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.
ROUND TABLE ON FEDERAL TAXATION
ASSOCIATION DE PLANIFICATION FISCALE ET FINANCIÈRE - 1994 ANNUAL MEETING
QUESTIONS AND ANSWERS
CONTENTS
TRANSLATION FROM FRENCH
1 -
2Adjusted Equity within the Meaning of Proposed Subsection 20.2(2)
3Use of the Tax Losses of a Partnership Controlled by an Individual through Conclusion of a Contract of Employment
4Reserve in Respect of Certain Goods and Services - Paragraph 20(1)(m)
5Transfer of Property with a View to Securing a Loan by a Company
6Portion of a Bad Debt
7Share Purchase Option
8Deemed Loss from Disposition to a Corporation
9Gift Certificates
10Opinions Issued by Revenue Canada
11Inducement or Gain on Settlement of Debt
12Inventory Evaluation
13-
14Increase of Cost of Property Acquired on a Winding-Up of a Corporation
15Late Filed Election
16-
17-
18-
19Sale of Real Property
20Interpretation Bulletin IT-114
21Retiring Allowance
22Reasonable Expectation of Profit
23Section 160 and the Algoa Trust Case
24Option to Purchase a Property - Subsection 75(2)
25Amounts Receivable
26Election Concerning Property Owned by a Taxpayer on 22 February 1994
27-
28Canada-USSR Convention
29Alimony - the Thibaudeau Case
30Investment Business - Subsection 95(1)
31Partition of Undivided Interest in a Limited Partnership
32Interest Bearing Note Issued on Redemption of Shares
33Canadian-Controlled Private Corporation
34Avoidance Transactions - Surplus Stripping
35Qualified Small Business Corporation Share
36Prepaid Municipal Taxes
37Credit to Promote the Capitalization of Small and Medium-Sized Businesses
38Winding-Up a Partnership that Holds a Rental Property - Subsection 98(5)
39-
40Method of Accounting for Expenses
41Inducements
42Tax Rollover under Subsection 85(1)
43Disposition of Property
44Permanent Establishment
45Tax Equalization Payment
46Costs Incurred Prior to Incorporation
47Capital Gain or Income from a Concern in the Nature of Trade
48"De jure" Control of a Corporation
49General Anti-Avoidance Provision
50Home Buyers' Plan
51Application of Subsections 110.6(8) and (9)
52Interest Expenses - Bill Dated 20 December 1991
53Family Trusts
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 2
Adjusted Equity within the Meaning of Proposed Subsection 20.2(2)
Should deferred taxes (tax expenses and/or credits) be taken into account in establishing the net worth of the property owned by a distributor and/or the total liabilities of the distributor for purposes of computing the adjusted equity contemplated in subsection 20.2(2) of the draft legislation on the tax treatment of interest expenses?
Answer by the Department of Revenue
Subsection 20.2(2) stipulates that the accounting value of properties owned by the distributor and the liabilities of the distributor determined in accordance with generally accepted accounting principles must be taken into account.
Deferred tax expenses do not constitute property for purposes of computing adjusted equity. Furthermore, deferred tax credits may not constitute liabilities.
This problem was brought to the attention of the Department of Finance in a paper submitted by the CICA and the Canadian Bar Association.
The Department of Finance has informed us that it is considering this matter within the general framework of the draft legislation on interest.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 3
Use of the Tax Losses of a Corporation Controlled by an Individual through Conclusion of a Contract of Employment
Mr. X has been employed by Opco Inc. for a number of years. Mr. X is also the sole shareholder of Investco Inc., which has accumulated non-capital losses totalling $250,000. Mr. X deals at arm's length with Opco Inc.
Opco Inc. concluded an agreement with Investco Inc., under the terms of which the services previously rendered directly by Mr. X are to be rendered by Investco Inc. The annual fees paid to Investco Inc. by Opco Inc. are to be $75,000. Mr. X will be the sole person to render these services for Investco Inc.
Can the non-capital losses of Investco Inc. be applied against the net income from services rendered to Opco Inc.?
Would the answer be different if Mr. X did not deal at arm's length with Opco Inc.?
Answer by the Department of Revenue
As long as the legal requirements of Mr. X's resignation from his employment have been met, the fees arising from a legally valid service contract between Opco Inc. and Investco Inc. would constitute Investco Inc. income.
If Investco Inc. and Opco Inc. are not related, the fees would arise from a personal services business and paragraph 18(1)(p) of the Act would disallow deduction of specific expenses in computing the income derived from this business.
The deduction of a non-capital loss would not be limited or disallowed under paragraph 18(1)(p) of the Act since this paragraph does not apply to a deduction from taxable income.
The Act provides no restriction in respect of the deduction of a non-capital loss in a situation of this kind, i.e. in the absence of acquisition of control of the corporation.
The use of a personal services business with a view to allowing the deduction of non-capital losses arising from another business results in a tax benefit for Mr. X. These transactions would be avoidance transactions within the meaning of subsection 245(3) of the Act.
We are unable to make a definitive ruling on the application of subsection 245(2) of the Act without examining all the facts and circumstances relating to the transactions. In the absence of additional facts or circumstances relating to the transactions, we are nonetheless of the opinion that subsection 245(2) of the Act would not generally apply as a result and by reason of transactions such as those described above, since there would be no abuse having regard to the provisions of the Act read as a whole within the meaning of subsection 245(4) of the Act.
The answer would be the same even if Opco Inc. and Mr. X were not dealing at arm's length, unless Opco Inc. were related to Investco Inc. In a situation of that kind, the fees would not arise from a personal services business.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 4
Reserve in Respect of Certain Goods and Services - Paragraph 20(1)(m)
Paragraph 20(1)(m) of the Act allows deduction of a reasonable amount as a reserve in respect of goods that will have to be delivered after the end of the year and services that will have to be rendered after the end of the year.
Can a taxpayer claim as a deduction for a taxation year an amount (other than nil) less than the maximum amount that may otherwise be considered reasonable?
Answer by the Department of Revenue
Yes. A taxpayer, in computing the income derived by that taxpayer from a business for a taxation year, may deduct under paragraph 20(1)(m) of the Act a reserve amount less than the maximum allowable, provided this lesser amount is otherwise an amount that is reasonable for purposes of the provision.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 5
Transfer of Property with a View to Securing a Loan by a Company
What is the Department's position on the application of paragraph (d) of the definition of "disposition of property" in section 54 of the Income Tax Act (hereinafter the Act) in a case where a transfer of property is made for the sole purpose of securing a loan by a related company? (106443 Canada Inc. v. Her Majesty the Queen, 1994 E.T.C. 247).
Answer by the Department of Revenue
Sale with right of redemption is discussed at article 1750 of the Civil Code of Quebec. Furthermore, article 1756 of the Civil Code of Quebec covers the situation where a sale with right of redemption is made with the sole object of securing a loan. In this case, the vendor is deemed a lender and the purchaser is deemed a hypothecary creditor.
When property is transferred with a view to securing repayment of a debt or loan, the Department considers that there has been no "disposition of property" within the meaning of section 54 of the Act. The fact that the property is given to secure a loan from a related company does not pro tanto imply a "disposition of property".
