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.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 1
Application of section 43.1 in Quebec
Pursuant to section 43.1 of the Income Tax Act, the gift of a remainder interest in real property triggers the deemed disposition of the life estate. However, there is no deemed disposition if this gift is made to a registered charitable organization.
Pursuant to subsection 248(3) of the Act, the creation, in the province of Quebec, of a usufruct, a substitution or a right of use or of habitation triggers a deemed disposition of the property subject to the severance of the right of ownership.
In light of this difference in treatment, does the Department plan to apply the exception provided for in section 43.1 of the Act when a usufruct, a substitution or a right of use or of habitation is created in the province of Quebec?
Revenue Canada’s reply
The Department is of the view that the situations referred to in section 43.1 of the Act do not apply to usufructs, substitutions and rights of use or of habitation created in the province of Quebec. These severances of the right of ownership are not life estates. The former are civil law concepts, while the latter is a common law concept.
We have advised the Department of Finance of this situation.
Department of Finance comments
The common law concept of remainder interest is, in our view, similar to a usufruct with a term of life or a right of use concerning a real property in Quebec civil law. We are of the opinion that the usufructuary with a term of life and a right of use could be in a situation comparable to the holder of a remainder interest within the meaning of common law and we would be willing to consider granting similar treatment if such a request were submitted.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 3
Application of subsection 55(2)
Mr. A holds non-participating voting shares in corporation ABC Inc. which allow him to exercise de jure control of said corporation. His two adult children, Mr. B and Mrs. C, each hold 50% of the participating non-voting common shares of ABC Inc. through their respective holding companies, i.e. B Inc. and C Inc. Each common share issued and outstanding of ABC Inc. has a paid-up capital of $1, an adjusted cost base of $1 and a fair market value of $1,000. The earned income on hand per share is $600.
Does subsection 55(2) of the Act apply in each of the following two situations?
1. ABC Inc. buys back all of its common shares owned by Mr. B’s holding company. C Inc. then becomes the sole common shareholder of ABC Inc.
2. ABC Inc. simultaneously buys back all of its common shares issued and outstanding and Mr. A subscribes for new common shares.
Revenue Canada’s reply
Mr. A and Mrs. C are related to each other pursuant to paragraphs 251(2)(a) and 251(6)(a) of the Act because they are connected by a blood relationship. Mr. A and Mr. B are also related to each other according to paragraphs 251(2)(a) and 251(6)(a) of the Act. However, Mr. B and Mrs. C are not related to each other for the purposes of section 55 of the Act by reason of subparagraph 55(5)(e)(i), which provides that persons are deemed not to be related to each other if one is the brother or sister of the other.
Mr. A and ABC Inc. are related to each other pursuant to subparagraph 251(2)(b)(i) of the Act because Mr. A controls ABC Inc. B Inc. and Mr. A, as well as C Inc. and Mr. A, are related to each other according to subparagraph 251(2)(b)(iii) of the Act since Mr. A is related to each of the persons who control these two corporations. B Inc. and ABC Inc., as well as C Inc. and ABC Inc., are related to each other pursuant to subparagraph 251(2)(c)(ii) of the Act because each corporation is controlled by a person and the person controlling one of the corporations is related to the person who controls the other corporation.
B Inc. and C Inc. are related to each other pursuant to subsection 251(3) of the Act because they are both related to the same corporation, i.e. ABC Inc. Subparagraph 55(5)(e)(i) of the Act does not prevent B Inc. and C Inc. from being related to each other for the purposes of section 55 of the Act. In our view, this result seems questionable from a tax policy standpoint and we have so informed the Department of Finance.
Subsection 55(4) of the Act could, however, result in B Inc. and C Inc. not being related to each other for the purposes of section 55 of the Act if it can reasonably be considered that one of the main purposes of Mr. A’s acquisition of shares in corporation ABC Inc. was to cause B Inc. and C Inc. to be related to each other so that subsection 55(2) of the Act would not apply.
It therefore follows, for the purposes of the application of paragraph 55(3)(a) of the Act, except if subsection 55(4) of the Act is otherwise applicable, that in the case where B Inc. is the dividend recipient, ABC Inc. and C Inc. would not be “unrelated persons” within the meaning of paragraph 55(3.01)(a) of the Act; and that, in the case where B Inc. and C Inc. are the dividend recipients, ABC Inc. and Mr. A would not be “unrelated persons” within the meaning of paragraph 55(3.01)(a) of the Act.
Consequently, subsection 55(2) of the Act would not apply by reason of the buy-back of the shares in B Inc. in situation 1 above, or by reason of the buy-back of the shares in B Inc. and C Inc. in the second situation, insofar as subsection 55(4) does not apply, because there is no “unrelated person” involved in the transactions and consequently none of the facts referred to in paragraph 55(3)(a) of the Act has occurred.
Department of Finance comments
Subsection 55(4) of the Act constitutes a specific anti-avoidance provision which ensures that subsection 55(2) applies. Subsection 55(4) provides, among other things, that when it can reasonably be considered that one of the purposes of a series of transactions or events was to cause persons to be related to each other so that subsection 55(2) does not apply, these persons shall be considered not to be related to each other. It is a question of fact as to whether or not subsection 55(4) applies to particular circumstances. When the ownership structure of the capital stock pre-dates the series of transactions or events, subsection 55(4) would generally not apply to cause persons who are otherwise related to be unrelated.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 4
Inducement payments
Following the decisions handed down by the Supreme Court in the Toronto College Park and Canderel cases, what is the position of Revenue Canada with respect to the deduction of tenant inducement payments, whether paid in the form of:
- cash payments,
- free rent, or
- interior fit-up.
Revenue Canada’s reply
For the purposes of this reply, we consider the Toronto College Park and Canderel cases to be equivalent. Our comments are therefore limited to the latter case.
We would first of all like to point out that these two cases dealt with payments which the parties had recognized as running expenses. In our view, one of the main features of this case is the affirmation by the Supreme Court that the goal of computing profit for income tax purposes is to obtain an accurate picture of a taxpayer’s income for the year.
The matching principle is one of the generally accepted business (or accounting) principles examined in the decision handed down in the Canderel case. In light of the Supreme Court ruling, the Department accepts that the matching principle is not a rule of law. However, the matching principle remains a factor to be taken into consideration in establishing as accurate as possible a picture of the profit. The following is what the Supreme Court had to say on this point (on page 16 of the English version of the ruling):
It would be unwise for the law to eschew the valuable guidance offered by well-established business principles. Indeed, these principles will, more often than not, constitute the very basis of the determination of profit.
Finally, the Supreme Court commented further on this point (on page 23 of the English version of the ruling):
In circumstances where an expenditure is incurred principally for the specific purpose of earning a discrete and identifiable item of revenue, it will generally yield a more accurate picture of profit to deduct that expenditure from taxable income in the year in which the revenue is realized.
The Supreme Court set out six principles for the computation of profit for the purposes of the Income Tax Act which must be applied to each particular case in order to determine whether the income was computed in accordance with the existing legal framework and whether this income yields an accurate picture of the taxpayer’s profit for the year in question.
Running expenses
In applying these six principles to the decision handed down in the Canderel case, the Supreme Court held that the tenant inducement payments in question were running expenses not subject to the matching principle. The Court ruled that the deduction of these payments gave an accurate picture of profit for the year and that it had not been proven to the Court that matching these payments with income over the term of the leases would have yielded a more accurate picture of profit in the particular circumstances of this case. The Court referred to the conclusions of Brûlé J. of the Tax Court of Canada, who found that the payments made by Canderel created significant and numerous benefits immediately in the year of the payment.
When the facts are identical to those of the Canderel or Toronto College Park cases, the Department accepts that tenant inducement payments are deductible as running expenses. However, as was mentioned earlier, the basic question in any specific situation is to establish as accurate as possible a picture of a taxpayer’s profit, and in situations different from the Canderel case it might be appropriate to apply the matching principle in respect of the deductibility of inducement payments. This question can be resolved only after an examination of each particular situation.
As for the value of free rent given as an inducement, the Department is of the opinion that this transaction has no effect on the income or expenses of the lessor or the lessee.
Capital expenses
When the tenant inducement payments take the form of interior fit-up expenses incurred by the lessor, we are of the opinion that it must first be determined whether these payments constitute running expenses or instead an amount to be added to the capital cost of a property of the lessor.
Adjustments requested by taxpayers
The question arises as to whether the Department would allow taxpayers who filed their returns based on the decision handed down by the Federal Court of Appeal in Canderel to request adjustments in order to take the Supreme Court decision into account.
The Department’s policy in this regard is set out in Information Circular 75-7R3. Point e) of paragraph 4 of this circular specifies that a reassessment for the purpose of creating a refund will not be made if the refund request is based solely on a successful appeal to the courts by another taxpayer. Consequently, adjustment requests which are based solely on the Supreme Court decision in Canderel will not be processed.
Undepreciated balance of inducement payments
The question also arises as to whether the Department would allow taxpayers who filed their 1995 and 1996 returns based on the decision handed down by the Federal Court of Appeal in Canderel to claim the undepreciated balance of inducement payments in 1997, based on the Supreme Court decision.
