News of Note
Dynamic hedging might be on capital account
Email this ContentA dynamic hedge, for example, where a taxpayer has written a call option on a number of shares of X Co, involves the taxpayer continually buying or selling shares of X Co in predictable numbers and at predictable times based on changes over time in the market price of the X Co shares.
[B]ased on George Weston … a compelling argument can be made that gains and losses resulting from a dynamic hedging strategy to hedge a capital asset should also be on capital account despite the fact that there may be numerous transactions. … [T]he relevant issue is the character of the risk that is being hedged (depreciation in value of a foreign-currency-denominated capital asset), not the number of transactions.
The derivative forward arrangement definition was amended in response to concerns that it could apply to conventional currency forwards. However, there are concerns that the new wording does not adequately deal with currency forwards that hedge foreign-currency denominated borrowings (as contrasted to investments).
Under hedge accounting, recognition of income or loss on the hedge of a trading-account item can be deferred until the year of recognition of loss or income on the underlying hedged item. A company,
having chosen hedge accounting, could argue on the basis of Kruger that hedge accounting provided a more accurate picture of income; it matched the results of the hedged item with the results of the hedging item, thus producing a better match of profit and related loss than the realization principle.
Neal Armstrong. Summaries of Nigel P.J. Johnston and Roger E. Taylor, "Taxation of Hedges and Derivatives: Recent Developments," 2016 Conference Report (Canadian Tax Foundation), 13:1-36 under s. 9 - timing, s. 9 – capital gain v. profit – futures/forwards/hedges, and s. 248(1) – derivative forward agreement – s. (b)(iii).
CRA rules that the purchase of an IP royalty gives rise to non-creditable GST/HST to the investor unless there is a specified minimum royalty
A Canadian registrant (Investor) enters into an agreement with a Canadian corporation (Corporation 1) under which it pays lump sums in consideration for the right to receive monthly royalties calculated as a percentage of intellectual property (IP) related revenue streams of Corporation 1. CRA ruled that the lump sums so paid are consideration for the taxable supply to Investor of intangible personal property (the right to the royalty payments). However, CRA ruled that Investor is not making any taxable supply in exchange for the royalty payments when Corporation 1 makes the subsequent royalty payments – so that Investor would not be entitled to claim input tax credits for the GST/HST paid or payable on related inputs. Apparently, this means that the GST/HST charged to it on its lump sum investment is non-creditable. This analysis could be troubling to the companies which invest in Canadian resource or other royalties.
A second agreement with Corporation 2 was similar, except that a minimum monthly royalty was specified. CRA ruled that because the Investor now had a non-contingent right to receive money, the right to the royalties qualified as a “debt security” (defined in ETA s. 123(1) as “a right to be paid money”), so that the purchase of the royalty agreement was now the exempt purchase of a financial instrument. This seems to suggest that the revenue potentially payable under a “debt security” can be highly variable provided that there is a specified minimum.
Neal Armstrong. Summaries of 10 February 2017 Ruling 162056 under ETA s. 123(1) - debt security, s. 169(1) and s. 182(1).
CRA finds that a corp. held 50-50 by two 100% grandchildren of A was closely related for ETA purposes to A and to another 100% grandchild of A
One of the requirements for the ETA s. 156 nil consideration election is that the parties be closely related. The basic building block for the closely-related definition is the concept of a “qualifying subsidiary,” which references the holding of 90% or more of the value and number of the issued and outstanding shares, having full voting rights under all circumstances, of the mooted subsidiary. There is a somewhat ambiguous reference in ETA s. 128(1)(a)(v) to the 90% closely-related test being satisfied by a “combination” of corporations.
This did not give CRA pause, and it found that a corporation which was held on a 50-50 basis by two wholly-owned grandchildren of A was closely related to A as well as to another wholly-owned grandchild of A held through another chain.
Neal Armstrong. Summary of 11 October 2017 Interpretation 181628 under ETA s. 128(1)(a)(v).
Lichtman – Tax Court of Canada finds that religious instructors at a Hebrew academy did not qualify for the clergy residence deduction
Campbell J found that ordained rabbis who taught Judaic studies curriculum to children attending the Vancouver Hebrew Academy were ineligible for the s. 8(1)(c) clergy residence deduction given that teaching (although a component of ministering) is not itself “ministering,” and the students at a school meeting the provincial educational standards were not a “congregation.”
Neal Armstrong. Summary of Lichtman v. The Queen, 2017 TCC 252 under s. 8(1)(c) and Statutory Interpretation - noscitur a sociis.
Mac & Mac – Tax Court of Canada denies SR&ED claims because of inadequate notes of the work done
Mac & Mac was approached by a potential client to use its expertise in hydrodemolition to develop a technique to remove the worn inner linings from pipelines, so that the necessity of replacing them would be eliminated. Mac & Mac used numerous different approaches to applying high-pressure water to this end. In denying Mac & Mac’s SR&ED claims, Graham J stated:
Mac & Mac’s claims … do not meet the last test [in Northwest Hydraulic which] … requires Mac & Mac to have kept detailed records of hypotheses, tests and results as the work progressed.
