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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
4M0462 November 30, 1991
PARTICIPANTS FOR REVENUE CANADA, TAXATION:
Carole Gouin-Toussaint
Director
Manufacturing Industries, Partnerships
and Trusts Division André Thibault
Chief
Manufacturing Industries, Partnerships
and Trusts Section
PARTICIPANTS FOR FINANCE CANADA: Marc Cuerrier Senior Counsel Tax Counsel Division
Robert Dubrule Senior Officer/Legislation Tax Policy Branch
ROUND TABLE ON THE FEDERAL TAXATION SYSTEM
1991 APFF CONGRESS
CONTENTS
I. TAX POLICY
Question 1.1 - Fairness of the taxation system (Finance)..........33.2
Question 1.2 - The Symes case (child care expenses) (Finance).....33.3
Question 1.3 - Liability of directors (s. 227.1) (Finance)........33.4
II. REMUNERATION AND OTHER BENEFITS RECEIVED FROM EMPLOYMENT
Question 2.1 - Automobile loan (s. 15(2)(a)(iv) (Revenue)
#7 - Pierre
Bourgeois..............................33.5Question 2.2 - Automobile (car rental) (Revenue)
#33 - Charles
Thériault............................33.5Question 2.3 - Housing loan (s. 15(2)(ii)) (Revenue)
#8 - Pierre
Bourgeois..............................33.6Question 2.4 - Employee Benefit (compensation paid by the
employer) (Revenue)
#4 - Andrée Simard
(Revenue).......................33.7Question 2.5 - Meal allowance (Revenue)
#27 - Pierre
Bourgeois.............................33.7Question 2.6 - Moving allowance (the Splane case) (Revenue)
#1 - Andrée
Simard.................................33.8
III. BENEFIT CONFERRED ON A SHAREHOLDER
Question 3.1 - The McClurg case (discretionary dividends)
(Finance)..........................................33.9
Question 3.2 - Intercompany loan (Revenue)
#14 - Danielle
Bouffard............................33.10
Question 3.3 - Issuing of shares: consideration less than the
F.M.V.
#16 - Marc Seguin
(Revenue)........................33.11Question 3.4 - Series of loans and repayments (Revenue)
#32 - Robert
Gagnon................................33.13
IV. DEDUCTIBILITY OF INTEREST
Question 4.1 - The Livingston International Inc. case (Revenue)
#2 - Charles
Thériault.............................33.13Question 4.2 - Loans vs. other forms of indebtedness (Revenue)
#12 - Charles
Thériault............................33.14
Question 4.3 - Legislation on interest (Finance)..................33.15
V. DEDUCTIBLE EXPENSES
Question 5.1 - Acquisition of a business
#24 - Vicki
Plant..................................33.15Question 5.2 - Fees for an impartial opinion (Revenue)
#20 - Charles
Thériault............................33.17
VI. PARTNERSHIPS
Question 6.1 - Contribution of knowledge vs. financial
contribution (Revenue)
#25 - Vicki
Plant..................................33.18
VII. REORGANIZATION
Question 7.1 - "Butterfly" transactions (Finance).................33.18
Question 7.2 - Section 51: exchange of shares between two
shareholders (Revenue)
#30 - André
Payette................................33.19
VIII. PAYMENT AS INDUCEMENTQuestion 8.1 - Acquisition of a business (Revenue)
#29 - André
Payette................................33.20Question 2.2 - Subscription to preferred shares by a
government body (Revenue)
#21 - Marc
Séguin..................................33.20
IX. CAPITAL COST ALLOWANCE
Question 9.1 - The Fortin/Moreau case (Finance)...................33.21
Question 9.2 - Conditional sale (Revenue)
#3 - Marc
Séguin...................................33.22
X. ESTATES PLANNING
Question 10.1 - Non-arm's length relationship and death (Revenue)
#22 - Marc
Ton-That...............................33.22Question 10.2 - Application of subsection 85(4) to an estate
(Revenue)
#13 - Marcel
Querry...............................33.23
XI. CAPITAL GAINS EXEMPTION
Question 11.1 - Subsection 110.6(8) as regards dividends on
preferred shares
(Finance)........................33.25Question 11.2 - Subsection 110.6(8): consequences of rights
granted to non-prescribed shares (Revenue)
#10A - Marcel
Querry..............................33.25Question 11.3 - Scope of subsection 110.6(8) of the I.T.A.
(Revenue)
#1OB - Marcel
Querry..............................33.27Question 11.4 - Small business corporation (term deposit)
(Revenue)
#18 - Robert
Gagnon...............................33.28
Question 11.5 - Small business corporation (Revenue)
(purchase and sale of vacant land)
#5 - André
Payette................................33.28Question 11.6 - Eligible assets (receivable dividend refund)
(Revenue)
#26 - Robert
Gagnon...............................33.29
XII. RETIRING ALLOWANCE
Question 12.1 - Payment of certain amounts into an RRSP (Revenue)
#17(b) & (c) - André
Payette......................33.30Question 12.2 - Source deductions (Revenue)
#17(a) - André
Payette............................33.31
XIII. INCOME OR LOSS FROM A BUSINESS
Question 13.1 - Conversion of capital property into inventory
property (Revenue)
#6 - André
Payette................................33.32Question 13.2 - Refundable tax credit on hand (Revenue)
#19 - Marc
Séguin.................................33.33
Question 13.3 - Disabled persons (Finance)........................33.34
XIV. MISCELLANEOUS
Question 14.1 - Reserve for insurance agents and brokers (s. 32(1))
(Finance).........................................33.35
Question 14.2 - Research and development (prescribed equipment)
(Finance).........................................33.36
Question 14.3 - Sale of debts, section 22 I.T.A. (Revenue)
#15 - Danielle
Bouffard...........................33.37
Question 14.4 - Capital gain (s. 11(2)) (Finance).................33.38
Question 14.5 - Capital dividend account (Revenue)
#10 - Marc
Ton-That...............................33.3833.2 1991 A.P.F.F. Congress
I. - TAX POLICY
1.1. - FAIRNESS OF THE TAXATION SYSTEM
Comment on the recent Statistics Canada report that married persons are treated unfairly in comparison with those who are unmarried.
Answer by the Department of Finance
Canada's taxation system must make sure that taxpayers are as a whole treated more or less in the same way no matter what matrimonial regime they have selected. Nevertheless, in the light of the differences that can be observed in family make-up and in the nature of their unions, it is inevitable that discrepancies will exist with respect to a given tax provision looked at in isolation. Such discrepancies take account of the socio-economic situation within our society but do not affect the fundamental rights. While we recognize that some forms of relief, such as the equivalent-to-married credit, may favour persons living in cohabitation, it must be emphasized that there are a number of forms of relief reserved exclusively for married persons. Thus, in respect of non-refundable tax credits alone, a married person may claim a married credit in addition to his spouse's medical expenses and, on an administrative basis, his spouse's charitable donations. Some unused credits may also be transferred to the spouse. Finally, a taxpayer may make contributions to an R.R.S.P. on behalf of his spouse.
It should be noted that some of the study's results are exaggerated or implausible. For example, it assumes that a couple living in cohabitation will prefer to maintain two residences in order to maximize their tax savings without taking the additional housing expenses that would result from such a decision into account.
Our taxation system also takes account to a certain extent of each person's ability to pay income tax, which means that some of its elements, such as the progressiveness of tax rates, may distort some comparisons.
Round Table - Federal Taxation System 33.3
It should be remembered that cor,mon law spouses represent no more than 10 percent of all couples. What is more, only 30 percent of common law spouses have children. Since common law spouses with children born of their union must, like married persons, combine their incomes in calculating refundable tax credits, such as the G.S.T. credit and the child tax credit, only a small percentage of common law spouses are placed in an advantageous position. ln spite of what has been said above, the government has agreed to review its tax policy in respect of provisions affecting the family.
1.2. - THE SYMES CASE (child care expenses)
Please comment on the Symes case in relation to child care expenses.