We are of the opinion that this will depend on the individual facts in a given situation. When the facts are identical to those in the Canderel case (or in the Toronto College Park case) and the inducement payments are rightly considered running expenses which would have been otherwise deductible in the year they were incurred, it would be appropriate to deduct the undepreciated balance of the inducement payments in the current year’s return.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 5
Late-filed designation under paragraph 55(5)(f) ITA
Following the decision of the Federal Court of Appeal in R. v. Nassau Walnut Investments Inc. (97 DTC 5051), does the Department of Finance plan to amend the provisions of section 55 of the Act to limit the situations where a late-filed designation under paragraph 55(5)(f) ITA will be allowed?
Department of Finance reply
The Department of Finance is considering the advisability of recommending an amendment to the Act to allow a late-filed designation subject to the payment of a penalty.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 6
Income splitting
The Supreme Court of Canada confirmed in Neuman v. R. (98 DTC 6297) that subsection 56(2) ITA was not applicable to dividends unless the taxpayer in question had a pre-existing entitlement to the dividends.
Does Revenue Canada plan to change its position with respect to income splitting by means of declaring dividends? Will Revenue Canada vacate the assessments issued to a number of taxpayers by reason of the payment of discretionary dividends? Does the Minister of Finance plan to amend subsection 56(2) ITA?
Revenue Canada’s reply
In the Neuman case, Mr. Neuman transferred in 1981, in the course of a tax rollover to the corporation Melru Ventures Inc., shares he owned in another corporation in exchange for a certain number of class “G” shares having a fair market value of $120,000. In addition, Mr. Neuman’s wife subscribed for class “F” shares of the corporation in exchange for a consideration of $99. The class “F” and “G” shares paid discretionary dividends. In 1982, the corporation paid a dividend of $5,000 to the holder of the class “G” shares and a dividend of $14,800 to the holder of the class “F” shares. After cashing her dividend, Mrs. Neuman loaned an equivalent amount to Mr. Neuman. The loan was never repaid. The Department included the $14,800 dividend received by Mrs. Neuman during 1982 in computing Mr. Neuman’s income under subsection 56(2) of the Act.
Subsection 56(2) of the Act applies to a taxpayer if the following four conditions are satisfied:
a) a payment or transfer of property is made to a person other than the taxpayer;
b) the payment or transfer is made pursuant to the direction of or with the concurrence (even if only implicit) of the taxpayer;
c) the payment is made for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person;
d) the amount would have been included in the taxpayer’s income if the payment or transfer had been made to the taxpayer.
The Supreme Court of Canada did not uphold the Department’s position in the Neuman case. As you mention, the Court found that, unless the taxpayer in respect of whom a reassessment is made had a pre-existing entitlement to the dividend income paid to the shareholder of a corporation, the fourth pre-condition mentioned above cannot be satisfied. Consequently, subsection 56(2) of the Act cannot operate to attribute the dividend income to that taxpayer for income tax purposes.
Following this Supreme Court of Canada decision, the Department does not plan to assess taxpayers under subsection 56(2) of the Act in cases similar or identical to the Neuman case.
Similar or identical objections and appeals, set aside pending this decision, have been allowed.
However, with regard to taxpayers who were assessed under subsection 56(2) of the Act in respect of discretionary dividends before the ruling in the Neuman case was handed down by the Supreme Court and who did not object to such an assessment within the specified time limit, the Department will follow its usual policy in such cases and will not issue reassessments for the purpose of granting refunds to these taxpayers by reason of the Neuman decision.
Department of Finance reply
We are currently examining the effects of the Neuman decision. No decision has yet been taken on the advisability of recommending a legislative amendment in light of this decision.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 7
Income earned or realized by a corporation
For purposes of the application of section 55 of the Act, Revenue Canada makes an important distinction between income earned or realized by a corporation after 1971 (“earned income”) and earned income on hand. In calculating earned income on hand, the Department is of the view that the provincial and federal tax paid by the corporation must be deducted from earned income. To the extent that the corporation has realized a windfall gain that is in no way attributable to any increase in its goodwill, should its earned income on hand not be increased accordingly?
Revenue Canada’s reply
The earned income of a corporation corresponds to its net income calculated in accordance with section 3 of the Act, taking into account the adjustments provided for in paragraphs 55(5)(b) to (d) of the Act. Windfalls are not included in the calculation of net income and are not part of the adjustments provided for in paragraphs 55(5)(b) to (d) of the Act. Windfalls therefore cannot be added in calculating the earned income of a corporation.
Other adjustments must be made to earned income to arrive at the amount of the earned income which remains on hand (“earned income on hand”) and which would contribute to the capital gain that would have been realized upon disposition of a share of a corporation. For example, the provincial and federal taxes payable by a corporation are not deducted from the net income of the corporation since they represent non-deductible amounts. Therefore, they do not reduce the corporation’s earned income. However, since such amounts cannot be considered as contributing to the capital gain that would have been otherwise realized upon disposition of a share of the corporation, they must be deducted in calculating earned income on hand.
It therefore follows that the portion of a capital gain which, without a dividend, would have been realized upon disposition of a share and which can reasonably be considered attributable to something other than earned income includes not only the increase in value of the goodwill of a corporation, but also the untaxed realized gains.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 8
Effect of resolutory and suspensive clauses
Property transfers are subject to the principles of civil law and tax law. It has been established that the principles of tax law are subordinate to those of civil law (Perron v. MNR (1960) 25 TAX A.B.C. 166).
Articles 1507 and 1750 of the Quebec Civil Code set out the rules governing contracts containing suspensive conditions and resolutory conditions. A suspensive condition can be defined as a condition which suspends "the effects of the contract" while a resolutory condition can be defined as a condition which suspends the "cancellation of the contract". This resolutory condition, when satisfied, cancels the sale retroactively.
From a tax standpoint, the sale produces its full effects as soon as it is concluded and the vendor is immediately entitled to the sale price. Hence, disposition occurs at that moment. In the event that the transaction is not completed by reason of a resolutory condition, Revenu Québec recognizes the retroactivity from a tax standpoint and does not apply sections 484 to 484.13 of the Quebec Taxation Act.
According to paragraphs 5 and 17 of Interpretation Bulletin IT-170R, Revenue Canada does not recognize the retroactivity of the cancellation from a tax standpoint and applies sections 79 and 79.1 ITA depending on the case.
Does the Department of Finance of Canada recognize this position? Is it willing to review it in light of the rules of the Quebec Civil Code?
Does Revenue Canada still maintain this position? Is it willing to review it in view of the Quebec Civil Code which governs transactions effected in Quebec?
Revenue Canada’s reply
There are two legal principles which are in conflict in this question. As you point out, tax law applies to the effects produced by civil law. However, the Department must, in computing the taxes payable for a taxation year, operate on the basis of the facts as they exist at the end of a taxation year
In our opinion, recognition of the retroactive effect of the cancellation of a sale is not compatible with the Act read as a whole. The Act is not designed to allow the application of new facts that occur during a taxation year to a prior taxation year. To this end, it does not allow reassessments in respect of statute-barred taxation years in order to apply retroactivity.
Moreover, in Clément Alepin (79 DTC 5259) and Michel Larose (92 DTC 2045), the courts refused to apply, for the purposes of the Act, the retroactivity provided for in civil law. In these two cases, the honourable justices stressed that the rights of the Department could not be affected following the cancellation of sale contracts.
Department of Finance reply
The Department of Finance agrees that the tax legislation must take the relevant provincial law into account. However, certain basic principles of tax law, such as those applicable to retroactivity, may not be entirely compatible with certain effects of provincial law. This is also the case of partnerships, which, regardless of their attributes, rights and obligations under provincial law, are generally not recognized in tax law.
We wish to examine the analysis of Revenue Canada, Revenu Québec and Justice Canada on this question in greater detail before concluding that Revenue Canada’s position is not appropriate in the circumstances. However, we share Revenue Canada’s concerns about certain practical aspects, such as the restrictions imposed in the case of statute-barred years.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 9
Oerlikon Aerospace Inc. and Part I.3 tax
In Oerlikon Aerospace Inc. (97 DTC 694), Archambault J. of the Tax Court of Canada upheld Revenue Canada’s position by concluding that the provisions of Part I.3 of the Act (tax on large corporations) had to be interpreted based on accounting concepts. However, in the brief filed with the Federal Court of Appeal, this argument was not taken up by Revenue Canada. Can Revenue Canada explain its position?
Revenue Canada’s reply
The Department prefers not to comment on this case since this case is currently under appeal.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 10
Immigrant trust and attribution rules
A non-resident individual who plans to become a resident of Canada could establish a non-resident trust in order to take advantage of the provisions set out in section 94, pursuant to which this individual could reside in Canada for a period of up to 60 months before the income from the trust is taxable under this section. However, other provisions of the Act could apply in a particular situation, notably subsections 75(2) and 56(4.1) as well as sections 74.1 to 74.5 (hereinafter referred to as “attribution rules”). The Department has already stated that where the non-resident trust has been structured in such a way as to avoid the application of these other provisions, the general anti-avoidance provision may apply.
In the context of the establishment of such a trust, could the Department specify in what situations it plans to invoke the general anti-avoidance provision when the attribution rules are avoided?
Has Revenue Canada already issued or would it be willing to issue advance rulings with respect to the establishment of such a trust?
Revenue Canada’s reply
The question of determining whether subsection 245(2) of the Act applies to a transaction or to a series of transactions is a question of fact. In the current context, the Department comments on the application of subsection 245(2) only after examining all the facts and circumstances relating to a given situation.
