News of Note
Landbouwbedrijf Backx – Federal Court of Appeal confirms that a Dutch company with a sole Dutch director was resident in Canada
Email this ContentWhen a Netherlands couple immigrated to Canada in 1998 to acquire a dairy farm here, they created a structure under which the farm was held in a partnership which was held by them directly as to 51% and as to 49% through a Netherlands holding company (“B.V.”) of which the wife’s sister (a Netherlands resident) was the sole director. On a subsequent disposition by B.V. in 2009 of the partnership interest, they took the position that B.V.’s gain was exempt from tax under the Canada-Netherlands Treaty, as being from the disposition of a substantial interest in a partnership holding a property (the farm) in which its business was carried on.
Rivoalen JA found that there was no reversible error in the Tax Court’s finding that B.V.’s central management and control was in Canada, given the evidence that “the shareholders in Canada were making the decisions, not the director in the Netherlands.”
Rivoalen JA next addressed the Tax Court’s finding that that there had been no previous step-up to B.V. in the adjusted cost base of the partnership interest under s. 128.1(1)(c), as it was likely that B.V. had been resident in Canada from the time of the acquisition of the farm. She allowed B.V.’s appeal and referred the matter back to the Tax Court for reconsideration of this finding based on what appears to be a minor linguistic quibble: in one part of its reasons, the Tax Court had expressed its finding in this regard on the basis that “there was no evidence that [B.V.] actually ceased to be a resident of the Netherlands” - rather than stating that there was no evidence that B.V. had not been resident in Canada at all times. (Given that central management and control was in Canada at all times, this appears to be a distinction without a difference.)
Furthermore, the Tax Court had found that B.V. was resident in Canada for Treaty purposes as its effective management and control was in Canada - and if it was resident in both countries, this was a matter for the competent authorities to address, which had not been done. The Tax Court merely quoted Art. IV(3) of the Treaty in this regard – which provides:
Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both States, the competent authorities of the States shall endeavour to settle the question by mutual agreement ... . In the absence of such agreement, such person shall be deemed not to be a resident of either State for the purposes of Articles 6 to 21 inclusive and Articles 23 and 24.
The Tax Court did not go on to indicate (presumably because this was obvious) that, given that the competent authorities had not been engaged, this meant that the Treaty could have no application to B.V. Rivoalen JA found that there also was an error here:
[T]he Convention provides an exception or relief to the appellant, it would take precedence over the Act. The Tax Court did not apply and consider the provisions of the Convention to the facts of this case.
The allowing of its appeal likely will be an illusory victory for B.V.
Neal Armstrong. Summaries of Landbouwbedrijf Backx B.V. v. Canada, 2019 FCA 310 under s. 2(1), s. 128.1(1)(c) and Treaties - Income Tax Conventions - Art. 4.
CRA indicates that there can be no interest ultimately payable to the extent that a life interest trust realizes a capital loss in the stub period following death
Life interest trusts, such as alter ego trusts and joint spousal trusts, are deemed under s. 104(4)(a) to have a deemed year end on the date of the death of the last life interest beneficiary and to have disposed of certain property on the date of death. However, if there is a loss in the first taxation year after death, this loss will be reported on the tax return filed for that year and carried back to offset or reduce the gain for the year ending with the death.
However, CRA noted that s. 104(13.4)(c), which postpones the balance due date for the first deemed taxation year to March 31 (or March 30 for a leap year), can provide relief. Suppose that a capital loss sustained in the second taxation year ending on December 31 equals or exceeds the capital gain realized in the first taxation year ending on, say, July 31. By filing the two tax returns, and the loss-carryback request before the balance due-date of March 31, once the first taxation year has been reassessed to recognize the loss for the second taxation year, the effect should be that no Part I tax is payable, and the Part I tax that was initially assessed on the first taxation year should be reversed.
Neal Armstrong. Summary of 3 December 2019 CTF Roundtable, Q.15 under s. 104(13.4)(c)(i).
CRA indicates that a replacement property can be acquired before disposing of the former property
In order to expand its operations, a manufacturer acquires vacant land, takes three years to build a new plant, moves its operations there and, eight months later, sells the former property. CRA indicated that there is no requirement that the replacement property be acquired after the former property is disposed of – so that the acquisition of the new property in advance of the disposition of the former property would not prevent it from being a replacement property for ss. 13(4.1) and 44(5) purposes.
Neal Armstrong. Summary of 3 December 2019 CTF Roundtable, Q.14 under s. 44(5).
CRA indicates that GAAR may apply to the use of a “Midco” to step up the tax basis of a target investment on a triangular amalgamation
In a conventional domestic triangular amalgamation, in which the shareholders of Targetco receive shares of Parentco, and Parentco receives shares of the Amalco resulting from the amalgamation of Targetco and Subco (a wholly-owned subsidiary of Parentco), ss. 87(9)(a.4) and (c) limit the cost of such Amalco shares to Parentco. Some ancient technical interpretations of CRA indicated that Parentco could achieve a step-up of its investment to fair market value if it inserted a “Midco” between it and Subco. On the amalgamation, Parentco receives additional shares of Midco (having an FMV equaling the FMV of the shares of Parentco issued to the former shareholders of Targetco and to compensate it for such issuance (and Midco receives compensatory shares of Amalco).
CRA continues to acknowledge that as a purely technical matter, the “compensatory” shares issued by Midco to Parentco have full (FMV) basis (although of course the cost of the shares issued by Amalco to Subco continues to be limited by ss. 87(9)(a.4) and (c).) However, CRA indicated that if an amalgamation is subject to the application of s. 87(9), and is structured in a manner to frustrate the application of ss. 87(9)(a.4) and (c), it will potentially be subject to the application of GAAR.
