5 October 2018 APFF Financial Strategies and Instruments Roundtable
Email this ContentTranslation disclaimer
The translations below of the CRA written responses were prepared by Tax Interpretations Inc. The CRA did not issue these responses in the language in which they now appear, and is not responsible for any errors in their translation that might impact a reader’s understanding of them or the position(s) taken therein. See also the general Disclaimer below.
This page contains our summaries of questions posed at the 5 October 2018 APFF Financial Strategies and Instruments Roundtable together with our translations of the full text of the Income Tax Ruling Directorate’s provisional written answers (which were orally presented by Mélanie Beaulieu and Louise Roy), as well as those of the Department of Finance (provided by Robert Duong, whose written responses were noted to be provisional). We also provide links to the final written responses of the Directorate, which have been translated by us along with the full text of the questions posed.
We use our own titles, and footnotes are (depending on how routine they are) either excluded or moved to the body of the answer. We did not prepare summaries of questions posed to the Department of Finance for which no written responses were provided.
The (regular) 5 October 2018 APFF Roundtable is provided on a separate page. The final versions of these items as released under the Income Tax Directorate's severed letter program are also linked below. (Finance responses are not released under this program.)
Q.1 Policy distributed on share redemption
2017-0690331C6 found that a dividend-in-kind by a subsidiary to its parent of a life insurance policy would result in proceeds of disposition to it equal to the greater of the policy’s cash surrender value (CSV) and its adjusted cost basis (ACB), rather than equaling the policy’s higher fair market value (FMV), given that the dividend would not result in consideration being given for the policy. If the subsidiary instead transfers a policy with a CSV and ACB of $50,000 and $25,000, respectively, on the redemption of preferred shares having an FMV equal to the policy’s FMV of $100,000, would its proceeds of disposition be $100,000 notwithstanding that the proceeds would only have been $50,000 if there instead had been a dividend-in-kind?
Preliminary CRA written response
The jurisprudence indicates that the word "consideration" is a broad term, which can be either a right, an interest, a profit or a benefit for one party, or a waiver, a disadvantage, a loss or a liability for the other party.
A shareholder who receives property from a corporation in connection with the repurchase of the shareholder’s shares by the corporation disposes of those shares to the corporation in exchange for the property the shareholder receives. In the absence of an indication to the contrary in the context, it appears to us that the word "consideration" must, for the purposes of subsection 148(7), receive the broad meaning generally accorded to it in the jurisprudence. Thus, for purposes of clause 148(7)(a)(ii)(B), where, on a share redemption, the redemption price paid by a corporation is an interest in a life insurance policy that the corporation transfers to the shareholder, the CRA is of the view that the shareholder gave consideration (the redeemed shares) to the corporation for the interest thus transferred.
The CRA is aware that in light of that conclusion, the result differs depending on whether the transfer of interest is by way of a dividend in kind or a redemption of shares. It is not clear that that inconsistency is consistent with tax policy. At the CLHIA Roundtable in May 2017, the CRA indicated that it was not clear that the result, in the case of a dividend-in-kind transfer, was consistent with tax policy. The CRA also indicated that it had notified the Department of Finance of this situation. The CRA will also bring to its attention its conclusion where the transfer occurs as part of a share redemption.
Finally, note that in the presence of a taxable inter-corporation dividend (actual or deemed), the potential application of subsection 55(2) should be considered, depending on the facts and circumstances of a particular situation.
Official response
Q.2 Excluded share status re property income
2018 STEP Roundtable Q.7 indicated that the shares of a corporation that did not generate business income (e.g., a corporation that generated rents that, given the level of activity, constituted income from property ) cannot qualify as excluded shares, whereas Examples 10 of CRA’s “Guidance on the application of the split income rules for adults” found that dividends received by siblings (now, over 25) following a sale of one of Real Estateco’s rental properties at a gain were from excluded shares, and Example 12 found that Spouse A, aged 65 who owned 95% of the shares of Investco, whose active business was actively managed by Spouse A (with no involvement of Spouse B) before it became a portfolio company, held that 95% bloc as excluded shares. Could CRA comment on these two examples.
Preliminary CRA written response
The CRA's response to Question 7 of the Canadian STEP CRA Roundtable of May 29, 2018 ("Question 7") was based on the assumption made in the statement of that question that the corporation had no business income. Thus, since the condition provided in subparagraph (a)(i) (that is, less than 90% of the business income of the corporation was from the provision of services) of the definition of "excluded shares" in subsection 120.4(1) was not satisfied, the corporation’s shares could not qualify as excluded shares. Consequently, the CRA response was dependent on the specific statement in Question 7.
The purpose of the Guidance Document is to provide, inter alia, general guidance on how the CRA intends to administer the different types of exclusions described in the definition of "excluded amount" in subsection 120.4(1).