Revenue Canada has already issued and will issue advance rulings concerning the application of the general anti-avoidance provision in respect of planned transactions, including the creation or establishment of a non-resident trust by a non-resident individual who plans to become a resident of Canada.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 11
Limited liability company and tax convention
A limited liability company (LLC), incorporated in the United States and all of whose members are residents of the United States, signs a computer software licensing contract with a resident of Canada. Under the licensing contract, royalties are paid to the LLC and, pursuant to subsection 212(1)(d) of the Act, the Canadian resident must make a source deduction of 25%.
According to Revenue Canada, a LLC is not considered a resident under the tax convention and, a priori, the exemption in paragraph XII(3)(b) of the tax convention is not available. It is probable that the source deduction of 25% of the gross amount exceeds the U.S. tax payable by the members of the LLC in the United States, with the result that the Canadian source deduction will not be fully eligible for the foreign tax credit in the United States.
In these circumstances, could Revenue Canada consider granting an administrative exemption from the source deduction requirement under Part XIII of the Act?
Could the Department of Finance inform us about the current status of the negotiations between Canada and the United States concerning the application of the tax convention to a LLC?
Revenue Canada’s reply
When a LLC is not subject to U.S. tax, it is not considered resident in the United States for the purposes of the application of the Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital. Consequently, paragraph XII(3)(b) of the convention does not apply and the royalty payment is subject to tax under Part XIII of the Act at a rate of 25%.
Revenue Canada does not plan to grant the payer an administrative exemption from the source deduction requirement under Part XIII of the Act in respect of amounts paid or credited or deemed under Part I of the Act to be paid or credited to a LLC.
Department of Finance reply
As you probably know, there are several issues raised by the convention and “hybrid entities”, i.e. entities that are partnerships under the law of one State and corporations under the law of another State.
To simplify, these issues can be divided into two types. Those of the first type relate to payments made to residents of Canada by a LLC which they own. These are northward payments. Those of the second type concern income derived from Canada by a LLC held by American investors. These are southward payments.
Of these two types of payments, northward payments were the greatest cause of concern for the United States. We had informal preliminary discussions with the U.S. delegation before Congress decided to settle the matter unilaterally, a few months ago, by denying the advantages of the convention when the payments are not immediately subject to Canadian tax. At that point, it appeared that these issues had become less of a priority from the American standpoint.
Having said this, we remain willing to discuss important questions, such as the one asked here. However, since this question concerns the taxation of U.S. residents, one would expect that it be asked instead by the U.S. delegation.
In any event, we expect to hold discussions with the U.S. delegation shortly concerning the convention, in light of the commitment we made in 1995 to review certain aspects of the relevant provisions after three years. It is possible that this issue may be raised in the context of these discussions.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 12
Holding of residential real property located in the United States - Single purpose corporation
According to Revenue Canada administrative policy, it is possible to use a Canadian corporation to hold a residential real property located in the United States without a taxable benefit being deemed to have been received by the shareholder using the real property for personal purposes. Following the new protocol to the Canada-U.S. Income Tax Convention in 1995, Revenue Canada announced that this administrative policy was under study. Could the Department give us an update on the status of this study? If the administrative policy is changed, does Revenue Canada plan to apply grandfathering measures to existing arrangements?
Revenue Canada’s reply
During the 1980 annual conference of the Canadian Tax Foundation, we indicated that we would not attribute a taxable benefit under subsection 15(1) of the Act to a shareholder in the situation where a corporation was used for the sole purpose of holding a condominium or other residence located in the United States in order to reduce U.S. estate taxes, provided certain conditions were met. We then replied to other questions on the same topic and added other pre-conditions.
Following the new Canada-U.S. Protocol in 1995, the Department decided to reconsider the objective of such single purpose corporations. When we announced that this administrative policy was under study, the Department required that the following seven conditions be met before applying this administrative policy:
1. The corporation must be a Canadian corporation within the meaning of subsection 89(1) of the Act.
2. The corporation’s only objective is the holding of a residential real property in the United States for the personal use or enjoyment of the shareholder.
3. The shares of the corporation are held by an individual or an individual and persons (other than a corporation) related to the individual.
4. The only transactions of the corporation relate to its objective of holding property in the United States for the personal use or enjoyment of the shareholder.
5. The shareholder would be charged with all the operating expenses of the property by the corporation, with the result that the corporation would show no profit or loss with respect to the property on any of its returns.
6. The corporation acquired the property with funds provided solely by the shareholder and not by virtue of his holdings or that of a related person in any other corporation.
7. The property must be acquired by the corporation on a fully taxable basis, that is, without the use of any of the rollover provisions of the Act.
At this time, we have not completed the study concerning single purpose corporations or decided whether grandfather protection will be granted to the shareholders of such corporations. We are still planning to publish the conclusions of this study in an edition of the “Technical News” bulletin. In the meantime, the administrative policy referred to above remains in effect.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 13
Reporting of foreign investments
On October 2, 1997, Revenue Canada and the Department of Finance announced that they were suspending the requirement to file information returns in respect of specified foreign property exceeding $100,000 pending a report by the Auditor General of Canada.
Following the tabling of the report of the Auditor General of Canada on June 5, 1998, what is the reaction of the Department of Finance and of Revenue Canada on this matter?
Does the Department of Finance plan to make the amendments proposed by the Auditor General of Canada?
Can the Department of Finance confirm that taxpayers will not be required to file an information return for the 1996 and 1997 taxation years?
Revenue Canada’s reply
On March 5, 1996, the government made public a draft bill aimed at implementing the new reporting requirements for foreign investments announced in the budget of February 27, 1995. The bill stipulated that taxpayers who own certain foreign property whose total cost exceeds $100,000 would be required to file information returns in respect of this property. These measures were intended to combat tax avoidance and evasion stratagems involving foreign financial arrangements. These arrangements usually involved tax havens where tax rates are low or non-existent and where secrecy laws hamper the process of verifying foreign-source income.
As you mention, in a release on October 2, 1997, the Ministers of National Revenue and Finance announced that the government was delaying until April 1999 the requirement to report foreign investments whose total cost exceeds $100,000. This measure contained in Bill C-92, which received Royal Assent on April 25, 1997, was initially supposed to apply beginning in April 1998. In the interim, the Auditor General of Canada was asked to determine the effectiveness of this reporting requirement. This release also stipulated that trust and foreign affiliate tax reporting requirements continued to apply to the 1998 return filing period. Furthermore, it was announced that the requirement to file the new foreign investment reporting return was suspended for the duration of the study.
The Auditor General of Canada tabled his report on June 5, 1998. The Auditor General’s mandate included determining whether the requirement under section 233.3 of the Act to report foreign property was the appropriate mechanism for encouraging greater compliance with the Act. In his report, the Auditor General concluded that the filing requirement under section 233.3 of the Act constitutes an appropriate mechanism, in the context of an overall strategy, both for enhancing compliance with legislative provisions and for providing Revenue Canada with information enabling it to verify the assessments calculated by taxpayers. However, the Auditor General suggested changes in the form of the filing requirement in order to reduce the compliance burden and alleviate taxpayers’ concerns.
After studying the Auditor General’s recommendations, the Minister of National Revenue announced, on August 20, 1998, the institution of measures aimed at simplifying the process of verifying foreign-source income.
The main measures proposed are as follows:
a) For the 1996 and 1997 taxation years, taxpayers are no longer required to file the return specified in section 233.3 of the Act. For individuals, the first filing deadline was delayed until April 30, 1999 for the 1998 taxation year.
b) Proposed form T1135 will be simplified. Taxpayers will only have to indicate the type, location and range of their foreign investments, by checking boxes, and specify the amount of the income from this property.
c) Various penalties are provided for in the Act with respect to filing the return specified in section 233.3 of the Act. The Department will assess the level of compliance with the rules to determine whether the 5% penalty based on the cost amount of the property, stipulated in paragraph 162(10.1)(d) of the Act, is really necessary.
d) To promote voluntary compliance with the Act, the Department will emphasize public information and awareness-raising activities and not only penalties.
Department of Finance reply
The government’s position was made public by the Minister of National Revenue at a press conference held on August 20, 1998. The Minister announced simplified procedures for verifying foreign-source income earned by Canadian residents. Under a new simplified reporting method, taxpayers will have to indicate only the type and location of the investment for various asset classes by checking the appropriate box on the return form. A detailed description for each specific investment will no longer be required. Mr. Dhaliwal also announced that the measures aimed at improving verification of foreign income, including penalties calculated based on the cost of the asset, will be reviewed in light of the analysis of the first two years affected by the reporting procedure. During the review period, Revenue Canada may emphasize information and the search for measures aimed at ensuring maximum voluntary compliance. Penalties for failure to file or late filing, as well as for underreporting of income, will be applied beginning in April 1999.
The changes announced by Minister Dhaliwal do not require any legislative amendment other than establishing the requirement to file a return for investment income and income from foreign property for any taxation year of the taxpayer after 1997. We intend to include this amendment in an upcoming bill.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 14
Emigration from Canada
On October 2, 1996, the Department of Finance announced proposed amendments to section 128.1 concerning the tax rules at the time of emigration from Canada. These proposed amendments were included in a Notice of Ways and Means Motion aimed at amending the Act, but have not yet been drafted in a bill.
How does Revenue Canada administer this provision for residents of Canada who became or will become non-residents after October 2, 1996? Must taxpayers file form T1161, which is still in draft form?
Could the Department of Finance indicate what is the current status of the proposed amendments and whether it intends to make changes to the amendments set out in the Notice of Ways and Means Motion?
