News of Note
Kone Inc. – Quebec Court of Appeal confirms that a cross-border repo was not an abuse of the s. 17 rule
Email this ContentThe taxpayer (“KQI”), a Canadian operating subsidiary in the Kone multinational group, used group funds advanced to it by a group company (Kone Canada), in part as an interest-bearing loan, to purchase, for a cash purchase price of $394 million, cumulative preferred shares of a US affiliate (Kone USA) from the non-resident affiliated company (Kone BV) to which such shares had recently been issued as a stock dividend. At the same time, KQI agreed to resell such preferred shares at pre-agreed higher prices, to Kone BV in three and five years’ time, which in fact occurred. The gain arising under this resale was deemed under s. 93 to be dividends coming out of exempt surplus of Kone USA.
The ARQ sought to impute interest income to KQI under TA s. 127.6, the Quebec equivalent of ITA s. 17(1), on the basis that the above “repo” transaction was a sham that should instead be characterized as an interest-free loan by KQI to Kone BV or, alternatively, that the repo transaction represented an abusive avoidance of such s. 17 equivalent for Quebec GAAR purposes.
After rejecting the sham argument, the Court also rejected the application of the Quebec GAAR, stating:
One cannot ignore the fact that financing transactions that are not loans will not generate interest but may provide for other forms of return. … A repo with a reasonable return in the form of dividends does not defeat the OSP [object, spirit and purpose] of Section 127.6.
… KQI is taking advantage of … a mismatch between the tax treatment of its income (the dividends from Kone US are not taxable because they are paid out of its exempt surplus) and its expense (the interest in pays to Kone Canada is deductible). …
However, the mismatch arises from the Taxation Act and the policies underlying it … . The exempt surplus in Kone US is made up of its earnings from an active business on which it has already paid income taxes.
Neal Armstrong. Summaries of ARQ v. Kone Inc., 2024 QCCA 678 under s. 245(4) and General Concepts - Sham.
We have translated 8 more CRA interpretations
We have translated 2 interpretations released by CRA last week and a further 6 CRA interpretations released in November of 2001. Their descriptors and links appear below.
These are additions to our set of 2,852 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 22 2/3 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
CRA rules on absorptive foreign mergers
After giving effect to some preliminary transactions, a U.S. corporation which was a qualifying person for purposes of the Canada-US Treaty (the “Treaty”) wholly-owned four stacked corporations in Country 1. The “bottom” Country 1 corporation, in turn, wholly-owned a resident of Canada (Canco). The shares of Canco and of the above Country 1 corporations were taxable Canadian property (TCP).
The proposed transactions include:
- The US corporation will contribute its shares of a Country 1 corporation to a newly-formed wholly-owned US corporation (Taxpayer 6), which is a qualifying person.
- Three downstream absorptive mergers of Country 1 corporations will occur.
- In addition, there will be an upstream merger of a Country 1 corporation which is a subsidiary of one of the above Country 1 corporations but whose shares are not TCP (because it is not “above” the Canco) into its Country 1 parent as the survivor.
Where there is a downstream absorptive merger under the Country 1 corporate law of a parent into its wholly-owned subsidiary: the subsidiary as the surviving entity does not dispose of its assets or liabilities (other than amounts owing between it and the parent); all of the assets and liabilities of the parent (other than such intercompany amounts and the shares of the subsidiary) are transferred to the subsidiary; the shares in both parent and subsidiary are cancelled; and the subsidiary allocates new shares to the current shareholder(s) of the parent.
An upstream absorptive merger is similar (in reverse) except that the shares of the subsidiary are cancelled and the current shareholder(s) of the parent continue to hold their shares of the parent.
CRA ruled that the disposition in 1 above will be exempted under Art. XIII(4) of the Treaty (presumably, because the transferred TCP was not shares of a company resident in Canada).
CRA gave rulings based on the mergers qualifying as absorptive mergers under s. 87(8.2) (so that the s. 87(4) rollover, and the para. (n) of “disposition” exclusion, applied). For instance, on each downstream merger, the shareholder of the parent will dispose of its shares of the parent for their ACB and will have an ACB for its shares of the surviving subsidiary for the same amount, and the parent will be deemed by para. (n) not to have disposed of its shares of the subsidiary.
