News of Note
Tiessen Interior Design – Tax Court of Canada applies s. 256(2.1) to prevent a professional firm from multiplying the small business deduction
Email this ContentAn incorporated firm of architects and interior designers restructured. Their practice was now carried on by a partnership between “Partnercos” owned by each of the principals. The principals were now exclusively employed by respective Servicecos controlled by them, which provided their services to the respective “paired” Partnerco for fees. These fees were deemed to be business income under s. 129(6). In their tax filings, each Serviceco treated itself as not being required to share the business limit with any other Serviceco - or with any Partnerco other than its paired Partnerco. As a result, the aggregate business limit claimed by the 15 Servicecos for their taxation years ending on January 1, 2013 was $4.6 million. CRA assessed on the basis that the Servicecos and Partnercos were associated with each other under the “one of the main reasons” test in s. 256(2.1), so that this multiplication of the business limit for small business deduction purposes was nullified.
Monaghan J confirmed these assessments (partly in light of a non-privileged presentation and spreadsheet provided at the planning stages by the tax advisor), stating:
Multiplication of the SBD was the reason the Reorganization was proposed and the resulting tax savings presented to the Principals led to the decision to undertake the Reorganization. Most of the reasons advanced by the Appellants for reorganizing were not convincing as main reasons. … They constitute benefits that the Principals enjoyed, to varying degrees, as a result of the Reorganization, but I have no doubt reduction of taxes was one of the main reasons for it.
Neal Armstrong. Summary of Nicole L. Tiessen Interior Design Ltd. v. The Queen, 2021 TCC 29 under s. 256(2.1).
CRA refers to an “ongoing review” of what is a participant in a JV for GST purposes
Medallion expanded the concept of a “participant” beyond CRA’s administrative definition of that term, by characterizing a person who contributed services to the joint venture to be a “participant” in the joint venture. P-106 only includes a person who has contributed property to the joint venture, or a person with no financial interest, who is responsible for the managerial or operational control of the joint venture.
When asked whether it has completed its review of Medallion, CRA stated:
Whether the Court’s decision in Medallion …would apply to another situation would require examination of all the relevant facts and documents. As part of our ongoing review of the policy, we will continue to consider similar cases as they arise.
Neal Armstrong. Summary of 27 February 2020 CBA Roundtable, Q.12 under ETA s. 273(1).
We have translated 13 more CRA Interpretations
We have published translations of 3 interpretations released by CRA last week from the APFF Roundtable, and a further 10 translations of CRA interpretation released back to July 2008. Their descriptors and links appear below.
These are additions to our set of 1,496 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 12 3/4 years of releases of Interpretations by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall.
Nonis – Tax Court of Canada finds that a U.S. resident avoided Canadian tax on employment income from a Canadian employer when he ceased performing active duties
The taxpayer, Mr. Nonis, who was a U.S. resident, had been employed as the general manager of the Toronto Maple Leafs pursuant to an employment contract entered into in 2013. For his 2013 and 2014 taxation years, Mr. Nonis included in his Canadian returns a pro-rated portion of his employment remuneration based on the number of days spent in Canada performing services to earn such income, and this was accepted by CRA. On April 12, 2015, his employer notified him that no further active services were required of him in order to fulfill his contract, and Mr. Nonis returned permanently to the U.S. However, under his contract, he continued to be entitled to remuneration for a number of years thereafter. In filing his returns for 2015 and 2016, Mr. Nonis used the same proration formula based on his days of service in Canada: 37 days for 2015; and zero days for 2016. The Minister reassessed Mr. Nonis on the basis of using the days of service that had been accepted for 2013 and 2014.
After finding that Mr. Nonis continued to be an employee after his “termination” (albeit, with virtually non-existent duties), Bocock applied the principle that, under “paragraph 4(1)(b) of the Act, if a taxpayer works partly in Canada and partly in another country in the same taxation year, the taxpayer’s taxable Canadian income for the year is the amount earned while working physically in Canada” – so that Mr. Nonis’ reporting based on the 37 and 0 days of service in Canada was correct.
The Crown advanced s. 115(2)(c.1). Bocock found that s. 115(2)(c.1)(i) essentially dealt with signing bonuses received by non-residents regarding pending Canadian employment, and that s. 115(2)(c.1)(ii), which refers to “remuneration … for services to be performed in Canada” was there to prevent avoidance “where a signing bonus is represented as something else.”
