26 July 1994 External T.I. 9402515 - APPLICATION OF SUBSECTION 15(1) IN A SPECIFIC SITUATION

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.

Principales Questions:

interpretation of subsection 15(1) of the ITA with respect to a specific situation.

Position Adoptée:

In a situation such as submitted, the benefit would normally apply in the hands of the shareholder (the Canadian trust). Concerning the calculation of the amount of the benefit without being reduced by the interest free loans provided by the shareholder to the corporation in order to finance the acquisition of personal use property. No requirement in subsection 105(1) that the taxpayer who receives a benefit from a trust has to be a beneficiary of the trust. Moreover, a benefit in respect of the upkeep, maintenance or taxes paid by a trust may arise pursuant to subsection 105(2). It would seem to us that a corporation is a "foreign affiliate" within the meaning of paragraph 95(1)(d) could be subject to proposed paragraph 95(2)(a.3), on this point to the C.I. Burland Properties Limited, 1968 DTC 5220 (SCC) that stated that the payment by a person of annual expenses in respect of a residence owned by a corporation could constitute rent or a similar payment.

Raisons POUR POSITION ADOPTÉE:

Youngman v. M.N.R., 86 D.T.C. 6584

Arthur Donovan v. Her Majesty the Queen (T.C.C) (as yet unreported (date of judgment:January 5, 1994))
question 8 of the 1990 Canadian Tax Foundation Revenue Canada Round Table
Minister of National Revenue v. C.I. Burland Properties Limited, 1968 DTC 5220(SCC)

			5-940251
XXXXXXXXXX 	 Carole Pronovost

Attention: XXXXXXXXXX

July 26, 1994

Dear Madam:

Re: Subsection 15(1) of the Income Tax Act (Canada) (the Act) - Valuation of benefit

This is in response to your letter of november 29, 1993 in which you requested our comments with respect to the application of subsection 15(1) of the Act. You describe a specific situation which can be summarized as follows:

A Canadian individual settles an irrevocable trust (the Canadian trust) in favour of his adult children. There are three trustees, namely the settlor and two arm's length professional advisors. The Canadian trust uses the settled funds to invest in a residence for the family in a European country. The purchase of that residence is made using a non-resident company (NRCo) as bare trustee for the Canadian trust. The end result is that the Canadian trust capitalizes NRCo with the purchase of common shares for a nominal amount and an interest-free loan for the bulk of the funds. NRCo will be a "controlled foreign affiliate" of the Canadian trust, which is its sole shareholder. The settlor and his wife would like to lease the residence from NRCo under which it would pay all of the annual expenses incurred with respect to the residence including upkeep and maintenance. Alternatively, the settlor and his wife could be given free use and enjoyment of the residence during their lifetimes. The annual ongoing costs relating to the property would be borne by the Canadian trust. The beneficiaries of the Canadian trust would also have the free use and enjoyment of the residence.

You have asked us to confirm that if the settlor and his wife enter into a lease as described above, they would not be assessed a taxable benefit with respect to the use of the property on the basis that the payments under the lease are in excess of the fair market rent for the property. In your view, the amount of the benefit would be calculated based on the imputed rate of return on the funds invested by NRCo in the residence, plus the cost of upkeep, less any amount paid by the Canadian trust towards such costs, less imputed interest on the interest-free loan given to NRCo to enable it to purchase the residence. You have also asked us to confirm that only the Canadian trust would be assessed a benefit since it is the only shareholder. Finally, you have asked us, if the above income tax consequences cannot be confirmed or if there are additional consequences that may apply, if the Department could provide details.

Our comments

It appears that the interpretation you seek relates to proposed transactions to be undertaken by specific taxpayers and, therefore, we bring to your attention Information Circular 70-6R2 dated September, 1990 and the Special Release thereto dated September 30, 1992, issued by Revenue Canada, Customs, Excise and Taxation. Confirmation with respect to proposed transactions involving specific taxpayers will only be provided in response to a request for an advance tax ruling. If you wish to obtain an advance income tax ruling for a particular taxpayer with respect to specific transactions which are contemplated, a written request for an advance income tax ruling can be submitted in accordance with the Information Circular. Moreover, in our view, the determination as to whether such a benefit has arisen in a particular situation, as well as the quantum thereof, involve questions of fact which can only be resolved after a review of all of the relevant facts of that particular situation. Nevertheless, we can offer the following general comments. These may or may not apply to your particular fact situation.