Specifically with respect to the examples discussed above, Example 10 was intended to illustrate the exclusions with respect to reasonable return (being in summary, and as defined in subsection 120.4(1), generally an amount derived directly or indirectly from a related business in respect of the specified individual and that is reasonable having regard to the factors - described in subparagraphs (b)(i) to (v) of that definition - relating to the relative contributions of the specified individual and of each source individual) and excluded shares. As for Example 12, the latter covered not only the exception for excluded shares, but also the deeming rule provided in subparagraph 120.4(1.1)(c)(i) providing relief for spouses of business owners who turned 64 before the end of the year. Briefly, by virtue of this subparagraph, an amount received by a specified individual is deemed to be an excluded amount if: (1) the spouse or common law partner of the specified individual has attained the age of 64 years before the year, and (2) the amount would have been an excluded amount in respect of an individual who was the specified individual’s spouse or common-law partner, if the amount were included in computing the spouse or common-law partner’s income.
In addition, to demonstrate that the various exclusions were applicable not only to entities that earn income from an active business, such as a manufacturing corporation, but also to entities that carry on a business of earning income from property, such as a property rental business (in Example 10) or an investment management business (in Example 12), we had assumed that these corporations had a sufficient level of activity such that their income could be considered as derived from a business.
That being said, the income or loss from a business or property is computed in Subdivision b of Division B of Part I. Nevertheless, those are two separate sources of income for purposes of the Income Tax Act.
In that regard, the question of whether a particular income constitutes income from a business or income from property is a question of fact that can only be resolved following a comprehensive analysis of all the facts present with respect to a particular situation.
The term "business" is not defined in the Income Tax Act, as subsection 248(1) simply expands the concept of "business" for the purposes of the Income Tax Act by including, inter alia, an undertaking of any kind whatever.
Furthermore, the Income Tax Act contemplates that the principal purpose of a business may be to derive income from property, including interest, dividends, rents and royalties (see the definition of “specified investment business” in subsection 125(7).)
Based on the foregoing, if the assumption in Question 7 were modified so that the corporation carried on a business, the condition in subparagraph (a)(i) of the definition of “excluded shares" in subsection 120.4(1) would be satisfied.
Although it was determined - taking into account the wording of Question 7 - that the shares of the capital stock of the corporation in question could not qualify as excluded shares, an amount received from that corporation by a specified individual could nevertheless be an excluded amount.
For example, subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1) provides that, in respect of an individual who has attained the age of 17 before a particular taxation year, an amount is an excluded amount if it is not derived directly or indirectly from a related business in respect of the individual.
The expression "related business" in respect of a specified individual for a taxation year is defined in subsection 120.4(1) of the Income Tax Act and means, in respect of a corporation, (1) a business carried on by the corporation, if a source individual in respect of the specified individual at any time in the year is actively engaged on a regular basis in the activities of corporation related to earning income from the business; or (2) a business of a corporation, where a source individual in respect of the specified individual owns shares of the capital stock of the corporation, or property that derives, directly or indirectly, all or part of its fair market value from shares of the capital stock of the corporation, and the aggregate FMV of the foregoing shares and property is equal to or greater than 10% of the FMV of all issued and outstanding shares of the capital stock of the corporation.
Thus, if it is determined that a corporation does not carry on a business, and that that corporation pays a dividend to a specified individual, the amount of that dividend, provided it does not come directly or indirectly from a related business in respect of the specified individual, could be an excluded amount for the individual. Consequently, the amount of the dividend would not be included in the calculation of the split income of the specified individual and the specified individual would not be subject to split income tax in respect of the amount of that dividend.
Official response
Q.3 TOSI where spousal trust distributes interest on investments derived from decedent
Jean on his decease left proceeds of an insurance policy and non-registered investments (which had been acquired by him out of accumulated savings) under a trust (“Trust”) for the exclusive benefit of his surviving spouse (“Jeanne,” also a Canadian resident), and with two of their children as trustees. The management of the investments is passive and does not result in business income. Is the income generated by Trust and distributed to Jeanne subject to the tax on split income where the Trust investments are managed by: the two trustees; an independent third party; or a child of Jean and Jeanne who is not a Trust beneficiary but is a stock broker?
Preliminary CRA written response
First, for the purpose of this question, we have assumed that the proceeds of the life insurance policy were invested by Trust in investments similar to those it received as a result of Jean's death.
In addition, since the question as stated only briefly describes a hypothetical particular situation, including the composition of Trust's investment portfolio and the nature of the amounts included in computing its income, we have assumed that Trust's income from its investments consists of taxable dividends in respect of shares of a class listed on a designated stock exchange ("Dividends"), taxable capital gains from the disposition of such shares ("Capital Gains") and interest on debt obligations ("Interest").
The definition of "split income" in subsection 120.4(1) describes the types of income that are subject to the split income tax under subsection 120.4(2).
First, the amount representing the portion of the distribution received from Trust ("Distribution") relating to the Dividends would not be split income for Jeanne, as appears from the exceptions provided for in subparagraph (a)(i) and in clause (c)(ii)(A) of the definition of "split income" in subsection 120.4(1).
Second, the amount representing the portion of the Distribution that relates to the Capital Gains would not be split income for Jeanne by virtue of the exception provided in clause (e)(ii)(A) of the definition of "split income" in subsection 120.4(1).
