News of Note
Application of the fill-in-the-hole rule may necessitate use of the suppression election
Email this ContentEric Lockwood and Maria Lopes have provided excellent numerical examples of the application of the proposed qualifying liquidation and dissolution (QLAD) rules respecting the winding of a non-resident subsidiary (Foreignco 1) into a Canadian parent (Canco). Canco generally will realize a capital gain on the disposition of its shares of the disposing affiliate (Foreignco 1) – even on an elected QLAD - where the adjusted cost base of Foreignco 1 in the distributed property, i.e., the inside basis, exceeds Canco’s ACB of its Foreignco 1 shares, i.e., the outside basis - unless it makes the "suppression election" under proposed s. 88(3.3).
For example, the suppression election may be required on the liquidation of a foreign affiliate (Foreignco 2), with a "blocking deficit," into Foreignco 1, followed by a liquidation of Foreignco 1 into Canco on an elected QLAD basis, because the application of the fill-the-hole rule in proposed Reg. 5905(7.2) can result in the inside basis being greater than the outside basis – and in fact they "suspect that the suppression election was specifically intended to apply to circumstances such as these."
Neal Armstrong. Summary of Eric Lockwood and Maria Lopes, "Subsection 88(3): Deferring Gains on Liquidation and Dissolution", Canadian Tax Journal (2013) 61:1, 209-28 under Reg. 5905(7.2) and s. 93(1).
Gwartz - Tax Court finds that circumvention of the "kiddie tax" was not abusive
As a result of a surplus strip of a dentist's management corporation, the receipt of surplus was reported as capital gains by the dentist's two minor children, who were beneficiaries of a family trust. Because this amount was a capital gain rather than taxable dividends, s. 120.4 - the "kiddie tax" provision - did not apply.
Hogan J. found that the series of transactions did not abuse s. 120.4, and therefore was not caught by the general anti-avoidance rule. He reasoned that, in drafting s. 120.4, "Parliament preferred simplicity over complexity," and was surely aware that capital gains could be generated using surplus-stripping techniques, yet it did not include any capital gains in the s. 120.4 income-splitting rules (although it changed its mind after the years in question).
Scott Armstrong. Summary of Gwartz v. The Queen, 2013 TCC 86, under s. 245(4) (with diagram).
Income Tax Severed Letters 8 May 2013
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Spin-off by Resverlogix is structured so that the Spinco bears the full burden of Part VI.1 tax on a “royalty” preferred share of Resverlogix
Resverlogix is proposing to spin-off a "Newco" subsidiary holding RVX Therapeutics to its shareholders. The mechanics (which look vaguely like a butterfly reorganization, although this is not a butterfly) are somewhat more complicated than the usual (s. 86 exchange – then spin-off through redemption of new shares) plumbing because it is also part of the deal that Newco will hold "Royalty" preferred shares of Resverlogix which will participate in a portion of any revenues which are generated by Resverlogix from one of the pharmaceutical products in its development pipeline. The dividends on these Royalty shares are reduced so that Newco effectively bears the full burden of the 40% Part VI.1 tax payable by Resverlogix on any such dividends: Resverlogix does not have to "pay" anything for the Part I deductions generated to it from the Part VI.1 tax.
Newco will not be listed, so that some precise footwork will be required to ensure that it has elected to be a public corporation at the time RRSPs and the like receive its shares.
Neal Armstrong. Summary of Resverlogix Circular under Spin-Offs – S. 86 reorganization spin-offs.
Resource Capital Fund – Australian decision suggests that many or most Canadian mining company shares may not be taxable Canadian property
The Australian Federal Court found that even if a sale of shares of an Australian gold mining company had not been Treaty-exempt (as discussed in the post below), the company should not be considered to have more than 50% of its assets as Australian real property (i.e., its mining rights), so that the gain also would not have been taxable under the Australian equivalent of the taxable Canadian property rules.