Valuation of the benefit

The Department's position is that there may be situations where the fair market value rental does not indicate the real value of the benefit conferred. In such cases, a better indicator of the true value of the benefit could be determined by taking into account a normal rate of return on the greater of the cost or the fair market value of the corporate asset, plus the operating costs, less any consideration paid to the corporation by the shareholder and that regardless of whether there is a lease or not. Accordingly, the payments under a lease would be relevant in determining the amount of the benefit under subsection 15(1) of the Act.

Concerning the calculation of the amount of the benefit where a shareholder has provided interest free loans to a corporation in order to finance the acquisition of personal use property, the Department has stated at question 8 of the 1990 Canadian Tax Foundation Revenue Canada Round Table that it is not prepared at this time to extend a benefit offset beyond the facts of the Youngman case (L. Youngman v. M.N.R., 86 D.T.C. 6584). The recent decision of Mr. Justice Teskey in Arthur S. Donovan v. Her Majesty the Queen (T.C.C.) (as yet unreported (date of judgment: January 5, 1994)) supports our view that the Youngman decision should be restricted to similar fact situations. In addition, the Donovan decision would appear to support the position that to the extent any imputed interest reduces the amount of a benefit under subsection 15(1), it should be included in the shareholder's income under paragraph 12(1)(c) of the Act. In the Donovan decision, Justice Teskey points out that the use of the residence is taxable because the Appellant, in fact, received interest in specie, namely exclusive use of the Florida residence which is taxable whether he is a shareholder or not of Holdings. In our opinion the situation described above is not identical to the situation found in the Youngman case.

Taxation of the benefit

The Department generally considers that a benefit has been conferred where a corporation acquires and holds property solely for the personal use of a shareholder, whether or not the shareholder has advanced the purchase price to the corporation. The extent to which the shareholder has paid related operating expenses would generally be relevant in determining the amount of the benefit. Subsection 15(1) of the Act would apply only to a person who is shareholder or to a person who receives a benefit in contemplation of becoming a shareholder. However, Revenue Canada has stated that it could apply subsection 56(2) in conjunction with subsection 15(1) of the Act so that the conferral of a benefit potentially subject to subsection 15(1) of the Act on other people with the shareholder's direction or concurrence may be taxed as income of the shareholder under subsection 56(2) of the Act. Indeed, where a corporation confers a benefit on a person other than a shareholder, the courts have considered who caused the benefit to be conferred and the purpose for conferring the benefit. Consequently, in a situation such as you submitted, the benefit would normally be taxable in the hands of the shareholder (the Canadian trust).

Other comments

We would like to point out that there is no requirement in subsection 105(1) of the Act that the taxpayer who receives a benefit from a trust has to be a beneficiary of the trust. Moreover, a benefit in respect of the upkeep, maintenance or taxes paid by a trust may arise pursuant to subsection 105(2) of the Act.

Please note also that the payment by a person of annual expenses in respect of a residence owned by a corporation could constitute rent or a similar payment. On this point, we refer you to the

Minister of National Revenue v. C.I. Burland Properties Limited, 1968 DTC 5220 (SCC). Under these circumstances, it would seem to us that a corporation that is a "foreign affiliate" within the meaning of paragraph 95(1)(d) of the Act could be subject to proposed paragraph 95(2)(a.3) of the Act (see Revised Draft Amendments to the Income Tax Act and Regulations, Foreign Affiliates and Corporate Divisive Reorganizations issued by the Minister of Finance in June 1994), that is, the rent would be required to be included in computing the income of the corporation from a business other than an active business of a foreign affiliate.

These opinions do not constitute advance income tax rulings and consequently are not binding on the Department.

We trust that the above comments will be of assistance to you.

Yours truly,

for Director
Reorganizations and Foreign Division
Rulings Directorate
Policy and Legislation Branch