News of Note
Income Tax Severed Letters 26 February 2020
Email this ContentThis morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA rules on a self-cancelling circular transaction to convert net capital losses into stepped-up UCC
Aco, and its subsidiary Bco, have available capital losses that they wish to use in stepping up the undepreciated capital cost of trademarks (Class 14.1 properties, presumably having a nominal or modest capital cost) which Bco uses in the course of carrying on its business. In broad terms, this is accomplished by Bco using up its losses in spinning the trademarks off to Aco on a partial rollover basis, and by Aco dropping the trademarks down to Bco to also use up its losses. More specifically:
- Aco establishes a new sister to Bco (Newco) to which Aco does an s. 85(1) drop-down of preferred shares of Bco having a fair market value equaling that of the trademarks;
- Bco spins-off the trademarks to Newco on a partial rollover basis in consideration for prefs of Newco, thereby using Bco’s net capital losses to effect a ½ step-up of the UCC of the trademarks under s. 13(7)(e)(ii) – and with Newco licensing the trademarks back to Bco for royalties;
- The prefs in 1 and 2 above are cross-redeemed (with reliance on the s. 55(3)(a) exception to s. 55(2));
- Newco is wound-up under s. 88(1);
- Aco does an s. 85(1) drop-down of the trademarks back to Bco, but choosing an elected amount so as to uses up its net capital losses and to effect a further ½ step-up of the trademarks' UCC under s. 13(7)(e)(ii).
The CRA summary of this transaction emphasizes that Reg. 1102(14) deems the trademarks to have the same (Class 14.1) class to Newco, Aco and Bco in succession. It is unclear whether this reflects someone’s sensitivity to a Mara Properties issue (property retaining its character as it is bounced around in the group) or a Hickman Motors/Reg 1102(1)(c) issue (transitory income-producing purpose).
Neal Armstrong. Summary of 2019 Ruling 2018-0772921R3 under s. 13(7)(e)(ii).
Clément – Tax Court of Canada finds that s. 8(1)(b) did not cover legal costs of an action to extend the period of employment
The taxpayer worked as a provisional judge for the Montreal Municipal Court up until 2005, and then served as a full-time judge up until 2012, at which time he was forced to resign as he had attained the age of 70 – which meant that he was 23 months short of the requisite years of full-time service required to generate a full pension.
Lafleur J found that the legal expenses he incurred in an unsuccessful court action to obtain redress were not deductible under s. 8(1)(b). Respecting the first ground of his action - seeking a declaration that he was entitled to continue to exercise his office as a judge of the Montreal Municipal Court after the age of 70, thereby accumulating credits for obtaining a full pension - Lafleur J essentially noted that this did not represent attempted recovery of amounts he earned for working up to 70, but instead related to an attempted extension of his employment. Respecting his alternative ground - seeking a declaration that the three years during which he acted as a provisional judge be taken into account in the calculating his pension – she noted inter alia that s. 8(1)(b) did not extend to amounts that would have been included in his income under s. 56 rather than s. 5.
Neal Armstrong. Summary of Clément v. The Queen, 2020 CCI 33 under s. 8(1)(b).
Al-Rubaiy – Tax Court of Canada finds that the common law rule of discoverability does not apply to GST/HST rebate claim deadlines
The taxpayer was charged HST on his purchase of a dental practice and, after changing accountants, applied for a rebate of the HST (presumably on the basis that the purchase was exempt under inter alia ETA ss. 141.1(1)(b), 200(3) and 167.1).) Although his rebate application was made well after the two-year limitation in s. 261(3), he unsuccessfully argued that under the common law principle of discoverability, the two-year period did not start running until he discovered his overpayment on his change in accountants. Wong J added, obiter:
No evidence was introduced to show that the joint election was made with respect to subsection 167(1) for the tax-free supply of the Vendor’s business assets. Therefore, since no election appears to have been made, this transaction was subject to GST/HST and the tax in issue was likely not paid in error.
Neal Armstrong. Summary of Al-Rubaiy v. The Queen, 2020 TCC 34 under ETA s. 261(3).
Dilalla – Federal Court of Appeal articulates the purpose of the fresh start rule
Rennie JA confirmed the decision below that the “fresh start” rule (Rule 8) precluded the taxpayer from bringing a motion to strike the Crown’s Reply more than two years after all pre-trial proceedings had been completed, stating:
The fresh step rule is designed to ensure the orderly movement of litigation through to trial. The rule is based on the view that if a party pleads over to a pleading, it implies a waiver of any irregularity that might have been attacked. Here, the judge’s discretion was exercised consistent with the objective of this rule … .
Neal Armstrong. Summary of Dilalla v. Canada, 2020 FCA 39 under Rule 8.
Our translations of CRA interpretations go back 9 years
We have published a further 5 translations of CRA interpretations released in February, 2011. Their descriptors and links appear below.