106443 Canada Inc. v. Her Majesty the Queen upholds the application of paragraph (d) of the definition of "disposition of property" at section 54 of the Act, even if the redemption value is different from the value attributed to the property at the time of transfer.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 6
Portion of a Bad Debt
Can a portion of a debt deemed a bad debt be disposed of under subsection 51 of the Act even if another portion of the same debt is recoverable?
Answer by the Department of Revenue
As stated in paragraph 10 of Interpretation Bulletin IT-159R3 dated 1 May 1989, "a bad debt is considered bad for the purpose of section 50 only when the whole amount is uncollectible or when a portion of it has been settled and the remainder is uncollectible. Otherwise, where a portion of a debt can be considered uncollectible, this portion is not considered to be bad for the purpose of section 50 even though accounting practice may require a write-down to realizable value."
Nothing in the wording of subsection 50(1) of the Act leads us to believe that a portion of a debt may be deemed a bad debt. This interpretation rests on the fact that the deemed acquisition of the debt at a cost equal to nil seems to be possible only in a situation where, at the end of a particular taxation year, the original debt has no known value. In our opinion, if a portion of a debt is to be deemed a bad debt, subsection 50(1) of the Act would have to be more specific in this regard.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 7
Share Purchase Option
Mr. X, president of Opco Inc., concluded his contract of employment four years ago. One clause in this contract specifies that he is to receive progressive employee stock options as part of his remuneration package. Furthermore, the contract of employment specifies that changes may be made to the employee stock option plan.
Mr. X deals with Opco at arm's length.
The shares contemplated by the employee stock options are prescribed shares for purposes of paragraph 110(1)(d) and as such are defined in section 6204 of the Income Tax Act Regulations.
At this time, 100,000 options may be exercised.
Mr. X and Opco Inc. intend to amend Mr. X's contract of employment in order that Mr. X may, on behalf of Mr. X, obtain the market value of the stock options in the form of a cash payment rather than acquiring shares and disposing of them on the market. This cash payment will entail cancellation of the corresponding options.
Questions
1)In computing its income, can Opco deduct the total amount paid to Mr. X? Do paragraphs 7(3)(b) and 18(1)(b) and section 67 apply in the circumstances?
2)Is the amount paid to Mr. X taxable under paragraph 7(1)(b)?
3)Can Mr. X claim the 25% deduction under paragraph 110(1)(d)?
Answer by the Department of Revenue
The Department is currently reviewing its interpretation of paragraphs 7(1)(b), 7(3)(b) and 110(1)(d) of the Act in a context similar to the example used in your question.
For this reason, the Department is unable to express an opinion or give an advance ruling until the review has been completed.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 8
Deemed Loss from Disposition to a Corporation
An estate holds non-voting preferred shares of Investco Inc.
Mr. X is executor and trustee of the estate and controls Investco Int.
The Investco Inc. shares held by the estate are redeemed by the latter, entailing a deemed dividend under subsection 84(3) of the Act and, as a direct result, a capital loss. Does the Department maintain the position, stated in answer to question 42 of the Revenue Canada Round Table at the 1991 annual meeting of the Canadian Tax Foundation (CTF), that subsection 85(4) does not apply to the situation described?
Answer by the Department of Revenue
The Department's position regarding this situation is currently under review. In the meantime, the Department takes the position stated in our response to question 42(b) of the 1991 CTF Round Table, i.e. that subsection 85(4) is not deemed applicable in the situation described above inasmuch as the corporation is not, immediately after disposition of the shares, controlled, directly or indirectly, in any manner whatever by the estate.
The question of whether, immediately after disposition of the shares, the estate has a direct or indirect influence, the exercise of which would entail de facto control of the corporation, is a question of fact.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 9
Gift Certificates
A corporation gives its clients gift certificates from major department stores for goods other than food, beverages and entertainment.
Are these expenses deductible in full by the corporation?
Answer by the Department of Revenue
An expense is deductible for purposes of the Act only if it has been incurred or made by a taxpayer with a view to earning business income or income from property and the expense is reasonable in the circumstances.
Every expense incurred or made by a taxpayer must be supported by source documents. The nature of a source document supporting an expense varies with the type of expense. In the case of gift certificates given by a corporation to its clients, in order to ensure that the expense claimed is valid and that the amount has been accounted for or declared by the recipient, the Department requires, inter alia, the names and addresses of the client recipients, the date on which the gift certificates were given to them and the value of the gift certificates. If all this information is not available, deduction of all or part of the cost of the gift certificates may be disallowed. Furthermore, in the case of a corporation, where the recipient of the gift certificates is not identified, the Department may include the value of the gift certificates in computing the income of the directors or shareholders who may have authorized or benefited from the gift certificates under subsection 15(1) or 56(2) or paragraph 6(1)(a) of the Act, depending on the circumstances.
If gift certificates were purchased by a corporation but remain in hand at the end of a taxation year, no expense is allowable in computing the corporation's income for that taxation year.
Given that the eventual user of the gift certificates will apparently use them directly or indirectly to pay for personal expenses or purchase personal goods or services, the Department expects that any intermediary between the purchaser of the gift certificates and their eventual users be in a position to supply the information described above so that the value of gift certificates that may be taxable can be declared in computing the income of the recipients.
Inasmuch as the gift certificates may not be used to pay for food, beverages or entertainment, section 67.1 of the Act is not applicable in computing the business income or income from property of a corporation. The same would hold true if, for example, the value of the gift certificates were included in computing the income of an employee of the corporation under paragraph 6(1)(a) of the Act, even if these gift certificates could otherwise be used by the employee to pay for food, beverages or entertainment.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 10
Opinions Issued by Revenue Canada
During the 1993 APFF meeting, it was mentioned that district taxation offices may give opinions on specific questions. This does not appear to be the current practice at Revenue Canada. Can district offices be consulted for an opinion on a specific case?
Answer by the Department of Revenue
As stated in paragraph 21 of Information Circular 70-6R2, district offices consider requests for written opinions on completed transactions. Furthermore, they provide over-the-counter advice and assistance on routine matters. District offices may provide written opinions only with regard to routine situations (usually not complex) or completed transactions.
Only the Rulings Directorate at Headquarters is responsible for issuing written opinions on the interpretation of hypothetical situations involving establishment of general Department policy concerning interpretation of the Act. Furthermore, only the Rulings Directorate is authorized to issue an advance tax ruling requested by a particular taxpayer.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 11
Inducement or Gain on Settlement of Debt
At the time a business is acquired, the loans granted to the business by the government are extinguished.
Is the advantage thus conferred considered an inducement (paragraph 12(1)(x)) or a settlement of debts (section 80)?
Answer by the Department of Revenue
The question of whether a loan by a government may be an inducement contemplated by the provisions of paragraph 12(1)(x) or a gain on settlement of debts under section 80 is a question of fact that may only be determined following review of all the relevant facts.