Answer by the Department of Finance
As you will recall, the Federal Court of Appeal held in June 1991 that the restrictions imposed by section 63 of the Income Tax Act, which concerns child care expenses, do not infringe the principle of equality before the law established by section 15 of the Canadian Charter of Rights and Freedoms. According to Mrs. Symes, by placing a restriction on the child care expenses that can be deducted in calculating income, section 63 of the Income Tax Act discriminates against women because it is they who are most often responsible for paying child care expenses. She therefore submitted that where such expenses are paid in the course of a business (she was a self-employed lawyer) they should be considered to be business expenses in order to remove them from the section 63 restrictions and to avoid infringing the equality principle. In a unanimous judgment of the Court of Appeal, Decary J.A. held that child care expenses cannot be considered to be business expenses under paragraph 18(1)(a) because section 63 deals specifically with such expenses and because such expenses of a personal nature have historically never been considered to be related closely enough to the business, but rather to its managers. The Court added that even if women on
33.4 1991 A.P.F.F. Congress
the labour market are still the victims of social or economic inequality, section 15 of the Charter and the equality principle are not infringed merely because an injustice, which moreover is not caused by the Income Tax Ace, may exist. The Charter imposes no obligation on legislatures to redress all social or economic equalities. Subsection 15(2) permits, inter alia, the implementation of laws and programs aimed at improving the conditions of individual so as to alleviate or eliminate inequalities. Furthermore, the deduction of child care expenses, which would not normally be deductible because of their personal nature, is not discriminatory in so far as both the father and the mother may take advantage of it and in so far as it may I favour women as a whole.
This decision clarifies considerably the meaning of the equality principle in the context of the Income Tax Act. Thus, it says that in matters related to taxation everything may be closely or distantly related in some way to the concept of equality and that, consequently, a strict equality of all in terms of numbers should not be sought, while fair and desirable socio-economic distinctions should not be rejected as contrary to the equality principle. Finally, it states the principle that the right to equality must not be trivialized by applying it strictly and without distinction to the nuts and bolts of taxation.
This decision marks a major watershed as regards the scope of the equality principle in tax and economic matters. The message is clear: distinctions are permitted in tax matters if they contribute to the development of a fair and desirable taxation policy.
1.3. - LIABILITY OF DIRECTORS (s. 227.1, I.T.A.)
Comment on the Department's position on the liability of directors.
Answer by the Department of Finance
The provision on the liability of directors was instituted in response to significant losses of tax revenue due to the failure to remit source deductions.
Round Table - Federal Taxation System 33.5
In 1982, Revenue Canada was faced with a total of $555 million in unremitted source deductions.
Section 227.1 of the Act was therefore adopted to make the directors of a corporation jointly and severally liable to pay amounts deducted in accordance with section 135, 153 or 215 of the Act. The liability obliges persons who were directors at the time of the failure to withhold or remit the required tax and also extends to interest and penalties.
The defence of reasonable diligence was incorporated into section 227.1 in response to arguments that the establishment of such a liability would discourage competent persons from accepting positions as directors of corporations.
One of the positive aspects of section 227.1 is that directors are now more aware of their responsibility as regards source deductions, and this encourages them to show appropriate diligence by taking positive action to comply with it. As was anticipated, the "reasonable diligence" argument has been employed in a number of appeals from application of the section.
The Department of Finance is ware of this situation, but it is delighted that an extensive case law has made it possible to develop more subtle tests for reasonable diligence, which will make it easier to predict how the law will be interpreted. Thus, the amount of litigation will decline significantly as those tests become known.
II. - REMUNERATION AND OTHER BENEFITS RECEIVED FROM EMPLOYMENT
2.1 - AUTOMOBILE LOAN (s. 15(2)(a)(iv), I.T.A.)
A corporation made a loan to an employee to enable him to acquire an automobile to be used by himself; he uses the vehicle from time to time in the performance of the duties of his office or employment (500 km for employment purposes out of a total of 20,000 km travelled).
33.6 1991 A.P.F.P. Congress
Should a reasonableness test be applied in determining whether the loan qualifies as an exempt loan under subparagraph 15(2)(a)(iv)?
Answer by the Department of Revenue
The Department has not subjected the exemption under subparagraph 15(2)(a)(iv) of the Act to tests of minimum degree or percentage of use of an automobile in the performance of the duties of an employee's office or employment. The loan must enable the employee to acquire an automobile to be used by him in the performance of the duties of his employment.
Each case should be judged on its merits on the basis of the relevant specific circumstances in order to determine whether or not the exemption is justified. It goes without saying that the exemption might not be allowed in borderline cases.
2.2. - AUTOMOBILE (car rental)
The employee signs a lease directly with a garage.
The employer agrees to pay the lessor for as long as the employee is in his employ.
Does the Department permit subsection 6(2) of the Act to be applied or does it consider this to be a reimbursement to be taxed on the basis of the percentage of personal use?
Is the answer different if the employee pays the lessor and gets the employer to reimburse him?
Answer by the Department of Revenue
The payment made by the employer to the garage or to the employee in respect of his employee's lease is a taxable benefit for the employee under paragraph 6(1)(a) and subsection 5(1) of the Act. In our opinion, the payment is part of the employee's remuneration. As for the possibility of applying paragraph 6(1)(e) and subsection 6(2) of the Act in this situation, we are of
Round Table - Federal Taxation System 33.7
the opinion that neither the employer nor a person related to the employer has made an automobile available to the employee if the employer is not a party to the lease. This means that paragraph 6(1)(e) of the Act is not applicable, as the essential condition for its application has not been satisfied.
On the other hand, the employee would be able to claim any expenses he has incurred for travel in the performance of the duties of his employment if he satisfies all the requirements of paragraph 8(1)(h) of the Act.
2.3. - HOUSING LOAN (s. 15(2)(a)(ii), I.T.A.)
In 1989, a corporation loaned $400,000 to an employee to enable him to acquire a dwelling for his habitation. The loan bears interest at a rate of 10 percent. In 1990, the parties concerned are interested in amending the agreement so that the said loan no longer bears interest. According to paragraph 7 of Interpretation Bulletin IT-448 , "Dispositions 0 Changes in terms of securities", changing an interest-bearing security into an interest-free security represents a change with a fundamental impact on the holder's economic interest, which results in a disposition of the security.
Is this therefore a new loan and, if yes, does it continue to qualify as an exempt loan under subparagraph 15(2)(a)(ii) of the Act?
Answer by the Department of Revenue
We will assume that the original loan in question satisfied the conditions listed in subparagraph 15(2)(a)(ii) of the Act.
In our opinion, changing an interest-bearing security into
an interest-free security does not result in a disposition of the
security and the acquisition of another security if the original
terms of the loan provided that the parties could change the
interest rate.
33.8 1991 A.P.F.F. Congress
If the contract between the parties does not provide for changes in the interest rate, whether a new contract is created by a change in the interest rate must be determined in accordance with the applicable civil legislation in the jurisdiction in question and with the terms of the contract.
If the issuing of the new security does result in a disposition of the old security, the new security, because it serves to refinance an existing debt, would not qualify for the exemption provided for in subparagraph 15(2)(a)(ii) of the Act. On this subject, we refer you to paragraph 17 of Interpretation Bulletin IT-119R3 , "Debts of shareholders, certain persons connected with shareholders, etc."
2.4. - EMPLOYEE BENEFIT (compensation paid by the employer)
An employee leaves a first employer to join a second. The second employer pays the first employer an amount in compensation.
Should the employee include the amount of the compensation in his income?
Answer by the Department of Revenue
If the compensation in question is paid to the first employer in respect of a non-competition clause included in a contract signed earlier by the employee or if the payment is made to release the employee from an obligation he would otherwise be under, the Department is of the opinion that the compensation amount paid by the second employer on the employee's behalf constitutes remuneration for the employee under section 5 of the Income Tax Act.
2.5. - MEAL ALLOWANCE
What is the tax treatment of meal allowances paid to employees who have worked overtime? Does the treatment change if the employee does not have to account for the allowance?
Round Table - Federal Taxation System 33.9
Answer by the Department of Revenue
Generally speaking, the Department does not consider a meal allowance paid to an employee working overtime to be income if the following tests are satisfied:
a) the employee works at least three hours of overtime immediately after his normal hours of work;
(b) the allowance is reasonable (not exceeding the value or cost of a normal meal); and
(c) the overtime is infrequent or occasional.
If an employee works overtime frequently, however, meal allowances could be considered to be additional remuneration.
2.6. - MOVING ALLOWANCE (the Splane case)
An employee is required to move in the course of his employment and receives compensation from his employer for the additional interest to be paid due to a change in interest rates.
Does the Department accept the decision in Splane v. The Queen, 90 DTC 6442, that such compensation is not taxable?
What is the Department's position in the case of an employee required to acquire a more expensive residence when he moves?