This rested on a finding that one of the quite valuable non-real estate assets of the company was its "mining information." The logic was that if a purchaser acquired only the mining rights and not the drilling results and mining model, it would have to spend a huge sum on exploration in order to be able to commence production approximately four years later.
This case suggests that many or most Canadian mining company shares may not be taxable Canadian property – as well as not being real property under many or most of the applicable Treaties.
Neal Armstrong. Summary of Resource Capital Fund III LP v. Commissioner of Taxation, [2013] FCA 363 (Fed. Ct. of Austr.) under Treaties – Art. 13.
Resource Capital Fund – Australian Federal Court decision respects the flow-through character of a reverse hybrid
A Caymans LP with US-resident partners, which was treated for Australian purposes as a corporation and for US purposes as fiscally transparent, was assessed on a gain under the Australian equivalent of the taxable Canadian property rules. In nullifying the assessment, Edmonds J quoted comments in the OECD commentary that the source jurisdiction (Australia) should apply the provisions of the applicable (Australia-US) Treaty "as if the partners had earned the income directly," so that assessments instead should have been made of the (numerous) US-resident partners.
Neal Armstrong. Summary of Resource Capital Fund III LP v. Commissioner of Taxation, [2013] FCA 363 under Treaties – Art. 4.
MacDonald - Federal Court of Appeal affirms breadth of "in any manner whatever" in s. 84(2) anti-stripping rule
In a surplus-stripping transaction, a New Brunswick doctor sold a cash-rich corporation to his brother-in-law for a promissory note, with his resulting capital gain sheltered by unrelated capital losses - and with his brother-in-law extracting the corporate funds following a transfer of the corporation to a Newco he owned, and then paying off the promissory note.
Reversing the trial judge, Near JA found that s. 84(2) applied to treat the amounts the doctor received as a taxable dividend rather than a capital gain, notwithstanding that he was no longer a shareholder at the time he received the funds - and that this broad construction of the words "in any manner whatever" in s. 84(2) accorded with Merritt, Smythe, and RMM.
Scott Armstrong. Summary of MacDonald v. The Queen, 2013 FCA 110 under s. 84(2).
CRA indicates that, absent s. 216(4) elections, Canadian rents paid to a non-Canadian partnership are subject to full withholding notwithstanding Canadian partners
Consistently with earlier statements (see, for example, 30 October 1997 T.I. 971673), CRA considers that the full amount of rent paid by a Canadian tenant to a non-Canadian partnership is subject to Part XIII withholding notwithstanding that some of the partners are Canadian residents: there is no indication that an advance waiver can be obtained to reduce the Part XIII withholding.
The non-residents can elect under s. 216(4), so that an agent can collect the gross rents from the tenant and withhold non-resident tax at 25% on the net rental income. CRA states that although "the appointment of the agent… technically does not release the tenant from the requirement to withhold Part XIII tax," it accepts that the tenant normally is not required to withhold in this situation.
Neal Armstrong. Summaries of 27 March 2013 T.I. 2012-0450491E5 under ss. 212(13.1)(b) and 216(4).
CRA accepts that deeply subordinated intercompany debt is debt
As a preliminary step to a loss utilization transaction, LossCo will be rendered solvent by adding an option to convert its intercompany debt into an "A" Note and a deeply subordinated "B" Note (ranking behind the unsecured creditors), with the resulting B Note then being eliminated under a debt tuck-under and winding-up transaction (avoiding the debt forgiveness rules).
ProfitCo then will then utilize the LossCo non-capital losses by transferring depreciable assets to LossCo on a rollover basis for preferred shares, then redeeming the preferred shares a day later (on a non-rollover basis), thereby stepping up the UCC of the depreciable assets. There’s no superficial gain rule!
Neal Armstrong. Summary of 2012 Ruling 2012-0451431R3 under s. 111(1)(a).
Income Tax Severed Letters 1 May 2013
This morning's release of 10 severed letters from the Income Tax Rulings Directorate is now available for your viewing.