17 May 2022 IFA Roundtable
This provides the text of written questions that were posed, and summaries of the CRA oral responses, at the CRA Roundtable hosted on May 17, 2022 by the International Fiscal Association. The presenter from the Income Tax Rulings Directorate was:
Yves Moreno, Acting Director, International Division
The questions were orally presented by Michael Kandev (Davies) and Kim Brown (McCarthy).
Q.1: Meaning of “Habitual Abode” in Canadian Tax Treaties
As you know, Canada’s extensive treaty network contains residency “tie-breaker” provisions – usually in Article IV:2 of most of the treaties. For example, in the Canada-US treaty, the residency “tie-breaker” rule is indeed in Article IV:2. Paragraph (b) of the provision states:
“…if the Contracting State in which he has his centre of vital interests cannot be determined, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;”
Can the CRA comment on its views of what an habitual abode is of an individual and what factors the CRA reviews to make a determination?
Under Canada domestic law, individuals resident in Canada are taxed on their worldwide income and their residence can be factual, or deemed under certain provisions of the Act. The leading case on residence is Thomson v. MNR which states that it is a matter of “the degree to which a person in mind and fact settles into or maintains or centralizes his ordinary mode of living with its accessories in social relations, interests and conveniences at or in the place in question.” This is mainly a factual determination, and the CRA has often phrased that determination in terms of “significant, secondary or other ties.”
Where an individual is considered to reside in Canada and another country, treaties must be taken into account, and the tie-breaker rules must be considered, which are cascading tests that must be applied in sequence. The first is the determination of whether the individual has a permanent home in one of the states. If the taxpayer has a permanent home in both or neither states, the next test is to consider the centre of vital interest. It is only as the third test that we get to that of the habitual abode, which is what this question is about.
The objective of the habitual abode test can be generally described as identifying where the individual usually lives. Stays would have to be considered. Again, if we get to the habitual abode, the other elements of the individual’s residence and of the centre of vital interests would not have been determinative, so stays would have to be considered, and the nature of the activities of the individual in a given country would be considered as well, to determine whether the individual usually lives in that state or not compared to the other. The length of time would have to be appropriate, so there is no set period of time – it depends on the circumstances as to which period should be considered to make the determination. See Folio S5-F1-C1 for more information.
Q.2: Apportionment of a Royalty Payment for the Purposes of Subparagraph 212(1)(d)(vi)
Should the application of the exception in subparagraph 212(1)(d)(vi) be based on an apportionment of a royalty payment between copyrights and trademarks agreed to by arm’s length parties to a mixed contract?
The circumstance of a resident making payment to a non-resident for its use of certain intellectual property is addressed in s. 212(1)(d).
The royalty payment might be for more than one type of intellectual property. S. 212(1)(d) provides for an exception under s. 212(1)(d)(vi) for payments that are in respect of a right in respect of the production or reproduction of literary, dramatic, musical, or artistic works. In the context of this question, an artistic work is the most likely.
A payment might be for a trademark and for a copyright in some circumstances. A logo, for example, entails both copyright and trademark. It is protected under the holder’s copyright, but also carries the goodwill of the company’s branding. The payment might, therefore, be blended and it might be difficult to dissociate them if the right to use the same drawing, for example, has a component that is both for trademark and copyright, and the copyright component might be exempted from withholding in some circumstances under s. 212(1)(d)(vi). That is the kind of “mixed contract” referred to in this question.
The parties might have indicated, in their agreement, the breakdown between both the rights, which, if accurate, will determine how much of the payment is exempted. Where the apportionment of the royalty payment is agreed to by arm’s-length parties under a mixed contract, the CRA will generally accept that apportionment provided that it is reasonable and realistic. By “reasonable and realistic,” the CRA means that it should be reflective of the actual consideration paid for the copyright described under the exception in s. 212(1)(d)(vi).
If the apportionment of the royalty payment between copyrights and trademarks is not reflective of the actual consideration paid for the copyright, then the role of the CRA is to administer s. 212(1)(d) and to assess its application to the parties in light of their obligations as dictated by the Act. Consistent with Paletta, paras. 105-106, the taxpayer would not have the prerogative to define the scope of the tax implications under s. 212(1)(d) by setting an amount that is not reflective of what is paid for that right.
