News of Note

CRA issued a letter to Tellza under ETA s. 288(1) (similar to ITA s. 231.1(1)) to obtain all of Tellza’s electronic accounting data for a 20-month period. Fuhrer J rejected Tellza’s position that this letter was a "requirement" and not a "request" and hence, should have issued under the ETA s 289(1) (similar to ITA s. 231.2(1)), instead of the ETA s 288(1), and found that it was not unreasonable for CRA to have issued the letter under the latter provision instead. In this regard, she indicated that, although s. 288(1) was narrower in scope than s. 289(1), s. 288(1) nonetheless “grants an authorized person the power to request or require a taxpayer to provide information in any form,” and further stated that “the authorized person is not limited, in a modern, electronic era, to an inspection, audit or examination of the taxpayer’s documents and records at their premises.”

After having noted that the word “document” (used in s. 288(1)), was effectively defined in s. 123(1) to include “any other thing containing information, whether in writing or in any other form” (her emphasis), she also rejected the contention of Tellza that “the request for records in an electronically readable format, along with the system administrator’s user ID and password, where applicable, falls outside the scope of the inspection power in the ETA s 288(1).”

Neal Armstrong. Summary of Tellza Inc. v. Canada (National Revenue) 2021 FC 853 under ETA s 288(1).

Non-dividend distributions from foreign subsidiaries often occur under the foreign corporate law as a return of “paid-in capital” ( PIC), e.g., contributed surplus, share premium, or additional PIC, so that use of the QROC election under s. 90(3) in such circumstances is problematic.

Interpreted literally, Reg. 5901(2)(b)(ii) precludes the election - for a whole dividend paid by a foreign affiliate (FA) of a corporation resident in Canada (a “CRIC”) to come out of preacquisition surplus – if any other CRIC (or a foreign affiliate of any other CRIC) is a member of a partnership that is a shareholder of the FA, regardless whether the other CRIC is related to the particular CRIC, or the partnership is a recipient of any portion of the dividend. However, the Explanatory Notes implicitly suggest that only the electing CRIC (or CRICs jointly filing the election), and any foreign affiliates thereof, are to be taken into consideration. Nonetheless, CRA considers that the election would not be available where a dividend was paid by the FA on a single class of shares to a Canco, and an LP with an unrelated CRIC as a member.

S. 93(1.1)(b) contemplates that any s. 40(3) capital gain that would otherwise would be deemed to be realized by the CRIC as a result of a Reg. 5901(2)(b) election is automatically converted back into a dividend to the extent of the net surplus of the foreign affiliate that is deemed to be otherwise available at the time of the distribution. However, s. 93(1.1)(b) may not entirely restore the tax treatment of the dividend that would have arisen if the Reg. 5901(2)(b) election had not been made.

For example, Canco wholly-owns all the shares (having an ACB of $50 million) of FA 1, which has no surplus balances other than $10 million of taxable surplus, with FA 1 owning all the shares of FA 2, which has no surplus balances other than $20 million of taxable surplus. FA 1 pays a $100 million dividend to Canco.

If Canco does not elect under Reg. 5901(2)(b), $10 million and $90 million of the dividend are deemed to be paid from taxable surplus, and preacquisition surplus, respectively, thereby triggering a $40 million capital gain.

If Canco instead elects, the $100 million dividend is treated as having been paid from preacquisition surplus, triggering a $50 million gain – but s. 93(1.1)(b) then applies to recharacterize a portion of that gain as a distribution from taxable surplus. However, because s. 93(1) takes into account the “consolidated” net surplus of FA 1 and its subsidiaries, the portion of the gain recharacterized as a taxable surplus dividend also includes the additional $20 million of taxable surplus of FA 2, so that Canco is deemed to receive a taxable surplus dividend of $30 million (not $10 million), and to have realized a s. 40(3) capital gain of only $20 million.

There can be adverse (or favourable) consequences of making the Reg. 5901(2)(b) election rather than using surplus.

Example 1

Canco (which has not made a functional currency election) holds all the shares (having an ACB of $150 million) of a single class of shares of FA, which pays a US$ 100 million dividend (equivalent to Cdn.$140 million) at a time that its only surplus/deficit accounts (which it maintains in US dollars) is an exempt surplus balance of US $100 million. If it subsequently realized operating losses of US$ 100 million (thereby wiping out any unutilized exempt surplus balance), it would have been better off not to have elected (so that the dividend came out of exempt surplus) - as maintaining the ACB of $150 million would permit FA to distribute up to that amount to Canco as preacquisition surplus dividends notwithstanding FA’s exempt deficit.