These are additions to our set of 1,094 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 9 years of releases of Interpretations by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall. Next week is the “open” week for March.
| Bundle Date | Translated severed letter | Summaries under | Summary descriptor |
|---|---|---|---|
| 2011-02-25 | 8 October 2010 Roundtable, 2010-0373161C6 F - Paragraphs 256(3) and 256(6) ITA | Income Tax Act - Section 256 - Subsection 256(6) | application could prevent acquisition of control or preclude loss of CCPC status |
| 8 October 2010 Roundtable, 2010-0373191C6 F - Computation of safe income | Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) | where interest in partnership holding Subco with safe income is rolled into Holdco for prefs, dividends from Subco do not change consolidated SIOH of prefs – or increase commons’ SIOH | |
| 2011-02-18 | 8 October 2010 Roundtable, 2010-0373131C6 F - Présomption d'action concertée | Income Tax Act - Section 251.2 - Subsection 251.2(2) - Paragraph 251.2(2)(a) | Q of fact re whether 3 or more CCPC shareholders form a group |
| 9 December 2010 Internal T.I. 2010-0371741I7 F - Automobiles mises à la disposition des employés | Income Tax Act - Section 248 - Subsection 248(1) - Automobile | qualification as automobiles turns on design, not use | |
| Income Tax Act - Section 6 - Subsection 6(1) - Paragraph 6(1)(e) | employer-provided automobile to attend occasional off-site meetings did not generate a benefit | ||
| 24 January 2011 Internal T.I. 2010-0389251I7 F - Farm-out agreement and warrants | Income Tax Act - Section 66.1 - Subsection 66.1(6) - Canadian exploration expense - Paragraph (j) | CEE to be incurred under simple farmout reduced by an allocation to warrants issued by farmee | |
| Income Tax Act - Section 15 - Subsection 15(1) | valuation of “free” warrants issued as part of a simple farmout agreement determined based on what would be a s. 15(1) benefit | ||
| General Concepts - Fair Market Value - Options | amount allocated out of consideration to “free” warrants based on the greater of their trading and in-the-money value | ||
| Income Tax Act - Section 66.1 - Subsection 66.1(6) - Canadian exploration expense - Paragraph (f) | application of farmout policy to situation where free warrants issued along with incurring of CEE |
Burlington Resources – Crown abandons its position that s. 247(2)(c) applied to reduce guarantee fees paid by a ULC to its non-resident parent
Burlington, a Nova Scotia ULC, borrowed approximately U.S.$3 billion in 2001 and 2002 by issuing notes that were guaranteed by its non-resident parent (“BRI”). The Minister reassessed Burlington’s 2002 to 2005 taxation years to deny, under ss. 247(2)(a) and (c), deductions for the “guarantee fees” paid by Burlington to BRI. The October 2012 Reply to Burlington’s Notice of Appeal relied on s. 247, and also asserted that the fees were not incurred for the purpose of earning or producing income under s. 20(1)(e.1) (they were “redundant” due to Burlington’s status as a ULC).
D’Auray J has now granted a Crown motion to file an amended Reply in which it has abandoned its position that the transfer pricing rules in s. 247 applied to the quantum of the fees, and takes the position that the deductions instead should be denied on the grounds that they were not “guarantee fees” within the meaning of s. 20(1)(e.1) and, in the alternative, they were not incurred by Burlington for the purpose of borrowing money, within the meaning of s. 20(1)(e.1).
Burlington argued that the Court should not grant leave for the making of the amendments since they constituted purported withdrawals of admissions that the fees had been paid as guarantee fees. D’Auray J found that, in the broader context, such admissions had not been made, and that even if they had been, they could now be withdrawn given inter alia that “there is a triable issue which ought to be tried in the interests of justice.”
The requested amendments were granted in light inter alia of the request having been made well in advance of the trial, and the position on s. 20(1)(e.1) having been made known on discoveries of the Crown in 2014.
Neal Armstrong. Summary of Burlington Resources Finance Company v. The Queen, 2020 TCC 32 under Rule 132.
After the PPT, Luxcos or other group Holdcos preferably should have significant substance
It is common for multinationals or international private equity funds to use a subsidiary holding company in a jurisdiction with a favourable Treaty network, such as Luxembourg, to hold many of the group subsidiaries or investments. However, the principal purpose test (PPT) in Art. 7 of the Multilateral Instrument (MLI) now makes this practice more fraught. Regarding the Examples in Art. 29 of the OECD Commentary, it is suggested that:
Examples G and H appear to be consistent with the existence of a potential safe harbour for multinational groups in consolidating certain activities in an entity not resident in the parent company's jurisdiction. There are a number of jurisdictions with well-developed management services and financing capabilities, from both a workforce and a service provider perspective, that make it practical for multinationals to set up substantial group services and financing operations in those locations. At the same time, many of those jurisdictions have extensive treaty networks. Examples G and H recognize that it is not necessarily the residence of the parent company within a group that establishes a baseline for treaty-shopping analysis.
