27 November 2018 CTF Roundtable

This provides the written questions that were posed, and summarizes the oral responses provided, at the CRA Roundtable held in Vancouver on November 27, 2018 at the annual conference of the Canadian Tax Foundation. The presenters from the Income Tax Rulings Directorate were:

Stéphane Prud'Homme, Director, Reorganizations Division, Income Tax Rulings Directorate

Milled Azzi, CPA, CA, Director, International Division, Income Tax Rulings Directorate, Legislative Policy and Regulatory Affairs Branch

The questions were orally presented by R. Ian Crosbie (Davies) and Patrick Lindsay (PwC Law).

We have adopted various of our own titles. The final responses as published under the Directorate's severed letter program are linked at the end of each question.

Q.1 - Allocation of safe income to discretionary dividend shares

At the 2016 CTF Annual Conference, the CRA indicated that it was conducting a study in connection with the proper allocation of safe income in circumstances involving a corporation that has issued shares that are entitled to discretionary dividends. We understand that the study is completed.

Can CRA provide an update regarding its view on this issue?

Preliminary response

Prud’Homme: In response to Question 2 of the 2016 Roundtable of the CTF Annual Conference, the CRA indicated that it would be expressing no further views on the matter of the allocation of safe income to discretionary dividend shares until the completion of an internal study. That study is now completed. As a result, we would like to make the following announcement.

First of all, the CRA stands by all positions on this matter that it has expressed since the 2015 CTF Annual Conference.

Secondly, on a going-forward basis the CRA is willing to provide assurance on the tax treatment of the discretionary dividend shares, but only in the context of a ruling request. Therefore, the CRA will no longer express its views on this matter in Technical Interpretations or Roundtable responses.

CRA considers ruling requests to be the more appropriate avenue for the following reasons: first of all, the determination of safe income that is attributable to specific shares of the corporation is mainly a question of fact. We need to consider all the circumstances in a given situation to be able to arrive at the right answer. Secondly, situations involving discretionary dividend shares generally require an analysis as to whether provisions, such as ss. 15(1), 56(2), 69(1), 245(2), and 246(1) apply in the circumstances. Such analysis also requires review of the relevant facts, the proposed transactions, and the purpose of the transactions. Finally, we find that technical interpretations and roundtable answers contain, by nature, summary facts that may be misleading for a specific fact pattern.

Crosbie: So we will have to wait for a body of rulings to develop and, even then, the rulings will be fact-specific and may be difficult to apply to their own circumstances.

Official response

27 November 2018 CTF Roundtable Q. 1, 2018-0780061C6 - Allocation of safe income

Q.2 - Impact of 55(2) deeming rules

At the 2017 CTC Conference, the CRA indicated that it was studying a series of questions regarding the impact and application of 55(2) to the computation of cost, calculation of CDA and the application of 112(3).

Can the CRA now provide an update?

Preliminary response

Prud’Homme: We have considered the remaining issues that were submitted by the Joint Committee.

First, I will address the effect of the application of s. 55(2) on the calculation of cost. Consider the situation where a dividend in kind is paid by a corporation, and the dividend is subject to s. 55(2). In our view, it should remain a dividend for purposes of the application of s. 52(2). Therefore, the dividend recipient will be considered to have acquired the property received as a dividend in kind, at a cost equal to the fair market value of the property at that time.

Consequently, the views expressed in 9830665 are no longer valid.

With respect to stock dividends, the calculation of the cost of the dividend is governed by s. 52(3). Finance’s intent is to give cost to the portion of the stock dividend that is supported by safe income, but also to a portion of the stock dividend that was technically subject to the application of s. 55(2). Furthermore, when we look at the preamble of 52(3)(a), it is quite clear that the stock dividend that was subject to s. 55(2) remains a dividend for the purpose of 52(3) and, consequently, cost should be recognized on the amount of stock dividend that has been subject to the application of s. 55(2).

Therefore, again, the views expressed in 9830665 are no longer valid.

Regarding PUC increases, our view is that a dividend on paid-up capital increase, that was subject to the application of s. 55(2), remains a dividend for the purposes of the application of s. 53(1)(b)(i). However, we would consider that the dividend that was subsect to s. 55(2) was not permitted a deduction under s. 112(1), for purposes of the application of s. 53(1)(b)(ii).

We understand that there is a reduction of cost under s. 53(1)(b)(ii) to deny cost on the amount of the dividend that exceeds safe income, and on which a deduction under s. 112(1) was obtained. CRA thinks that such denial should not apply to the portion of the dividend that was subject to the application of s. 55(2) because, in that scenario, no s. 112(1) deduction was received.

We feel that this position will provide a fair result to taxpayers, in the sense that cost will not be denied when a dividend on a paid up capital increase has been subject to s. 55(2).

As for capital dividend account calculations, see the pending official response. In summary, the CRA will ensure that the taxpayer will not be penalized in the CDA calculation when the stock dividend or paid-up capital increase was previously subject to s. 55(2). In other words, the CRA will restrict the exclusion of 53(1)(b)(ii), and the similar provision found in s. 52(3)(a), in the calculation of the CDA, to situations where s. 55(2) did not apply to the stock dividend or the paid-up capital increase.

Regarding the effect of s. 55(2) on the application of s. 112(3), the scheme of s. 112(3) is fairly clear – it is to deny the losses caused by non-taxable dividends. In our view, denying the loss on a share that is caused by a dividend that has been subject to s. 55(2) (subject to tax, in other words) would appear to be contrary to the scheme of those provisions. CRA would therefore consider a dividend that was taxed under s. 55(2) not to be a taxable dividend referred to under s. 112(3)(b)(ii).