Whether a particular apportionment of the consideration paid is reflective of the actual payments described in the exemption under s. 212(1)(d)(vi) depends on the legal nature of what is being provided under a mixed contract. The relationship between the parties and the facts of the particular situation, including the commercial reality of the parties and the consideration paid, would be considered. In determining if an apportionment provided under a mixed contract is reflective of the obligations of the parties under s. 212(1), consideration would be given, amongst others, to the terms of the mixed contract and whether the parties have divergent interests in respect of the apportionment. Where the payer is economically indifferent to the apportionment, the apportionment provided under the terms of the mixed contract might not be reasonable, realistic and reflective of the tax obligations of the recipient under s. 212(1)(d), and the CRA might determine that a different portion of the payment is subject to withholding tax.
Q.3: Meaning of “Goods” in Paragraph 95(3)(b)
Consider a situation where marketing services are provided by a wholly-owned foreign affiliate (“FA”) of a corporation resident in Canada (“Canco”) in respect of the sale of residential condominiums located in Canada.
The residential condominiums are owned either by Canco or entities that do not deal at arm’s length with Canco.
The following is assumed:
- Canco and non-arm’s length entities are subject to Canadian tax in relation to income earned on the sale of the residential condominiums; and
- Reasonable consideration is paid for the provision of the marketing services and that these costs are deductible against income earned in Canada.
Does real estate inventory, such as residential condominiums, held for sale in the regular course of business, qualify as “goods” for purposes of paragraph 95(3)(b)?
S. 95(2)(b) provides that, where services are provided by a foreign affiliate, such activity, and the income related to the activity, may generate FAPI where certain conditions are met.
This question supposes that the consideration was reasonable for those services, and would be deductible in computing income in Canada, so that the conditions for s. 95(2)(b) would apply and might make the income subject to FAPI treatment under s. 95(2)(b), subject to the exception in s. 95(3). S. 95(2)(b) applies to services and s. 95(3) provides exclusions from such services. S. 95(3)(b) concerns services performed in connection with the purchase or the sale of “goods.” Here, there are payments for marketing services in the context of a sale of condominiums.
The ambiguity here is the word “goods.” Would the condominiums be captured by this exception to the definition of services? Are these services for the sale of goods? “Goods” is not defined in the Act, so we refer to the court cases. The Canadian Wirevision decision turned on whether radio signals or TV signals were “goods." The judge found that “goods" is used in common parlance to refer to merchandise or wares, or to put it in legal jargon, "tangible, movable property.” Black’s Law Dictionary defines goods as “tangible or movable personal property other than money,” and other dictionaries are consistent with that definition.
In this case, the marketing services would be rendered in respect of immovable property under Quebec’s civil law or real estate at common law, and on that basis would not be “goods” in the CRA’s view. That view is also consistent with the other exceptions to the word “services” in s. 95(3). Looking at the other paragraphs, para. (c) addresses the transmission of electronic signals or electricity as an example of movables and para. (d) refers to manufacturing and processing outside of Canada. If we take those different elements into account, the CRA conclusion is that the services in this case would not be covered by the exception under s. 95(3)(b) and would be subject to s. 95(2).
Q.4: PLOI Late-Filed Penalties and Administrative Relief
Where subsection 15(2) or the foreign affiliate dumping rules under section 212.3 would otherwise apply to an amount owing to a corporation resident in Canada (CRIC) or certain partnerships, subsections 15(2.11) and 212.3(11) allow for a pertinent loan or indebtedness (PLOI) election to be filed in respect of that amount. Where there is more than one amount owing between the two parties, the CRA has indicated in technical interpretation 2014-0534541I7 that a separate PLOI election is required for each amount owing, notwithstanding that a taxpayer may prepare and file a single written communication containing each such PLOI election. At the May 26, 2016 IFA CRA Roundtable, the CRA stated (2016-0642031C6) that, based on the language of subsections 15(2.13) and 212.3(13), the late-filing penalty calculations must be applied separately for each amount that is elected to be a PLOI. However, the CRA also stated that it was exploring whether an administrative position could be taken to aggregate certain amounts for purposes of the PLOI election late-filing penalty calculation.
