News of Note
CRA finds that revocation of a Treaty S Corp. agreement with CASD resulted in double taxation of the S Corp income when now dividended to Canada
Email this ContentA Canadian resident (and US citizen) had an agreement with the Canadian Competent Authority under Art. XXIX(5) of the Canada-US Treaty, by virtue of which he included his share of the S Corporation’s income as FAPI, claimed a s. 126 credit for the US taxes on that income, and added such FAPI to the ACB of his shares. However, before he received any dividend, he revoked the S Corp’s status as a fiscally transparent entity for US purposes, so that the Agreement thereupon terminated. The S Corp then paid a dividend to him of income that previously had been included in his income as FAPI (and now was included in his income under s. 90(1).)
The Directorate indicated that where the S Corp was a CFA of the individual, he could take a s. 91(5) deduction of the dividend paid after the Agreement invalidation, with a corresponding reduction to the ACB of his shares.
However, where the S Corp was not a FA at the time of the dividend, no s. 91(5) deduction would be available (but with no corresponding ACB reduction) because in such absence of FA status, Reg. 5900(3) would not deem the dividend to come out of taxable surplus.
The Directorate noted that it could be argued that s. 248(28) would apply to exclude the dividend from his income given that “both the dividend and FAPI arise from the same source, namely the shares of S Corporation.” However, the Directorate preferred the double inclusion alternative:
[T]he better view … is that the dividend income and FAPI inclusion are not the same amount …
[T]he dividend income is a cash distribution on the shares of S Corporation while the FAPI is a notional allocation of the income of S Corporation deemed to be FAPI on its shares of S Corporation … [so that] the dividend income and FAPI are separate amounts of a different nature … [which] would preclude the application of subsection 248(28).
Neal Armstrong. Summary of 18 July 2018 Internal T.I. 2018-0766441I7 under s. 91(5) and s. 248(28).
Income Tax Severed Letters 29 September 2021
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA confirms that a group company can have one payroll account with CRA as agent for the various group companies
Among the updates in 2021 to its Q&A page on CEWS:
- CRA indicates that the companies in a group can continue to have one group entity handle the payroll matters (e.g., source deductions, and presumably also T4 reporting) – in one payroll account with CRA in its name - for employees that it pays as agent for other group companies even where the other group companies were required to open up their own payroll accounts with CRA to make CEWS claims.
- CRA provides an example concerning a TSX-listed corporation whose executive compensation disclosed on Form 51-102F6 (pursuant to National Instrument 51-102) increased from $4,500,000 in 2019 to $8,000,000 in 2021 and which claimed wage subsidies totaling $4,000,000 in periods 17 to 20. It is required to repay the executive compensation repayment amount of $3,500,000 ($8,000,000 - $4,500,000) in accordance with an ordering rule, whereby later wage subsidy amounts are required to be repaid first, until the total equals the eligible employer’s executive compensation repayment amount.
- CRA now provides the registry listing the over 408,000 corporations that have applied for the CEWS, including around 90,000 numbered companies. This doubtless is diverting CRA audit resources.
Neal Armstrong. Updated summaries of Frequently asked questions - Canada emergency wage subsidy (CEWS) CRA Webpage 24 September 2021 under s. 153(1)(a), s. 125.7(1) – qualifying revenue, executive compensation repayment amount and s. 241(3.5).
Seica – Quebec Court of Appeal applies the tax shelter definition on a property-by-property basis, and excludes interest from cost
Each taxpayer acquired rights to use software licences (treated as Class 12 property) for $190,000, and a franchise right for the non-exclusive right to distribute the software licences in specified territories (treated as eligible capital property), for $10,000. The consideration paid included a promissory note for $190,000 with a five-year term and bearing interest at 7.5%.
The Court confirmed two findings below relevant to the “mathematical test” in the “tax shelter” definition being satisfied:
- The taxpayers had acquired two properties (the franchise right and the software rights) rather than one composite property, so that the mathematical test could be applied to the software rights separately.
- The “cost” of the mooted tax shelter (against which the intimated deductions including CCA and interest expense were to be compared) should not be increased by the amount of interest covenanted to be paid under the promissory note (citing Coast Capital Savings and Stirling).
