News of Note
Income Tax Severed Letters 21 February 2024
Email this ContentThis morning's release of six severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA publishes a new Folio on inter-provincial corporate income allocation
CRA has released a new Folio on the corporate interprovincial income allocation rules in Part IV of the Regulations. Positions noted include:
- Gross revenue for Pt. IV purposes including the general allocation formula in Reg. 402(3) (generally giving equal weight to relative gross revenues and relative salaries and wages) does not include expenditure-related credits, such as expenditure reimbursements, volume rebates (“as these amounts would normally relate to expenditures incurred”) and governmental assistance respecting taxpayer expenditures.
- Reg. 402(5), which provides that, for Reg. 402(3) purposes, corporate gross revenue does not include interest on bonds, debentures or mortgages, dividends - or rentals or royalties from property that is not used in connection with the principal business operations – is broadly interpreted by CRA to also extend to interest on promissory and other notes, bankers’ acceptances, intercompany loans, certificates, guaranteed investment certificates, and any unsecured debt instruments.
- Regarding the allocation pursuant to Regs. 402(4)(j) and 402(5) of rents from land that is used in the corporation’s principal business operations, CRA considers that gross revenue from non-financial leases (generally, operating leases) should be allocated:
- to the permanent establishment in the province in which the leased property is being used, where the corporation has reasonable knowledge of such information (based on what it already was required to know for business reasons); or.
- if the corporation does not have reasonable knowledge of where the property is being used, or does not have a permanent establishment in the jurisdiction described in (a) above, the gross revenue should be allocated to the permanent establishment to which the person negotiating the lease may reasonably be regarded as being attached.
- Regarding the recharacterization under Reg. 402(7) of fees paid by a corporation to a services provider as salary where the services are in respect of services that would “normally” be performed by the corporation’s employees, CRA considers that these rules apply where:
- The service or function performed by the service provider must be one that is already performed by an employee of the corporation. Subsection 402(7) will not apply in situations where the corporation does not have any employees.
- The need for the individual service provider to perform a particular service or function is short-term.
- Each member of a partnership has a permanent establishment where the partnership has PEs, and the gross revenue and salaries and wages of the partnership for a taxation year are considered to be allocated under Reg. 402(6) based on the respective corporate partners’ shares of the partnership income for that year.
Neal Armstrong. Summaries of Income Tax Folio S4-F3-C2, Provincial Income Allocation, 30 January 2024 under Reg. 402(3), Reg. 402(5), Reg. 402(4)(g), Reg. 402(4)(j). Reg. 402(7), Reg. 402(8), Reg. 402.1(1) and Reg. 402(6).
We have translated 8 more CRA interpretations
We have translated 2 CRA interpetations released last week and a 6 further CRA interpretations released during April of 2002. Their descriptors and links appear below.
These are additions to our set of 2,756 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 21 3/4 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
Messrs. Jones and Love discuss numerous fund taxation issues including restrictions on pushing out capital gains, and the onerous investment fund and EIFEL rules
There is space in this post to mention only a few of the fund issues discussed.
S. 132(5.3)(b) produced an inappropriate result for exchange-traded funds (ETFs) where a market maker, in order to avoid the units trading at a significant discount to NAV, would purchase units on the exchange and redeem them, and also subscribe for units, so that effectively all the redemption proceeds were paid to a unitholder (the market maker) with full cost for its redeemed units, without account being taken of the gains of the unitholders selling their units to the market maker.
This led to s. 132(5.31). However, if a significant portion of an ETF’s capital gains related to satisfying units redemptions rather than being from ordinary course trading activities, and the amount paid to redeeming unitholders was small relative to the aggregate NAV of all ETF units, then the ETF would only be able to allocate a small portion of those capital gains to redeemed unitholders (and a July 29, 2020 IFIC submission suggested that the ETF should be allowed to allocate to redeemed unitholder a proportionate amount of the ETF’s unrealized gains at the beginning of the day on which the redemptions occurred).
A trust breaching any of the conditions in paras. (a) or (b) of the definition of investment fund, even momentarily, will permanently lose its investment fund status and thus lose protection from the occurrence of a loss restriction event.