A loan by a government may, in some circumstances, be a payment contemplated in paragraph 12(1)(x) at the time it was made. As stated in response to question 46 at the 1988 Round Table, the Department considers that any loan that the lender is obliged to forgive if certain conditions are met is contemplated by subparagraph 12(1)(x)(iii) or 12(1)(x)(iv). Only unconditionally reimbursable loans are excluded. Assuming existence of the other conditions required for application of paragraph 12(1)(x), the Department is of the opinion that the amount of the loan would be added to the income of the person who receives it under paragraph 12(1)(x), unless the conditions contemplated in subparagraphs 12(1)(x)(v), (vi), (vii) or (viii) were met. When a loan is included in income under paragraph 12(1)(x), it is excluded from the application of paragraphs 80(1)(a) and (b) by reason of paragraph 80(1)(f).
Furthermore, if it is reasonable to assume that paragraph 12(1)(x) would not apply at the time the loan was made, that loan could be contemplated by section 80 at the time it was settled or extinguished without any payment having been made or by payment of an amount less than the principal.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 12
Inventory Evaluation
When highly specialized goods are manufactured, one accounting method used to establish the cost of inventory is program accounting. The method is primarily used in cases where production cost of the first item is clearly higher than the usual production cost and these costs are inversely proportional to the number of items made. Program accounting consists of averaging the additional initial costs over the forecast number of units. When this method is used, deferred costs are created during the initial phase of production.
What is the tax treatment of deferred costs? Are they deductible in the year in which they are incurred?
Answer by the Department of Revenue
The profit for purposes of section 9 of the Act must be established in accordance with generally accepted accounting principles, unless the Act contains express contrary provisions, taking into account the fair presentation method and the principle of matching goods and cost.
The tax treatment of costs deferred during the initial phase of production is a function, inter alia, of the nature of the costs incurred and the method used in preparing the financial statement in accordance with generally accepted accounting principles.
If there are no express contrary provisions in the Act, and if the initial production costs are considered an inventory cost or deferred costs for purposes of preparing the financial statements, the Department would not usually allow a deduction in the year in which the costs were incurred unless the method used to prepare the financial statement does not comply with generally accepted accounting principles or does not enable a fair presentation of profits or clear matching of goods and costs.
The comments in Interpretation Bulletins IT-417R and IT-473 provide further details on determining cost price of inventory and treatment of deferred costs.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 14
Increase of Cost of Property Acquired on a Winding-Up of a Corporation
Supplement 1 to Information Circular 88-2 concerning the general anti-avoidance rule gives, at section 8, an example of an increase of cost of property acquired on a winding-up of a corporation, and the situation described is not considered an abuse in the application of the Act read as a whole. Section 8 reads as follows:
Facts
Canco operates three businesses, A, B and C, and owns investment property. Purchaseco intends to purchase all the shares of Canco, wind it up and dispose of business A and B. Prior to this purchase, Canco transfers all of the property used in business A and B to wholly-owned subsidiaries X and Y, respectively, and elects pursuant to subsection 85(1) of the Act in respect of the transfers. Purchaseco buys all the shares of Canco and winds up Canco and designates an amount, pursuant to paragraph 88(1)(d) of the Act, to increase the adjusted cost base of the shares of the subsidiaries X and Y. Purchaseco sells the shares of X and Y to different arm's length parties.
Interpretation
The shares of the subsidiaries issued in consideration for the property comprising businesses A and B are deemed by section 54.2 of the Act to be capital property of Canco. Paragraph 88(1)(d) of the Act provides that the cost to a parent of a capital property owned by a subsidiary may be increased in certain circumstances. The rules of this paragraph apply to a property of a subsidiary that is deemed to be a capital property as well as one that is in fact a capital property. Since the transactions described are consistent with the intention of section 54.2 and paragraph 88(1)(d) of the Act, the transfers by Canco of business A to X and business B to Y would not be an abuse of the Act read as a whole. Following the amendments to paragraph 88(1)(d) in the draft legislation of 23 June 1994, is it still correct to say that section 245 does not apply to this type of transaction?
Answer by the Department of Revenue
Section 8 of the Circular continues to reflect the Department's position and the situation it refers to is not deemed to be contemplated by the provisions of section 245 of the Act since the shares of X and Y are sold to different arm's length parties.
This obviously assumes that the series of transactions was not structured for the express purpose of avoiding the new rules in paragraph 88(1)(d) of the Act.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 15
Late Filed Election
Following a rollover, the transferor was liquidated to the parent corporation. An application for late election must be filed in respect of a rollover filed by the liquidated subsidiary.
May the transferor's parent corporation sign the election form on behalf of the liquidated subsidiary?
Answer by the Department of Revenue
In general, no. A late filed election under subsection 85(7) of the Act must be made and signed by the transferor. From the time the subsidiary is dissolved within the meaning of applicable corporate law, it has no legal existence and, consequently, may not file a late election. The parent corporation may not sign the form on behalf of the liquidated subsidiary. The Department would, however, be prepared to consider situations in which the election form prescribed at section 85 of the Act was not filed before the date of liquidation, by omission or inadvertence, by the liquidated corporation. This could be considered to be the case if all the corporate documents and transfer agreements clearly show the parties' intention to so elect, and clearly indicate the agreed amounts. The requirements include payment of the consideration before liquidation of the subsidiary, authorization of the signatories to sign for the subsidiary before its liquidation, and prejudice to the corporation or its shareholders by refusal of the election. The election would not be allowed if income tax returns must be amended as a result thereof.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 19
Sale of Real Property
According to the Civil Code, sales of real property must be registered to be valid with respect to third parties. In a corporate group, a sale can be made without necessarily being registered. Would the Department allow this type of transaction as the parties understand it? Would the sale be recognized as such?
Answer by the Department of Revenue
If a sale is valid between parties, each party must take the sale into account in its return of income. However, if one party wishes its rights to be set up against the Department, these rights must first be published in accordance with articles 2941 and following of the Civil Code of Quebec.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 20
Interpretation Bulletin IT-114
Interpretation Bulletin IT-114 concerning discounts, premiums and bonuses on debt obligations was cancelled on 10 June 1994 because it did not take into account the complex changes in financial transactions that have occurred in recent years.
Could you please tell us what type of changes were contemplated by the cancellation? May one consider that the general principles found in this bulletin still apply to the transactions described therein, and that the distinctions apply only to financial transactions more complex than those described there? Is it your intention to publish a new bulletin in future?
Answer by the Department of Revenue
Interpretation Bulletin IT-114, issued in 1973, was cancelled in full because it did not reflect significant changes to the Income Tax Act and was no longer a useful guide to the taxation of discounts, premiums and bonuses relating to a multiplicity of financial products that have changed considerably.
For example, the bulletin was issued before the introduction of the rules concerning prescribed debts. The comments in the bulletin in respect of debts issued at a discount (Treasury bonds) or with a bonus on maturity were no longer relevant taking these rules into account. The bulletin also contemplated obligations with a premium on issue by reason of a small variation between the interest rates on the obligations and prevailing market rates at the time of their issue. The comments relating to this type of premium were not appropriate to new types of financial transactions (e.g. weak currency borrowings).
