News of Note

This morning, CRA released its official version of the questions and answers at the (regular) 7 October 2022 APFF Roundtable. (Its official version of the 7 October 2022 Financial Strategies and Instruments Roundtable has not yet been released by it.) We translated the full text of the preliminary answers, and summarized the questions posed, in October.

The table below provides links to our translations of the full text of both questions posed and answers given to the official version of the regular Roundtable, as well as links to our summaries. We did not notice any changes going from the preliminary to final version, other than that the following paragraph was deleted from the end of the answer to Q.11 (perhaps because, in context, it was gratuitous, rather than suggesting a repudiation of this position):

It should be noted that once the taxpayer has filed the taxpayer’s return for the year, an election as to the fiscal period end has been made. In this regard, we are of the view that an amended tax return with a different fiscal period end, filed before a notice of assessment is issued, constitutes a request for a change of fiscal period end that must be accepted by the Minister.

Neal Armstrong. 7 October 2022 APFF Roundtable.

proceeds and Part IV tax circularity issues

CRA provided standard rulings for a one-wing split-up butterfly respecting the “Transferor,” which computed the income from what likely was a farming business under s. 28(1) in which two brothers, A and B (survivors of their father, C), were both actively involved. They held the common shares, and the estate of C and their mother held preferred shares.

As provided for in the shareholders agreement, the transactions were to commence with the Transferor paying a capital dividend equal to the excess of the proceeds received by it on the policy on the life of C over the adjusted cost basis of the policy, with the Transferor then redeeming the preferred share held by the estate for its redemption value.

A will then transfer his common shares of the Transferor to a newly incorporated “Transferee” on a s. 85(1) rollover basis for shares of the Transferee. There then will be a pro rata spin-off of the two types of property of the Transferor (cash and near cash assets, and business property) on a net asset basis to the Transferee using the usual mechanics.

As might be expected, CRA implicitly regarded the cash distribution of the life insurance proceeds to the estate as being separate and apart from the pro rata distribution occurring on the butterfly. It provided its usual ruling that the strict requirements of s. 85(1)(e) could be ignored, so that there could be a pro rata division of the UCC of the depreciable property, rather than disproportionate UCC going to the transferee corporation.

In its closing comments, CRA indicated that the transactions may give rise to circular Part IV tax issues and that the Transferor and Transferee should consult their local TSO to determine which corporation should receive the dividend refund and which corporation would be subject to Part IV tax.

Neal Armstrong. Summary of 2021 Ruling 2020-0852541R3 F under s. 55(1) – distribution.

Observations on the revised draft EIFEL rules include:

• Under the excluded entity definition, the test of all or substantially all of the businesses, undertakings and activities of each eligible group entity in respect of the taxpayer being carried on in Canada throughout the entity’s taxation year appears to apply on an entity-by-entity basis, so that the failure of the test by even an insignificant group entity will cause the whole group to not qualify for the domestic exception.
• Also under the excluded interest definition, the test of the total fair market value of all property of a foreign affiliate of the taxpayer or of an eligible group entity in respect of the taxpayer not exceeding $5 million applies irrespective of whether the taxpayer has a 10% interest or 100% interest in the foreign affiliate – and even an insignificant interest in a special class of shares causing a non-resident corporation to be a foreign affiliate, would require the fair market value of its property to be considered in applying the $5 million threshold.
• The anti-avoidance rule in s. 18.2(9) would be engaged where a Canadian-resident subsidiary with a foreign business or holding of a significant foreign affiliate was sold by the taxpayer so that the excluded entity test could be met, whereas a direct sale by the subsidiary of its non-Canadian business or of its shares of the foreign affiliate would not engage s. 18.2(9).
• The inclusion under para. (g) of the interest and financing revenues definition of the relevant affiliate interest and financing revenues (“RAIFR”) of a controlled foreign affiliate of the taxpayer, is generally reduced by any deduction under s. 91(4) in respect of foreign accrual tax to the extent that it relates to the RAIFR, even where there is a deduction under s. 91(4) in a subsequent taxation year – so that taxpayers may be required to estimate their foreign accrual tax deductions that will be claimed in subsequent years.
• Any over-designation, including an immaterial one, will invalidate a transfer of excess capacity under s. 18.2(4). An amended transfer election may be filed, but only as provided in s. 18.2(4)(i).
• Under s. 18.21(2), if an election is made that allocates an amount greater than the specified limits, the allocated group ratio amount will be deemed to be nil – a potentially punitive result for what might be a small error.

Neal Armstrong. Summaries of Saira Bhojani and Eivan Sulaiman, “EIFEL Rules,” Draft 2022 CTF Annual Conference paper under s. 18.2(1) – excluded entity – (c)(i), (c)(ii), (c)(iii)(A). s. 18.2(9), s. 18.2(1) – interest and financing revenue – (g), excess capacity, s. 18.2(4), and s. 18.21(2).

Under the rule against accumulations in Ontario (and other provinces), any trust income after a specified period (“surplus income”) may not be accumulated in or added to the capital of the trust and must go to the person(s) who would have been entitled to it had the accumulation not been directed. A trust established for a dependent mentally-infirm child (the “Dependent Beneficiary”) in such a province could address the rule by directing the surplus income to be paid to a designated beneficiary (a “designated beneficiary clause”) or stipulate that the surplus income be paid to the person(s) entitled to receive that income (an “accumulation clause”). Such a clause would cause the trust not to meet the requirements under s. 60.011(1)(b) for being a lifetime benefit trust (“LBT”) if (as might normally the case, due to the mental infirmity of the Dependent Beneficiary) someone other than the Dependent Beneficiary was named in a designated beneficiary clause or the accumulation clause was drafted to have a similar effect.

Absent such a clause, the surplus income would become part of the residue of the estate and be distributed in accordance with the residuary clause, so that the recipient of the surplus income would receive it by operation of law. However, using this operation-of-law approach would not solve the desire to avoid having the surplus income distributed to the Dependent Beneficiary.

CRA did not suggest any solutions to this dilemma, and stated:

[T]he mere possibility that pursuant to the terms of the trust or will, or by operation of law, a person other than the Dependent Beneficiary can receive the surplus income will cause the trust not to comply with the conditions of subsection 60.011(1). Therefore, such a trust will not qualify as an LBT from the time that the trust is created.

Neal Armstrong. Summary of 14 October 2022 External T.I. 2021-0913801E5 under s. 60.011(1)(b).