Example 2

Rather than there being subsequent operating losses, the only relevant subsequent change is that the Canadian dollar appreciates relative to the US dollar. If Canco does not make the election, it will have a greater relative benefit from having maintained most of its Canadian dollar basis in the FA shares rather than maintaining a US dollar exempt surplus balance.

Example 3

FA, a US subsidiary, which has exempt earnings, pays two dividends of US$ 100 million in the same year: the first being subject to 5% US withholding tax because it is paid out of earnings and profits for US purposes; and the second being not subject to withholding because it was not paid out of E&P. Respecting the first dividend, the ACB reduction will only be $95 million if the Reg. 5901(2)(b) election is made, whereas if the election is not made, the exempt surplus balance is reduced by the gross amount of the dividend irrespective of whether there is withholding tax. Accordingly, it may be preferable to make the election only respecting a dividend that is subject to withholding tax.

Example 4

Canco, which in accordance with s. 261 computes its Canadian tax results in US dollars, holds cumulative preferred shares of FA with a face value and ACB of US $100 million. The dividends come out of exempt surplus unless Canco makes the Reg. 5901(2)(b) election. If it makes the election, it might seem that this would increase the amount of exempt surplus it could access so as to shelter under s. 93(1) the resulting gain when the preferred shares are subsequently redeemed. However, the rules in Reg. 5902 might limit its access in that redemption scenario to exempt surplus only in the amount of the accrued but unpaid dividends on the shares at the time of redemption, thereby resulting in the realization of a capital gain that could have been avoided if the election instead had not been made.

It may be beneficial for the payer of an interaffiliate dividend, who has sufficient tax-free surplus, to pay a dividend to a higher-tier foreign affiliate from such tax-free surplus, so as to elevate tax-free surplus up the foreign affiliate chain, thereby making such surplus more readily available to shelter the payment of any subsequent dividends to the CRIC – and also safeguarding that tax-free surplus from erosion by any subsequently-incurred losses of the payer affiliate – but a counter-example is provided.

Neal Armstrong. Summaries of Tim Fraser and Jim Samuel, “The Preacquisition Surplus Election: More Than Meets the Eye?” Canadian Tax Journal (2021) 69:2, 595 - 627 under s. 90(3), Reg. 5901(2)(b)(i), Reg. 5901(2)(b) and s. 93.1(1.1)(b).

The Superior Court of Quebec found:

• that the two taxpayers, who were minority shareholders, employees and directors of a private family corporation (“Comairco”), were the victims of oppression in that they had been summarily dismissed from their positions in order that their sharing in the profits of Comairco through bonuses and dividends could be substantially reduced; and
• that their suit for oppression pursuant to s. 241 of the CBCA should be answered inter alia through the Court’s order that the shareholding of each be redeemed for $4.5 million and that they be paid lump sums (of $65,000 and $50,000, respectively) by reason of their wrongful dismissal.

In finding that the latter sums were taxable as retiring allowances, Dortélus JCQ stated:

The fact that the award was made pursuant to the CBCA section 241 and not under the Civil Code does not alter the reason for the award, which was to compensate the plaintiffs for damages directly resulting from the loss of their employment.

Neal Armstrong. Summary of Nadeau v. Agence du revenu du Québec, 2021 QCCQ 4638 under s. 248(1) – retiring allowance.

A non-resident (the “Assignor”) entered into an agreement to acquire a new condo (the “Strata Lot”) with the stated intention of moving into it with her family but, while the condo was being constructed, also purchased a townhouse in the same province and lived there with her family. She then assigned the agreement to purchase the new condo at a gain before the purchase closed.

In contrast to the ruling referenced in the previous post, CRA ruled that the Assignor had not established that this transaction was not an adventure in the nature of trade, so that she was a builder for GST/HST purposes, and her sale of her purchase agreement was a taxable supply. CRA stated:

In the absence of any outward indicators to support your assertion …the CRA views the Assignor’s action of selling the interest in the Strata Lot as evidence that the Assignor acquired the interest in the Strata Lot for the primary purpose of selling the interest in the course of a business or an adventure or concern in the nature of trade.

Neal Armstrong. Summary of 10 January 2020 GST/HST Ruling 190414r under ETA s. 123(1) – builder – para. (f).