It is unlikely that another bulletin on the topic will be published. However the Department may issue a series of bulletins on individual topics in the future.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 21
Retiring Allowance
An employee is discharged by his employer and receives no amount from his employer at the time of his discharge. The employee applies for and obtains unemployment insurance benefits. At the same time, the employee institutes legal proceedings against his employer and the employer is obliged to pay a retiring allowance. Part of this allowance must be used to reimburse the unemployment insurance that the employee would not have received if he had been entitled to the said retiring allowance from the time of his discharge. Is the employer obliged to make a deduction at source in accordance with paragraph 153(1)(c) of the Act for the portion of the retiring allowance that must be returned to unemployment insurance?
Answer by the Department of Revenue
In general, the employer is obliged to withhold amounts at source as provided in paragraph 153(1)(c) of the Act and in Part I of the Regulations when he pays to an employee or to his benefit an amount contemplated by the said paragraph. However, the Department may set an amount below the amount contemplated by the Regulations when the Department believes that deduction of the amount set by the Regulations would unduly prejudice the beneficiary. In the circumstances described above, the taxpayer may apply in writing to the director of his district taxation office, who is authorized to exercise the powers of the Minister in this matter, to have an amount less than the amount contemplated in the Regulations withheld from his retiring allowance.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 22
Reasonable Expectation of Profit
In the past few months, a number of Court decisions have dealt with the matter of reasonable expectation of profit, specifically where a taxpayer attempted to deduct losses incurred in the context of a rental real estate operation. We understand that the Department has even disallowed such losses in situations where the building had produced a profit in previous taxation years and was not used for personal reasons by the owner. Is this a new trend at the Department and, if so, could we please be told the reason for the increased interest in this type of matter?
Answer by the Department of Revenue
The Department has initiated no specific audit project at the national level concerning the determination of a reasonable expectation of profit in files for which leasing losses were claimed.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 23
Section 160 and the Algoa Trust Case
In what circumstances does the Department intend to apply section 160 of the Act to the payment of dividends by a corporation to its shareholders? For example, in Algoa Trust, 93 DTC 405, it appears that the dividend was not declared for the purpose of defrauding the Department, but rather with a view to avoiding the new Part II tax. Furthermore, at the time the first dividend was paid, the directors were not aware that the Department was conducting an audit for prior taxation years. Should one conclude that payment of any dividend may give rise to application of section 160? And yet, in a September 1991 memorandum from Rulings Directorate, Revenue Canada stated its intention of restricting application of section 160 in the case of a dividend payment.
Answer by the Department of Revenue
This ruling was appealed. We are however of the opinion that, as stated by the judge of the Tax Court of Canada in the decision, the payment of dividends in cash constitutes a transfer of property.
The Department, in response to question 48 at the Round Table of the September 1991 meeting of the Canadian Tax Foundation, stated that non arm's length shareholders in the corporation have every latitude to see to it that the corporation declares and subsequently pays dividends up to the point where it is no longer in a position to pay its taxes and that, in these circumstances, the provisions of subsection 160(1) of the Act should be applied.
Each case is particular and will be decided on the circumstances peculiar to it. In this regard, the Department has issued no general directives on restricting the application of subsection 160(1) following the payment of dividends and intends to apply the provisions of this subsection whenever the circumstances so require.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 24
Option to Purchase a Property - Subsection 75(2)
We understand that the Department has already issued an opinion to the effect that subsection 75(2) of the Act applies where the person who contributed a property to a trust maintains the right to reacquire the property at its fair market value, even if that person is not a beneficiary of the trust and has no control over it. Could you please explain how the Department, in a case of this kind, concludes that the property may revert to that person under the terms of the trust?
Answer by the Department of Revenue
The Department considers that subsection 75(2) of the Act could apply if the deed of trust or any other contract between the trustees and a person who contributes a property to a trust specifies that that person has a right to reacquire the property or a property substituted therefor, even if that person does not control the trust property and has no other right as a beneficiary of the trust.
The Department's position to which you refer was expressed in a situation where it was stated that the person who contributed a property to the trust had no right as a beneficiary in the trust other than the right to reacquire the transferred property.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 25
Amounts Receivable
Paragraph 12(1)(b) of the Act specifies the time at which amounts receivable by a taxpayer in respect of property sold or services rendered in the year are added in computing income. Inasmuch as a taxpayer transfers property to his customers by conditional sale (i.e. continues to own the said property until complete payment therefor), is it the Department's view that paragraph 12(1)(b) is applicable to a conditional sale of this kind?
Answer by the Department of Revenue
The Department's position is to the effect that the profit for purposes of section 9 of the Act must be established consistent with generally accepted accounting principles, unless the law contains express contrary provisions, taking into account the fair presentation method and the matching of revenue and expenditures principle.
Paragraph 12(1)(b) of the Act provides no alternative method for computing business income. The paragraph was "enacted for greater certainty" as contemplated in subsection 12(2) of the Act and to ensure that specific amounts that were invoiced (or should have been invoiced) are included in computing income.
Thus, in light of all the facts of a specific case and, inter alia, in a situation similar to the one described above, it appears to us that the conditional sale of property to a client could be included in computing income under subsection 9(1) of the Act. Alternatively, paragraph 12(1)(b) of the Act could be invoked, as specified in section 5 of Interpretation Bulletin IT-170R: "... it is the Department's view that the sale price of any property sold is brought into account for income tax purposes when a vendor has an absolute but not necessarily immediate right to be paid."
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ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 31
Partition of Undivided Interest in a Limited Partnership
Is the Department of the view that subsection 248(21) of the Act can apply at the time of partition of undivided interest in a limited partnership in a situation in which the facts are as described below?
1.A number of limited partnerships (the "limited partnerships") have publicly issued units.
2.A limited partnership ("partnership A") is incorporated to acquire the assets of each limited partnership. Subsection 97(2) of the Act is used so that each transfer is tax-free.
3.Partnership A issues a number of units to each limited partnership in consideration of the transfer of their assets.
4.Immediately following the transfer of assets to partnership A, the limited partnerships are wound up. An election under subsection 98(3) of the Act is made in respect of the dissolution of each of the limited partnerships. Undivided interest in the property of the limited partnerships, consisting solely of units of partnership A, is distributed to the partners in the said limited partnerships.
5.Following partition, each partner in the dissolved limited partnerships receives exclusive joint ownership of a specific number of units of partnership A in exchange for his undivided share of the units of partnership A that were held by the limited partnership of which he was a member immediately before it ceased to exist. The FMV of the units to be received by each partner is equal to the FMV of the undivided interest that this partner held in the units of partnership A held by the limited partnership of which he was a member immediately before it ceased to exist.