Revenue Canada’s reply
A taxpayer who ceased to be a resident of Canada after October 1, 1996 has the option of filing his income tax return on the basis of the current provisions of the Act, or on the basis of the measures proposed on October 2, 1996 as if they had been adopted, provided the taxpayer so wishes to file his return on the basis of the proposed measures.
The Department accepts, on an administrative basis, to assess taxpayers on the basis of the proposed measures if they file their returns on that basis.
A taxpayer who files his income tax return on the basis of the current provisions of the Act can still provide, with his income tax return, the necessary information with respect to deemed dispositions under the proposed measures in order to allow the Department to reassess him when the proposed measures have been adopted. Taxpayers are not, however, required to provide this information as long as the proposed amendments have not been adopted. However, taxpayers who did not provide this information will have to do so without delay once the proposed measures have been adopted.
Taxpayers are not required to file form T1161 “List of Properties by an Emigrant of Canada” published in draft form. The only purpose of this form for the time being is to facilitate matters for taxpayers who wish to file their return on the basis of the proposed measures.
Taxpayers are not required to pay the additional taxes resulting from the proposed measures before the date said measures are adopted. Taxpayers who intend to take advantage of the proposed measures allowing payment of the taxes to be deferred until the property has actually been sold will have to provide security acceptable to the Department. However, the Department may not demand such security until after the proposed measures have been adopted. On the other hand, the Department will not assess a taxpayer on the basis of the proposed measures if the taxpayer refuses to pay the additional taxes as assessed on the basis of the proposed measures or to provide security acceptable to the Department with respect to those additional taxes.
Finally, the Department cannot comment on the application of interest or penalties on the additional taxes resulting from the proposed measures before a bill is made public.
Department of Finance reply
These proposals, announced in October 1996, have been maintained. We have examined the suggestions of tax specialists and taxpayers in order to draft detailed proposals that are consistent with the policy announced, while taking into account the comments and concerns expressed.
At the technical level, our work is progressing and we have reached the essentially political decision to move ahead with these proposals. You will understand that we are not in a position to specify either the date or the content of a possible release on the subject. However, we can assure you that all the comments received have been carefully studied.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 15
Inactive foreign affiliates
On forms T1134A and T1134B, Revenue Canada provides an administrative exemption from the requirement to file an information return in the case of an “inactive” foreign affiliate, the criteria for which are described in the guide.
Does the Department of Finance plan to amend the Act in order to make specific provision for this filing exemption?
Department of Finance reply
The Department agrees with the administrative position of Revenue Canada on this point and therefore does not intend to recommend amendments to the Act. Subsection 233.4(4) of the Act provides that a reporting entity shall file with Revenue Canada a return in prescribed form in respect of each of its foreign affiliates. The legislation deliberately authorizes the use of a “prescribed form” for the avowed purpose of granting Revenue Canada the necessary latitude to design and modify forms as necessary to meet its information needs.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 16
Exemption from filing a return in respect of foreign investments for first-year residents
In its French version, section 233.7 of the Act provides an exemption from filing the information returns specified in sections 233.2, 233.3, 233.4 and 233.6 if the individual began residing in Canada in the year. The French version of the Technical Notes on this section is similarly worded. However, according to the English version of the Act and the Technical Notes, individuals will not be required to file a return for the year in which they first become residents of Canada.
Can Revenue Canada confirm that the exception provided for in section 233.7 would apply to a non-resident who is a former resident of Canada and who again becomes a resident of Canada in the year?
Revenue Canada’s reply
We are of the opinion that the intention of the legislator is to grant an exemption from the requirement to file these returns only in the case where an individual becomes a resident of Canada for the first time. We believe that the French version of section 233.7 of the Act and the associated Technical Notes do not correctly reflect the legislator’s intention and we have so informed the Department of Finance.
Consequently, an individual who has already been a resident of Canada during a prior year, whether he was a de facto resident of Canada or a deemed resident of Canada at that time, could not take advantage of the exception provided for in section 233.7 of the Act when he again becomes a resident of Canada during a given year.
Department of Finance comments
A former resident of Canada who again becomes a resident of Canada in a year cannot take advantage of the exception provided for in section 233.7 of the Act. The intention of section 233.7 of the Act is to grant a filing exemption to individuals in the year they first become residents of Canada. An individual can begin to reside in Canada only once. We are studying the possibility of amending the wording of the French version of this section to make this point clear.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 17
Charitable gifts
According to paragraph 3 of Interpretation Bulletin IT-110R3, a gift, for the purposes of sections 110.1 and 118.1 of the Act, is a voluntary transfer of property without valuable consideration to a registered charitable organization. According to paragraph 9 of this same bulletin, any legal obligation on the payor to make a donation would cause the donation to lose its status as a gift. However, the paragraph also notes that when a taxpayer honours a pledge, the amount can be considered to be a gift despite its having been paid to honour an obligation, if the obligation was entered into voluntarily and without consideration.
Is the gift made to a charitable organization eligible for the purposes of section 118.1 of the Act in the following situation which is not an exception but a normal sentencing method?
A director of a corporation pleads guilty before a criminal court to a charge of fraud against Employment and Immigration Canada (but solely for the benefit of the corporation’s employees) in the course of administering the unemployment insurance plan. The director’s attorney suggests to the court, which accepts, a conditional discharge accompanied by a probation order stipulating a gift to a registered charitable organization instead of a fine, so that the director will not have a criminal record.
The amount of the gift suggested by the director is equivalent to the amount of the fine which would be levied in the event of a conviction and it should be noted that it is up to the court to decide, when it receives the request, whether the conditions prescribed by law for a conditional discharge are met, i.e. whether it considers that it is truly in the interest of the accused and does not harm the public interest.
Revenue Canada’s reply
The word “gift” is not defined in the Act; we must rely on the ordinary meaning of the term and the legal precedents. It should be noted that the exception mentioned in paragraph 9 of Interpretation Bulletin IT-110R3 concerns a situation where a taxpayer personally guarantees a loan made to a charitable organization. In this case, the taxpayer entered into the obligation voluntarily and without consideration and, in our opinion, this situation cannot be considered equivalent to the one discussed here.
We are of the opinion that when an amount is paid to a charitable organization pursuant to an agreement with a court, as described in the situation above, the amount does not constitute a gift for the purposes of section 118.1 of the Act. The amount in question represents a consideration paid to avoid a fine and a criminal record, and therefore the payment to the charitable organization was not made voluntarily, without consideration and without any benefit of any kind. Furthermore, it cannot be said that the payment was motivated by generosity or disinterested magnanimity.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 18
Stock options
Mr. A is an employee of corporation Opco X, which holds preferred and common shares of corporation Opco Y.
Opco X offered to Mr. A the option of acquiring the preferred shares held in corporation Y at par value. This option was granted to him in the context of his employment. When the options expire, Mr. A will be subject to the provisions of subsection 7(1) ITA.
Corporation Opco Y’s sole asset is all of the shares in a corporation which a public corporation would be interested in acquiring.
Mr. A would like to be able to acquire options of the public corporation in exchange for the options he holds in corporation Opco Y without triggering the application of the provisions of subsection 7(1) of the ITA.
To this end, a new corporation would be incorporated, Opco Z, whose common shares would be issued to corporation Opco X. Opco X would transfer its preferred shares in corporation Opco Y to corporation Opco Z. In consideration, it would receive shares of Opco Z of the same type and having the same value. There would be a new stock option agreement between Opco X and Mr. A which would provide for the exchange of the options to acquire the preferred shares of Opco Y for options to acquire the preferred shares of Opco Z.
Opco Z would then transfer, by means of a tax rollover, the shares it now holds in Opco Y at their fair market value to the public corporation in consideration for shares of the public corporation of the same value. This transaction would be followed by the amalgamation of the public corporation and Opco Z, with the result that Mr. A then holds options to acquire shares of the public corporation.
A reading of subsection 7(1.4) ITA makes it immediately clear that the benefit described in subsection 7(1) ITA is applicable when the public corporation and Opco Z amalgamate because the corporation cited in the example above is not Opco Z, but rather Opco X, which is not related to the corporation resulting from the amalgamation.
However, the Technical Notes suggest that such a transaction would be allowed without immediate tax consequences.
What do you think?
Revenue Canada’s reply
We agree with your interpretation on the application of subsection 7(1) and we believe that the Technical Notes are not drafted with sufficient precision to allow us to conclude that such a transaction could be made without tax consequences.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 19
Deductibility of interest
Corporation X is held by several persons including corporation Y. Corporation X wishes to buy back the shares held by corporation Y.
If corporation X borrowed money to buy back the shares of its capital stock held by corporation Y, the interest on the loan would not be deductible since the money borrowed would exceed the total of the paid-up capital of the shares bought back and the accumulated earnings.
In addition, corporation B wishes to acquire shares in corporation X.
Corporation B incorporates a wholly-owned subsidiary, corporation C, which borrows an amount of money from a financial institution and then invests it in corporation X in exchange for common shares of the latter.
Corporation X then buys back the shares held by corporation Y.
Finally, corporations X and C are merged.
Will the interest on the money borrowed by corporation C, and now incurred by the corporation resulting from the amalgamation of corporations X and C, be deductible?
Revenue Canada’s reply
The situation described above concerns the Department’s position set out in Interpretation Bulletin IT-315, which allows the deductibility of the interest on a loan contracted by a corporation to acquire the shares of another corporation which is then amalgamated with the acquiring corporation under subsection 87(1) or wound up under subsection 88(1) of the Act.
