News of Note
Private company split-up butterfly raises Part IV tax/dividend refund circularity issue
Email this ContentA CCPC (DC) whose only significant asset is a shareholding (not exempt from Part IV tax) in a Canadian public company (Pubco) is butterflying that asset out to its numerous CCPC shareholders (TCs), who are owned by 3rd or 4th generation family members and to which it is not connected for Part IV tax exemption purposes. As both the deemed dividends arising on the redemption of the preferred shares issued by the TCs to DC on the butterfly, and the deemed dividends arising on the winding-up of DC (on which the promissory notes received by DC on the redemption of the TC preferred shares are distributed to the TCs) are subject to Part IV tax and generate a dividend refund, there is a classic circularity problem.
The ruling letter does not address this issue directly, but indicates that the stated capital of the TC preferred shares is nominal, and the stated capital of DC's shares is reduced to a nominal amount before its winding-up, in order "to ensure that each of the TCs and DC’s respective dividend refund ... and respective Part IV tax liabilities ... will approximately be equal to each other."
Neal Armstrong. Summary of 2012 Ruling 2011-0416001R3 under s. 55(1) - distribution.
Berg - Tax Court allows leveraged donation participant to receive credit for his cash outlay
Bocock J. found that, although the documents generated for the taxpayer's leveraged charitable donations were a flagrant attempt to deceive the CRA (the taxpayer was never at risk for the purported leveraged portion), the cash component of the taxpayer's "donation" was nevertheless a valid charitable gift. On reviewing the authorities, he concluded that the receipt of a collateral benefit in the form of a tax credit will not in itself nullify donative intent.
Maréchaux, 2010 FCA 287, was "easily distinguishable" because the transaction documents in Berg were "pretenses and thereby not legally effective documents." This suggests that the effective purchase of "fake" documents, which if successful in fooling CRA will generate a large charitable credit, nonetheless represents a gift for which the taxpayer expects no return.
Scott Armstrong. Summary of Berg v. The Queen, 2012 TCC 406 under s. 118.1 - Total Charitable Gifts.
CRA accepts withholding tax exemption on interest paid on undivided interests in mortgages
In a heavily redacted ruling (20 of the 21 paragraphs describing the proposed transactions were deleted!) CRA indicated that interest paid on instruments representing undivided interests in pools of mortgages (presumably, CMHC-guaranteed) represented "fully exempt interest." This seems to imply that CRA accepts that a co-ownership interest in a mortgage qualifies as a "bond, debenture, note, mortgage, hypothecary claim or similar debt obligation."
Neal Armstrong. Summary of 2012 Ruling 2011-0431891R3 under s. 212(3) - fully exempt interest.
CRA affirms its policy on accepting bilateral adjustments to domestic or cross-border management fees
CRA has affirmed that, where the deduction of part of a management fee or similar charge has been disallowed as a result of differing interpretations of reasonableness, it will allow the recipient of the fee to refund the disallowed amount and accept a written request from the recipient to reduce the recipient's income accordingly. Where in a cross-border context, the finding by CRA that the fee was excessive would otherwise give rise to an assessment of Part XIII tax on a deemed dividend, the non-resident may repatriate the excess amount to avoid the withholding tax assessment.
Scott Armstrong. Summaries of 19 October 2012 T.I. 2012-0440071E5 under s. 67 and s. 214(3)(a).
Income Tax Severed Letters 28 November 2012
This week's release of seven severed letters from the Income Tax Rulings Directorate is available for your viewing.
Morguard - Federal Court of Appeal finds that break fee was taxable
A break fee received by Morguard was fully taxable as business income. This essentially followed from the finding of fact by Boyle J in the Tax Court that Morguard's ordinary business activities included the making of business acquisitions - so feel free to argue that any break fee received by you arose only in the course of an investment undertaking!
Neal Armstrong. Summary of Morguard Corporation v. The Queen, 2012 FCA 306 under s. 9 - exempt receipts.
CRA finds that an immediate right to elect a majority of the board is not necessary in order to have corporate control
CRA agreed that a corporation (the "Parent"), with a significant majority of the shares of another corporation ("Lossco"), controlled Lossco notwithstanding that the Class B shares of Parent did not have the right to vote on the election of the directors of Lossco, whereas the Class A shares of Lossco held mostly by an arm's length individual had full voting rights. Accordingly, Lossco could be amalgamated with a "Profitco" subsidiary of Parent without the loss streaming rules applying to Lossco's losses.
The key to getting CRA to agree to this was that Parent's voting rights gave it the right to engage in a consolidation transaction in which the Class A shares would be cashed out, after which Parent as the holder of the only remaining class of shares would now have the right to elect the board. For example, if Parent held 20M Class B shares and the other shareholders held 1M Class A shares and the shares were consolidated on a 2,000,000-for-1 basis, the fractions of shares now held by the other shareholders would be eliminated for a cash payment, and Parent would hold the 10 remaining outstanding shares. Although more esoteric than the deferred rights of the majority shareholder in Donald Applicators to get rid of the full-voting shares in that case, the potential for this transaction was considered sufficient to give Parent control of Lossco.
Neal Armstrong. Summary of 2012 Ruling 2011-0402571R3 under s. 251(2)(b).
CRA rejects Tawa case
In a spirited and lengthy analysis, CRA has rejected an argument that a private corporation does not have a "dividend refund" amount if, in fact, it is not eligible to receive the dividend refund because it did not file for the refund on a timely basis. According to CRA, the Tax Court in Tawa Developments was fooled by the ordinary meaning of the word "refund" in the defined term "dividend refund" (suggesting to the Tax Court that the amount must actually be received), whereas the wording of the definition itself contains no such requirement.
Neal Armstrong. Summary of 18 October 2012 T.I. 2012-0436181E5 under s. 129(1).
Mac's Convenience Stores - Tax Court finds that an ITC entitlement for a related financial supply arises whenever there is "some connection" between the financial supply and the registrant's commercial activities
An HST/GST provision (ETA s. 185(1)) entitles a registrant (other than a financial institution) to claim input tax credits on purchases used in the making by it of financial services, provided that the purchased goods or services "relate" to a commercial activity of the registrant. The Tax Court has found that this test was satisfied by ABM machines of Mac's Milk which were used by it to make exempt ABM services to its customers, but which also generated additional sales at its stores. Accordingly, it was entitled to full ITCs for the HST or GST payable on its purchases of the machines.
Hogan J. rejected CRA's submission that this rule is restricted to financial services which are "incidental or ancillary to a registrant's primary business operations."
Neal Armstrong. Summaries of Mac's Convenience Stores Inc. v. The Queen, 2012 TCC 393 under ETA - s. 185(1) and ETA - s. 123(1) - financial service.
CRA confirms that the interest deduction followed s. 75(2) attributed income
CRA has confirmed that where an individual borrows money to acquire an income-producing property and then settles the property on an inter vivos trust to which s. 75(2) applies to attribute the property income to him or her, the individual generally will still be entitled to an interest deduction.
Neal Armstrong. Summary of June 2012 STEP Roundtable, Q. 13 2012-0449811C6 under s. 20(1)(c).