News of Note

CRA indicates that a UK LLP is a corporation in light [inter alia?] of its separate legal personality

Under the UK’s Limited Liability Partnerships Act 2000, a limited liability partnership (“UK LLP”) is treated in the UK as a separate legal entity, but the profits of its business are taxed as if the business were carried on by partners in partnership, rather than by a body corporate

CRA orally indicated that it would consider the UK LLP to be a corporation under its two-step approach, in light of the LLP’s separate legal personality.

There presumably is more to the CRA’s position than this – otherwise it would contradict its position that an ordinary Delaware LP (as contrasted to an LLP or LLLP) is a partnership for ITA purposes notwithstanding that such “a limited partnership is a separate legal entity:” 14 August 2008 External T.I. 2004-0104691E5. Also note that Scottish partnerships have been found to be partnerships under a two-step approach despite their separate legal personality (see Anson, [2013] EWCA Civ 63, at para. 64, rev'd on other grounds).

Neal Armstrong. Summary of 27 October 2020 CTF Roundtable, Q.9 under s. 248(1) – corporation.

CRA generally accepts that formula-based appreciation plans are not SDAs where the formula closely tracks the FMV of the employer’s shares over the plan’s duration

CRA reiterated its statements in 2020-0850281I7 that it will no longer consider any ruling requests to whether a formula-based appreciation plan is a a salary deferral arrangement, unless the plan is one described in ATR-45 (re share appreciation rights plans), or the request is about whether one of the exceptions, listed in the SDA definition, applies - but went on to note that it accepts that many formula-based appreciation plans are not SDAs where the underlying formula closely approximates the FMV of the relevant shares of the corporate employer over the duration of the plan.

Neal Armstrong. Summary of 27 October 2020 CTF Roundtable, Q.8 under s. 248(1) – SDA.

CRA intimates that use by the children of the cottage held in an alter ego or joint spousal trust is not permitted

The general CRA position is that where, pursuant to the terms of the trust indenture or will, a trust owns personal-use property (e.g., a cottage) for the benefit or personal use of a beneficiary, no taxable benefit will be assessed to that beneficiary for the rent-free use of such property.

When asked whether this position also applies to a trust that is an alter ego trust or a joint spousal trust or a common-law partner trust, CRA noted that in order to meet the conditions of s. 73(1.01)(c), the alter ego trust must be a trust under which no person except the settlor may receive or otherwise obtain the use of any of the income or capital of the trust before the settlor’s death – and similarly, for a joint spousal trust or a common-law spousal trust.

CRA’s anemic language may suggest that this is not a point it will pursue with gusto.

Neal Armstrong. Summary of 27 October 2020 CTF Roundtable, Q.7 under s. 73(1.01)(c) and s. 105(1).

CRA indicates that it will be guided by the OECD examples in applying the PPT

The OECD provided various examples on the application of the principal purpose test (PPT) in the MLI. CRA noted that no comments or reservations were made by Canada regarding those examples, and it will look at those examples for guidance in interpreting the PPT.

To date, no ruling requests on the PPT have been received.

Neal Armstrong. Summary of 27 October 2020 CTF Roundtable, Q.6 under Treaties – MLI – Art. 7(1).

CRA indicates that where Canco is held by fiscally transparent Franceco, which is held by LP with only some US partners, there is a choice as to which Treaty to apply

A partnership whose partners are resident in the U.S. and in other countries with which Canada does and does not have a treaty owns a French entity (that is fiscally transparent for U.S., but not Canadian or French purposes) that earns dividends and interest from a Canadian company. Can the Canadian payor of the dividends determine its withholding tax obligations in accordance with the relevant articles under either the Canada-France, or Canada-US, Treaty?

CRA noted that the first option is that, if IV(6) of the Canada-US Treaty applies, and some of the dividend paid by the Canadian company to the French company is deemed to be derived by the US partners, US Treaty benefits can be claimed to reduce the withholding rate on the portion of the dividend attributable to those partners, under Art. IV(6).

The second option is that, from a Canadian perspective, there is a single dividend payment from a Canadian entity to a French entity, so that the French Treaty is applicable to the entire amount of the dividend.

CRA indicated that the two options are mutually exclusive and exhaustive – either the French Treaty applies to the full amount of the dividend, or the US Treaty applies pro-rata to the US partners. (Presumably, the same analysis would apply to the payment of interest.)

Neal Armstrong. Summary of 27 October 2020 CTF Roundtable, Q.5 under Treaties – Income Tax Conventions – Art. 4.