Finally, unless it qualifies as an excluded amount, the amount representing the Interest portion of the Distribution could be split income under clause (c)(ii)(C) of the definition of "split income" in subsection 120.4(1). Indeed, Jeanne is a specified individual (since Jeanne is resident in Canada at all relevant times) and the amount of the Distribution must be included in the computation of her income by virtue of subsection 104(13). For the purposes of clause (c)(ii)(C) of the definition of "split income" in subsection 120.4(1), it must be reasonable to consider that the portion of that Distribution was income derived directly or indirectly from one or more related businesses in respect of Jeanne.
As appears from the question as stated, the Distribution was derived solely from the assets held by Trust and not from any other related business in relation to Jeanne. Thus, the question is whether Trust carries on a related business in respect of Jeanne.
The term "related business" in respect to a specified individual is defined in subsection 120.4(1) and includes, in respect of a trust (in subparagraph (a)(ii) of the definition of "related business" in subsection 120.4(1)) a business carried on by a trust if a source individual in respect of the specified individual is actively engaged on a regular basis in the activities of the trust related to earning income from the business.
The expression "source individual" in respect of a specified individual for a taxation year is defined in subsection 120.4(1) and means an individual (other than a trust) who, at any time in the year, is resident in Canada and related to the specified individual. Jeanne and her three children are individuals connected by blood relationship by virtue of section 251(6) and are therefore related persons by virtue of subsection 251(2). Consequently, under the assumption that Jeanne's children were resident in Canada at all relevant times, each of these children is a source individual in respect of Jeanne.
For the purposes of the definition of "related business", it must therefore be determined, inter alia, that: (1) Trust is carrying on a business; and 2) a source individual is actively engaged on a regular basis in the activities of Trust related to earning income from the business. These are essentially two questions of fact that can only be resolved after a comprehensive analysis of all the facts and circumstances with respect to a particular situation.
If it were determined that Trust does not carry on a business, the Interest portion of the Distribution would not be included in the computation of Jeanne's split income. Indeed, one of the conditions to be satisfied in the definition of "related business" in subsection 120.4(1) is that there must be in the first place a business carried on by an entity. Consequently, in the event that Trust does not carry on a business, the Interest could not come, directly or indirectly, from a related business in respect to Jeanne, but rather would come from property held by Trust.
If it were instead established that Trust is carrying on a business and that, under any of the scenarios contemplated in the question as stated, a source individual in respect of Jeanne is actively engaged on a regular basis in the activities of Trust related to earning income from the business, then the portion of the Distribution related to the Interest would come, directly or indirectly, from a related business in respect of Jeanne for the purposes of the application of clause (c)(ii)(C) of the definition of "split income" in subsection 120.4(1).
On the other hand, the interpretive rule provided in subparagraph 120.4(1.1)(c)(ii) could apply in respect of Jeanne so that the portion of the Distribution relating to the Interest is deemed to be an excluded amount.
By virtue of subparagraph 120.4(1.1)(c)(ii), the amount that is Jeanne's income from property is deemed to be an excluded amount to the extent that the amount would have been an excluded amount in respect of an individual - Jean – who was, immediately before his death, Jeanne's spouse or common-law partner, if the amount were included in computing Jean's income for his last taxation year.
The portion of the Distribution with respect to the Interest would be an excluded amount in respect of Jean since it was not derived directly or indirectly from a related business in respect of Jean by virtue of subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1).
Official response
Q.4 TOSI where spousal trust holds managed rental properties
A spousal trust for Jocelyne (“Trust”) holds five commercial rental properties (generating $250,000 in annual rents, which had been managed by her deceased husband). Is the income generated by Trust and distributed to Jocelyne subject to the tax on split income where the Trust investments are managed by: Jocelyne’s son Julien who, as the sole trustee, manages the properties (e.g., repairs, rent collections, accounts); Julien not as trustee but as Trust employee; and Julien, as neither.
Preliminary CRA written response
The definition of "split income" in subsection 120.4(1) describes the types of income that are subject to the split income tax under subsection 120.4(2).
Regarding Jocelyne, the distribution received from Trust (the "Distribution"), unless it qualifies as an excluded amount, could constitute split income under clause (c)(ii)(D) of the definition of "split income" in subsection 120.4(1).
Indeed, Jocelyne is a specified individual (since the question as stated indicates that Jocelyne is resident in Canada at all relevant times) and the amount of the Distribution should be included in computing her income by virtue of subsection 104(13).
For purposes of clause (c)(ii)(C) of the definition of "split income" in subsection 120.4(1), it must be reasonable to consider that the Distribution is income derived directly or indirectly from one or more related businesses with respect to Jocelyne.
As appears from the question as stated, the Distribution is derived solely from the assets held by Trust and not from any other related business with respect to Jocelyne. Thus, it is necessary to determine whether Trust carries on a related business with respect to Jocelyne.
The term "related business" in respect of a specified individual, is defined in subsection 120.4(1) and includes, with respect to a trust (in subparagraph (a)(ii) of the definition of "related business" in subsection 120.4(1)), a business carried on by a trust if a source individual in respect of the specified individual is actively engaged on a regular basis in the activities of the trust related to earning income from the business.
