29 November 2016 CTF Annual Conference Roundtable
This summarizes questions posed by Sandra Mah and Karen Nixon at the Annual CTF CRA Roundtable held on November 29, 2016, as well as summarizing the CRA responses. The CRA presenters were:
Randy Hewlett, Director, Financial Industries and Trusts Division, Income Tax Rulings Directorate
Stéphane Prud-Homme, Director, Reorganizations Division, Income Tax Rulings Directorate
The last five of the fifteen questions, were not answered in the session but the answers were included in the written version provided on December 13.
Q.1: Avoidance of 104(5.8) by 107(2) distribution to corp.
A discretionary trust (Old Trust) that is approaching its 21st anniversary distributes property with an unrealized gain under s. 107(2) to a corporate beneficiary (Canco) that is wholly owned by a newly-established discretionary trust (New Trust – also resident in Canada) . S. 104(5.8) should not affect the timing of the 21st anniversary of New Trust since the property was not transferred directly from Old Trust to New Trust. Does CRA agree?
Randy Hewlett: The transactions described in the question would effectively result in the old trust indirectly transferring property to the new trust on a tax-deferred basis, thereby avoiding the application of the anti-avoidance provision in s. 104(5.8), and essentially restart the 21 year clock in s. 104(4). The capital gains that would otherwise have been realized by the old trust would be deferred beyond its 21st anniversary while the property continues to be held in a discretionary trust arrangement. The new trust is provided with another 21 years to decide who, from the potential beneficiaries, will receive the property. This could result in deferring the unrealized gain beyond the lifetime of the individual beneficiaries alive on the date of the old trust’s 21st anniversary.
These proposed transactions came before the GAAR Committee in the context of a request for an advance income tax ruling. The Committee was of the view that such planning circumvents the anti-avoidance rule in s. 104(5.8) in a manner that frustrates the object, spirit and purpose of that provision, of the deemed disposition rule in 104(4)(b) and of the scheme of the Act as a whole as it relates to the taxation of capital gains. If the distribution is made by an existing discretionary trust to a Canadian-resident corporation wholly owned by a new discretionary trust resident in Canada, it will generally be inferred that the primary purpose of the distribution is to defer the income tax otherwise applicable in respect of the 21-year deemed disposition rule in s. 104(4).
CRA will generally apply the GAAR when faced with a similar set of transactions –unless there is substantial evidence supporting its non-application. CRA is also concerned that the proposed transactions may be repeated where the terms of the new trust were similar to the old trust. Thus the realization of the capital gains inherent in the property could be deferred for several generations, or even indefinitely. In CRA’s view, this contravenes one of the underlying principles for the taxation of capital gains, which is to prevent the indefinite deferral of tax on capital gains.
CRA is also considering whether the GAAR should apply to the situation - involving a distribution from a discretionary family trust to a Canco that is wholly owned by the newly established discretionary trust - in which the deferral of the gains is extended beyond the 21-year period - but the fact pattern is such that the realization of the gain occurs in the lifetime of the existing beneficiaries. The GAAR Committee has yet to actually review that case, and has not taken a definite position.
Sandra Mah: CRA is not looking at cases where a trust has a Canco as the beneficiary, or a trust has individual beneficiaries, but is only looking at a Canco beneath a wholly-owning trust?
Randy Hewlett: CRA will be looking at all planning to avoid the taxation of the capital gains at the end of the 21st anniversary. A distribution to a corporation will generally be acceptable if the individual shareholders of that corporation are resident in Canada because, ultimately, what that means is that, as the individuals are residents of Canada, there will be taxation in their lifetime or as a result of a deemed disposition of the corporate shares on death, unless of course the spousal rollover applies.
Sandra Mah: What about an individual non-resident beneficiary?
Randy Hewlett: In that situation, CRA is looking to see that there will be taxation within Canada in the lifetime of the beneficiary.
Q.2: Computation of safe income on discretionary dividend shares
In Year 1, Holdco A and Trust B (a discretionary personal trust with Holdco B as a discretionary beneficiary and with both of whom Holdco deals at arm’s length) subscribed nominal amounts for 50 Class A and 50 Class B common shares, respectively, of Opco. The Opco articles of Opco provide that all classes of common shares are voting, participating, entitled to discretionary dividends independent of other classes, and entitled to pro-rata sharing of net assets with other common share classes upon liquidation.
