News of Note

An individual holds the common shares of Holdco having an FMV of $1 million, and Holdco’s only asset is the common shares of Opco, also with an FMV of $1 million. $700,000 of Opco’s assets are used principally in its active business carried on primarily in Canada and $300,000 are excess cash. Stopping there, the para. (d) tainting rule in the qualified small business corporation share (QSBCS) definition would not be engaged because 100% of Holdco’s assets were qualified assets, being shares of Opco which satisfied the 24-month 50% asset test in para. (c).

Suppose, however, that, under a “purification” transaction, Opco pays a cash dividend of $150,000 to Holdco, which immediately pays a dividend in the same amount to the individual. At the instant in time in which Holdco held such cash, more than 10% of its assets would not be the qualifying assets listed in para. (d), which would apparently mean that Opco at the relevant times would now be required to satisfy a "substantially all" rather than 50% asset test, which perhaps would not be met because its excess cash assets were $150,000/$850,000, or 18%.

If such holding of the $150,000 in cash by Holdco for an instant in time would “contaminate” it under para. (d), would this problem be solved if instead Holdco declared and paid a $150,000 dividend, payable to its shareholder by a note, and then Opco declared a dividend payable through discharging the note?

CRA indicated that Holdco would be tainted if it did not satisfy the “all or substantially all” test in para. (d) “even for a short period” – but “recognize[d] that the ‘all or substantially all’ test could be met even if the 90% threshold is not satisfied, depending on the circumstances and context.” In indicating that, if the “all or substantially all” test was violated for a short period by the above transaction, the problem would not be solved through the payment-in-kind proposal, CRA stated:

Holdco has an interest in the dividend declared by Opco and … the interest in such a dividend is an "asset" for the purposes of the definition of QSBCS, regardless of whether it is recorded on the corporation's balance sheet. In particular, Holdco benefits from the dividend declared by Opco even if the amount of the dividend does not pass through Holdco because it allows Holdco to have its liabilities reduced following the payment made by Opco.

Neal Armstrong. Summary of 2 November 2023 APFF Roundtable, Q.3 under s. 110.6(1) – qualified small business corporation share – (d).

A corporation resident in Canada ("Parent") owning 100% of "Target" accepts an offer from an unrelated third party ("Purchaser") to purchase all of the Target shares for $3 million, with the sale agreement specifying that assets which Purchaser does not wish to acquire ("Excluded Assets") are assigned a value of zero. The ACB of the Target shares is $3 million and the safe income attributable to them is nil.

Immediately prior to its sale to Purchaser, Target pays a dividend in kind of $250,000 (the "Dividend") to Parent by transferring an Excluded Asset to Parent.

CRA rejected a suggestion that since, whether or not the Dividend was paid, the value of the Target shares would be $3 million, and the capital gain would be nil, s. 55 could not apply, stating:

[I]t seems difficult to argue that none of the purposes of the payment or receipt of the Dividend is to significantly decrease the FMV of the shares of the capital stock of Target.

Consequently, subsection 55(2) should likely apply … .

Neal Armstrong. Summary of 2 November 2023 APFF Roundtable, Q.2 under s. 55(2.1)(b).

CRA has revised and expanded its webpage on the mandatory disclosure rules.

It has added a statement that:

Standard commercial indemnities provisions in standard client agreements or documentation, which do not contemplate a specific identified tax benefit or tax treatment would not, in and of themselves, result in a reporting obligation.

It has expanded its examples of acceptable contractual clauses, including expanding its example of public company bump covenants to those given respecting private-company bumps, and also added the following examples:

• “Indemnities or covenants to a purchaser and/or target in respect of Part III tax liabilities and other adverse tax consequences arising from dividends paid as part of a pre-closing reorganization.”
• “Standard contractual representations and indemnities with respect to the failure to deduct or withhold an amount under section 215, in an arm's length situation … “
• A standard clause in a partnership agreement providing for reasonable assistance to a partner to help resolve an audit.
• On an s. 132.2 merger, the fund manager indemnifying the trustee of the terminating fund for any liabilities that might arise in respect of the terminating fund (commercial disputes, securities law claims, etc.).

CRA states:

The contractual protection hallmark will not apply in a normal commercial or investment context in which parties deal with each other at arm's length and act prudently, knowledgeably and willingly, and does not extend contractual protection for a tax treatment in respect of an avoidance transaction.

Examples provided include tax indemnities in standard provisions such as gross-up clauses in loan or ISDA agreements, or in employment or severance agreements.

CRA has added a detailed footnote on transitional issues, stating, for instance:

If a person enters into a series of transactions that straddle the effective date of designation, the reporting requirement will be triggered with the first transaction entered into after the effective date of designation that is part of a series of transactions that is the same as, or substantially similar to one that is designated at that time by the Minister.

Neal Armstrong. Summaries of Mandatory disclosure rules – Guidance, 2 November 2023 CRA Webpage under s. 237.3(1) – reportable transaction – (a), confidential protection, contractual protection, s. 237.3(2), s. 237.4(6), s. 237.4(7), s. 237.5(1) - relevant financial statements, reportable uncertain tax treatment.

CRA has published its list of notifiable transactions pursuant to s. 237.4(3). The wording of the list is identical to the consultation draft published by Finance on February 4, 2023, except that the transactions regarding manipulation of CCPC status have been dropped. In summarized form, the list now consists of:

• A taxpayer buys an interest in a partnership which, immediately prior thereto, had realized the gain legs on straddle transactions in FX forward contracts (with such gain allocated to the selling partner) – and with the loss legs then being realized and allocated to the taxpayer.
• A trust (“Old Trust”) that is approaching its 21st anniversary transfers its property under s. 107(2) to a resident corporate beneficiary (“Holdco”) which is held by “New Trust” - or that is held by non-resident beneficiaries of Old Trust, where the distributed property is not described in any of ss. 128.1(4)(b)(i) to (iii).
• Alternatively, Old Trust and Holdco hold shares of Opco, with Holdco in turn held by New Trust, and Opco redeems its shares held by Old Trusts for a note, with Old Trust allocating the resulting s. 84(3) dividend to Holdco on an s. 112(1)-exempt basis.
• A debtor is assigned into bankruptcy, its debt is settled with no “forgiven amount” arising due to the exception in (i) of the definition, and the debtor then files a proposal resulting in the bankruptcy being annulled.
• One of the following transactions is engaged in, and the taxpayer takes the position that the “attribute trading” rules in s. 256.1 do not apply because the “one of the main reasons” or “one of the reasons” tests in ss. 256.1(2), (4) or (6), respectively, is not satisfied:

1. Aco acquires shares of Lossco so as to exceed the 75% of FMV threshold but without an acquisition of control;
2. Profitco and a person not dealing at arm’s length with it (Aco) acquire shares of Lossco such that Profitco (which does not control Lossco) would satisfy the 75% of FMV threshold if the acquisition of Lossco shares by Aco was ignored; and
3. Lossco acquires Profitco.

• A relevant non-resident in respect of a taxpayer (NR1) enters into an arrangement with an arm’s length non-resident (NR2) to indirectly provide financing to the taxpayer, with the taxpayer filing on the basis that the thin capitalization rules do not apply to it or that the interest paid by it directly to NR1 is not subject to Part XIII tax (or subject to a reduced withholding tax rate).
• Alternatively, similar arrangements are entered into in respect of rents, royalties or other payments of a similar nature, or to effect a substitution of the character of the payments.

Neal Armstrong. Summary of 1 November 2023 CRA Webpage, "Notifiable transactions designated by the Minister of National Revenue" under s. 237.4(3).