The expression "source individual" in respect of a specified individual for a taxation year is defined in subsection 120.4(1) and means an individual (other than a trust) who, at any time in the year, is resident in Canada and related to the specified individual. As Julien is the son of Jocelyne, those individuals are connected by blood relationship by virtue of section 251(6) and are therefore related persons by virtue of subsection 251(2). Consequently, Julien is a source individual in respect of Jocelyne.
For the purposes of the definition of "related business", it must therefore be determined, inter alia, that: (1) Trust is carrying on a business; and 2) a source individual is actively engaged on a regular basis in the activities of Trust related to earning income from the business. These are essentially two questions of fact that can only be resolved after a comprehensive analysis of all the facts and circumstances with respect to a particular situation.
For purposes of clause (c)(ii)(D) of the definition of "split income" in subsection 120.4(1), it must be reasonable to consider that the Distribution is income from the leasing of property by Trust in the case where a person who is related to Jocelyne is actively engaged on a regular basis in the activities of Trust related to the leasing of property.
To the extent that it was established that Julien actively engages on a regular basis in the activities of Trust, the Distribution could constitute split income for Jocelyne by virtue of clause (c)(ii)(D) of the definition of split income in subsection 120.4(1), except in the case of an excluded amount.
However, by virtue of subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1), the Distribution could be an excluded amount for Jocelyne if was not derived directly or indirectly from a related business in respect of Jocelyne.
In light of the foregoing, if it could be determined that the Distribution was not derived directly or indirectly from a related business in respect of Jocelyne, the Distribution would be an excluded amount with respect to Jocelyne and, therefore, would not be not included in the computation of her split income.
However, for the purpose of applying clauses (c)(ii)(C) or (D) of the definition of "split income" in subsection 120.4(1) with respect to the situation described in this question, if it was determined that the Distribution was derived directly or indirectly from a related business in respect of Jocelyne, the interpretive rule under subparagraph 120.4(1.1)(c)(ii) could apply in respect of Jocelyne so that the Distribution is deemed to be an excluded amount.
By virtue of subparagraph 120.4(1.1)(c)(ii), the amount that is Jocelyne's income from property is deemed to be an excluded amount to the extent that the amount would have been an excluded amount in respect of an individual - Joseph – who was, immediately before his death, Jocelyne's spouse or common-law partner, if the amount were included in computing Joseph's income for his last taxation year.
The Distribution would have been an excluded amount in respect of Joseph since it was not derived directly or indirectly from a related business in respect of Joseph by virtue of subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1).
Since Joseph owned the commercial rental properties directly, and even under the assumption that Joseph derived income from a business, that business could not be classified as a related business.
Indeed, by virtue of subparagraph (a)(i) of the definition of "related business" in subsection 120.4(1), the business carried on by an individual must be carried on by a source individual in respect of the specified individual. Since Joseph could be a source individual in respect of himself, the hypothetical business could not be a related business in respect of Joseph.
Official response
Q.5 Payment of dividend out of disability insurance proceeds and s. 55
Messrs. A and B wholly-own Holdco A and B, respectively, each of which, in turn, holds half of the Class B shares of Opco having an FMV of $500,000. Messrs. A and B also each hold half of Opco’s Class A shares having in each case an FMV of $1,000,000. Opco holds an insurance policy that pays out in part in the event of disability. In the case of disability of either individual, Opco will receive the proceeds of the policy in order to then pay a special dividend of $1,000,000 to the Holdco of the active shareholder to fund the purchase by the latter of the shares held directly by the disabled individual – with Opco then redeeming shares held by the purchased Holdco of the disabled individual for $500,000.
Would the s. 55(2) rules apply to the special dividend paid to the Holdco of the active shareholder?
Preliminary CRA written response
The question as stated did not specify how the distribution of the value of the insurance policy received by Opco among the shareholders would occur and did not describe the attributes of the issued shares in the capital stock of Opco. In addition, it was not specified by what mechanism the special dividend could be paid solely to the holding corporation of the active shareholder. Consequently, we have not commented on those elements.
With respect to the special taxable dividend paid by Opco to the holding corporation of the active shareholder, it must be determined whether one of the purposes of payment or receipt of the dividend is one referred to in subparagraphs 55(2.1)(b)(i) and (ii). In Technical Interpretation 2015-0613821C6, with respect to the application of the purpose test under the above subparagraphs, the CRA indicated that, subject to certain conditions, the payment of a dividend under of a well-established policy of paying regular dividends would not be considered to have one of the purposes referred to in subparagraphs 55(2.1)(b)(i) and (ii). In addition, the CRA indicated that in other circumstances, the determination of the presence or absence of any of the purposes in subparagraphs 55(2.1)(b)(i) and (ii) could only be made through a review of all the particular facts of a situation and that this could not be done in the context of a Roundtable question or a simple statement of purpose. Finally, the CRA indicated that despite paragraph 19(h) of Information Circular IC70-6R7, "Advance Income Tax Rulings and Technical Interpretations", it could issue a favorable advance ruling on such a determination where all manifestations of purpose and corroborating circumstances support the absence of one of the purposes described in subparagraph 55(2.1)(b)(ii) and (ii). This determination, in an advance ruling request, would, however, be conditional on the representation made by the taxpayer that the purposes for which the dividend was paid do not include one of the purposes described in proposed paragraph 55(2.1)(b)(i) and (ii) and that the description of the facts represents a complete description of all the manifestations of such purpose and all the relevant facts.