Could you please provide an update on the status of this review?
A couple of months ago, the CRA changed the page on its website dealing with employee elections. The changes are twofold: first, additional reporting requirements were added, as there is no prescribed form under the Act for the employee election. Where there is no prescribed form, CRA requires the election to be made by letter. Again, the webpage describing the employee election lists the required information for that letter. The CRA’s new reporting requirements are meant to help the CRA more readily determine the correctness of the amount included under s. 17.1.
The other change is more directly relevant to this question. CRA announced that it would adopt an administrative policy of accepting a single election for different amounts covered by the same agreement. That position is in respect of employee elections filed after April 11, 2022. Under this policy, only one employee election is required in respect of separate amounts owing to a CRIC by a non-resident, provided that each amount is governed by the same agreement.
For example, where there is a revolving loan, even if there are multiple amounts, the revolving loan and all the amounts under the agreement that governs it would be covered by a single election, even if there are multiple amounts borrowed and repaid under the same agreement. The policy would also be applicable in a situation where intercompany trade receivables were involved, like the ones that are referred to in the 2016 IFA Roundtable question referenced above.
For full details, see the webpage discussing employee elections on the CRA website. Regarding late filing penalties for employee elections that were filed before the period covered by this new policy, i.e., elections filed before April 11, 2022, the CRA would provide relief in some circumstances where penalties were charged, where the request was made to the CRA to alleviate penalties in those circumstances.
Q.5: Surplus Account Maintenance
At the 2019 IFA Conference, the CRA commented on the requirement to prepare detailed surplus account calculations to support a deduction under subsection 113(1). It was also mentioned that in situations where calculations are not provided, it is the CRA’s general practice to deny any deduction under subsection 113(1).
Given that surplus account calculations are relevant in various situations, and in order to give better clarity to taxpayers, can the CRA provide additional guidance on the required documentation and on the best practices to adopt in respect of the preparation of surplus account calculations?
The surplus account calculations are cumulative, the account runs on a continuous basis from the later of 1972 and the date the corporation last became a foreign affiliate of the taxpayer. It is a cumulative account that is relevant for many purposes under the Act and the written answer lists a number of those provisions where surplus computations are relevant. I will mention a few.
Obviously, where a dividend is received, the surplus computations would support a deduction under s. 113(1) or s. 91(5). Where there is a disposition of shares, the stop-loss rules under s. 93(2.01) or the election rules under s. 93(1) would also turn on the surplus computations. The deduction under s. 90(9), and in some circumstances safe income computations under s. 55(5)(d), might be affected by tax-free surplus balances that are also informed by surplus computations. There are also the fresh start rules under s. 95(2)(k). For reporting purposes, surplus is relevant to filling form T1134.
In summary, surplus accounts are relevant in many places under the Act, and our self-assessing system in Canada requires that taxpayers keep records of their affairs and provide supporting computations on their different tax obligations determined under the above provisions.
Taxpayers are required to prepare up-to-date surplus account calculations in support of those surplus account balances. Taxpayers are also responsible for documenting their affairs in a reasonable manner. S. 230 obliges taxpayers to maintain records and books of account containing the information that enable the determination of taxes and, under s. 231.1, those records can also be inspected, audited or examined. It is therefore very important to keep surplus account calculations up to date, as the CRA may request or review taxpayer computations and supporting documents pertaining to the surplus account balances when auditing compliance to provisions of the Act.
Those obligations are described in more detail in Information Circular IC77-9, “Books, Records and Other Requirements for Taxpayers having Foreign Affiliates,” including details regarding the mandatory record-retention period. The Circular clarifies that, where the records are necessary to support future tax consequences, the amount that they support must be documented. Records and documents that support surplus account balances must be prepared and maintained by the taxpayer until it is clear that that the surplus balances are no longer relevant to the taxpayer – see paras. 3 to 8 of IC77-9.
