17 May 2022 IFA Roundtable - Draft CRA Written Response
IMPORTANT NOTE: The following questions and answers are not official and are subject to change until they are published by the Canada Revenue Agency.
Unless otherwise stated, all statutory references in this document are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Suppl.) (the “Act”), as amended to the date hereof.
Question 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?
Please refer to the official response to be published by the Canada Revenue Agency.
Question 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?
Where arm’s length parties enter into a royalty agreement in respect of property that is protected by both a trademark and a copyright (referred to as a “mixed contract” in this response), the parties might decide to include in the agreement an apportionment of the royalty payment between the copyright and the trademark.
If the payment is made to a non-resident of Canada, a portion of this royalty payment might be subject to tax under part XIII (“withholding tax”). In this regard, paragraph 212(1)(d) generally provides that an amount paid as a royalty to a non-resident person should be subject to withholding tax, unless one of the exclusions described in subparagraphs 212(1)(d)(vi) or (x) applies. In particular, subparagraph 212(1)(d)(vi) provides that a royalty or similar payment “on or in respect of a copyright in respect of the production or reproduction of any literary, dramatic, musical or artistic work” is not subject to withholding tax.
An apportionment of a royalty payment agreed to by arm’s length parties under a mixed contract, to the extent that it is reasonable and realistic, in the sense that it is reflective of the actual consideration paid for a copyright described under subparagraph 212(1)(d)(vi), will generally be accepted by the CRA.
However should the apportionment of the royalty payment between copyrights and trademarks not be reflective of the actual consideration paid for a copyright described in the exemption provided under subparagraph 212(1)(d)(vi), the role of the CRA is to administer that provision and to assess the parties based on their statutory obligation. A taxpayer does not have the prerogative to define the scope of its tax obligations under paragraph 212(1)(d) by including in a mixed contract an apportionment that is based on its preferred tax outcome. This is consistent with the comments of the court in paragraphs 105 and 106 of the decision rendered in Paletta v. The Queen, 2019 TCC 205.
Whether a particular apportionment of the consideration paid is reflective of the actual payments described in the exemption under subparagraph 212(1)(d)(vi) depends on the legal nature of what is being provided under the 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 in these circumstances. In determining if an apportionment provided under a mixed contract is reflective of the obligation of the parties under subsection 212(1), consideration would be given, amongst others, to the terms of the mixed contract and to whether the parties have divergent interests in respect of this apportionment. Where the payor 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 obligation of the recipient under subsection 212(1)(d) and the CRA might determine that a different portion of the payment is subject to withholding tax.
Question 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:
a) Canco and non-arm’s length entities are subject to Canadian tax in relation to income earned on the sale of the residential condominiums; andI
b) 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)?
Paragraph 95(2)(b) provides that where certain conditions are met:
“the provision, by a foreign affiliate of a taxpayer, of services or of an undertaking to provide services
(i) is deemed to be a separate business, other than an active business, carried on by the affiliate, and any income from that business or that pertains to or is incident to that business is deemed to be income from a business other than an active business, to the extent that the amounts paid or payable in consideration for those services or for the undertaking to provide services”
The conditions turn in part on the deduction of the amount paid or payable for those services in computing the income from a business carried on in Canada and or in computing the foreign accrual property income of a controlled foreign affiliate.
Paragraph 95(3) provides that:
“For the purposes of paragraph (2)(b), “services” includes the insurance of Canadian risks but does not include
(b) services performed in connection with the purchase or sale of goods;
The term “goods” is not defined in the Income Tax Act or the Income Tax Regulations for the purposes of paragraph 95(3)(b).
In Canadian Wirevision Ltd. v the Queen (79 DTC 5101(F.C.A.), affirmed. 78 DTC 6113 (F.C.T.D.)), the Court addressed the meaning of the word “goods” in the context of the processing and manufacturing deduction. It held that television and radio signals transmitted by the company to subscribers were not “goods” within the meaning of section 125.1:
I agree with the trial judge that the word “goods” in section 125.1 “is used in the common parlance of merchandise or wares, or, to put it in legal jargon, tangible moveable property”. In that sense, the signals captured by the appellant, in my view, are not goods.