At the end of Year 2, when the shares of Opco have an aggregate fair market value (FMV) of $2 million and its aggregate safe income on hand (SIOH) was $2 million:
- Holdco C (related to Holdco A) subscribed $1 million for 50 Opco Class C common shares.
- Holdco D (unrelated to the above entities) used $500,000 borrowed from Opco to purchase 25 Class B common shares from Trust B.
At the end of Year 3 (after earning SIOH of $3.6 million during the year), Opco declares a $3 million dividend on its Class C shares, and $2.6 million dividend on its Class B shares ($1.3 million to each of Trust B and Holdco D) to effect a significant reduction in Opco’s FMV.
Trust B allocates and pays the entire $1.3 million it receives to Holdco B, whereas Holdco D repays the $500,000 it owes to Opco using part of the dividend proceeds it receives.
- Would each of the dividends paid in Year 3 fall outside of the safe income exception in s. 55(2.1)(c), and if so, how much would be re-characterized as a gain?
- Would the response be different if, at the same time as the subscription by Holdco C, Holdco A exchanged all of its Class A Opco shares under s. 86 for 50 preferred shares of Opco redeemable and retractable for $1 million and bearing a cumulative dividend of 1%?
- What are the information requirements for safe income computations? Are detailed computations required in the simple case of a holdco/opco structure and no or limited differences in accounting versus taxable income?
Stéphane Prud’Homme: This example is unrepresentative of situations commonly encountered by taxpayers. Holdco A, and its related corporation Holdco C, have given up a portion of their collective value in Opco to two unrelated persons, Trust B and Holdco D. This departs from normal business standards, and relevant facts are clearly missing in the example. A detailed analysis would have to be made in order to determine whether ss. 15(1), 56(2), 69(1), 246(1), or 245(2) could apply.
This type of share-structure could become problematic if a butterfly distribution under s. 55(3)(b) were contemplated by Opco. It could be impossible to determine whether the butterfly distribution would qualify as a distribution under 55(1) because of the uncertainty in establishing the fair market value of the Opco shares.
Recent CRA comments on the application of safe income to discretionary dividend shares were not intended to suggest that CRA has no concern about the use of such shares. CRA will study the subject and will not provide additional views until that study is completed.
The application of safe income to discretionary dividend shares is only one of the difficulties associated with the use of those shares. In our view, the larger issue is that their use may effect significant value shifts, and also result in income-splitting. Furthermore, the uncertainty related to the valuation of those shares makes it difficult to apply provisions of the Act in addition to those for butterflies. Hence, CRA’s decision to undertake the study.
Sandra Mah: You have now announced a moratorium on giving clarification on the allocation of safe income. That moratorium does not apply to rulings on the interpretation of s. 55(2) amendments and to questions on safe income calculations?.
Stéphane Prud’Homme: The moratorium will be applied with respect to interpretive issues relating to the use of discretionary dividend shares, and we are still “open for business” with respect to other issues relating to 55.
Response to Q. 2(c)
Stéphane Prud’Homme: The calculation of safe income has a purpose of supporting the claim that a dividend is not subject to the application of 55(2). It is the duty of taxpayers and their representatives to be careful making such claims, which is one of the foundations of a self-assessing system.
An incorrect claim could be subject to the application of s. 152(4), 163(2), or 239(1), depending on the circumstances (although application of s. 239(1) would be very rare).
Q.3: S. 39(2) loss on convertible debenture under Agnico-Eagle
The Agnico-Eagle methodology would appear to potentially result in an issuer of U.S.-dollar debentures (where the underlying shares have appreciated even if the U.S. dollar has appreciated) being considered to have realized a loss. Does CRA agree that an issuer could be considered to realize a loss on the conversion and, if so, that the loss is a loss described in subsection 39(2) or an otherwise deductible capital loss?