Accordingly, for transactions implemented after the Conference date of December 3, 2019 (or for amalgamations implemented before March 31, 2020 as part of a series of transactions or an arrangement that were substantially advanced, as evidenced in writing, before December 3, 2019) taxpayers should not rely on the old technical interpretations.
CRA has now provided its official written responses to the Canadian Tax Foundation, which are available to those who attended the conference. In its oral comments, CRA queried whether giving FMV tax basis to Parentco for the shares issued by Midco, which would be in excess of the basis described in ss. 87(9)(a.4) and (c), would be in accordance with the scheme of such provisions, and the scheme of the Act’s rollover provisions in general.
Neal Armstrong. Summary of 3 December 2019 CTF Roundtable, Q.13 under s. 87(9)(a.4).
CRA indicates that a cost-recovery method earnout can be based on the earnings of a lower-tier corporation
The proceeds of disposition of the shares of Company A are determined pursuant to an earnout clause, which is basede on the future earnings (i.e., its goodwill) generated by Company B , whose shares are held by Company A.
CRA indicated that the mere fact that the earnout feature relates to the underlying goodwill of Company B will not preclude the application of the cost recovery method in IT-426R. This position reverses 2013-0480561E5, and follows 2015-0589471R3.
Neal Armstrong. Summary of 3 December 2019 CTF Roundtable, Q.12 under s. 12(1)(g).
Canada uploads common reporting standards (CRS) data onto its systems for full-spectrum compliance use
Canada so far has activated CRS exchange relationships with 90 jurisdictions for incoming CRS data and 64 for outgoing CRS data. This data assists inter alia in identifying Canadians’ overseas financial accounts and in complementing CRA’s existing risk assessment process, and is being incorporated in CRA’s system and made available to those involved in the spectrum of compliance and collection efforts.
Neal Armstrong. Summary of 3 December 2019 CTF Roundtable, Q.11 under s. 217(1).
CRA indicates that earnout payments under cost recovery method generally are not subject to Pt XIII tax
At the 2005 APFF Roundtable, CRA indicated that an amount payable under an earnout feature in a sales agreement is subject to s. 212(1)(d)(v), but indicated that, in a situation where the shares are taxable Canadian property, it would not generally apply s. 212(1)(d)(v) to the TCP, assuming that the first four conditions in IT-426R, para. 2 (re use of the cost recovery method) were met.
CRA has now reaffirmed this position and indicated that it also applies where the shares that were sold were not TCP.
Neal Armstrong. Summary of 3 December 2019 CTF Roundtable, Q.10 under s. 212(1)(d)(v).
626468 New Brunswick – Federal Court of Appeal finds that safe income from asset sale was reduced by accrued, but not yet payable, taxes on the gain
An individual rolled his apartment building into a Newco in consideration for a mortgage assumption and shares with nominal paid-up capital, and then rolled those shares into a new Holdco. Following the realization shortly thereafter by Newco of a taxable capital gain and recapture of depreciation on a sale of the building, Newco increased the adjusted cost base to Holdco of its shares by effecting a series of s. 84(1) dividends (including a capital dividend) – following which the individual sold his shares of Holdco to a third party for a sale price based on the amount of cash sitting in Newco.
Webb JA (as did D’Auray J below) agreed with the Deuce Holdings finding that the safe income of Newco was reduced by the amount of corporate income tax ultimately payable by it on its gain on the building sale, notwithstanding that at the time of sale, no income taxes had yet become payable. Webb JA stated:
Both the fair market value of the shares and the portion of the resulting capital gain that would be attributable to the income earned or realized would reflect the tax liability that, although not payable immediately, would eventually have to be paid. …
This tax liability would not disappear if, as contemplated by subsection 55(2) … the shares of Tri-Holdings would have been sold immediately before the dividend in question.
Respecting the mechanics of how the pre-April 20, 2015 version of s. 55(2) operated to generate a capital gain as a result of the denial of safe income, he indicated that:
- The final s. 84(1) dividend in issue was deemed by s. 55(2)(a) to not be a dividend, so that there was no corresponding addition to the adjusted cost base of the shares of Newco for that amount under s. 53(1)(b).
- This s. 53(1)(b) ACB denial resulted in an increased capital gain on the shares’ sale to the third party.
- As this amount was reflected in the amount paid by the third party, no additional amount was to be added to the proceeds under s. 55(2)(b).
Neal Armstrong. Summary of 626468 New Brunswick Inc. v. Canada, 2019 FCA 306 under s. 55(2.1)(c), s. 55(2) and General Concepts - FMV.
CRA indicates that a transitional services agreement with an arm’s length purchaser can engage the TOSI rules
For TOSI purposes, an “excluded amount” includes (under (e)(i) of the definition) an amount, such as a dividend, that the individual does not derive directly or indirectly for the year from a “related business,” whose definition includes a business of the corporation in which the specified individual is actively (etc.) engaged. CRA indicated that this exclusion applied where the corporation in question (which presumably is paying dividends to a specified individual who was never relevantly engaged in its business) has in a previous year sold its business to an arm’s length corporation which continues to actively carry on that business – unless the source individual in question continues an active involvement in that business, for example, under a transitional services business, in which case the related business exception would not be available to the specified individual.
Neal Armstrong. Summary of 3 December 2019 CTF Roundtable, Q.9 under s. 120.4(1) – related business – (a)(ii).
Income Tax Severed Letters 11 December 2019
This morning's release of two severed letters from the Income Tax Rulings Directorate is now available for your viewing.