That view is reflected in various legal and English dictionaries, where the term “goods” is defined broadly to generally include all tangible, moveable, personal property intended for sale. The Black’s law Dictionary for example defines goods as “[t]angible or moveable personal property other than money; esp., articles of trade or items or merchandise” [emphasis added]. The Oxford English Dictionary (“OED”) defines goods as “personal property, possessions; esp. movable property. Cf. Chattel.” The term “marchandises” used in the French version of paragraph 95(3)(b) is defined as tangible property that is bought and sold and is generally understood to be moveable.
Based on the general definitions above, residential condominiums being real estate (immovable property in Québec), they would not be considered “goods” under paragraph 95(3)(b). The view that the word “goods” in that provision refers to moveable property is also consistent with paragraph 95(3)(a), which also refers to “goods” and excludes services related to their transportation. It is also consistent with the other paragraphs which, although not using the word “goods”, refer to:
(c) the transmission of electronic signals or electricity along a transmission system located outside Canada; or
(d) the manufacturing or processing outside Canada […] of tangible property, or for civil law corporeal property” [emphasis added]
If no other exclusions are met, 95(2)(b) would apply to services provided in connection with the sale of real estate inventory, including residential condominiums.
Question 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?
On March 25, 2022, the CRA published revised taxpayer instructions for filing a PLOI election at: https://www.canada.ca/en/revenueagency/services/tax/businesses/topics/corporations/corporation-payments/understandinginterest.html#lns (the “PLOI election webpage”). These revised instructions continue to require the election to be made by submitting a letter to the taxpayer’s tax centre of record. However, the information that is required to be included in the election has been changed. This additional information will allow the CRA to more readily confirm that the income inclusion deemed under section 17.1 is computed correctly.
In addition to the revised information requirements, the PLOI election webpage describes a new administrative policy adopted by the CRA in respect of PLOI elections filed on or after April 11, 2022. According to this administrative policy, only one PLOI election is required to be filed in respect of separate amounts owing to a CRIC by a non-resident person, provided that each such amount is governed by the same agreement. For example, a revolving loan will require one single election notwithstanding that there have been or will be multiple amounts borrowed and repaid under that same agreement. The policy would also be applicable in a situation involving intercompany trade receivables, such as the one described at the 2016 IFA conference, provided that each amount is subject to the terms and conditions of the same agreement.
For full details regarding the revised information requirements and new administrative policy, please refer to the PLOI election webpage.
Relief for late-filing penalties applicable to previously filed elections
For taxpayers who have filed a PLOI election before April 11, 2022 and been assessed late filing penalties in respect of loans or indebtedness to which the new administrative policy described above would otherwise have applied, had the election been filed on or after March 25, 2022, the CRA will offer relief in certain circumstances upon request. Please refer to the PLOI election webpage for further information.
Question 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 Act provides that surplus accounts are to be calculated according to the detailed rules in Part LIX of the Income Tax Regulations (the “Regulations”), as an accumulation of year-by-year computations, starting from the later of 1972 or the beginning of the foreign affiliate’s taxation year in which it last became a foreign affiliate of the taxpayer.
When a taxpayer has one or more foreign affiliates, surplus account balances are relevant for various reasons in determining tax payable under the Act including, but not limited to:
- Determining the tax consequences of a dividend received by a Canadian corporation from a foreign affiliate where a deduction under subsection 91(5) or subsection 113(1) is claimed;
- Determining the tax consequences on the disposition of shares of a foreign affiliate by a Canadian corporation (including the application of the loss limitation rules in subsection 93(2.01), and where a subsection 93(1) election was made or was deemed to be made);
- Substantiating the claim of a deduction under subsection 90(9);
- Determining the tax-free surplus balance of a foreign affiliate that has to be included under paragraph 55(5)(d) of the Act in the safe income of a corporation;
- Where a foreign affiliate has issued more than one class of shares and where there is more than one shareholder:
- Determining a specified amount to be included under subsection 90(6) of the Act where the surplus entitlement percentage is computed under subsections 5905(10) and (11) and paragraph 5905(13)(b) of the Regulations; or
- Determining the foreign accrual property income inclusion in respect of a controlled foreign affiliate under subsection 91(1) of the Act where the participating percentage is computed under section 5904 of the Regulations.