Randy Hewlett: The loss did not arise because of the fluctuation in a foreign currency relative to the Canadian dollar. Therefore, it was not a loss described in s. 39(2). Instead, the loss arose because of appreciation in the value of the shares of Agnico-Eagle. Furthermore, the loss arose on the settlement of a debt rather than on the disposition of a property, so that it does not come within s. 39(1). Therefore, the loss could not be recognized as a capital loss under the Act and could not be applied against a capital gain.
Although this point was not argued in Agnico-Eagle, if CRA were presented with a similar case in the future, it would consider the application of s. 143.3(3) to be appropriate. This provision applies in computing a corporation’s income (including capital gains) to reduce the amount of an expenditure that the corporation would otherwise be considered to have incurred where it issued its own shares and, therefore, to change the calculation of the gain or loss in a fact pattern similar to Agnico-Eagle.
CRA would rely on s. 143.3(3)(b) and consider that, on conversion of a convertible debenture, the holder had actually exercised an option for the purposes of that provision, so that the amount paid for the shares under the terms of the options would be the cash value paid for the debenture.
Q.4: 55(2) and Part IV tax
Taking its RDTOH of $383,333 into account, Opco pays a taxable dividend of $1,000,000 to Holdco (its wholly-owning parent also with a calendar taxation year), so that Opco expects to receive a dividend refund of $383,333. Holdco then pays a $1,000,000 taxable dividend to its individual shareholder. Consequently, Holdco will pay Part IV tax of $383,333 but will be eligible for an offsetting dividend refund. Also assume no relevant safe income and s. 55(2.1)(b) applies to the dividend received by Holdco.
In Holdco’s tax return, it would report a $1,000,000 capital gain and no Part IV tax on the dividend, and Holdco would add $153,333 (30 2/3% of $500,000) to its RDTOH account, which could be fully refunded by paying a taxable dividend of $400,000 to its individual shareholder. Therefore, instead of paying a taxable dividend of $1,000,000 to the individual shareholder, could Holdco instead pay a capital dividend of $500,000 and a taxable dividend of only $500,000?
Stéphane Prud’Homme: Although a taxpayer can self-assess under s. 55(2), here the application of s. 55(2) is based on the actual payment of the Part IV tax, and the actual receipt of the refund of the Part IV tax. This is consistent with Ottawa Air Cargo Centre.
Accordingly, Holdco would be required to file both an original and amended return for the taxation year in question. The first return would report the Part IV tax owing, and its refund. For the Part IV tax to be fully refunded, the taxable dividend paid to the individual shareholder must be $1,000,000. The second return would provide adjustments resulting from the application of s. 55(2) to the dividend received by Holdco. However, the amount of the taxable dividend paid by Holdco to the individual shareholder would not change, since the reduction of that amount would result in a reduction of the refund of the Part IV tax established in the original return, and s. 55(2) would become applicable on a declining amount resulting from a circular calculation.
A textual, contextual, and purposive interpretation of ss. 55(2) and 129(1) indicates that Holdco’s s. 83(2) election - on the dividend paid to the individual shareholder that resulted in the refund of Part IV tax - would be invalid, as it would retroactively access the application of s. 55(2) to the dividend received from Opco. Consequently, the $500,000 CDA resulting from the application of s. 55(2) will be available to Holdco, but only for CDA elections made on future dividends.
Q.5: Annuitant payment of RRSP, RRIF and TFSA fees
CRA has a long-standing administrative policy accepting that the payment of fees for investment management of an RRSP, RRIF or TFSA by the plan annuitant or holder (the “controlling individual”) will not be considered to be a contribution or gift to the plan for purposes of the over-contribution rules. Would the advantage tax rules in Part XI.01, which have been in force since 2009 for TFSAs and 2011 for RRSPs and RRIFs, apply?
Randy Hewlett: CRA has reviewed the application of the advantage rules, not only to investment-management fees, but to a number of other fees, in preparing a Folio on the advantage rules that will be released in early 2017.
Of particular relevance to this specific question is the definition of “advantage” in 207.01(1) – advantage - (b)(i). The key features are the “directly or indirectly” wording, the arm’s length standard and the purpose test respecting benefiting from the plan’s exempt status.
CRA considers that the increase in the value of the property in a registered plan that indirectly results from the plan investment management fees being paid outside of the plan would likely constitute an “advantage.”
