News of Note
CRA confirms that compensatory payments made by a US C-corp to LLC subsidiaries were FAT pursuant to Regs. 5907(1.3) and (1.5)
Email this ContentA corporation resident in Canada wholly owns a US “C” corporation (“Holdco”), which earns foreign accrual property income (“FAPI”) and is the sole member of two fiscally-transparent LLCs. In each relevant taxation year (the “FAPI Year”), Holdco both uses losses incurred by the LLCs to fully offset its taxable income for the U.S. tax purposes and makes compensatory payments under a group tax sharing agreement to the LLCs (“Loss LLC 1” and “Loss LLC 2”) for the utilization of their losses (the “Compensatory Payments”). The loss of Loss LLC 1 is a “foreign accrual property loss” (“FAPL”); and the loss of Loss LLC 2 is neither a FAPL, nor a “foreign accrual capital loss” (“FACL”).
Do the Compensatory Payments made to the two LLCs qualify as foreign accrual tax (FAT) pursuant to Reg. 5907(1.3); and, if so, do Regs. 5907(1.4) to (1.6) apply to the Compensatory Payments made to Loss LLC 2?
In finding that Reg. 5907(1.3)(b) would be satisfied, CRA noted that, as a result of the two LLCs being treated as fiscally transparent, in computing its income or profits subject to tax in the U.S. for the FAPI Year, Holdco deducts the losses incurred by the LLCs, which are losses of other corporations. Holdco, as the particular affiliate, pays the Compensatory Payments to the loss transferors and such payments may reasonably be regarded as being in respect of income or profit tax that would otherwise have been payable by Holdco. Thus, Reg. 5907(1.3)(b) would deem the Compensatory Payments made to Loss LLC 1 and Loss LLC 2 to be FAT, subject to the application of Reg. 5907(1.4).
Reg. 5907(1.4) will deny the amount prescribed to be FAT of Holdco under Reg. 5907(1.3)(b) to the extent it relates to the Compensatory Payment made to Loss LLC 2 - on the basis that the Compensatory Payment cannot reasonably be considered to be in respect of a FAPL or a FACL. However, Regs. 5907(1.5) and (1.6) would reinstate the FAT if for the subsequent 5 years, Holdco earns active business income in excess of its losses, and any losses of Loss LLC 2 for the FAPI Year, as well as their losses that can be carried back and used in those five years.
Neal Armstrong. Summaries of 22 February 2024 External T.I. 2016-0667251E5 under Reg. 5907(1.3) and Reg. 5907(1.5).
Income Tax Severed Letters 23 October 2024
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA confirms the conversion of vehicle lease payments into recapture on option exercise and vehicle sale
An individual, after having paid $12,500 in lease expenses during the first 48 months of an automobile lease, exercises the option under the lease to acquire the automobile for $15,000, at a time that its FMV is $20,000, then immediately sells it for $20,000.
CRA confirmed that if the individual had been using the vehicle in the course of carrying on a business then, by virtue of s. 13(5.2), the capital cost would be deemed to be $20,000 (i.e., the lesser of the vehicle’s FMV, and the sum of the actual cost of $15,000 and the lease expenses), and the individual would be deemed to realize recapture of depreciation of $5,000 on the sale, rather than a capital gain.
On the other hand, if there was no business use of the automobile, s. 13(5.2) would not apply. Assuming that the relationship between the parties was legally that for a vehicle lease and that no part of the leasing costs was reasonably attributable to the acquisition of the purchase option, the ACB of the purchase option under the s. 49 rules would be nil. If so, the ACB of the vehicle was equal to the exercise price of $15,000 plus the nil ACB of the option, for a total of $15,000, so that there would be a $5,000 capital gain on the sale.
Neal Armstrong. Summaries of 10 October 2024 APFF Roundtable, Q.9 under s. 13(5.2) and s. 49(3).
CRA indicates that the exclusions under (e) of the “automobile” definition, in the case of a leased vehicle, are to be applied in the year of lease signing
The conditions in (e)(i) to (iii) for exclusion from the “automobile” definition specify that such conditions must be satisfied “in the taxation year in which it is acquired or leased.” In the case of a leased vehicle, is the referenced taxation year the year of the signing of the leasing contract, or does it apply to each of the years within the lease term?
CRA responded:
With respect to leased vehicles, the CRA is of the view that the use tests apply in the taxation year in which the lease agreement comes into effect, i.e., generally in the taxation year in which the lease agreement is signed.
Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.8 under s. 248(1) - automobile.
