News of Note

The taxpayer’s systematic process of trying different combinations of coding changes to its software to eliminate problems of integrating that software with that of a third party (Oracle), which had made poorly documented coding changes, was characterized by Russell J as a “trial and error” procedure that was “routine engineering” and not SR&ED.

Russell J also accepted the view of the Crown’s expert that a second mooted “SR&ED” effort to enhance the ability of the taxpayer’s software to calculate optimal timelines for concurrently run projects used an established methodology termed "metaheuristics, which in essence search the solution space based on some algorithms and converge to a solution … [and] did not involve experimentation or analyses to resolve scientific or technological unknowns,” so that for this activity as well, the claimed SR&ED credits were denied.

Neal Armstrong. Summary of Clevor Technologies Inc. v. The Queen, 2019 TCC 166 under s. 248(1) - SR&ED.

An individual (Spouse B) who, quite unlike Spouse A, was not involved in the business of Opco, received distributions of s. 104(19) dividends from a discretionary family trust following their declaration and payment by Opco to Holdco, and by Holdco to that trust. These dividends could not qualify in Spouse B’s hands as being from excluded shares, and CRA also found that they could not qualify under the “reasonable return” exception in the “excluded amount” definition for exclusion from split income, notwithstanding that all the shares of Opco originally had been issued to Spouse A for cash subscription proceeds that came out of a joint bank account of Spouses A and B.

CRA stated:

[A]lthough the cash used to fund Spouse A’s initial share investment … was stated to be from cash that came from a joint account … the legal form of these transactions strongly suggests that Spouse B has not made any direct or indirect contribution of property to Opco. …

[T]aking an overly broad interpretation that a specified individual has made an indirect financial contribution to a business such that the reasonable return exception in subparagraph (g)(ii) of the definition of excluded amount would apply to prevent the amount from being split income would appear to frustrate the underlying tax policy of the TOSI rules.

Neal Armstrong. Summary of 7 August 2019 External T.I. 2019-0814161E5 under s. 120.4(1) - reasonable return.

Comments of the Joint Committee on the June 17, 2019 draft stock option legislation include:

• Both (i) the denial of the s. 110(1)(d) deduction for benefits respecting “non-qualified securities” and (ii) the granting of a corresponding employer deduction under s. 110(1)(e) should apply respecting agreements to sell or issue securities entered into after 2019, rather than the first change coming into force on January 1, 2020 – and the continuity rule in s. 7(1.4) should apply for such purposes.
• The conditions for the s. 110(1)(e) deduction should be relaxed to permit the stock option issuer (e.g., a resident or non-resident parent) to differ from the deducting employer, to permit the employer not to be a specified person, and to require that the specified person status of the issuer be tested only at the time of grant – but s. 110(1)(e) should not permit multiple employers to each take the deduction.
• A successor rule should be added to permit s. 110(1)(e) to apply following a reorganization.
• The vesting year definition in s. 110(0.1) is part of the system for placing a numerical limit on the number of options that can become exercisable in a particular vesting year. Para. (b) of that definition, which utilizes the intractable concept of when vesting may reasonably be expected to occur, should instead provide for deemed ratable vesting over the term of the option.
• It is inappropriate for D(ii) of the numerical limit formula in s. 110(1.31) to include the FMV of securities to be issued under earlier options where they were non-qualified securities.
• Also, under that formula, the $200,000 limit is applied to the first options granted having a particular vesting year, therefore producing a blocking effect even when they become uneconomic (i.e., under water). Where a subsequent option is granted having a lower exercise price, the specified person should be able to designate the securities issuable under the earlier option to be non-qualified securities in order to cleanse the securities issuable under the subsequent option.
• Furthermore, where an option is cancelled or replaced (including under s. 7(1.4) or 110(1.7)), the securities which were to be issued under such option should be considered to be options not described in D(ii).
• Requiring same-day written notification (in s. 110(1.9)(a)) can be impracticable – at least 30 days should be allowed.

Summaries of 13 September 2019 Joint Committee Letter entitled “Employee Stock Option Amendments” under s. 110(1)(e), s. 110(0.1) – vesting year, s. 110(1.31) and s. 110(1.9).

It is suggested that CRA’s interpretation of s. 40(3.5(c)(i) (which can prevent the release of a suspended loss):

appears to be driven by a policy goal that suspended losses should not be released as a result of a winding up that is not subject to Canadian tax (either because the winding up qualifies for Canadian tax deferral or because the parties to the winding up are outside the reach of the Canadian tax system).

CRA's expansive interpretation of s. 40(3.5)(c)(i) (in, e.g., 2017-073715117) interprets "merger or combination" as including a winding-up, and the reference to "the corporation formed" on a merger combination as including a shareholder of a wound-up corporation. It is suggested that this interpretation renders ss 40(3.5)(c)(ii) and (iii) redundant. Based on this and other considerations, including the French version - which effectively refers to an “amalgamation” rather than the somewhat broader term “merger” (which nonetheless is not cognate with a winding-up) – it is suggested that s. 40(3.5)(c)(i) applies to Canadian amalgamations and similar foreign reorganizations, in which two or more companies merge to form a single corporate entity (such as foreign mergers described in subsection 87(8.1).).

Even if a winding up could be considered a "merger" or "combination," it would not result in the “formation” of a corporation.

Furthermore, CRA considers that a s. 40(3.5)(c)(i) merger or combination can include the winding-up of a corporation into multiple shareholders. In addition to being linguistically untenable, this interpretation effectively forces CRA to apply the stop-loss rule in ways not contemplated by its language.

For example, Canco, which owns FA3 directly and (as to the other 50% shareholding) through FA1, has a suspended loss when it drops its directly-held 50% shareholding of FA3 into FA2. CRA considers that s. 40(3.5)(c)(i) prevents the release of this suspended loss when FA3 is wound-up into (i.e., “merged” with) FA2 and FA1.

But what if Canco then sells FA1 to a third party? CRA apparently would consider FA1 to continue to own 50% of the FA3 shares, suggesting that the sale of FA1 could release 50% of the suspended loss. However, there is no support for such an approach in the words of the provision.

Neal Armstrong. Summaries of Ian Bradley and Jonathan Bright, “The Stop-Loss Rules and Corporate Reorganizations – Interpretive Challenges,” Canadian Tax Journal, (2019) 67:2, 383-410 under s. 40(3.5)(c)(i) and Statutory Interpretation - Interpretation Act, s. 33(2).