It is good practice for a taxpayer to maintain surplus accounts calculations on a continuous basis with supporting documentation readily available, and also as part of the Form T1134 compliance or foreign accrual property income determinations. Even if the determination of the tax payable in a given year does not rely on surplus balances, accurate surplus account balances of a foreign affiliate with respect to taxpayers should be prepared on an annual basis, and relevant books, records, and supporting documentation should be retained.
Each component of the surplus account balance must be validated by appropriate documentation and such documentation should be maintained and retained accordingly. If documentation is not available to accurately support surplus account calculations at the time the surplus is utilized, any deduction claimed based on surplus account balances will be denied, and other adjustments may also be required. Therefore, preparing annual surplus account calculations will facilitate claims for future deductions.
What is appropriate documentation? The written answer provides a list of documents that would be considered appropriate documentation of the foreign affiliate, and that might include non-consolidated financial statements, trial balances, minute books, tax returns, support for the income tax paid, and also a description of the business of the foreign affiliate, the nature of its income, the transactions it is involved in, as well as the dividends that are paid or received.
Q.6: Exempt Earnings and Residency Information
A corporation resident in Canada (Canco) receives a dividend from a wholly-owned foreign affiliate (FA). Canco claims a full deduction under paragraph 113(1)(a) in respect of the dividend. Canco prepares a complete calculation of the FA’s exempt surplus account.
FA is incorporated in a country (Country A) with which Canada has entered into a comprehensive agreement for the elimination of double taxation on income (the “Treaty”). FA has been carrying on an active business in Country A since its incorporation. The Treaty includes a dual residency tie-breaker rule based on the place of incorporation. Canco considers the FA to be a resident in Country A for purposes of the Treaty.
Should Canco maintain any other information, in addition to the surplus calculation, to support a deduction claimed under paragraph 113(1)(a)?
The deduction under s. 113(1)(a) is available if the dividend is prescribed to be paid out of the exempt surplus of the foreign affiliate, which requires a determination of the exempt earnings of the foreign affiliate.
The definition of “exempt earnings” in Reg. 5907 requires that the foreign affiliate be a resident of a designated treaty country throughout the relevant year. The expression “resident in a designated treaty country” is not defined, and there are a number of prior CRA positions that essentially described the process as a two-pronged test. The first is the common-law test of residence – whether, under Canadian common law principles, the foreign affiliate is a resident of the other country, which turns on where the central management and control of that entity takes place. The second is going over the conditions in Reg. 5907(11.2)(a) to (d).
As mentioned in Q.5, taxpayers are responsible for keeping books and records supporting their tax obligations. One of the conditions in the definition of “exempt earnings” is that the foreign affiliate be resident in a foreign country. Therefore, the entity’s records should be sufficient to substantiate the computation of foreign accrual property income, and any deductions claimed under s. 91(5) or s. 113 in respect of dividends received by a foreign affiliate. Taxpayers in this question would also have to keep records to support that the foreign affiliate is a resident of Country A, under common law principles, to support the claim for a deduction.
The information in these records needs to be detailed, and complete enough to demonstrate that the central management and control of the foreign affiliate takes place in a treaty country, and should include information relating to the whole course of business and trading of the foreign affiliate. “Course of business and trading” is the language used by the courts when describing where the central management and control of the corporation takes place.
The documentation should therefore not be limited to the location of the board meetings or where the members of the board are resident, but should extend to the actual course of business and trading of the corporation to support the condition that the foreign affiliate is a resident of Country A.
Under s. 231.1, the records may be inspected, audited, or examined by the CRA.
A deduction under s. 113(1)(a) will be available where all the requirements are met, and substantiated by supporting documentation.
Q.7: Compliance Requirements for Taxpayer Owning Cryptocurrencies and Situs of Cryptocurrencies
Section 233.3 imposes the requirement for a “specified Canadian entity” to disclose its ownership of any “specified foreign property” on CRA form T1135 - Foreign Income Verification Statement. This obligation generally arises in respect of a taxation year if the total cost of such property exceeds $100,000 at any time during that taxation year. “Specified foreign property” includes (among other things) “funds or intangible property, or for civil law incorporeal property, situated, deposited or held outside Canada.”
