Income Tax Severed Letters - 2016-07-20

Principal Issues: Whether notional expenses determined under the AOA and attributable to a taxpayer’s permanent establishment in Canada can be deducted for Canadian tax purposes?

Position: Notional expenses are generally not deductible, except if there is an agreement entered into between the competent authorities of the parties to the particular tax convention in question and such agreement expressly provides for such deduction.

Reasons: See below.

Principal Issues: Can the exception in par. 90(8)(a) apply to an upstream loan which is repaid and then indirectly converted to a new loan which is subject to a PLOI election?

Position: Yes.

Reasons: The repayment would not be considered to be part of a series of loans and repayments in the scenario presented.

Principal Issues: Whether a payment made under a "profit transfer agreement" by a German subsidiary to its German parent could be deemed to be a "dividend" under subsection 90(2)?

Position: Yes, provided the payment meets the pro rata distribution condition in subsection 90(2).

Reasons: The wording of subsection 90(2) supports this position.

Principal Issues: (1) Canco holds two classes of shares in an FA (FA1). The proceeds from the issuance of the Class A shares were used to fund an active business while the proceeds from the issuance of the Class B shares were used to purchase shares in another FA (FA2) that are not excluded property. If FA1 borrows funds from another FA (FA3) and uses those funds to return capital to Canco in respect of its Class A shares, would FA3’s interest income on the loan be recharacterized as active business income? (2) Would the answer be different if there was only one class of shares issued by FA1?

Position: (1) Yes. (2) Yes.

Reasons: (1) It is our view that the loan to FA1, which replaced capital that was being used for eligible purposes, would have qualified for interest deductibility under paragraph 20(1)(c) if FA1 had borrowed the money for that purpose, as such, the interest income received by FA3 on the loan should be recharacterized into income from an active business pursuant to clause 95(2)(a)(ii)(B). (2) In the situation where FA1 has issued only one class of shares the pro-rata treatment should be used such that income from the loan to FA1 is recharacterized proportionate to borrowed funds used by FA1 to return capital that was used by it in its active business.

Principal Issues: Whether paragraph 95(2)(c) applies in a situation where a taxpayer transfers shares of a foreign affiliate to another foreign affiliate that is a “non-resident corporation without share capital”, within the meaning of subsection 93.2(1), without any “shares” being issued as consideration?

Position: Yes, provided the conditions set out in subsection 93.2(3) are met.

Reasons: See below.

Principal Issues: At the 2015 CLHIA Tax Officers’ Meeting, a CRA official indicated that there is a review underway relating to new types of leveraged insured annuity arrangements. Can the CRA provide more details relating to the structures of these arrangements and its particular concerns?

Position: Comments provided below

Principal Issues: A contract holder designates a registered charity as beneficiary of a segregated fund policy. Does paragraph 38(a.1) apply in respect of the property transferred to the qualified donee upon the death of the annuitant?

Position: No.

Reasons: The property transferred to the qualified donee is in the form of a cheque or other negotiable instrument and not a property listed in subparagraph 38(a.1)(i).

Principal Issues: Will the CRA clearance certificate process be modified in situations where a clearance certificate is needed before a gift can be completed by a graduated rate estate?

Position: The overall process to receive a clearance certificate is currently under review. A legal representative may request a clearance certificate for a partial distribution.

Reasons: CRA policy and clearance certificate procedures.