act, it is our view that “subject to income taxation” means that the income is included in the computation of the taxable income in the relevant country. A shareholder or member of a fiscally-transparent entity would still be considered to be subject to income taxation on the income earned by that fiscally-transparent entity notwithstanding that it does not pay any tax in a particular year because the entity has incurred interest or other expenses in the year. In our view, the requirement in sub-subclause 95(2)(a)(ii)(D)(IV)(2) that the shareholders or members of the Third Affiliate are subject to income taxation “on all or substantially all of the income” of that affiliate does not mean the Second Affiliate cannot incur expenses. Rather, it means that the requirement will not be met where, generally, more than 10% of the income of the Third Affiliate is ultimately not subject to income taxation in a country other than Canada (e.g., a 20% shareholder or member is tax-exempt or otherwise not subject to income tax in the foreign jurisdiction). Therefore, provided that the requirements in sub-subclause 95(2)(a)(ii)(D)(IV)(2) are otherwise satisfied, the fact that the Second Affiliate has incurred interest or other expenses will not cause the requirements of sub-subclause 95(2)(a)(ii)(D)(IV)(2) not to be met.

Question 10: Thin Capitalization – Debt Denominated in Foreign Currency

Where a specified non-resident shareholder of a Canadian corporation (“Canco”) makes a contribution in foreign currency to Canco in exchange for shares of Canco and a loan denominated in foreign currency, the paid-up capital amount of the shares is denominated in Canadian dollars at the time the shares are issued, thus effectively fixing the “equity amount” in Canadian dollars for the thin capitalization ratio in subsection 18(4) of the Income Tax Act (“Act”). However, when determining the amount of the “outstanding debts to specified non-residents” at any particular time, what foreign exchange rate should be used to determine that amount in Canadian dollars: the exchange rate on the date the debt arose (i.e., the loan was issued) or the exchange rate on each calculation date?

CRA Response

Subsection 261(2) of the Act is applicable when determining the amount of outstanding debts to specified non-residents for purposes of the thin capitalization computation in subsection 18(4) of the Act. Provided a taxpayer did not make a functional currency election under subsection 261(3), subsection 261(2) requires that Canadian currency be used in determining the Canadian tax results of the taxpayer and an amount expressed in foreign currency be converted to Canadian currency using the relevant spot rate for the day on which the particular amount arose. Since in the situation described, the amount of the debt arose when the loan was issued, the foreign currency amount of the loan should be converted to Canadian dollars for purposes of the computation in subsection 18(4) using the relevant spot rate for the day on which the loan was issued.

Question 11: Impact of the Descarries Decision on Intergenerational Family Business Transfer Tax Planning

In the advance income tax ruling F 2005-0134731R3 (October 26, 2006), an individual (“Mr. X”) owned all of the issued and outstanding shares of a holding corporation (“HOLDCO”). In turn, HOLDCO owned all of the issued and outstanding shares of an operating corporation (“OPCO”). Mr. X wanted to retire and transfer his HOLDCO shares to his 2 children who were actively involved in the OPCO business. Under the proposed transactions, Mr. X sold all of his HOLDCO common shares to his children in consideration for promissory notes. Mr. X realized a capital gain in respect of the sale but did not claim the capital gains deduction (“CGD”) under subsection 110.6(2.1).

HOLDCO then repurchased all of the HOLDCO preferred shares owned by Mr. X. The preferred shares had nominal paid-up capital (“PUC”) and a high adjusted cost base (“ACB”) as a result of a previous crystallisation of the CGD. The share repurchase gave rise to a deemed dividend to Mr. X as well as a capital loss. A portion of the capital loss was applied to offset the capital gain that arose on the earlier sale of the HOLDCO common shares to the children. The loss denial rules in subsection 40(3.6) did not apply as Mr. X and HOLDCO were not affiliated immediately after the share repurchase.

The CRA issued favourable rulings with respect to this series of transactions. Among others, the CRA confirmed that subsection 245(2) would not apply, notwithstanding the fact that it could be argued that this series of transactions allowed Mr. X to indirectly monetize his CGD.


Following the Descarries v. The Queen21 decision, would the CRA agree to issue a favourable ruling to the effect that subsection 245(2) would not apply to a series of transactions similar to the ones described in F 2005-0134731R3?

CRA Response

In Descarries, the Tax Court of Canada held that transactions similar to the proposed series of transactions described in F 2005-0134731R3 resulted in an abuse of section 84.1.

In the Descarries case, the individual shareholders of L’immobilière d’Oka Inc. (“OKA”) were involved in a series of transactions in which, among others, they exchanged their OKA shares for shares of another corporation (“NEWCO”), some of which (the “NEWCO V-day Shares”) had low PUC and a high ACB equal to the FMV of the OKA shares on V-Day (December 22, 1971). As a result, the V-Day value of the OKA shares became isolated/crystallized in the ACB of the NEWCO V-day Shares.

The NEWCO V-day Shares were repurchased, giving rise to a deemed dividend to the individual shareholders as well as a capital loss that was applied to offset a capital gain realized earlier in the same series of transactions.

The Tax Court of Canada made the following comments in Descarries:

In this light, the analysis shown above allows me to find that the additional value accumulated before 1971 was used to avoid the tax payable on the capital gain. Since the capital gain was created to allow the appellants to receive the Class A shares with a maximum adjusted cost base and paid-up capital, I find that the transactions at issue allowed the appellants to use the value accumulated before 1971 to indirectly distribute part of Oka’s surpluses tax-free.