We have also relayed these views to the Department of Finance.

Crosbie: In summary, your response is policy-based and recognizes the aims of safe income in the s. 55(2) regime. On a first listen, that sounds like a good outcome for taxpayers.

There were a number of things raised by the Joint Committee – for example, common share stock dividends, which you have not been able to address. You see them as legislative problems that cannot be “rationalized away” or dealt with as an interpretive matter, and those will stand, but otherwise you have responded to the package.

Prud’Homme: Yes, there are some limits to the TCP (textual, contextual and purposive) approach. I think we were able to stretch the TCP approach as much as we could.

All these positions are based on one thing – what is the scope of the deeming rule in s. 55(2)? You have to mix this with the notion of integration and cost, and we feel that the positions above are much more in line with tax policy and with the context and purpose of the provision.

Official response

27 November 2018 CTF Roundtable Q. 2, 2018-0780071C6 - Impact of 55(2) deeming rules

Q.3 - Impact of the MLI

Canada introduced legislation to implement the Multilateral Convention to Implement Tax Treaty Measures to Prevent Base Erosion and Profit Shifting (the “MLI”).

What comments can the CRA provide regarding the anticipated impact of the MLI?

Preliminary response

Azzi: To review the background, Canada signed the MLI on 7 June 2017. At the time of signature, Canada made a provisional notification, listing tax treaties it wished to have covered by the MLI, and made provisional reservations with respect to the optional provisions under the MLI. On 28 May 2018, the Minister of Finance tabled a Notice of Ways and Means Motion to introduce legislation to enact the MLI. The Minister also issued a press-release at that time, indicating the intention to remove its provisional reservations for a number of the optional provisions.

These provisions include the 365-day holding period for certain shares of Canadian companies held by non-resident companies. The provision imposes a 365-day holding period for non-residents who realize capital gains on the disposition of shares or other interests that derive their value from Canadian immovable property.

They also include the provision dealing with dual-resident entities.

For the MLI to come into force for a signatory, the signatory must first complete any domestic procedures required to implement the MLI. It must then deposit a notice of ratification, acceptance and approval with the Secretary General of the OECD. On 20 June 2018, the Government of Canada introduced Bill C-82, an Act to implement the MLI. It received its second reading on 25 October 2018.

Note that the MLI does not at the same time operate to modify the application of Canada’s tax treaties. For the MLI to come into effect for a particular treaty, both Canada and the other party must have listed the treaty and ratified the MLI. Furthermore, the impact of the MLI on any particular treaty will depend on the notifications and reservations made by the parties to the treaty under the MLI. In addition, mandatory arbitration, where applicable, requires further matching of the MLI positions taken by Canada and the other treaty partner before it applies to the treaty.

See also comments made by CRA on the MLI and the principal purpose test at the 2017 CTF Annual Conference and the IFA 2018 conference.

Official response

27 November 2018 CTF Roundtable Q. 3, 2018-0779891C6 - MLI Issues

Q.4 - OECD TP guidelines

With respect to the new OECD transfer pricing guidelines can the CRA comment regarding:

  • Q4A: Whether the CRA is still of the view that the 2017 OECD transfer pricing guidelines could be applied retroactively?
  • Q4B: Whether and when can we expect to see additional transfer pricing guidance (for instance, new versions of IC 87-2R, TPM- 14, etc.)?

Preliminary response

Azzi: The 2017 update to the transfer pricing guidelines generally clarify the interpretation and application of the arm’s-length principle, and do not generally represent a change in the analysis of transfer pricing issues.

Therefore, the CRA does not consider that the guidelines are being applied retroactively, because the content on deviation, risk, and intangibles reflects the interpretation and practice of the OECD countries, including Canada, before and after releasing the 2017 guidelines.

The CRA is of the same view regarding any guidance issued since 2017, such as the guidance on profit splits, hard-to-value intangibles, and attribution of profits to permanent establishments.

We will not comment on the discussion draft on financial transactions until it is finalized.

Regarding additional guidance, yes, CRA will be updating its transfer pricing policy documents in due course. The financial transactions paper represents the final guidance required under the scope of BEPS Actions 8 to 10. Once that is finalized, CRA will develop transfer-pricing policy where needed.

Official response

27 November 2018 CTF Roundtable Q. 4, 2018-0779931C6 - OECD TP Guidelines

Q.5 - GAAR and s. 88(1)(b)

We understand that the CRA has considered circumstances where it would, and where it would not, invoke the GAAR in circumstances where paid up capital (“PUC”) is reduced to nil in order to avoid a potential s. 88(1)(b) gain on a wind up.

Using the following four examples, can the CRA identify whether it would seek to invoke the GAAR and, if so, why?

Example 1: Subco was formed by Xco with an injection of capital of $1,000. The PUC of the Subco shares is $1,000. Parentco acquires Subco for $1. On the winding-up of Subco into Parentco, Subco owned assets with a cost amount of $1,000 and Subco had no liabilities and no retained earnings. Furthermore, no retained earnings were realized by Subco after its acquisition of control by Parentco.

Example 2: Subco was formed by Xco with an injection of capital of $1,000. The PUC of the Subco shares is $1,000. Subco realized a non-capital loss of $1,000 with the investment made by Xco. Parentco then acquired Subco for $1. Subsequent to the acquisition, Subco realized income of $1,000 (reflected on the cost amount of its assets). The income of Subco was sheltered by its losses. On a cumulative basis, Subco had no retained earnings. Subco was then wound-up into Parentco. At the time of winding-up, Subco owned assets with a cost amount of $1,000 and Subco had no liabilities and no retained earnings.

