15 September 2020 IFA Roundtable
This provides the written questions that were posed, and summaries of the CRA oral responses, at the CRA Roundtable webinar hosted on 15 September 2020 by the International Fiscal Association (Canadian branch). The presenters from the Income Tax Rulings Directorate and CASD were:
Nicolas Bilodeau, Manager, International Division
Yves Moreno, Director, International Division
Patrick Massicotte, MAP-Technical Cases Section, Competent Authority Services Division
The questions were orally presented by Claire Kennedy (Bennett Jones) and Lynn Moen (Enbridge Inc.). It is understood that the prepared written responses will be available by the end of this week.
Q.1 - S. 85 elections where different tax reporting currencies
Where a taxpayer transfers property to another corporation on a tax-deferred basis pursuant to section 85, form T2057 must be jointly filed by the transferor and the transferee.
The transfer will have implications for both parties’ Canadian tax results (CTR), as that term is defined in subsection 261(1), though the impact on the transferee’s CTR will be prospective only.
Where the two parties have different tax reporting currencies, within the meaning of subsection 261(1), can the CRA confirm that the amounts to be reported on form T2057 should be denominated in the transferor’s elected functional currency?
Bilodeau: When section 85 applies in respect of a property transfer by a transferor that has a tax reporting currency (as defined in s. 261(1) of the Act) that is different from that of the transferee, CRA requires that two separate forms T2057 be filed. In such case, the amounts would be reported and denominated in the transferor’s tax reporting currency on the first form T2057, and in the transferee’s tax reporting currency on the second T2057.
Q.2 - Withholding if swap mismatches
A Canadian resident taxpayer (Canco) enters into a Swap Agreement (Swap Agreement) with a non-arm’s length non-resident company (NRco). Payments under the Swap Agreement are made by Canco to NRco annually, while NRco makes its payments to Canco quarterly.
The position expressed in Question 60 at the 1984 CTF Roundtable suggests that, in cases where swap payments are not made contemporaneously, as in the example above, withholding tax may apply to a portion of the outbound payments that represents an interest element.
Does this continue to be CRA’s position?
Bilodeau: CRA has previously opined, in several documents, that all amounts payable or receivable under the terms of a swap agreement are on account of income and are deductible or are included in income under s. 9 of the Act.
That is based on our longstanding view that payments under a swap agreement do not have any specific legal character - that is, at law, swap payments are not interest, dividends, rent, royalties, payments for any services or proceeds of disposition, and they do not represent a substitute for legal obligations to pay such an amount.
Therefore, in order for withholding tax to apply to the interest component of a swap payment, as in the example given in the question, the legal character of the amount made by Canco to NRco must be recharacterized as interest for tax purposes.
Whether the legal character of an amount paid or received can be recharacterized for tax purposes was addressed by the Supreme Court in Shell Canada, which observed that, absent the application of a specific provision of the Act to the contrary or a finding of sham, the taxpayer’s legal relationships must be respected. Therefore, in an application of this principle, it is our view that, generally, withholding tax would not apply in the example described above absent a finding of sham or the application of specific provision of the Act, for example, s. 245(2) or 247.
Q.3 - MAP procedure for s. 247(2)(b)
We understand that Information Circular IC71- 17R5 Guidance on Competent Authority Assistance Under Canada’s Tax Conventions is currently being revised. In paragraph 43 of this revised draft information circular, it is stated that paragraph 247(2)(b) is one of the “anti-avoidance provisions of the Act”. Could the CRA elaborate further on its views with respect to this position?
In addition, in the case where paragraph 247(2)(b) is applied to (re)assess, does the CRA intend to restrict a taxpayer’s right to access the Mutual Agreement Procedure (MAP) provision of the pertinent international tax treaty? If so, would the CRA be willing to provide further details regarding this position?
Massicotte: Yes, the IC is being updated. The last update was in 2005 and a lot has occurred internationally since then, including the BEPS project. Especially relevant is BEPS Action 14, which concerns the Competent Authority and Mutual Agreement Process in our Treaties, and includes minimum standards and requirements for countries to publish guidelines on access to the Mutual Agreement Procedures - and is also subject to peer review.