Neal Armstrong. Summary of Seica v. Agence du revenu du Québec, 2021 QCCA 1401 under s. 237.1(1) – tax shelter.
We have published 10 more CRA interpretations
We have published a further 10 translations of CRA interpretation released in December and November, 2006. Their descriptors and links appear below.
These are additions to our set of 1,734 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 14 ¾ years of releases of such items by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall. Next week is the “open” week for October.
BMO – Federal Court of Appeal approves the extensive reasons of Walker J in confirming that CRA did not unreasonably reject the Bank’s proposed ITC methodology
In affirming the decision of Walker J below in the BMO case, Noël CJ stated:
[T]he Federal Court identified the correct standard of review and applied it properly. In order to explain why we come to this view, we can do no better than adopt as our own the reasons of the Federal Court.
That decision concerned the rejection by the Minister of the request of the Bank for approval of an “output method formula” ITC allocation method on the basis inter alia that such method “did not result in a reasonable approximation of the inputs it used to provide zero-rated financial services to non-residents of Canada.” “Distorting factors” identified by the Minister included what she considered to be a violation of the “first order supply rule” that “a business cannot recover GST incurred on inputs acquired to make exempt supplies, even when those exempt supplies enable the business to make other taxable supplies” and the factor that the Bank’s method, by taking into account cross-border branch loans and excluding domestic intra-bank loans effectively ignored that the latter activity also “represent[ed] real activities” that consumed inputs in a largely exempt activity.
She also stated:
I agree with the Bank’s submission that the effect of section 141.02 is to strip QIs [such as banks and investment dealers] of the right to appeal to the TCC the question of whether their ITC computation methods are fair and reasonable. ...
Both the Bank’s methodology and what the Minister might have been prepared to accept appeared to treat interest costs on foreign borrowings by the Bank as a proxy for zero-rated supplies made by it, and Walker J did not demur.
Neal Armstrong. Summary of Bank of Montreal v. Canada (Attorney General), 2021 FCA 189 under s. 141.02(18), and summaries of Bank of Montreal v. Canada (Attorney General), 2020 FC 1014, aff'd 2021 FCA 189 under s. 141.02(18), s. 141.01(5), s. 123(1) – financial service – para. (d) and Sched. VI, Pt. IX, s. 1.
CRA indicates that a s. 82(3) election can convert a TOSI dividend to a dividend on an excluded share
The s. 82(3) election allows a taxpayer (the higher income earner in a couple) to elect to have a taxable dividend from any taxable Canadian corporation received by the taxpayer’s spouse or common-law partner be deemed to be included in the taxpayer’s income, where such inclusion increases the taxpayer’s married or common-law partner credit under s. 118(1)(a).
In addressing the interaction between the s. 82(3) election and the tax on split income (“TOSI”) under s. 120.4, CRA indicated that the TOSI rules should apply based on dividends that in fact are received by the other spouse from the family corporation being treated as instead being received by the electing spouse, so that if the shares on which such dividends were actually paid were not excluded shares, but those of the electing spouse were, the TOSI rules would not apply to the dividends.
CRA is willing to reach this conclusion even though such dividends are not explicitly deemed to have been received on the excluded shares of the electing spouse. However, the two spouses cannot aggregate their positions to arrive at excluded share status (e.g., the recipient spouse and electing spouse each held 6% votes and value of the corporation). Also, of course, the CRA position produces an unfavourable result in the reverse situation of the recipient spouse holding excluded shares, and the shares of the electing spouse not being excluded shares.
CRA’s favourable view does not change if the s. 82(3) election is filed late.
Neal Armstrong. Summary of 23 August 2021 Internal T.I. 2020-0856081I7 under s. 82(3).
G E Financial Investments – First-Tier Tribunal finds that a deemed US resident was not a US treaty resident
A US company (“GEFI Inc.”) and UK company (“GEFI”) in the GE group formed a Delaware LP (“LP”) with GEFI Inc. as the 1% general partner and GEFI as the 99% limited partner. LP acquired five intercompany loans.