Foreign accrual property income or loss, income or loss from an active business, capital gains or losses from the disposition of property by the foreign affiliate, and various other transactions, could affect or could be affected by the surplus account balances. Examples of such transactions include, but are not limited to:
- A transaction involving, directly or indirectly, a foreign affiliate of a taxpayer that would trigger the application of any of the provisions in section 5905 of the Regulations;
- A change in the business of the foreign affiliate that triggers the application of the fresh start rules under paragraphs 95(2)(k) and (k.2) of the Act and subsection 5907(2.9) of the Regulations; and
- The payment of a dividend between two foreign affiliates or a deemed subsection 93(1) election because of paragraph 93(1.1)(a) of the Act.
Furthermore, some of the questions on Form T1134 refer to surplus accounts and their components.
In Canada’s self-assessing system, the onus to compute and report taxable income pursuant to provisions of the Act and to determine the amount of tax owing is on taxpayers.
Therefore, where surplus account balances of a foreign affiliate are relevant in determining tax payable under the Act based on one of the elements listed above, amongst others, taxpayers are required to prepare up-to-date surplus account calculations in support of those surplus account balances.
In addition, taxpayers are responsible for documenting their affairs in a reasonable manner. In that respect, subsection 230(1) of the Act specifically requires taxpayers to maintain records and books of account, in such form and containing such information as will enable the determination of taxes payable under the Act. Pursuant to paragraph 231.1(1)(a) of the Act, the books and records of a taxpayer may also be inspected, audited or examined, by an authorized person of the CRA.
It is therefore very important to keep surplus account calculations up to date as the CRA may request and review taxpayer computations and supporting documents pertaining to the surplus account balances when auditing compliance to the provisions of the Act including the reporting of the amounts listed above.
As mentioned in information circular IC77-9R, Books, Records and Other Requirements for Taxpayers Having Foreign Affiliates (the “Circular”), taxpayers must retain records and any other relevant document with respect to their foreign affiliates beyond the mandatory retention period if they refer to transactions that may have future tax consequences, such as any amount involved in calculating surplus balances due to the cumulative nature of surplus. Records and documents that support surplus account balances must be prepared and maintained by the taxpayer until it is clearly established the surplus account balances are no longer relevant to the taxpayer. Guidance on the records and documents required can be found in paragraphs 3 to 8 of the Circular.
It is a good practice for a taxpayer to maintain surplus account calculations on a continuous basis, with supporting documentation readily available, and as part of their annual form T1134 compliance or foreign accrual property income determination. Even if the determination of tax payable by a taxpayer in a given year does not rely on surplus balances, accurate surplus account balances of a foreign affiliate with respect to a taxpayer should be prepared by the taxpayer on an annual basis, and relevant books, records, documents and information to support such surplus accounts balances should be retained. Each component of the surplus accounts 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 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 supporting a future filing or the claim of a future deduction.
What constitutes appropriate documentation depends on the specific facts and circumstances, but may include:
- non-consolidated financial statements of the foreign affiliate,
- trial balance of the foreign affiliate,
- complete minute books of the foreign affiliate,
- income tax returns and all relevant supporting schedules for the income tax returns of the foreign affiliate,
- support for income tax paid by the foreign affiliate, and
- relevant supporting documentation:
- describing the business(es) of the foreign affiliate,
- related to the nature of the income earned by the foreign affiliate,
- related to transactions involving the foreign affiliate, and
- related to dividends paid or received by the foreign affiliate.
Question 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)?
A deduction under paragraph 113(1)(a) is available if the dividend is prescribed to be paid out of the exempt surplus of the FA. Exempt surplus of the FA includes its exempt earnings. In order to accumulate exempt earnings under paragraph (d) of the definition of “exempt earnings” in subsection 5907(1) of the Income Tax Regulations (the “Regulations”), the FA must be “resident in a designated treaty country” throughout the relevant year.
The expression “resident in a designated treaty country” is not defined in the Act or the Regulations. The CRA has previously stated (see, for example, CRA documents 2007-0261551I7, 2003-0007347, 9619090, 6M12570) that there is a two-pronged test for an FA to qualify as a resident of a designated treaty country:
1. First, the FA must be resident in a designated treaty country under Canadian common law principles, which has generally established that a company is resident in the country in which its central management and control is exercised. This determination depends on the facts and, therefore, can only be made on a case-by-case basis. The fact that the FA is resident in Country A under the Treaty because of the dual residency tie-breaker rule is not relevant for the purposes of the residency test under common law.
