News of Note
A significant percentage increase in the direct share interests of shareholders occurring as a result of a preferred share redemption will engage the exemption-denial rule in s. 55(3)(a)(ii) even if there is no change in their indirect interest in the corporate assets
Email this ContentA and B each directly hold 50% of the common shares of a company (Quebeco 2) and indirectly each hold 50% of the preferred shares of Quebeco 2 "through" an intermediate holding company. If a redemption by Quebeco 2 of its preferred shares results in a "significant increase" in their percentage interest in the shares of Quebeco 2 held by them directly, s. 55(3)(a)(ii) or (v) will not exempt the resulting deemed dividend, notwithstanding that there is no change in their indirect 50/50 corporate ownership of the corporate assets now represented by the redemption proceeds. Further, such application of s. 55(3)(a)(ii) will result in any other deemed dividend occurring as part of the same series also being tainted.
Neal Armstrong. Summary of 25 April 2014 T.I. 2014-0528011E5 F under s. 55(3)(a).
Last – Federal Court of Appeal finds that the principle that CRA cannot appeal its own assessments applies on a source-by-source basis
The principle that the Minister cannot appeal her own reassessment by arguing for an even higher level of tax on appeal to the Tax Court applies on a source-by-source basis.
The taxpayer was successful in Tax Court in establishing additional deductible expenses respecting his rental operation but was also found by the Tax Court to have realized an unrelated gain on income account notwithstanding that the Minister had reassessed on the basis that it instead was a capital gain. In light of the above principle, the taxpayer was in effect allowed to "keep" the additional expense deductions rather than those expenses in effect being netted against the additional income arising from the income-account finding, which related to another source. Dawson JA reasoned that to follow the netting approach advocated by the Crown would be to indirectly allow the Minister to appeal her reassessment on the disposition issue to the extent of the additional expenses.
Neal Armstrong. Summary of The Queen v. Last, 2014 FCA 129 under s. 152(1).
Significant pre-closing transactions on the day of closing of a target acquisition and its amalgamation will result in two deemed taxation year ends
If there is an acquisition of control of Target followed by its amalgamation with Buyco on the same day and no s. 256(9) election is made, the occurrence of transactions by Target out of the normal course of business on the closing date and prior to the closing will "technically" result in there being two deemed taxation year ends. As per 2014-0523251E5 F, the same problem arises if the s. 256(9) election is made.
Neal Armstrong. Summary of 15 April 2014 T.I 2014-0527231E5 F under s. 87(2)(a).
CRA rules that an Irish common contractual fund is a co-ownership arrangement
CRA has provided another ruling that an Irish arrangement for investors to invest on a pooled basis in shares of listed companies through a custodian (who in some respects is described as acting as trustee) and a manager, and which is styled as a co-ownership arrangement, will be respected as such for purposes of the Act.
Neal Armstrong. Summaries of 2014 Ruling 2013-0496831R3 under s. 104(1) and s. 96.
CRA equates “enterprise” in the services p.e. rule in the Canada-U.S. Convention with a “business division”
The determination of whether Canadian construction projects for a Canadian client of a U.S.-resident company (USCo) will be deemed to be permanent establishments under Art. V, para. 3 of the Canada-U.S. Convention will not take into account project-related services which it provides off-site. However, if it does not have a deemed p.e. under para. 3, its off-site services performed in Canada will be reviewed to determine if they cause it to have a services p.e. under para. 9. Conversely, if it has a deemed p.e. under para. 3, its on-site services will be ignored for purposes of determining whether it also has a services p.e. under para. 9.
Para. 9 refers to an "enterprise" of a contracting state. CRA considers that a U.S. company will be a separate "enterprise" respecting each of its businesses (as determined under the IT-206R criteria).
Neal Armstrong. Summary of 25 February 2014 Memo 2013-0475161I7 under Treaties – Art. 5.