Answer by the Department of Revenue
In the Department's opinion, an allowance received by an employee from his employer to compensate for additional interest to be paid due to changes in mortgage interest rates constitutes a payment in respect of personal expenses. The payment is a benefit received in respect of employment that is taxable under paragraph 6(1)(d) or, as the case may be, an allowance for personal expenses that is taxable under paragraph 6(1)(b) of the Income Tax Act. The Department has
33.10 l991 A.P.F.F. Congress
therefore appealed the decision in Splane to the Federal Court of Appeal.
The Department takes the same position concerning
allowances paid by an employer to an employee to compensate for a
price differential between the new residence and the old
residence when an employee who moves has to acquire a more
expensive residence.
III. - BENEFIT CONFERRED ON A SHAREHOLDER
3.1. - THE MCCLURG CASE (discretionary dividends)
What is the Department of Finance's position on discretionary dividends following the McClurg case?
Answer by the Department of Finance
In McClurg, the Supreme Court of Canada held that discretionary dividends are not inconsistent with the principles of corporate law and do not lead to the application of subsection 56(2) because the payment of a dividend by a corporation to a shareholder is not usually a benefit granted without consideration. Thus, the Court interpreted subsection 56(2) as requiring that the indirect payment be in the nature of a benefit without consideration. However, it was only after having considered the contributions made by the related shareholder -- which were described as "real contributions, financial and operational," under the terms of a "bona fide business relationship" -- that the Court held that subsection 56(2) did not apply to a discretionary dividend payable to Mrs. McClurg.
We therefore feel that the case is limited to the specific circumstances of the McClurg case and that it does not provide support for dividends paid to a related shareholder in order to apportion income among the shareholders. As the Court said itself, the decision not to apply subsection 56(2) was based on the size of the shareholder's contributions and the bona fide nature of the business relationship. No payment of a discretionary dividend that does not satisfy these specific tests can benefit from a decision not to apply
Round Table - Federal Taxation system 33.11
subsection 56(2). Similarly, it appears that subsection 56(2) will be applied to a discretionary dividend that is out of proportion to the real contribution of a related shareholder, especially if it is paid in order to apportion income.
3.2. - INTERCOMPANY LOAN
Does the Department consider a taxable benefit to have been conferred on Mr. X or, if applicable, on his spouse or daughter under subsection 15(1) or 56(2) of the Income Tax Act in the following two situations?
Situation A
X
SPOUSE
50% 50% 100%
OPCO A - - -D e m a n d - - - OPCO
B
n o t e
Opco A and Opco 8 are two taxable Canadian companies earning active business income, but their businesses are in no way related. Opco A advances $200,000 to Opco B by means of an interest-free note.
Situation B
X DAUGHTER (OF AGE) OF
X
100% 100%
OPCO A - - -D e m a n d - - - OPCO B
n o t e
Opco A and Opco B are two taxable Canadian companies.
Opco A is an operating company earning active business
income. Opco B is an investment company.
33.12 1991 A.P.F.F. Congress
Opco A advances $200,000 to Opco B by means of an interest-free note.
Answer by the Department of Revenue
To determine whether an intercompany loan might result in a benefit for a shareholder, all the specific circumstances of a situation must be considered. In so far as the intercompany loan is a bona fide loan subsection 56(2) will not apply in either of these situations because, as has been corroborated by the courts, such a loan does not constitute a payment or transfer of property.
Generally speaking, the Department follows the long-established practice of not applying subsection 15(1) of the Act to intercompany loans made in the normal course of carrying on the business of two corporations. However, if the loan is not a bona fide loan, it could be treated differently. For example, if Opco B is, when Opco A grants the loan or advance, unable to repay its loan or advance or to provide reasonable guarantees, Opco A has then given up property (money) without receiving adequate consideration. The result of this is a reduction in the value of Opco A. The consequence in situation A is that the spouse might be subject to subsection 15(1) since a benefit has been conferred on her by Opco A. In situation 3, subsection 56(2) might apply to Mr. X.
3.3. - ISSUING OF SHARES: CONSIDERATION LESS THAN THE F.M.V.
According to subsection 15(1) of the Income Tax Act (the "Act ), a shareholder of a corporation who receives a benefit from the corporation is generally taxed on the value of the benefit so received.
According to subsection 246(1) of the Act, a taxpayer must
include the value of a benefit he has received from a person in
his income unless the benefit in question has been included in
his income under another provision of the Act.
Round Table - Federal Taxation System 33.13
In some situations, a corporation might issue shares of
its capital stock for an amount lower than the fair market value
of such shares, as in the following example:
Mr. A -------- unrelated -------- Mrs. B
1 common share 1 common share
FMV = $1,000 FMV = $1,000 OPCO
In the above example, Opco issues another share to Mrs.
B for $1. Mrs. B is not an employee of Opco.
How does the Department intend to apply subsections 15(1) and 246(1) of the Act to the issuing of this share? Does the Department of Revenue feel that other provisions of the Act apply to the issuing of the share? In the light of Albert Kieboom v. M.N.R., (1990) 2 C.T.C. 2090, is it the Department's opinion that Mr. A has disposed of his interest in Opco to Mrs. B?
Answer by the Department of Revenue
Generally speaking, the Department would not consider
applying subsections 15(1) and 246(1) of the Act in this type of
situation.
However, the Department is of the opinion that I, Mr. A has indeed disposed of a portion of his economic interest in Opco. The Department would therefore apply subparagraph 69(1)(o)(ii) of the Act, as Mr. A, in agreeing to the issuing of the share, has made a gift of part of his economic interest in Opco to the other shareholder. Thus, Mr. A would be deemed to have received proceeds of disposition of $333 and Mrs. B would be deemed to have acquired property for the same amount. Since Mr. A has disposed of part of his economic interest in Opco and not of the shares in Opco, the adjusted cost base of the property is nil.
33.14 1991 A.P.F.F. Congress
3.4. - SERIES OF LOANS AND REPAYMENTS
A corporation makes monthly advances to its sole shareholder on a permanent basis. These advances are subsequently repaid by a payment of dividends immediately before the end of each taxation year of the corporation following the year during which the advances were made. Would such transactions be considered to have been made as part of a series of loans or other transactions and repayments" for the purposes of subsection 15(2) of the Act? Would the answer be the same if the dividend was paid immediately before the end of the year?
Answer by the Department of Revenue
According to the Department's position stated in paragraph 26 of Interpretation Bulletin IT-119R3 concerning the application of subsection 15(2) of the Act to a shareholder advance account, we are of the opinion that the repayments in the two series of transactions presented above would, for the purposes of the Act, be made as part of a series of loans or other transactions and repayments.
In the first situation set out above, therefore, we are of the opinion that the repayment by payment of |l a dividend would not be applied to the oldest advances such that subsection 15(2) of the Act would apply to the balance of advances not yet repaid at the end of each year. In the second situation, seeing as the amounts of the advances would be repaid in full at the end of each year, subsection 15(2) would in our opinion not apply. The application of subsection 15(9) and of section 80.4 of the Act would have to be taken into account, however.
IV. - DEDUCTIBILITY or INTEREST
4 .1. - THE LIVINGSTON INTERNATIONAL INC. CASE
What is the Department's position following Livingston International Inc. v. The Queen, 91 DTC 5066? Is interest paid to redeem preferred
Round Table - Federal Taxation System 33.15
shares whose paid-up capital is less than the redemption price deductible?
Answer by the Department of Revenue
In our opinion, the Department's position as to the deductibility of interest on money borrowed by a corporation to redeem its shares is consistent with the decision rendered in Livingston International Inc.
If a corporation has used its capital for purposes that are eligible, the Department recognizes that the interest on money borrowed by the corporation in order to repay capital to its shareholders is deductible under the draft amendments to paragraph 20(1)(c) of the Act announced by the Department of Finance on June 2, 1987, and December 20, 1990. However, the corporation's capital may include no operating surplus resulting from transactions that transform the operating surplus into profits accumulated on a non-taxable or tax-deferred basis.