2. Second, the FA must satisfy one of the conditions stipulated under paragraph 5907(11.2)(a), (b), (c) or (d) of the Regulations.
Pursuant to subsection 230(1) of the Act, and as described in Information Circulars IC77-9R, Books, Records and Other Requirements for Taxpayers Having Foreign Affiliates and IC78-10R5, Books and Records Retention/Destruction, taxpayers must keep records and books of account in such form and containing such information as will enable the taxes payable to be determined, including records to substantiate a deduction claimed under section 113. More specifically, paragraphs 7 and 8 of IC77-9R indicate that:
7. The requirements for the retention of records and books of account of a Canadian taxpayer are set out in Information Circular 78-10R. These requirements also apply to the books, records and information maintained by the Canadian taxpayer on the affairs of a foreign affiliate.
8. As a minimum, these records should be sufficient to substantiate the computation of foreign accrual property income and any deductions claimed under subsection 91(5) or section 113 in respect of dividends received from the foreign affiliate. It will be necessary to retain records relating to the surplus accounts, foreign taxes paid, reorganizations, amalgamations and changes in participating percentage or surplus entitlement percentage and any other relevant information beyond the mandatory retention period if these transactions have future tax consequences.
In addition to surplus calculations, Canco is required to keep records that support that FA is resident in Country A under common law principles to substantiate that the condition under paragraph (d) of the definition of “exempt earnings” in subsection 5907(1) of the Regulations that the FA is “resident in a designated treaty country” is met. In order to do so, the information in those records needs to be detailed and complete enough to support that the central management and control of FA is exercised in the treaty country, and include information relating to the whole “course of business and trading” of the FA and, thus, not be limited to the location of board meetings or where members of the board are resident.
Pursuant to paragraph 231.1(1)(a) of the Act, the books and records of a taxpayer may be inspected, audited or examined, by an authorized person of the CRA.
A deduction under paragraph 113(1)(a) will be available where all requirements are met and substantiated. If all of the requirements for claiming a deduction under paragraph 113(1)(a) have not been met and substantiated, the deduction will be denied.
Question 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?
The question of where a cryptocurrency is located, deposited or held within the meaning of section 233.3 is still under review by the CRA.
In parallel, work is underway at the Organisation for Economic Co-operation and Development (the “OECD”) to develop the Crypto-Asset Reporting Framework (the “CARF”), a standardized package that will include reporting requirements to tax administrations and exchange of information procedures related to taxpayers’ transactions with crypto-asset service providers. A public consultation process on the CARF was initiated on March 22, 2022 and closed on April 29, 2022. A public consultation meeting will be held at the end of May 2022. More information can be found on the OECD website.
The CRA “Guide for cryptocurrency users and tax professionals” provides general guidelines explaining to Canadian taxpayers their tax obligations in respect of cryptocurrency. In particular, taxpayers engaging in crypto-asset transactions are required to keep proper financial records of all their activities, including records related to the acquisition or disposition of cryptoassets. Subsection 230(1) specifically requires taxpayers to maintain records and books of accounts, in such form and containing such information as will enable the determination of taxes payable under the Act. Pursuant to paragraph 231.1(1)(a), the books and records of a taxpayer may also be inspected, audited or examined by an authorized person of the CRA.
The CRA conducts audit activities related to crypto-assets, including audits of individuals acquiring and disposing of crypto-assets as well as crypto-asset businesses involved in developing, mining, staking, or effectuating the exchange of crypto-assets.
Question 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?
The CRA’s approach to the classification of a foreign entity or arrangement in respect of a property, venture or other object (collectively referred to in this response as the “foreign entity or arrangement”) remains the same as indicated in prior years. That is, to determine the status of an entity or arrangement for Canadian tax purposes, the CRA generally follows the two-step approach described below:
1) Determine the characteristics of the foreign entity or arrangement under applicable foreign law, relevant constating documents, indentures, partnership agreement, contracts and other relevant terms or documentation (the “applicable law and documentation”).