The stock of GEFI Inc. and GEFI were stapled, which caused GEFI to be deemed to be resident in the US under the Code, with a view to increasing the US foreign tax credit capacity in the US. GEFI claimed credit for the US income taxes payable by it against its UK income tax liabilities.
HMRC denied the credit. The first issue was whether GEFI was a US resident for purposes of Art. 4 of the UK-US treaty, which relevantly referred to “any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature.” Brooks J effectively applied commentary - that the quoted wording requires “effective personal attachment to a territory,” and the effective finding in Crown Forest that full or worldwide taxation is a necessary feature of the connecting criterion but is not sufficient of itself - to find that the mere stapling of the GEFI stock did not give rise to the required connection to the U.S., so that GEFI was not a US treaty resident.
This then left the issue as to whether the US taxes imposed on GEFI were imposable in accordance with the Treaty on the basis of GEFI, through its participation in LP, having a permanent establishment in the US - so that the UK was required to accord a foreign tax credit to GEFI in accordance with Art. 24 of the Treaty (similar to Art. 24 of the Canada-UK Treaty). In finding that the LP did not have a permanent establishment in the US on the basis that it was not carrying on business there under the UK concept of a business (having regard to Art. 3(2)), Brooks J indicated that there was a mere holding of five affiliate loans (albeit, in very large amounts) over the course of approximately six years, which represented “more of a passive, sporadic or isolated activity than a regular and continuous series of activities” – and noted the there was “nothing to suggest that personnel or agents acting on behalf of the LP made or conducted continuous and regular commercial activities in the US.”
Neal Armstrong. Summaries of G E Financial Investments v. The Commissioners for Her Majesty's Revenue & Customs, [2021] UKFTT 0210 (TC) under Treaties – Income Tax Conventions – Art. 4, Art. 5.
Pomeroy Acquireco – Federal Court of Appeal indicates that amendments to pleadings need only assist (and not be prejudicial) to be allowed
The taxpayer opposed a proposed amendment by the Crown (raised before trial) to its pleadings to raise an argument that the subject transaction was a sham and that shares acquired as part of the transaction should have their value discounted to reflect the corporations’ latent tax liabilities. In reversing the decision below and allowing the amendments, Rennie JA disagreed with the trial judge (whom he reversed) that amendments must be “vital” to the case in order to be allowed, stating:
The controlling principle is that an amendment should be allowed at any stage of an action if it assists in determining the real questions in controversy between the parties, provided it would not result in an injustice not compensable in costs and that it would serve the interests of justice. A court should give significant consideration to amendments which further the ability of the trial court to determine the questions in controversy … .
Neal Armstrong. Summary of Canada v. Pomeroy Acquireco Ltd., 2021 FCA 187 under Rule 54.
Castle Building – Federal Court finds that it was not unreasonable of CRA to refuse a late ETA s. 156 election based on a corporation’s failing to file nil returns
A parent corporation (“Castle”) made some of its taxable supplies of building materials to its wholly-owned subsidiary (“CBS”), which on-sold the goods to retailers. There was a s. 171(1) billing election in place between them, so that Castle was responsible for the GST/HST reporting of CBS’s sales - and so that if CBS had bothered to register and file GST/HST returns (which it did not), they would have been nil returns (assuming that a s. 156 election applied to Castle’s sales to CBS – otherwise, Castle was required to charge GST/HST, with CBS effectively being required to claim ITCs).
New rules, effective January 1, 2015, required a fresh s. 156 election to be filed with CRA. Castle and CBS filed their election late. CRA refused to exercise its discretion to accept the late election on the basis of its Guidelines in Policy Statement P-255 which relevantly required that “both corporations must have filed all GST/HST returns as required.”
Walker J found that this refusal was not unreasonable. She noted that although Castle was responsible for reporting and remitting the GST/HST on CBS’s sales, this did not detract from CBS technically being a registrant who in fact was the supplier, so that it technically was still required to file (nil) returns.
Neal Armstrong. Summary of Castle Building Group Ltd. v. Canada (National Revenue), 2021 FC 947 under ETA s. 156(4)(b)(ii).