4.2. - LOAN v OTHER FORMS OF INDEBTEDNESS
The Notice of Ways and Means Motion tabled in the House of Commons on December 20, 1990 (hereinafter referred to as the "N.W.M.M."), which concerns the deduction of interest, refers in a general way to money borrowed with interest that may be deducted when the proceeds of the loan are used for certain specified purposes. The fact that the N.W.N.H. concerns only borrowed money and does not cover other forms of indebtedness causes serious problems. For example, rather than borrowing to redeem shares (subsection 1(b) of the N.W.M.M.), corporations often redeem their shares by means of interest-bearing notes. Such notes do not constitute borrowed money within the meaning of the N.W.M.M. What is the Department of Revenue's policy on this subject where the other form of indebtedness clearly satisfies the conditions of the N.W.M.M.? Similarly, it sometimes happens that someone who purchases a business must acquire an interest-free advance from the vendor to the acquired corporation in addition to the vendor's shares in the corporation. The cost of the shares and of the advance is financed by a
33.16 l991 A.P.F.F. Congress
bank loan. Does such en advance satisfy the conditions of subsection l(d) of the N.W.M.M. even though the borrowed money has been used not to make a loan but to acquire the loan in question?
Answer by the Department of Revenue
In the judgment of the Supreme Court of Canada in T.E.
McCool Limited, Estey J. wrote the following passage: "Terms such
as 'borrowed capital', 'borrowed money' in tax legislation have
been interpreted to mean capital or money borrowed with a
relationship of lender and borrower between the parties. It is
necessary in determining whether that relationship exists to
ascertain the true nature and character of the transaction."
The Department is therefore of the opinion that the redemption of shares by means of a note does not constitute borrowed money within the meaning of the provision of the N.W.M.M. in question. There is no relationship of borrower and lender when the vendor grants an interest-free advance to the acquired corporation.
In the light of the clear wording of the N.W.M.M., no broadening of the application of this provision is being considered.
4.3. - LEGISLATION ON INTEREST
What is the state of the legislation on interest?
Answer by the Department of Finance
The deductibility of interest is one of the broadest, most complex and most important questions; it overlaps with problems extending from exotic methods of financing foreign affiliates through the tax treatment of bonuses and discounts to a business' most basic purchasing policy. The Department is continuing its efforts to achieve a reasonably complete and acceptable text that lays down the administrative practices being followed by Revenue Canada at the time of the decision in Bronfman, which have been announced in the Notice of
Round Table - Federal Taxation System 33.17
Ways and Means tabled on an annual basis since that decision. The new legislation will be issued in the form of a draft bill in order to get comments from financial and tax experts. We are confident that the Notice of Ways and Means will not have to be renewed for 1992, even if this means that certain aspects of the problem of interest will only be resolved later.
V. - DEDUCTIBLE EXPENSES
5.1. - ACQUISITION OF A BUSINESS
In acquiring a business, the purchaser frequently takes responsibility for certain liabilities. It may happen that some of these liabilities have not been deducted by the vendor. Examples might be deferred remuneration or certain reserves that have been registered as expenditures for accounting purposes but have not been deducted for taxation purposes. What is the tax treatment of such liabilities for the purchaser and for the vendor? Which of these taxpayers may claim the expenditure related to these liabilities for taxation purposes?
Can deferred charges that have not been deducted for taxation purposes be transferred from one company to another at the time of the sale of a business? Does the nature of the deferred charges remain the same in the purchaser's possession, and can they be written off over the same period as that of the vendor?
Answer by the Department of Revenue
We cannot give definitive answers to these questions without knowing all the facts of a specific case.
Nevertheless, we will make the following general observations:
(a) Generally speaking, the amount of the liabilities assumed when acquiring business assets will be reflected in the transfer price and will be included in the consideration that is paid. For
33.18 1991 A.P.F.F. Congress
the purchaser, payment of the debts being assumed
constitutes a part of the purchase price for the
business. In the case of a contingent liability -- that is, a debt
that might materialize as a result of current or past
circumstances on the condition that a future event
occurs -- assumed by the purchaser, the amount of the
contingent liability cannot be reflected in the cost of
assets transferred when the business is acquired. At
that time, neither the purchaser nor the vendor will be
allowed a deduction. The future tax treatment should the
debt materialize can only be determined on the basis of
the facts and circumstances at that time. (b) To establish whether charges deferred for taxation
purposes can be transferred when a business is sold, it
is necessary to determine whether property has been
transferred and what the nature of that property is
(e.g. goodwill). The amount and method of deduction for
the purchaser will depend on the value of the
consideration paid and on the nature of the transferred
property. The fact that the vendor has deferred charges
does not necessarily imply that assets related to those
charges have been transferred.
5.2. - FEES FOR AN IMPARTIAL OPINION
During a take-over bid, the board of directors of the target corporation is required under the Canada Business Corporation is Act to submit to all holders of the shares in question a circular containing a reasoned notice recommending that the shareholders accept or reject the offer made to them. The corporation must incur accounting, legal and appraisal fees in preparing the circular.
Is the expense incurred by the corporation deductible when it computes its income under either paragraph 20(1)(o) or section 9 of the Act in the light of the decision in B.C. Power, 67 DTC 5259, or under any other provision of the Act?
Round Table - Federal Taxation System 33.19
Answer by the Department of Revenue
According to paragraph 18(I)(a) of the Act, an expense may not be deducted in computing the income of a taxpayer from a business or property unless it was incurred boy the taxpayer for the purpose of gaining or producing income from the business or property.
It is the Department's opinion that the cost of issuing a circular that a corporation's board of directors is required to submit to its shareholders during a take-over bid for its shares does not constitute a part of its expenses for the purpose of gaining income. As a result, expenses incurred in preparing and distributing such a circular may not be deducted under paragraph 18(1)(a) of the Act. The Department is also of the opinion that such an expense is not covered by paragraph 20(1)(g) of the Act. The circular is not a financial report within the meaning of subparagraph (iii) of that paragraph. The B.C. Power case concerned the deductibility of expenses incurred in order to keep assets of the corporation following an expropriation. That case was decided in the taxpayer's favour because it was held that the corporation had made the expenses in order to protect its ability to gain income. In the Department's opinion, the facts of that case are different from those in the present situation.
VI. - PARTNERSHIPS
6.1. - CONTRIBUTION OF KNOWLEDGE vs. FINANCIAL CONTRIBUTION
When a partnership is formed, it often happens that one partner contributes knowledge or personal know-how while the other partners contribute their financial resources to the partnership. In such circumstances, does the Department feel that the partner who has not made a financial contribution receives a taxable benefit conferred on him by the other partners?
33.20 1991 A.P.F.F. Congress
Answer by the Department of Revenue
The contribution of know-how and of knowledge by a partner in a partnership constitutes a valid interest for recognizing in him the status of a real partner. In so far as no credits are made to the partner's "capital" account in any circumstances when he enters the partnership and no withdrawal of funds in any manner is permitted in this regard either immediately, later or when the partner withdraws, we feel that the partner has not received a taxable benefit in contributing his knowledge or know-how to the partnership. However, if property, such as class 14 depreciable property or eligible capital property transferred at its fair market value, has been transferred and a corresponding amount has been credited to the "capital" account subject to the application of subsection 97(2), no taxable benefit other than those provided for in sections 13, 14 and 39 will result.
It should be noted that no amount may be credited in consideration of personal goodwill of any value because personal goodwill is not a transferable asset.
A payment made, or a credit made to a partner's "capital" account, in consideration of his commitment to perform work for the partnership will be considered to be business income for the partner.
The Department agrees that the value of the partner's knowledge or know-how should be taken into account in determining his share of the partnership's profits.
VII. - REORGANIZATION
7.l. - BUTTERFLY" TRANSACTIONS
Are there any developments in relation to subsection 55(2)?
Round Table - Federal Taxation System 33.21
Answer by the Department of Finance
You are of course aware that the Department of Finance has for some time been concerned about the growing use of subsection 55(2) in what are known as "butterfly" transactions to defer tax when selling assets to third parties. This subsection should be restricted to genuine reorganizations of corporations within a group, that is, to those resulting from divisions, splits, operational changes, etc.
Thus, studies are under way to amend subsection 55(2) so as to restrict its application to the situations for which it was originally drafted. You may recall that our rollovers in corporate reorganization matters were inspired by the system applicable to corporate reorganizations in the United States and United Kingdom. However, those systems are much more restrictive than ours and do not accept tax-free transfers to third-party purchasers. The subsection should therefore be limited to genuine reorganizations aimed at dividing a business assets among its shareholders. Nevertheless, it is clear that the economic climate is not always favourable to major changes in respect of corporate reorganization.
7.2. - SECTION 51: EXCHANGE OF SHARES BETWEEN TWO SHAREHOLDERS
Subsection 51(1) of the Act provides for the transfer at the adjusted cost base of shares of the capital stock of a corporation acquired in exchange for a capital property that was, inter alia, a share of the corporation the terms of which conferred upon the holder the right to make the exchange. Since it does not specify that the exchange has to be made with the corporation, we would like you to tell us if the exchange could be made between two consenting shareholders if the conditions of their shares of different classes include a right of exchange between the shareholders.