CRA comments on the potential conversion of ERDTOH to NERDTOH through inter-corporate dividends
CRA was provided with the following example to illustrate a potential erosion of the eligible refundable dividend tax on hand (ERDTOH) account where a corporation with a ERDTOH and NERDTOH accounts pays an eligible and non-eligible dividend in the same year to two connected shareholders.
Aco has two connected shareholders, each held by the same resident individual (the “Shareholder”): Bco holding all its common shares; and Cco holding all its preferred shares.
At the end of the applicable taxation year, Aco has ERDTOH and NERDTOH balances of $38,333 and $100,000, respectively.
In the course of that taxation year, it paid an eligible dividend to Bco of $100,000, generating a dividend refund (DR) of $38,333 from its ERDTOH account; and it redeemed the preferred shares held by Cco, generating a deemed dividend of $500,000 for which Aco received a DR of $100,000 from its NERDTOH account.
Bco and Cco were subject to Pt. IV tax on such dividends based on the total DR received by Aco, in accordance with s. 186(1)(b):
Bco: $100,000/$600,000 X $138,333 = $23,055;
Cco: $500,000/$600,000 X $138,333 - $115,278.
For Bco, as the dividend received permitted Aco to receive a DR from its ERDTOH, the $23,055 was added to its ERDTOH account. For Cco, as the dividend received did not generate a right to a refund from its ERDTOH, the $115,278 was added to its NERDTOH account.
Thus, there was a conversion of a $15,278 amount from ERDTOH to NERDTOH for the corporate group.
After noting that this ERDTOH-NERDTOH shift resulted “from the fact that paragraph 186(1)(b) makes no connection between the type of RDTOH account entitling Aco to the DR and the type of dividend received by Bco and Cco,” CRA indicated that, here, “the conversion of an amount of ERDTOH into an amount of NERDTOH results in an increase in the tax payable by the Shareholder … but only at … the stage where the amount of dividends paid is limited to the amount necessary to give entitlement to the DR of the ERDTOH and the NERDTOH of Bco and Cco totalling $138,333.” However, CRA indicated that this “conversion of an ERDTOH amount into a NERDTOH amount … does not ultimately result in additional tax to the Shareholder once all of the dividends received from Aco are paid to the Shareholder by Bco and Cco.”
Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.7 under s. 129(4) - NERDTOH.
GAAR may apply where the purpose of a s. 55(3)(a) redemption for a note is increasing outside basis, but not where freeze shares are redeemed for personal cash needs
CRA, when asked to comment on the application of s. 55(3)(a) to the redemption of a preferred share that was not supported by safe income (as all the safe income instead supported an accrued capital gain on the common shares), stated that in such a context:
[T]he redemption in question should be analyzed with respect to the purpose of the dividend resulting from the redemption and the GAAR could potentially apply in such a situation. In this regard, see Example 5 in the [“CRA Update on Subsection 55(2) and Safe Income: Where are we Now”].
Example 5 may be summarized as follows:
- Parent, which owns shares of Subco with an ACB of $0 and FMV of $1,000 and no safe income, wishes to increase its cost in the shares of Subco or other property held in Subco, so that shares of Subco are redeemed for a note and the note is either held by Parent or subsequently reinvested back in the shares of Subco held by Parent.
- The redemption for a note has no purpose other than to effect an increase in the cost to Parent of any property, which is a circumvention of the restriction in s. 55(2.1), so that CRA would seek to apply GAAR to the redemption.
CRA then stated:
On the other hand, in the context of a share redemption the purpose of which is ultimately to finance the personal needs of a shareholder-individual, for example in a situation involving a redemption of freeze preferred shares of the capital stock of an operating corporation held by a holding company of the shareholder-individual followed by the payment of that amount by the holding company to the shareholder-individual, the CRA would accept that paragraph 55(3)(a) could apply.
Neal Armstrong. Summaries of 10 October 2024 APFF Roundtable, Q.6 under s. 55(2.1)(c) and s. 55(3)(a).
CRA indicates that a reporting-entity partnership with a partner related to other group members can qualify as a member of a related group for T1134-reduced reporting purposes
The T1134 instructions indicate that to access the relief for related reporting entities, they should be related as per s. 251(4). How is it determined whether a partnership is part of a related group for purposes of this relief?
After noting that a “partnership described in paragraph 233.4(1)(c) is a reporting entity for the purposes of section 233.4 as soon as a partner who is resident in Canada and who is not exempt from Part I tax has an interest of at least 10% in the income or losses of the partnership for the fiscal period,” CRA stated:
If a partnership is a reporting entity in respect of a foreign affiliate, the administrative relief for related reporting groups extends to the partnership if at least one of its members (or if another partnership is a member, one of its members) is related to each of the other reporting entities forming a related group in respect of that same foreign affiliate.
Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.5 under s. 233.4(4).