This position, applicable when transactions are made between persons who deal at arm’s length, is based on the principle that the funds borrowed by a corporation to acquire all or almost all of the shares of another corporation which will be amalgamated or wound up are essentially borrowed to acquire the assets of the corporation amalgamated or wound up. It applies to cases where a person simultaneously acquires control and all or almost all of the shares of a target corporation through a loan whose interest would be deductible; furthermore, these cases must not result in avoidance or undue tax advantage.
The facts described above do not allow us to conclude that the interest is deductible for the corporation resulting from the amalgamation. Moreover, in our view the loan was essentially made to buy back shares of corporation X and the purpose of the sequence of transactions was to circumvent the rules set out in Interpretation Bulletin IT-80.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 21
Deemed capital gain - paragraph 55(3)(a) of the Act
A corporation (“Parent Ltd”) has two wholly-owned subsidiaries (“Loss Ltd” and “Profit Ltd”). Profit Ltd has one wholly-owned subsidiary (“Subsidiary Ltd”). Profit Ltd wishes to sell Subsidiary Ltd to an unrelated person through Loss Ltd in order to use the latter’s available losses. Profit Ltd therefore transfers the shares of Subsidiary Ltd to Loss Ltd by means of a rollover under subsection 85(1) of the Act and receives preferred shares in Loss Ltd in exchange. Loss Ltd sells the shares in Subsidiary Ltd to Buyer Ltd and receives in exchange cash and preferred shares in Buyer Ltd. An election under subsection 85(1) of the Act is made to defer a portion of the capital gain. The agreed amount is less than the fair market value of the shares of Subsidiary Ltd. Loss Ltd uses the money received to buy back part of its preferred shares owned by Profit Ltd, and this buy-back gives rise to a deemed dividend under subsection 84(3) of the Act.
The exceptions provided for in subparagraph 55(3)(a)(i) and (ii) of the Act concerning disposition for proceeds of disposition not less than the fair market value do not apply, i.e. the disposition of the shares of Loss Ltd to Buyer Ltd and the significant increase in the total direct interest of Buyer Ltd in Subsidiary Ltd. Consequently, subsection 55(2) of the Act would apply to the buy-back of the preferred shares of Loss Ltd mentioned above since these events involve an unrelated person within the meaning of paragraph 55(3.01)(a) of the Act.
Does Revenue Canada agree with this conclusion?
Revenue Canada’s reply
The disposition by Loss Ltd of the shares of Subsidiary Ltd constitutes a disposition referred to in subparagraph 55(3)(a)(i) of the Act, since the disposition is made to a person (Buyer Ltd) that was an unrelated person immediately before the transfer, for proceeds of disposition less than the fair market value by means of a rollover.
The acquisition of the shares of Subsidiary Ltd by Buyer Ltd constitutes a significant increase in the total direct interest in a corporation referred to in subparagraph 55(3)(a)(ii) of the Act, since it constitutes the acquisition of a 100% interest in a corporation, the acquisition is made by an unrelated person (Buyer Ltd) immediately before the particular time and the significant increase in the total direct interest of Buyer Ltd in Subsidiary Ltd results from a disposition of shares for proceeds of disposition less than the fair market value because of the rollover.
Consequently, we concur that in this instance, subsection 55(2) of the Act could apply to the dividend received by Profit Ltd.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 22
Price adjustment clauses
Paragraph 1 of Interpretation Bulletin IT-169 (dated August 6, 1974) provides that taxpayers must accept Revenue Canada’s valuation in order for Revenue Canada to agree to take a price adjustment clause (“PAC”) into account. Taxpayers and their advisors are not usually willing to allow Revenue Canada the last word with respect to determining the fair market value (“FMV”) of property disposed of for the purposes of the adjustments provided for by a PAC.
Is Revenue Canada willing to give effect to the PACs included in the rights, privileges and restrictions of preferred shares which stipulate that the redemption price will be adjusted based on the FMV determined by a final ruling of a court when the parties do not agree with the FMV recommended by Revenue Canada, have a bona fide intention to deal at FMV, have made reasonable efforts to determine the FMV for the purposes of the transfer, and undertake to make the adjustments stipulated by the CAP on the basis of the FMV established by a court?
Moreover, it appears that subsections 51(2) and 86(2) and paragraph 85(1)(e.2) are not applicable in such a situation because it would not be reasonable to consider that the transferor wished to confer a benefit on a related person.
Revenue Canada’s reply
Interpretation Bulletin IT-169 is of long standing (dated August 6, 1974) and does not appear to take into consideration all the types of price adjustment clauses nor all the situations where price adjustment clauses are now usually used.
It is our view that subsections 51(2) and 86(2) and paragraph 85(1)(e.2) of the Act would not be applicable when a PAC such as that described in the question above is used in the context of an estate freeze, the parties have a bona fide intention to deal at FMV, have made reasonable efforts to determine the FMV for the purposes of the transfer, and make the adjustments stipulated by the PAC on the basis of the FMV established by a court. The Department should therefore take the PAC into account in such a situation after the final decision of a court.
However, in order for a court to be able to rule on the FMV in such a situation, it may be necessary for the Department to assess the transferor on the basis of the application of subsection 51(2), 86(2) or 85(1)(e.2) of the Act because the parties refuse to make the adjustments stipulated by the PAC based on the FMV determined by the Department.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 23
Price adjustment clause and subsection 84(3) of the Act
The price adjustment clauses (“PACs”) contained in the rights, privileges and restrictions of preferred shares which are used for estate freezes usually provide that the redemption price of the shares will be increased if it is determined that the transfer price used at the time of the freeze is less than the FMV of the common shares. PACs also provide that in the event that the redemption price of the preferred shares frozen is adjusted upward after the share redemption, the corporation must pay to the holders of the shares redeemed the difference per share between the redemption price as adjusted and the amount actually received at the time of the redemption (“supplementary payment”). What is the tax treatment for such supplementary payments received by an individual during a taxation year subsequent to the year of the share redemption?
It appears that subsection 84(3) of the Act does not apply in respect of the supplementary payment because this subsection applies only to the time of the redemption and in respect of an amount paid at the time of the redemption. Consequently, it appears that the supplementary amount cannot constitute a dividend. It is instead a supplementary proceeds of disposition and therefore a capital gain (if the shares are capital property).
Revenue Canada’s reply
The Department’s position is to consider the supplementary payment as a dividend, for both the payer and the beneficiary, for the following reasons:
a) The payment results from a right relating to a share.
b) The payment is made by reason of a redemption of shares referred to in subsection 84(3) of the Act; it is accessory to such a redemption.
c) Treating the payment as a capital payment would change the nature of the payment otherwise made and of the income otherwise realized.
d) This position promotes uniform treatment of shareholders and corporations in respect of the application of subsection 84(3) of the Act.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 24
Partnership - subsection 112(1) of the Act
A corporation (Corporation A) owns an interest in a partnership. During a taxation year, the partnership receives a taxable dividend from a taxable Canadian corporation (Corporation B). In view of the fact that the Quebec Civil Code provides that partnerships have a separate asset base, does the Department consider that Corporation A received a taxable dividend for the purposes of subsection 112(1) of the Act when the amount received by Corporation A corresponds to its interest in the partnership income and this amount is attributable to the taxable dividend received by the partnership from Corporation B?
Revenue Canada’s reply
Interpretation Bulletin IT-138R, dated January 29, 1979, outlines the Department’s position with respect to the calculation and flow-through of the income of a partnership. Paragraph 1 of this bulletin reads as follows:
For purposes of the Income Tax Act, a partnership is not a person and is not deemed to be a person. However, in determining a member's share of the income or loss of the partnership from a source or from sources in a particular place, the partnership first computes its income as if it were a person. A member's share of the income or loss of the partnership from each source then flows through to him pursuant to paragraphs 96(1)(f) or (g), retaining its characteristics in respect of its source and nature.
The Department is of the view that the existence of the separate asset base provided for by the Quebec Civil Code does not affect the application of the provisions set out in paragraph 96(1)(f) and in subsection 112(1) of the Act.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 25
Subsection 112(3) - Order of disposition of identical shares
Corporation A made several acquisitions of common shares of Corporation B. Corporation A owns more than 5% of the common shares issued and outstanding of Corporation B. The amount of the dividends received per share in respect of the shares is different because certain shares were not owned by Corporation A at the time certain dividends were paid. Corporation A sells part of its common shares and realizes a capital loss. It appears that the Act does not provide a method for identifying an order of disposition of identical shares for the purposes of subsection 112(3) of the Act.
In such situations, does the Department accept that Corporation A may choose the shares which were disposed of for the purposes of subsection 112(3) of the Act?
Revenue Canada’s reply
Subsection 112(3) of the Act contains rules which have the effect of reducing the loss resulting from the disposition of a share by the amount of certain dividends actually received on this share. As you mention, no rule is provided for determining an order of disposition of shares which are identical property in a situation such as you describe. Furthermore, we believe that subsection 112(3) of the Act does not allow us to assume that a dividend received on a share can be considered attributable to other shares acquired at that time.
Consequently, the Department will adopt the order of disposition of shares chosen by the taxpayer for the purposes of the application of subsection 112(3) of the Act.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 26
Life insurance policy used as security for indebtedness
Paragraph 6 of Interpretation Bulletin IT-430R3 (which replaces and cancels paragraph 6 of IT-430R2) was changed to indicate that a debtor corporation cannot add to its capital dividend account the proceeds of a life insurance policy when the proceeds are received by the lender as beneficiary, even if the debtor corporation pays the premiums.