… There is simply no way that someone, even someone very experienced in the industry, could hope to replicate or confirm Mac & Mac’s results from [its] notes.
Neal Armstrong. Summary of Mac & Mac Hydrodemolition Services Inc. v. The Queen, 2017 TCC 256 under s. 248(1) - SR&ED.
Zhang – Tax Court of Canada finds that “may deduct” means “is permitted to deduct” rather than “chooses to deduct”
The formula for an individual’s unused tuition, textbook and education tax credits states that it is reduced each year by “the amount that the individual may deduct” for that year. Graham J found that this was referring to “the amount that the individual is permitted to deduct” for the year, irrespective whether or not she wants to do so, rather than to “the amount that the individual chooses to deduct” for the year. The effect of this was that the taxpayer could not defer claiming the credits until a later year when they were of more use to her.
Neal Armstrong. Summary of Zhang v. The Queen, 2017 TCC 258 under s. 118.61(1).
Huntly Investments – Tax Court of Canada finds that associated-corp equivalent services can be added to the actual full time employees under the SIB definition
Paris J clarified that the over-five full time employee exclusion from a specified investment business involves a two-step test:
[I]t is first necessary to know how many full-time employees the [corporation] in fact employed in the years in issue.
The next step is to determine how many full-time employees would be required in respect of the services performed by … associated corporations [had those services not been provided].
A private corporation with a smallish portfolio of rental apartments in Vancouver fell well short of the mark. Under the first step, its building managers were mostly couples who split a full-time position, so that neither qualified as a full-time employee.
In the course of rejecting various taxpayer submissions on the second step relating to services provided by two associated corporations, he stated:
The Appellant’s contention that it would have required a full‑time CEO, executive assistant, accountant or CFO and accounting clerk is in large part predicated on the proposition that it was actively pursuing a redevelopment proposal in respect of its Stadacona site during its 2010 to 2012 taxation years. ...[T]he evidence does not support [such] a finding… .
Neal Armstrong. Summary of Huntly Investments Limited v. The Queen, 2017 TCC 255 under s. 125(7) – specified investment business.
CRA indicates that a late s. 83(3) election causes a retroactive increase to the CDA of the corporate recipient of the dividend
CRA indicated that a late but valid capital dividend election retroactively validates the dividend, so that the recipient of the dividend thereby has an addition to its capital dividend account at the time of the receipt of the dividend.
Neal Armstrong. Summary of 30 August 2017 External T.I. 2017-0718311E5 F under s. 83(3).
Finance narrowed the potential overreaching in its amendment to s. 212.3(1).
The recent amendment to s. 212.3(1) expands the scope of the foreign-affiliate dumping rules to include investments in non-resident corporation that are not foreign affiliates of the corporation resident in Canada (the “CRIC”) that makes the investment but are foreign affiliates of a corporation that does not deal at arm’s length the CRIC (the “other Canadian corporation”). As compared to the September 16, 2016 version of the amendment (which arguably could have referred to another non-arm’s length Canadian corporation of which the subject corporation was not an FA), the final version of this amendment:
clarifies that the reference to the "other Canadian corporation" is only relevant where the CRIC made an investment in a subject corporation which is not its FA (or becomes its FA as part of the series of transactions) but is an FA of the non-arm's length corporation (or become the non-arm's length corporation's FA as part of the series of transactions). This clarification appears to largely address the Joint Committee's concerns of the potential overly broad application of the FAD rules.
Neal Armstrong. Summary of Sabrina Wong, "Summary of International Amendments in Bill C-63, Budget Implementation Act, 2017, No. 2", International Tax (Wolters Kluwer CCH), No. 97, December 2017, p. 6 under s. 212.3(1).
CRA finds that the substituted-debt exclusion did not deny s. 18(9.1) deductibility of a redemption premium where the new debt was to new investors
A public company issued Series A Debentures (“SAD”), and subsequently issued Series B Debentures (“SBD”), and redeemed the SAD together with an early redemption premium. Whether it was entitled to deduct the redemption premium under s. 18(9.1) turned on whether (as per s. 18(9.1(a)) it could reasonably be considered to have paid the premium “in respect of the substitution” of the SAB for the SAD. In finding that this was not the case, the Directorate stated:
[S]ince the SAD Investors are a substantially different group of investors than the SBD Investors … it could not reasonably be considered that the SAD Investors were paid the Redemption Premium “in respect of the substitution of the [SAD]” since it was the SBD Investors, and not the SAD Investors, who provided a substitute debt for the SAD.
This upshot appears to be that the “substitution” exclusion in s. 18(9.1)(a) will not apply to an early redemption premium where the replacement debt is issued to a different group of investors.
Neal Armstrong. Summary of 29 May 2017 Internal T.I. 2017-0689161I7 under s. 18(9.1)(a).