Example 3: Parentco owned all Subco shares which have a PUC and an ACB of $1,000. Subco borrowed $2,000 from a third party. Subco acquired assets with a cost amount of $3,000. The assets of Subco subsequently lost all their value. Parentco took the position that Subco became insolvent because it was unable to pay off its debt and did not have any commitment or any undertaking from Parentco to support its debt. The FMV of the shares of Subco was also nil. Parentco claimed a capital loss of $1,000 under subsection 50(1) prior to winding up Subco. As a result, the ACB of the shares of Subco is reduced to nil. On the winding-up of Subco, Parentco assumed Subco's debt.

Example 4: Shareholders of DCco transfer shares of DCco having an aggregate PUC of $10,000 and an ACB of $1,000 to TCco in consideration for shares of TCco. The shares of DCco have a FMV in excess of the PUC. The transfer of shares of DCco is made as part of a distribution of property of DCco to TCco. The DCco shares owned by TCco are subsequently redeemed and the dividend from such redemption is exempt from the application of subsection 55(2) under either paragraph 55(3)(a) or 55(3)(b).

Preliminary response


Prud’Homme: At the 2006 APFF Roundtable, we offered the view that, generally, we would not invoke GAAR to counter a paid-up capital deduction without payment on shares of a corporation in order to avoid a possible gain under s. 88(1)(b).

We subsequently observed that the tax community has come to regard PUC reduction without payment, prior to any wind-up or short-form amalgamation, as a sensible planning step.

We would like to clarify that the “generally” qualifier does not apply in all cases. There are circumstances where an s. 88(1) winding-up can result in a capital gain on the shares where the PUC reduction without payment frustrates the scheme of the Act.

In considering the scheme of the Act, note that redemption of the shares would yield essentially the same result. Where you have an amount of proceeds of redemption that is received by a shareholder that exceeds the PUC of the shares, such excess will be treated as a dividend for the shareholder.

If the PUC of the share is in excess of the ACB of the shares, such excess will result in a gain to the shareholder.

Crosbie: I think a number of people might question whether the redemption is really the right model to look to for the scheme of the Act here – I know I personally have found the scheme of s. 88(1)(b) rather difficult to locate.

Prud’Homme: In the written version, when we refer to the “scheme of the Act,” we are also referring to other provisions, such as ss. 40(1), 40(3), 84(3), 112(1), the definition of “proceeds of disposition” with a carve-out with respect to the dividend, s. 88(1)(b), and 87(11).

We have a feeling that the previous position, when taken literally, had the effect of reading s. 88(1)(b) out of the Act.

Example 1

Prud’Homme: The cost amount of the assets of Subco was not increased by income earned or realized by Subco after its acquisition of control by Parentco.

In our view, this indicates that Parentco has made a bargain purchase, basically, in the tax attributes in the assets of Subco. In our view, the scheme of s. 88(1)(b) dictates a gain to be realized by Parentco on the winding up of Subco in the amount of $999, being essentially the bargain made by Parentco when the Subco shares were acquired.

In such a case, the CRA would seek to apply GAAR to a reduction of PUC without payment prior to the winding up of Subco.

Example 2

Prud’Homme: Here the result is different, because the notion of safe income should be recognized, even if there are losses, and they will be used to offset the retained earnings that were generated.

In this situation, the increase in the cost amount of the assets of Subco was due to income earned, realized after Subo’s acquisition of control by Parentco. Even though the income was essentially sheltered by the loss of Subco, Parentco did not technically realize a bargain purchase in the tax attributes of the assets of Subco.

The use of Subco’s loss is, in our view, a permissible transaction under 111(5), to the extent that the conditions of the provision are met, and that the acquisition of Subco is not part of a loss-trading transaction.

One important thing to realize here is that, but for some corporate law restrictions in some jurisdictions, it would have been possible to pay a safe income dividend of $1000 to Parentco prior to the winding up, such that the fair market value of the Subco shares would be reduced by $1000, or there would be an increase in basis in the Subco shares by $1000, such that no gain would be realized under s. 88(1)(b) on the winding up of Subco’s shares.

In this particular fact-pattern, we would not seek to apply GAAR to a reduction of PUC without payment prior to the winding up of the sub.

Crosbie: As with the 55(2) answers, this continues the theme of safe income as a governing principle in the application of these provisions.

Prud’Homme: Safe income is clearly an important element in the integration system, and the other part of this is what is done with the losses that will be used to offset the safe income that has been generated. The position that we are taking here has been the position of the CRA for many years.

Example 3

Prud’Homme: Interestingly enough, this scenario is very similar to a file that we recently had at the GAAR Committee, and the Committee recommended that the GAAR be applied.

What we see in this situation is that the net cost amount of the assets of Subco is $1000, and consequently we feel that Parentco should realize a capital gain of $1000 on the winding up of Subco, under s. 88(1)(b).

In our view, this is very similar to a situation where the parent had realized a bargain purchase of the tax attributes in the assets of Subco. Remember that, if the gain is not realized under s. 88(1)(b), or under the GAAR, Parentco would essentially have taken two deductions for the same loss of $1000 – first the $1000 loss on the Subco shares under 50(1), and an additional loss of $1000 on the assets of Subco.

The loss of $2000 on the assets of Subco is not an issue per se, considering that it is supported by the debt that is assumed by Parentco in the examples.

In conclusion, if 50(1) applied to allow a capital loss of $1000 on the Subco shares, the CRA would seek to apply GAAR to a reduction of PUC without payment on the shares of Subco prior to its winding up.

