News of Note

CRA confirms that there generally is no domestic secondary adjustment doctrine

The secondary adjustment doctrine in the transfer pricing area indicates, for example, that if it is found that Canco has been understating its income by undercharging for sales to its non-resident parent, then not only should there be a transfer-pricing adjustment to increase its income accordingly, but there also is a taxable benefit (subject to Part XIII tax) conferred on its parent if it does not promptly charge for the additional amount (see, e.g., TPM-02).

There is no comparable general doctrine lurking within the domestic attribution rules (e.g., s. 74.1 et seq.) or reallocation or imputed benefit rules (e.g., s. 103, 69 or 56(2)) so that, for example, if Partner B from a s. 103 perspective should rightfully have received 40% rather than 10% of the income of the partnership, there is no imputed obligation of Partner A to repay its excess draws to the partnership or Partner B.

Neal Armstrong. Summaries of 7 October 2016 APFF Roundtable, Q.19 under s. 103(1) and s. 74.1(1).

Income Tax Severed Letters 26 October 2016

This morning's release of eight severed letters from the Income Tax Rulings Directorate is now available for your viewing.

CRA accepts Poulin distinction between accommodation parties and tax advantaged arm’s length dealings

In the Poulin decision, D’Auray found that s. 84.1 applied to the sale by an individual of his shares of a CCPC to the holding company of an unrelated employee (“Hélie Holdco”), given that Hélie Holdco was essentially just acting as an accommodation party (i.e., the sale was not an arm’s length transaction)– but also found that s. 84.1 did not apply to a purchase of shares in the same CCPC under a similarly structured transaction from the other major shareholder, as they each were advancing their own interests (arranging an exit on advantageous terms, and acquiring control of the CCPC, respectively) – so that it was an arm’s length transaction.

CRA accepts both aspects of the decision. It accepts the finding in Poulin that the structuring of a sale transaction so that the vendor secured a tax advantage (the capital gains deduction) “does not mean that the parties acted in concert without separate interests.” Respecting the accommodation party aspect, it stated:

Hélie Holdco… incurred no economic risk in participating in the transaction, did not derive any benefit from the purchase of shares, had no interest other than to allow the employee/shareholder to realize a capital gain and benefit from the deduction, and had no function independent of the employee/shareholder or the operating corporation - and, in short, it only participated in the transaction as an accommodation for the benefit of the employee/shareholder.

Neal Armstrong. Summary of 7 October APFF Roundtable, Q. 20 under s. 251(1)(c).

CRA considers that s. 7 can govern bonuses paid in shares where discretion ceases prior to the issuance

A magnanimous reader provided copies of CRA’s written answers to the 2016 APFF Roundtable questions. We will be uploading translations thereof (together with brief summaries of the questions) over the next week. We are starting with Q.21 and working our way backwards.

CRA considers that where a Canadian-controlled private corporation has agreed in writing “to award a bonus based on the employee reaching certain measurable performance objectives and the employer agrees to pay this bonus in shares” equal in value to the bonus amount, then the value of the shares generally will not be included in the employee’s income when issued by virtue of ss. 7(3)(a) and 7(1.1). In addition, although an arrangement in which the employer has full discretion as to whether to award the bonus or as to the mode of payment will not come within the s. 7 rules, such a discretionary arrangement could become a qualifying one if, for example, “after the first year, the employer exercises its discretion and sets the amount of the bonus at [say] 75 shares, which is payable in shares at the end of the year if the employee is still employed by the employer.” The right of the employee to elect to be paid in cash does not detract from this analysis if that right is not exercised.

The paid-up capital of the shares issued generally could be equal to their value.

Neal Armstrong. Summaries of 7 October APFF Roundtable, Q. 21 under s. 7(3)(a) and s. 84(1)(b).

Yamana Gold is proposing a taxable dividend of options to acquire shares of a Yamana gold subsidiary

Yamana Gold is proposing to distribute a part interest in a gold-mining subsidiary (Brio Gold) to its shareholders through a dividend-in-kind of rights to purchase common shares of Brio Gold from Yamana for a specified per-share price. These purchase rights will trade on the TSX. Yamana will be providing its shareholders with its estimate of the value of this dividend.

Neal Armstrong. Summary of Brio Gold preliminary prospectus under Public Transactions - Spin-offs and Distributions - Taxable rights offerings.

To date, only brief notes of CRA remarks at the 2016 APFF Roundtable are available

We have summarized questions posed at the October 7, 2016 APFF Roundtable for which we have brief written notes of the oral response, together with a summary of those notes. Points covered include:

  • Q.1B: After studying the issue, CRA has determined that it will not be providing relief from the requirement to issue T4As for fees paid for services.
  • Q.1C: Where there is an acquisition of control of a corporation with a calendar year end, thereby resulting in two taxation years ending in that year, CRA will permit the filing of a T106 to cover both taxation years.
  • Q.3: Where a purchaser defaults on its purchase of a rental property, CRA considers that the damages paid by the purchaser to the vendor cannot be recognized as a capital loss given that there has been no disposition of property by it.
  • Q.4: A right which otherwise might be taxable under the salary deferral arrangement rules is excluded from the SDA definition if it is a right to a bonus for services rendered in Year 1 which is paid within three years following the end of Year 1 (i.e., by the end of Year 4). CRA will not extend this deadline by a few months to permit performance-based criteria for Year 4 (which affect the amount of the ultimate payout) to be measured based on year-end results for Year 4.
  • Q.7: Ss. 256(1.4) and 251(5)(b) reference a right (including a contingent right) to shares and a right to cause a corporation to redeem shares. There is not considered to be such a right where the shareholders’ agreement for a corporation carrying on a franchised operation (“Franchisee”) specifies that in the event that the individual manager of Franchisee (who holds 50% of Franchisee’s commons shares) departs, the other 50% common shareholder (the Franchisor) has the mandate to find a third party to purchase the manager’s shares – or that, in such event, the manager’s shares are to be automatically redeemed by Franchisee.
  • Q.20: CRA accepts the finding in Poulin that the structuring of a sale transaction so that the vendor secured a tax advantage (the capital gains deduction) “does not mean that the parties acted in concert without separate interests.” However, if the only reason for the existence of a Buyco is a tax benefit to the vendor, then there is an accommodation, so that the transaction is not an arm’s length one.
  • Q.21: Where a Canadian-controlled private corporation has agreed in writing to pay specified bonuses in its shares, the value of the shares will not be included in the employee’s income when issued, and their paid-up capital can be equal to that value.

Neal Armstrong. Summary of 7 October 2016 APFF Roundtable.

CRA applies its view that a contribution of FA1 shares to FA2 causes the FA2 shares to be substituted property for s. 93(2.01) purposes

The stop-loss rule in s. 93(2.01) applies to grind the capital loss realized on the disposition of a share of a foreign affiliate by the amount of exempt dividends previously received on that share “or on a share for which [it] was substituted.”

The 2016 IFA Roundtable dealt with a contribution Canco made to a foreign subsidiary (FA2) of its shares of a non-resident Finco subsidiary (FA1 – which previously had paid exempt dividends to Canco). CRA found that s. 93(2.01) denied a subsequent capital loss realized on an arm’s length sale of the FA2 shares to the extent of such dividends, on the grounds that the shares of FA2 were substituted shares for those of FA1. This was so even though the contribution did not entail any exchange of property and even though the FA1 shares likely would never have generated an accrued loss (given that its asset was an interaffilate loan).

This answer was a foreshadowing of an internal technical interpretation (i.e., dealing with an actual audit situation involving Luxcos) which CRA issued on June 22.

Neal Armstrong. Summary of 22 June 2016 Internal T.I. 2016-0632821I7 Tr under s. 93(2.01).

CRA finds that a “legal representative” of a taxpayer has potential personal liability for the maximum value of the property under its control from the moment that the taxpayer’s tax debt was assessed

A trust, whose sole individual beneficiary has an unpaid tax liability for 2014 of $150,000 (which was assessed on April 30, 2015), holds a portfolio with a fair market value of $125,000 on December 31, 2014 and (due solely to market declines) of $100,000 on April 30, 2015 and of $70,000 on January 1, 2016, being the date when the sole trustee (viewed for s. 159 purposes as the beneficiary’s ”legal representative”) receives a demand for payment.

CRA appears to consider that the trustee can be assessed for $30,000 under s. 159(3), being the deficiency between the $70,000 that was used (following the sale of all the trust property) to satisfy the payment demand, and the maximum value of the property under the control of the trustee after “the taxpayer’s liability arose on April 30, 2015.” This position is unfavourable in that it treats a legal representative as being personally liable for failing to immediately liquidate a portfolio (which is subject to market fluctuations) in respect of tax debts of which it may have no knowledge even though doing so may breach fiduciary or other obligations, and favourable in that it treats a tax liability as not arising for s. 159 purposes until it is assessed. If you are a legal representative, be careful about holding anything other than cash!

Neal Armstrong. Summary of 14 September 2016 External T.I. 2016-0638171E5 under s. 159(3).

CRA indicates that a general power to encroach on capital is not sufficient to make a deemed gain payable to a trust beneficiary

CRA indicated (similarly to the 2016 STEP Roundtable ) that in order for a deemed gain (e.g., under s. 48.1) to be made payable for purposes of s. 104(24):

  • the terms of the trust must specifically permit an amount equivalent to the deemed capital gain to be paid or payable, or
  • the trustee must have the discretionary power to pay out amounts that are defined as income under the Act.

CRA provided an expanded rationale for this position in the following terms:

Under trust law, capital gains would typically be considered to be part of the capital of a trust; however, a deemed capital gain created under a provision of the Act is a “nothing” for trust purposes. It is not possible to define a deemed capital gain to be income (or a capital gain) for trust purposes. A power to encroach on capital is not in and of itself sufficient to make a deemed capital gain payable.

Neal Armstrong. Summary of 8 June 2016 External T.I. 2015-0604971E5 under s. 104(24).

Herman Grad 2000 Family Trust – Ontario Superior Court of Justice finds that trusts, whose Alberta-lawyer trustees did not make substantial decisions, were resident in Ontario

In finding that a family trust and a spousal trust, that had two Alberta lawyers as their trustees, were resident in Ontario, Wilton-Siegel J noted that, in the context of an investment trust, “the principal decisions taken by trustees pertain to the investment of the assets of the trust and distributions to beneficiaries,” and noted the principle that “management and control of a trust may rest with a trustee who has little investment experience provided that the trustee has the power to retain others for advice and remains the ultimate decision-maker.” He found here that the ultimate decision maker instead was the family patriarch along with the CFO of the family companies, in the absence of evidence that there was any real decision-making by the trustees in relation to the core investing function or with respect to all but perhaps one of the trust distributions.

Neal Armstrong. Summary of Herman Grad 2000 Family Trust v. Minister of Revenue, 2016 ONSC 2402 under s. 2(1).

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