News of Note

Frank-Fort Construction – Tax Court of Canada reverses gross negligence penalty for failure of new home builder to report two sales

D’Auray J found that a one-man corporation that had a business of constructing (through using third-party contractors) and selling about 10 or 20 new homes per year had not been demonstrated by the Crown to be liable for gross negligence penalties for failure to report in its GST returns two of the home sales it made in the 2 ½ year audit period. Factors noted by her included:

  • all the necessary information for preparing the tax returns and financial statements had been provided to the taxpayer’s CPA firm
  • due to an inexplicable error on the part of the CPA firm, the receipts from the two sales had been recorded as proceeds of mortgage loans received by the taxpayer
  • the GST returns were prepared and signed by an accountant at the CPA firm, which delegation did not constitute gross negligence on the part of a taxpayer whose principal had no accounting background and a modest education
  • although there also had been failures to report sales in preceding reporting periods for which QST penalties had been assessed, the taxpayer had been assured by a different accountant at the CPA firm that he would now personally attend to the file

Neal Armstrong. Summary of Frank-Fort Construction Inc. v. The Queen, 2020 CCI 6 under ETA s. 285(1).

CRA finds that the making of a loan at the prescribed rate under s. 189(1) does not prelude a penalty under s. 188.1(4)

S. 189(1) generally imposes tax on a taxpayer to the extent that the interest paid on loan made to the taxpayer that is a non-qualifying interest was less than the prescribed rate. Under s. 188.1(4), where an “undue benefit” (defined in s. 188.1(5)) has been conferred on a person by a registered charity, the charity is liable to a penalty equal to 105% (or 110%) of the value of the undue benefit conferred.

Headquarters rejected the proposition that where a registered charity that is a private foundation makes a loan at the prescribed rate of interest when the loan recipient receives the loan because of that debtor’s relationship with the private foundation or the foundation’s board of directors, the avoidance of any s. 189(1) tax on the debtor (because of the prescribed rate being used) means that there cannot be a penalty for undue benefits imposed on the private foundation under s. 188.1(4) in respect of the loan.

Neal Armstrong. Summary of 5 December 2019 Internal T.I. 2017-0683831I7 under s. 188.1(4).

[Corrected title] CBS – Federal Court of Appeal finds that Galway did not permit the Crown to resile from a settlement agreement negotiated in good faith

The Justice Department entered into a settlement agreement with the taxpayer in which it agreed to permit the taxpayer to carryforward an agreed portion of a $23.4M non-capital loss – and then promptly sought to repudiate the agreement on the basis that CRA had discovered that the non-capital loss in question did not exist, so that implementing the settlement would be contrary to law, which Galway said was bad. In affirming the decision below that the Crown was bound by the settlement agreement, Woods JA stated:

Galway does not address the circumstances in which one party seeks to resile from an agreement.

Second, the parties in this case intended to enter into an agreement that applied the law to the facts. The agreement was not intended to be a compromise settlement of the type considered in Galway.

Third, the Crown does not suggest that the defect within the settlement agreement is self-evident to the Court as it was in Galway. …

The general rule is that parties should be bound by the agreements that they make.

She also found that a Tax Court order implementing a provision in the settlement agreement that tax was to be increased in a subsequent year did not violate the Last principle that the Crown was not permitted to appeal its own reassessment.

Neal Armstrong. Summaries of CBS Canada Holdings Co., 2020 FCA 4 under s. 169(3) and s. 171(1)(b).

Krumm – Tax Court of Canada applies the tax shelter rules on a private purchase of property described as Class 12 available-for-use property

The taxpayer acquired a 50% interest in software after being provided with a valuation report that indicated that the software was Class 12 property and qualified as being available for use. Visser J found that this was sufficiently tantamount to representing that the cost of the software could be written off over two years and found that there thus was an unregistered tax shelter, resulting in the CCA claims being denied under s. 237.1(6). He also rejected a submission that “the tax shelter rules are intended to apply only to publicly marketed tax shelters and not to private transactions between two parties.”

Neal Armstrong. Summary of Krumm v. The Queen, 2020 TCC 7 under s. 237(1) – tax shelter – (b).

CRA indicates that a grandfathered LLLP cannot treat itself prospectively as a corporation without losing grandfathering

2017-0691131C6 stated that one of the conditions for allowing Delaware or Florida LLLPs formed before April 26, 2017 to file as a partnership was that “no member of the entity and/or the entity itself takes inconsistent positions from one taxation year to another … between partnership and corporate treatment.” Two LLLPs (held by Canadian resident corporations) that had filed as partnerships for Canadian tax purposes since the time of their formation proposed to now treat themselves as corporations on a prospective basis. CRA found that this would violate such condition (“the change by the LLLPs from partnership to corporate treatment constitutes taking an inconsistent position from one taxation year to the next”) and added:

As stated at IFA 2017, where any of these conditions is not met in respect of any such entities formed before April 26, 2017, the CRA may issue assessments or reassessments to the members and/or the entity, for one or more taxation years, on the basis that the entity was always a corporation.

The LLLPs will not be viewed as corporations for Canadian tax purposes on a solely prospective basis.

Neal Armstrong. Summary of 1 August 2019 External T.I. 2018-0768561E5 under s. 96.

Income Tax Severed Letters 22 January 2020

This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.