Neal Armstrong. Summaries of 2023 Ruling 2022-0958521R3 under s. 87(8.2) and Treaties – Income Tax Conventions – Art. 13.
CRA indicates that its practice is to not apply s. 18(9) where the adjustments would be minimal
CRA indicated that an expenditure incurred for the anti-theft marking of an automobile used in carrying on a business (entailing engraving a code on the principal parts of the automobile), likely would be incurred on current account assuming that the only benefit resulting from the expenditure related to insurance premiums, and it did not improve the automobile (for example, in improving its performance or lifespan. Although, s. 18(9) might be applicable, “the current practice is to disregard adjustments for minimal amounts.”
Neal Armstrong. Summaries of 14 March 2024 External T.I. 2015-0596761E5 F under s. 18(1)(b) – capital expenditure v. expense – improvements v. running expense, s. 18(9) and s. 6(1)(k) – A(iv).
CRA indicates that the salary of a status Indian from his corporation may be exempted based on the relative sourcing of its income on and off reserve
A physician and status Indian who lives off the reserve and is the sole shareholder of a corporation that is managed from an office on the reserve spends 70% of his time as employee on the reserve (mostly on patient care) and 30% off the reserve performing hospital duties. CRA indicated that although this was a question of fact, it might be considered that since 70% of the corporation's business income was located on a reserve, 70% of the physician’s salary from his corporation should be exempted.
Neal Armstrong. Summary of 4 April 2024 External T.I. 2023-0996201E5 F under Indian Act - s. 87.
CRA indicates that income from solar array panel might not be income from property, so that there was no specified investment business
The sole business activity of a Canadian-controlled private corporation was to build a small utility-scale solar array on bare land and sell the electricity that was generated to a local utility service under the terms of a long-term contract. It hired approximately 5 part-time employees to run the solar panel electricity generating business. In suggesting that the revenues generated from the corporation’s business might not be from property, so that it very well might not have a specified investment business notwithstanding having fewer than six full-time employees, CRA stated:
[I]ncome from property would generally mean the production of revenue from the use of such property that generates income without active and extensive business-like intervention. …[I]ncome from a business requires organization, systematic effort, and a certain degree of activity.
If the course of conduct of the Corporation indicates that the income is produced with active and extensive business-like intervention, and the nature or legal character of the business transactions supports that, then the Corporation could be considered to derive income from a business rather than income from property.
Neal Armstrong. Summary of 5 March 2024 External T.I. 2023-0962831E5 under s. 125(7) - specified investment business.
CRA finds that Gabon and Ivory Coast sociétés en commandite simple were partnerships notwithstanding separate legal personality
Before finding that two “sociétés en commandite simple” (the SCSs) formed in the Ivory Coast and Gabon were partnerships for ITA purposes, CRA indicated:
- Given that the Ivory Coast and Gabon are civil law systems, it was appropriate to primarily compare the SCSs to Quebec partnerships.
- A comparison of the provisions of the Quebec Civil Code and the Uniform Act governing the SCSs showed substantial similarities, except that Québec partnerships are not legal persons whereas SCSs have legal personality.
- Nonetheless, a Quebec general or limited partnership has many of the characteristics typically associated with legal personality such as being able or subject to suing or being sued in its own name, and having a separate patrimony – and CRA has “previously stated that the existence of a separate legal personality alone is generally not sufficient to distinguish certain foreign partnerships from Canadian partnerships.”
- “[T]he unlimited liability of the general partners of an SCS is an important trait that favours partnership status under the Act since the sharing of responsibility for partnership debts is a primary trait of partnerships in Canada while the limited liability of shareholders is generally a primary trait of corporations in Canada.”
Neal Armstrong. Summary of 22 December 2022 Internal T.I. 2021-0892121I7 under s. 96.
