17 May 1993 Income Tax Severed Letter 3M05840 F - Edmonton/CICA Roundtable

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

 

Draft replies or comments on material reviewed or prepared by the Rulings Directorate in connection with the C.I.C.A. 1993 Roundtable on May 20, 1993 chaired by the Edmonton District Office

MEMORANDUM TO:  Mr. E.J. Schermann Chief of Audit, Edmonton D.O.

ATTENTION:  Mr. Rob Kissinger

C.I.C.A. 1993 ROUND TABLE

Attached are our comments on your draft responses to questions 1, 2, 3, 4, 6, 8 and 12.

With regard to question 5, our position in the situation described is currently under review. Therefore, we would suggest that your response to question 5 might, instead, reflect that fact. The review is expected to be completed soon.

We agree with your responses to questions 7, 9 and 10.

R.J.L. Read Director GeneralRulings DirectorateLegislative and Legislative Affairs Branch

ANNUAL PROVINCIAL ROUND TABLE QUESTIONS

Question 1

FACTS

(as presented)

1.     LossCo is owned by three arm's length individuals (1/3 share each):

Individuals     (A)     (B)     (C)

     33 1/3%     33 1/3%     33 1/3%

Corporation LossCo

2.     LossCo is controlled by the following groups of individuals; A&B, B&C, and C&A.

3.     A, B, and C transfer their shares to their respective wholly owned holding companies, A-Co, B-Co, and C-Co.

Individuals     (A)     (B)     (C)

     100%      100%      100%

Holding Corp.      A-Co      B-Co      C-Co

     33 1/3%     33 1/3%     33 1/3%

Loss Corporation LossCo

4.     LossCo may still be considered to be controlled by the same group of individuals as noted in Fact 2 (i.e. A&B, B&C, and C&A), however it may also be considered to be controlled by the following groups of companies; A-Co & B-CO & C-CO, and C-CO & A-Co.

Response 1

We would suggest the following response:

"Whether subsection 111(5) would apply to restrict the losses of LossCo would be dependent on a determination of whether the transactions described resulted in a group of persons acquiring control of LossCo.

The fact that there are numerous combinations of shareholders who together have sufficient numbers of shares to control LossCo, does not mean that each of these combinations constitutes a group of persons which controls the company. In the Department's view, in order to conclude that there is a group of persons which controls a company there must exist a common link or interest between them (which must involve more than their mere status as shareholders). In other words, they must act in concert to control the corporation. Consequently, it is possible that none of the possible combinations of shareholders constitute a group that controls the corporation.

In Vineland Quarries and Crushed Stone Limited v. MNR, 66 DTC 5092 (Ex. Ct.), affirmed by 67 DTC 5283 (S.C.C.) it was held "that a taxpayer who controls one corporation will be considered to control any corporation that is controlled by the first corporation." Such control is referred to as indirect control.

Except for the purposes of determining whether two or more corporations are associated or where there is one group of persons which has direct control over a corporation and another group which has indirect control, it is our opinion that there cannot be more than one group of persons which control a corporation at the same time. Consequently, we do not believe that it can be concluded that each of A and B, B and C, and C and A control LossCo at the beginning of the series of transactions described in the question.

If we were to assume that A and B constitute a group that controls LossCo before the share transfers and that A-Co and B-Co is a group which controls LossCo after the share transfers, there will be an acquisition of control of LossCo, notwithstanding that there has been no change in the indirect control of LossCo. The provisions of paragraph 256(7)(a), which provide that control of a corporation will be deemed not to have been acquired by a person if that person was related to the corporation immediately before such acquisition of control, will not apply to deem A-Co and B-Co not to have acquired control of LossCo since neither of them was related to LossCo immediately before they acquired their shares of LossCo.

T. Harris  May 11, 1993 Ref. # 931366

Question 2

Investment tax credits ("ITC's") not used in the year earned can be carried forward ten years. Qualified scientific research and experimental development expenditures entitle taxpayers to claim ITC's. If a corporate taxpayer incurred qualifying scientific research and experimental development expenditures seven years ago (clearly beyond the "normal reassessment period") and only recently became aware that they qualify for ITC's, could the taxpayer now file a T661 and a T2038 substantiating the entitlement and claim the ITC's in the current year, well within the ten year carry forward period?

Response 2

We suggest the following reply to question # 2

The Department will permit a taxpayer to file a T661 and T2038 substantiating the entitlement to ITC's for years beyond the "normal reassessment period". These ITC's could be claimed in the current year when the current year is within the ten year carry forward period.

C.R. Brown 931324

Question. 3

In Year 1, a taxpayer incurs a $75,000 ABIL and an ordinary non- capital loss of $100,000 so that its non-capital losses available for carry forward are $175,000.

