News of Note
Klopak – Federal Court confirms an apparent denial of penalty relief for voluntarily disclosing a tax return error
Email this ContentAlthough the facts are quite unclear, what may have happened is that the Canadian-resident individual, who worked in the U.S. as a subcontractor to a rock band, originally filed late Canadian tax returns on the basis that his Canadian tax liability was offset by foreign tax credits for the U.S. taxes payable on his income. However, on getting advice, he later determined that he was Treaty-exempt on that income, sought a refund of the U.S. taxes, and filed amendments to his Canadian returns, showing Canadian taxes payable. CRA (in addition to assessing the Canadian income taxes payable and interest) also assessed him penalties since it now appeared that at the time of the original filing of his “nil” returns, Canadian taxes in fact had been owing.
The taxpayer argued inter alia that as he “came forward with a voluntary disclosure in a timely fashion … it was unreasonable for the [CRA] Delegate to not exercise discretion in waiving the penalties.” McVeigh J denied penalty relief essentially on the basis that the taxpayer did not fall within the conventional narrow criteria of CRA in IC-07 for penalty relief, e.g., no extraordinary circumstances justifying the late filing of the returns, such as natural disaster, had been established, and that this situation also did not fall within the four corners of CRA’s published voluntary disclosure program.
It is unclear why it was reasonable for the Delegate not to consider that the Applicant presumably could have received relief if he had formally applied under the voluntary disclosure program rather than simply sending in a T1 adjustment.
This case illustrates that the common practice of sending in nil returns quite late is fraught.
Neal Armstrong. Summary of Klopak v. Canada (Attorney General), 2019 FC 235 under s. 220(3.1).
Kaye v. Fogler Rubinoff – Ontario Superior Court of Justice stays a negligence action against a law firm pending disposition of the related tax appeal
An estate sued its law firm in negligence after CRA assessed it over $9 million on the basis that the method used to transfer shares to a charitable foundation did not generate a donation credit.
In granting the motion of the defendant law firm for a stay of the negligence action pending the disposition of the tax appeal, Josefo, M. stated:
[T]he ultimate decision of the Tax Court on the propriety of the method or structure for transferring shares recommended by the law firm and lawyer to the Estate will, in my view, very much influence if not be determinative of much if not all of this within negligence action.
Neal Armstrong. Summary of Kaye et al. v. Fogler Rubinoff LLP et al., 2019 ONSC 1289 under Courts of Justice Act (Ontario), s. 106.
Tax authorities may be increasing their use of the profit-split method
The profit-split method “identifies the relevant profits to be split for the associated enterprises from a controlled transaction and then splits those profits between the associated enterprises on an economically valid basis that approximates the division of profits that would have been agreed at arm's length."
A one-sided transfer-pricing (TP) analysis hypothesizes that if the tested party earns an arm's-length return that is appropriate for its functional characterization, then the other related entity is assumed to earn an arm's-length return, too. The tax authorities can be concerned because there is no visibility of the profitability of the other related entity, and may favour the PSM which is a two-sided analysis that explicitly evaluates whether the profit split between the related entities is appropriate.
Furrthermore, country-by-country reporting (CbCR) requires the multinational corporation (MNC) to disclose relative profitability in each jurisdiction and the required master file (MF) entails the disclosure of the drivers of business profits, such as a description of the supply chain and intellectual property used within the group. It is suggested:
Tax authorities, armed with the additional information available through the CbCR and the MF, are expected to use the PSM as either a primary or a secondary TP method to assess the reasonableness of the TP policies that are applied by an MNC.
Neal Armstrong. Summary of Adrian Tan, “The Emergence of the Profit-Split Method,” Canadian Tax Highlights, Vol. 27, No. 2, February 2019, p. 1 under s. 247(2).
CRA considers shares of Targetco now held 100% by Acquisitionco, and with a formal delisting imminent, to still be listed
There is a problem in the wording of the definition of a public corporation. Even if a heretofore public corporation has made a good election under (c)(i) of that definition to cease to be a public corporation, it will continue to be a public corporation under para. (a) of the definition at that time if its shares are still listed. Accordingly, the Joint Committee has submitted that para. (a) should be amended by adding a proviso that the corporation nonetheless will not be considered to be a public corporation under para. (a) if it ceased to be a public corporation under para. (c) because of a valid election or designation.
The background is this. 2017-0723771C6 indicated that where Acquisitionco acquired all the shares of Targetco, a public corporation, and immediately amalgamated with it, Amalco could potentially make an election on behalf of Targetco under (c)(i) of the public corporation definition for Targetco not to be a public corporation so that Amalco was not deemed to be a public corporation under s. 87(2)(ii). This response was problematic because this election could not be made by Amalco until the Targetco shares were delisted, which might take several days to occur, and because CRA needed to accept that the fact that the Targetco shares no longer existed did not preclude the making of this election (as to which it was prepared to rule on a case-by-case basis rather than giving any blanket assurances).
CRA recently declined to give a Technical Interpretation that if, shortly before the amalgamation of Targetco with Acquisitionco, Acquisitionco held all the Targetco shares and the Stock Exchange had been notified to delist the shares, the Targetco shares would not be considered to be listed for purposes of paragraph (a) of the definition of public corporation.