Answer by the Department of Revenue
The Department is of the view that the conditions for applying subsection 248(21) of the Act cannot be met when the property that is the subject of a partition is an undivided interest in a partnership (general or limited). In spite of the general terms in the preamble, the Department is of the view that subsection 248(21) of the Act usually applies only to property listed in its paragraph (c), i.e. to buildings and parcels of land. The preamble to subsection 248(21) of the Act must be interpreted in light of the presumption made in paragraph (c) of the same subsection.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 32
Interest Bearing Note Issued on Redemption of Shares
A corporation redeems its shares for cancellation and issues in consideration an interest bearing note. Since the note is not borrowed money, the Department's position stated in Interpretation Bulletin IT-80 does not apply for deduction of interest. What is the Department's position on the deductibility of the interest on this note?
Answer by the Department of Revenue
The interest paid or payable on the note is not deductible under subparagraph 20(1)(c)(i) of the Act because the note is not borrowed money. Subparagraph 20(1)((c)(ii) allows deduction of the interest incurred on an amount payable for property acquired for the purpose of earning or producing income from a business or property. In our view, a note issued at the time of a redemption of shares is not an amount payable for property acquired for the purpose of earning or producing business income.
The problem was brought to the attention of the Department of Finance, which has informed us that it is considering the question in the context of the draft legislation on interest.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 33
Canadian-Controlled Private Corporation
Does a private corporation most of whose voting shares are held by a very large number of arm's length non-residents in Canada qualify as a Canadian-controlled private corporation within the meaning of subsection 125(7) of the Income Tax Act?
Answer by the Department of Revenue
The Department's position is that a private corporation does not qualify as a "Canadian-controlled private corporation" when most of the voting rights attached to the shares issued by the corporation belong to non-residents of Canada.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 34
Avoidance Transactions - Surplus Stripping
An individual holds all the common and preferred shares of a management corporation ("MANAGEMENT"). Management holds a number of properties, including shares of a Canadian corporation carrying on an active business ("OPERATING"). The preferred shares of the management corporation held by the individual have an adjusted cost base (ACB) and a fair market value of $400,000 as the result of crystallization of the capital gain, and low paid-up capital. The shares of OPERATING have an "income earned or realized on hand", within the meaning of paragraph 55(5)(b) of the Act, and a fair market value of $400,000.
A third party wishes to acquire the shares of OPERATING. In order to complete the sale, the individual incorporates a new corporation ("NEWCO") to which he transfers his redeemable preferred shares of MANAGEMENT in exchange for common shares of NEWCO (having an adjusted cost base of $400,000 and low paid-up capital). Subsequently, MANAGEMENT transfers to NEWCO the shares of OPERATING that it holds through a tax rollover in exchange for redeemable preferred shares of NEWCO. MANAGEMENT and NEWCO then proceed to a criss-cross redemption of their respective preferred shares and the individual sells the purchaser his common shares of NEWCO with no tax consequences.
Does the Department consider that these transactions entail an abuse in the application of the Act read as a whole and that section 245 of the Act would apply?
Answer by the Department of Revenue
It appears to us that, by proceeding with the series of proposed transactions, the taxpayer would contravene the provisions of subsection 245(2) of the Act. The series of transactions would allow the individual to withdraw a portion of MANAGEMENT assets tax-free. If MANAGEMENT sold its shares of OPERATING directly to the purchaser (what he really wants), the individual could realize the proceeds of the disposition solely by receiving a taxable dividend from MANAGEMENT, since the paid-up capital of its shares is low. The individual is proposing to do indirectly that which the Act does not allow him to do directly.
In our view, subsection 247(1), repealed by 1988, c. 55, s. 187(1), would have been applicable to the series of transactions described above. Subsection 247(1) was repealed by reason of the addition of the general anti-avoidance rule to subsection 245(2) of the Act, which is sufficiently broad in scope to apply to the transactions contemplated in subsection 247(1).
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 35
Qualified Small Business Corporation Share
Mr. X is the sole shareholder of Investco Inc., which has always been a Canadian-controlled private corporation. Investco Inc. has two Canadian subsidiaries in which it holds all the shares. Over the past 24 months, the only assets of Investco Inc. consisted of the shares of the two subsidiaries. Over the same time period, the assets of Subsidiary A consisted exclusively of assets used principally in a business that Subsidiary A carries on actively principally in Canada. Conversely, over the same time period, 40% of the fair market value of the assets of Subsidiary B consisted of assets used principally in a business that Subsidiary B carries on actively principally in Canada. The remainder of Subsidiary B's assets consisted of funds not used in its business.
Mr. X wishes to sell the shares of Investco Inc. Subsidiary B pays the funds not used in its business as a dividend to Investco Inc., which repeats the process in favour of Mr. X.
Assuming that Investco Inc.'s investment in Subsidiary A has always represented approximately 70% of the fair market value of its assets, does Revenue Canada consider that the conditions contemplated in paragraph (c) of the definition of "qualified small business corporation share" in subsection 110.6(1) of the Act (hereinafter the "definition") are met for purposes of determining if, following the transactions ("determination time"), Mr. X's shares are qualified small business corporation shares?
Answer by the Department of Revenue
Over the time period beginning 24 months before "determination time" and ending at the time of the payment by Investco Inc. of a dividend to Mr. X, all or substantially all of the fair market value of the assets of Investco Inc. is not attributable to assets contemplated in subparagraph (c)(i) of the "definition" nor to shares contemplated in division (c)(ii)(B) of the "definition". As a result, the criteria specified in paragraph (d) of the "definition" must be applied in order to determine whether the shares of the subsidiaries are shares contemplated in division (c)(ii)((B).
Shares in the capital stock of Subsidiary A are shares of a private corporation of which all or substantially all of the fair market value of the assets is attributable to assets used principally in a business that the corporation carries on actively principally in Canada. Furthermore, these shares are shares contemplated in subparagraph (c)(ii) of the "definition", taking into account the criterion specified in paragraph (d). These shares at all times represent 70% of the fair market value of the assets of Investco Inc. for the period ending at the time of Investco Inc.'s payment of the dividend to Mr. X, thus meeting the condition specified in paragraph (c) of the "definition" for the period.
As a result of the dividend paid by Subsidiary B to Investco Inc., the shares of Subsidiary B capital stock are shares in a private corporation of which all or substantially all of the fair market value of the assets is attributable to assets used principally in a business that the corporation carries on actively principally in Canada. These shares and the shares of Subsidiary A are thus shares described in subparagraph (c)(ii) of the "definition", taking into account the criterion specified in paragraph (d), for that part of the time period following payment of the dividend to Investco Inc.
Following the payment by Investco Inc. of the dividend to Mr. X, all or substantially all of the fair market value of the assets of Investco is attributable to shares contemplated in division (c)(ii)(B) of the "definition".
Consequently, in our view, the condition contemplated in paragraph (c) of the definition of "qualified small business corporation share" at subsection 110.6(1) of the Act is met throughout the 24-month period preceding "determination time" for purposes of determining whether the shares of Mr. X are qualified small business corporation shares.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 36
Prepaid Municipal Taxes
A city signed a loan by-law for local improvements. The term of the loan is 15 years. After 5 years, the city offers taxpayers two options: continue to pay the municipal local improvement tax over the next 10 years at $1,000 a year (as in the first 5 years), or pay a lump sum of $6,000.