In Year 2, the taxpayer earns $75,000 of income and utilizes $75,000 of its non-capital loss carry forward to eliminate the income.

In Year 3, there is a change of control. Subsection 111(5) indicates that only non-capital losses arising from the carrying on of a business survive a change of control. Presumable, it is unlikely that a ABIL would be considered a loss from carrying on a business. Thus, how much of the non-capital loss is still available for carry forward?

$100,000 on the basis that the $75,000 utilized in Year 2 came first from the ABIL?

OR $57,143 on the basis that $75,000 utilized in Year 2 had to be prorated between the ABIL portion and the ordinary portion?

Or some other amount?

Response 3

We would suggest the following reply to question 3:

"Since an allowable business investment loss (an "ABIL") is not a loss from carrying on a business, pursuant to subsection 111(5) of the Act, the amount of any ABIL which has been included in a taxpayer's non-capital loss will not be available for carry forward following an acquisition of control of the corporation. By virtue of clause 111(8)(b)(i)(A), a taxpayer's non-capital loss for a year includes the portion of any ABIL realized in the year and which has not been utilized in the year to reduce the taxpayer's income. The amount of any ABIL included in computing a taxpayer's non-capital loss balance does not, however, lose its identity as an ABIL. For example, subparagraph 111(8)(a)(ii) provides that the amount of any ABIL which has not been utilized within the 7 year carry-forward period allowed for non-capital losses will become part of the taxpayer's net capital loss except where the taxpayer is a corporation control of which has been acquired by a person or group of persons subsequent to the realization of the ABIL.

Other than paragraph 111(3)(b), the rules in section 111 are silent on the order in which losses are to be applied. Consequently, the various types of losses may be deducted in any order except that a loss of any particular type for a taxation year may only be deducted once all deductible losses of the same type for all previous taxation years have been deducted. It is, therefore, the Department's view that a taxpayer may choose to apply any losses in the manner which is most beneficial to his or her circumstances. Consequently, in the situation described, the Department would generally allow the taxpayer to choose whether the $75,000 applied in Year 2 came first from the ABIL, the other non-capital losses or some combination of the two."

T. Harris May 11, 1993 Ref. # 931367

Question 4

Change of Control

If a corporation owns a rental property which generates losses, do non-capital losses arising from that rental property survive a change in control?

Response 4

Although we agree with the conclusion that non-capital losses from a rental operation which constitutes a business may survive a change of control, we would suggest that the last paragraph of the answer be replaced by the following:

"Whether rental income constitutes income from business or property is a question of fact and is discussed in IT-73R4. Paragraph 5 of this IT explains:

"Where a corporation was incorporated to earn income by carrying on business, there is a general presumption that profits arising from its activities are derived from a business (or from separate businesses as discussed in IT-206R). Thus, from the time that the activities contemplated commence (see IT-364) until they permanently cease, most corporations will be carrying on one or more businesses. However, in some circumstances, a corporation's entire profits can be characterized as income from property, as might be the case where the corporation is formed for the sole purpose of holding shares of a second corporation or holding a property to be rented with limited landlord responsibilities. It is, of course, quite possible that a corporation will earn income from property as well as income from a business carried on, if such property is not income from another separate business.

For greater certainty, a rental operation which constitutes a specified investment business, as defined in paragraph 125(7)(e) of the Act, will generally be considered to be a business for purposes of subsection 111(5).

T. Harris May 11, 1993 Ref. # 931368

Question 5

Capital Property:

UCC - $200,000 FMV - $500,000

Mortgage $300,000

Can property be rolled to a company under Section 85 in the following manner?

A corporation acquires capital property and a note receivable in amount of $100,000 from an individual in exchange for assuming the mortgage and issuing some shares. A transfer amount of $200,000 is elected for the capital property. $200,000 of the consideration re assuming the mortgage is allocated to the capital property with the remaining $100,000 allocated to the note created to accommodate the transaction.

Response 5

This issue is currently under review.

Question 6

Assume that a taxpayer claims a capital gains deduction of $75,000 under subsection 110.6(2) of the Act for 1991. The taxpayer clearly indicates on his income tax return and T657 that the capital gains deduction is with respect to qualified farm property.

In 1995, the taxpayer intends to sell a property, realize a capital gain and claim a capital gains deduction under subsection 110.6(3).

Since Revenue Canada has not reassessed the 1991 income tax return within three years of the date of mailing of the notice of assessment for 1991, can the taxpayer assume that his deduction for 1991 has been allowed under subsection 110.6(2) as opposed to subsection 110.6(3)?