CRA indicates that the s. 116 certificate limit and the purchase price can coincide even where the vendor partnership has resident partners

CRA’s practice of accepting a consolidated s. 116 certificate request from a partnership disposing of taxable Canadian property (rather than requiring each partner to submit the request) created in its mind a technical issue where that partnership has both Canadian and non-resident partners, namely, that the certificate limit could only be based on the interests in the partnership property (that was TCP) disposed of by the non-resident partners, whereas the potential liability of the purchaser under s. 116(5) could be based on the excess of the global purchase price (reflecting also the interests in the partnership TCP property being sold by the resident partners) over the certificate limit.

However, CRA indicated that it considered that s. 116 can be interpreted such that, in determining the amount of the s. 116(5) liability, the purchase price is only the portion that is attributable to the interest sold by the non-residents, such that the certificate limit and the purchase price would line up, and there would be no resulting s. 116(5) liability.

Neal Armstrong. Summary of 27 October 2020 CTF Roundtable, Q.4 under s. 116(5).

Income Tax Severed Letters 28 October 2020

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

CRA indicates that it may apply GAAR to s. 55(3)(a) spin-offs that effect a disproportionate distribution of high basis assets to the Spinco

We have uploaded summaries of the oral responses provided by CRA at the CTF Annual Roundtable to Q.1 and Q.4 to Q.9. We likely will provide summaries of the balance of the responses (including to Q. 2 and Q.3, which were discussed by CRA last) late tomorrow evening.

In Q.1, a wholly-owned subsidiary (Subco1) of Parentco effects an s. 55(3)(a) spin-off of one of its assets (all the shares of Subco2) to Newco, which is newly-formed by Parentco. If the spin-off is done in the most obvious way, the result is that the shares of Newco held by Parentco will have a pro rata ACB (based on their relative fair market value and the starting ACB of the shares of Subco1). This means that if the shares of Subco2 had a disproportionately high ACB relative to the other assets of Subco1, then on an s. 88(1) winding-up of Subco1, that high ACB would generally flow through under s. 88(1)(c) to Parentco, so that its low-ACB shares of Newco would be replaced by high-ACB shares of Subco2.

CRA indicated that the reorganization results in a misalignment between outside and inside basis, and would consider applying GAAR, because there is an undue ACB increase in the hands of Parentco that is contrary to the scheme of the Act, and, more specifically, of s. 55(2).

On the other hand, CRA indicated that it could be prepared to rule favourably on such a transaction if the transactions resulted in an increase in the ACB of the Newco shares corresponding to the ACB of the spun-off assets (the shares of Subco2). This is somewhat ironic: GAAR potentially would be applied if the spin-off is implemented in the most straightforward manner; whereas, CRA considers it to be preferable to engage in artificial steps to increase the tax basis transferred to Newco (e.g., engaging preliminarily in a “dirty” 85 exchange of the shares of Subco1 in order to isolate cost base in preferred shares.)

Neal Armstrong. Summary of 27 October 2020 CTF Roundtable, Q.1 under s. 55(2.1)(b).

Trustees may be required to report contingent beneficiaries under Reg. 204.2(1)

Regulation 204.2(1) will require disclosure of any person who is a "beneficiary" of the trust. Propep stated obiter that a person should be regarded as a "beneficiary" throughout the Act if that person was "beneficially interested" in the trust, and stated that "[a] person who has a contingent right to the capital or income of a trust is 'beneficially interested' for the purposes of the Act." Propep was adopted in 2014-0538021C6 in interpreting s. 55(5)(e)(ii).

There is an expressed concern that, starting with the 2021 taxation year, trustees for many trusts may be required to report contingent beneficiaries.

Neal Armstrong. Summary of Kate Harris and Balaji (Bal) Katlai, “New Trust Disclosure Rules: The Unfolding of the Propep Nightmare,” Tax for the Owner-Manager,” Vol. 20, No. 4, October 2020, p. 7 under Reg. 204.2(1).

Use of partnerships to hold investment portfolios may reduce the s. 125(5.1) SBD grind

The quantum of the small business deduction (SBD) grind under s. 125(5.1) based on the adjusted aggregate investment income (AAII) for the associated group may be reduced or eliminated if the investment portfolio generating the AAII is held through a joint partnership rather than a joint investment company (Investco). For example if Mr. X owns 100% of Opco (generating active business income) and 51% of Investco (with his spouse holding the other 49%), then all of the AAII of Investco will have to be accounted for in computing the SBC grind to Opco.

However, if the investment portfolio instead is held in a partnership that is owned by a 51/49 basis by respective holding companies for Mr. and Ms. X, only 51% of the AAII of the partnership will be included in computing the SBD grind of the Opco of Mr. X.

Neal Armstrong. Summary of Stan Shadrin, Alex Ghani and Josh Harnett, “Corporate Partnership May Avoid the Paragraph 125(5.1)(b) Grind,” Tax for the Owner-Manager,” Vol. 20, No. 4, October 2020, p.4 under s. 125(5.1).