Mr. Nonis’ appeal was allowed.
Neal Armstrong. Summary of Nonis v. The Queen, 2021 TCC 31 under s. 115(2)(c.1)(ii).
CRA indicates that the purchase of future contingent royalty payments is subject to GST/HST
Similarly to Ruling 162056, CRA found that the purchase in Canada by a financial institution of the rights of a research company to royalties that the latter expected to receive (but with no guarantee) pursuant to a Royalty Agreement with a drug manufacturer represented the purchase of contingent rights rather than of existing receivables, so that such sale would be subject to GST/HST rather than being an exempt supply of a “debt security.” However, if there were guaranteed minimum payments for the purchased future receivables, they would qualify as debt securities, so that their sale would instead be an exempt financial service.
Neal Armstrong. Summary of 27 February 2020 CBA Roundtable, Q.11 under ETA s. 123(1) – debt security.
CRA finds that s. 104(13), unlike s. 104(19), can apply contemporaneously with a trust dividend distribution, and that ss. 186(2) and 251(1)(b) can apply synergistically
A personal trust wholly-owns Opco, which also has a December 31 year end, and has a corporate beneficiary ("Holdco") with a September 30 taxation year end. On September 20, 20X1, Opco pays a taxable dividend of $5,000 to the Trust, which immediately on-pays that amount to Holdco.
CRA reiterated previous positions (most recently, in 2018-0757591I7 F and 2020-0839891C6) that a s. 104(19) designation by a trust cannot be effective until the trust’s year end. Accordingly, if by the effective time of the deemed dividend payment as a result of the designation (December 31, 20X1), the above trust had disposed of Opco to a third party, whether Opco was connected for Pt. IV tax purposes would be tested at that time, so that there would be no exemption from Pt. IV tax under s. 186(1)(a).
However, a similar timing issue would not arise if, for some reason, Holdco ceased, after the receipt by it of the $5,000 from the Trust (September 20, 20X1) and before the trust year end (December 31, 20X1), to be a trust beneficiary, but with Opco continuing to be connected on December 31, 20X1 with Holdco pursuant to s. 186(4)(a) by virtue of common control as described in s. 186(2). CRA stated:
[A] taxpayer does not have to be a beneficiary of a trust throughout the taxation year of the trust in which an amount becomes payable to the taxpayer in order for that amount to be included in computing the beneficiary's income pursuant to subsection 104(13),”
[S]ince Holdco is a beneficiary of the Trust at the time the $5,000 became payable to Holdco, the condition in paragraph 104(19)(b), that Holdco be a beneficiary of the Trust in the Trust's taxation year, is satisfied. The Trust could therefore designate the $5,000 amount to Holdco in accordance with subsection 104(19) if all the other conditions for the application of that provision are otherwise satisfied.
The question addressed by CRA was premised on Opco initially being connected with Holdco under ss. 186(4)(a) and 186(2) on the basis that Holdco was controlled by a person (X) who did not deal at arm's length with the person who controlled Opco. CRA indicated that there would be no effect on Holdco's liability for Pt. IV tax if Holdco, while continuing as a beneficiary of the trust, ceased to be controlled by X. The reason: the trust and Holdco were deemed not to deal with each other at arm's length by virtue of s. 251(1)(b), so that (under the control test in s. 186(2)) more than 50% of the fully-voting Opco shares belonged to a person (the Trust), which did not deal at arm's length with Holdco.
Neal Armstrong. Summaries of 7 October 2020 APFF Roundtable Q. 17, 2020-0845821C6 F under s. 104(19), s. 104(24) and s. 186(2).
Grenon – Tax Court of Canada finds that the purported establishment of “alter ego” MFTs through which an RRSP invested in operating businesses was a GAAR abuse
In order that the taxpayer’s RRSP could indirectly invest in operating businesses in which he had a management role, he instigated the formation of various unit trusts (the “Income Funds”) which were intended to be mutual fund trusts on the basis that 171 individuals (the “Investors”) - immediate and extended family members, friends, employees, business associates and others - each subscribed $750 for units of each Income Fund. The taxpayer’s RRSP invested a total of $315 million for units of the Income Funds, which then invested directly or indirectly in underlying LPs carrying on businesses or making loans to other group entities.