Response 6

Because the taxpayer claimed the capital gains deduction in 1991 under subsection 110.6(2) as indicated on his tax return and T657, Revenue Canada would have assessed the return to allow the claim under suvsection 110.6(2). Our system would be updated on initial assessing to show that it was a disposition of qualified farm property and thus allowable under subsection 110.6(2) of the Act. However, Revenue Canada would not be precluded at any time from changing the assessing section in 1991 if the deduction claimed under 110.6(2) was not allowable.

931328 M. Bisson May 11, 1993

Question 7

Please advise whether the following individuals are related or not related, as the case may be, for income tax purposes:

(a)     individual A, his wife, his wife's sister and his wife's sister's husband

(b)     individual A, his sister, his sister's husband, his sister's husband's sister or brother, and

(c)     individual A, and his nephew or niece.

Response 7

These responses are based on the existing legislation at April 1993. The Notice of Ways and Means Motion of June 12, 1992 proposed changes to the definitions under Section 252(2) for purposes of determining related parties. These changes were included in Bill C-92 which was passed in the House of Commons on April 1, 1993. Bill C-92 has not yet passed through the Senate. However, the proposed legislation does not alter the responses to this question.

(a)     (i)     individual A, his wife

Individual A and his wife are related by marriage under Section 251(2)(a).

(ii)     individual A, his wife's sister

     Individual A and his wife's sister are related by blood under Section 251(2)(a). Section 251(6)(a) states, "that persons are connected by blood if one is the sister of the other." Section 252(2)(d) further defines sister to include one's sister- in-law. Therefore, individual A and his wife's sister (ie. his sister-in-law) are related for purposes of the Act.

(iii)     individual A, his wife's sister's husband

     Individual A and his wife's sister's husband are related by marriage under Section 251(2)(a). Section 251(6)(b) states, "that persons are connected by marriage if one is married to a person who is so connected by blood relationship to the other." Given that individual A's wife is related by blood to her brother-in-law under 252(1)(a), then by marriage individual A is also related.

(b)     (i)      individual A, his sister

     Individual A and his sister are related by blood under Section 251(2)(a) as defined in Section 251(6)(a).

(ii)     individual A, his sister's husband

     Individual A and his sister's husband are related by blood under Section 251(2)(a). Section 251(6)(a) states, "that persons are connected by blood if one is the brother of the other." Section 252(2)(a) further defines brother to include one's brother-in-law. Therefore, individual A and his sister's husband (ie. his brother-in-law) are related for purposes of the Act.

(iii)     individual A, his sister's husband's sister or brother

     Individual A and his sister's husband's sister or brother are not related for purposes of the Act. Individual A's sister's brother-in-law or sister-in-law does not meet the definition of person's connected by blood under Section 251(6)(a). However, even though these two individuals are not related, it is a question of fact whether these unrelated persons deal with each other at arm's length under 251(1)(b) of the Act.

(c)     (i)      individual A, and his nephew or niece

     Individual A and his niece or nephew are not related for purposes of the Act. Individual A's niece or nephew does not meet the definition of person's connected by blood under section 251(6)(a). However, it becomes a question of fact under Section 251(1)(b) as to whether these unrelated persons deal with each other at arm's length. Question 8

In the course of a settlement of an outstanding debt for less than the principal amount, a taxpayer transfers ownership of an asset to the creditor at its then fair market value as a payment upon the debt. Would Revenue Canada view this as a situation where section 79 would apply in that the creditor has the beneficial ownership of property in consequence of the other person's failure to pay all or any part of the amount, or would section 80 apply? Would it make a difference if the asset was previously pledged as security for the debt or not?

Response 8

In the above situation, it would appear that Section 79 would not apply since a property is transferred in the course of a settlement of an outstanding debt and not in consequence of the taxpayer's failure to pay all or any part of an amount owing by him to the creditor.

However this issue has now been referred to the Department of Justice for their opinion.

931329 M. Bisson May 11, 1993

Question 9

The definition of a share of the capital stock of a family farm corporation includes, among other things, the requirement that a designated individual have been "actively engaged on a regular and continuous basis" in the business of farming in Canada. Does Revenue Canada have any guidelines or can it provide some direction as to its understanding of what is required to meet this test? Is it a criteria that the individual be involved in the actual farming activities of planting, harvesting, caring for livestock or is it possible for the qualifying individual to be in a management position providing the direction and planning for the business as a whole without directly doing the farming himself?

Response 9

Paragraph 70(10)(b) of the Income Tax Act defines the term "share of the capital stock of a family farm corporation." This definition mainly serves sections 70 and 73 of the Act which permit certain elections to be made on the transfer of qualifying property between parents, children and spouses.

The Round Table question refers specifically to the term "actively engaged on a regular and continuous basis" to describe the eligible farming activities of the person, spouse or child. This term is used in the December, 1991 Technical Amendments which defines share of capital stock of a family farm corporation differently from the definition that existed prior to 1992.