We have translated 6 more CRA interpretations
We have translated a further 6 CRA interpretations released in June of 2001. Their descriptors and links appear below.
These are additions to our set of 2,978 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 23 ¼ years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
| Bundle Date | Translated severed letter | Summaries under | Summary descriptor |
|---|---|---|---|
| 2001-06-22 | 19 June 2001 Internal T.I. 2000-0053887 F - STATUTE-BARRED YEARS - GST CREDIT | Income Tax Act - Section 122.5 - Subsection 122.5(3) | a taxpayer’s non-capital loss claimed for a statute-barred year eliminated his GSTC for that year, without repayment thereof being required |
| Income Tax Act - Section 152 - Subsection 152(4) | where a taxpayer claims a non-capital loss for a statute-barred year so that his GSTC is eliminated, CCRA cannot recover the overpaid GSTC | ||
| 14 June 2001 External T.I. 2000-0060085 F - Transfert à une société | Income Tax Act - Section 74.4 - Subsection 74.4(2) | Holdco with one discretionary share in Opco (an SBC) and which received periodic purification dividends form Opco likely would not be an SBC | |
| 12 June 2001 External T.I. 2001-0072345 F - Émigrant du Canada et statut de résident | Income Tax Act - Section 2 - Subsection 2(1) | cessation of Canadian residency status not significantly affected by leaving adult children behind to pursue Canadian studies (who generally would continue as residents) | |
| 2001-06-08 | 4 June 2001 External T.I. 2000-0047145 F - Revenu protégé - crédit impôt investis | Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) | investment tax credit does not reduce safe income |
| 5 June 2001 External T.I. 2000-0055765 F - Revenu gagné en main | Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) | s. 85(1) exchange of common shares for preferred shares transferred the safe income on hand to the pref | |
| Income Tax Act - Section 248 - Subsection 248(1) - Small Business Corporation | purification transaction accords with object and spirit of Act | ||
| 1 June 2001 External T.I. 2001-0075455 F - Remaniement et capital versé | Income Tax Act - Section 86 - Subsection 86(2.1) | PUC reduction under s. 86(2.1) of new shares to PUC of old shares | |
| Income Tax Act - Section 84 - Subsection 84(5) | no s. 84(3) deemed dividend on s. 86 reorg by virtue of ss. 86(2.1) and 84(5) |
CRA provides an example of a designated related-group entity filing a single T1134 for the group
Regarding the situation where Canco transferred all the shares of USco (which, in turn, wholly-owned a US LLC) to a newly-incorporated Canadian holding company (Holdco) on a s. 85 rollover basis; and then USco was wound up into Holdco before the end of the same taxation year (a June 30, 2023 year end for both Canco and Holdco), CRA indicated that since Canco and Holdco each held the USco shares directly for a portion of their 2023 taxation year, each would be a reporting entity that was required to file a T1134 for their 2023 taxation year. However, as a related group with the same year end, and using the same functional currency, they could designate one of them as their representative to file a single T1134 information return with the required information for both.
Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.4 under s. 233.4(4).
CRA indicates that Foix established that s. 84(2) should be construed broadly
When asked to comment on the Federal Court of Appeal decision in Foix, which found that s. 84(2) applied to a particular hybrid sale transaction, CRA stated:
According to the broad interpretation of subsection 84(2) adopted by the Court, “transactions leading to an alleged distribution or appropriation of funds or property are to be considered as a whole in a way that is temporally flexible”. With respect to the expression “in any manner whatever’ in subsection 84(2), the Court noted that “[t]hese far-reaching words are anchored in history as they have always been part of this provision, and they faithfully reflect its anti-avoidance purpose”. Finally, the Court emphasized that when a facilitator is involved, “the distribution or appropriation of the target corporation’s funds or property can be carried out in a variety of different ways and take place through various steps that are organized so as to occur at different times”. It then added that “in the presence of an orchestrated attempt to extract surpluses without tax or at a reduced rate, the intention of Parliament requires a reading of subsection 84(2) that balances the words that are used, as an overly literal reading would defeat its anti-avoidance mission”.
[Foix] also resolved the uncertainties arising from certain decisions that taxpayers frequently invoked against the application of subsection 84(2), namely, McNichol … Descarries … and Robillard … [and] warn[ed] against the formalistic and restrictive application of subsection 84(2) put forward in those decisions.
CRA also indicated that “Foix did not express an opinion on the Tax Court of Canada's analysis in Geransky” and implied that Geransky has been overtaken by the subsequent decisions of the Federal Court of Appeal in MacDonald and Foix, which “clearly ruled that subsection 84(2) should be given a broad interpretation.”
Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.3 under s. 84(2).