News of Note
Starlight No. 3 Fund will avoid FAPI treatment of gains on sale in three years’ time of U.S. apartment buildings by U.S. private REIT subsidiary
Email this ContentThe public offering for the Starlight U.S. Multi-Family (No. 3) Core Fund (an Ontario LP) is similar to those for the No. 1 and No. 2 funds. It will invest in U.S. apartment buildings through LLC subsidiaries of a private U.S. REIT. An Ontario subsidiary LP (which will be a corporation for Code purposes) and a Delaware LP will be sandwiched between the public LP and the U.S. private REIT. This will help insulate the public Ontario partnership from the U.S. public partnership rules and may simplify U.S. FIRPTA withholding requirements - while at the same time the structure will still be treated as transparent (under Art. IV.6) for the purposes of U.S. withholding on dividends and interest paid by the U.S. private REIT.
It is intending avoid FAPI treatment on the net rental income and gains on dispositions of the apartment buildings (expected to occur in three years’ time) by relying on the over-five employee safe harbor for leasing businesses and the mother ship tests. 3.5% of the anticipated annual returns of 12% per annum over the three year (partly extendible) term of the Fund are anticipated to come from gains from the sale of the buildings. If the returns from the U.S. business came mostly from (income account) gains from the buildings, the FAPI exclusion would be quite problematic but, as noted, this is not projected to be the case. From a U.S. REIT rule perspective, there is a safe harbour for properties that are held for at least two years if no more than seven properties are sold in a year.
Neal Armstrong and Abe Leitner. Summary of preliminary prospectus for Starlight U.S. Multi-Family Core (No. 3) Fund under Offerings – REIT and LP Offerings - Foreign Asset Income Finds and LPs.
CRA rules on use of s. 88(1)(d) bump to eliminate sandwich structure following a spin-off by public company Target and cash acquisition of Target shares by the Canadian buyco of U.S. public company
A s. 88(1)(d) bump letter deals with a Canadian target with indirect non-resident subsidiaries which, under a plan of arrangement, spins off a Spinco to its shareholders under s. 86, with its remaining shares then acquired by a Canadian subsidiary (BidAmalco) of a U.S. public company (Buyer) in order that there can be a winding-up of Target into BidAmalco, a bump of the shares of the non-resident subsidiaries and their distribution out of BidAmalco so as to eliminate the sandwich structure. As it was an all cash deal, there was no need to wrestle with the new rules which accommodate share consideration paid by Buyco provided that not more than 10% of the value of the Buyer shares is attributable to Target’s property – and, in any event, the transactions may have been implemented before the effective date of those new rules. The ruling letter was issued after the bump designation had already been made by BidAmalco.
Spinco agreed with Buyer that for the following two years it would not purchase Buyer shares or debt, or any securities that derive their value, directly or indirectly, from such securities. (Such a purchase would be problematic under s. 88(1)(c)(vi)(B)(III)(2) given that initially Target and Spinco2 have the same shareholders in common.)
Neal Armstrong. Summary of 2013 Ruling 2011-0397081R3 under s. 88(1)(c)(vi)(B)(III).
CRA rules on using Treaty step-up to avoid the application of s. 55(2) to a spin-off made to effect an arm’s length sale
The U.S. parent of a Canadian corporation (Amalco) is indirectly selling the "XYZ" business, carried on through subsidiaries of Amalco, to an arm’s length purchaser (Buyer). This will be accomplished through a spin-off transaction in which the shares of Amalco are split on a s. 86 reorg into "Keep" pref and new common shares, the U.S. parent transfers its Keep pref to its newo subsidiary ("Canco") on a Treaty-exempt basis in consideration for common shares of Canco, Amalco sells the "Keep" assets to Canco on a taxable basis for a note, and Amalco redeems the Keep pref by way of set-off against the note it received for the Keep assets (and, contrary to the usual Rulings practice, not first issuing a redemption note). As Amalco now only holds the XYZ business, it can be sold by the U.S. parent on a Treaty-exempt basis to Buyer.
This is the opposite of the purchase butterflies of yesteryear: there is no outside gains tax (under the Treaty); but there is inside gain on the spin-off of the Keep assets. S. 55(2) does not apply to the deemed dividend arising on the redemption of the Keep pref as their basis was stepped up under the Treaty.
Neal Armstrong. Summary of 2012 Ruling 2011-0403291R3 under s. 55(2) and s. 248(1) – disposition.
Howard – High Court of Australia finds that merely assigning a future damages award rather than the law suit entitlement is not effective to shift the resulting income
At the same time as the taxpayer launched an action against some co-venturers, he assigned any resulting award of damages to a corporation of which he was a director. The corporation included the ultimate award in its income. Before considering the effect of this assignment, the High Court found that the award was his income rather than corporate income on general principles, as in the circumstances he would not have breached his fiduciary obligations to the corporation if he had pocketed the damages himself.
As for the assignment, the reasons suggest that the taxpayer would have successfully avoided a personal income inclusion if he had assigned his entitlements under the law suit to the corporation rather than just assigning any future damages award.
The second point is generally consistent with Canadian cases finding that amounts received by a taxpayer subject to a pre-existing obligation to pay them to a third party should be excluded from its income (Premium Iron Ores, Wilson, Leonard Pipeline, Canadian Fruit, Minet, cf. Canpar), and might be viewed as partially codified by s. 56(4).