It is not commercially reasonable for an arm’s length party to agree to pay the expenses of another party, and there is a strong inference that a motivating factor underlying the transaction is to maximize the savings of the plan so as to benefit from the tax exemption afforded to the plan. As a result, the plan’s controlling individuals could be subject to an advantage-tax of 100% the amount of the fees paid.
To avoid the adverse tax consequences from the application of the advantage tax rules, any existing arrangements, in which the management fees are charged directly to the plan’s controlling individual, will be required to be changed so that the fees are charged to the registered plan. Should this result in an overdraft, no adverse tax consequences will be assessed.
CRA is working with the investment industry to identify the different types of fee structures and the application of the advantage rules to these structures. This review and the application of the advantage rules will require a transitional period of transition to allow the investment industry to review our new position. To give the investment industry time to make the required system changes, the CRA will defer applying its new position until January 1, 2018. Investment management fees that are reasonably attributable to periods ending before 2018, and are paid either by the registered plan or the controlling individual, will have no adverse tax consequences.
Paragraph 18(1)(u) of the Act will apply to deny the deduction of such payments by the controlling individual in computing income (as with any other registered plan fees).
Karen Nixon: (referenced implementation issues)
Randy Hewlett: The investment industry is working with CRA, and CRA is reviewing the different types of fees and structures, with a view to coming to a resolution as to how to appropriately apply the new position. The advantage rules do not apply automatically, as there is a purpose test: it must be shown that the purpose of the transaction or series is to benefit from the plan’s exempt status.
Although there is no automatic application, there is a strong inference of an advantage, especially where there is a large plan and the investment management fees are determined on a percentage basis.
Q.6: Arm’s length determination under Poulin
Poulin involved two unrelated shareholders, both of whom attempted to extract corporate surplus as a capital gain by selling shares of a subject corporation to a holding corporation owned and controlled by another employee/shareholder of the subject corporation. The Tax Court determined that s. 84.1 did not apply to Mr. Poulin as he and the holding corporation dealt at arm’s length; whereas s. 84.1 applied to Mr. Turgeon, as he and the holding corporation did not deal at arm’s length.
What does CRA regard as the differentiating factors? Does this decision impact CRA’s view of employee buyco arrangements?
a. What is CRA’s view of a share sale identical to Mr. Turgeon’s except the holding corporation benefits from its involvement via dividends on the shares it purchased? The benefit is real in that such dividends are in addition to subsequent share redemption amounts received by the holding corporation and used to pay off debt owed to the original vendor of shares. Would CRA’s view differ if the holding corporation was compensated for its involvement otherwise than by dividend?
Stéphane Prud’Homme: The issue raised in this case extends from the issue of preferred shares in the context of the reorganization of the corporate structure of the subject corporation, to structure the departure of Mr. Poulin and integrate a new employee of Opco, Mr. Hélie, into the share-structure.
Mr. Poulin sold his shares to a corporation controlled by Mr. Turgeon, and Mr. Turgeon sold his shares to another corporation that was controlled by the Holdco of Mr. Hélie. Both individuals declared a capital gain and claimed the capital gains deduction.
Based on all of the evidence, the Court was of the opinion that Mr. Poulin, in departing Opco, wished to sell his interest at the best price and so as to benefit from the capital gains deduction, whereas Mr. Turgeon wanted to acquire the shares of Opco held by Mr. Poulin, so as to acquire control of Opco.
In the case of Mr. Poulin, the Court concluded that 84.1 did not apply. The CRA generally agrees with the Court that, in and of itself, the fact that Mr. Poulin and Mr. Turgeon structured the transaction so that Mr. Poulin could benefit from the capital gains deduction did not mean that the parties acted in concert without separate interests. However, the Court went on to find that Mr. Turgeon and the Hélie Holdco acted in concert and without separate risk and, consequently, they were not dealing at arm’s length.
The CRA is, and has always been, of the view that the question of whether unrelated persons are dealing at arm’s length at any particular time is a question of fact, that requires a review of all the facts and circumstances surrounding the specific situation.
In this particular situation, it could be established that the employee-shareholder and the employee-buyco were acting in concert without separate interests where, for example:
- the employee-buyco assumes no economic risks;
- the employee-buyco does not benefit from acquiring the Opco shares;
- the employee-buyco has no interest other than to enable the employee-shareholder to realize a capital gain and benefit from the capital gains deduction; or
- the employee-buyco has no role independent of the employee-shareholder or the operating corporation.