Neal Armstrong. Summary of 4 March 2019 Joint Committee Submission on Definition of “Public Corporation” under s. 89(1) - public corporation – para. (a).
FTQ – Federal Court of Appeal affirms that a payment in substance made to walk away from a worthless investment did not qualify under s. 18(1)(a)
The taxpayer agreed with the City of Chandler that it would no longer use any loan repayment proceeds received by it from a City-owned corporation - that had failed in an costly attempt to restart a paper mill close to the City – to invest in a prospective replacement economic-development LP to be sponsored by the City, but would instead make a “gift” of the loan repayment proceeds (which ended up totalling $9.3 million) to the City, for which it received charitable receipts. Ouimet J found that there was no “gift” in the context of the taxpayer being relieved of its obligation to invest in an enterprise of questionable worth.
He also rejected the taxpayer’s alternative argument that the payments qualified for current deduction consistently with the s. 18(1)(a) income-producing purpose test given that their purpose instead was to avoid involvement in the proposed LP and to leave to the City alone the responsibility of using the sums to economically develop the region.
The case was appealed on the second ground and has now been briefly affirmed by the Federal Court of Appeal.
Summaries of Fonds de solidarité des travailleurs du Québec (F.T.Q) v. The Queen, 2018 CCI 3, aff'd on s. 18(1)(a) grounds 2019 CAF 36 under s. 110.1(1)(a) and s. 18(1)(a) – income-producing purpose.
Income Tax Severed Letters 6 March 2019
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
The response to the new U.S. anti-hybrid Regs. may not generate much revenue to the IRS
Code s. 267A and the regulations thereunder target deduction/non-inclusion situations. All of the common structures used by Canadian (and other non-U.S.) multinationals with U.S. operations have been adversely affected. What come to mind are cross-border repo financing structures, tower structures, Lux Fincos with MRPS, and branch mismatch structures.
Some taxpayers are exploring clever technical changes to their existing hybrid structures, notwithstanding that this approach may bump up against the PPT antiavoidance rule in the proposed Regulations. Others may throw in the towel.
[O]ther MNEs based in Canada (and elsewhere) might opt for a third approach that relies on simpler, non-hybrid, third-country financing structures. Some countries that have tax treaties with the United States — for example, Bulgaria, Hungary, Ireland, and Switzerland — have been carefully preparing for a post-BEPS world and offer very competitive corporate tax rates around 10 percent that may bring in business. Trading a 21 percent rate for a 10 percent rate is likely to be an attractive option for many tax managers.
Neal Armstrong. Summaries of Nathan Boidman and Michael N. Kandev, “Expected Adverse Effects of Proposed U.S. Anti-Hybrid Regulations on Inbound Financing by Canadian MNEs,” Tax Notes International, February 11, 2019, p. 623 under s. 95(2)(a)(ii)(B)(II) and s. 113(1)(a).
CRA ruling letter indicates that an intercompany subordinated loan will bear interest at the rate for a senior secured financing
CRA provided the usual rulings (including on s. 55(2)) respecting a transaction for the transfer of non-capital losses from Profitco to its Lossco parent by means of Lossco lending at interest to Profitco, Profitco subscribing for pref of a newly-incorporated sister corp (Newco) and Newco lending without interest to Lossco.
Notwithstanding that the loan made to Profitco was subordinated, the ruling letter states that the interest rate is “based on a comparison to the most recent arm’s length senior secured financing issued” by Lossco. It is unclear whether this was volunteered or volun-told.
The only financial capacity reps given are that Profitco has the financial capacity to pay the interest on the loan to it from its own cash flow and that Lossco has cash of a specified level and will fund annual contributions of capital to Newco (to fund dividend payments on the Newco pref) out of an independent source of income.
Neal Armstrong. Summary of 2018 Ruling 2018-0742641R3 under s. 111(1)(a).
Zdzieblowska – Tax Court of Canada finds that CRA is required to grant an unclaimed and available new rental housing rebate when assessing to deny a new home rebate
ETA s. 296(2.1), generally requires CRA to take unclaimed rebates into account when assessing a taxpayer.
D’Arcy J dealt with a situation where a new home purchaser had claimed a new home rebate on the purchase, whereas in fact a new rental home rebate should instead have been claimed. He found that s. 296(2.1) is applicable where such an individual is assessed to deny a new home rebate. CRA in assessing must take into account any unclaimed new rental housing rebate that was available, as was the case here. However, CRA failed to do so, and the individual failed to file a notice of objection. The individual instead made a late filing for the new rental housing rebate, which was the incorrect thing to do as the two year deadline for making such a filing was inflexible (whereas there is no time limitation for requiring CRA to take that rebate into account at the time it assesses the individual to deny a new home rebate.)
Thus, the individual had no recourse for the mistake of CRA in not applying s. 296(2.1) when it assessed her.
Neal Armstrong. Summary of Zdzieblowska v. The Queen, 2019 TCC 40 under s. 296(2.1).
6 further full-text translations of CRA interpretations are available
We have published a further 6 translations of interpretations released in June 2012. Their descriptors and links appear below.
These are additions to our set of 795 full-text translations of French-language Rulings, Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers the last 6 ¾ years of releases by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall. You are currently in the “open” week for March.