Smith J found that there had been a failure to satisfy the requirement in Reg. 4801(a)(i)(A) that there had been a “lawful distribution” of the units to the Investors in accordance with the offering memorandum exemption from a prospectus-filing requirement, given that a substantial number of the Investors were adults who did not pay for their own units, or minors. As the Income Fund units thus did not qualify as MFT units, the RRSP was subject to tax under s. 146(10.1) and penalty tax (under former s. 207.1(1)) on the basis of not holding qualified investments.
In the alternative, Smith J considered whether GAAR should apply even if the units in the Income Funds were qualified investments. After finding that there was a tax benefit and avoidance transactions (being the establishment of the Income Funds through which the RRSP could invest in the businesses), Smith J also found that there was an abuse under s. 245(4), stating:
[T]he object, spirit and purpose of subsection 146(4) is to prevent an annuitant from making tax deductible contributions … and then using those funds for business purposes and thus take advantage of the tax-exempt status of the plan. …
[T]he acquisition by the RRSP Trust of 99% of the units of the Income Funds defeated the object, spirit and purpose of the provision and was contrary to the Parliament intention that a mutual fund trust was to be widely held. It was certainly not within the contemplation of Parliament that a mutual fund trust that was a qualified investment for RRSP purposes would effectively become one investor’s alter ego. …
[T]he Appellant sought to abuse the RRSP regime and the provisions of the Act by establishing the Income Funds … .
After finding that the Minister’s assessment of the taxpayer himself respecting the RRSP income pursuant to s. 56(2) was unsupported by the wording of that provision, Smith J went on to indicate that he would have upheld the reassessments of the taxpayer in those amounts on the basis of the GAAR, but for this resulting “in a duplication of the tax which the Minister has also sought to impose on the RRSP Trust pursuant to subsection 146(10.1)” – which could not “be considered ‘reasonable in the circumstances’ as contemplated in subsection 245(5).” Accordingly, only the assessments of the RRSP under s. 146(10.1) and not of the taxpayer under s. 56(2), were sustained.
Neal Armstrong. Summaries of Grenon v. The Queen, 2021 TCC 30 under Reg. 4801(a)(i)(A), s. 245(4), s. 204 2(1) and General Concepts - Window Dressing.
CRA no longer imputes interest on mismatched cross-border swap payments
At 1984 CTF Roundtable, Q.60, the Department suggested that where swap payments are not made contemporaneously, for example, payments under the swap agreement are made by Canco to a non-arm’s length non-resident corporation (NRco) annually, whereas NRco makes its payments to Canco quarterly, withholding tax may apply to a portion of the outbound payments that represents an interest element.
CRA indicated that this position was contrary to Shell Canada, which found that absent a specific provision to the contrary or sham, the taxpayer’s legal relationships must be respected – so that withholding tax would not apply in such a situation absent a finding of sham or the application of a specific provision, e.g., s. 245 or 247. CRA gave a similar response at 5 September 2020 IFA Roundtable, Q.2
CRA also stated that “CRA considers that all amounts payable or receivable under the terms of a swap agreement are on account of income and are to be included or deducted under section 9.” This is an over-simplification – for example, CRA would recognize that on a cross-currency swap hedging an FX borrowing, the hedge of the principal component generally would be on capital account.
Neal Armstrong. Summary of 7 October 2020 APFF Roundtable, Q. 16, 2020-0867071C6 F under s. 16(1) and s. 9 – capital gain vs. profit – swaps.
CRA indicates that s. 74.4(2) could apply to a s. 51 estate freeze-style reorganization by two spouses in favour of two discretionary trusts for them and their spouse
Mr. X and Mrs. X, each owning 50% of the common shares of corporation that is not a small business corporation, effect a s. 51 exchange of their respective shareholdings for the issuance of freeze preferred shares, with a discretionary trust created for each spouse (but with discretion to pay income or capital thereof to the other spouse) subscribing nominal and equal amounts for new common shares of the corporation.
CRA indicated that the s. 74.4(2) could apply following this transaction, given that “one of the spouses could potentially be entitled to more than 50% of the income of the Corporation because of his or her beneficial interest in both trusts,” so that there could be a resulting transfer of income from one spouse to the other.
Neal Armstrong. Summary of 7 October 2020 APFF Roundtable Q. 15, 2020-0852271C6 F under s. 74.4(2).
Income Tax Severed Letters 14 April 2021
This morning's release of six severed letters from the Income Tax Rulings Directorate is now available for your viewing.