News of Note
Income Tax Severed Letters 12 September 2018
Email this ContentThis morning's release of six severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Joint Committee comments on the new trust-reporting rules, 2-tier partnership losses, cross-border surplus stripping and tracking interest rules
The Joint Committee has submitted that the exceptions in draft ss. 150(1.2)(a) to (n), for the required expansion of trust reporting, are too narrow. For example, there should be an exception for trusts whose principal purpose is to secure arm’s length sale-agreement covenants, and the apparent requirement for lawyers to file a tax return disclosing inter alia the client name and trust amount re a client-specific trust is contrary to s. 8 of the Charter (see Chambre des Notaires).
Under the revised at-risk amount rules for multi-tier partnerships, there will be no ability to carryover unutilized limited partnership losses. A loss of a lower-tier partnership that exceeds an upper-tier partnership’s amount at risk in that lower-tier partnership is denied forever. This seems harsh, and alternatives are suggested that would not be overly complex.
Proposed s. 212.1(6)(b), which applies a look-through rule for the purpose of having s. 212.1 apply on a disposition by a partnership or trust, is overly broad as it looks through corporations. For example, when the non-resident seller (NRco) sells its interest in a partnership owning USco which owns Canco representing only 20% of the fair market value of the USco shares, s. 212.1 would appear to apply to the “sale” of the underlying Canco shares.
Where foreign investment funds are structured as corporate umbrella funds (i.e., with each sub-fund of the corporation being a separate investment fund for commercial and regulatory purposes), it is quite possible that there would only be a few Canadian investors in a particular Canadian-dollar sub-fund (with the manager typically hedging the sub-fund’s non-Canadian assets back to the Canadian dollar), so that the Canadian investor’s shares may very well be tracking interests. Making the s. 95(12) election may not be an adequate solution as the sub-fund may still be a controlled foreign affiliate to the electing Canadian investor if the sub-fund hedges its non-Canadian dollar exposures back to the Canadian dollar, since the Canadian dollar class or series will be seen as a separate tracked interest from the other interests in the sub-fund. Accordingly, such electing Canadian investors, holding a relatively small number of shares of the sub-fund, but more than 10% of the shares of the Canadian dollar class or series of the sub-fund, may be caught by the tracking interest rules.
Neal Armstrong. Summaries of Joint Committee 10 September 2018 Submission on the July 27, 2018 Legislative Proposals Released July 27, 2018 under s. 150(1.2), s. 163(6), s. 96(2.1)(f), s. 212.1(6)(b) and s. 95(12).
The proper operation of the s. 94.2(3) rule to avoid double taxation from a non-resident commercial trust requires a purposive reading
Paragraph 94(2)(k.1) catches a situation where a non-resident contributes to a non-resident trust for the purpose of paying benefits to employees for services rendered to a Canadian corporation. For example, a non-resident member of a multinational group funds a non-Canadian trust in order for the trust to buy shares of the publicly-traded parent, with the trust then transferring those shares under a share award plan to group employees including potentially employees of a Canadian subsidiary. Thus, such a trust can be deemed to be resident in Canada notwithstanding the absence of a contribution by a Canadian resident.
An investment in foreign commercial trusts can be subject to imputed interest inclusions under s. 94.1 if “one of the main reasons” for the investment was a significant tax reduction (as described). However:
Many if not all of the foreign commercial trusts ... encountered in practice are ones that are managed by a foreign manager that does not offer a similar product in Canada, and indeed many of these trusts distribute all or substantially of all of their investment income currently. As a result, reduction of Part I tax will typically not be one of the main reasons for a Canadian taxpayer, or its controlled foreign affiliate, investing in such foreign commercial trusts.
If s. 94.2 applies to deem a resident beneficiary to earn foreign accrual property income from the non-resident commercial trust, the s. 94.2(3) rule is intended to apply to avoid double taxation by providing for a deduction in computing the trust’s FAPI allocable to the affected beneficiary equal to that portion of FAPI that is included in the beneficiary’s income under s. 104(13). However, it is necessary to read this rule in a purposive manner in order to make it work given that the operation of s. 104(13) dovetails with the s. 104(6) rule, which references an amount of income “that the trust claims” – whereas “it could be expected that such a trust will not file a Canadian tax return and will not be expressly claiming any deductions under the Act.”
Neal Armstrong. Summaries of Michael N. Kandev and Matias Milet, "Foreign Trusts", 2017 Annual CTF Conference draft paper under s. 94(2)(k.1), s. 94.1(1)(b) and s. 94.2(3).