One taxpayer elects to pay the $6,000 lump sum. In computing his income from business or property, can he deduct the lump sum payment in question? If not, what amount is deductible in the taxation year in which the payment is made?
Answer by the Department of Revenue
In our view, under subparagraph 18(9)(a)(ii) of the Act, a portion of the lump sum paid may reasonably be considered to be made or incurred in respect of taxes on a time period subsequent to the end of the taxation year in which the payment is made.
In computing his income from business or property, the taxpayer may annually deduct, under paragraph 18(9)(b) of the Act, an amount determined either based on the term of the municipal improvement tax (i.e. $600 for the year in which the lump sum payment is made and $600 for each of the 9 subsequent taxation years), or use a method based on payment of the municipal local improvement tax that would have been paid had he not made the lump sum payment, i.e. $1,000 for the taxation year of the payment and $1,000 for each of the subsequent 5 taxation years. We would allow either of these two methods selected by the taxpayer.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 37
Credit to Promote the Capitalization of Small and Medium-Sized Businesses
The Taxation Act (Quebec) allows a tax credit in the provisions of section 1029.8.52.
This tax credit is given with reference to the Act to promote the capitalization of small and medium-sized businesses (L.Q. 1992 c. 46). A "qualified corporation" within the meaning of this Act may take advantage of a refundable tax credit if a qualified investor (e.g. a chartered bank) invests in the corporation in the form of common shares, convertible debentures or convertible preferred shares.
The conditions for a corporation to be a "qualified corporation" are listed in section 3 of the Act to promote the capitalization of small and medium-sized businesses. It must work principally in one of the industries determined by regulation, in particular the manufacturing and tourist industries. In all cases, the corporation must carry on a business.
Is the tax credit under section 1029.8.52 of the Taxation Act contemplated by paragraph 12(1)(x) of the Income Tax Act?
Answer by the Department of Revenue
The Department is of the view that it is not the aim of paragraph 12(1)(x) of the Income Tax Act to tax the tax credit under section 1029.8.52 of the Taxation Act with reference to the Act to promote the capitalization of small and medium-sized businesses.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 38
Winding-Up a Partnership that Holds a Rental Property - Subsection 98(5)
Where a partnership ceases to exist, subsection 98(5) of the Act provides, under specific conditions, for a tax-free transfer of partnership property to the member who continues to carry on the business of the partnership. One of the important conditions to be met is that one, but not more than one, member of the partnership continue the business formerly carried on by the partnership.
Does the Department of Revenue consider that operating a rental property is a business for purposes of applying subsection 98(5) of the Act? If the answer is "yes", is the Department of Revenue of the view that subsection 98(5) of the Act applies to the transfer of a rental property to a member who continues to operate the property?
Answer by the Department of Revenue
The Department considers that operation of a rental building by a partnership is a business for the purposes of applying subsection 98(5) of the Act. Consequently, if all the conditions listed in subsection 98(5) of the Act are met, the Department is of the view that a rental property may be transferred tax-free to the member who continues to operate the building. However, this position for purposes of applying subsection 98(5) of the Act does not change the nature of the income to its recipient for other purposes of the Act. Interpretation Bulletin IT-434R states the Department's position on the nature of income generated by a rental property held by an individual.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 40
Method of Accounting for Expenses
Pursuant to Canderel Ltd. v. The Queen (94 DTC 1133) (TCC) and Toronto College Park v. The Queen (94 DTC 6172) (FC), which allowed a deduction in the current year of inducements to tenants, and pursuant to The Queen v. Friedberg (92 DTC 6031) (FCA), in which Linden J. of the Federal Court of Appeal established that a taxpayer may use an acceptable accounting method to account for his revenue and expenditure, even if it is not the best method in the circumstances or even the method used to prepare the financial statements: is the Department prepared to allow a taxpayer to use an acceptable accounting method for taxation purposes in deducting expenditures even if it is not the "best" method or even the method used to prepare the financial statements?
Answer by the Department of Revenue
The Department's position is to the effect that the profit for purposes of section 9 of the Income Tax Act must be established in compliance with generally accepted accounting principles, unless the Act contains express contrary provisions, taking into account the fair presentation method and the principle of revenue/expenditure matching.
When a single accounting method is acceptable according to generally accepted accounting principles and when this method is used to prepare the financial statements, the profit for tax purposes should be computed using this method unless the Act contains express contrary provisions.
In some cases, a taxpayer may select from among a number of accounting methods, each one equally valid. The profit for tax purposes should be established using the method that gives the fairest presentation of the profit and the best revenue/expenditure matching. Determining this method requires meticulous study of the taxpayer's situation.
Friedberg was heard before the Supreme Court. Although the Court found for the taxpayer, the reasons were different from those used by Linden J. On the one hand, the Court indicated that it was not convinced the accounting method recognized by the Department was capable of describing the taxpayer's tax revenue. Furthermore, because the taxpayer deducted no losses he had not incurred, the Court was unable to determine the validity of the consequences of the accounting method advocated by the taxpayer.
Canderel Ltd. and Toronto College Park were appealed by the Department.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 41
Inducements
Paragraph 12(1)(x) of the Act includes in income a range of inducements received by a taxpayer in the context of a business or an investment.
In Everett's Truck Stop Ltd. v. The Queen (1993 DTC 965), the taking over by a supplier of a taxpayer's debt to a third party was considered a payment received by the taxpayer to induce him to purchase the supplier's products.
We would like to know the Department's position on the scope of the word "received" in paragraph 12(1)(x) of the Act. Practical examples of your position, drawn from recent Department interpretations, would be appreciated.
Answer by the Department of Revenue
The word "received" is not defined in the Act or the Regulations. Its interpretation is determined according to the usual meaning of this word which, in some circumstances, has been extended by the courts.
The jurisprudence has indicated that it is not necessary for a sum to have actually been paid. For example, there may be constructive receipt by a taxpayer when an amount is entered as a credit to his account or, as in Everett's Truck Stop Ltd., a debt is paid by the supplier on behalf of the taxpayer. A tax reduction is also considered an amount received as assistance from a government.
The answers to question 9 of the CTF 1986 Round Table and question 15 of the 1987 APFF Round Table respectively give the Department's position on a tax credit for scientific research considered received as an inducement for purposes of paragraph 12(1)(x).
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 42
Tax Rollover under Subsection 85(1)
One of the conditions for application of the tax rollover contemplated in subsection 85(1) of the Act is that the taxpayer receive a consideration that includes shares in the capital stock of the transferring corporation.
In Dale et al. v. The Queen (94 DTC 1100) ("Dale"), counsel for the Department appeared to hold that a rollover would be allowable inasmuch as the shares in consideration were issued before the end of the taxation year in which the transfer was made. The presiding judge adopted a broader position, allowing the rollover if, at the time of transfer, there was a commitment to issue shares and the shares were in fact issued within a reasonable time.
Could the Department please inform us of current policy on this matter?
Answer by the Department of Revenue
An appeal has been filed with the Federal Court, Trial Division in Dale. For this reason, we are unable to make any comments on the matter at this time.