In practice, it is possible for funds to violate the concentration test in (b)(vi)(D) of the investment fund definition by investing in a bottom fund that is a partnership, a Canadian resident trust that is not an investment fund, or a non-resident trust or corporation, given that the fund might have obtained exemptive relief in this regard from the application of NI 81-102.
The s. 18.2 limitations on deducting interest and financing expenses can be relevant to a fund, for example, if the bank-owned asset manager (by virtue of providing seed capital) or the bank-owned broker-dealer (by virtue of its market-maker function) owned more than 50% of the FMV of the fund units.
The adjusted taxable income (ATI) definition in relation to a trust requires adding back (under Variable B(g)) the s. 104(6) deductions of the trust except to the extent of any portion designated under s. 104(19) in respect of taxable dividends, and Variable C(h) deducts any s. 104(13) inclusion to the trust except to the extent of the portion designated under s. 104(19).
A trust with interest and financing expenses of $30 (e.g., loan interest) which invested in Canadian equities, received $100 of taxable dividends and distributed $70 to its unitholders which it designated under s. 104(19), would have an ATI of $30 (reflecting the add-back of the IFE, but with not the add-back of the $70 under B(g) because of the s. 104(19) designation) so that the trust could deduct no more than $9 of interest in the year, thereby requiring a further distribution of $21 of income.
A trust receiving all of its income (being $100 of ordinary income) from a trust investment would have an ATI of nil - since, although it would have an addback of its $30 of IFE under B(a) and of $70 under B(g) for its s. 104(6) deduction, the $100 of income received from the subtrust and included in its income under s. 104(13) would be deducted under C(h), so that the IFE could not be deducted.
Neal Armstrong. Summaries of Josh Jones and Jeffrey Love, "Recent Developments in Asset Management", draft 2023 CTF Annual Conference paper under s. 132(5.3)(a), s. 132(5.3)(b), s. 104(7.1), s. 132(4) – capital gains redemption, s. 132(5.31), s. 251.1(2)(b), s. 251.2(1) – investment fund, s. 18.2(1) – excluded entity – (c), eligible group entity, adjusted taxable income, and s. 94(1) - fixed interest.
CRA finds that a carpooling arrangement is inherently unreasonable under s. 6(1)(b)(x)
In order to encourage carpooling and have a positive effect on the environment, a company pays a car travel allowance as follows:
- Per kilometre rate: $0.50
- Additional allowance of $0.10 per kilometre for each additional person accompanying the driver.
In finding that the additional allowance rendered the total allowance as a taxable benefit, CRA stated:
[T]he two parts of the allowance constitute a single allowance since they relate to the same use of the vehicle. … [T]his allowance is deemed not to be reasonable under subparagraph 6(1)(b)(x) because the use of the vehicle is not determined solely on the basis of the number of kilometres driven to perform the duties of the employment.
Neal Armstrong. Summary of 29 November 2023 External T.I. 2019-0812661E5 F under s. 6(1)(b)(x).
CRA finds that interest but not penalties on municipal taxes incurred as a business expense are deductible
Regarding interest on municipal taxes, CRA stated:
[I]nterest charged on an unpaid balance of property taxes will be deductible if the property taxes themselves are deductible.
Regarding a tardiness penalty of 0.5% per month of the unpaid taxes added by a municipality pursuant to s. 250.1 of the Quebec Act respecting municipal taxation ("AMT"), CRA stated:
[S]ection 67.6 … prohibits the deduction in computing income of any penalty imposed under the laws of a country or a political subdivision thereof. A penalty imposed under section 250.1 of the AMT therefore comes within this provision and cannot be deducted in computing business income.
It did not discuss whether the “penalty” was in substance something else such as interest.
Neal Armstrong. Summaries of 26 June 2020 External T.I. 2017-0688121E5 F under s. 18(1)(a) – income-producing purpose, and s. 67.6.
CRA has released the final version of the 3 November 2023 APFF Financial Strategies and Instruments Roundtable
We have translated the complete 3 November 2023 APFF Financial Strategies and Instruments Roundtable. Q.2 was released in final form on January 24, and the balance of the Roundtable was released by CRA in final form today. It does not vary significantly from the preliminary version that was provided in November. For your convenience, the table below provides links to the questions, and to the summaries that we prepared in November.