Answer by the Department of Revenue
Subsection 51(1) of the Act applies when a taxpayer has acquired shares of the capital stock of a
33.22 1991 A.P.F.F. Congress
corporation in exchange for a capital property of the taxpayer that was a share, bond, debenture or note of the corporation the terms of which conferred upon the holder the right to make the exchange. A right of conversion is a right that permits a shareholder holding a security bearing this right to acquire other shares of the corporations capital stock directly from the corporation. The Department is of the opinion that section 51 applies only to an exchange between a taxpayer and the corporation that issues the said capital property. In our opinion, that section does not cover exchanges of shares between two consenting shareholders.
VIII. - PAYMENTS AS INDUCEMENT
8.1. - ACQUISITION OF A BUSINESS
When a person acquires a business and in the course of the transaction receives a payment as an inducement, does the Department consider that amount to have been received by the taxpayer in the course of earning income from a business or property within the meaning of paragraph 12(1)(x) of the Act?
Answer by the Department of Revenue
Paragraph 12(1)(x) is a broad provision that provides, inter alia, for inclusion of an amount received in the year in the course of earning income from a business or property as an inducement.
A payment as an inducement covered by subparagraphs 12(1)(x)(i) to 12(1)(x)(iii) that is received as part of the acquisition of a business will be considered to be an amount coming from the business in question because there is a cause-and-effect relationship between the payment and the business. The Department is therefore of the opinion that the amount will, for the purposes of paragraph 12(1)(x), be received in the course of earning income from a business or property.
Round Table - Federal Taxation System 33.23
8.2. - SUBSCRIPTION TO PREFERRED SHARES BY A GOVERNMENT BODY
A government body subscribes to preferred shares of the capital stock of a corporation that have the following characteristics:
- they are callable at all times by the corporation alone
for an amount equal to the consideration issued;- they do not give a right to dividends;
- they are senior to all other classes of issued shares in
case of distribution upon liquidation.
Considering that these shares are not liquid and are non-yielding, their fair market value is less than the amount subscribed for when they were issued.
Does the Department consider the difference between the fair market value of the preferred shares described above and the amount subscribed for when they were issued to be a payment received by the issuing corporation as an inducement that must be included in its income under paragraph 12(1)(x) of the Act?
Answer by the Department of Revenue
Provided that the investment made by the government body does not represent an ordinary business investment, the Department is generally of the opinion that the difference between the fair market value and the amount subscribed for such shares may constitute government assistance for the purposes of subsections 13(7.1) and 127(11.1) and paragraphs 127(a) and 53(2)(k) of the Act. If none of those provisions applies, paragraph 12(1)(x) might apply.
33.24 1991 A.P.F.F. Congress
IX. - CAPITAL COST ALLOWANCE
9.1. - THE FORTIN/MOREAU CASE
Please comment on the decision in Fortin/Moreau and give your position on the results of differences that might apply between the common law provinces and the province of Quebec.
Answer by the Department of Finance
In Fortin/Moreau, the Tax Court of Canada adopted an interpretation of the definition of "depreciable property" in paragraph 13(21)(b) that had the effect of denying a capital cost allowance to a lessee under a leasing arrangement because he was not technically speaking the owner of the property. The Court also felt that the lessee had acquired the property for the purposes of deducting money borrowed to acquire property (subparagraph 20(1)(c)(ii)) and for the purposes of the investment tax credit (subsection 127(10)). The case has been appealed. The Department of Finance feels that it is important to define the concepts of acquisition and ownership under the civil law in the same way as under the common law in order to avoid inconsistency between the taxation of transactions occurring in Quebec and the taxation of transactions occurring in a common law province. As can be seen from the case law on acquisition, it has been possible so far to adopt a uniform approach in spite of the legal differences. That is the situation we favour, and we hope that the same result can be achieved as regards the interpretation of the concept of ownerships in the Act.
9.1. - CONDITIONAL SALE
The judgment in Fortin/Moreau Inc. v. N.N.R., 90 DTC 1450, appears to say that a person who acquires depreciable property under a conditional sales contract may not claim a capital cost allowance.
Can you confirm or refute this?
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Answer by the Department of Revenue
The Department has appealed Fortin & Moreau to the Federal Court-Trial Division. The Department's position continues to be that when it is established that an agreement can be translated into the disposition and acquisition of property within the meaning of the Act, only the person who acquired the property is entitled to the capital cost allowance and investment tax credits related to the property in question. When property is acquired under a conditional sales contract, whether or not an acquisition has taken place will be determined by the nature of the conditions of the sale. The Department is of the opinion that, as long as there is indeed a disposition and acquisition of property, a capital cost allowance can be granted to the taxpayer who made the acquisition.
X. - ESTATES PLANNING
10.1. - NON-ARM'S LENGTH RELATIONSHIP AND DEATH
Considering that the marriage relationship ends at death and that a spouse acquires the capital property immediately after the time of death (paragraph 70(5)(c)), are shares bequeathed by a taxpayer to his spouse acquired from a person being dealt with at arm's length?
Since the marriage relationship has, at the time of the acquisition by the spouse, come to a legal end, the acquisition is made from a person being dealt with at arm's length. As a result, the taxpayer can transfer the shares she has received by bequest to a company and receive a note for the equivalent of the A.C.B. without fearing that subsection 84.1(1) will be applied. This is true even if the deceased taxpayer used a capital gains exemption in respect of the capital gain realized at the time of death. The A.C.B. of the shares would not be subject to the reduction provided for in paragraph 84.1(2)(a.1) because this is an acquisition from a person with whom the taxpayer was dealing at arm's length.
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If the legatee is the taxpayer's child, the parent-child relationship does not cease to exist when the taxpayer dies, so the A.C.B. of the shares bequeathed to the children should be reduced in accordance with paragraph 84.1(2)(a.1).
Answer by the Department of Revenue
The Department is of the opinion that under the Civil Code property bequeathed to an inheriting spouse is received by the spouse after the testator's death.
As was held in Pembroke Ferry Ltd. v. M.N.R., we feel that a person's non-arm's length relationship with his spouse within the meaning of paragraph 251(2)(a) disappears when the spouse dies because he is no longer related to her by a marriage relationship after her death. However, the non-arm's length relationship is also an issue of fact. In accordance with the principles stated in Estate of Karna May v. M.N.R., Special Risks Holdings Inc. v. The Queen and M.N.R. v. Thomas Rodman Merritt, the Department is of the opinion that shares acquired by a taxpayer from his deceased spouse are acquired from a person with whom the taxpayer is not dealing at arm's length and are therefore subject to the reduction of the adjusted cost base under paragraph 84.1(2)(a.1) of the Act.
10.2. - APPLICATION OF SUBSECTION 85(4) TO AN ESTATE
In an estate freeze, the owner of a corporation's common shares usually exchanges his shares for redeemable preferred shares and his children subscribe to new common shares. Then the owner dies, the preferred shares of the estate freeze are, assuming that there is no rollover to a surviving spouse, deemed to be disposed of at the fair market value. A sizeable capital gain may therefore result from the estate freeze at the time of death.
In some situations in which this could result in costly double taxation of the same gain (for example, if the corporation holds as its only asset a building that will yield a sizeable capital gain when it is eventually sold), it is common practice to redeem the preferred shares in the estate's possession in order to create a
Round Table - Federal Taxation System 33.27
capital 1099 that cancels out the deceased's capital gain under subsection 164(6) of the Act. The estate is then taxed on a dividend income equal to the resulting capital loss.
The question concerns the application of subsection 85(4) of the Act to the redemption of the preferred shares, the result of which would be to cancel out the capital loss. Subsection 85(g) applies when a taxpayer has disposed of property to a corporation that, immediately after the disposition, was controlled, directly or indirectly in any manner whatever, by the taxpayer, by the spouse of the taxpayer or by a person or group of persons by whom the taxpayer was controlled, directly or indirectly in any manner whatever.
Is an estate a taxpayer under subsection 85(4) of the Act considering that the expression "spouse of the taxpayer" appears to rule out the estate? If the answer is yes, would the estate still be covered in the following circumstances:
- control lies in the common shares held directly by the
children after the redemption; - the children are the heirs of the deceased but the
executor is another related or unrelated individual?