In a technical interpretation issued in April 2015 (CRA document no. 2014-0561061E5), the CRA took the position that cryptocurrency constitutes funds or intangible property and would be specified foreign property of a person or partnership to the extent that it is situated, deposited or held outside of Canada and is not used or held exclusively in the course of carrying on an active business.
In the context of the 2021 APFF Financial Strategies and Instruments Roundtable held on October 7, 2021, the CRA was asked to provide its view on the situs of cryptocurrency (CRA document no. 2021-089602). At that time, the CRA responded that the question of where a cryptocurrency is located, deposited or held within the meaning of section 233.3 was under review.
Could the CRA provide an update?
2021 APFF Roundtable, Q.11 is still under study by the CRA.
Work is also underway at the OECD to develop a crypto asset reporting framework. That work was announced recently and the OECD conducted consultations. The reporting framework turns on the reporting requirements to tax administrations, and exchange-of-information procedures related to the transactions with crypto asset service-providers.
The Guide for Cryptocurrency Users and Tax Professionals describes the obligations related to the holding and transacting of crypto assets.
There is a common theme with the two prior responses – crypto is subject to the same obligations of keeping proper supporting documentation, in respect of crypto asset transactions. Taxpayers are expected to keep proper financial records of their activities, including records related to the acquisition or disposition of crypto assets. Those books and records are subject to review by the CRA in the course of a compliance audit.
The CRA conducts audit activities relating to crypto assets, including audits of individuals acquiring or disposing of crypto assets, as well as crypto asset businesses involved in developing, mining, stacking, or effectuating the exchange of crypto assets.
Q.8: Foreign Entity Classification
In Income Tax Technical News No. 38 (Sept. 22, 2008), the CRA updated its two-step approach to foreign entity classification and also confirmed how the CRA would classify a number of specific foreign entities. Given the CRA's recent announcements on the classification of certain US LLLPs and the introduction of anti-hybrid mismatch rules in countries like Luxembourg, which may apply depending on how Canada treats a particular Luxembourg entity for tax purposes (e.g., a Luxembourg special limited partnership), will the CRA publish and maintain an online list of foreign entities that the CRA has classified for reference purposes?
First, some context:
The approach to characterizing foreign entities, that do not have an equivalent in Canada, continues to follow the CRA’s established two-step approach: first, determine the characteristics of the entity abroad, taking into account the foreign legislation and any governing documents, contracts, or arrangements for the entity, and the rights of any stakeholders; and, second, compare those characteristics to the types of entities that exist in Canada and, thus, determine which provisions in Canada should apply.
Under this two-step approach, the CRA examines the nature of the relationship between the various parties that are involved, and their rights and obligations in respect of the foreign entity or arrangement, under the applicable law and documentation.
The classification of a particular foreign entity or arrangement is to be determined on a case-by-case basis, and does not lend itself to the type of standard or universal classification that the question suggests.
However, the Rulings Directorate would be receptive to providing the CRA’s view on the nature of a foreign entity that has no equivalent in Canada. There is a paragraph in IC70-6R12 indicating that no rulings will be issued that turn on the interpretation of foreign law. The CRA does not consider the classification of a foreign entity to entail an interpretation of foreign law, strictly speaking. Rather, the exercise is about establishing the nature of an entity so as to determine the application of the Canadian tax Act.
When entertaining requests for entity classifications, the CRA will need detailed information. A paragraph in the Circular discusses factual determinations and, although this is not strictly a factual determination, the spirit of the paragraph is still relevant – it essentially states that the CRA will consider ruling requests on questions of fact, provided that sufficient information is given. (By analogy, the CRA is in better position to say that the Loch Ness Monster exists if provided with a good photograph, taken in daylight, with proper zoom, than if provided with a blurry photo taken in fog!)
Q.9: Subsection 247(4) – Contemporaneous Documentation and COVID-19
Canada’s contemporaneous documentation (“CD”) rules in subsection 247(4) require the completion of CD meeting statutory requirements within six months of the end of the relevant taxation year, a shorter time limit than is found in the analogous rules of most of Canada’s G7 contemporaries (typically one year). Meeting the required standard involves finding suitable comparables and determining appropriate transfer pricing methodologies and documenting the various relevant items within the statutory six-month deadline from year-end. Many taxpayers are finding it particularly challenging to meet the CD standards set out in subsection 247(4) in a COVID-19 environment, due to significant business disruptions that make finding genuine comparables harder and staff shortages that reduce taxpayers’ capacity for generating and documenting this analysis.