2) Compare these characteristics with those of recognized categories of entity or arrangement under relevant Canadian law in order to classify the foreign entity or arrangement under one of the categories around which the provisions of the Income Tax Act and the Income Tax Regulations are drafted.
As part of 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 generally lend itself well to the type of standard or universal classification requested by this question. On that basis, the CRA would not be in a position to publish and maintain an online list of foreign entity or arrangement classifications. However, the CRA would not see paragraph 19 k) of the most recent version of Information Circular IC 70-6 (Advance Income Tax Rulings and Technical Interpretations) as preventing it from entertaining an income tax ruling request. The CRA does not consider that the classification of a foreign entity or arrangement is strictly speaking an issue “that would require interpretation of a law not administered by the CRA, including foreign law”. On that basis, the CRA would consider confirming the classification of a foreign entity or arrangement, in one of the categories around which the provisions of the Income Tax Act and the Income Tax Regulations are drafted, in the form of an advance income tax ruling.
Consistent with the general spirit of paragraph 19.1 (although the classification is not strictly speaking only a question of fact either) and of Appendices A and A.1 of the most recent version of IC 70-6, taxpayers are expected to include with their request a complete description of the characteristics described above, their analysis as to the proper classification of the entity or arrangement for purposes of the Income Tax Act and the Income Tax Regulations along with a discussion on the way their relevant provisions would appropriately apply to proposed transactions involving or affecting the rights and obligations of the entity or arrangement and its stakeholders, a copy of the foreign legislation applicable to the entity or arrangement and any other relevant documents described above.
Question 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.
The CRA does not intend to provide, in the context of the situation described above, an administrative relief to extend the “documentation-due date”, as defined in subsection 247(1), of a taxpayer or partnership for the purposes of the CD rules in subsection 247(4), or to otherwise administratively relieve taxpayers or partnerships from meeting their obligations under subsection 247(4).
In determining whether a taxpayer or a partnership has made or obtained records or documents that provide a description that is complete and accurate in all material respects of the items listed in subparagraphs 247(4)(a)(i) to (vi), the CRA will continue to rely on the guidance found in the Transfer Pricing Memorandum TPM-09, Reasonable efforts under section 247 of the Income Tax Act. In this regard, the CRA recommends that 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.
Finally, as allowed under subsection 220(3.1), the Minister may grant taxpayer relief by waiving or cancelling all or any portion of any penalty or interest otherwise payable under the Act. Such discretionary relief is granted on a case-by-case basis, by the appropriate delegated authority, pursuant to subsection 220(2.01), with due consideration to all of the relevant circumstances. To request this type of relief, a taxpayer has to complete Form RC4288, Request for Taxpayer Relief – Cancel or Waive Penalties and Interest. For more information on existing taxpayer and partnership relief provisions, including the administrative guidelines that the CRA applies when considering requests for relief and the types of circumstances that may qualify, please consult the Information Circular IC07-1R1, Taxpayer Relief Provisions.
Question 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 role of the CRA is to administer the Act. Under the Act, the residence of a corporation that is incorporated outside of Canada is generally based on common law principles dictated by the Courts, subject to the enactment of statutory rules generally initiated by the Department of Finance. Subsection 250(5), for example, can deem a corporation not to be resident in Canada where the corporation is, under a tax treaty with another country, resident in the other country and not resident in Canada.
The common law test for determining corporate residence is generally based on where the corporation’s central management and control actually abides. This depends on the facts and must thus be determined after a scrutiny of the whole “course of business and trading” of the corporation (De Beers Consolidated Mines Ltd. v. Howe,  AC 455 (HL)).
Usually, central management and control is considered to abide where the members of the board of directors meet to make important and strategic decisions regarding the affairs of the corporation, unless central management of control is actually exercised elsewhere. However, the presence of board meetings in the country in which the corporation is asserting residence would not, in and of itself, be sufficient to conclude that the corporation is resident in that country. It is well-established under common law that it is the actual place of management, not the place in which it ought to be managed, which fixes the residence of a corporation. The courts have repeatedly considered evidence beyond the location of board meetings in order to look at the whole “course of business and trading” of a corporation.