While awaiting the Court decision, the Department intends to pursue its current practice, which is to allow election under subsection 85(1) of the Act when all the conditions listed below are met:
1.there exists an agreement between the transferor and the transferee and the said agreement requires, inter alia, that the transferor issue the shares required;
2.the transferor immediately undertakes the steps necessary to issue the shares, i.e. files an application for supplementary letters patent or articles of amendment, whichever is appropriate;
3.when the necessary changes to the articles of incorporation have been made, the transferor issues the shares promptly.
If for some reason the transferor does not receive the required authorization under the applicable corporate legislation for issuing the said shares, the election under subsection 85(1) is deemed invalid.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 43
Disposition of Property
Following crystallization of the exemption of capital gains on SBDC shares, a taxpayer holds shares that have the following characteristics:
Situation A
100 common shares
Paid-up capital 100
ACB 500 000
FMV 1,200,000
Situation B
100 non-voting common shares
1,000 preferred shares
Paid-up capital 100 1,000
ACB 100 500 000
FMV 100 1,200,000
The taxpayer wishes to segregate his $500,000 ACB in a class of shares that have a redemption value of $500,000.
Situation A
The taxpayer exchanges his 100 common shares for 1,000 new redeemable voting preferred shares at a fixed value of $500,000 and 100 new common shares.
Situation B
The taxpayer exchanges his 1,000 non-voting common shares for 1,000 new redeemable voting preferred shares at a fixed value of $500,000 and one new common share.
In each situation, does the Department consider a disposition of property resulting in the application of section 85 of the Act to have occurred?
Answer by the Department of Revenue
In situation A, the Department would examine the characteristics of the new common shares to establish whether there was in fact a disposition of all the common shares. If there is essentially no difference between the characteristics of the shares, the Department could conclude that there was no disposition of the common shares that were exchanged for new common shares.
In situation B, the Department considers that there was disposition of property.
The overall context of the transactions should also be examined to determine whether there was an avoidance transaction and if it is reasonable to consider that it resulted in an abuse in the application of the provisions of the Act read as a whole.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 44
Permanent Establishment
In a technical interpretation issued by the Reorganizations and Foreign Division on 28 June 1993, Revenue Canada states the view that the sales force of a corporation resident in a country may be a permanent establishment in another country within the meaning of the Canada-US tax convention regardless of whether or not the sales persons are empowered to bind the corporation. Could the Department please elaborate on the subject? Do the American tax authorities share this view?
Answer by the Department of Revenue
The Department usually considers that, where the Canadian activities of a foreign business are carried on through an organized and structured sales force, the sales force may represent for the non-resident sufficient substantial presence in Canada to be considered a permanent place of business and thus a permanent establishment. It remains to be determined whether the fact that a corporation has a permanent establishment in Canada is a question of fact.
The scope of activities in Canada, the sales volume, the person who has real authority to bind the non-resident, the place where the inventory is located, the time required to have a contract approved and the duration of the organization's presence in Canada are all factors that may be used to determine the presence of a permanent establishment in Canada. The importance of these factors may vary from one situation to another.
We have not sought the position of the American tax authorities on this matter.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 45
Tax Equalization Payment
With a view to attracting foreign experts to Canada, some corporations add compensation payments to the wage envelope for the additional income tax that will be paid in Canada compared to the tax that would have been paid in the usual country of residence (tax equalization payment). What is the Department's policy on the taxation of these amounts in light of The Queen v. Phillips, 1994 DTC 6177?
Answer by the Department of Revenue
The Department's position with regard to tax equalization payments is always to consider these payments as taxable amounts under paragraph 6(1)(a) or (b) of the Act. This position is consistent with the decision in The Queen v. Phillips, in which an amount paid to compensate for the higher cost of purchasing a new residence (higher cost of living) in a new place of work was deemed a taxable benefit within the meaning of paragraph 6(1)(a) of the Act. A payment made by a Canadian employer to an employee to compensate for additional tax in Canada compared to the tax that would otherwise have been payable in his usual country of residence is an economic benefit that the employee receives from his employer, in the same capacity as the benefit in The Queen v. Phillips and, as a result, is a taxable benefit for the employee.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 46
Costs Incurred Prior to Incorporation
In the context of a joint venture that involves a number of taxpayers and is intended to lead eventually to incorporation, incorporation may be deferred until acceptance of the venture by government authorities. The preliminary costs incurred by the taxpayers prior to incorporation, some of which give rise to tax credits, are usually transferred to the corporation under the terms of a pre-incorporation mandate. Can the Department confirm that the tax credits may be claimed by the Corporation on the expenditures which it takes over and ratifies?
Answer by the Department of Revenue
The Department's position on the subject is described in Interpretation Bulletin IT-454, which indicates that the Department usually agrees to allow a newly incorporated corporation to account for transactions prior to incorporation if specific conditions are met.
These conditions were also expressed in response to question 15 at the 1981 APFF annual meeting.
1.The business had in fact commenced and expenditures had been incurred before the preliminary steps leading to the commencement of normal operation.
2.The facts clearly demonstrate that the persons authorizing the transactions had the intention of incorporating the business.
3.The time elapsed from the purchase or commencement date and the date of incorporation is relatively short.
4.The persons authorizing the transactions and the new corporation agree on the question of who should account for the transactions.
5.The combined fiscal effect is negligible.
6.The corporation ratifies any written contract concluded before its creation in its name or on its behalf.
In the matter of costs prior to incorporation that may give rise to tax credits, in our view such credits could be claimed by the new corporation inasmuch as the conditions cited at the 1981 meeting are met.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 47
Capital Gain or Income from a Concern in the Nature of Trade
In the context of acquiring all the shares of a corporation in financial difficulty, a taxpayer acquires shares having a paid-up capital of $500,000 at a cost (ACB) of $100,000. When the situation improves, the taxpayer wishes to withdraw funds and reduce the paid-up capital to $300,000.
Under the terms of subsection 40(3) of the Act, an amount of $200,000 should be taxed as a capital gain. If one assumes that the purchase was speculative in nature, might the Department consider the $200,000 gain as income from a concern in the nature of trade even if there was no disposition of shares?
Answer by the Department of Revenue
A taxpayer who holds shares in a corporation for reasons of speculation complies with the definition of the word "business" at subsection 248(1) of the Act.
In our view, the profit derived from the transaction would be business income to be included in computing the taxpayer's income under subsection 9(1) of the Act.
We are of the further view that the amount of the business profit would total $300,000 since the taxpayer did not dispose of the shares. We believe that redemption of a portion of the shares by the corporation would have been preferable, as this would allow the taxpayer to claim a part of the cost of the shares in computing his business income for the year.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 48
"De jure" Control of a Corporation
In establishing de jure control of a corporation, it seems that the Department's policy is to consider the agreement signed by the shareholders on matters of, inter alia, decision making and the appointment of directors. Under the terms of the Companies Act (Quebec) and the Canada Business Corporations Act, only unanimous agreement by shareholders can validly restrict the powers of directors. Other agreements (e.g. on flips, first refusal, vote at shareholders' meeting) have no such effect.
