News of Note
Sharpcan – High Court of Australia finds that 10-year gaming licences required to maintain existing gaming revenues were purchased on capital account and were not goodwill
Due to a regulatory change, a hotel owner which had been sharing in the revenues generated from 18 gaming machines on its premises was required to bid for 18 assignable gaming machine licences (“GMEs”) in order to be able to continue with the 18 machines, as a result of which it was allocated 18 GMEs that permitted it to operate gaming machines at its premises for 10 years.
In finding that the $600,300 payable in annual instalments to the state government for the allocation of the 18 GMEs was a capital expenditure, the Court stated:
[T]he identification of what (if anything) is to be acquired by an outgoing ultimately requires … a comparison of the expected structure of the business after the outgoing with the expected structure but for the outgoing, not with the structure before the outgoing. Other things being equal, it makes no difference whether the outlay has the effect of expanding the business or simply maintaining it at its present level.
… It was necessary for the Trustee to purchase the GMEs in order to continue to carry on its business as it had done up to that point. But the purchase price was a once-and-for-all payment for the acquisition of an asset of enduring advantage – the 18 GMEs – which once acquired formed part of the profit-earning structure of the Trustee's business. It was incurred on capital account.
Potential relief for the expenditure might instead have been provided under a more specific provision if it had qualified as being made for maintaining “goodwill.” In rejecting this characterization, the Court stated:
[T]he GMEs were assets which could be individually identified and quantified in the accounts of the Trustee's business, which had a value quite apart from any contribution that they may have made to goodwill. That value resided in their capacity to generate gaming income and the fact that they could be sold and transferred to other venue operators, albeit subject to some restrictions and qualifications.
Neal Armstrong. Summaries of Commissioner of Taxation v Sharpcan Pty Ltd  HCA 36 (High Court of Australia) under s. 18(1)(b) – Capital Expenditure v. Expense – Contract Purchases and Concessions and Licences, and s. 13(34)(b).
CRA finds that a debenture with a contingent conversion right and non-participating conversion ratio entailed loss of CCPC status
Opco is wholly-owned by a resident Canadian holding common shares with a current fair market value (FMV) of $2 million. However, a $5 million debenture held by a non-resident is convertible by the holder, in the event that Opco proceeds to a second round of financing, into that number of Opco common shares which, at that time, have an FMV of $5 million.
CRA appeared to find that Opco is not a Canadian-controlled private corporation, indicating that in computing the number of common shares into which the debenture was convertible at any particular time for purposes of s. 251(5)(b)(i), “the fair market value of the common shares of the capital stock of Opco then outstanding should be used.”
Holdco had two very different subsidiaries. It subscribed $100 for the shares of Opco 1, which realized $900,000 in safe income over the years, and its shares now have a fair market value (FMV) of $1,000,000. Holdco also subscribed $499,900 for the shares of Opco 2, which realized operating losses of $2,000,000 in building up an intangible asset. As it financed the losses in part with third-party debt of $1,500,100, the shares of Opco have an FMV of $499,900. Should the safe income attributable to the shares of Holdco be reduced by the negative safe income of Opco 2?
After noting that (based on Brelco) “the losses of an affiliate can reduce a parent corporation's safe income on hand even if the parent corporation has not directly or indirectly guaranteed the affiliate's losses.” CRA stated:
[T]he fact that Opco 2's trading losses ultimately did not have the net effect of reducing the fair market value of the Holdco shares, and assuming that no entity in the Holdco Group had guaranteed or financed the debt of Opco 2, the CRA is of the view that Opco 2's trading losses should not reduce the consolidated safe income attributable to the shares of the capital stock of Holdco. … [T]he safe income attributable to the shares of the capital stock of Holdco should be $900,000, which is the safe income attributable to the shares of the capital stock of Opco 1 held by Holdco.
CRA indicates that discretion of a spousal trust’s trustees to encroach on capital in favour of the spouse likely offends s. 256(7)(i)(ii)
S. 256(7)(i) deems a change in the trustees of a trust that controls a corporation to not entail an acquisition of control of the corporation. One of the two conditions for its application is in s. 256(7)(i)(ii), which required that at any time after the replacement of the trustee, no amount of income or capital to be distributed in respect of an interest in the trust depends upon the exercise, or the failure to exercise, by any person or partnership of a discretionary power.
Although it used buffering words, CRA appeared to consider that the discretion accorded to the trustees of a spousal trust to encroach on capital in favour of the spouse would violate this condition.
Louie – Federal Court of Appeal finds that advantages generated in Year 1 from swap transactions continued to produce indirect advantages thereafter
From May 15 to October 17, 2009, the taxpayer directed 71 “swaps” under which TSX-listed shares were transferred between her self-directed TFSA and her taxable trading account at a discount brokerage (“TDW”), or between her TFSA and her self-directed registered retirement savings plan (also with TDW). The transfers were made near the close of trading for the day, and at the high trading price for the day if she was transferring out of her TFSA, and at the low price where she was transferring in. She ceased directing the swaps on the introduction of specific “swap transaction” rules effective October 17, 2009. However, she was assessed under s. 207.01(2) in amounts equalling 100% of the increase in the fair market value of her TFSA in 2009, 2010 and 2012 of $200,795, $70,841 and $29,217, respectively (her TFSA having decreased in value in 2011), on the basis that those FMV increases were “advantages” described in s. (b)(i) of the s. 207.01(1) definition.