In Technical News No. 10 of July 11, 1997, you indicate the following:
It was not intended that there be a change in the Department’s position with regard to situations where a life insurance policy has been assigned as collateral for securing indebtedness, as opposed to an absolute assignment of the policy, and the debtor remains beneficiary under the policy. In such a case, as the proceeds of the insurance policy would be constructively received by the debtor/beneficiary, even though paid directly to the creditor in accordance with the assignment, the proceeds in excess of the adjusted cost basis of the policy would be included in the capital dividend account of the debtor. Paragraph 6 of IT-430R3 will be revised in this regard.
This change is effective for proceeds of a life insurance policy received on or after February 10, 1997.
Are transitional rules provided for life insurance policies offered by financial institutions (creditor insurance) used as security for indebtedness, where the debtor corporation pays the premiums of the policy of which the financial institution is the policyholder and beneficiary, which were in effect on February 10, 1997?
Revenue Canada’s reply
We would like to point out that paragraph 6 of IT-430R2 was amended to indicate that a debtor corporation cannot add the proceeds of a life insurance policy to its capital dividend account when the proceeds are paid to the lender as beneficiary, even if the debtor corporation pays the premiums. This is so because the debtor corporation does not receive the proceeds of the life insurance policy as beneficiary.
This is a change in interpretation which is consistent with the Act and which is effective from the date of publication of IT-430R3, i.e. February 10, 1997. There is no transitional rule. It is possible to amend a life insurance policy so that the debtor corporation, as beneficiary, can add the proceeds of that policy to its capital dividend account.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 27
Trust for minor children
A trust is established for the benefit of three (3) minor children. The three children are beneficiaries of the trust income. According to the terms of the trust deed, the three children are entitled to an equal share of the trust income, and this right is not subject to any discretionary power. The trust deed provides that the income will be held in trust for each of the beneficiaries until the beneficiary has attained 21 years of age. It also provides for the creation of separate accounts composed of the income held in trust for each of the beneficiaries. These accounts are separate from the initial capital of the trust and from any increase in capital not arising from the trust income so held.
Does the fact that the trust deed contains one of the following provisions mean that subsection 104(18) of the Income Tax Act (hereinafter referred to as the “Act”) would not apply for a taxation year in which the beneficiaries attained 21 years of age before the end of the year?
a) Beginning when the youngest of the children attains 21 years of age, the trust income will be apportioned in a different manner from that described above; the apportioning of the trust income for taxation years which end after all the beneficiaries have attained 21 years of age would be subject to a discretionary power; this discretionary power would not extend to the trust income for prior taxation years which has been held in trust and it would not affect in any way the right to this income held in trust.
b) The trustee has discretionary powers with respect to the distribution or apportionment of the initial capital of the trust and of any increase in capital not arising from the trust income held in trust (he cannot exercise his discretion on the separate accounts composed of the income held in trust for each of the beneficiaries).
c) The right to demand the income held in trust for each child is delayed until the child has attained a certain age not exceeding 40 years.
Revenue Canada’s reply
a) We are of the opinion that such a provision would not have any impact on the analysis of compliance with the conditions set out in subsection 104(18) of the Act for a taxation year in which a beneficiary did not attain 21 years of age before the end of the year, since the discretionary power would not apply in respect of the income for such a taxation year.
When all the beneficiaries have attained 21 years of age, subsection 104(18) of the Act will no longer apply, whether or not the right to the trust income is vested by reason of the exercise of or the failure to exercise a discretionary power.
b) Taking into account the fact that, based on the hypothetical situation you describe, the income held in trust for each of the children is not part of the capital of the trust which is subject to the exercise of or the failure to exercise a discretionary power, we are of the opinion that the existence of such discretionary powers in respect of the capital would not, in itself, prevent the application of subsection 104(18) of the Act.
c) We are of the opinion that subsection 104(18) of the Act does not stipulate any requirement as to the date of handing over or payment of the income accumulated in the trust. The condition set out in paragraph 104(18)(d) of the Act states that the right to part of the amount is not subject to any future condition, other than a condition that the individual survive to an age not exceeding 40 years. We are of the opinion that the provisions of this paragraph would not be met if the beneficiary’s vested right to part of the amount could be extinguished by reason of a future condition other than the condition of surviving to an age not exceeding 40 years. The exception referred to in paragraph 104(18)(d) of the Act would apply to situations where trust deeds contained a clause stipulating that the right of a beneficiary will be extinguished if the latter dies at an age not exceeding 40 years. We are of the opinion that a provision delaying the right to demand payment of the income held in trust, as mentioned, would not have the effect of rendering subsection 104(18) of the Act inapplicable.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 28
Grandfathered shares for the purposes of subsection 112(3) of the Act
On April 26, 1995, a shareholder holds 100% of the shares of a management company. As of April 26, 1995, there is no will and, of course, no shareholders’ agreement has been signed. A life insurance policy was taken out by the corporation. On the insurance application, it is mentioned that the purpose of the insurance application is to fund the redemption or purchase of the taxpayer’s shares. No correspondence was exchanged concerning the purchase of the life insurance policy.
Will the brief reference on the life insurance application be deemed sufficient for the tax authorities to conclude that the shares are grandfathered shares for the purposes of the application of subsection 112(3) of the Act?
Revenue Canada’s reply
First of all, in order to conclude that a disposition of shares of the corporation enjoys grandfather protection, it would be necessary to demonstrate that on April 26, 1995, the corporation was the beneficiary of a life insurance policy on the life of the shareholder in accordance with subparagraph 131(11)(b)(ii) of Bill C-28, which received Royal Assent on June 18, 1998 (“the Bill”); this is not evident from the wording of the question. In this respect, we are of the opinion that a simple insurance application which was made before April 27, 1995 could not be sufficient to conclude that a corporation was the beneficiary of a life insurance policy on the life of the shareholder on April 26, 1995.
With respect to the question of determining whether it was reasonable to conclude, on April 26, 1995, that a main purpose of a life insurance policy was to fund, directly or indirectly, in whole or in part, a redemption, acquisition or cancellation of a share by the issuing corporation, as provided for in subparagraph 131(11)(b)(iii) of the Bill, we specified in Technical News No. 12 of February 11, 1998, that the determination of a main purpose of the acquisition of a life insurance policy can only be made based on the evaluation of the facts and circumstances of each particular case. In a case similar to the one you submit, we are of the opinion that the insurance application would be a relevant factor to be considered in determining the main purpose of the acquisition of a life insurance policy. However, we cannot affirm that the brief statement: “the purpose of the insurance application is to fund the redemption or purchase of the taxpayer’s shares” would be sufficient to conclude that the condition set out in subparagraph 131(11)(b)(iii) of the Bill would be met.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 29
Grandfathering - application of subsection 112(3)
Transitional rules apply to the shares of a corporation held by an individual when a corporation, owned by the individual’s corporation, is the beneficiary, on April 26, 1995, of an insurance policy on the life of the shareholder and it is reasonable to conclude that one of the purposes of the insurance is to redeem the individual’s shares on his death.
In such a situation, could the individual’s corporation, or another corporation that he owns, take out an additional life insurance policy or a new insurance policy on the life of the shareholder, even if the value of the first life insurance policy represents only an insignificant percentage of the value of the individual’s shares?
Is it reasonable to conclude that the transitional rules will continue to apply to the shares of the corporation held by the individual?
Revenue Canada’s reply
Indeed, paragraph 131(11)(b) of Bill C-28, as given Royal Assent on June 18, 1998 (“the Bill”), provides that a disposition of shares made by a taxpayer after April 26, 1995 can benefit from grandfather protection if, among other things, the following conditions are met:
a) it involves the disposition of a share of the capital stock of a corporation that is made to the corporation;
b) on April 26, 1995, the share was owned by an individual;
c) on April 26, 1995, the corporation was a beneficiary of a life insurance policy on the life of the individual; and,
d) it was reasonable to conclude on April 26, 1995 that a main purpose of the life insurance policy was to fund, directly or indirectly, in whole or in part, a redemption, acquisition or cancellation of the share by the issuing corporation.
The Explanatory Notes issued by the Department of Finance concerning grandfathering provide the following clarifications:
The shares owned by the taxpayer on April 26, 1995 need not be shares of the corporation which is beneficiary of the life insurance policy; it is necessary only to demonstrate that the proceeds of the policy were intended to be used to acquire the taxpayer’s shares. For example, the taxpayer may hold an interest in the corporate beneficiary through one or more holding companies.
The shares need not be acquired with the proceeds of the life insurance policy that was in place on April 26, 1995. Therefore, policies may be renewed, converted, replaced or entered into after April 26, 1995 without necessarily eliminating the application of these grandfathering rules.
Consequently, in the situation outlined, if all the conditions of paragraph 131(11)(b) of the Bill are otherwise met, the fact that a subsidiary of the corporation is the beneficiary of the life insurance policy that is to be used to fund the redemption of the shares of the corporation held by the individual would not prevent the disposition of such shares from benefiting from the grandfather protection referred to in paragraph 131(11)(b) of the Bill.