Has the CRA considered providing relief to taxpayers making good faith efforts to produce satisfactory CD within the six-month time limit comparable to administrative relief for other cross-border COVID-related tax issues previously announced (e.g., permanent establishment status, residency, etc.)? The binary nature of subsection 247(4) compliance (i.e., one either meets the standard and gets the resulting penalty protection, or does not and gets no protection) makes this an area where administrative relief is particularly necessary for affected taxpayers.
In the context of the situation described in this question, the CRA does not intend to provide administrative relief to extend the documentation due date of the partnership or taxpayer for the purpose of contemporaneous documentation, or to otherwise administratively relieve the taxpayers or partnerships from meeting their obligations under s. 247(4).
In determining whether a taxpayer or partnership has met its s. 247(4) obligation, the CRA will continue to rely the guidance found in the Transfer Pricing Memorandum, TPM-09. The CRA recommends that the taxpayers or partnerships determine their transfer pricing on an ongoing basis, during the taxation year or the fiscal period, even if the Act allows them to make or obtain the documentation up to the documentation due date.
As allowed under s. 220(3.1), the Minister may grant relief on interest and penalties by waiving them, partly or fully, where requested. The discretionary relief has to be requested in prescribed form – RC4288. For more information, see IC07-1R1.
Q.10: Changes to Corporate Residence Approach
It was raised at the 2021 United Nations climate change conference (COP26) that the corporate residency rules are not only out of date in the age of video conferencing but potentially also not in sync with Environmental, Social and Governance (ESG) concerns. In particular, too much focus on the location of board meetings encourages both waste of time and energy in that motivated taxpayers will simply fly where they need to and distracts from ensuring board composition is based on good governance. In light of the developments of the last two years is the CRA considering changes to its approach to corporate residency?
The CRA’s role is to administer the Act.
The residence of a corporation is a matter governed by the courts. There are a number of decisions that provide guidance on the question of residence. There are some statutory exceptions, which are generally initiated by Finance.
Courts often look at the central management and control of the corporation, which is typically where the board of directors meets to make strategic decisions. However, the location of board meetings to assert residence will not, in itself, be sufficient to conclude that the corporation is resident in that jurisdiction.
It is well settled at common law that the actual place of management is not the place where the corporation ought to be managed, but the place where it is effectively managed. In other words, the courts have repeatedly considered evidence beyond the location of board meetings in order to look at the whole of the business and trading of the corporation, and those are the elements that the CRA would be required to consider in determining the residence of a corporation.
Q.11: Employee Equity Incentive Notice Requirements Under New Non-Qualified Securities Rules
Under the recent amendments to the employee stock options rules in section 110, if a non-resident corporation agrees to issue securities to its Canadian employees or employees of a Canadian subsidiary, the new non-qualified securities rules in section 110 will generally apply if the issuer is a specified person because the $500 million gross revenue threshold is exceeded.
Under these new rules, the employee deduction under paragraph 110(1)(d) is subject to the $200,000 annual vesting limit and in certain cases an issuer may be eligible for a deduction under paragraph 110(1)(e) in respect of the non-deductible portion of the benefit realized by the employee. These rules also contain employee and Minister of National Revenue notice requirements in subsection 110(1.9).
“If a security to be issued or sold under an agreement between an employee and a qualifying person is a non-qualified security, the employer of the employee shall (a) notify the employee…and (b) notify the Minister…”
If the employer does not comply with the notice requirements, then no employer deduction can be claimed because of subparagraph 110(1)(e)(vi).
If a non-resident corporation (or any other specified person) issues restricted stock units to an employee that can only be settled for shares, and therefore are effectively treated as section 7 stock options with no exercise price, and the shares to be issued are non-qualified securities, one could argue that in policy terms, the non-resident corporation should not have to comply with the notice requirements in subsection 110(1.9) because no deduction can be claimed under paragraph 110(1)(e). However if the non-resident corporation does not comply with the notice requirements, there is arguably a risk of penalty under the general non-compliance provision in subsection 162(7).