Example 4

Prud’Homme: This concerns an excess of PUC over ACB, with respect to the DC shares but, since the main concern here with 55(3)(a) and (b), is to allow for tax-free reorganization. the CRA would not attempt to challenge the reduction of PUC without payment in that scenario, where the potential gain on DC shares essentially transferred to the TC shares.

In other words, if the PUC and ACB of the TC shares are equal to the PUC and ACB of the DC shares at the beginning of this series, we would be fine with that.

Of course, these four examples are all of a general nature. The application of GAAR is based on the specific facts and circumstances.

Our message here is: please come forward with ruling requests, should there be any uncertainty in this area.

Finally, CRA’s position on this matter will be applied on a prospective basis to PUC reductions without payment after 31 December 2018.

Crosbie: I can’t think of a lot of cases over the years where s. 88(1)(b) has actually been there to bite. It’s always been something to worry about, but it doesn’t actually come up that often.

It does seem to me that, day-to-day, the biggest problem here is that you’ve made a relatively simple transaction more complicated, because I can think of many more cases where ascertaining the PUC of the shares is actually a relatively complicated situation. You might be 80% or 95% sure that you’re good, but you can’t proceed until you know.

You might be saying that that is a cost of doing business, but I see that as one of the major spin-offs from this change in position.

Official response

27 November 2018 CTF Roundtable Q. 5, 2018-0780041C6 - GAAR on PUC reduction

Q.6 - CRA Appeals update

The 2016 Auditor General’s report critiqued certain aspects of the Appeals process and, in response to that report, the CRA committed to several actions to improve the Appeals process.

Can CRA provide an update regarding progress to date?

Preliminary response

Azzi: Following the release of the Auditor-General’s report in 2016, CRA committed to a number of action-plans in response to the recommendations, and also in response to Parliament’s Standing Committee on Public Accounts.

The action-plans have resulted in the following improvements:

The implementation on 1 April 2017 of the service standard aiming to resolve low-complexity income tax objections in 180 calendar days 80% of the time. This service standard has been met 90% of the time, as of the end of Q2 2018-19.

There was also an implementation on 1 April 2018 of a service standard aiming to resolve medium-complexity tax objections within 365 calendar days 80% of the time, with the expectation of hitting that target in 2020-21. This target is currently at 73%.

The inventory of regular objections (that is, non-group objections) has been reduced by 25% since Q2 of 2017.

Improvements have been made to the CRA website in order to better inform taxpayer expectations. This includes adding the average time for the assignment and resolution of low- and medium-complexity objections, as well as a decision tree to identify the best channels to address tax issues.

CRA has collaborated with CPA Canada on treed logs on the objections process enough to help accelerate dispute-resolution.

The Auditor General’s Report showed that 84% of decisions fully or partially in favour of taxpayers resulted from new facts being presented at the objection stage. To improve on these results, the Agency implemented the feedback loop process. The feedback loop provides meaningful information back to the assessing, verification, and audit programs through regular communication between the Appeals Branch and these programs. These include the distribution of national-, regional-, office-, and case-level objections decision reports, as well as research and analysis of those objections decisions.

A review of key processes related to the processing of objections was conducted, resulting in the identification of a number of improvements and efficiencies. Examples of initiatives already implemented include automation of some data collection and data entry, updated forms and procedures, and the introduction of the triage function for low-complexity and some medium-complexity objections. In many cases, this triage function has resulted in taxpayers being contacted for additional information within 30 days, which is over 100 days earlier in the process.

CRA has also added resources to address the high-complexity objections

Going forward, the CRA will continue to improve the objections program’s timing and efficiency, and will target the resolution of group objections.

Official response

27 November 2018 CTF Roundtable Q. 6, 2018-0779901C6 - Appeal Process Update

Q.7 - Negligence cases

There have been recent cases involving damage claims against Canadian tax authorities for negligent conduct.

Have these cases impacted tax administration?

Preliminary response

Azzi: Some of these cases are under appeal, and therefore will not be directly commented on. However, in broad terms, they have not caused changes in tax administration practices.

There is a spectrum of the facts in the various cases: some cases involve the CRA, one involves Revenu Quebec, some are under the Civil Code while others are under common law jurisdiction. The tax administration involved in these cases span from domestic audit, the criminal investigations of tax avoidance and offshore transactions.

There have been efforts to update the process for informal disclosure of information to taxpayers during an audit and ongoing efforts to improve the internal processes.

The CRA has for many years had a code of conduct for its staff, the Taxpayer Bill of Rights, and the office of the taxpayer’s ombudsman. These all serve to set expectations and provide service redress options.

CRA has announced the appointment of Chief Service Officer as part of a renewed focus on service. The CRA is also always looking to improve policies, procedures and training of its staff, including areas which deal face-to-face with taxpayers.

However, taxpayers should not expect different results on the technical merits of their case based on their level of representation and available resources. Also, where reliance is placed on CRA’s published views on domestic plain-vanilla arrangements, taxpayers should not be surprised if the CRA might take a view that the underlying facts and issues are sufficiently distinguishable in an offshore situation to result in a challenge to the taxpayer’s position.

The CRA remains committed, however, to arriving at reasonable assessing positions in a timely and transparent fashion, to communicating with taxpayers adopting positions that deviate from longstanding interpretations, to treating taxpayers fairly, and in supporting auditors who may have been singled out for legal action in order to prevent an audit or reassessment. Most importantly, the CRA is committed to professional, fair and unbiased conduct as the best defence to any civil litigation.

Official response

27 November 2018 CTF Roundtable Q. 7, 2018-0779951C6 - Recent Negligence Cases

Q.8 - RPIs and risk-based audits

CRA has followed the international trend of directing more audit resources towards wealthy families and large business in part through the “related party initiative” and “risk based audits”.