5551928 Manitoba – B.C. Supreme Court rectifies the amount of an erroneously calculated capital dividend
A private company made the common mistake of declaring a capital dividend in an amount that assumed an addition to its capital dividend account for a disposition of eligible capital property, even though such addition would not occur until year end. Branch J found in light of the resolution’s wording (which referenced the intention to declare the dividend in the amount of the corporation’s CDA) and statements deposed as to the directors’ intentions that
there was a definite and ascertainable agreement between the directors to effectively “clean out” the petitioner’s capital dividend account.
As the Fairmont test for rectification thus was met, he granted an order to rectify the resolution to reduce the declared dividend by the erroneous amount.
Neal Armstrong. Summary of Re 5551928 Manitoba Ltd., 2018 BCSC 1482 under General Concepts – Rectification.
Six further full-text translations of CRA interpretations are available
The table below provides descriptors and links for six Interpretation released in March 2013, as fully translated by us.
These (and the other full-text translations covering all of the 645 French-language Interpretations released in the last 5 1/2 years by the Income Tax Rulings Directorate) are subject to the usual (3 working weeks per month) paywall.
| Bundle Date | Translated severed letter | Summaries under | Summary descriptor |
|---|---|---|---|
| 2013-03-20 | 5 December 2012 Internal T.I. 2012-0451331I7 F - Déductibilité de frais juridiques | Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(a) - Legal and other Professional Fees | legal expenses incurred to minimize responsibility under guarantee were not connected to operations which were necessary or incidental to the earning of income |
| Income Tax Act - Section 60 - Paragraph 60(o) | sales tax disputes not covered; expenses start running from audit review | ||
| 5 July 2012 Internal T.I. 2010-0388551I7 F - Fiducie - retour de sommes | Income Tax Act - 101-110 - Section 110.6 - Subsection 110.6(6) | Foisy test of mental element accepted | |
| Income Tax Act - Section 75 - Subsection 75(2) | s. 75(2) does not apply to an estate freeze as the corp does not own its treasury shares issued to the trust | ||
| Income Tax Act - 101-110 - Section 105 - Subsection 105(1) | income distributed to daughter-in-law who in fact was not a beneficiary includible in her income under s. 105(1) but not deductible by trust under s. 104(6) | ||
| Income Tax Act - 101-110 - Section 104 - Subsection 104(13) | capital gain distributed by family trust to children and purportedly lent by them to their parents (also beneficiaries) was instead included in the parents’ income under s. 104(13) | ||
| 31 January 2013 Internal T.I. 2012-0466641I7 F - Réduction du coût en capital d'un bien | Income Tax Act - Section 13 - Subsection 13(7.1) | reduction for Quebec M&P ITC occurs in year following incurring of the eligible expenses | |
| 25 September 2012 Internal T.I. 2011-0409281I7 F - Papier commercial - Obligations XXXXXXXXXX | Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(b) - Capital Loss v. Loss | compensating clients for half their loss was currently deducible, whereas purchasing securities at original cost was its cost | |
| Income Tax Act - Section 54 - Adjusted Cost Base | acquiring client securities at the clients' cost rather than their lower FMV was reflected in portfolio manager's cost | ||
| 2013-03-13 | 7 January 2013 External T.I. 2012-0460021E5 F - Remboursement de cotisations à un club | Income Tax Act - Section 6 - Subsection 6(1) - Paragraph 6(1)(a) | where “membership in a fitness centre allows the employee to meet … specific conditions [of employment,” the test of “more than 50% … to the employer's advantage” may be met |
| Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(l) | denial applies to fitness centre fees, irrespective of benefit to employer | ||
| 8 February 2013 External T.I. 2012-0464131E5 F - Transfert de propriété | Income Tax Act - Section 248 - Subsection 248(1) - Disposition | determination of disposition date is assisted by IT-170R |
Loblaw Financial – Tax Court of Canada finds that a Barbados bank subsidiary did not satisfy the FAPI-exclusion test of conducting an arm’s length business (there was no competitor), and narrowly construes the “series” concept
The taxpayer, an indirect wholly-owned subsidiary of Loblaws, wholly-owned a Barbados subsidiary (GBL), that was licensed in Barbados as an international bank and that used funds mostly derived from equity injections by the taxpayer to invest in U.S.-dollar short-term debt obligations, loans to several thousand independent U.S. distributors of Weston baked goods and intercorporate loans – and entered into cross-currency and interest rate swaps with an arm’s length bank to effectively convert much of its income stream into fixed rated Canadian-dollar interest. CRA assessed the taxpayer on the basis that GBL had realized $473 million of foreign accrual property income (FAPI) between 2001 and 2010.
