News of Note
Revised s. 212.1(4) rule generates anomalous results
Email this ContentThe exception in s. 212.1(4) from the application of the surplus-stripping rule in ss. 212.1(1) permits the unwinding of a sandwich structure resulting from a Canadian corporate purchaser having acquired a non-resident corporation holding a Canadian subsidiary – so that such non-resident corporation can transfer the shares of the Canadian subsidiary to the Canadian purchaser. The 2016 federal budget proposed a significant narrowing of s. 212.1(4), so that it will not apply where, at any time as part of the series of transactions, a non-resident who did not deal at arm’s length with the Canadian purchaser owned directly or indirectly any share of the purchaser.
Even accepting the general policy of this proposal, it could produce inappropriate results. For example:
- The proposed rule could penalize a Canadian shareholder of the Canadian purchaser if a non-resident shareholder of the purchaser does not deal at arm’s length with the purchaser.
- If a Canadian corporation (with no non-resident shareholders) had previously acquired the purchaser from a non-resident vendor, and the purchaser corporation now is used to acquire a non-resident corporation holding an underlying Canadian corporation, the s. 212.1(4) exception will not be available if the prior acquisition occurred as part of the same "series" - even though no non-resident now indirectly holds any interest in the acquired corporation.
- Similarly, if a Canadian corporation (with no non-resident shareholders) had previously acquired the purchaser from a non-resident vendor, and the purchaser already held a non-resident corporation that, in turn, held an underlying Canadian corporation, s. 212.1(4) will not apply to permit the sandwich to be unwound into the purchaser.
- Where the s. 212.1(4) exception is not available because there is a non-resident corporation atop a double-decker sandwich structure, the unwinding of that structure could result in double withholding tax.
- Purchasers who are Canadian public corporations with non-resident shareholders, or private-equity funds with non-resident partners, may have difficulty in demonstrating satisfaction of the arm’s length test.
Neal Armstrong. Summary of Angelo Nikolakakis, "Cross-Border Surplus Stripping – Stripping Bona Fide Non-Resident Purchasers," International Tax (Wolters Kluwer CCH), No. 87, May 2016, p.4 under s. 212.1(4).
0741449 B.C. Ltd. – Federal Court grants a s. 164(1.2) order based on taxpayer’s low net worth and poor payment history
A corporation had a refund claim of $1.2 million respecting its previous payment of income taxes that were still in dispute. In granting a jeopardy order under s. 164(1.2) that the refund claim not be paid, Hughes J referred to the corporation’s principal asset being subject to a foreclosure order and to its shareholder having “a history of non-payment of taxes and bankruptcy.”
Neal Armstrong. Summary of Canada (National Revenue) v. 0741449 B.C. Ltd., 2016 FC 530 under s. 164(1.2).
Rice – Quebec Court of Appeal finds that status Indians were required to collect sales tax on sales to non-Indians
Status (Mohawk) Indians selling gasoline on the Kahnawake Reserve to non-Indian purchasers were not exempted by s. 87 of the Indian Act from the requirement to collect and remit GST, QST and Quebec fuel tax, given that these taxes were designed to be borne by the ultimate purchasers and the retailers’ obligations were merely those of statutory collection agents. (Various constitutional arguments also were rejected by Hesler CJQ.)
Similar issues can arise respecting whether crown agents or non-residents can be required to collect or withhold tax on payments collected or paid to counterparties.
Neal Armstrong. Summaries of Rice v. ARQ, 2016 QCCA 666 under Constitution Act, 1982, s. 35(1), s. 25, Indian Act, s. 87, Constitution Act, 1867, s. 91(24).
CRA should adhere to the OECD transfer-pricing guidelines on “reasonable efforts”
If a taxpayer satisfies the contemporaneous documentation requirements of s. 247(4), s. 247(3) provides a safe harbor from its penalty provisions if the taxpayer made “reasonable efforts” to determine an “arm’s length transfer price.”
The following statement in TPM-09 is generally consistent with the 1995 OECD Guidelines which inspired this safe harbor (and which referred to "prudent business management principles that would govern the process of evaluating a business of a similar level of complexity and importance:"
What is reasonable is based on what a reasonable business person in the taxpayer's circumstances would do, having regard to the complexity and importance of the transfer pricing issues that arise in the taxpayer's case. …
However, the authors note that “regardless, we have seen the CRA assert penalties in circumstances where it ought to be uncontroversial that reasonable efforts were made.”
Neal Armstrong. Summaries of Michael Colborne, Michael McLaren, Mark Barbour, "Subsection 247(3): What are "Reasonable Efforts"?", Canadian Tax Journal, (2016) 64:1, 229-43 under s. 247(3) and s. 247(4).