Were the facts reversed so that Howard as fiduciary had been obligated, but failed, to pay the award over to the corporation, the amount likely would have been income to him under Canadian principles notwithstanding his lack of legal entitlement to it (Angle, Penny).
Neal Armstrong. Summaries of Howard v. Commissioner of Taxation, [2014] HCA 21 under s. 9 – compensation payments and s. 9 – nature of income.
CRA considers that the HST/GST treatment of new residential housing purchased for head leasing is different than if it is purchased for leasing
If a person purchases newly constructed housing for the purpose of leasing or licensing it to an individual as a place of residence, it generally will pay the GST/HST on the purchase price subject to any new housing rebate arrangements, and that will be the end of it. However, as explained in News No. 91, if it instead purchases such housing for the purpose of supplying it under a head lease to another person (the head lessee) who in turn subleases the housing to an individual as a place of residence, it will be required to self-assess itself for GST/HST on the fair market value of the housing at the time possession is given to the head lessee, and it can claim an input tax credit for the GST/HST paid on the housing purchase.
This different treatment of the second (head lease/sublease) scenario is significant if the housing continues to appreciate between its purchase and the time of taking possession.
Neal Armstrong. Summary of Excise and GST/HST News – No. 91 under ETA – s. 191(1).
Galachiuk – Tax Court of Canada finds that the taxpayer can demonstrate due diligence for either of the two years at issue under a s. 163(1) penalty
S. 163(1) imposes a 10% penalty on the amount of underreported income in a return (or 20% taking into account what usually is a matching provincial penalty) if any amount of income was also underreported in one of the three preceding taxation years. Graham J found (in the face of conflicting decisions on the point) that there was a due diligence defence for a s. 163(1) penalty if the taxpayer established due diligence in either of the two years, so that it was not necessary for the taxpayer to establish due diligence for the second year. Accordingly, because it was reasonable for the taxpayer not to notice that he had not received a T3 slip for $683 for 2008, he could avoid the penalty for not reporting a $436,890 withdrawal from his pension plan in 2009 (for which his excuse was lame).
Neal Armstrong. Summary of Galachiuk v. The Queen, 2014 DTC 1153 [at 3494], 2014 TCC 188 under s. 163(1) and General Concepts - Onus.
KWG proposes to effect a de facto share consolidation through creating a multiple/subordinate voting share structure
KWG Resources, which has about 800M outstanding common shares trading at about $0.07 per share, is proposing a s. 86 reorg under which its common shares will be replaced by subordinate voting shares (also carrying one vote per share) that are convertible into multiple voting shares on a 1-for-50 basis. Each multiple voting share carries 50 votes per share and has 50-times the entitlement of a subordinate voting share to participate in dividends and any liquidation distributions. The Circular indicates that the reason for this reorganization is to have marginable shares that would be more attractive currency in any future acquisition transaction. The Circular does not explain why they didn’t just simply consolidate the existing common shares.
Neal Armstrong. Summary of KWG Resources under Public Transactions - Other – Share Consolidation.
Sifto Canada – Federal Court of Appeal finds that the Federal Court may declare that transfer-pricing penalties assessed contrary to the VDP should not have been made
Sifto Canada brought a motion in the Federal Court alleging that: the Minister had reassessed it for s. 247(3) transfer pricing penalties notwithstanding that the misreported sales to its U.S. affiliate had been validly disclosed under the voluntary disclosure program; and the reassessed transfer prices were contrary to an agreement reached with the U.S. under the Mutual Agreement Article. Sifto Canada also appealed the reassessments to the Tax Court.
Sharlow JA found that as the two proceedings dealt with distinct questions (Were the reassessed penalties invalid? If they were valid, should the Minister have granted s. 220(3.1) relief?), the Federal Court motion could continue, and noted that potentially available relief could include "a declaration that the penalties should not have been assessed in the face of the valid voluntary disclosure."
(It is not clear whether she is referring to a Henry IV, Pt. 1-style declaration: GLENDOWER-I can call spirits from the vasty deep. HOTSPUR-Why, so can I, or so can any man, but will they come when you do call for them?)
Neal Armstrong. Summary of MNR v. Sifto Canada Corp., 2014 DTC 5083 [at 7090], 2014 FCA 140 under s. 220(3.1).
CRA finds that an incentive Caribbean trip is “entertainment” under s. 67.1
A Canadian company provided free annual trips to Caribbean (or the like) resorts to the high-performing brokers and sales agents for its products or services (the "Sellers"). Where the Seller was an individual independent contractor, 50% of the Canadian company’s costs were denied under s. 67.1 because the trips constituted "entertainment" (notwithstanding that the Sellers were required to attend some morning sessions explaining the company’s products).
Where the Seller worked for his or her own personal corporation, "the value of the trip must be included in the computation of the income of the [personal] corporation by virtue of section 9." (Note that on similar facts in Philp, only half of the cost of the trip was included in the personal corporation’s income.) Furthermore, the Canadian promoting company was not in this case subject to the 50% expense denial under s. 67.1 if the value of the trip enjoyed by the shareholder-employee of the personal corporation (i.e., the Seller) was included in his or her income qua employee under s. 6(1)(a) rather than in income under s. 15 qua shareholder.
Neal Armstrong. Summaries of 18 December 2013 Memo 2012-0472211I7 F under s. 67.1(4)(b), s. 6(1)(a), s. 9 – Nature of income, and s. 67.1(2)(d).
Income Tax Severed Letters 11 June 2014
This morning's release of six severed letters from the Income Tax Rulings Directorate is now available for your viewing.