Question 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 rule is to impose limits on the amount of employee stock options that may vest in an employee in a calendar year and qualify for a subsequent 110(1)(d) deduction against taxable stock option benefits. Therefore, this particular question raises the larger issue of whether restricted share units and other rights to securities that are subject to section 7, which would never entitle the recipient employee to a deduction under paragraph 110(1)(d), should count towards the employee’s $200,000 annual vesting limit.
The Department of Finance is aware of this larger issue and is contemplating potential remedial measures. This particular question will be addressed at a later date in the context of this larger exercise.
In the interim, employers can avoid this problem by designating securities that do not give rise to a paragraph 110(1)(d) deduction as non-qualified securities under subsection 110(1.4). This would exclude the securities from the annual vesting limit with respect to any options that are subsequently issued to the employee with the same vesting year. However, pursuant to paragraph (b) in variable D of the formula in subsection 110(1.31), such designation must be made prior to the issuance of the subsequent options.
Question 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 the general anti-avoidance rule (“GAAR”) is being applied. 2) Has CRA received any PPT ruling requests?
The PPT is set out in article 7(1) of The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). The MLI entered into force for Canada on December 1, 2019, and entered into effect for a number of Canada’s tax treaties as early as January 1, 2020 (for taxes withheld at source on amounts paid or credited to non-residents), and as early as taxation years beginning on or after June 1, 2020 (for all other taxes).
(1) As indicated at the 2021 International Fiscal Association (“IFA”) Conference on May 5, 2021, in view of the international efforts which led to the MLI and its considerable importance to both tax administrations and taxpayers, the CRA has started monitoring compliance with the MLI on a priority basis in advance of the normal audit cycles. To date, the CRA has not issued any assessments on the basis of the PPT, although compliance review processes are underway.
With respect to the GAAR, the CRA took note of the decision that was rendered by the Supreme Court of Canada (“SCC”) in The Queen v. Alta Energy Luxembourg SARL (“Alta Energy”). The SCC considered a matter central to the CRA’s ongoing efforts to protect Canada’s tax base and the integrity of its tax treaties. The meaning and effect of the decision continues to be analyzed by the CRA, the Department of Finance and the Department of Justice as the processing of the files that were held in abeyance at different audit or litigation stages pending the decision of the Supreme Court in Alta Energy resumes.
In any situation where the CRA is considering the application of the PPT and/or the GAAR, the matter will be referred by the International and Large Business Directorate in the context of proposed assessments or by the Income Tax Rulings Directorate in the context of income tax ruling request, to the Treaty Abuse Prevention Committee (the “TAP” Committee) in accordance with its administrative policy.
The potential application of the GAAR and the PPT in each case will be examined in light of the directives provided by the Courts in different decisions where relevant as informed, amongst others, by the relevant facts, the taxpayer’s motives and the relevant tax treaty provisions. Practitioners may refer to the 2020 CTF Conference CRA Roundtable for general guidance on determining whether any arrangement or transaction has, as one of its principal purposes, the obtaining of a treaty benefit. Similar guidance may apply to determine the primary purpose of a transaction under the GAAR.
In addition to the GAAR and the PPT, the CRA will consider where appropriate the taxpayer’s corporate residency, the application of judicial doctrines and anti-avoidance rules, either domestic or in the relevant bilateral tax treaty.
(2) The CRA received one pre-ruling consultation request with respect to the application of the PPT, the details of which can be found in our published response to the 2021 IFA Conference CRA roundtable questions (CRA document no. 2021-0887581C6). To date, the CRA has not received any other ruling or pre-ruling consultation request relating to the PPT.
Question 13: Current Statistics on Mutual Agreement Procedures
Could the CRA give current statistics on Mutual Agreement Procedures (MAPs)?