CRA reverses a Code s. 338(h)(10) step-up of goodwill so as to boost exempt earnings of a U.S. foreign affiliate – but finds that there was no corresponding boost to safe income on hand of a Canco shareholder
Where Canco had indirectly purchased the shares of "US-Opcos" with appreciated goodwill, with the U.S. tax basis of the goodwill then being stepped-up under IRC 338(h)(10), the resulting reduction in the gain realized on a subsequent disposition of that goodwill was to be reversed under Reg. 5907(2)(f) in computing the exempt earnings of Canco respecting the US-Opcos – or alternatively (i.e., getting to the same spot), the step-up-related gain was to be excluded in the first place from the "earnings amount" determined under s. (a)(i) of the Reg. 5907(1) definition, apparently on the basis "that ‘notional’ income or deductions are simply excluded from the earnings amount."
However, the resulting boost in the safe income of Canco (as computed in accordance with s. 55(5)(d)) did not do a shareholder of Canco (PrivateCo) any good as this accrued gain "did not contribute to the gains that accrued on [the relevant U.S.] shares in the Post-acquisition period and, therefore, did not contribute to the gains that accrued on PrivateCo's ... Canco common shares [up to] immediately before their redemption."
Neal Armstrong. Summaries of 14 March 2014 Memo 2013-0499141I7 under Reg. 5907(2)(f), s. 55(2), Reg. 5907(1) – exempt earnings and Reg. 5907(1) – earnings.
Income Tax Severed Letters 28 May 2014
This morning's release of 14 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Shares issued for a promissory note might or might not be respected for tax purposes
Federally and in eight provinces the subscription for shares of a business corporation through the issuance of a promissory note of the subscriber is prohibited. Consequences of breach are unclear:
- the shares might be invalidly issued (see Ball); or
- their issuance might be valid by virtue of s. 16(3) of the CBCA (or its provincial equivalent) stating that "no act of a corporation ... is invalid by reason only that the act ... is contrary to ... this Act" (a statement which, per Continental Bank, might be respected for tax purposes) – or as a result of an exercise of judicial discretion as per a line of provincial cases.
Neal Armstrong. Summary of Marshall Haughey, "Issuing Shares for a Promissory Note," 24 Can. Current Tax, May 2014, p. 85 under s. 89(1) – paid-up capital.
CRA replicates IT-492R in its Folio on relatedness/arm’s length
Virtually no substantive changes from IT-492R, dated 8 June 2004, were made in drafting the new Folio on "Related persons and dealing at arm’s length." It is doubtful that there is nothing to be learned from the last 10 years of jurisprudence on accommodation parties (9101-2310, Remai Estate, Livingston) or acting in concert (Petro-Canada, Alberta Printed, McMullen, Brouillette, Wagner), nor does the Folio discuss the occasionally mooted question of the time at which the presence or absence of an arm’s length relationship should be assessed (see Brown, Yelle, Deptuck, cf. Kiperchuk) or mention Lyrtech (s. 248(25) does not apply for s. 251(5)(b) purposes – which is consistent with the CRA position on shotguns and ROFRs in that s. 251(5)(b) was read restrictively).
Neal Armstrong. Summaries of S1-F5-C1: "Related persons and dealing at arm's length" 1 May 2014 under s. 251(1)(c) and s. 251(5)(b).
The new surplus reclassification rule may not apply to fresh starts
The fresh start rule (which generally deems a disposition of property of a foreign affiliate (FA) carrying on an active business at fair market value if it commences to carry on an investment business) may significantly boost the exempt surplus balance in respect of FA. Would Reg. 5907(2.02) reclassify this increment as taxable surplus?
The first condition for Reg. 5907(2.02) to apply is that the increment result from a disposition "to" a non-arm’s length person (or other "designated person or partnership"). Instead the fresh start rule provides for a deemed disposition and reacquisition by the same person (FA) – although the Explanatory Notes do not recognize this point.
Respecting the second ("avoidance transaction" as defined in s. 245(1)) condition (which also must be satisfied for the reclassification rule to apply), the business change engaging the fresh start rule often will have occurred for non-tax reasons and will have occurred even more rarely with a view to distributing exempt earnings.
Neal Armstrong. Summary of Jenny Li, "The Interaction of the Fresh Start and Surplus Reclassification Rules", International Tax, Wolters Kluwer CCH, April 2014, No. 75, p. 8 under Reg. 5907(2.02).