Furthermore, we are of the opinion that the corporation could take out another life insurance policy on the life of the individual for the purpose of funding the redemption of its shares held by the individual without calling into question the grandfather protection applicable in this instance, even if the value of the first life insurance policy represents only an insignificant percentage of the value of the individual’s shares on April 26, 1995. Our position would be the same if another corporation were interposed between the individual and the corporation in the context of a rollover under section 85 of the Act and this other corporation became the beneficiary of a life insurance policy on the life of the individual for the purpose of funding the redemption of its shares issued to the individual at the time of the rollover in exchange for the shares of the corporation.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 30
The impact of Sherway Centre Limited on interest deductibility
Will Revenue Canada change its position with respect to participatory interest payments following the decision of the Federal Court of Appeal in Sherway Centre Limited? What is the Finance Department’s position on this matter?
Revenue Canada’s reply
With respect to the treatment of such payments as interest payments referred to in paragraph 20(1)(c), we were of the opinion that in order for participatory interest payments to be considered interest payments, the payments must be limited to an agreed percentage of the principal of the loan, the percentage limited must reflect the prevailing market interest rates at the time the loan was made and there is no other indication of equity participation.
Although the participatory interest payments in the Sherway decision did not meet these criteria, in our view the Court’s decision was factual because all the documents and evidence presented to the Court demonstrated that the sole purpose of the participatory interest payments was to increase the yield of the loan so that it would correspond to market rates.
We therefore plan to broaden our current position. If it is clearly demonstrated that the participatory interest payments were made in lieu of interest, for example when they were intended only to increase the interest rate of the loan so that it corresponds to the market rate, we will allow their deduction as interest in application of paragraph 20(1)(c) of the Act. However, if it is demonstrated that the parties did not really try to evaluate whether the payments would approach market rates, we will deny the deduction of such payments as payments referred to in paragraph 20(1)(c) of the Act on the grounds that they constitute distributions of profits and not interest.
With respect to the possibility of deducting such payments under paragraph 20(1)(e) of the Act, since the Court allowed the deduction of the payments under paragraph 20(1)(c) of the Act and dealt with paragraph 20(1)(e) only incidentally, we are of the view that no change is necessary for the time being in our position that such payments cannot be deducted under paragraph 20(1)(e) of the Act. In particular, we continue to believe that this provision does not allow the deduction of payments made as consideration for the use of funds.
Department of Finance reply
In this decision, the Court noted that this was not a tax avoidance situation and even suggested that it could have reached a different conclusion had it been convinced of the contrary. Under the circumstances, the Department of Finance does not intend to recommend amendments following this decision.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 31
Calculation of the penalty provided for in subsection 163(2) of the Act
How must the provisions of subsection 163(2.1) of the Act be interpreted in the following situation:
- A taxpayer has only one source of income.
- In his income tax return, the taxpayer declared a loss of $20,000 in respect of this source, resulting in a non-capital loss of $20,000.
- The taxpayer never applied this loss against his income for prior years or against his income for subsequent years.
- Following an audit, the taxpayer received a notice of reassessment in which his income was increased by $30,000, with the result that the non-capital loss of $20,000 became income of $10,000.
Can you confirm that the penalty provided for in subsection 163(2) of the Act would be calculated on the amount of $10,000?
Revenue Canada’s reply
Subsection 163(2.1) of the Act provides, for the purposes of calculating the penalty under subsection 163(2) of the Act, that the taxable income reported by a person in his return for a taxation year is deemed not to be less than nil. Furthermore, subsection 163(2.1) of the Act determines what constitutes “understatement of income” of a person for a year.
“Understatement of income” means, among other things, the amount calculated in paragraph 163(2.1)(a) of the Act, i.e. the amount by which the amounts that were not reported by the taxpayer in his return and that were required to be included in computing his income for the year exceeds the amounts deductible in computing his income for the year, as were wholly applicable to these unreported amounts and were not deducted by him in computing his income for the year in his return. In our opinion, in this situation, the “understatement of income” would be $30,000, i.e. the total of the unreported income.
Consequently, for the application of paragraph 163(2)(a) of the Act, it would be necessary to calculate the amount by which the tax which would be payable if it were added to the taxable income reported by the taxpayer, which is deemed not to be less than nil, namely that portion of this “understatement of income” that is reasonably attributed to the false statement or omission, exceeds the tax which would have been payable if it had been assessed on the basis of the information provided in the taxpayer’s return for the year. The penalty would therefore be calculated on the tax payable in respect of an amount of $30,000 rather than $10,000.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 32
Spousal trust
According to subsection 104(4) of the Act, the death of the second spouse triggers a deemed disposition of the property of the trust at its fair market value at the end of the day of death.
When the trust owns shares in a private corporation and the latter holds insurance on the life of the shareholder, the market value of the shares at the end of the day of death includes the proceeds of the insurance on the life of the second deceased. This deemed disposition can result in heavier taxation of the value of the shares for the estate.
According to the administrative position of the government, the trust should not be taxed on this deemed capital gain.
Does the Department of Finance intend to correct the Act accordingly?
Department of Finance reply
The same considerations were raised in question 41.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 33
Protective trust
In Technical News No. 7 of February 21, 1996, Revenue Canada specified what a trust deed or indenture must contain in order for a trust to be considered a protective trust. Notably, the deed must contain the following provision:
The settlor is entitled to so much of the annual income of the trust and any realized capital gains of the trust as he or she may request or, in the absence of such a request, such amounts as the trustees, in their absolute discretion, deem advisable.
If the trust satisfies all the other required provisions, does the trust qualify as a protective trust if the settlor is entitled to receive any part of the annual income and of the realized capital gain of the trust but this right is left solely to the discretion of the trustees and the settlor does not have the right to demand it?
Revenue Canada’s reply
The Department is of the view that in order for there to be a protective trust, the settlor must always have the right to receive any annual income and any capital gain of the trust. This right to the income and to the capital of the trust cannot be left to the discretion of the trustees.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 35
The Brouillette case
Following the Brouillette decision (1997 DTC 624), it would appear that the rollover under subsection 73(3) of the Act would not apply to a transfer to a trust on behalf of a child, since the Act would require a transfer directly to the child.
1. Does the Department of Finance plan to suggest an amendment to the Act to eliminate this problem?
2. What will be Revenue Canada’s administrative policy pending such a legislative amendment (if there is to be an amendment)?
Revenue Canada’s reply
In this case, the taxpayers transferred, in 1987, part of the shares they owned in a corporation to a trust for the exclusive benefit of their minor child. A few hours after this transfer, all of the shares of the corporation held by the taxpayers and the trust were sold to an unrelated third party. At the time of the transfer of the shares to the trust, the taxpayers took advantage of the rollover provided for in subsection 73(5) of the Act. This provision, in effect until 1987, allowed deferral of the capital gains tax up to $200,000 when a taxpayer transferred shares in a small business corporation to his child.
The Department denied the application of subsection 73(5) of the Act in the Brouillette case, despite the fact that paragraph 10 of Interpretation Bulletin IT-486R stipulated that the Department was administratively willing to accept the application of subsection 73(5) of the Act to a transfer of shares to a trust for the exclusive benefit of a minor, subject to the conditions outlined in the bulletin. The Department considered the transaction abusive because the transfer did not comply with the spirit of subsection 73(5) of the Act, i.e. tax deferral at the time of an actual transfer of the shares to the children, and because it also did not meet all of the conditions set out in paragraph 10 of Interpretation Bulletin IT-486R.
Subsection 73(3) of the Act provides, for farm property, a rollover similar to the rollover provided for in former subsection 73(5) of the Act. Paragraph 13 of Interpretation Bulletin IT-268R4 sets out an administrative policy similar to that outlined in Interpretation Bulletin IT-486R with respect to the transfer of a property to a trust for the exclusive benefit of a minor. Transfers of farm property in the context of the application of subsection 73(3) of the Act may continue to be made to a trust created solely for the benefit of a minor child provided that the following conditions, set out in the above-mentioned bulletin, are met:
a) the trust must be irrevocable;
b) the terms of the trust must provide for the property to be held in trust for the exclusive benefit of the child and there must not be any trust provision which could have the effect of depriving the child of any rights as the beneficial owner of the property; and
c) the terms of the trust must provide for the distribution of the property to the child absolutely upon reaching a certain age and for the distribution of that property to the child’s estate upon the child’s death before that age.
Department of Finance reply
In the Brouillette case, the attempted rollover under section 73 of the Act was intended to increase access to the capital gains deduction. The Department of Finance does not intend to recommend amendments which would facilitate this type of activity.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 36
De jure control - the Duha Printers (Western) Ltd. case
During the federal round table of the 1997 APFF Congress, the Department indicated in reply to question 5.2 that it was awaiting the decision of the Supreme Court in Duha Printers (Western) Ltd. before ruling definitively on whether the incorporating instruments, including a unanimous shareholders agreement, must be considered in determining de jure control, as Stone J. of the Federal Court of Appeal indicated, or whether, as Linden J. of this same Court suggested, other documents, such as an agreement other than a unanimous agreement, could be examined.
Following the ruling of the Supreme Court in this case, does the Department recognize the position of Stone J.?
Revenue Canada’s reply
In this case, the Supreme Court mentioned in its “Summary of principles and conclusion as to control”, that in determining the “effective control” of a corporation, it is necessary to consider the corporation legislation by which the corporation is governed, the share register of the corporation, and any specific limitation on either the majority shareholder’s power to control the election of the members of the Board of Directors or the power of the Board of Directors to manage the business and affairs of the corporation. Such specific limitations must stem from the constating documents of the corporation (including its by-laws and regulations) or from a unanimous shareholder agreement.
