News of Note
Husky Energy – Tax Court of Canada finds that a securities loan between residents of two Treaty countries eliminated access to Treaty benefits on the dividend payments
Email this ContentBefore a Canadian public corporation (“Husky”) paid a dividend on its shares, two significant shareholders of Husky resident in Barbados (the “Barbcos”) transferred their shares under securities lending agreements to companies resident in Luxembourg with which they did not deal at arm’s length (the “Luxcos”). On payment to the Luxcos of the dividends on those shares, Husky withheld at the Luxembourg treaty-reduced rate of 5% (based on the Luxcos being the beneficial owners of the dividends and controlling at least 10% of the voting power in Husky).
Owen J found that Husky was liable under s. 215(6) for not having withheld at the non-Treaty rate of 25% (although he had no power to increase the assessment of the Minister, which had imposed tax based on the Barbados Treaty-reduced rate of 15%). S. 212(2) imposed tax at 25% on the basis of the persons to whom the dividends had in fact been paid (the Luxcos). Since the dividends had not been paid to Barbados residents (the Barbcos), the Barbados treaty rate of 15% was unavailable. Furthermore, the Luxembourg Treaty rate was unavailable because the Luxcos were not the beneficial owners of the dividends, given that they were required to make matching dividend compensation payments to the Barbcos. In this regard, Owen J stated:
Under the securities lending arrangements, [the Luxcos] enjoyed nothing more than temporary custodianship of the funds received in payment of the Dividends. The compensation payments were preordained by the terms of the borrowing requests, and this preordination ensured that at all times, the Barbcos retained their rights to the full economic value of the Dividends.
Although Husky was thus liable under s. 215(6), Owen J went on to consider the GAAR assessments of the successors to the Barbcos for the difference between the 15% withholding tax they would have borne without the securities loans, and the claimed rate of withholding at the 5% rate.
As to whether there were avoidance transactions, he rejected submissions that the transactions were carried out primarily to avoid the risk of Barbados tax on the dividends, and found that the purpose of the arrangements was primarily to reduce Part XIII tax.
The transactions were not an abuse, because they did not reduce Part XIII tax, and instead increased the rate from 15% to 25%. However, if for completeness, one assumed that the conditions for the 5% rate under the Barbados Treaty had been satisfied, then under this hypothesis there would appear to be no abuse. After referring to the similar analysis in Alta Energy, he stated:
Given the absence of any rule in Article 10 or elsewhere in the Luxembourg Treaty to supplement the residence requirement, the beneficial owner requirement, and the voting requirement, it is reasonable to conclude that Canada and Luxembourg were satisfied with the protection against “conduits” and flow-through arrangements afforded by the inclusion in Article 10(2) of those requirements. In other words, the true intentions of Canada and Luxembourg are fully reflected in the scope of the concepts of residence, beneficial owner and voting power adopted in Article 10(2).
Neal Armstrong. Summaries of Husky Energy Inc. v. The King, 2023 TCC 167 under s. 212(2), Treaties – Income Tax Conventions – Art. 10, s. 245(1) – tax benefit, s. 245(4).
Pinnacle International – Tax Court of Canada reallocates partnership profit under s. 103(1) based on relative contribution
The taxpayer and another wholly-owned subsidiary (“Taylor”) of the same corporation (“PIRG”) were the 5% and 95% partners, respectively, of a partnership, with an October 31 year end, which was engaged in developing a Vancouver condominium project. In October 2006, after virtually all of the profits from the development had been realized, PIRG transferred the shares of Taylor to a “Lossco” with which it dealt at arm’s length (“Meston”), with Taylor then being wound-up into Meston.
D’Arcy J noted that the taxpayer accepted that s. 103(1) applied because the allocation to Meston “was principally motivated by tax”. In applying s. 103(1) to confirm a CRA assessment which allocated 95% of the partnership profit for that year (minus the amount of a “deal fee” paid to Meston) to the taxpayer, D’Arcy J found:
- As Meston became a partner after over 99% of the partnership profits had been earned, so that it would be unreasonable to allocate 95% of those profits to Meston, the question then became as to how the 95% of the profits should be allocated as between Taylor and the taxpayer.
