News of Note
CRA states that it will continue to issue post-mortem pipeline rulings following the GAAR amendments, but will not rule on surplus stripping by individuals
Email this ContentRegarding the status of post-mortem pipeline transactions following the amended GAAR rule, the Directorate stated:
The Directorate does not consider the use of a pipeline transaction as a means to preserve the capital gain arising on the death of a shareholder while limiting double taxation on the subsequent distribution of Opco’s assets to be a … [GAAR] abuse … . Accordingly, the Directorate will continue to issue favourable Rulings on the non-application of the amended GAAR in the context of post-mortem pipeline transactions that meet our existing administrative guidelines described in document 2018-0748381C6.
However, the Directorate noted the example provided in the Explanatory Notes of a surplus-stripping transaction of Jane in which she realized a capital gain on a dirty s. 85 exchange of her Opco shares, transferred her stepped-up Opco shares to another corporation controlled by her (Buyco) in consideration for a Buyco note, with Opco then dividending its earnings to Buyco for application in repaying the note. It indicated that it will not provide Rulings in respect of transactions of this type or “in similar circumstances where an individual shareholder proposes to engage in non-arm’s length transactions, one of the main purposes of which is to create cost basis to extract retained earnings.”
Neal Armstrong. Summary of 29 February 2024 Internal T.I. 2023-0987941I7 under s. 245(4).
CRA indicates that the quantum of offshore investment fund property income earned through a CFA is unaffected by dividends paid by that CFA
A wholly-owned non-resident subsidiary (“CFA”) of Canco owned 50% of the common shares of a non-resident corporation (“FA”) which were assumed to constitute offshore investment fund property (“OIFP”). CFA received annual dividend distributions from the OIFP. Headquarters rejected Canco’s argument that a dividend paid by CFA to Canco generated a deduction pursuant to s. 94.1(1)(g) from the imputed income inclusion to Canco under the OIFP rules pursuant to s. 94.1(1)(f). The effect of C of the FAPI formula was that the OIFP rules generated FAPI to CFA, and Canco then picked up its share of such FAPI – and this combined operation of the FAPI and OIFP rules was not affected by dividends paid by FA to the CFA (inter-FA dividends are excluded form FAPI) nor was it affected by any dividends paid by CFA to Canco.
Neal Armstrong. Summary of 23 August 2023 Internal T.I. 2021-0882371I7 under s. 94.1(1)(g).
Income Tax Severed Letters 6 March 2024
This morning's release of five severed letters from the Income Tax Rulings directorate is now available for your viewing.
DEML Investments – Tax Court of Canada finds that the generation of a capital loss on a partnership interest representing a successful investment was a GAAR abuse
In early 2008, the sale of petroleum and natural gas (PNG) rights by an arm’s length vendor (Transglobe) to the parent (Direct Energy) of the taxpayer (DEML) was structured on the basis that Transglobe transferred 99% and 1% of the PNG rights, at a nominal s. 85(1) elected amount, to two wholly-owned Newcos (137 and 138, respectively), which then transferred the rights on an s. 97(2) rollover basis to a newly-formed partnership (DERP2). Direct Enery then acquired the shares of 137 and 138 for $51 million and $0.5 million, respectively.
A year later, Direct Energy transferred the shares of 137 to DEML on an s. 85(1) rollover basis, with 137 then distributing its partnership interest in DERP2 to DEML on its winding up, with the ACB of that partnership interest being bumped under s. 88(1)(d).
DERP2 then distributed its resource properties to DEML as a return of capital, thereby increasing the COGPE balance of DEML and reducing the ACB of DEML’s partnership interest by the FMV of the rights (higher than the value a year earlier) – but with these items effectively being approximately reversed at the partnership year end as a result of DERP2’s proceeds of the distribution of the PNG rights being allocated to its partners.
After then reseeding DERP2 with a small resource property that was of interest to a third-party purchaser, DEML sold its partnership interest to that purchaser, thereby realizing a capital loss. In confirming CRA’s GAAR assessment to deny the capital loss, Russell J stated:
Here the substantial Capital Loss was claimed where there was no economic loss or impoverishment, thus per Triad Gestco breaching the OSP [object, spirit and purpose] of the Act’s capital loss provisions, including paragraph 39(1)(b). …
As the purpose of the capital loss provisions is to recognize real losses, there is clear abuse where artificial losses are deducted. That is even more so when those losses are based on non-capital CRP [Canadian resource property], that will also be deducted through CCOGPE pools at a 100% inclusion rate thus creating a double deduction.
Similarly, regarding the use of the s. 88(1)(d) bump to effectively create most of the quantum of the loss, he stated:
[I]t seems incomprehensible that an artificial loss would signal misuse of capital loss provisions of the Act without equally indicating misuse of the very “bump” provisions of the Act used to achieve the artificial loss through the “bumping” of an ACB.