The question: Will the CRA provide administrative relief to the subsection 110(1.9) notice requirements if no amount is deductible under 110(1)(d) or (e)?
The objective of the employee stock options rules is to impose limits on the stock options that may vest in a given calendar year and on subsequent s. 110(1)(d) deductions.
The question really raises a broader concern – whether the restricted share units described in the question, or other rights that are otherwise subject to s. 7 and would never give rise to the deduction under s. 110(1)(d), should count towards the $200,000 limit in the first place.
Finance is aware of this broader issue, and is contemplating remedial measures. The specific issue raised in this question, as to the penalties owing by non-residents for not providing this information, would be considered as part of that broader exercise.
In the interim, the response suggests a possible workaround in the form of an election under s. 110(1.4), so employers could avoid this problem by designating securities as non-qualified securities, which would not give rise to a s. 110(1)(d) deduction, but this would exclude the securities from the annual vesting limit with respect to any options that are subsequently issued to the employee within the same vesting year.
The election would be a workaround for the penalty issue. However, the designation must be made prior to the issuance of the subsequent options.
Q.12: Principal Purpose Test
Could CRA please comment on the following:
1. The number of matters in which CRA has recommended applying the principal purpose test (PPT) and examples of situations in which it has done so. Please also indicate if GAAR is being applied.
2. Has CRA received any PPT ruling requests?
The principal purpose test can be found in Article 7(1) of the MLI. It entered into force in December 2019, and went into effect in January 2020, in respect of the withholding obligations in some treaties, and June 2020 for all other taxes.
In IFA 2021, CRA indicated that it had received a pre-ruling request in respect of the PPT. The Rulings Directorate has not received any further ruling requests so far.
Regarding the GAAR, in view of the international efforts which lead to the MLI and its considerable importance to both tax administrations and taxpayers, CRA has started monitoring compliance with the MLI on a priority basis, in advance of the normal audit cycles.
To date, CRA has not issued any assessments on the basis of the PPT, although compliance-review processes are underway.
With respect to the GAAR, CRA took note of the decision that was rendered by the Supreme Court of Canada in the Alta Energy decision. The court considered a matter that is essential to the CRA’s ongoing efforts to protect Canada’s tax-base and the integrity of tax treaties. The meaning and effect of the decision continue to be analyzed by the CRA, the Department of Finance, and the Department of Justice, along with the processing of the files that were held in abeyance until the decision was rendered.
CRA’s process for applying the PPT was described in prior Roundtable responses. In brief, Audit and the Rulings Directorate would bring the matter to the attention of the Treaty Abuse Prevention Committee, which provides recommendations in respect of both the PPT and the GAAR in a treaty-abuse or avoidance context. The Treaty Abuse Prevention Committee makes its decisions and recommendations in light of available jurisprudence, the relevant facts, the taxpayer’s motives, and the relevant treaty provisions.
In addition to the GAAR and PPT, CRA will consider, where appropriate, the taxpayer’s corporate residence, the application of judicial doctrines and anti-avoidance rules (including anti-avoidance rules in the relevant treaty).
See also CRA’s response to the 2021 CTF Roundtable, Q.4 [i.e., 27 October 2020 CTF Roundtable Q. 6, 2020-0862471C6?] on the criteria the CRA considers when determining whether one of the principal purposes of a transaction is to obtain a treaty benefit.
Q.13: Current Statistics on Mutual Agreement Procedures
Could the CRA give current statistics on Mutual Agreement Procedures (MAPs)?
CRA had 165 negotiable MAP cases at the beginning of 2020. During 2020, the CRA accepted 72 new MAP cases, and closed 74 MAP cases.
The average time to complete a negotiated MAP case was 17.83 months.
Of the 74 cases closed in 2020:
- 46% resulted in full relief from double-taxation;
- 12% treated objections as not justified;
- 11% were resolved with unilateral relief; and
- 28% of the cases were resolved by a domestic remedy.