In short, the facts of the particular situation could support the position that the employee-buyco is only involved in the transaction as an accommodation party.
In summary, the message that we want to get across is that CRA’s position on the application of 84.1 in situations involving employee-buycos has not changed because of the Poulin/Turgeon decision and, in fact, is supported by the decision.
Sandra Mah: Is this consistent with the discussion at the 2012 Annual Conference?
Stéphane Prud’Homme: I think it is. What we’re saying is that we’ll take a close look at the transactions involving employee-buycos and we’ll review all the facts and circumstances in the particular situation in considering the application of 84.1.
Sandra Mah: Would CRA now entertain rulings on employee-buycos?
Stéphane Prud’Homme: Yes, assuming that all the relevant facts are submitted to us and that we are comfortable with those facts.
Q.7: GAAR Committee and assessment procedures
What is the composition of the GAAR committee? What is the procedure for bringing GAAR assessments (including in the alternative) and for keeping the taxpayer informed?
Randy Hewlett: I am the current chair of the GAAR Committee and the co-secretaries are also from the Income Rulings Directorate. We generally organize and facilitate all the meetings of the Committee. All the Directors of the Directorate are also members of the GAAR Committee. However, there are also Directors and Managers from the Legislative Policy Directorate, the Abusive Tax Avloidance and Technical Support Division and the International Large Business Directorate. They are the main sources of referrals to the Committee – although the Committee also considers advance income tax ruling requests on the GAAR. Another important member of the Committee is from the Department of Finance. Also, the Department of Justice and CRA’s Internal Legal Services are on the GAAR Committee. Although some representatives attend all the GAAR Committee meetings, others attend based on the subject matter being discussed.
The GAAR Committee was originally established to provide advice on the application of the GAAR to the Income Tax Act, to ensure that the GAAR was being applied consistently. It was established when the GAAR was introduced to ensure that concerns of taxpayers and their representatives respecting inconsistent application of such a tool of broad application were alleviated. The audit process for GAAR issues is essentially the same as for any other audit issue, except that the advice is obtained from the Abusive Tax Avoidance area in Headquarters and, where applicable, the GAAR Committee. Headquarters' role is to review the files where the Tax Services Office is considering the application of the GAAR, whether as a primary or alternative assessment position.
The stage at which the Tax Services Offices sends a proposal letter to a taxpayer respecting a file involving the GAAR depends on the circumstances. The TSO will generally review the particular facts of each file to establish the purpose of the transactions to determine if any of the transactions are avoidance transactions. Where the transactions under audit are similar to situations previously considered by the GAAR Committee, and resulted in a recommendation to apply the GAAR, generally the Tax Services Office will proceed with a proposal letter and obtain the taxpayer’s representations. The TSO will subsequently refer the matter to Headquarters, with the taxpayer’s representations, to obtain a GAAR recommendation.
Where the TSO reviews the file and determines that the matter has not been previously considered by the GAAR Committee, and the GAAR is likely going to be an assessment position, they will refer the matter to Headquarters prior to the issuing of the proposal letter. In this circumstance, the TSO would generally only proceed with the issuance of a proposal letter if it obtains a recommendation from Headquarters on the application of the GAAR. Headquarters will generally, in turn, refer the matter to the GAAR Committee for consideration. Headquarters might sometimes recommend not to proceed with the GAAR reassessment, without consulting with the GAAR Committee, in circumstances where they believe that there are no grounds to consider the application of the GAAR.
However, Headquarters may still submit the case to the GAAR Committee to obtain its recommendation. Any submissions received from the taxpayer or the taxpayer’s representative are forwarded in their entirety at the outset to Headquarters and, where applicable, to the GAAR Committee. Taxpayers and their representatives should be assured that when the application of the GAAR is considered, all their arguments will receive careful consideration. This process would be the same regardless of whether the GAAR is a primary or secondary assessment position.