Perhaps the best guidance as to the interpretation of the above mentioned concepts is provided in Interpretation Bulletin 268R3 at paragraphs 15 and 26. Paragraph 15 states that it must be determined on the facts of each case whether a particular taxpayer or the children or spouse of the taxpayer are carrying on a particular farming business. Further, that paragraph indicates that farm management, in terms of planning and control can be separated from the actual farm duties, and that management activity will qualify. This view is also expressed in paragraph 26. In effect, the farm management, direction and control can be done by one person while the farm work can be done by another.

In conclusion, a person in a management capacity could be actively carrying on the business of farming. An examination of the facts and circumstances should determine if that person is engaged on a regular and continuous basis for that particular type of farming operation.

Question 10

Subsection 248(1) defines a "retiring allowance" to include an amount received in respect of a loss of office or employment.

Many agreements reached between labour and management provide for mandatory payments to employees if they are laid off permanently or for the foreseeable future. In many instances an employee maintains a seniority status, if and when, the employer decides to again increase its work force.

Would Revenue Canada comment and provide explanations as to whether, or not, payments of this nature would qualify as a retiring allowance if:

(a)     there is no realistic chance of recall (b) recall might reasonably be expected to happen in two to three years (for instance due to planned retirements etc.); and (c) recall is anticipated in less than two years.

Response 10

The Department's views on the subject of retiring allowances are contained in Interpretation Bulletin IT-337R2.

It is always a question of fact whether an individual has suffered the loss of an office or employment.

It is the Department's position that, where in an arm's length situation, a long term employee is laid off or has retired without any assurance at the time of retirement of being rehired by his former employer, and receives an amount from his employer in recognition of long service or in recept of a loss of an office or employment, such amount would be considered a "retiring allowance" regardless of the fact that employee might be rehired by the former employer at a later date when circumstances have changed.

Where an employee is rehired by his former employer or an affiliate of the former employer, shortly after leaving an office or employment, it is the Department's position that the employee has not suffered a loss of employment if, at the time the employee retires it was foreseen that the employee would be rehired by his former employer or an affiliate. Accordingly, an amount received by the employee on account of his "retirement" would not be considered a retiring allowance.

The word "shortly" is not intended to have a distinctive sense. Its usage in combination with the term "affiliate" is a figure of speech intended to indicate that there is continuity between the present position and the terminated position such that the employee cannot be said to have retired or suffered a loss of office or employment. In determining whether or not this continuity exists, it is inappropriate in our view to comment based on a certain period of time (for instance 0 to 3 years) as requested in the question.

Where a transaction is proposed, confirmation of the tax implications arising therefrom should be sought by way of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R2, dated September 28, 1990.

Question 12

Subsection 66.1(3) allows a taxpayer, other than a principal business corporation, to claim a discretionary deduction for cumulative Canadian exploration expense (CCEE). Paragraph 66.1(6)(b) defines CCEE as including, among other amounts, Canadian exploration expense (CEE) made or incurred before that time. CCEE is reduced by any amount deducted in previous taxation years.

Does Revenue Canada accept the premise that the balance in the CCEE pool is a question of fact and is not fixed by previous assessments or reassessment of CCEE claims? For example:

(a)     In year 1, Revenue Canada reassesses the taxpayer to deny a CCEE claim on the basis that CEE purportedly incurred in that year is not CEE.

(b)     The taxpayer does not object to the reassessment.

(c)     year 5, it is determined that the CEE was, in fact, incurred in year 1 by the taxpayer.

(d)     In filing his return for year 5, the taxpayer reflects an opening CEE balance equal to the CEE incurred in year 1 and claims a deduction.

Assuming that Revenue Canada now agrees that the CEE was incurred in year 1, is the taxpayer's CCEE claim in year 5 allowable? Does it matter if the taxpayer could not object to the reassessment in year 1 because it was a "nil assessment"?

Response 12

We suggest the following response:

"If Revenue Canada reassessed a tax return of a taxpayer to deny a CEE deduction in computing the taxpayer's income in year 1 in respect of an expense, but determined in year 5 that the expense was in fact CEE incurred by the taxpayer in year 1 and that the amount of the expense was never deducted in computing the taxpayer's income, such amount may be added to CCEE of the taxpayer in year 5 pursuant to subparagraph 66.1(6)(b)(i) of the Act and be deducted in computing the taxpayer's income pursuant to subsection 66.1(3) of the Act. Our response would be the same if the taxpayer did not appeal the reassessment or the taxpayer could not object to the reassessment because it was a nil assessment."

Peter Lee May 10, 1993 931330