Furthermore, Example K:
suggests that it is acceptable to use a holding company that is resident in a third jurisdiction to manage a group of regional investments, so long as that holding company has sufficient substance in the jurisdiction in which it is resident. … Arguably, the threshold in, for example, Prévost Car, and Alta Energy may be insufficient.
More generally:
[T]here will be less risk of challenge under the PPT if there are demonstrable reasons for having a presence in a particular jurisdiction (such as key decision makers located in the jurisdiction, commercial or other regulatory reasons, proximity to jurisdictions into which investments are made, etc.) … .
Neal Armstrong. Summary of Nelson Whitmore and Owen Strychun, “Canadian Inbound Investment After the MLI,” Canadian Tax Journal, (2019) 67:3, 831-80 under Treaties – MLI – Art. 7(1).
CRA indicates that the “primarily operated” test for GST/HST-exempt supplies of ESL or FSL instruction will be tested on an annual-revenues basis
ETA Sched. V, Pt. III, s. 11 exempts:
a supply of a service of instructing individuals in, or administering examinations in respect of, language courses that form part of a program of second-language instruction in either English or French, if the supply is made by a school authority, a vocational school, a public college or a university or in the course of a business established and operated primarily to provide instruction in languages.
In the case of the four listed types of schools, this exemption overlaps with s. 7, which may exempt for-credit courses that they offer.
In its new GST/HST Memorandum on s. 11, CRA states that the “program” exception generally requires that there be “a series of courses” and provides an example of this requirement being satisfied where a continuing education program of a public college provides course in four languages including French, and provides for three levels of French language instruction.
Respecting the requirement, for the final type of listed organization, that it make the supplies “in the course of a business established and operated primarily to provide instruction in languages,” CRA states that it:
will consider a business to be operated primarily to provide instruction in languages if more than 50% of its total annual revenues are derived from fees/tuition for, or can be attributed to instruction in, language courses
and conversely that:
if the portion of the business’s total annual revenues that is derived from language course fees/tuition or that can be attributed to instruction in these courses falls to 50% or less during the following fiscal year, the business would no longer be considered to be operated primarily to provide instruction in languages in the next fiscal year.
Neal Armstrong. Summaries of GST/HST Memorandum 20-7 “Second-language Instruction” December 2019 under ETA Sched. V, Pt. III, s. 11 and Equivalent Courses (GST/HST) Regulations, s. 2.
CRA publishes a new GST/HST Memorandum on private instruction and tutoring
ETA Sched. V, Pt. III, s. 9 exempts:
a supply of a service of tutoring or instructing an individual in
- a course that is approved for credit by, or that follows a curriculum designated by, a school authority;
- a course that is a prescribed equivalent of a course described in paragraph (a); or
- a course the successful completion of which is mandatory for admittance into a particular course described in paragraph (a) or (b) and not for admittance into any other course that is a prerequisite to the particular course”.
Most of the discussion in CRA’s new GST/HST Memorandum is on (a) above. CRA states:
The service of tutoring or instructing an individual need not be limited to material contained in a course approved for credit by, or that follows a curriculum designated by, a school authority [and] … could also include general concepts dealing with the relevant subject matter … in order to assist the individual in understanding the material contained in a course approved for credit by, or that follows a curriculum designated by, a school authority. … In order for the exemption to apply, it must be evident that there is some direct connection between the supply of the service of tutoring or instructing in question and the course approved for credit by, or the curriculum designated by, a school authority.
CRA then provided examples of general reading proficiency instruction qualifying, but general study skills course not qualifying. CRA also provided an example of a private corporation (“Corporation A”) providing a course that involved children working through a progression of non-customized math workbooks at their own pace as not qualifying given that there was little assistance from the instructor and there was “no evidence of a relationship between the supply being made by Corporation A and a course approved for credit by, or that follows a curriculum designated by, a school authority.”
Note that s. 9(a) only requires that the course be a credit course of the school authority and not that the course actually be taught by the school authority. CRA provided examples of a private driving school providing exempt driving courses to students for high school credit, and a similar example respecting a high school authorizing jazz dance classes at a private dance academy.
The prescribed equivalent in s. 9(b) is music lessons, which CRA defines somewhat as one would expect.
CRA illustrates the somewhat convoluted language of s. 9(c) by indicating that where there is a three-level ballet course, with only the third level recognized by a private school for a physical education credit, level 2 would qualify because it is a prerequisite to entering level 3, but level 1 would not qualify because it is merely a prerequisite to entering a prerequisite course (level 2).
Neal Armstrong. Summaries of GST/HST Memorandum 20-6 “Tutoring and Equivalent Services” December 2019 under ETA Sched. V, Pt. III, s. 9 and Equivalent Courses (GST/HST) Regulations, s. 2.