Fiducie Historia – Tax Court of Canada finds that trust distributions were lawful and deductible even though on paper the trustees had improperly delegated their powers
A discretionary family trust, whose beneficiaries included the family patriarch (LR) and his two sons (the Rémillard Brothers), was a shareholder of a family corporation (Maybach) along with LR and the Rémillard Brothers. The proceeds of an asset sale were used by Maybach to redeem the shares held by LR and the Rémillard Brothers. However, since the trustees of the trust would thereafter all be unrelated individuals, this would have caused an acquisition of control of Maybach-group companies and an extinguishing of losses. To avoid this result, the trustees entered into an agreement with the Rémillard Brothers, in intended reliance on s. 256(7)(a)(ii), providing:
The Trustees hereby undertake to exercise their powers … according to the directives provided by the Brothers and to make no decision regarding the Historia Trust without first obtaining the agreement of the Rémillard Brothers. …
If the Trustees or any of them disagree with the directives received from the Rémillard Brothers, they must then resign … .
The trust then paid distributions of over $50 million to LR that were authorized by the Rémillard Brothers.
Article 1275 of the Civil Code of Quebec (the CCQ) provided:
The … beneficiary may be a trustee but he shall act jointly with a trustee who is neither the settlor nor a beneficiary.
CRA considered that the above agreement had the effect of constituting the Rémillard Brothers as de facto trustees of the trust, contrary to the trust deed and Art. 1275, so that the determinations to make the distributions pursuant to such unlawful agreement were a nullity, with the result that the distribution amounts were not “payable” as required by s. 104(6).
Smith J rejected the trust’s argument that the distributions should be considered to have “became payable” for purposes of s. 104(6) solely because they were paid to the beneficiary and irrespective of whether they were unlawful.
However, he went on to find (at paras. 83, 104), in light of the testimony, that the independent trustees, although consulting with the Rémillard Brothers, had in fact been making the trust decisions:
Even if clauses 2.1 and 2.2 of the Agreement were contrary to the trust deed and Article 1275 of the CCQ … the Court concludes based on the preponderance of the evidence submitted that the Rémillard brothers did not act as trustees or “de facto trustees.” …
[D]espite the Agreement, the Rémillard brothers did not, in fact, usurp the trustees' powers.
Accordingly, the distributions were not unlawful, and had been payable.
Neal Armstrong. Summaries of Fiducie Historia v. The King, 2024 CCI 76 under s. 104(6)(b) and General Concepts – Illegality.
Income Tax Severed Letters 29 May 2024
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA indicates that a Canadian resident may access the Art. XVIII Treaty exemption re his 401(k) plan by renouncing his US citizenship then collapsing his plan
Shortly after renouncing his U.S. citizenship, a Canadian resident fully collapsed his IRA and 401(k) plan, so that all funds were distributed to him.
Under the U.S. tax rules, by virtue of the expatriation, he was treated as having received a distribution of his entire interest in the IRA, and of the present value of his 401(k) plan, the day before the expatriation date, resulting in an income inclusion for such purposes. The subsequent collapse of the plans did not result in an income inclusion for such purposes to the extent the amounts had been subject to tax on expatriation.
CRA indicated that the deemed distribution for U.S. purposes of his entire interest in the IRA upon expatriation resulted in a corresponding deemed receipt in his income under s. 56(12) and that, by virtue of the exclusion to this effect in s. 56(1)(a)(i)(C.1), on the subsequent actual distribution there was no inclusion under s. 56(1)(a)(i) to the extent that the amount was not taxed in the U.S.
There was no ITA income inclusion upon expatriation regarding the 401(k) plan which (unlike the IRA) was not a “foreign retirement arrangement,” but there was an income inclusion pursuant to s. 56(1)(a)(i) in respect of a “superannuation or pension benefit” on the distribution. However, to the extent that the distribution would have been excluded from taxable income in the U.S. were he a resident thereof, Art. XVIII(1) of the Canada-US Treaty would provide relief from tax for the same amount in Canada.
Neal Armstrong. Summary of 6 December 2023 External T.I. 2017-0735631E5 under s. 56(1)(a)(i).