Aggressive Tax Planning frequently interacts with their TSO colleagues on the application of the GAAR as well. Just because an issue does not go to the GAAR Committee does not mean that there are not ongoing discussions between me, my Directors and their colleagues in the Aggressive Tax Planning area to determine whether or not a case should go to the GAAR Committee. Frequently we have discussions offline, and we consider whether or not the case should go to the Committee. It is important to remember, as well, that the GAAR has been around a long time. The CRA has extensive experience in applying the GAAR and substantial jurisprudence to guide it, so that there should not be concerns that decisions are being made inconsistently as to whether a case should or should not go to the GAAR Committee.
Q.8: Cash as “property” under 55(2.1)(b)(ii)(B)
Is cash considered to be property for purposes of the application of s. 55(2.1)(b)(ii)(B)?
Stéphane Prud’Homme: The analysis is informed by underlying principles. S. 55(2) essentially negates the effect of the dividend deduction under s. 112(1), where such deduction is not warranted. Its underlying principle is to eliminate the duplication of corporate tax on income moving through a corporate chain. The cost of shares ensures that the value of the property that was included in income as a dividend does not get included in income a second time when the property is disposed of – so that such cost ensures that only the future increase in value of the property is taxed. Consequently, the objective of the concept of cost of shares and s. 112(1) is preventing the duplication of corporate tax.
When a dividend is paid from income and has been subject to corporate tax, it will normally be a safe income dividend – and, if so, it is appropriate for the corporate shareholder to obtain the deduction under s. 112(1). Where the dividend is paid from a source that has not been subject to corporate tax, the dividend will normally not be a safe income dividend, and the role of s. 55(2) is to question whether one of the purposes of the dividend is to reduce the value of a share, or to increase the cost amount of the property of the dividend recipient. If so, the purpose of s. 55(2) is for the dividend to not be tax-free.
The concept of cost in s. 55(2) shares the objective of preventing the duplication of corporate tax, while ensuring that tax is paid on an amount received in the form of a dividend, where the dividend is not supported by the income that was subject to tax.
The scheme of the Act generally does not allow for a tax-free increase in costs. Therefore, there is a lack of tax integration where a corporate shareholder receives property on a payment of a dividend that is not taxable, but the cost of the property is greater than the amount on which tax is paid by the dividend payor or the dividend recipient.
Now turning specifically to the question, cash is considered property for the purpose of s. 55, and “property” is defined in s. 248(1) as including money unless a contrary intention is evident. It should also be noted that cash received on a dividend can be used to purchase any other property or even additional shares of the dividend-payor, and this results in an increase in the cost amount of the shares of the dividend payor.
Accordingly, cash is property for this purpose.
Q.9: Reasonable efforts and BEPS 13
Does CRA expect that the “reasonable efforts” that a taxpayer must make to determine and use arm’s length transfer prices include the preparation of transfer pricing documentation consistent with the OECD recommendations in Action 13 of the BEPS initiative (i.e., Master File and Local File transfer pricing documentation)?
CRA considers that BEPS Action Item 13 had been dealt with by the introduction of proposed s. 233.8 relating to country-by-country reporting. The reasonable efforts requirement is contained in s. 247, particularly, the requirement thereunder to produce contemporaneous documentation in accordance with s. 247(4). Proposed s. 233.8 has no direct relation to s. 247 and does not include a requirement to produce a Local File or a Master File. Accordingly, CRA has not altered its criteria regarding whether a taxpayer has made reasonable efforts to determine and use arm’s length transfer pricing.
Q.10: Transitional relief for US LLPs & LLLPs
At the 2016 Society of Trust and Estate Practitioners (“STEP”) and the International Fiscal Association (“IFA”) CRA Roundtable, the CRA announced that it considers Florida and Delaware limited liability partnerships (“LLPs”) and limited liability limited partnerships (“LLLPs”) to generally be corporations for the purposes of Canadian income tax law. As part of this announcement, the CRA offered administrative relief to existing LLPs and LLLPs that meet certain criteria such that the CRA would accept their treatment as partnerships for the purposes of the Act.
Certain U.S.-based Florida and Delaware LLPs and LLLPs, with many partners, which carry on business in Canada. are unable to qualify for relief, from CRA’s position on such entities being corporations, by converting to LPs because, for business reasons, they cannot do so. Amending all previous years’ returns for all individual partners would be impractical. Would the CRA consider allowing these entities to file as a corporation on a go-forward basis while leaving its previous years’ partnership/partner filings unchanged?