Neal Armstrong. Summary of DEML Investments Limited v. The King, 2024 TCC 27 under s. 245(4).
CRA discusses the different treatment of losses under Pt. XIV, and Art. X(6) of the Canada-US Treaty
The Directorate confirmed the position in 9408985 that in light of the branch profits limitation under Ar. X(6) of the Canada-US Treaty of 10% of cumulative untaxed "earnings," a two-step process should be followed under which branch tax is first computed in accordance with Part XIV, then the upper limit is computed under Art. X(6) which, if applicable, reduces the branch tax computed under the first step.
Regarding the effect on “earnings” under Art. X(6) where a non-resident corporation applied a loss carryback to reduce its taxable income earned in Canada in the prior year, the Directorate noted that, in contrast to the Part XIV rules, the Art. X(6) earnings for a particular year are not reduced by the carryback of losses to that year from a subsequent year, so that such loss only reduces the cumulative earnings for Art. X(6) purposes in the loss year. Furthermore, although Art. X(6)(b) contemplates the deduction of Part I federal, and provincial income tax in computing earnings, when there is a loss carryback to a prior year which reduces such taxes for that year, the impact of such tax reduction on earnings for Art. X(6) purposes should be to reduce the loss for the current year rather than to increase earnings for the prior year.
The Directorate further stated:
[T]he amount of Allowance for Investment Property in Canada claimed in the prior year and that is being added back to the branch tax base under paragraph 219(1)(g) should not be added back in the same manner in computing “earnings” under Article X(6). Instead, the amount of Allowance for Investment Property in Canada for the current year, calculated under Regulation 808, would be deducted in the “earnings” calculation in accordance with subparagraph (c) of Article X(6).
Neal Armstrong. Summary of 21 October 2021 Internal T.I. 2020-0872281I7 under Treaties – Income Tax Conventions – Art. 10.
We have translated 6 more CRA interpretations
We have translated 6 further CRA interpretations issued in April of 2002. Their descriptors and links appear below.
These are additions to our set of 2,768 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 22 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
| Bundle Date | Translated severed letter | Summaries under | Summary descriptor |
|---|---|---|---|
| 2002-03-29 | 4 April 2002 External T.I. 2001-0103525 F - Identical Property | Income Tax Act - Section 54 - Superficial Loss - Paragraph (i) | right to convert Class A shares into Class B shares would cause the loss on disposing of Class B shares, followed immediately by acquiring Class A shares, to be a denied superficial loss |
| 18 April 2002 Internal T.I. 2001-0105007 F - RECOMPENSE POUR UN SAUVETAGE MARITIME | Income Tax Act - Section 3 - Paragraph 3(a) | salvage received by crew members was not an exempt windfall | |
| Income Tax Act - Section 5 - Subsection 5(1) | salvage received by employed crew members likely employment income | ||
| 5 April 2002 External T.I. 2002-0122055 F - BIEND D'UN REER DONNES EN GARANTIE | Income Tax Act - Section 146 - Subsection 146(12) | where property used as security, s. 146(12) rather than s. 146(10) applies to a depositary RRSP | |
| Income Tax Act - Section 146 - Subsection 146(10) | s. 146(10) rather than s. 146(12) applies to a non-depositary RRSP where its property is used as security | ||
| Income Tax Act - Section 146 - Subsection 146(7) | s. 146(7) can reverse only the current year’s inclusion under s. 146(10) | ||
| 12 April 2002 External T.I. 2002-0122495 F - PRIME PAYEE SUR OBLIGATION | Income Tax Act - Section 54 - Adjusted Cost Base | premium on bond acquired as capital property produces a capital loss at maturity | |
| Income Tax Act - Section 9 - Capital Gain vs. Profit - Debt/ receivables | short holding time to maturity does not preclude a bond from being capital property | ||
| Income Tax Regulations - Regulation 7000 - Subsection 7000(1) - Paragraph 7000(1)(b) | determination of Reg. 7000(1)(b) proportions made on a taxpayer-specific basis | ||
| 11 April 2002 External T.I. 2002-0125675 F - REER DECOUVERT BANCAIRE | Income Tax Act - Section 146 - Subsection 146(4) - Paragraph 146(4)(a) | bank overdraft due to admin fee charge to RRSP could constitute money borrowed from the trust | |
| Income Tax Act - Section 146 - Subsection 146(10) | overdraft in RRSP bank account due to admin fee charge could represent the use of trust property as loan security | ||
| 21 March 2002 External T.I. 2001-0115265 F - 89(1)(c.1)(i)&(c.2)(i) Capital Div. Acc. | Income Tax Act - Section 89 - Subsection 89(1) - Capital Dividend Account | under revised rules, CDA from goodwill disposition can only be accessed in the following year |
CRA finds that capital for purposes of determining a Canadian Treaty-reduced dividend withholding rate of 5% references stated capital
An Israeli company held 100,000 preferred shares of Canco with an FMV and stated capital of $1,000,000 and $100, respectively, whereas the other five shareholders held 1,000 common shares with an FMV and stated capital of $1,000 and $100, respectively. Article 10(2)(a) of the of the Canada-Israel Treaty provided for a reduced withholding rate of 5% on dividends paid by a company resident in Canada to a resident of Israel where “the beneficial owner of the dividends is a company (other than a partnership) which holds directly at least 25 per cent of the capital of the company paying the dividends.”