We have undertaken to update the IC to reflect all these changes and formal public consultation took place this summer. We have received a lot of comments and we are still reviewing them. We hope to be done by the end of 2020 and will specifically deal with paragraph 43 of the draft IC dealing with domestic Canadian anti-avoidance provisions.
Canada has not changed its position, which is the same as expressed in para. 27 of the current version of the IC. The position is that any assessment that relies on a domestic anti-avoidance rule will be eligible for MAP consideration - but Canada will simply present the Canadian position relying on the anti-avoidance rule to the other Competent Authority for potential relief by the other country.
The only change that was made in paragraph 43 of the update was to add an additional example. Previously, we only referred to GAAR, so now we have added another example of a specific anti-avoidance rule: paragraph 247(2)(b), in the context of transfer pricing. That provision is an anti-avoidance rule because it applies only where transactions are undertaken mainly for tax benefits rather than business reasons.
Thus, where an assessment relies on s. 247(2)(b) as the primary assessing position, the Canadian Competent Authority’s position will be that MAP is still available – however, if it is a primary position of the CRA that 247(2)(b) applies then, as with GAAR assessments, Canada will simply present that position to the other Competent Authority and, if there is double-taxation, seek relief from the other country.
Q.4 - COVID-19 response
As CRA and taxpayer offices commence re-opening in a number of provinces, would the CRA be able to provide an update on the following matters?
- What is the current CRA work situation in connection with the conduct of international audits and requests for foreign based information?
- How has the CRA been managing both the Advance Pricing Arrangement (APA) and Mutual Agreement Procedure (MAP) requests in the current environment and what is the plan going forward?
- Has the Transfer Pricing Review Committee (TPRC) been meeting regularly during the COVID- 19 pandemic and what is the plan going forward?
- As there have been significant domestic and international travel restrictions imposed because of the COVID- 19 pandemic, how has the CRA been managing APA and MAP matters with treaty partners?
- Where Article 9 of a Treaty provides for an express and specific calendar year limitation for assessing or reassessing tax on certain transfer pricing adjustments (Treaty Based Limitation Periods), how is the CRA addressing issues surrounding impending Treaty-Based Limitation Periods? Have extensions been discussed with treaty partners?
Massicotte: This is a lengthy question, I will try to condense it and combine (b) and (d), as both discuss the MAP and APAs.
Regarding (a), initially most non-critical operations were interrupted. International programs were identified as critical services in June 2020, and we have been gradually resuming operations, focusing on delivering benefits to taxpayers at the top of the priority list and secondly any issues that may have any strategic importance to CRA, i.e., there are high dollar issues involved in an audit or there are audits that are close to completion. Other high-priority situations involve approaching statutory or treaty deadlines.
Regarding (b) and (d) (the APA and MAP programs), these have also been part of the international program, and, thus, were identified in June as critical services. We have gradually resumed those operations and we are in contact with our treaty partners using virtual tools such as teleconferencing and, where possible, video-conferencing.
Regarding APAs and site-visits, we seek to have video conferencing and teleconferencing or other virtual tools (using secure lines) jointly with our treaty partners. We actually managed to close some MAP cases using teleconferencing without having to travel outside Canada. So that is still working well.
It is understood that the Transfer-Pricing Review Committee has not been interrupted and they have kept on going throughout this crisis, with the Committee members meeting using virtual tools such as teleconferencing with secure phone lines.
There have been no discussions with our treaty partners to extend treaty time limits. These are still applicable, and even the recent Bill C-20 (the Time Limits and Other Periods Act) that was recently adopted does not apply to treaties. It only applies to domestic time-limits in the Income Tax Act.
If a Treaty has no time-limits itself, then the usual domestic limits apply. For example, section 152 reassessment periods would apply – again, subject to any changes provided in Bill C-20, that extend those delays for periods up to six months, but no later than December 31st 2020. If there are additional delays or time needed due to COVID situations, then we would suggest that waivers should be used.