A Starlight LP realized and distributed gains on US rental properties through use of partnerships

The Starlight U.S. Multi-Family (No. 1) Value-Add Fund is an Ontario LP established in June 2017 that was targeted to stay in existence for three years, during which time it was to acquire US rental apartment buildings, undertake “high return, light value-add capital expenditures” and then sell the buildings for a price reflecting the resulting increased rents. That now has occurred.

In order to avoid the realization of foreign accrual property income gains, and instead realize (non-FAPI) capital gains that could be integrated with capital gains treatment to the Fund unitholders, the gains were not realized within the corporate subsidiary (a US private REIT) and instead were realized on internal transfers by subsidiary LPs. In order to get the proper basis adjustments for the distribution of such capital gains, various tiers of partnerships were wound-up on a bottom-up basis as a part of the distribution of proceeds, and with the net sales proceeds ultimately distributed in redemption of the Fund units.

FIRPTA of course was recognized on the gains on the sales.

Neal Armstrong. Summary of Starlight U.S. Multi-Family (No. 1) Value-Add Fund Circular under Other – Asset Purchases.

CRA’s position that s. 84.1 dividends can be capital dividends and generate dividend refunds raises tax-deferral possibilities

11 October 2019 APFF Roundtable, Q.1 and 3 December 2019 CTF Roundtable, Q.4 confirmed that a s. 84.1 deemed dividend can benefit from both the s. 129(l)(a) dividend refund and the capital dividend account (CDA) mechanism. This might facilitate share sale planning.

For example, Bob would realize a capital gain of $999,999 and around $240,000 of capital gains tax if he sold all the shares of Opco to a third-party purchaser for $1 million.

He could instead transfer ½ of his Opco shares on a rollover basis to newly-formed Holdco, with Holdco then realizing a $500,000 capital gain on those shares on an internal transfer, so that Holdco is subject to $127,000 of corporate tax, has a $250,000 addition to its CDA and generates $77,000 of non-eligible RDTOH. He then transfers his remaining Opco shares to Holdco in two tranches for two $250,000 notes, resulting in the receipt of a $250,000 capital dividend and in a second $250,000 (taxable) dividend that generates a full refund of the $77,000 of NERDTOH to Opco.

The result (leaving aside ss. 245(2) and 129(1.2)) is that Bob pays $102,500 in personal tax and Holdco bears net corporate tax of $50,000. The total of $152,500 is less than $240,000, because tax is deferred until further dividends are paid by Holdco.

Neal Armstrong. Summary of Aasim Hirji and Kenneth Keung, “Planning Possibilities Resulting from CRA Policy Reversal on Section 84.1,” Tax for the Owner-Manager, Vol. 20, No. 1, January 2020, p.9 under s. 129(1).

Planning for intercorporate dividends can now be more fraught

There is increased complexity associated with the payment of dividends by private corporations.

Where a subsidiary corporation has non-eligible refundable dividend tax on hand (NERDTOH), ERDTOH, or GRIP balances, attention is needed to ensure that dividends from the subsidiary result in additions to the same pools in the parent company. Eligible dividends may add to the parent company's GRIP and ERDTOH, but will not recover NERDTOH in the subsidiary. Non-eligible dividends can increase the parent company's ERDTOH, but not its GRIP.

In addition, the usual Pt IV tax considerations should be addressed including that shares held by a trust will not qualify for the votes and value test in s. 186(4)(b). Staggered year-ends create planning challenges.

Neal Armstrong. Summary of A.G. (Sandy) Stedman, “Intercorporate Dividend Planning: More Complexity,” Tax for the Owner-Manager, Vol. 20, No. 1, January 2020, p. 7 under s. 129(1).

5 more translated CRA interpretations are available

We have published a further 5 translations of CRA interpretations released in March, 2011. Their descriptors and links appear below.

These are additions to our set of 1,068 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 8 ¾ years of releases of Interpretations by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall.

Bundle Date Translated severed letter Summaries under Summary descriptor
2011-03-04 8 October 2010 Roundtable, 2010-0373311C6 F - Oeuvres d'artistes étrangers Income Tax Regulations - Regulation 1102 - Subsection 1102(1) - Paragraph 1102(1)(e) foreign art work decorating corporate offices is non-depreciable
Income Tax Act - Section 15 - Subsection 15(1) art used to decorate the office of a shareholder-employee generally does not generate a s. 15(1) benefit
Income Tax Act - Section 54 - Listed Personal Property art work in corporate boardroom is not personal use property, perhaps also where decorates office
8 October 2010 Roundtable, 2010-0373251C6 F - Immeuble détenu par une société Income Tax Act - Section 15 - Subsection 15(1) determining the "normal rate of return" used in computing imputed rent
8 October 2010 Roundtable, 2010-0373691C6 F - T4A et T5018 - Honoraires Income Tax Regulations - Regulation 238 - Subsection 238(2) unlike T4A, amounts paid include GST/HST
Income Tax Regulations - Regulation 200 - Subsection 200(1) GST/HST excluded from services payments
8 October 2010 Roundtable, 2010-0373431C6 F - Montants payés ou payables par une fiducie Income Tax Act - 101-110 - Section 104 - Subsection 104(24) requirements for distributing income in the year pursuant to issuance of unconditional promissory note
8 October 2010 Roundtable, 2010-0373541C6 F - Mise à part de l'argent après Lipson Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) - Subparagraph 20(1)(c)(i) cash damming still respected following Lipson