The CRA can provide the following statistics on MAPs for the 2020 calendar year:
- The CRA had 165 negotiable MAP cases on January 1, 2020;
- During 2020, the CRA accepted 72 new MAP cases and closed 74 MAP cases;
- The average time to complete a negotiable MAP case was 17.83 months;
- Of the 74 MAP cases closed in 2020, 36 cases (i.e., 48.6%) resulted in full relief from double taxation upon negotiation, 9 cases (i.e., 12.2%) had objections not justified, and 8 cases (i.e., 10.8%) were resolved through unilateral relief. The remaining 21 cases (i.e., 28.4%) were either withdrawn by the taxpayers, resolved via domestic remedy, resulted in no agreement or were denied MAP access;
- Of the 74 MAP cases closed in 2020, 60 (i.e., 81%) were initiated by Canada and 14 (i.e., 19%) were initiated by countries other than Canada; and
- The CRA is currently engaged in negotiable MAP cases involving taxpayers from 31 different jurisdictions. The United States represents 46% of these MAP cases.
Question 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) of the Act 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?
Based on the facts of this question, the conditions in subparagraphs 96(3)(a)(i) and (ii) are met and a subsection 90(3) election in respect of the Distribution will be valid if made only by FA1 in its capacity of the general partner on behalf of LP because there is no “connected person or partnership” in respect of LP within the meaning of subsection 90(4).
Such election has to be made in the manner and within the timeframe specified in subparagraph 5911(6)(a)(i) of the Regulations. The election has to be made by FA1 by notifying the Minister in writing on or before the filing-due date of FA2 for its taxation year ended on December 31, 2021.
As there is no prescribed form for a subsection 90(3) election, the election is to be made in a form of a letter signed by FA1 in its capacity as the general partner of LP and filed with the Minister of National Revenue by the earliest of the filing-due dates set out in subsection 5911(6) of the Regulations.
The letter needs to contain information sufficient to allow the CRA to determine that the election is made in compliance with paragraph 96(3)(a) and the election must be made within the applicable time period prescribed in subsection 5911(6) of the Regulations. The general partner shall use its best efforts to identify in the letter all Canadian resident taxpayers of which FA3 (the entity making the distribution) is a foreign affiliate for the purposes of subsection 90(3).
Where the partnership making the election is not subject to Canadian filing requirements, the election letter is to be sent to the tax center of record of one of the Cancos. Since Canco2 has the same filing-due date as FA2, attaching this election to Canco2’s income tax return for its December 31, 2021 taxation year would be the recommended manner of notifying the Minister of the election on the facts at issue (assuming the income tax return is filed with the Minister by its filing-due date).
The following information needs to be included in the letter when subsection 90(3) election is made by a partnership:
- name, address and taxpayer identification number (if any) of the foreign affiliate making the distribution;
- partnership’s name, address, account number (if any) and fiscal period end;
- names, addresses and business numbers of each Canadian resident taxpayer of which the foreign affiliate making the distribution is a foreign affiliate;
- amount of the distribution made;
- the date(s) the distribution was made.
The information required by the CRA to be included on the election letter as listed above is dictated by the text of subsection 90(3) as informed by its context and purpose.
From an administrative perspective, the following practices are recommended in the interest of ensuring that the information described on a duly completed subsection 90(3) election letter is processed appropriately without delays or complications:
- A copy of the election is to be provided to each Canadian resident taxpayer identified on the election letter.
- In addition to being filed by the partnership as indicated above by the relevant filing-due date, the Canadian resident taxpayer may choose to attach a copy of the election to the taxpayer’s earliest T1134 Information Return Relating To Controlled and Non-Controlled Foreign Affiliates or income tax return for the taxation year that includes the relevant fiscal period end of the partnership.
If a joint election is made by LP, Canco1 and Canco2, CRA would accept it as valid and would accept the required election made by FA1 on behalf of LP, Canco1 and Canco2 provided such election letter includes all the required information as outlined in response to Question 14(i).
If an election is made jointly by Canco1, Canco2 and LP in respect of the Distribution, it is required to be made on or before the earliest of the filing-due dates of Canco1, Canco2, FA1 and FA2 for their respective taxation years that include December 31, 2021, in accordance with paragraph 5911(6)(b) of the Regulations.
1 For details, go to canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/compliance/digitalcurrency/cryptocurrency-guide.
2 Decision rendered on November 26, 2021; [2021 SCC 49]
3 As stated in the 2019 Canadian Tax Foundation (CTF) Conference CRA Roundtable, the responsibility to provide a recommendation in situation where a tax benefit emanates from a bilateral tax treaty was transferred from the GAAR Committee to the TAP Committee.