Q.5 - TPM-17 and COVID-19
According to CRA’s Transfer Pricing Memorandum on the impact of government assistance on transfer pricing (TPM- 17), the cost base should not be reduced by the amount of government assistance received unless there is reliable evidence that arm’s length parties would have done so given the specific facts and circumstances. It is presumed that the Canadian taxpayer will keep the government assistance, unless it can be proven that arm’s length enterprises would effectively share all or part of that assistance.
What are the CRA’s views on the impact and treatment of the COVID- 19 related government assistance programs in the context of TPM- 17, and whether CRA’s position may in any way be different given the unprecedented business circumstances caused by the pandemic (i.e. what sort of market evidence would CRA expect to see if the taxpayer decides to offset costs against the COVID- 19 government assistance received in determining the final transfer pricing charge)?
Massicotte: CRA’s policy in TPM-17 is that, generally, the government assistance should be kept by the Canadian recipient. In this instance, we are talking about COVID-related government assistance, which is generally intended to help Canadians and Canadian businesses dealing with financial hardship resulting from the COVID situation.
However, the policy in TPM-17 still applies, which means that, if some marketplace evidence can be provided to show that type of exceptional and temporary government assistance would be shared with arm’s length parties, then CRA is open to considering that.
Due to lack of precedent, it is not completely clear what type of evidence we would expect. Generally we would expect, given the temporary and exceptional objectives of this COVID-related government assistance, that it should be kept by the Canadian recipient. For example, in a cost-based transfer pricing methodology, the cost base should not be reduced by the amount of a wage subsidy that a Canadian company receives.
These tables show what CRA would, in the first instance, consider as the appropriate transfer-pricing treatment for a wage subsidy.
|Appropriate transfer pricing treatment of the CEWS|
|Transfer price calculation||CanCo income statement|
|Salary costs||$60||Revenue (transfer price to ForCo)||$110|
|Other costs||$40||Salary costs||$60|
|Add 10% mark-up||$10||Other costs||$40|
|Transfer price to ForCo||$110||Total costs||$90|
The left column shows how CRA expects the calculation to be done, and on the right side shows how Canco’s income statement should be recorded. There would be revenues based on the transfer price established of $110, minus salary costs of $60. This is where the wage subsidy – we’ll say $10 in this case – would be taken into account. It is a $10 subsidy applied against $60 of wages and $40 of other costs, for a total of $90. With $110 of revenue, there is $20 of net income, being $10 of profit plus the $10 wage subsidy.
This example assumes that we are looking at one year in total so that, because the wage subsidy would be tied to a decrease in revenues or activities of Canco, presumably the $10 wage subsidy would link to costs incurred while the Canadian company is either inactive or reducing its activities. It would be intended to cover those costs as opposed to the costs that were incurred while providing services and generating revenues.
|Inappropriate transfer pricing treatment of the CEWS|
|Transfer price calculation||CanCo income statement|
|Salary costs||$60||Revenue (transfer price to ForCo)||$99|
|Less: (CEWS)||($10)||Salary costs||$60|
|Tota costs||$90||Other costs||$40|
|Add 10% mark-up||$9||Total costs||$90|
|Transfer price to ForCo||$99||Net income||$9|
The next table shows how it would not be appropriate, from CRA’s perspective, to take into account the wage subsidy. On the left side, starting with salaries of $60 and other costs of $40, it would be inappropriate to reduce the salary costs by the $10 wage subsidy to determine total costs on which a mark-up is applied. That would reduce the computed value of the services from $110 down to $99, which would be improper unless it could be shown that the value of those services should be affected by the wage subsidy.
Plugging the numbers in on the right, the $11 decrease in revenue results in income of $9, down from $20. Again, we consider this to be inappropriate.
Q.6 – S. 212.3(9) and GAAR
At all relevant times, a non-resident corporation (NRco) owns all the common shares of a corporation resident in Canada (Canco), which shares are the only issued and outstanding shares of Canco.
After March 28, 2012, Canco acquires all the shares of the capital stock of a non-resident corporation (FA1) for $100.
This is an investment by Canco described in paragraph 212.3(10)(a), such that the combined application of subsection 212.3(2) and 212.3(7) requires the reduction of the paid-up capital (PUC) on the common shares of Canco by $100.