- Taylor was a “shell corporation” with “no physical assets, employees, or bank accounts” and which had not made “any significant financial contributions to the Partnership”.
- The taxpayer was “a corporation of substance” with employees who managed the development; and it also helped finance the development.
- Although the individual shareholder of PIRG testified that he provided his services on behalf of Taylor, he was paid millions in salary by the taxpayer, and nothing by Taylor.
Neal Armstrong. Summary of Pinnacle International Realty Group II Inc. v. The King, 2023 TCC 161 under s. 103(1).
Income Tax Severed Letters 13 December 2023
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Walby – Tax Court of Canada finds that s. 248(30) provided no credit for the cash component under a gifting program
MacPhee J applied Maréchaux to find that since the gifting program participated in by the taxpayers was a single interconnected arrangement with a view to profiting from large charitable receipts, none of the “gifts” made by the taxpayers including their cash contributions, qualified as gifts for s. 118.1 purposes, so that no credit could be claimed for even the cash components, as now argued by the taxpayers.
He further found that since s. 248(30) only operated to cure for certain advantages where there was a “gift,” their lack of donative intent also meant no relief under s. 248(30). Furthermore, even if there were a cash “gift”, the amount of the related advantages (being the dollar amount of the software licences that were to be received and donated or, alternatively, the inflated tax credits to be received or, in the further alternative, the value of the “pretence” documents to be received) should be valued for s. 248(32) purposes based on the value of what was expected to be received at the time of the “donation” rather than on what in fact was received under a bogus arrangement. So valued, the advantage amount exceeded the cash contribution amount and, thus, exceeded the 80% threshold under s. 248(30).
Neal Armstrong. Summary of Walby v. The King, 2023 TCC 164 under s. 248(30).
Stackhouse – Tax Court of Canada finds that deductions of losses from a farming business carried on for profit were severely limited because it was a subordinate source of income
Owen J found that the taxpayer’s “farming business has always been subordinate to [her] medical practice as a source of income … and there is no evidence that that will change in the foreseeable future” so that, in light of the amendments to s. 31(1) to overrule Craig, her large farming losses were limited to $17,500 per annum.
Owen J noted that the “[t]here is no evidence that calls into question … that the Appellant pursued her clearly commercial farming activity for profit”, and then stated:
The result in this appeal is most unfortunate. The amended version of the rule has the effect in this case of precluding the operator of a bona fide farming business from deducting losses that would be available to the operator of any other type of business.
Neal Armstrong. Summary of Stackhouse v. The King, 2023 TCC 156 under s. 31(1).
Montour – Quebec Superior Court finds that tobacco duty could not be imposed on Mohawks because Finance had failed to consult with them in designing the tobacco duty provisions
Bourque JCS held that the tobacco duty imposed by s. 42(1) of the Excise Act, 2001 unjustifiably infringes the Aboriginal right and the treaty right of the Mohawks as guaranteed by s. 35(1) of the Constitution Act, 1982 and is of no force and no effect against them, so that the criminal procedures against the Mohawk accused (who had imported tobacco in bulk from the U.S. without paying excise duty) were permanently stayed.
In this regard, she concluded that the participation of the Mohawks in the tobacco trade was protected by their aboriginal right to “freely pursue economic development”. Furthermore, “the Excise Act, 2001 violates their Aboriginal rights by giving broad discretion to the Minister to issue licences without providing any guidance regarding Aboriginal or treaty rights, thereby imposing an unreasonable limitation of the rights”. In addition, there was “no evidence that the interests of the Mohawks of Kahnawà:ke have been taken seriously in the elaboration of the Excise Act, 2001” (para. 1605) so that the “the Crown did not discharge its duties to consult - and even less to accommodate”.
Neal Armstrong. Summary of R. v. Montour, 2023 QCCS 4154 under Constitution Act, 1982, s. 35(1).
We have translated 7 more CRA interpretations
We have translated a CRA interpretation released last week and 6 further CRA interpretations released during July of 2002. Their descriptors and links appear below.