C Miller J found that GBL met the requirement, in the exclusion from the investment business definition, of being a foreign bank given that it was licensed in Barbados as an international bank. GBL also satisfied the further test, for the exclusion to apply, that the business employ the equivalent of more than five full-time employees in its active conduct (given that some time spent by its employees in servicing related affiliates, as described in s. 95(2)(b)(i), was not sufficient to reduce the equivalent number to below this threshold). However, he nonetheless confirmed the assessments on the basis that such business was conducted principally with the Loblaw group (i.e, it was not conducted principally with arm’s length persons.) “In looking at both aspects of a foreign bank’s business [namely] the receipt of funds and use of funds, there should be emphasis on the receipt side as that is where one would expect to find the completion element.” GBL clearly flunked on the receipt side (its funds came from Loblaw - although no authority was cited for the proposition that equity funding was part of the conduct of a business) and, even on the fund use side, the purchases of the short-term debt were impressed with their character of researching the best return for a non-arm’s length party, the distributor loans “were effectively handed over to GBL by Loblaw,” the intercompany loans clearly were with non-arm’s length persons and “even the swap activity has a considerable element of conducting business with non-arm’s length person, as the swaps were subject to Loblaw derivative policies.”
In finding that GBL realized foreign exchange gains and losses under s. 95(2)(f) on its U.S.-dollar denominated short-term debt portfolio on income account, he stated:
The acquisition of the short term securities, taking their yield and funding a derivatives program to produce a greater yield is … using these short term securities in a manner akin to inventory in an income producing scheme.
Now, for some obiter. He found that CRA would have been statute-barred from applying the general anti-avoidance rule (GAAR) to the pre-2008 taxation years of the taxpayer and that, even for the 2008-2010 years, GAAR would not have been applicable had he concluded that the GBL income was not FAPI. He appeared to consider that CRA could only assess those open years if there was a relevant avoidance transaction that occurred in those (rather than the earlier statute-barred) years. The only mooted transaction in those years was the renewal of GBL’s international banking licence. Was this renewal part of a “series of transactions” that constituted an avoidance transaction? In this regard, C Miller J focused most on the hiring of three employees by GBL in 1994, which appeared to be motivated by the legislative adoption of the investment business definition containing the five full-time employees test, and stated that this was “a one-off transaction that has no bearing beyond the year in which it occurred.” Instead the relevant series was that of the taxpayer engaging in an offshore investment strategy “in a low tax jurisdiction with a recognized international financial infrastructure” with a view to avoiding FAPI, and the bona fide commercial purpose therein outweighed the FAPI-avoidance objective.
It thus would have been unnecessary to consider “misuse" or "abuse” under s. 245(4). However, he indicated (in what you might term 2nd-tier obiter) that there would have been such misuse:
The policy, or underlying rationale, of the exemption … is to promote competition of affiliates operating in international markets. …
[I]t follows that Loblaw Financial was misusing this exemption as it was not competing in any manner in any international market. It basically managed an investment portfolio for Loblaw.
Neal Armstrong. Summaries of Loblaw Financial Holdings Inc. v. The Queen, 2018 TCC 182 under s. 165(1.11), s. 95(1) – foreign bank, investment business, para. (a), para. (c), s. 9 – capital gain v. profit – foreign exchange, s. 152(4.01)(a)(ii), s. 245(3), s. 248(10), s. 245(4), s. 95(2)(l).
Catlos – Tax Court of Canada finds that a s. 8(1)(b) deduction was unavailable respecting a defence to shareholders’ claims of unjust enrichment including excessive salaries
Russell J was prepared to accept a dictum in Fenwick that the deduction under s. 8(1)(b) for establishing a right to receive remuneration extended to an employer seeking a return of remuneration paid, but found that s. 8(1)(b) did not extend to legal fees incurred in defending against claims made against individuals who were officers and shareholders of a private company for allegations of unjust enrichment and breach of fiduciary obligations to the other shareholders – notwithstanding that success of such claims likely would have required them to “disgorge” their allegedly excess remuneration.
Neal Armstrong. Summary of Catlos v. The Queen, 2018 TCC 177 under s. 8(1)(b).
CRA considers the Treasury Board per-kilometre travel rates to always be “fair and reasonable”
In connection with confirming that for medical expense tax credit purposes regarding medically-necessary travel, CRA uses the per-kilometre rates set by the National Joint Council (NJC) of the Public Service of Canada (which have been adopted by the Treasury Board), CRA stated:
The CRA has always accepted the NJC rates as fair and reasonable. The NJC determines the rates by analyzing new vehicle prices, depreciation and financing rates, current fuel prices, insurance premium rates, and operating costs in each province or territory.