Now that these programs have been operation for several years, can CRA provide an update and comment on the future direction of these initiatives?

Preliminary response

Azzi: The Related Party Initiative, or RPI, is the primary CRA audit program that focuses on high net-worth individuals. The RPI program has grown as a result of recent federal budget funding and has also undergone certain changes. A key change in recent years is that high net-worth individuals and their related entities are grouped and risk-assessed and audited by a team using a holistic approach for an economic group. Previously, compliance measures were more likely to focus on only one specific entity by a single auditor. Given the size of some of these economic groups, and how similar the compliance approach is to the large file program, the HQ unit responsible for the RPI is currently in the International, Large Business and Investigations Branch.

The scope of the program generally includes those with a net-worth of $50 million. As of 31 March 2018, the program had identified more than 800 groups that meet this criterion. The program utilizes data available from tax filings, other jurisdictions, and public information to risk-assess the population, in identifying entities to include in their work lines. The work of dedicated RPI teams in assessing risk improves the examining of the role of personal trusts, private foundations, partnerships, offshore activities, as well as corporations, domestic and foreign, in the organizational structure.

There are over 30 RPI teams across the country, and the RPI work role is portable, meaning that the file may be audited by any of our teams nationally. RPI audits are complex and, as a result, our lead time can span a number of years. As RPIs are a component of the Agency’s overall compliance strategy, the results of the initiative are included in the Agency’s annual report to Parliament.

Regarding business audits, the International and Large Business Directorate is the CRA’s centre of expertise for managing this area of compliance. With respect to taxpayers in the large business segment, the CRA envisions an integrated risk-based approach. This approach allows the CRA to focus its audit resources on highest-risk cases and non-compliance. Taxpayers who do not engage in abusive transactions, maintain an effective tax control framework, and are open and transparent with the CRA, are considered low risk. Large businesses are generally defined as an entity having an annual revenue in excess of $250 million with multiple legal entities. There are approximately 20,000 legal entities within the large business population.

On an annual basis, the large business population is subject to a comprehensive risk assessment using CRA’s integrated risk assessment system, and this system generates a risk-ranking of the large business population. This is known as the Tier 1 Assessment. Subject to review by regional and national calibration committees, at the Tier 2 stage, the highest-risk taxpayers form the basis of regional and national work plans. The taxpayers that are considered to be at highest risk within these work plans will be selected for a full audit starting in the Tier 3 stage – the risk assessment and validation stage. At this stage, integrated large business audit teams will contact the taxpayer and conduct the audit-planning and the governance document review process. The team will take into account whether the taxpayer has an effective tax-control framework. Taxpayers who are open and transparent about their tax risks and uncertain tax positions will enable the team to work quickly to determine whether the taxpayer remains high-risk or is in fact is at low-risk. To the extent that the taxpayer is low-risk, the Tier 3 case will be closed, thereby providing certainty for taxpayers.

The integrated teams are lead by the international and large business case manager. The case manager is responsible for the overall audit case, and acts as the single point of contact between the CRA and the taxpayer, thus providing the concept of one team, one voice, and one audit.

For taxpayers that remain high risk, and less than transparent about their risks and uncertain tax positions, the CRA will proceed to a full compliance-audit. The CRA will communicate to the taxpayer the significant tax and significant audit issues in the case and the reasons for assigning more resources, where applicable. The CRA will also conduct face-to-face meetings towards the conclusion of the audit of the highest risk and least cooperative taxpayers to communicate to the entity’s senior management the unresolved compliance issues and, where it exists, the lack of openness and transparency experienced by the audit team.

The CRA continues to grow voluntary compliance by increasing transparency and strengthening mutual trust and cooperation with Canada’s largest business entities. Obviously, the overall objective is to promote voluntary and cooperative compliance.

Official response

27 November 2018 CTF Roundtable Q. 8, 2018-0779961C6 - RPI and Risk-Based Audits

Q.9 - TOSI – excluded amount and non-related business

The CRA has been asked to clarify its position regarding “excluded shares” and “related business exclusions” under the tax on split income rules (“TOSI”). We understand that the CRA has developed some hypothetical scenarios to try to add clarity.


Scenario 1: Mr. A and his spouse, Mrs. A, are both over 25 years old and are resident in Canada. Each own 50% of the shares of ACo, which in the past had carried on a business (the “Old Business”) in which Mrs. A had been actively engaged on a regular, continuous and substantial basis for at least five prior taxation years. Mr. A was never involved in or contributed to the Old Business. ACo disposed of the Old Business two years ago, and ACo’s sole activity since then has been the investment of the sale proceeds and the historical retained earnings from the Old Business. In the current year, ACo declared a taxable dividend to Mr. A and Mrs. A.

If ACo’s investment activities constituted a business during ACo’s last taxation year and generated positive gross revenue during that year, can the CRA confirm that Mr. A’s and Mrs. A’s shares in ACo constitute “excluded shares” in the current year?

Preliminary Response

Prud’Homme: The excluded shares exception would be available here.

If we consider that the investment activities are in fact carried on, and those activities constitute a business, they would be able to avail themselves of the excluded shares exception.

There are essentially three conditions in paragraphs (a) to (c) of the definition of excluded shares. The conditions set out in paragraph (a) essentially would be satisfied here because Aco is not a professional corporation, and Aco carries on a business, the income of which was solely derived from property and not the provision of services.

Turning to paragraph (b), both Mr. A and Mrs. A would have the requisite share ownership to satisfy the votes and value tests in this example, such that the paragraph (b) condition would be met.

