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.
DRAFT
Recent Cases
Revenue Canada Round Table
Canadian Tax Foundation Conference
October 1998
Case: Brelco Drilling Ltd.
Tax Court of Canada
March 6, 1998
Brelco Drilling Ltd.
The issue before the Tax Court involved the proper interpretation of subsection 55(2) and its interaction with the computational rules in paragraph 55(5)(d). The Department considers many of the issues raised in Brelco key to the interpretation of subsection 55(2) and the concept of safe income. Although the Department agrees with the learned trial judge’s conclusion that the language of paragraph 55(5)(d) does not require that the “income earned or realized” by a foreign affiliate be reduced by the losses of a sister foreign affiliate corporation, we believe that the learned trial judge erred when he did not undertake the further determination of the amount of that “income earned or realized” to which the unrealized capital gain in the shares in Tricil could reasonably be attributed. The Department has, therefore, appealed the decision to the Federal Court of Appeal. The appeal should be heard some time this fall.
The computational rules in paragraphs 55(5)(b), (c) and (d) determine the "income earned or realized" by a corporation for purposes of section 55. Although the statutory requirement in subsection 55(2) is to identify the portion of the notional capital gain that could reasonably be attributable to anything other than “income earned or realized” by the corporation, the Department has, in administering section 55, permitted taxpayers to comply with subsection 55(2) by instead computing the portion of the unrealized gain on the shares (computed before the payment of the dividend) which could reasonably be considered to be attributable to such income earned or realized. In the Department’s view a gain can reasonably be considered to be attributable to income earned or realized only to the extent that it is on hand and available for distribution to the corporation’s shareholders as a dividend. Any dividend that is paid is assumed to be paid first out of income earned and therefore not subject to subsection 55(2) provided that the amount of the dividend does not exceed the income earned or realized which is on hand. The alternative approach would be to require taxpayers to do a valuation of the corporation’s shares and assets to determine the extent to which the notional gain in the shares of the company is attributable to any appreciation in its assets each time a dividend which may be subject to subsection 55(2) is paid. In our view, this alternative approach is not administratively feasible.
Although the issue in Brelco involves the computation of income earned or realized by a foreign affiliate pursuant to paragraph 55(5)(d), in our view, the interpretive issues apply similarly to amounts determined under paragraphs 55(5)(b) and (c).
The Department agrees that, on the facts of this case, the income earned or realized computed under paragraph 55(5)(d) would not take into account the "exempt deficits" of certain foreign affiliates in the relevant corporate group. However, to the extent that such deficits reduce the fair market value of the corporation’s shares, they will reduce the accrued gain inherent in those shares. It is, therefore, the Department's view that such deficits cannot be ignored when determining the portion of the unrealized gain on the shares that is reasonably attributable to such income earned or realized. This is similar to the stance of the Department with respect to numerous other amounts which may affect the extent to which the unrealized gain on the shares is reasonably attributable to the income earned or realized by a corporation. For example, losses incurred by the corporation, dividends paid by a corporation, income taxes and non-deductible expenses would all affect the extent to which the unrealized gain on the shares at a particular time is reasonably attributable to the income earned or realized of any corporation computed in accordance with paragraphs 55(5)(b), (c) and (d). The Department’s position remains that in order for the unrealized gain on the shares of a corporation to be attributable to the income earned or realized, as computed, such income earned or realized must be "on hand" at the relevant time and capable of contributing to the unrealized gain.
As mentioned previously, it is our view that the Court erred when it failed to consider what portion of the unrealized capital gain on the shares in question could reasonably be considered to be attributable to the income earned or realized as computed in accordance with the rules in paragraph 55(5)(d). In essence, the learned trial judge seems to be concluding that any amount which reduces the notional gain on the share and which is not specifically included in the calculation of the amount which is deemed by paragraphs 55(5)(b), (c) or (d) to be “income earned or realized” by the corporation must reduce the portion of the gain which is attributable to anything else. Subsection 55(2) is intended to prevent receipt of a tax-free dividend by a corporate shareholder where that dividend reduces the portion of the gain on the share that is attributable to unrealized gains on property. If losses incurred by members of a corporate group do not reduce the portion of the gain on the shares which is attributable to the consolidated income earned or realized by the group, the portion of the accrued gain on the share that is attributable to unrealized gains on property will be understated. This result is contrary to the intent of subsection 55(2).
Author: Tim Kuss
File: 982167
Date: September 21, 1998
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