Does the Department distinguish between the types of agreement among shareholders in determining de jure control of a corporation? In general, what aspects of an agreement between shareholders are relevant for the Department in determining de jure control?
Answer by the Department of Revenue
In general, the Department's position is that an agreement signed between shareholders has no influence whatever on determining de jure control of a corporation for purposes of the Act, regardless of the type or nature of the agreement among shareholders. Generally speaking, if they are to have any impact on de jure control, agreements between shareholders must be included in the company by-laws and articles of incorporation.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 49
General Anti-Avoidance Provision
Section 245 of the Act always raises a good deal of uncertainty considering the lack of jurisprudence on the subject. What is the volume of assessment notices issued in Quebec and in Canada on the basis, inter alia, of section 245 of the Act? Will the Courts soon be seized of cases on the matter?
Answer by the Department of Revenue
The Department issued thirteen (13) notices of assessment, 2 of them in Quebec, in which the basis of or an alternative to assessment is section 245 of the Act. The courts are currently seized of three (3) cases, one of them in Quebec, in which section 245 is invoked.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 50
Home Buyers' Plan
An amendment to the Home Buyers' Plan (HBP) in draft legislation dated 28 March 1994 provides (new paragraph 146.01(1)(d.1)) that a withdrawal may be made if neither the individual nor the individual's spouse had an owner-occupied home in the period that began at the beginning of the fourth preceding calendar year that ended before the particular time and ended on the 31st day before the particular time. Paragraph 146.01(2)(a.1) defines owner-occupied home as the individual's principal place of residence.
Questions
1.Can a taxpayer who, during that four-year period, owned one residence only, was used only on weekends and annual holidays, be eligible for a withdrawal from the HBP to purchase a residence closer to the taxpayer's place of work?
2.Would the answer be the same if the taxpayer had sold that residence during the four-year time period and had designated it as the individual's principal place of residence for purposes of paragraph 40(2)(b)?
Answer by the Department of Revenue
The expression "principal place of residence" is not defined in the Act or the Regulations. The question of whether or not a residence is a principal place of residence is a question of fact that can only be determined after a study of all the relevant facts. The Department believes that, in general, a residence that is inhabited only a few weeks per year is not considered a principal place of residence.
The sole fact that a property has been designated by a taxpayer for purposes of paragraph 40(2)(b) is not sufficient grounds for claiming that the taxpayer inhabited it as a principal place of residence.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 51
Application of Subsections 110.6(8) and (9)
Has Revenue Canada defined its administrative policy on the application of subsections 110.6(8) and (9) of the Act in circumstances where shares not contemplated by subsection 6205(2) of the Regulations were issued before the May 1985 introduction of the capital gains exemption?
What is the situation where a single shareholder holds all the shares (those contemplated by the Regulations and those not contemplated by the Regulations) in a qualifying corporation before and after May 1985? In such circumstances, is it reasonable to consider that a significant portion of the capital gain arising from the sale of shares contemplated by the Regulations is due to the insufficiency or absence of dividends on shares not contemplated by the Regulations?
Would the answer be the same if members of the same family (parents and children) divided up shares contemplated by the Regulations and shares not contemplated by the Regulations in the same qualifying corporation?
When the only shares issued by a qualifying corporation are shares not contemplated by the Regulations for the simple fact that they are convertible to shares that do not meet the conditions set out in subsection 6205(1) of the Regulations, is it reasonable to consider that a significant portion of the capital gain arising from their disposition is due to the absence or insufficiency of dividends thereon?
Answer by the Department of Revenue
Our position is to the effect that nothing in the wording of subsection 110.6(8) of the Act or subsection 6205(2) of the Regulations enables us to ignore a non-prescribed share issued before a particular date or to consider it a "prescribed share". If, in terms of fiscal policy, it had been deemed necessary to exclude from the application of subsection 110.6(8) of the Act the non-prescribed shares issued before a particular date, we are of the view that specific provisions in this regard could have been made in subsection 6205(1) of the Regulations. This is the case, for example, in the definitions of "short-term preferred shares", "term preferred shares" and "taxable preferred shares" at subsection 248(1) of the Act, where the scope of these provisions is limited to shares issued after a particular date.
Moving on to your second question: The Department would not usually apply subsection 110.6(8) of the Act to a capital gain arising from the disposition of prescribed shares where the shareholder disposing of the shares of an active corporation carrying on a small business has always been the sole shareholder of the corporation, regardless of the date of issue of prescribed and non-prescribed shares.
If the prescribed and non-prescribed shares are divided among a number of individuals (arm's length, non arm's length), the Department, in its advance tax rulings, has taken into account the fiscal policy on capital gains deduction contemplated for qualified shares in small businesses and the 110.6(8) anti-avoidance provision when assessing the facts of a given situation; it has not applied subsection 110.6(8) of the Act to the letter. Thus, in some cases, the Department has considered that subsection 110.6(8) of the Act did not apply to disallow any capital gains deduction with regard to a capital gain made by disposing of prescribed shares, even if the increase in value of the prescribed shares may be due to the absence of dividends on other non-prescribed shares in circulation.
Finally, the question of whether a given share is or is not a "prescribed share" is a question of fact: determination of the facts rest not only on the characteristics of the share in a company's by-laws, but on any agreement in respect of the share. In a given situation, it may reasonably be concluded that, at the date of conversion of a given share, the share received in exchange is a "prescribed share" and that, as a result, the given share was a "prescribed share" on the date of issue. However, if such is not the case, in a given situation such as the one you describe, where a single class of shares is and has always been the only class of shares in circulation, and a request for an advance tax ruling was submitted in respect of planned transactions, the Department would assess the facts taking into account the fiscal policy underlying subsection 110.6(8) of the Act and the specific circumstances of the particular case in order to ensure a fair and uniform interpretation of tax legislation that respects the spirit of the law.
ROUND TABLE ON FEDERAL TAXATION
APFF - 1994 ANNUAL MEETING
Question 52
Interest Expenses - Bill Dated 20 December 1991
On 20 December 1991, the Department of Finance published draft legislation on the tax treatment of interest expenses. One of the topics covered by the Bill is interest on loans for paying dividends, redeeming shares or making loans to subsidiaries.
This draft legislation represents in many regards a change in Revenue Canada practice as stated in a number of interpretation bulletins and other publications.
(a)Does the Minister of Finance intend to table a revised version of the draft legislation?
(b)Taking into account the strict interpretation by the courts in Bronfman, illustrated, for example, in the recent 74712 Alberta Ltd. v. The Queen (1994 D.T.C. 6392), does the Department of Finance foresee measures to relax the restrictions on the deduction of interest, specifically in the matter of the criterion on "direct use" of the funds borrowed?
(c)Can a taxpayer cite the draft legislation as representing Revenue Canada's administrative policy with regard to the subjects dealt with therein?
Answer by the Department of Finance
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Answer by the Department of Revenue
(c)At the time the draft legislation was published, the Ministers of Finance and Revenue stated that Revenue Canada practices in force at that time were to be maintained until the bill was tabled. The amendments proposed in the draft legislation are thus not applicable.
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