Answer by the Department of Revenue
An estate is deemed to be an individual in respect of the trust property. The Department is accordingly of the opinion that for the purposes of subsection 85(4) of the Act the term "taxpayer" may include an estate.
On the other hand, in both of the situations that have been set out, the Department is of the opinion that subsection 85(4) would not apply to cancel out the capital loss incurred in the redemption of the preferred shares provided that the corporation is, immediately after the disposition, not controlled directly or indirectly in any manner whatever, within the meaning of subsection 256(5.1) of the Act, by the estate.
33.28 1991 A.P.F.F. Congress
XI. - CAPITAL GAINS DEDUCTION
11.1. - SUBSECTION 110.6(8) AS REGARDS DIVIDENDS ON
PREFERRED SHARES
Please make general comments on the rules concerning preferred shares and the capital gains deduction.
Answer by the Department of Finance
The purpose of subsection 110.6(B) of the Act is to prevent the conversion of what would basically be dividend income into a capital gain that is eligible for deduction. Subsection 110.6(8) was included in the Act following several attempts by taxpayers to implement such conversions. Since the techniques used to achieve such conversions were as numerous as they were varied, it was necessary to lay down a very broad anti-avoidance rule.
Along these lines, although tax statutes recognize the right of taxpayers to organize their transactions with a real business character in a manner that minimizes their tax burden, it goes without saying that those same taxpayers cannot expect that the relevant tax provisions will necessarily -- and to the extent they would like -- apply to every single one of their transactions.
Be that as it may, the Department of Finance is willing to co-operate with Revenue Canada in examining any situation that, although it does not conform perfectly with the wording of a particular provision, is nevertheless consistent with its spirit.
11.2. - SUBSECTION 110.6(8): CONSEQUENCES OF RIGHTS
GRANTED TO NON-PRESCRIBED SHARES
The application of subsection 110.6(a) of the I.T.A. is currently the cause of much concern for tax practitioners. Subsection 110.6(8) cancels out the basic deduction of $100,000 and the additional capital gains deduction of $400,000 when it may reasonably be concluded, having regard to all the circumstances, that
Round Table - Federal Taxation System 33.29
a significant part of the capital gain is attributable to the fact that dividends were not paid on a share, other than a prescribed share, of a corporation. If dividends have been paid on the share, the cancellation of the deduction arises if the dividends were less than 90 percent of the average rate of return on the shares as defined in paragraph 110.6(9) of the I.T.A.
Let us take the case of a corporation owned by a single shareholder or by shareholders related to each other within the meaning of section 251 of the I.T.A. It often happens that such shareholders hold, in addition to their common shares, preferred shares either for financing purposes or as consideration following a rollover of other property under subsection 85(1) of the I.T.A. Such shares are usually non-voting and do not give a right to a cumulative dividend.
In our opinion, it is not reasonable in the circumstances to believe that a part of a capital gain resulting from the disposition of common shares results from the fact that dividends have not been paid on the preferred shares, because it is in practice unusual for dividends to be paid in such a situation. The standard must be usual business practices.
Question
Is it Revenue Canada's policy to apply subsection 110.6(8) of the I.T.A. in a disposition of common shares with respect to a corporation held by a sole shareholder or by related shareholders when the non-prescribed shares are non-voting and non-cumulative? Is the answer the same if the non-prescribed shares are voting and give control? How about if the said shares give no right to a dividend or give a right to a discretionary dividend?
Answer by the Department of Revenue
The capital gains deduction covered by subsections 110.6(2), (2.1) and (3) of the Act is subject to restrictions. The purpose of subsection 110.6(8) is to prevent income that should normally be distributed to the shareholders in the form of taxable dividends from being distributed in the form of exempt capital gains.
33.30 1991 A.P.F.F. Congress
The wording of the subsection has a very broad scope and must be interpreted accordingly. The Department has not established exceptions covered by the subsection that would benefit from the deduction.
One of the subsections first requirements is to establish whether it may reasonably be concluded that a significant part of the capital gain realized on the disposition of property is attributable to the fact that dividends were not paid on a non-prescribed share or that the dividends paid were less than 90 percent of the average annual rate of return thereon.
When the conditions set out above have been satisfied, the Department considers the subsection to be applicable. If it is recognized in a given case that the necessary conditions have not been satisfied, the gain might slip past the anti-avoidance provision.
We feel that the characteristics peculiar to the conditions placed on the shares as regards voting rights or the right to dividends are irrelevant to determining whether or not the subsection is applicable.
11.3. - SCOPE OF SUBSECTION 110.6(8) OF THE I.T.A.
This subsection lays down an anti-avoidance rule whose purpose is to prevent the conversion of dividend income into an exempt capital gain. Let us take a case in which the eligible capital gain on shares of a S.B.C. is in the order of $2,000,000 while the unpaid dividends on non-prescribed shares amount to 5500,000. While this may be a significant part of the capital gain, the taxpayer has a sufficient capital gain eligible for the deduction.
Question
What is Revenue Canada's policy on this subject?
Answer by the Department of Revenue
In applying subsection 110.6(8), it is necessary to consider whether the amount attributable to undeclared dividends constitutes a significant part of
Round Table - Federal Taxation System 33.31
the capital gain. In our opinion, this test must be based on the total gain rather than on the exempt gain, and it can only be determined with full knowledge of the facts of a particular case. The Department cannot suggest a universal percentage for determining the degree of significance to be applied in every case. In the example given in the question, it appears to us that the amount of the gain in relation to the undeclared dividends ($500,000 as compared with a gain of $2,000,000) would be significant enough to permit subsection 110.6(a) of the Act to be applied.
11.4. - SMALL BUSINESS CORPORATION (term deposit)
The definition of the term "small business corporation" in subsection 248(1) of the Act provides that all or substantially all of the fair market value of the corporation's assets must generally be used in an active business carried on primarily in Canada by the corporation or by a related corporation. Opco is a corporation carrying on a service business. Opco's clients have medium- and long-term contracts with it, and several of them pay opco's fees in advance. Thus, Opco may be in possession of large amounts, which it invests in term deposits and which represent services Opco must render in its current financial year. If Opco does not render the services in question, it must repay the amounts to its clients.
Is the Department of Revenue of the opinion that the term deposits held by Opco, which represent fees paid in advance, constitute assets used in the active business carried on by Opco?
Answer by the Department of Revenue
Whether or not a taxpayer's asset is used in a business for the purposes of the definition of the term "small business corporation" in subsection 248(1) of the Act is a question of fact. Generally speaking, the Department of Revenue considers that an asset is used in a business if it is used primarily in respect of the business and is really used and risked in the business, which implies more than a remote risk and more than just use of the asset for business purposes.
33.32 1991 A.P.F.F. Congress
Term deposits for which the funds come from fees paid in advance could be considered to be used in the corporation's business if the funds satisfy the requirements mentioned above and if they are held back ln anticipation of a possible repayment of the fees paid in advance. The Department will make this determination on the basis of the specific facts of a given situation.
11.5. - SMALL BUSINESS CORPORATION (purchase and sale of vacant land)
Does a corporation that is in the business of buying and selling vacant land, and of which all or substantially all of the fair market value of the assets consists of vacant land, qualify as a small business corporation as defined in subsection 248(1) of the Act?
Does the corporation still qualify if it has had no activities in a given year and there have been no movements as regards inventory?
Answer by the Department of Revenue
Generally speaking, a corporation in the business of buying and selling vacant land will qualify as a small business corporation as long as the vacant land is used in an active business carried on by the corporation. The term "active business" is defined in subsection 248(1) of the Act. Whether or not a person carries on a business is basically a question of fact. According to Tara Exploration and Development company Limited v. M.N.R., 70 DTC 6370, and Ward v. The Queen, 88 DTC 6212, which concerned the distinction between the carrying on of a business and an adventure or concern in the nature of trade, carrying on a business refers to activities carried on for the purpose of making a profit.
Although the definition of the term "business" in subsection 248(1) of the Act includes an adventure or concern in the nature of trade, the Department is of the opinion that an adventure in the nature of trade does not necessarily constitute the carrying on of d business.
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As for the second part of the question, the Department is of the opinion that for a corporation to have had no activities and to have had no movement in its inventories in a given year does not necessarily mean that it has not carried on its business during the year in question. It would be necessary to analyze the reasons and circumstances that contributed to the corporation's inactivity. For example, if the inactivity is due to a corporate decision to keep the land in inventory as an investment, the conclusion could be different from that in the case of inactivity due to an economic slowdown.