At a subsequent time, the following series of transactions is implemented:
- New FA2 is incorporated under the laws of a foreign jurisdiction and Canco subscribes for 100 common shares of New FA2 for a nominal amount. This is an investment by Canco described in paragraph 212.3(10)(a), such that subsection 212.3(7) requires the PUC of the common shares of Canco to be reduced by a nominal amount.
- New FA2 borrows $100 on a daylight basis (Daylight Loan) from an arm’s length third party.
- New FA3 is incorporated under the laws of a foreign jurisdiction. Using the proceeds of the Daylight Loan, New FA2 subscribes for 100 common shares of New FA3 for $100, such that New FA3 is at that time a wholly-owned subsidiary of New FA2.
- FA1 acquires the common shares of New FA3 from New FA2 in consideration for a promissory note in the amount of $100.
- FA1 makes an in-kind return of capital on its common shares held by Canco by transferring to Canco the common shares of New FA3. This acquisition of the New FA3 shares is an investment by Canco described in paragraph 212.3(10)(a) that is not subject to subsection 212.3(2) in application of subparagraph 212.3(18)(b)(vii).
- Canco contributes the common shares of New FA3 to New FA2 in consideration for additional common shares of New FA2, such that subsection 85.1(3) applies to this transfer of shares. This is an investment by Canco described in paragraph 212.3(10)(a) that is not subject to subsection 212.3(2) in application of subparagraph 212.3(18)(b)(ii).
- New FA3 is liquidated into New FA2.
- New FA2 repays the Daylight Loan using the proceeds received on the liquidation of New FA3.
Does the CRA agree that the in-kind return of capital in step 5 would give rise to a $100 reinstatement of the PUC on the common shares of Canco in application of subsection 212.3(9)? If so, assuming that one or more of the steps that are part of the series of transactions is an avoidance transaction, would the CRA be of the view that they would reasonably be considered to result in a misuse or abuse of the provisions of the Act such that subsection 245(2) would be applicable?
Moreno: To summarize the key steps, Canco invests in, and acquires shares of, FA1, Canco is held by a non-resident, and s. 212.3 would apply to reduce the PUC of the Canco shares.
S. 212.3(9), which provides for a reinstatement of such reduction of PUC, describes different circumstances that allow for a reinstatement of the PUC of $100 that was initially reduced. S. 212.3(9)(b)(i) essentially describes circumstances where there is an upstream distribution of the investment. Subpara (ii) describes other circumstances where distributions can be traced to the initial investment – in this case, the shares of FA1.
In our view, the $100 return of capital in the form of the distribution of the shares of FA3 to Canco by FA1 would arguably result in a reinstatement of the $100 of PUC that was initially reduced when Canco 1 invested in the shares of FA1.
Continuing the sequence of events, now FA3 is in Canco, is transitted through FA1 for a moment, and Canco then transfers FA3 to FA2 - so that the situation has returned to the starting point, when the shares of FA3 were in FA2. That transfer would be an investment for purposes of s. 212.3, but there would be no deemed dividend or PUC adjustment because of the way the provision applies. The situation is now essentially back to the starting point (even more so, after FA3 is liquidated), and there is $100 of paid-up capital in the shares held by Canco through the reinstatement.
Under s. 245(4), CRA views the series described above as resulting, directly or indirectly, in a misuse or abuse of the scheme of s. 212.3 read as a whole, and also specifically of s. 212.3(9), which provided for reinstatement of the PUC.
Q.7 - Siloed Reg. 5901(2)(b) election
Provided that the requirements of paragraph 5901(2)(b) of the Income Tax Regulations (Regulations) are met, an election (Regulation 5901(2)(b) election) may be filed by a corporation resident in Canada to “side step” the normal surplus ordering rules and treat a particular dividend paid by a foreign affiliate of that corporation as having been paid out of the pre-acquisition surplus of the affiliate in respect of the corporation. One of the requirements, as provided for in subparagraph 5901(2)(b)(ii) of the Regulations, is that no shareholder of the affiliate is, at the time of the dividend, a partnership a member of which is either “a” corporation that would, in the absence of subparagraph 5901(2)(b)(ii) of the Regulations, be eligible to elect under subparagraph 5901(2)(b)(i) of the Regulations in respect of the particular dividend, or a foreign affiliate of such a corporation.