The Supreme Court also mentioned that documents other than the share register, the constating documents and any unanimous shareholder agreement are generally not to be considered for the purposes of determining “effective control” over the affairs and fortunes of the corporation.
Furthermore, it is clear from this decision that shareholder agreements other than unanimous shareholder agreements of corporations recognized by a corporation’s constating instruments must not be considered in determining de jure control because these agreements give rise to obligations that are contractual and not legal or constitutional in nature.
Moreover, when shares of a corporation are held by a trust, it is clear from the precedents, including Duha Printers (Western) Ltd., that the trust agreement must be examined to ascertain whether the trustees’ voting rights are subject to restrictions in the determination of de jure control.
For the purposes of determining de jure control, the Department will therefore follow the principles set out by the Supreme Court in Duha Printers (Western) Ltd. Among other things, the Department will continue to consider the impact of unanimous shareholder agreements in determining de jure control.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 38
Subsection 17(3) ITA
It is common for a Canadian corporation that has several foreign subsidiaries to finance their activities through interest-free inter-corporation advances.
This type of financing can be more effective than a stock issue for business and legal reasons, for example in order to repatriate the funds without having to buy back capital stock.
However, Revenue Canada interprets the exception provided for in subsection 17(3) of the Act restrictively and applies subsection 17(1) of the Act (resulting in double taxation) in circumstances where there is no reason to avoid Canadian tax.
In the last federal budget of February 24, 1998, the Department of Finance proposed to amend subsection 17(3) of the Act in order to restrict this provision so that the exception applies only when the amount owing arises from the carrying on of an active business by a controlled subsidiary.
Would the Department of Finance be willing to consider instead extending the exception in subsection 17(3) of the Act in the following circumstances:
(i) advances are made to a foreign “holding” subsidiary, when the funds are loaned to a foreign “operating” subsidiary which uses the funds in the carrying on of an active business;
(ii) advances are made directly to a foreign “operating” subsidiary (which is held by a foreign “holding” subsidiary) and the funds are used in the carrying on of an active business by the foreign “operating” subsidiary;
(iii) advances are made to a controlled foreign affiliate of the Canadian taxpayer and used in the carrying on of an active business without this corporation being a controlled subsidiary of the Canadian corporation (for example, a foreign corporation owned equally by two Canadian corporations)?
Department of Finance reply
The 1998 federal budget includes a proposal to extend the scope of the general rule set out in section 17 of the Act and of the exception to this rule in subsection 17(3). Under the extended general rule, subsection 17(1) of the Act would apply to any amount owing by a non-resident to a corporation resident in Canada, not only to loans. Similarly, the expanded exception would also apply to any amount owing to a corporation resident in Canada by a subsidiary controlled corporation, provided that the amount owing is used to earn income from an actively operated business or is used in the carrying on of an active business by a controlled subsidiary.
The Department of Finance has received numerous comments on this measure, which have been taken into consideration in the choice of procedures for implementing the measure. The approach adopted by the government will be reflected in the draft legislation which will be made public shortly in connection with the most recent budget proposals.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 40
Triangular foreign amalgamation
In the February 24, 1998 budget, the Department of Finance proposed an amendment to subsections 87(8) and (8.1) of the Act in order to grant a tax deferral in respect of the disposition of shares in the context of a triangular foreign amalgamation. The Notice of Ways and Means Motion provides that the taxpayer must dispose of these shares in exchange for shares of the capital stock of another foreign corporation that, immediately after the merger, controlled the foreign corporation formed by the merger. The three corporations involved in the triangular amalgamation must therefore be foreign corporations.
Would the Department of Finance be willing to grant a tax deferral when shares of the capital stock of a Canadian corporation are issued to the taxpayer in the context of a merger of two foreign corporations?
Department of Finance reply
The draft bill implementing the Notice of Ways and Means Motion of the 1998 Budget with respect to triangular amalgamations is consistent with the Notice. Henceforth, it will be required, for a tax rollover with respect to a share of a foreign predecessor corporation of this corporation and of another foreign corporation, that the foreign predecessor corporation and the foreign corporation controlling the new corporation formed by this amalgamation all be resident in the same foreign jurisdiction. The draft bill will not provide for a triangular amalgamation in the case of multiple jurisdictions.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 41
Application of subsection 70(5.3) ITA
Context
Subsection 70(5.3) of the Act concerns the determination of the fair market value immediately before the death of a taxpayer referred to either in subsection 70(5) - Capital property of a deceased taxpayer - or in subsections 70(9.4) and 70(9.5), now repealed (which concerned the deemed disposition provisions applicable in respect of shares of small business corporations: the former $200,000 limit).
Pursuant to this subsection, when a corporation holds insurance on the life of the deceased, the fair market value of the deceased’s shares shall be determined as though the life insurance policy forming part of the assets of the corporation were worth only its cash surrender value (within the meaning assigned by subsection 148(9) of the Act) at that time. Of course, this becomes of paramount importance when it is a matter of valuing participating shares (that do not already have a fixed redemption value independent of any life insurance proceeds) of a deceased taxpayer.
In light of the estate planning very frequently proposed to clients, wills whereby participating shares in private corporations are transferred to exclusive spousal trusts are signed in order to allow deferral of the tax which would otherwise have been payable upon the first death.
When shares are the property of a trust and not of an individual, on the date of a death - resulting in a deemed disposition - subsection 70(5.3) does not apply because subsection 104(4)(a) is not applicable, and the trust therefore becomes the taxpayer deemed to have disposed of the property immediately before the death of the spouse beneficiary.
In light of the foregoing, corporate life insurance should not be taken out on the life of the spouse beneficiary of the trust that is a shareholder of the corporation. In our view, this conclusion is unjustified since life insurance proceeds should not in principle be taxable. Consequently, we are of the view that the restrictive effect of subsection 70(5.3) of the Act creates unwarranted injustices in such cases.
A technical interpretation dated June 2, 1994 (No. 9334535) demonstrates that Revenue Canada is aware of this problem.
First question
Has the Department of Finance been made aware of this situation? If so, what is its position on this matter?
Context
Furthermore, given the diversity of insurance products offered by the industry and the financial advantage of taking out life insurance policies on the life of two persons (often of different ages) when the proceeds become payable only upon the death of the last insured, it would appear that subsection 70(5.3) of the Act is not applicable because the policy would cover several insureds simultaneously.
Consequently, when an individual who owns participating shares in a private corporation is one several insureds under the terms of the same corporate life insurance policy, it appears that subsection 70(5.3) of the Act does not apply and it would be the market value of the policy rather than its cash surrender value which would have a impact on the market value of the shares of the deceased at the time of his death.
Furthermore, a shareholder who wished to minimize the tax burden associated with his shares upon the death of his spouse, for whom he wished to create an exclusive trust, would not be well advised to have the corporation take out a second-death life insurance policy, once again because subsection 70(5.3) of the Act would not apply.
We believe, again in these cases, that the restrictive effect of subsection 70(5.3) of the Act creates unwarranted injustices since life insurance proceeds should not in principle be taxable.
Current concern:
To prevent the application of the ordinary rules of valuation of a life insurance policy as outlined in Interpretation Bulletin IT-417R3 [Tr: IT-416R3?] only in the following cases:
- when the shares have been transferred by a deceased to the testamentary trust created for the exclusive benefit of his spouse;
- when several persons are insured by the same policy held by the corporation.
Second question
In light of the first question, what is the Finance Department’s position with respect to the issuance by the corporation of a separate class of shares (life insurance shares) whose only characteristic is the right to receive from the corporation the proceeds of the insurance on the life of the spouse or of the first insured of a group of insureds to die (shares having an ACB and a PC of $100 as well as a fixed redemption value of $100 plus any life insurance proceeds receivable by the corporation on the life of such a shareholder)?
Department of Finance reply
When an individual who owns shares of a corporation dies, his capital gain on these shares is calculated in the manner provided for in subsection 70(5.3) of the Act, as though the fair market value of an insurance policy held by the corporation on the life of the individual were cashed at the cash surrender value. From a tax policy standpoint, it would be appropriate to apply the same rule to a deemed disposition by a trust for the benefit of the spouse upon the death of the spouse beneficiary. We therefore plan to amend the Act accordingly. In the same context, we will examine the questions raised when there is more than one person insured under a single life insurance policy.
With respect to the second part of the question, we have some difficulty understanding the type of classes of shares referred to by the question and the business situations in which such shares could be issued. We are therefore not in a position to comment further.
FEDERAL TAXATION ROUND TABLE
1998 APFF CONGRESS
Question 42
Support paid by a succession to the former spouse of the deceased person
Under the terms of articles 684 and 685 of the Quebec Civil Code, the former spouse of a deceased person may claim from the succession a contribution representing twelve months of support.
According to Revenue Canada’s interpretation, the Act does not allow the deductibility of the amount representing support paid by the succession since the latter is not the former spouse of the creditor of support, as required by the definition of the term “support amount” in the Act.
Does the Department of Finance plan to amend the definition of “support amount” in the Act in order to permit the deductibility for the succession of such amounts paid to the former spouse of the deceased person?
Department of Finance reply
No. As has been pointed out, only the amounts paid by the former spouse are deductible. There are no plans to extend the deduction to other payers. Furthermore, the amount paid by the succession generally constitutes a lump sum payment (which may be paid in instalments that are not necessarily uniform or made at regular intervals) which may take into account factors other than the support payable before death.
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