Clarification has also been provided, inter alia, in the context of Technical Interpretations 2016-0627571E5 and 2017-0724021C6 on the issue of applying the purpose test for the purposes of paragraph 55(2.1)(b).
Although in certain circumstances the dividend paid by Opco to the holding corporation of the active shareholder may not be considered to have any of the purposes described in paragraph 55(2.1)(b), that determination can only be made after a review of all the facts of a particular situation.
As for the redemption of shares of the capital stock of Opco held by the holding corporation of the disabled shareholder, a result test would apply so that subsection 55(2) could, to the extent that all other conditions of application of this provision were satisfied, apply to the deemed dividend received by the holding corporation of the disabled shareholder.
It should be noted that any dividend or portion of the dividend that is attributable to income earned or realized by Opco would be exempt from the application of subsection 55(2).
In conclusion, this answer is limited solely to the analysis of the application of subsection 55(2) and nothing herein should be construed as acquiescence by the CRA that another provision of the Income Tax Act would not apply to the situation described in the question.
The application of one or more provisions of the Income Tax Act generally requires the analysis of all facts and circumstances pertaining to a particular situation.
Question to Finance
What are the Department of Finance Canada's comments on tax policy regarding the $1 million special taxable dividend paid by the operating corporation in the example?
Finance response
In general terms, the holding corporation of the active shareholder remaining in the share ownership may be subject to capital gains taxation in respect of the special taxable dividend received from the operating corporation pursuant to subsection 55(2) of the Income Tax Act (the Act) if the criteria set out in subsection 55(2.1) are satisfied, including the following criteria:
- One of the purposes of the dividend payment by the operating corporation or the receipt of the dividend by the holding corporation was to:
-
- significantly reduce the portion of the unrealized capital gain on a share;
- significantly reduce the fair market value of a share;
- significantly increase the cost of property.
- The portion of the dividend exceeds income earned or realized by a corporation that could reasonably be considered to contribute to the unrealized capital gain on Class B shares of the capital stock of the operating corporation held by the holding corporation ("safe income on hand").
In terms of tax policy, the exception for safe income is the main exception to the application of section 55 (other exceptions could apply in the context of a corporate reorganization). The concept of safe income is based on the concept of net income for the purposes of the Act, subject to adjustments provided in paragraphs 55(5)(c) to (e).
Consequently, amounts received by a corporation that are not included in its income, such as the disability insurance proceeds received by the operating corporation, are not included in safe income. The operating corporation must have safe income on hand that could reasonably be considered to contribute to the unrealized capital gain on Class B shares of the capital stock of the operating corporation held by the holding corporation of the remaining shareholder so that the safe income exception could apply.
Where a corporation receives a dividend that is deductible in computing its taxable income and the dividend does not benefit from the safe income exception, the determination of whether the dividend will be recharacterized as a capital gain under subsection 55(2) and the purpose test should be consistent with the tax policy underlying section 55. The purpose of the payment or receipt of a dividend is determined according to the facts relating to the series of transactions or events of which the payment and receipt of the dividend is a part. The Canada Revenue Agency can make this determination only in the light of all relevant facts and circumstances.
Official response
Q.6 Loss of tax basis in shares taken back on s. 85(1) roll of Class 14.1 property
An individual transfers a directly-held pharmacy business to a wholly-owned Newco in 2017. On January 1, 2017, the cumulative eligible capital (CEC) account of $1.5 million, reflecting a previous purchase price for goodwill of $2 million, was transferred to Class 14.1 resulting in an undepreciated capital cost (UCC) balance of $1.5 million. The FMV of the goodwill at the time of the drop-down in 2017 is $2.2 million. The s. 85(1) elected amount is $1.5 million to avoid recapture. However, the shares received by the individual in exchange therefor would have a cost only of $1.5 million, whereas if the drop-down had occurred in 2016, it could still have occurred on a rollover basis with an elected amount of $2.0 million (i.e., 4/3 of the CEC balance), thereby giving rise to a cost of the same shares to the individual of $2 million.
What are the comments of the Department of Finance on the tax policy respecting this $500,000 discrepancy in cost to the individual where the drop-down occurs in 2017 rather than 2016?
Finance response
The repeal of the eligible capital property regime was announced in the 2016 Budget. Since 2017, properties that were eligible capital property have become depreciable property of a new class of depreciable property, Class 14.1 of Schedule II to the Income Tax Regulations. Considering the nature and importance of this measure for the Department of Finance Canada and tax community professionals, the Department released legislative proposals with Budget 2016 for the most significant proposed changes so that taxpayers and their advisors could comment on the proposed rules before they came into force and could also plan for the transition to these rules. New subsections 13(38) and (39) of the Income Tax Act (the Act) were included in these legislative proposals.