Finally, Aco’s income for the last taxation year would not have derived directly or indirectly from another related business other than the business of Aco, so paragraph (c) would also be satisfied.

In this scenario, Aco could consider the shares to be excluded shares, and the dividends would not be subject to TOSI.


In the case where ACo’s investment activities did not constitute a business, can the CRA confirm that the dividend declared in favour of both Mr. A and Mrs. A will not be considered split income given that the dividend is not derived directly or indirectly from a related business in respect of the individuals for the year? More specifically, can the CRA confirm that even if the dividend is considered to be derived directly or indirectly from the historical retained earnings of the Old Business or from the proceeds of disposition of the Old Business, it is not deriving it from a related business “for the year”?

Preliminary Response

Prud’Homme: This question is very interesting, and we keep being asked it.

We begin with subparagraph (e)(i) of “excluded amount.” It provides that an amount that is not derived directly or indirectly from a related business for the year is an excluded amount. Accordingly, we must first determine whether the amount was derived directly or indirectly from a related business, and second whether such amount was from a related business for the year.

In our view, the expression “directly or indirectly from a business” is broad, so that the dividends that are received by Mr. A and Mrs. A would be considered to be derived directly or indirectly from a related business, which was the Old Business.

However, where the Old Business has been wound up in a previous taxation year, and where it can be determined that the corporation does not have a related business for a particular subsequent taxation year, then the dividend that would be received by the individual in the subsequent year will constitute an “excluded amount” under subparagraph (e)(i) of the definition.

Therefore, the dividend that would be received by Mr. A and Mrs. A in the current year from Aco would be considered to be an excluded amount and would not be subject to TOSI.

If it is determined that a transaction, either alone or as part of a series, has been untaken primarily to obtain a benefit from the excluded amount exemption in a manner that would frustrate the object, spirit and purpose of s. 120.4, of course we would consider the application of the GAAR in such a case.


Scenario 2: Mr. A and Mrs. A are both Canadian residents over 25. Mrs. A is the sole shareholder of Opco. For all relevant years, Opco is not a professional corporation and carries on an operating business that is not a services business. Mr. A is the sole shareholder of Serviceco but is not actively engaged on a regular, continuous and substantial basis in the activities of Serviceco. In Year 1, Serviceco’s income was derived from the provision of services rendered to Opco. Serviceco does not pay any dividends to Mr. A in Year 1. In Year 2, Serviceco does not render any services and its activities for the year do not rise to a level that is sufficient for Serviceco to be considered to have a business for the year.

Can the CRA comment on whether, in circumstances where Serviceco’s Year 1 after-tax income is paid as a dividend to Mr. A in Year 2, such dividend would constitute an “excluded amount” pursuant to subparagraph (e)(i) of the definition?

Preliminary Response

Prud’Homme: Here, things are a bit different from the situation in Q.9(b). The income earned by Serviceco in Year 1 was derived from the provision of services to Opco and, as such, will be deemed to be an amount derived, directly or indirectly, from Opco’s business, pursuant to s. 120.4(1.1)(d). Furthermore, the dividend paid in Year 2 can also be said to have derived directly or indirectly from the provision of services to Opco in Year 1, such that the dividend would also be deemed to derive directly or indirectly from Opco’s business, which would be a related business here.

Therefore, in this scenario, Opco continues to operate its business in Year 2. Accordingly, Opco’s business will constitute a related business in respect of Mr. A for Year 2.

Compare with Q.9(b), where the related business was wound up in a preceding taxation year. In Q.9(c), the dividend received by Mr. A in Year 2 would not constitute an “excluded amount” and would potentially be subject to TOSI.

Official response

27 November 2018 CTF Roundtable Q. 9, 2018-0779981C6 - TOSI–Excluded Amount - Non-Related Bus. Exception

Q.10 - TOSI – excluded shares and related business

In question 7 of the 2018 CRA Roundtable of the Society of Trust and Estate Practitioners the following question was asked: “Assume that a corporation has no business income because it derives income from property (possibly rental income from real property where the activities are not sufficient to constitute business income). In this case, can the shares of the corporation be excluded shares?”

The CRA answered the question in the negative. Relying on paragraph (a) of the definition “excluded shares” in subsection 120.4(1), the CRA mentioned that if a corporation has no business income, its shares cannot qualify as excluded shares.

However, in examples 8 and 12 of the Guidance on the Application of the Split Income Rules for Adults released by the CRA on December 13, 2017, shares of the capital stock of a corporation earning income from passive investment assets qualified as excluded shares.

How does CRA reconcile these positions and can the CRA confirm whether shares of an investment corporation could qualify as excluded shares?

Preliminary response

Prud’Homme: We have had several questions like this – people were perceiving a tension between the response given in Q.7 of the 2018 STEP roundtable and some of the examples given in the Guidance.

CRA’s response in the STEP Roundtable was based on the assumption provided in the question that the corporation was not carrying on a business, while Examples 8 and 12 of the Guidance assume that the corporations were carrying on a business. It is important to remember, when interpreting Roundtable responses, that stated assumptions will often drive the answer.

The Guidance is intended to provide general guidance on how the CRA will administer the variety of different exclusions described in the definition of “excluded amount.” In order to demonstrate that the different exclusions are not applicable only to entities carrying on an active business, but also to entities carrying on a business, the purpose of which is to derive income from property. CRA made the assumption in Examples 8 and 12 of the Guidance that the corporations maintain a sufficient level of activity to support the view that their income can be considered income from a business.

It is, of course, a question of fact as to whether the income of a corporation is from a business or property.