McCartie – Tax Court of Canada follows the exclusion in prior criminal proceedings under s. 24(2) of the Charter of much of the evidence against the taxpayers
CRA assessed the taxpayers to deny most deductions claimed by them and to impose gross negligence penalties. In addition, the taxpayers were charged with tax evasion. The BC Provincial Court in the criminal proceedings found that (i) the failure of CRA investigators to make notes, and the negligent loss of detailed notes made by another auditor, denied them of the right to a fair trial contrary to s. 11 of the Charter, and (ii) the failure by the CRA investigators to produce a copy of search warrant when asked was a significant breach of s. 8 of the Charter. The BC Court imposed remedies under s. 24 of the Charter in respect of these breaches at several stages of the criminal proceedings and, in the end, stayed the criminal charges on the basis that it would not be possible for the couple to receive a fair trial. The CRA assessments were based principally on bank records which CRA had collected pursuant to its statutory powers in an audit (the “second audit”) conducted by civil auditors but which had been prompted by a suspicion that the taxpayers had engaged in tax fraud.
In this voir dire, Boyle J held that s. 24 of the Charter permitted him to impose remedies for Charter breaches determined by another court for which it had already imposed its own remedy. This extended to breaches of the taxpayer’s rights under ss. 7 and 11 of the Charter, even though they could only be breached in the context of criminal proceedings. Boyle J exercised his discretion under s. 24(2) to determine that the Crown could not, in the context of the Tax Court proceedings, introduce or rely on any evidence that was (i) first collected from the search and seizure at the taxpayer’s home to justify (a) the amount of tax owing, or (b) reassessments after the normal assessment period had expired, and (ii) collected from the second audit of the taxpayers, or first collected from the search and seizure at their home, to support the penalties assessed.
He stated that “this Court [should] clearly impose consequences in the form of section 24 remedies to avoid Canadians losing faith in their Canadian justice system’s commitment and obligation to ensure that our shared tax burden is both lawfully shared by taxpayers, and lawfully administered and collected by our revenue authorities… .”
Neal Armstrong. Summaries of McCartie v. The King, 2024 TCC 16 under Charter s. 24(2) and General Concepts – Onus.
Income Tax Severed Letters 14 February 2024
This morning's release of 11 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Total Energy – Tax Court of Canada finds that an acquisition of an insolvent public company with losses by a SIFT trust was an abuse of s. 111(5)
In September, 2007, most of the equity of an insolvent public corporation (“Biomerge”) was acquired by the company (“Nexia”) of two individuals involved in acquiring and selling loss companies, resulting in Nexia holding all of non-voting common shares of Biomerge (representing 80% of its equity) and 45% of its voting common shares. The individuals then identified an income fund (“Total”) which was becoming subject to tax under the “SIFT” rules. In May 2009, a plan of arrangement was implemented under which the Total units were exchanged for new common shares of Biomerge, the existing voting common shares of Biomerge were largely cashed-out, and Total was wound-up into Biomerge (now, “New Total”) pursuant to s. 88.1(2). The former Total unitholders held 99.8% of the New Total equity.
In following Deans Knight in finding that these transactions were an abuse of s. 111(5), Pizzitelli J stated:
[T]he reality of what happened here is that a willing seller in the business of selling tax attributes of failed companies takes the reins of such a company and markets and sells them to a willing unrelated buyer for use against their income. If these are not the type of transactions Parliament sought to stop by the enactment of the loss streaming rules in s.111(5) and parallel provisions, I don’t know what are.
In rejecting the New Total position based on there being no rules, similar to the corporate loss-streaming rules in s. 111(5), relating to the streaming of losses of trusts, he noted inter alia that the transaction entailed the acquisition of a corporate lossco that effectively was merged with the corporate operating subsidiary of Total and that the subsequent introduction of s. 256(7)(c.1) “serves to clarify the policy as well as provide automatic denial of such losses rather than resorting to the GAAR.”
Neal Armstrong. Summaries of Total Energy Services Inc. v. The King, 2024 TCC 12 under s. 245(4) and s. 248(10).