CRA considers that the debt parking rule can apply even if no capital loss is recognized
If a corporation disposes of debt of a subsidiary at a substantial loss to another corporation which is related to it (and the subsidiary) by virtue only of s. 251(5)(b), the loss nonetheless is denied by s. 40(2)(e.1) and added to the adjusted cost base of the debt in the acquirer’s hands under s. 53(1)(f.1). However, the debt parking rule in s. 80.01(8) also applies to the acquisition, and deems that debt to be settled for an amount equal to its ACB to the acquirer.
CRA considers that the debt forgiveness rules could thereby apply to the debt because the deemed settlement under s. 80.01(8) occurs at the time of the acquisition, whereas the s. 53(1)(f.1) bump to the acquirer’s ACB occurs only immediately after that time, i.e., the debt apparently is deemed to be settled for an amount equal to the acquirer’s cost rather than its post-bump ACB.
Neal Armstrong. Summary of 31 March 2016 T.I. 2014-0524391E5 Tr under s. 80.01(8).
CRA seemingly reverses a previous position that s. 20(12) applies on a source-by-source basis, so that taxes paid on business income are not eligible where the Canadian taxpayer only earns property (dividend) income
In 2011-0394631I7, CRA indicated that a Canadian corporation (“Canco”), holding shares of disregarded LLCs through a US LP that was a corporation for Code purposes, was not entitled to a s. 20(12) deduction for its share of the U.S. corporate income taxes of the US LP, on the grounds that those US taxes were paid in respect of business income (as the LLCs were carrying on active businesses) rather than property income, whereas the only source of income of Canco was property income, namely, the LLC dividends.
Without mentioning it, CRA, in a laconic recent technical interpretation, appears to have reversed this 2011 interpretation. On essentially the same facts, except that the taxpayer was a Canadian-resident individual holding his interest in the US LP through a Canadian LP, CRA indicated that the taxpayer could claim an s. 126(1) foreign tax credit, or a deduction under s. 20(11) or (12), provided the usual conditions were satisfied. The relevant development since 2011 may be that in Smidth (affirmed on different ground by the FCA), Paris J stated, with apparent approval, that in 2008-0284351I7 “the CRA accepted that the 20(12) deduction was available where the U.S. tax was paid on income from a source that is different from the taxpayer’s source of income under the Act” (as well as referring with approval to 1999-0010295).
Neal Armstrong. Summary of 2015-0572461I7 under s. 20(12).
Income Tax Severed Letters 11 May 2016
This morning's release of ten severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA considers that installing interior access to the other unit in a duplex occupied by an elderly parent, who shares meals, does not make the whole a principal residence
CRA considers that in order for a duplex to be considered a single housing unit for principal residence purposes, the two units must be “sufficiently integrated so that it is not possible to live normally in the living areas of one of the units without also having access to the other unit in order to use its facilities.” CRA did consider this test to be satisfied where an individual purchases a duplex to support and provide care to an elderly parent, renovates it so that a door now provides interior access between the two units, and with the parent sharing most meals with the child and the child’s family. Thus, on resale, the child could claim the principal residence exemption only on the child’s unit and not the other. However, if the facts were the same except that the elderly parent was the owner, the parent could choose which of the two units to treat as a principal residence.
Neal Armstrong. Summary of 21 January 2016 Ordre des CPA du Québec Roundtable on Personal Taxation, Q. 9, 2016-0625141C6 Tr under s. 54 - principal residence.
Anderson – Tax Court of Canada finds that the principle of deference, in reviewing s. 67 expense deductibility, to presumed taxpayer business acumen does not extend to bone-headed decisions
After stating that “the presumed existence of business acumen should not be treated as absolute, irrefutable or sacrosanct” in the s. 67 context, Smith J allowed many of the $64,000 of expenses incurred in a year by an individual, with a salary of $117,000, in trying to convince successful sales people to sell coffee as his sub-agents in a business venture he was starting up on the side – but Smith J couldn’t countenance the deduction of U.S.$15,000 paid to a prospective salesman, supposedly with a phenomenal sales record, mostly as an enticement to become the taxpayer’s sub-agent and as an advance on his future commissions, stating:
I find that “no reasonable business man would have contracted to pay that amount” (Gabco...), certainly not without a more detailed business agreement.
Neal Armstrong. Summary of Anderson v. The Queen, 2016 TCC 106 under s. 67.
CRA rules that the home of a Canadian employee doing marketing (but no contracting) for a U.S. employer is not a PE
CRA has ruled, respecting an employee performing marketing work out of his Canadian home (which his U.S. employer has no access to and whose expenses are not borne by it) and who has no authority to contract, that the U.S. employer will not thereby be considered to have a permanent establishment in Canada.
Neal Armstrong. Summary of 2014-0550611R3 under Treaties – Art. 5.