Turning back to Q.7 of STEP 2018, if we were to instead assume that the corporation does carry on a business, the corporation’s shares could qualify as excluded shares. On the other hand, even if the corporation’s shares could not qualify as excluded shares in Q.7, the amount received from the corporation by the specified individual could still potentially be an excluded amount. This could be the case if it were determined that the corporation does not carry on a business, and if the amount of the dividend is not derived, directly or indirectly, from a related business in respect of the individual for the year. Consequently, the amount of the dividend would not be subject to TOSI in those circumstances.

Official response

27 November 2018 CTF Roundtable Q. 10, 2018-0780081C6 - TOSI – Excluded Shares & Related Business

Q.11 - Tax accrual working papers

The CRA has a published position regarding its authority and process for obtaining taxpayer records. Since that document was published there have been a number of cases such as BP that address CRA’s authority to access records.

Can the CRA provide its current view regarding its approach to requesting taxpayer records, in particular, a taxpayer’s analysis of their tax risks, and is the CRA updating its published position?

Preliminary response

Azzi: Following the BP decision, CRA communicated, in May 2017, that it would not be seeking leave to appeal this decision to the Supreme Court.

The CRA maintains its position that, in certain circumstances, it can request access to tax accrual working papers. The ability to obtain all information required to administer and apply Canadian tax laws is central to the integrity of the tax regime.

As previously communicated, the CRA considers the facts and circumstances of BP to be unique. Therefore, rather than appealing the decision, the CRA is addressing the issue on a broader scale by updating its procedures to clarify when and why information can be requested from taxpayers.

The CRA has updated its internal Communiqué entitled “Obtaining Information for Audit Purposes.” The communiqué outlines that CRA can seek the production of tax accrual working papers, provided that the request for such records is relevant to specific risks or items under audit, and CRA officials are using a certain amount of restraint in seeking the information.

Factors that may be considered in requesting such records include:

  • the taxpayer’s past level of compliance;
  • the existence of large amounts of unexplained tax reserves; and
  • the potential tax at risk.

The taxpayer’s list of uncertain tax positions with respect to tax reserves is considered to be part of the taxpayer’s books and records, and is not subject to solicitor-client privilege unless otherwise demonstrated.

As outlined in the Communiqué, CRA officials must be objective when reviewing any information or documentation obtained during examination. While CRA officials may, in certain circumstances, request a list of what the taxpayer considers to be its uncertain tax positions, CRA officials should first perform research and analysis in forming the basis of their reassessment.

Provided all relevant facts and transactions are included in the taxpayer’s uncertain tax positions, exclusions of the related advice and analysis may be accommodated. For example, the CRA does not need the taxpayer’s assessment of the general anti-avoidance provision.

The CRA’s position is that taxpayers are required to disclose sufficient detail regarding their business and transactions for the CRA to fulfil its mandate to assess tax. Where the criteria in the Communiqué are met, the CRA believes that it retains the right to certain tax positions as outlined in the recent Atlas Tube Canada ULC decision. Finally, the CRA recognizes the principle in BP that taxpayers are not required to self-audit.

The Communiqué will be posted on the Government of Canada website, and stakeholders will be notified through the CRA stakeholder desk notification service.

Official response

27 November 2018 CTF Roundtable Q. 11, 2018-0779971C6 - Record Retention Policy Guideline

Q.12 - Advantage rules and investment management fees

At the 2016 CTF Roundtable, the CRA announced its position regarding the application of the advantage tax rules where investment management fees relating to securities held in a registered plan. CRA set an initial date for that position to come into effect and that date was later extended to January 1, 2019.

Can the CRA provide an update on this position and timing?

Preliminary response

Prud’Homme: The CRA has considered a number of submissions from various stakeholders on this matter, and is sensitive to the concerns that were raised about the administrative difficulties in complying with the position. The Department of Finance advised us that they will be reviewing this matter from a tax policy perspective.

As a result, in our letter on 28 September 2018, we announced that we would be deferring implementation of this position, pending the completion of this review by Finance.

On 1 October 2018, the CRA published a Folio dealing with the notion of advantages in the context of registered plans, with a three-month comment period.

Following the conclusion of the comment period, and Finance’s review, CRA intends to update the Folio to provide additional guidance on fees, in addition to any changes resulting from suggestions received during the comment period.

Official response

27 November 2018 CTF Roundtable Q. 12, 2018-0785021C6 - Investment management fees

Q.13 - Interest deductibility, redeemed shares and triangular amalgamation

In a triangular amalgamation, where ParentCo obtains a third party loan to redeem preferred shares issued by TargetCo as part of the transaction.

Does CRA consider the interest on such loan to be deductible under paragraph 20(1)(c)?

Preliminary response

Prud’Homme: In this area, you would need to apply the fill-the-hole concept that was established by the case law.

In the Folio on interest deductibility, paragraph 1.48 indicates that:

Interest expense on borrowed money used to redeem shares or return capital can be an exception to the direct use test. In connection with this use, the purpose test will be met if the borrowed money replaces capital (contributed capital or accumulated profits) [when we are referring to contributed capital, our starting point is the legal stated capital] that was being used for eligible purposes that would have qualified for interest deductibility had the capital been borrowed money.

Paragraph 1.49 of the Folio indicates that “where some proportion of shares is being replaced with borrowed money, only the capital of those shares, computed on a pro-rata basis, would be considered to be replaced with the borrowed money.”

Applying these rules, interest on borrowed money used to redeem shares (preferred shares, in this example) would be deductible under s. 20(1)(c), to the extent that the amount of borrowed money does not exceed the capital of the shares, computed prior to the redemption of such shares, and provided of course that the capital replaced by the borrowing was previously used for eligible purposes.