Randy Hewlett: Taxpayers are now well aware of what are the obligations of LLPs and LLLPs, which will not be repeated here.
CRA has established an internal working-group to study some of the compliance-issues relating to LLPs and LLLPs. It is being led by the International Division (the audit group responsible). Some questions and submissions have already been received by CRA officials, and have been brought to the attention of the group.
If taxpayers were unable to convert to a partnership in accordance with our previous announcements on this issue, CRA is open to prospective treatment as a corporation, with prior problems being allowed to stand. Submissions from taxpayers and their representatives in this regard, are welcomed. We’ve created an email address (DELAWAREFLG@cra-arc.gc.ca), where you can have your specific compliance issues addressed.
The CRA not providing carte-blanche for accessing this relief as suggested in the question. It is open to relief, but only on a case-by-case basis. The CRA would wish to see facts and circumstances to ensure that is no unwarranted benefit or undue tax advantage. In particular, it would wish to examine the relevant tax attributes.
Q.11: Computation of earnings for disregarded US LLC
At the 2011 IFA Roundtable, Q.9, CRA indicated that a disregarded U.S. LLC that is a foreign affiliate and has a single member which is a regarded U.S. corporation should compute its “earnings” in accordance with Reg. 5907(1) – earnings - s. (a)(i). (a) Has this changed following the enactment in 2013 of Reg. 5907(2.03) requiring an affiliate computing its “earnings” in accordance with Canadian tax law to claim maximum discretionary deductions? b) Would the answer change if the LLC had one or more members which were not regarded U.S. resident corporations?
Summary of response:
[A]s a result of the context provided by subsection 5907(2.03)…[t]he CRA is now of the view that the “earnings” from a U.S. active business of a U.S.-resident, single member LLC that is disregarded for U.S. tax purposes and that is a foreign affiliate of a corporation resident in Canada should be computed in accordance with subparagraph (a)(iii) of the Earnings Definition. The change in the CRA’s position is effective for the first taxation year of the LLC for which subsection 5907(2.03) has effect, that year being the LLC’s first taxation year ending after August 19, 2011.17
The CRA recognizes that subsection 5907(2.03) does not contemplate a scenario where the “earnings” of a foreign affiliate are computed under subparagraph (a)(i) of the Earnings Definition in one taxation year and under subparagraph (a)(iii) of the Earnings Definition the next taxation year. However, for the purposes of such a transition, the CRA is prepared to accept that paragraph 5907(2.03)(b) applies under this scenario and that the deductions claimed in preceding taxation years in computing the LLC’s “earnings” under subparagraph (a)(i) of the Earnings Definition were “deductions…actually claimed under the Act”.
If [a U.S. LLC with two or more members] carries on an active business in the U.S and is required for U.S. tax purposes to compute its income to determine the partners’ distributive shares, it is the CRA’s view that the LLC must compute its “earnings” under subparagraph (a)(i) of the Earnings Definition in accordance with the income tax laws of the U.S.
Question 12: Support for U.S. Foreign Tax Credit claims
At the 2016 STEP Canada Roundtable, the CRA commented on its recent policy of requiring taxpayers to obtain official transcripts from U.S. federal, state, and municipal tax authorities in order to support foreign tax credits that were claimed in respect of U.S. tax paid. In its response, the CRA announced that a taxpayer who is unable to provide a copy of a notice of assessment, transcript, statement, or other document from the applicable foreign tax authority would be allowed to support its foreign tax credit claims by providing bank statements, cancelled cheques, or official receipts.
- The IRS does not issue NOA’s like the CRA and there is no online taxpayer portal. It takes much longer to get an IRS account statement than the allotted 30 days even if a 30 day CRA extension is applied for, and barring obtaining IRS power of attorney (difficult to be granted) the IRS statement must be requested by the taxpayer. Has the CRA8 considered reaching out to the IRS on this matter to streamline the process of obtaining verification of credits claimed.