11.6. - ELIGIBLE ASSETS (receivable dividend refund)
Does a dividend refund amount receivable by a corporation constitute an eligible asset as an asset used by the corporation in a business for the purposes of the definition of the term "small business corporation" in subsection 248(1) of the Act?
Answer by the Department of Revenue
Generally speaking, the Department is of the opinion that a dividend refund amount receivable by a corporation constitutes an eligible asset as an asset used by the corporation in a business. Tax on the taxable dividends is required by the Act, and collection of the refund of that tax is not entirely under the control of the corporation concerned.
In determining whether a corporation is a small business corporation, the Department does not take into consideration a portion of a corporation's refundable dividend tax on hand account receivable for which no dividend refund is made. The Department takes this position because, inter alia, of the mandatory nature of the refundable dividend tax on hand.
33.34 1991 A.P.F.F. Congress
XII. - RETIRING ALLOWANCE
12.1. - PAYMENT OF CERTAIN AMOUNTS INTO AN R.R.S.P.
Subsection 248(1) of the Act defines the term "retiring allowance". Paragraph 60(j.1) of the Act permits certain amounts to be paid into a registered retirement savings plan (R.S .S.P.) when a retiring allowance is paid to an employee.
(a) Mr. X has been an employee of opco for 30 years. He
retires and receives $20,000 as a retiring allowance. He
pays the $20,000 directly into his R.R.S.P. and benefits
from the rollover provided for in paragraph 60(j.1) of
the Act. Three months after being laid off, Mr. X is
rehired by Opco, which has a surplus of work. Does the
$20,000 constitute a retiring allowance for Mr. X? What
impact will his being rehired by Opco have on the
qualification of the $20,000 retiring allowance paid to
him? What impact will it have on Opco? (b) A retiring allowance of $17,000 is paid to an employee
following a court judgment. The $17,000 consists of a
$12,000 retiring allowance and 55,000 in interest. Is
the employer required to make the source deductions
provided for in paragraph 153(11(c) of the Act and in
the Regulations in respect of the $5,000 paid as
interest? What percentage of source deduction will apply
to the retiring allowance?
Answer by the Department of Revenue
(a) Generally speaking, the Department considers separation
from employment to be a retirement or a loss of
employment. Whether or not there has been a retirement
or loss of employment remains a question of fact,
however. If at the time of Mr. X's separation from
employment Opco did not expect to rehire him, the
Department will in the absence of subsequent information
to the contrary consider the $20,000 to qualify as a
retiring allowance if the other conditions are all
satisfied. However, an employee has not retired Round Table - Federal Taxation System 33.35
if he is rehired by Opco or by a subsidiary of Opco
shortly after his separation from employment or his
supposed non-mandatory retirement. In such a case, the
amount received will constitute employment income for
Mr. X and will be deductible by opco on the same basis
if it is reasonable in the circumstances. As for the
$20,000 contribution to an R.R.S.P., it will be subject
to the rules on overcontributions.(b) No source deduction is required to be made on amounts
received by a taxpayer in a court judgment for unfair
dismissal that are identified as interest accrued before
the date of the court's decision. As for the $12,000
paid as a retiring allowance, it will be subject to a
deduction of 10 percent in Quebec under subsection
103(4) of the Regulations.
12.2. - SOURCE Deductions
An $8,500 retiring allowance is paid to a former employee. The employer pays $4,000 directly into the employee's R.R.S.P. and $4,500 to the employee himself. For the purposes of the source deductions provided for in paragraph 153(1)(c) and in the Regulations, what rate of source deduction will apply to the $4,500 paid directly to the employee?
Answer by the Department of Revenue
When an employer pays a retiring allowance in the form of a lump sum to an employee who is a resident of Canada, source deductions must be made in accordance with subsection 103(4) of the Regulations. Thus, in so far as the TD 2 form has been filled out correctly so as to exempt the $4,000 from the deduction, the rate of deduction to be applied to the $4,500 will be 5 percent.
33.36 1991 A.P.F.F. Congress
XIII. - INCOME OR LOSS FROM A BUSINESS
13.1. - CONVERSION OF CAPITAL PROPERTY INTO INVENTORY PROPERTY
Where real property (capital property) used for the purpose of gaining or producing income from a business or property is converted into inventory property, the action of conversion does not constitute a disposition within the meaning of paragraph 54(c) of the Act. Paragraph is of Interpretation Bulletin IT-218R mentions that capital gains and losses, if any, will be calculated on the basis that a notional disposition occurred on the date of conversion but will be taxable or allowable only in respect of the taxation year during which the actual sale of the real property occurs.
On the other hand, subsection 10(1) of the Act permits property described in an inventory to be valued at the lower of its cost to the taxpayer and its fair market value.
(1) If real property is converted into inventory property at
a given time, what cost should subsequently be
considered for the purposes of subsection 10(1) of the
Act, the original cost or the market value of the
property on the date of conversion? (2) If at a later date the fair market value of property so
converted falls below the fair market value at the time
of conversion and the inventory can be valued at that
fair market value, may the realization of the potential
capital gain following the notional disposition at the
time of conversion continue to be deferred until the
date of the property's actual sale?
Answer by the Department of Revenue
(1) The Department is of the opinion that when real property
used for the purpose of gaining or producing income from
a business or property is converted from capital
property into inventory property the cost to the
taxpayer for the Round Table - Federal Taxation System 33.37
purposes of subsection 10(1) is the fair market value of the property on the date of conversion.
(2) As is stated in paragraph 15 of Interpretation Bulletin
IT-218R
, the notional capital gain or loss will be
considered to give rise to a taxable capital gain or
allowable capital loss for the taxation year during
which the actual sale of the real property occurs. It
will be necessary to report them in this way for that
same year no matter how the fair market value fluctuates
after the date of conversion.
13.2. - REFUNDABLE TAX CREDIT ON HAND
Subsection 256(2) of the Act provides that two corporations not associated with each other that are otherwise associated with the same corporation will be deemed to be associated with each other unless the third corporation either is not a Canadian-controlled private corporation or makes an election that subsection 256(2) of the Act is not to apply. In subsections 125(2) and (3) the Act establishes the amount of the business limit a corporation is allowed for computing the small business deduction under section 125 of the Act. That limit is $200,000 for all the associated corporations from a single group. In the definition of "qualifying corporation" found in subsection 127.1(2), the Act refers to the associated corporation concept.
A Inc. and C. Inc. are not associated with each other and are not associated with any other corporation under the Act except for B Inc., with which they are both associated. For the taxation year in question, B Inc. files the prescribed form provided for in subsection 256(2) of the Act so that A Inc. and C. Inc. have a business limit of $200,000 for the purposes of section 125 of the Act. For the purposes of the Act, will the total of the business limits of A Inc., B Inc. and C Inc. be $200,000 or $400,000?
Answer by the Department of Revenue
Under subsection 256(2) of the Act, A Inc. and C Inc. are not associated for the purposes of section 125 of the Act. To determine whether a corporation is
33.38 1991 A.P.F.F. Congress
a qualifying corporation for the purposes of the refundable investment tax credit, it is necessary to determine the total of the business limits, computed in accordance with section 125 of the Act, of the corporation in question and of the corporations associated with it. Since the corporations are not associated with each other for the purposes of section 125 because of the election under subsection 256(2) of the Act, which deems the business limit of B Inc. to be "nil", we are of the opinion that A Inc. and C Inc. will each have a business limit of $200,000 in respect of the definition of qualifying corporation" in subsection 127.1(2) of the Act. As a result, the total taxable income of A Inc., B Inc. and C Inc. for the preceding year may not exceed $400,000 if they are to qualify as qualifying corporations.
13.3. - DISABLED PERSONS
What is meant by prescribed equipment in the case of disabled persons?
Answer by the Department of Finance
The budget of February 26, 1991, proposed to permit the deduction, in computing income from a business or property, of costs incurred after 1990 in respect of eligible alterations to a building belonging to a taxpayer for the purpose of facilitating access to the building by disabled persons or of permitting them to circulate more easily in the building.
An amendment along these lines has been included in Bill C-18, which was tabled last May. The new paragraph 20(1)(gg) refers to "prescribed renovation" or alterations to a building of the taxpayer...." Although it is a little early to discuss the content of the future amendment to the regulations before the new paragraph 20(1)(gg) has even received sanction, it appears that certain clarifications should be made.