I would also add that, in order for interest to be deductible under s. 20(1)(c)(i), the amount of interest must be reasonable in the circumstances, and there must be a legal obligation to pay such interest.

Official response

27 November 2018 CTF Roundtable Q. 13, 2018-0779991C6 - 20(1)(c) & Triangular Amalgamation

Q.14 - Foreign exchange

What is the appropriate foreign exchange rate to use when computing a deduction pursuant to paragraph 20(14)(b) – i.e., does the purchaser bear foreign exchange risk on foreign currency interest accrued to the time of the purchase of the debt obligation?

Preliminary response

Azzi: Subsection 20(14) provides that the amount of accrued interest at the time of transfer of a debt obligation is included in the transferor’s income for the taxation year in which the transfer occurred. An offsetting deduction is permitted to the transferee for the year that interest is included in the transferee’s income.

Paragraph 261(2)(b) requires that, if a particular amount that is relevant in computing Canadian tax results is expressed in foreign currency, that particular amount must be converted into Canadian currency using the relevant spot rate for the day on which the particular amount arose.

Since subsection 20(14) requires the amount of accrued interest to be included in income of the transferor, and allows a deduction in income to the transferee, that amount is relevant to both of the taxpayers’ Canadian tax results.

Consequently, in applying 261(2)(b) and subsection 20(14), where a transferred debt obligation is denominated in a foreign currency, the particular amount to be converted to Canadian currency is the amount of foreign currency interest accrued at the time of transfer. The day the accrued interest is considered to arise in 261(2)(b) is the day of the transfer because this is the day when the amount of interest that has accrued is required by subsection 20(14) to be determined.

Therefore, the accrued interest converted to Canadian dollars, using the relevant spot rate for the date of transfer, will be the amount used in determining both the transferor’s income inclusion under s. 20(14)(a), and the transferee’s deduction under s. 20(14)(b). The use of the spot rate on the day of transfer is appropriate from the perspective of the transferor, as it is the day that the accrued interest is computed, and also the date that the transferor disposes of the right to receive the interest. It is also appropriate from the point of view of the transferee, as that is the day on which the transferee acquires the right to the accrued interest.

Official response

27 November 2018 CTF Roundtable Q. 14, 2018-0779911C6 - Foreign exchange

Q.15 - Class 14.1

Class 14.1 depreciable property references “property” of the taxpayer, a requirement that was not explicitly present under the former eligible capital “property” rules. In 2017-0727041E5, the CRA indicated that legal and accounting fees incurred in an aborted share acquisition transaction could be treated as an addition to Class 14.1 property in specified circumstances. Does the CRA consider that the reference in the Class 14.1 description to “property” does not have the effect of disqualifying, as Class 14.1 additions, expenditures that would have qualified as eligible capital expenditures if incurred before 2017?

Preliminary response

Prud’Homme: Effective 1 January 2017, the eligible capital property rules in Section 14 were repealed and replaced by new Class 14.1 of the CCA Regulations. Consequently, property, the cost of which would previously have been treated as ECE, is generally included in Class 14.1, subject to certain conditions in paragraphs 13(35)(a)-(e).

Subsection 13(35) provides that, if a taxpayer incurs an outlay or expense on or after 1 January 2017 on account of capital for the purpose of gaining or producing income from a business, the taxpayer is deemed to acquire property that is goodwill, with a cost amount equal to the amount of the outlay or expense.

Subsection 13(34) also specifies that there is a single goodwill property in respect of a particular business, and technically it is also interesting to note that the definition of “property” in 248(1) has been amended to clarify that goodwill is property for the purposes of the Act.

Official response

27 November 2018 CTF Roundtable Q. 15, 2018-0780011C6 - Class 14.1

Q.16 - Passive investment

For a corporation’s taxation year that ends December 31, 2018 or straddles December 31, 2018, assuming the taxation year is an ordinary 12-month year that is not shorter than it would have been because of a transaction or event or a series of transactions or events, is the “adjusted aggregate investment income” (“AAII”) for that year end necessarily $0, given that the definition of AAII only applies to taxation years beginning after 2018?

Consider the following scenario:

  1. Holdco and Opco are associated at all relevant times. There are no other corporations in the associated group.
  2. Opco had a June 30, 2019 year end which was a full 12-month year end. Its next year end is on June 30, 2020.
  3. Holdco also had a June 30, 2019 year end which was a full 12- month year end. In that June 30, 2019 year end, it had $150,000 of investment income.
  4. The new business limit reduction that is based on AAII, found in 125(5.1)(b) is applicable to Opco for its June 30, 2020 year end as the first taxation year that begins after 2018. The calculation of the reduction would bring Opco’s business limit down to $0 if Holdco has AAII of $150,000 in the year ending in the previous calendar year (June 30, 2019 year-end).
  5. Holdco has investment income of $150,000 in 2019, but may not have any AAII for its June 30, 2019 year end because of the 125(7) definition of AAII. This is because, in Bill C-74, the application for the definition of AAII is to taxation years that begin after 2018. Since Holdco’s June 30, 2019 year end began before 2018, and not after, the definition does not apply.
  6. Therefore, although 125(5.1)(b) applies to Opco’s June 30, 2020 year end, the first year in which the new passive investment income rules could affect Opco’s business limit is its June 30, 2021 year end. Does the CRA agree?

There was insufficient time to respond orally to this question.

Official response

27 November 2018 CTF Roundtable Q. 16, 2018-0780031C6 - 2018 CTF - Q16 - Passive Income Reduction Rules