After referring to para. 15 of the 2014 OECD commentary to Article 10, which stated inter alia that “[a]s a general rule … the term “capital” … should be understood as it is understood in company law," CRA found that the 25%-of-capital test should be applied on the basis of the shares’ stated capital, so that this test was not satisfied by the preferred shares.
Neal Armstrong. Summary of 14 December 2023 External T.I. 2019-0820291E5 under Treaties – Income Tax Conventions – Art. 10.
CRA provides favourable rulings on the s. 212.1(4) exception and on the s. 15(1.5) demerger rules
The Taxpayer (a Canadian public corporation with a widely-dispersed shareholder base) and Pubco (a corporation, governed by the laws of (foreign) Country 2 and dealing at arm’s length with the Taxpayer) engaged in transactions to permit the Taxpayer, with funding provided by Pubco, to acquire Target (a public limited company governed by the laws of (foreign) Country 1) so that: the Taxpayer will retain Target’s Canadian, Country 1, and certain other international businesses; Pubco will acquire 100% of Target’s businesses in Country 3 and Country 4; and the Taxpayer and Pubco will initially jointly own Target’s business in Country 2 and Country 5 branch business and subsequently sell them to an arm’s length party.
Somewhat curiously, the Target structure was acquired by a Bidco owned exclusively by the Taxpayer but funded in significant part (perhaps as to ½) by Pubco. Shortly after the acquisition by Bidco, there was a transfer of most of the Target holdings to a “JV Co” initially owned by the Taxpayer but with Pubco being transferred ½ of the shares of JV Co in consideration for the Bidco cash funding it had earlier provided. Shortly thereafter, a foreign holding company (Country 1 Subco) for the Canadian corporate structure (Canco 1 and its Canadian subsidiary) that had been retained in the structure still "beneath" the Taxpayer transferred its shares of Canco 1 to the Taxpayer. The “Purposes” of the transactions stated inter alia that:
The purpose of structuring the funding of the Acquisition in a manner that Pubco would not acquire any equity interest in Bidco was to comply with various anti-trust and regulatory requirements. As a consequence, the conditions of subsection 212.1(4) were satisfied and Pubco did not control Country 1 Subco immediately before the disposition of the shares of Canco 1.
Partly in reliance on this statement, CRA ruled that s. 212.1(4) would not apply to this transfer of the Canco 1 shares such that s. 212.1(1.1)(a) would not deem a dividend to be paid by Canco 1 to Country 1 Subco.
Well beneath JV Co was a foreign opco with “keeper” and “non-keeper” businesses (as referred to above), whose assets were excluded property. CRA gave detailed and favourable rulings on the application of the s. 15(1.5) demerger rules to a division of that opco between a Demergerco 2 and Demergerco 1 (which was to be sold).
Neal Armstrong. Summaries of 2021 Ruling 2020-0875391R3 under s. 212.1(4) and s. 15(1.5).
CRA confirms that an agent not acting in relation to a trust has no trust reporting obligations
Regarding whether the new trust-reporting rules apply to an arrangement under which a person can reasonably be considered to act as agent for one or more other persons with respect to all dealings with certain property, without the arrangement being a trust, CRA indicated that ss. 104(1) and 150(1.3) do not apply to an arrangement if it is not a trust, and that the determination of whether an arrangement is a trust is not something on which it generally comments as this is the responsibility of the parties, and then stated:
To the extent that a given arrangement is not a trust and does not give rise to the creation of a trust under the applicable private law, and is not otherwise deemed to be a trust for the purposes of the Act, it will not be an arrangement described in subsections 104(1) and 150(1.3). Accordingly, the arrangement will not be a trust for the purposes of section 150.
These comments generally support the proposition that a general partner holding limited partnership property as agent for the partners does not in this regard have trust reporting obligations. Note that, in the common law provinces, the GP cannot hold the partnership property as trustee for the partnership, which is not an entity, it cannot hold such property as bare trustee for the limited partners as it rather than they have the discretion as to such property’s use, and it is, vis-à-vis the limited partners, the one with the entitlement to exercise control and other ownership rights over the partnership property by virtue of the limited partnership law (see Hudson’s Bay v. OMERS, Kucor and Lehndorff) rather than by virtue of trust law.
Neal Armstrong. Summary of 27 February 2024 External T.I. 2024-1006681E5 under s. 150(1.3).
Income Tax Severed Letters 28 February 2024
This morning's release of six severed letters from the Income Tax Rulings Directorate is now available for your viewing.