Subsection 13(38) has the effect of preserving for a taxpayer the cost of an eligible capital expenditure where that property becomes depreciable property and of ensuring that the undepreciated capital cost that migrates to that new class of depreciable property reflects the cumulative eligible capital of these properties to the taxpayer transitioning to that class.
Subsection 13(39) is essentially a relieving measure for a taxpayer does not have excess recapture on the disposition of a property of the new Class 14.1. Special rules under this subsection apply where a property is disposed of on a rollover basis, including the rollover rule provided in subsection 85(1).
Subsections 13(38) and (39) and their interaction with other rules, including subsection 85(1), are the subject of a review by the Department of Finance Canada in order to ensure that the tax consequences of a rollover under subsection 85(1) are appropriate for the transferor and the transferee of property.
Q.7 Payment by purported spousal trust of premiums on trust’s policy on lives of residuary beneficiaries
Included in the property bequeathed by the decedent to a spousal trust was insurance policies (for which he had been the policyholder and beneficiary) on the lives of his children, which had a cash surrender value and on which premiums continued to be payable. In 2006-0174041C6, 2006-0185551C6 and 2012-0435681C6, CRA indicated that the fact that the spousal trust held a policy on the life of the spouse and paid the premiums had the effect of tainting the trust as its income or capital could benefit a third party if the capital was not paid to the spouse as the trust beneficiary. Would CRA have a different policy regarding a policy on the lives of the children who are the residuary beneficiaries of the trust, having regard to the trust being the policyholder and beneficiary of the policy and given that the insured amount could benefit the spouse were a child to predecease the spouse?
Preliminary CRA written response
As stated in the CRA documents referred to above, as well as in the answer to question 1 of the 2012 APFF Financial Strategies and Instruments Roundtable (2012-0453121C6), we are of the view that the obligation of a spousal trust for a spouse or common-law partner (the "Trust") to fund a life insurance policy out of the capital or income of the trust could, depending on the circumstances, result in a person other than the spouse or common-law partner obtaining the use of any part of the income or capital of the Trust for the purposes of subparagraph 70(6)(b)(ii).
The question of whether the condition set out in subparagraph 70(6)(b)(ii) is satisfied is a question of fact and law that can only be resolved after a thorough examination of all the facts, actions, circumstances and relevant documents surrounding each situation.
Assuming that the Trust is the revocable beneficiary of a life insurance policy and that the ownership of such contract has been lawfully transferred to it as a consequence of the death of the testator, the fact that the insured children are the residuary beneficiaries of the Trust and the insurance proceeds could benefit the surviving spouse or common-law partner in the event that the insured children predeceased the surviving spouse or common-law partner generally does not change the position provided by the CRA in the above documents.
In fact, the payment of a life insurance premium is presumed to maintain, for the period covered by the premium, the rights to receive the insurance proceeds by the beneficiary of the policy. In this case, the latter could at any time be a person other than the surviving spouse or common-law partner. Accordingly, we are of the view that the condition set out in subparagraph 70(6)(b)(ii) that no person except the surviving spouse or common-law partner may, before the death of such survivor, receive or obtain the use of any part of the income or capital of the Trust, is not satisfied.
Official response
Q.8 Home Buyer's Plan and withdrawals in two different years
At the 2010 APFF Financial Strategies and Instruments Roundtable, a Finance representative indicated that one of the factors which CRA could take into account in determining whether an HBP withdrawal made after January of a year was to be deemed to have been received at the end of the preceding year, was whether the RRSP balance at that year end was sufficiently elevated to support that withdrawal. If often occurs that a purchase that is made in one year does not close until during the first half of the following year.
- Given this reality, if the RRSP balance on December 31, 2017 is sufficient to cover the RRSP withdrawal subsequent to January of 2018, will CRA automatically apply its discretion under s. 146.01(2)(d) such that the withdrawal is deemed to have been made at the end of 2017?
- Which other factors if any does CRA take into account in determining to exercise that discretion, and how can an HBP participant avoid being taxed on a post-January withdrawal?
- Will CRA change its webpage to reflect this potential?
Preliminary CRA written response to Q.8(a)
The CRA does not automatically apply Ministerial discretion. The situations provided for in paragraph 146.01(2)(d) are evaluated according to the facts and circumstances of each case. The mere fact that, in the situation described, the RRSP balance at December 31, 2017 is sufficient to cover the RRSP withdrawal made in 2018, at a time that is after January 2018, would not, in itself, be sufficient for that Ministerial discretion to be automatically applied, since only a full examination of the facts and circumstances of a particular situation can permit the exercise of that discretion.
Preliminary CRA written response to Q.8(b)
In exercising her discretion, the Minister may consider, in addition to the RRSP balance at December 31, 2017, the dates on which the amounts required for withdrawal were contributed and the reasons for the withdrawals being made over a period that straddled two calendar years. However, this is not an exhaustive list. Other factors may be relevant depending on the circumstances. It is further understood that, for an amount to be deemed to have been received at the end of 2017, the other conditions set out in the definitions of "regular eligible amount" or "supplemental eligible amount" in subsection 146.01(1) should be satisfied as provided in subparagraphs 146.01(2)(d)(ii) and (iii). HBP participants who withdraw over more than one year will generally be contacted by the CRA to confirm details of their participation.