A foreign affiliate (FA) of a corporation resident in Canada (Canco1) has issued and outstanding Class A common shares and Class B common shares.
Canco1 owns 100% of the Class A shares and a limited partnership (LP) owns 100% of the Class B shares.
One (or more) of the members of LP is a corporation resident in Canada (Canco2) that has a sufficient partnership interest in LP, such that FA is considered to be a foreign affiliate of that corporation as defined under subsection 95(1) of the Income Tax Act (Act) for the purposes described in subsection 93.1(1.1) of the Act. None of the members of LP is Canco1, a foreign affiliate of Canco1, or a corporation resident in Canada that is related to Canco1 (or a foreign affiliate of such a corporation).
FA pays a dividend to Canco1 in respect of the Class A shares of FA (Class A dividend) that, absent paragraph 5901(2)(b) of the Regulations, would be deemed under subsection 5901(1) of the Regulations to have been paid out of the exempt surplus, hybrid surplus or taxable surplus of FA in respect of Canco1 and in respect of Canco2.
Canco1 will not make an election under subsection 90(3) of the Act in respect of the Class A dividend.
Canco1 wishes to elect under subparagraph 5901(2)(b)(i) of the Regulations for the Class A dividend to be treated as having been paid out of FA’s pre- acquisition surplus in respect of Canco1.
Is the CRA of the view that the requirement imposed by subparagraph 5901(2)(b)(ii) of the Regulations that no member of LP be eligible to elect under subparagraph 5901(2)(b)(i) of the Regulations would be met in these circumstances such that Canco1 is eligible to make a valid Regulation 5901(2)(b) election in respect of the Class A dividend?
Would the CRA’s view change if FA only had a single class of issued and outstanding shares and paid a dividend to both Canco1 and LP?
Moreno: There are a number of conditions in s. 5901(2)(b) that must be met for the election to be valid. The relevant condition here is in subpara. (ii), which provides an exclusion where a corporation that could make the election is a member of a partnership.
The difficulty is that the preamble of s. 5901(2)(b) makes no indication of who the recipient of that dividend would be. The preamble refers to “a whole dividend,” but does not state to whom the dividend is paid. That, in our view, raises an ambiguity - the exception in (ii) could be read as being very broad.
To resolve this ambiguity, we turn first to the context. The Technical Notes give an interesting hint:
This election is meant to allow the shareholders of a foreign affiliate to access their capital first as measured by the adjusted cost base ("ACB") of the shares rather than a legal notion of paid-up capital.
Based on that, the Regulation is about enabling shareholders to receive capital as measured by ACB.
The next question to address is which shares would see their ACB adjusted, where a pre-acq. dividend is paid. The answer is that it is the corporation that receives surplus from the foreign affiliate that gets to adjust its ACB, or the recipient affiliate.
Going back to this scenario, when looking at which shares are adjusted, Canco 2 does not receive a dividend, and the LP of which is a member does not receive a dividend, so that there is no ACB adjustment on that side of the corporate structure. It is our view that the condition would not be be met if there is no adjustment to the ACB. Therefore, even if Canco 2 were entitled to make the election, there would be no resulting adjustment here – there is no dividend on that side. On that basis, Canco 1 could make the election. There is no corporate member of the partnership that could make the election in this scenario.
This result makes sense in accordance with the purpose of s. 5901(2)(b), as explained in the Technical Notes. It basically refers to ss. 92(4) to (6), stating that (ii) is there “because of the special deferred treatment given to pre-acquisition surplus dividends paid on foreign affiliate shares held by a partnership” and, referring again to ss. 92(4) to (6) as justifying that carve-out. That is consistent with our reading of the provision.
The answer is different if there is only one class of shares. In that case, LP would have received its pro-rata share of the dividend on those shares, and on that basis Canco 2 would be eligible to make the election, which would disqualify both Canco 1 and Canco 2 from making the election.