The taxpayer’s appeal of 2009 was dismissed. In allowing the Crown’s appeal of 2010 and 2012, Dawson JA stated:
… [T]he use of the phrase “directly or indirectly” evidences Parliament’s intent “to capture any and all methods through which a transaction could increase” the fair market value of a TFSA.
[T]he Tax Court’s concern about “when or how far into the future an advantage … will be considered as attributable to” abusive transactions did not justify a restrictive interpretation of the definition of advantage.
… [W]hile the increase in value in the TFSA in 2010 and 2012 was directly attributable to the performance of the shares held in the TFSA each year, it was indirectly attributable to the swap transactions which increased the number of shares held in the TFSA and their value.
Neal Armstrong. Summary of Louie v. Canada, 2019 FCA 255 under s. 207.01(1) – advantage – s. (b)(i).
CRA repeats that it generally denies a s. 113(1) deduction where Canco has failed to prepare surplus accounts – which failure also will preclude a late-filed Reg. 5901(2)(b) election
The 2019 IFA Conference (2019-0798761C6) dealt with the situation where Canco does not prepare detailed calculations of its various surplus and underlying tax balances in respect of a wholly-owned subsidiary (FA) from which it received a dividend, and claims a full s. 113(1) deduction for that dividend (without knowing how much is a deduction under s. 113(1)(a) rather than, say, s. 113(1)(d).)
CRA indicated that if a complete surplus computation is not provided to it, its current general practice is to deny the s. 113(1) deduction. CRA also indicated that where Canco wishes to late-file an election under Regs. 5901(2.1) and (2.2) in order for the dividend to be completely sheltered by the s. 113 deduction (e.g., if it later discovered that it had hybrid or taxable surplus), such a request for a late election generally would not be granted - because relying on surplus balances unsubstantiated by a detailed computation would generally not meet the condition in Reg. 5901(2.1)(b) of having demonstrated making reasonable efforts before the filing-due date.
CRA essentially repeated these positions at the October 11, 2019 APFF Roundtable, which suggests that it is quite serious about them.
In IT-126R2, the CRA states that it considers that where the formal dissolution of a corporation is not complete but there is substantial evidence that the corporation will be dissolved within a short period of time, for the purpose of ss. 88(1) and (2) the corporation is considered to have been wound up. CRA confirmed that this position as to when the subsidiary had been “wound up” also applied as to when the capital dividend account of the subsidiary was to be added to that of the parent.
The limited facts provided were insufficient to determine whether indeed this time was before the time of the filing of articles of dissolution for the subsidiary.
By the way, translations of all the CRA responses provided at the (regular) APFF 2019 Roundtable are now available on our Roundtable pages. Translations of the written answers for the APFF 2019 Financial Strategies and Instruments Roundtable were published by us a week ago.
CRA indicates that s. 60(o)(i) generates professional fee deductibility from the moment that CRA informs that there is an audit
CRA considers that “subparagraph 60(o)(i) applies to [accord deductibility to] fees or professional fees incurred as part of an audit from the time that the taxpayer was informed that the taxpayer was subject to an audit or new examination respecting the taxpayer’s tax return” as well as to “the professional fees or expenses incurred to mount a challenge before the Administrative Tribunal of Québec following a decision rendered by Retraite Québec concerning the tax credit granting an allowance to families” – but that “professional fees or expenses incurred to make a claim for interest and penalty relief [are] not deductible.”
CRA discusses how to report the principal residence exemption when the residence had been expanded from 1 to 2 duplex units
After an individual acquired a duplex in January 2011, he used the two units for renting to a third party and as his personal residence, respectively. In July 2019 he ceased to rent out the first unit, and appropriated it to his residence. He made a s. 45(3) election respecting his change of use under s. 45(1)(c) from rental to personal use, so that he was deemed to have not disposed of the rental unit. (Prior to the 2019 Budget changes, this election would not have been possible because, in the view of CRA, changing the use of only one unit in a duplex represents only a partial change of use of a single property.)
He then will dispose of the duplex in December 2022.
CRA indicated that notwithstanding that it considered the duplex to be a single property, the principal residence designation on the 2022 disposition should be made on two designation forms – one respecting the smaller unit that had been used as a residence up to the expansion date, and the second for the expanded unit.
As to the making of the s. 45(3) election, CRA stated:
Where an election under subsection 45(3) is made, the taxpayer must inform the CRA by enclosing a duly signed letter to that effect with the taxpayer’s return for the year in which the taxpayer actually disposed of the property, or earlier if the CRA issues a formal demand for that election. In that letter, the taxpayer should provide all relevant information related to the change of use.