These are additions to our set of 2,662 full-text translations of French-language Technical Interpretation and Roundtable items (plus some ruling letters) of the Income Tax Rulings Directorate, which covers all of the last 21 1/3 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
Finance comments on the new GAAR rules
Points made by Trevor McGowan on the new GAAR rules included:
- The introduction of the economic substance rule in s. 245(4.1) was intended to counter what may be an existing default approach towards dealing with economic substance, arising from Canada Trustco, of considering that a lack of economic substance is generally irrelevant, unless the provisions otherwise indicates - so that economic substance now is relevant.
- The tests in s. 245(4.1)(a) to (c) need to be applied holistically to the transactions as a whole.
- Other than the change of indicating that economic substance has some relevance (which he would not want to portray as an inconsequential change) there is essentially no change to the GAAR analysis.
- He provided a detailed run-down of why the typical exchangeable share deal would satisfy the economic substance tests in s. s. 245(4.1).
- He did not state that there is no general due diligence defence (see Consolidated Canadian Contractors and progeny) to the new penalty (in addition to the narrow defence in s. 245(5.2)), even though invited to comment on this point.
Neal Armstrong. Summary of 26 November 2023 CTF Conference - "The Future of the GAAR" under s. 245(4.1).
PepsiCo - Federal Court of Australia finds that part of the purchase of concentrate by an Australian bottler from an Australian PepsiCo company was a trademark royalty
A U.S. company (PepsiCo) entered into an “exclusive bottling appointment” (“EBA”) with an independent Australian bottling company (“SAPL”). PepsiCo agreed in the EBA to sell, or cause a related entity to sell, beverage concentrate to SAPL for bottling and sale, and granted SAPL the right to use the Pepsi and Mountain Dew trademarks in this regard. In fact, the concentrate was sold by an Australian company in the PepsiCo group (“PBS”) to SAPL. There was a similar arrangement for the licensed bottling and sale by SAPL of Gatorade pursuant to an EBA with another U.S. company (“SVC”).
The definition in Art. 12(4) of the Australia-U.S. treaty (the “DTA”) of “royalties” referred inter alia to “payments or credits of any kind to the extent to which they are consideration for the use of or the right to use any … trademark.”
Moshinsky J found that Australia was permitted under the DTA to impose withholding tax of 5% on a portion of the purchases paid by SAPL to PBS (essentially determined by him to be 5.88%, based on expert evidence as to licensing “comparables”) on the basis that it constituted consideration for the use, or right to use, the trademarks to which PepsiCo or SVC were beneficially entitled, stating:
[W]hile the payments made by SAPL were, on their face, payments for the purchase of concentrate, this is not determinative of their characterisation for the purposes of Art 12(4) … .
PepsiCo and SVC nominated PBS to be the seller of the concentrate under the EBAs for the relevant years. This constituted a direction to SAPL to pay PBS rather than PepsiCo or SVC … .
PepsiCo and SVC … were entitled to receive the payments under the EBAs and directed SAPL to pay PBS. In these circumstances, PepsiCo and SVC were beneficially entitled to the relevant portions of the payments.
Neal Armstrong. Summary of PepsiCo, Inc v Commissioner of Taxation [2023] FCA 1490 under Treaties – Income Tax Conventions – Art. 12.
CRA rules that the domestication of an exempted Bermuda limited partnership under the DRULPA does not entail dispositions or the creation of a corporation
CRA ruled that the “domestication” of an exempted Bermuda limited partnership to become a limited partnership governed by the Delaware Revised Uniform Limited Partnership Act (the “DRULPA”) did not entail a disposition by the partnership of its property or by the members of their partnership interests, notwithstanding that the partnership did not have separate legal personality under Bermuda law, and acquired such personality under the DRULPA.
CRA accepted a representation that the partnership activity (of holding shares of subsidiaries) was carried on in common with a view to a profit and that the partnership was considered a partnership for purposes of the Act prior to the domestication transaction, and ruled that following the domestication, the partnership will be treated as a partnership for purposes of the Act. This suggests that a limited partnership governed by the DRULPA is a partnership rather than a corporation (see also 2006-0216451I7 F).
Neal Armstrong. Summaries of 2023 Ruling 2022-0950461R3 under s. 248(1) – disposition and s. 96.