The result of all three transactions described above is that the tax-exempt margin made it possible for part of Oka’s surplus to be distributed to the appellants tax-free in a manner contrary to the object, spirit or purpose of section 84.1 of the Act. For these reasons, I find that this provision was applied in an abusive fashion22.

Based on the reasoning in this decision, the CRA would now recommend to the GAAR Committee that subsection 245(2) be applied to a series of transactions similar to the proposed transactions described in F 2005-0134731R3. The proposed transactions result in the extraction of corporate surplus as capital gains. Furthermore, such capital gains are offset or reduced by capital losses realized on a disposition of shares whose ACB was increased by the CGD or V-day value.

In these circumstances and based on the Descarries decision, the CGD or the V-day value has been used to enable corporate surplus to be distributed to the shareholders tax-free, in a manner contrary to the object, spirit and purposes of section 84.1.

21 2014 TCC 75 (“Descarries”).

22 Idem, at paragraphs 57 and 59.

Question 12 - Form T1135 - reporting jointly held property

How would one report, on Form T1135, specified foreign property (“SFP”) held jointly by spouses? On this, we have 2 questions.

a) Two spouses, Mr. A and Mrs. A, intend to purchase a SFP with a total cost of $150,000, in joint ownership. Mr. A contributes $75,000 cash and gifts $75,000 cash to Mrs. A and they jointly acquire the SFP with these funds. Assuming the couple does not hold other SFPs, can the CRA confirm how this SFP should be reported on Form T1135?

b) Mr. and Mrs. A intend to increase their investment in the SFP to $400,000. Mr. A contributes $125,000 cash and gifts $125,000 cash to Mrs. A and they jointly acquire the SFP with these funds. Can the CRA confirm how the SFP should be reported on Form T1135?

CRA Response

In general, if there is joint ownership of a SFP between spouses, we would compare each spouse’s share of the property to the $100,000 threshold. Each spouse’s share of the SFP is generally based on the amount contributed by each person toward the cost of the purchase of the property.

a) In this situation, the cost amount of the SFP to each spouse is $75,000 and accordingly, neither spouse is required to file Form T1135.

b) Since each spouse’s share of the SFP now exceeds the $100,000 threshold, each spouse is required to file Form T1135, with a cost amount of $200,000.

Question 13: No METC for heading south for the winter

When a patient travels to a warm climate for the beneficial effects on his or her health, can the beneficial effects of the warm climate be considered a medical service for the purpose of paragraphs 118.2(2)(g) and 118.2(2)(h) of the Act?

CRA Response

Certain costs for transportation and travel expenses incurred to obtain medical services are eligible medical expenses for the purpose of the medical expense tax credit (“METC”) under paragraphs 118.2(2)(g) and (h) of the Act.

Under paragraph 118.2(2)(g) of the Act, an amount paid to a person engaged in the business of providing transportation services for transportation of a patient, and a necessary accompanying person, to a place where medical services are normally provided is an eligible medical expense under the following circumstances:

  • the patient travels to a place that is at least 40 kilometres away from the locality where he or she dwells to obtain the “medical services”;
  • substantially equivalent medical services are not available within the patient’s locality; * the patient takes a reasonably direct travel route having regard to the circumstances; and * it is reasonable, in the circumstances, for the patient to travel to that place to obtain those medical services.

Paragraph 118.2(2)(h) of the Act provides that eligible medical expenses include amounts paid for other reasonable travel expenses if, under the same circumstances, the patient must travel at least 80 kilometres away from the locality where he or she dwells to obtain the medical services. The CRA view is that for the purpose of the METC, medical services are diagnostic, therapeutic or rehabilitative services that are performed by a medical practitioner acting within the scope of his or her professional training. Payments may be made to a medical practitioner or to a public or licensed private hospital for medical services provided to a patient. In other words, a service must be provided to the patient by a medical service provider. In the CRA’s view, the beneficial effects of a warm climate are not medical services as no service has been provided to the patient. Therefore, travel expenses incurred to travel to a warmer climate to receive those beneficial effects, even if for health reasons, are not eligible medical expenses.

In Tallon v. The Queen, 2015 FCA 156, the Federal Court of Appeal affirmed the CRA’s position, stating that the term “medical services” in paragraph 118.2(2)(a) of the Act was clear and that “a medical service must be obtained from a medical service provider.” 23 The court concluded that the beneficial effects of a warm climate is not a medical service for the purpose of either paragraphs 118.2(2)(g) or (h) of the Act, as medical services “must be provided to the patient by a person or hospital.” 24 Thus the taxpayer’s transportation and travel expenses to Thailand and Indonesia were not allowed under paragraphs 118.2(2)(g) or (h).

23 Paragraph 36 of Tallon v. The Queen, 2015 FCA 156

24 Paragraph 41 of Tallon v. The Queen, 2015 FCA 156

We gratefully acknowledge the following Income Tax Rulings Directorate personnel who were instrumental in helping us prepare for these Q & As: Lata Agarwal, Gary Allen, Vitaliy Anissimov, Mary Pat Baldwin, Denise Basso, Dave Beaulne, Julia Belova, Pamela Burnley, Jack Chang, Stéphane Charette, Saskia deLang-Lenters, Lara Friedlander, Steve Fron, Judy Ho, Lita Krantz, Jean Lafrenière, Gwen Moore, Yves Moreno, Bob Naufal, Yannick Roulier, Nancy Shea-Farrow, Nerill Thomas-Wilkinson, Marc Ton-That, Phyllis Waugh, Dave Wurtele, and Terry Young.