- Where a taxpayer performs its employment duties in a large number of U.S. states and municipalities (e.g. professional athletes), it may be very laborious and cumbersome to obtain transcripts or official notices or statements from each of the states and municipalities. Some states and municipalities are very slow to or are incapable of confirming tax payments. Sometimes, no conventional proof of payment are available since the applicable U.S. tax is withheld directly from the taxpayer’s wages.
Would the CRA accept U.S. Form 1040-NR showing a deduction against the U.S. federal tax owed for state tax paid as satisfactory support for the amount of U.S. state tax claimed as foreign tax credit?
Q.13: Goodwill proceeds in straddle year
Proposed s. 13(38)(d)(iii) provides in the case of a taxation year straddling January 1, 2017, a taxpayer would have had a particular amount included from a business for the particular year under s. 14(1)(b) (as that paragraph applied immediately before January 1, 2017, the taxpayer can elect to include the particular amount in income from its business for the particular year, provided inter alia the taxpayer has incurred an eligible capital expenditure (ECE) in respect of a business before January 1, 2017. In a situation where a taxpayer has disposed of all of its business in a straddle year but before January 1, 2017, and the intangible business assets disposed of only include internally generated goodwill with no cost, will s. 13(38)(d)(iii) apply even though no ECE in respect of the business was incurred before January 1, 2017?
Where a taxpayer’s only intangible asset is internally-generated goodwill with no cost, that taxpayer cannot be said to have made or incurred an ECE in respect of the business. As such, the taxpayer would not meet the requirements of the election in subparagraph 13(38)(d)(iii). It is our understanding that this result is consistent with tax policy.
Question 14: Distribution of Income by an Estate to a Residual Beneficiary
Often a Will is drawn up that is quite simple and uncomplicated, providing minimal specific instructions to the chosen administrator. Such a Will typically directs the Executor to pay the debts and expenses of the deceased, makes specific bequests of property and finally specifies what is to be done with the residue of the estate.
Where during the administration of an estate, taxable income is generated yet all debts and specific bequests have been paid, can the Executor pay or make payable this taxable income to the residual beneficiaries, such that the amount of this taxable income would be considered payable, under subsection 104(24), for the purposes of subsections 104(6) and 104(13)?
Question 15: The New Small Business Deduction Provisions
There appears to be an anomaly in these new provisions, perhaps best illustrated by an example. Assume we have two corporations, Opco and Rentco. They are owned by the same person or group of persons, and as such are associated. Opco carries on an active business, and does not earn “specified partnership income” or “specified corporate income”. Rentco owns the real estate from which Opco operates, and earns net rental income of $150,000 from this activity. This income is deemed active business income by Subsection 129(6). The corporate group has under $10 million of taxable capital.
The Present Law
On an annual basis, Opco and Rentco file Schedule 23 to allocate 30% of their business limit to Rentco, and 70% to Opco. Rentco claims the small business deduction (SBD) on $150,000 of income, and Opco claims the SBD on $350,000 of its income.
The Proposed Law
Under the proposed changes, for fiscal years commencing after March 21, 2016, enabling Rentco to continue claiming the SBD on $150,000 per year will require the following steps:
- Continuing to allocate 30% of the annual $500,000 business limit to Rentco, in accordance with subsection 125(3). This will leave Opco with a $350,000 business limit. This is unchanged.
- Opco and Rentco must jointly elect an assignment of $150,000 of Opco’s SBD limit to Rentco, as these payments are “specified corporate income”. This assignment is required by subsection 125(3.2), and will be filed on a prescribed form yet to be released.
Pursuant to subsection 125(3.1), the amount assigned to Rentco will be subtracted from Opco’s business limit as computed in accordance with subsection 125(3).
In combination, then, it appears that Rentco may continue to claim SBD on $150,000, but that Opco will be restricted to $200,000 of income, as its business limit of $350,000 (determined in accordance with subsection 125(3)) will be reduced by $150,000 in accordance with subsection 125(3.1).
If 100% of the business limit is allocated to Opco under subsection 125(3), it would continue to have access to SBD on $350,000 of its income, but the assignment to Rentco would not result in10 Rentco having access to the SBD, as its business limit computed in accordance with Subsection 125(3) would be nil.
Can the CRA confirm that this is the manner in which they interpret the proposed legislation?