First of all, the deduction only applies to renovations and alterations. As a result, equipment and apparatus installed during the construction of a building are not eligible. Furthermore, the building must belong to the taxpayer; renovations to a rented
Round Table - Federal Taxation System 33.39
building are not eligible. As the budget documents indicate, installing interior and exterior ramps and hand-activated power door openers, widening doorways and modifying washrooms to permit them to be used by those confined to wheelchairs are eligible modifications.
We propose to recommend that the following items be added to this list:
(a) installing visual fire indicators for deaf persons;
(b) renovating a room to provide washrooms designed
specifically for disabled persons where such washrooms
are not already available; (c) modifying elevators to make it easier for blind persons
and those confined to wheelchairs to use them (e.g.
panels that are lower or in braille, voice floor
indicator, special adaptation for wheelchairs).
This is only a preliminary list. You are welcome to make suggestions.
XIV. - MISCELLANEOUS
14.1. - RESERVE FOR INSURANCE AGENTS AND BROKERS (s. 32(1), I.T.A.)
Comment on the amendment to subsection 32(1) with respect to the reserve for insurance agents and brokers.
Answer by the Department of Finance
The tax legislation was amended in 1953 to make it possible for insurance brokers to claim a special reserve. At that time, it was not unusual for part of the commission paid the broker to be for services to be rendered later.
Recent cases, and the Baker case in particular, have challenged the appropriateness from the point of
33.40 1991 A.P.F.F. Congress
view of tax policy of maintaining the reserve provided for in section 32. In the light of these events, and considering that the measure was no longer being used for the purpose for which it had been instituted, we decided to repeal the section 32 reserve in the technical bill made public in July 1990. Shortly after that announcement, a transitional measure spread over ten years was provided for in order to lessen the considerable impact this measure could have had on some brokers .
The purpose of the amendment is to correct a flaw in the Act through which the reserve for unearned commissions was applied in cases in which similar reserves were denied in other sectors of activity. The proposal ensures that tax policy on the deduction of reserves will be consistent from one sector of activity to another. For most taxpayers, there is no reserve available; this is true, for example, in cases in which reserves cannot be established for contingencies and in cases in which it is only possible that fees will have to be reimbursed or a service will have to be rendered during a future taxation year in respect of a particular sale.
Even when no deduction is possible under section 32 of the Act, insurance brokers, like all other taxpayers earning business income, will be able to claim a reserve by applying paragraph 20(1)(m) in respect of services to be rendered after the end of the year. Such services will obviously not include those to be rendered only on the basis of certain contingencies (e.g., changes of address or of beneficiary, and settlements of claims), but will instead include services the broker has contracted to render at a specific time in the future. It will be especially easy to evaluate these services because they are specified in this way.
14.2. - RESEARCH AND DEVELOPMENT (prescribed equipment)
Explain the reference in paragraph 37(7)(f) to prescribed equipment.
Round Table - Federal Taxation System 33.41
Answer by the Department of Finance
In the 1987 tax reform, certain amendments were made to the tax relief granted for research and development (R & D) in order to exclude expenses related to the cost of buildings and to occupancy costs from that relief. When the legislation laying down these changes was drafted, however, provision was made for an exception to the general exclusion of such costs in respect of a "special-purpose building".
The purpose of this exception is to avoid having an expense related to a structure that resembles a piece of R & D equipment rejected solely because the structure in question could be considered to be a building. However, the exception does not apply to buildings including a permanent R & D infrastructure.
Buildings and structures that should be covered by this exception are rare. An example of an eligible structure would be an installation whose work areas were designed and built in response to specific rigidity and air quality standards. Another example might be an installation designed to reproduce certain conditions prevailing in space.
A taxpayer who possesses an installation of the required nature -- which is more a piece of R & D equipment than a building -- can contact the Department of Finance if he wants it to be recognized as a "special-purpose building" for the purposes of paragraph 37(7)(f) of the Act.
14.3. - SALE OF DEBTS, SECTION 22, I.T.A.
Subsection 22(1) of the Act requires that all or substantially all the property used ln carrying on a business be sold if section 22 of the Act ir to apply.
Let us consider the following situation. A corporation has two divisions. Division A does printing and Division B does phototypesetting. Each division has its own operating structure and its own employees. On the other hand, the two divisions are operated in the same building, have several clients in common and keep common accounting records. All the assets of Division A are sold to another corporation, which continues as of
33.42 1991 A.P.F.F. Congress
the time of the purchase to operate the business in the same way and under the same name as before.
Does the Department feel that section 22 could apply to debts sold to the other corporation given that it was necessary in order to operate as of the time of the purchase for the purchaser to acquire a separate business?
Would the Department agree to applying section 22 all the same if the common assets of the two divisions, such as a building, remained the property of the vendor? Only assets used exclusively by Division A of the vendor would be sold.
Answer by the Department of Revenue
The fact that the corporation that has acquired the assets used in the printing division can be considered to be carrying on a separate business does not mean that the vendor corporation was operating its two divisions in the form of two separate businesses. Only after studying all the facts and circumstances of a specific case can the Department determine, on the one hand, if a corporation is carrying on one or more separate businesses and, on the other hand, if the said corporation has sold all or substantially all the property used in carrying on the business.
The degree of interrelationship, intertwining or interdependence and the extent of the unity in carrying on business operations serves to determine whether a taxpayer is carrying on one or more separate businesses. Interpretation Bulletin IT-206R gives further clarifications for establishing whether a taxpayer is simultaneously carrying on more than one business.
14.4. - CAPITAL GAIN (s. 11(2), I.T.A.)
Do the amendments to subsection 11(2) apply to a capital gain realized from the disposition of property used in the course of a business.
Round Table - Federal Taxation System 33.43
Answer by the Department of Finance
The purpose of the amendment to subsection 11(2) was not to change the method for computing income from the disposition of capital property used in the course of a business, but was only to defer the inclusion of certain amounts received in respect of the forced destruction of livestock referred to in section 80.3 of the Act.
In our opinion, it is doubtful that this section can be interpreted as requiring individuals to defer their capital gains or losses in respect of business property when their financial years overlap the calendar year. Be that as it may, we are not very clear for now as to how this interpretation could give rise to abuses.
14.5. - CAPITAL DIVIDEND ACCOUNT
It is provided in general terms that the amount by which the non-taxable portion of capital gains exceeds the non-allowable portion of capital losses for a period during which a corporation qualifies as a private corporation must be included in computing the capital dividend account. Furthermore, this account is reduced by the amount of any capital dividend payable by the corporation that has become due.
The computation of the capital dividend account is carried out on a cumulative basis; for example, the non-taxable portion of net capital gains for the various years of the period is accumulated until a payable dividend reduces the accumulated amount. A question arises as to the certainty that Revenue Canada will accept a capital gain (as opposed to business income) as such. Can the Department confirm that when a year is prescribed it will not dispute the non-taxable portion of the capital gains included in computing the capital dividend account for that year?
By analogy, for the purposes of computing the earned income provided for in subsection 55(2) of the Act, does the Department respect the tax treatment of the income and expenditure items for a prescribed taxation year?
33.44 1991 A.P.F.F. Congress
What is the Department's policy as regards a taxation year whose assessment was "nil"? Must a taxpayer request a notice of determination of losses in order eventually to obtain the benefits of a prescribed taxation year?
Answer by the Department of Revenue
Generally speaking, when a capital gain realized by a corporation is reported in a taxation year for which the Department has made an assessment, the Department's policy is to take account of the same capital gain amount in computing the capital dividend account. Of course, the capital dividend account should be modified if the capital gain amount is modified due to a reassessment, as for example if the capital gain is modified due to the acquisition of replacement property.
When circumstances so require, however, the Department may modify the capital gain amount of a prescribed year in computing the capital dividend account because the account itself is not, technically speaking, subject to the prescription period of 3 or 4 years.
The position mentioned above is the same with respect to computation of a corporation's earned income.
When a taxpayer has suffered a non-capital loss in a taxation year, it may be redetermined in any of the taxation years indicated in paragraph 111(1)(a) of the Act (year of application of the loss). However, the time limit imposed by subsection 152(4) applies when a revision of the non-capital loss results in a modification of the tax payable for the year in which the loss was suffered.
It should also be noted that the purpose of the notice of determination of a lose is to permit a taxpayer to object to the computation of that loss. If the determination of the loss is not requested, an objection to the computation of the amount of the loss can only be made in the year in which the loss is deducted under section 111 of the Act.
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© Her Majesty the Queen in Right of Canada, 1991
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© Sa Majesté la Reine du Chef du Canada, 1991
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