To the extent that you are of the view that the reference to January of the year given in subparagraph 146.01(2)(d)(i) is too restrictive and should be replaced by specific conditions, which your questioning seems to suggest, the issue should be brought to the attention of the Department of Finance. The CRA's mandate is to administer the Income Tax Act, while responsibility for the development of tax policies and amendments to the Income Tax Act rests with the Department of Finance. To that end, you may wish to provide that Department with details of the different situations that arise in practice as well as the frequency with which they occur.
Preliminary CRA written response to Q.8(c)
The CRA will consider the opportunity to modify its HBP webpage to reflect the potential for a taxpayer to request the exercise of Ministerial discretion under subparagraph 146.01(2)(d)(i).
Official response
Q.9. Limitation on student relocation expenses
Moving expenses incurred by students to move 40 kilometres closer to their postsecondary institution are usually deductible from certain types of taxable financial assistance received in the year, for example, the taxable portion of scholarships and research grants (see s. 62(1)(c)(ii).) Students can also receive other amounts to assist in their studies, for example, educational assistance payments received from a registered education savings plan. However, students cannot deduct their moving expenses from such amounts under s. 62(1). What is the tax policy rationale for this limitation?
Finance response
To facilitate the mobility of workers in Canada, taxpayers who move to occupy an employment, to carry on a business or to pursue higher education can deduct eligible moving expenses from their income.
Under subsection 62(2) of the Income Tax Act (the "Act"), a student may deduct from amounts taxable as scholarships (including scholarships, fellowships, bursaries and arts grants) and in respect of taxable research grants. In addition, that person can deduct the portion of eligible moving expenses, that exceed such bursaries and grants, from income from an employment in the location if the facts show that the move was intended to both pursue education and employment (such as a full-time student who also moves to take up an employment).
Section 62 of the Act is a relieving measure since moving expenses can be an obstacle to an individual who must relocate in order to pursue higher education and receive scholarships or research grants.
In terms of tax policy, an individual’s scholarships and research grants are more closely tied to a relocation site than income from a registered education savings plan.
In addition, scholarships, research grants and employment income are received directly by an individual, which is not the case for education assistance payments from registered education savings plans that may include investment income, amounts paid by the Government of Canada to help with education savings (such as the Canada Education Savings Grant and the Canada Learning Bond) and provincial student assistance program amounts.
The Department of Finance Canada is also continually reviewing the Income Tax Act and rules that could be changed through taking into consideration tax policies and competing priorities.
Q.10. Annual payment of interest on interspousal loan with promissory note
On June 1, 2018, Mrs. B lent $500,000 to Mr. B at the prescribed rate of interest (2%) and, at the beginning of January 2019, Mr. B issued a demand promissory note as absolute payment of the accrued interest of $5,863.01. Banner Pharmacaps (2003 FCA 367) stated:
[7] Second, we respectfully disagree with the conclusion of the Tax Court Judge that, as a matter of law, a dividend cannot be paid by delivery of a promissory note. The legal effect of delivery of a promissory note depends upon all the relevant facts, the most important fact being the intention of the maker of the note as determined by the evidence. For example, in some circumstances a promissory note may be evidence of a debt to be paid at some future time. In other circumstances, delivery of a promissory note may itself be payment of a particular obligation.
[8] In the context of this case, the most important evidence is the resolution declaring the dividend. That resolution must be presumed to express the intention of Banner Canada because there is no evidence to the contrary. It states in the clearest possible terms that a dividend in the amount of $5,647,775 was to be paid on the date of the resolution, and that the dividend was to be paid by means of delivery of a promissory note in that amount. As the promissory note was in fact delivered as the resolution required, it is impossible to conclude that the dividend was not paid when it was supposed to be paid, on February 15, 1996. It follows that Banner was required to include the amount of the dividend in its income for its 1996 taxation year. (Emphasis added)
- Does the issuance of this note satisfy the requirement in s. 74.5(1)(b) that the 2018 interest on the loan be paid no later than 30 days after the end of 2018?
- What are the tax consequences to this note not bearing interest?
Preliminary CRA written response to Q.10(a)
Where any of the attribution rules provided in subsections 74.1(1) and (2) and section 74.2 would otherwise apply as a consequence of the transfer of a property by an individual, subsection 74.5(1) provides an exception where certain conditions are satisfied. In particular, where the consideration received by the transferor included indebtedness, the indebtedness must bear interest at a specified rate, and the interest must be paid annually in accordance with the requirements of subparagraphs 74.5(1)(b)(ii) and (iii). As for subsection 74.5(2), it may apply in certain situations where the same attribution rules otherwise would as a consequence of a loan. Paragraphs 74.5(2)(b) and (c) provide requirements similar to those set out in subparagraphs 74.5(1)(b)(ii) and (iii). In the situation you described, since it was a loan that Mrs. B made to her spouse, it appears to us that subsection 74.5(2), and not subsection 74.5(1), would be relevant.