Neal Armstrong. Summary of 12 July 2018 Ministerial Correspondence 2018-0761301M4 under s. 118.2(2)(h).
Finance issues comfort letter respecting provision of a deemed repayment rule for B2B loans under s. 90(7)
The upstream loan regime in s. 90 provides for income inclusions under s. 90(6) for certain loans and indebtedness owing to FAs, and offsetting deductions on repayment under s. 90(14). The rules contain back-to-back loan (B2B) provisions in s. 90(7). Finance was provided with an example where a B2B loan from an foreign affiliate of Canco to Forco 1 and by Forco 1 to Forco 2 (both specified debtors respecting Canco but not foreign affiliates) was repaid, and a fresh loan was made to a third specified debtor respecting Canco. The concern was expressed that the repayment of such B2B loan would not result in repayment of the deemed direct loan under s. 90(7) from Canco to Forco 2, so that Canco would face double income inclusions from the still-outstanding deemed loan and from the new actual loan.
As foreshadowed at the 2018 IFA Finance Roundtable, Q.10, Finance indicated that it was recommending to the Minister that there be new repayment rules (effective for repayments after April 10, 2018) similar to the ones in s. 15, so as to eliminate a second income inclusion under the (now deemed-repaid) B2B loan. In particular, what is recommended are:
rules - similar to the deemed repayment rules in subsections 15(2.18) and (2.19) (which apply for the purposes of the back-to-back shareholder loan rules in subsections 15(2.16) and (2.17), but with such modifications as are required by the context of the upstream loan rules - that would deem all or a portion of a loan that is deemed to be made under subsection 90(7) to be repaid for the purposes of paragraph 90(8)(a) and subsection 90(14) if certain conditions are met.
These conditions would be similar to those in subsection 15(2.18). In general terms, a loan deemed to have been made under subsection 90(7) would be deemed to be repaid, in whole or in part, as a result of certain repayments, in whole or in part, of one or both of the loans between the "initial lender" and the "intermediate lender", and the "intermediate lender" and the "intended borrower" (as those terms are defined in subsection 90(7)).
Neal Armstrong. Summary of May 1, 2018 Finance Comfort letter under s. 90(14).
CRA’s published position on the imposition of branch tax on U.S. LLCs with non-resident U.S.-citizen members may not reflect its assessing practice
In response to a recent post on the hybrid rules in the Canada-U.S. Treaty, a correspondent suggested that the reference made in the post to the published CRA position on the imposition of Canadian branch tax on U.S. LLCs with a Canadian business does not reflect CRA’s actual assessing practices. Art. X(6) provides:
“Nothing in this Treaty shall be construed as preventing [Canada] from imposing a tax on the earnings of a company attributable to permanent establishments in [Canada], in addition to the tax which would be chargeable on the earnings of a company which is a resident of [Canada], provided that any additional tax so imposed shall not exceed [5%]… .”
Because Article X(6) only refers to “companies”, CRA has stated that it does not operate to reduce the branch profit tax rate on income that is deemed to have been derived by non-corporate LLC members through the LLC.
The point made was that, contrary to this view, Art. X(6) is not a relieving provision, but is instead an exception to Art. XXV which, inter alia, prevents Canada from subjecting U.S. nationals (e.g., U.S. citizens or companies) to taxation in Canada that is more burdensome than that imposed on Canadian nationals – as signalled by the Art. X(6) preamble, which states that it applies notwithstanding anything else in the Convention (i.e., Art. XXV) (thereby permitting the 5% branch tax to be imposed on U.S. companies).
A December 2013 article on this point states:
[T]he alternative interpretation advocated in this article, to the effect that Article X(6) serves as an exemption to the non-discrimination provisions contained in Article XXV of the Treaty and only permits Canada to impose a 5% branch profits tax on corporations, is, we would submit, entirely consistent with both the text and the spirit of the Treaty.
We are aware of several instances recently (either at the audit or the objection stage) where the CRA has backed away from its published views on the branch profits tax provisions, and instead opted to apply the interpretations advocated herein.
Neal Armstrong. Summary of Carl Irvine and Todd Miller, "Canadian Branch Profits Tax - Challenging the Denial of Treaty-Benefits for US LLCs," Newsletter - TerraLex Connections, 26 December 2013 under Treaties – Income Tax Conventions – Art. 4.