81% of cases closed in 2020 had been initiated by Canada.
CRA is currently engaged in MAP cases involving taxpayers from 31 jurisdictions, with the US representing 46% of the MAP cases.
Q.14: Partnership and Subsection 90(3) Election
A distribution made by a foreign affiliate of a taxpayer in respect of a share of its capital stock will be a qualifying return of capital pursuant to subsection 90(3) where the following conditions are met: (i) the distribution is a reduction of the paid-up capital of the foreign affiliate in respect of the share, (ii) the distribution would otherwise be deemed under subsection 90(2) to be a dividend paid or received on the share, and (iii) an election is made in respect of the distribution in accordance with prescribed rules.
Assume the following facts (see figure 1):
1) A Canadian corporation (Canco1) owns 100% of a foreign affiliate (FA1);
2) A related Canadian corporation (Canco2) owns 100% of a foreign affiliate (FA2);
3) LP is a partnership for purposes of the Act;
4) FA1 is the general partner of LP, is the only member that has authority to act for LP and has a 90% partnership interest in LP;
5) FA2 is a limited partner of LP and has a 10% partnership interest in LP; 6) LP owns 100% of a foreign affiliate (FA3);
7) Canco1 and FA1 each has a taxation year ending November 30; each of Canco2, FA2 and FA3 has a taxation year ending December 31; LP has a fiscal period ending December 31; and
8) On July 1, 2021 FA3 reduced its paid-up capital and made a distribution to LP (the “Distribution”).
FA3 is a foreign affiliate of LP, and for purposes of (inter alia) section 90 is a foreign affiliate of both Canco1 and Canco2 pursuant to subsection 93.1(1).
Our questions are:
(i) Would the CRA agree that only LP is required to make a subsection 90(3) election in respect of the Distribution?
(ii) If a joint election is required to be made, or is made, by LP, Canco1 and Canco2, can LP file the election on behalf of itself, Canco1 and Canco2?
(iii) Would the election, if a joint election, be required to be filed by the earliest of the filing-due dates for Canco1 and Canco2 for their taxation years that include December 31, 2021?
To recap, the partners of LP are FA1 and FA2, and their Canadian-taxpayer shareholders are Canco1 and Canco2. The distribution is from FA3, and the election is made on that distribution from FA3 to LP. FA3 is a foreign affiliate in respect of the taxpayer, irrespective whether that taxpayer is LP, Canco1, or Canco2.
When reading the provision, there are a number of cascading elements to take into account. The crux of the issue is that, because of this structure, there is no connected person or partnership in respect of LP, which would otherwise drive the exercise of a joint election.
When reading the provision on the basis that LP is the taxpayer referred to in respect of which FA3 is a foreign affiliate, CRA’s view is that the election made by LP would be valid. It would have to be made in the manner and within the timeframe specified in Reg. 5911. In this case, as FA1 is acting as the general partner of LP, FA1 would effectively be filing the election on behalf of LP. The election would be in the form of a letter (as there is no prescribed form). Such an election would be valid and binding on Canco1 and Canco2 under s. 96(3), which specifically provides that they would be bound be the election made by LP.
The written response provides the elements that should be included in the election letter. These elements are informed by the wording of s. 96(3), and the context in which it operates, while also taking into account the administrative imperatives for a flawless and smooth processing of the election – e.g. identifying which Canadian entities affected by the election (Canco1 and Canco2 in this case), along with the name and business account numbers of LP, Canco1, Canco2, and information about the distribution, such as its date. The letter should be filed to the appropriate Tax Centre for the Cancos.
The written response also recommends providing a copy of the election letter to each taxpayer identified in the letter, as well as attaching a copy of the election to the earliest T1134 form or income tax return filed that includes the relevant fiscal period of the partnership.
Part (ii) of the Question asks whether a joint election could be made. Such an election would be valid, e.g. a joint election by Canco1, Canco2 and LP would be valid.
Regarding part (iii), if any election is made jointly, it is required to be made on or before the earliest of the filing due dates of Canco1 or Canco2 that includes the partnership fiscal period – in this case, December 31, 2021.