In Banner Pharmacaps, the Federal Court of Appeal indicated that a dividend can be paid by issuing a promissory note where the resolution declaring the dividend states in clear terms that the dividend must be paid by the issuance of a note. Read in context, the excerpt cited in the question illustrates that in the combined application of paragraph 12(1)(j) and section 82, the issuance of a note may in itself constitute the payment of a dividend if that is the intention of the corporation which declared the dividend.
The CRA is of the view that, irrespective of the intention of the parties, the issuance of a note may not constitute the payment of a particular obligation for certain purposes of the Income Tax Act since each provision must be the subject of a textual, contextual and purposive interpretation.
Paragraphs 74.5(2)(b) and (c), as with subparagraphs 74.5(1)(b)(ii) and (iii), are part of a set of rules intended, inter alia, to prevent a taxpayer and the taxpayer’s spouse from sharing income from property (including by means of loans bearing insufficient or no interest) to reduce the total amount of tax payable on that income. In that context, a textual, contextual and purposive interpretation of paragraphs 74.5(2)(b) and (c) and subparagraphs 74.5(1)(b)(ii) and (iii) favours a more restrictive interpretation of the word "paid", according to which the issuance of a note, although irrevocable, unrestricted and payable on demand, does not satisfy the requirement provided for in those paragraphs and subparagraphs.
It follows that, in the situation described, the exception provided for in subsection 74.5(2) could not apply.
Preliminary CRA written response to Q.10(b)
Our comments are the same whether or not the $5,863.01 note bears interest.
Official response
Q.11. Late reporting of principal residence disposition
Commencing in 2016, an individual who had disposed of a principal residence was required to indicate particulars on page 2 of Schedule 3 and, where a particular case was tricked off, complete a Form 2091. For 2016 dispositions, CRA would accept a late designation, and without a penalty being imposed except in the most serious cases. An individual who disposed of the individual’s sole residence in 2016 may have neglected to report it due to lack of familiarity with the new rules or simply did not advising the individual’s accountant of the sale.
- In such cases, must the individual now amend the individual’s 2016 income tax return in order to provide the particulars requested on page 2 of Schedule 3?
- If an amendment is required, will no penalty be imposed for the late making of the principal residence designation respecting a 2016 disposition where this is not a serious case?
Preliminary CRA written response to Q.11(a)
As stated on our website, the CRA requires, for the 2016 and subsequent years, that taxpayers who have failed to report the disposition of their principal residence amend their income tax return if the disposition has not been declared.
For the sale of a residence in 2016, Schedule 3 of the T1 Income Tax and Benefit Return must be completed, on which must be stated the year of disposition of the property, its proceeds of disposition as well as its description. In addition, for the 2016 year, Form T2091 (IND), Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust) (or Form T1255, Designation of a Property as a Principal Residence by the Legal Representative of a Deceased Individual), is required for the designation if the property was not the taxpayer's principal residence for all the years in which the taxpayer was the owner.
For dispositions in 2017 and subsequent years, in addition to having to report the sale and designate the principal residence on Schedule 3 of T1, taxpayers will also be required to complete Form T2091 (IND) (or Form T1255). If the sold property was the taxpayer's principal residence for all years, or for all but one year, while the taxpayer was its owner, the taxpayer is only required to complete the first page of Form T2091 (IND) (or Form T1255).
Preliminary CRA written response to Q.11(b)
The CRA cannot confirm that no penalty will be imposed in the circumstances of your example. Each situation must be studied on a case-by-case basis, according to its specific facts. It should be noted that the administrative practice stated on the CRA's website, allowing the reduction of the penalty for late-filing a principal residence designation, except in the most serious cases, has been extended to dispositions that occurred over the course of the 2017 taxation year.
Official response
Q.12. Requirement to provide country-by-country breakdown on FTC audits
In the autumn of 2017, CRA requested numerous taxpayers to provide information respecting their foreign tax credit claims including as to the allocation of their income from Canadian mutual funds as between the U.S., Europe and Asia. This information was not available on the T3s issued by such mutual funds.
What has been occurring respecting this audit initiative, and what is CRA position respecting taxpayers who hold such funds for which they do not have the relevant information?
Preliminary CRA written response
The CRA noted an increasing number of returns in which the claimed federal foreign tax credit amounts were inconsistent with the amounts of foreign non-business income tax paid as reported on the information slips on file (for example, box 34 of the T3 slip).
In those latter cases, the CRA requested the taxpayer to provide information on the breakdown of foreign income by country, as well as the type of income and foreign tax paid by country, all for the purpose of verifying the correctness of the federal foreign tax credit amounts claimed under the Income Tax Act.
In response to the expressed concern where a mutual fund is invested in a significant number of countries and the burden of allocating the respective information may be burdensome to the taxpayer, the CRA will revise its administrative position and request taxpayers to provide an amended tax slip that correctly reflects the federal foreign tax credit amounts claimed. In general, the CRA will no longer systematically require a breakdown of foreign income by country, type of income and foreign taxes paid by country in such situations.