News of Note

CRA confirmed that its position - that an associated group of Canadian-controlled private corporations can file amended T2 Schedule 23s providing an amended business limit allocation agreement provided that this does not change the amount allocated to any associated corporation for a taxation year for which a reassessment is statute-barred – also essentially applies to an amended assignment of a partner’s specified partnership business limit.

Neal Armstrong. Summary of 5 April 2018 Internal T.I. 2017-0728581I7 under s. 125(3.2)(d) and s. 125(8)(c).

The Joint Committee has submitted that the exceptions in draft ss. 150(1.2)(a) to (n), for the required expansion of trust reporting, are too narrow. For example, there should be an exception for trusts whose principal purpose is to secure arm’s length sale-agreement covenants, and the apparent requirement for lawyers to file a tax return disclosing inter alia the client name and trust amount re a client-specific trust is contrary to s. 8 of the Charter (see Chambre des Notaires).

Under the revised at-risk amount rules for multi-tier partnerships, there will be no ability to carryover unutilized limited partnership losses. A loss of a lower-tier partnership that exceeds an upper-tier partnership’s amount at risk in that lower-tier partnership is denied forever. This seems harsh, and alternatives are suggested that would not be overly complex.

Proposed s. 212.1(6)(b), which applies a look-through rule for the purpose of having s. 212.1 apply on a disposition by a partnership or trust, is overly broad as it looks through corporations. For example, when the non-resident seller (NRco) sells its interest in a partnership owning USco which owns Canco representing only 20% of the fair market value of the USco shares, s. 212.1 would appear to apply to the “sale” of the underlying Canco shares.

Where foreign investment funds are structured as corporate umbrella funds (i.e., with each sub-fund of the corporation being a separate investment fund for commercial and regulatory purposes), it is quite possible that there would only be a few Canadian investors in a particular Canadian-dollar sub-fund (with the manager typically hedging the sub-fund’s non-Canadian assets back to the Canadian dollar), so that the Canadian investor’s shares may very well be tracking interests. Making the s. 95(12) election may not be an adequate solution as the sub-fund may still be a controlled foreign affiliate to the electing Canadian investor if the sub-fund hedges its non-Canadian dollar exposures back to the Canadian dollar, since the Canadian dollar class or series will be seen as a separate tracked interest from the other interests in the sub-fund. Accordingly, such electing Canadian investors, holding a relatively small number of shares of the sub-fund, but more than 10% of the shares of the Canadian dollar class or series of the sub-fund, may be caught by the tracking interest rules.

Neal Armstrong. Summaries of Joint Committee 10 September 2018 Submission on the July 27, 2018 Legislative Proposals Released July 27, 2018 under s. 150(1.2), s. 163(6), s. 96(2.1)(f), s. 212.1(6)(b) and s. 95(12).

A private company made the common mistake of declaring a capital dividend in an amount that assumed an addition to its capital dividend account for a disposition of eligible capital property, even though such addition would not occur until year end. Branch J found in light of the resolution’s wording (which referenced the intention to declare the dividend in the amount of the corporation’s CDA) and statements deposed as to the directors’ intentions that

there was a definite and ascertainable agreement between the directors to effectively “clean out” the petitioner’s capital dividend account.

As the Fairmont test for rectification thus was met, he granted an order to rectify the resolution to reduce the declared dividend by the erroneous amount.

Neal Armstrong. Summary of Re 5551928 Manitoba Ltd., 2018 BCSC 1482 under General Concepts – Rectification.

The taxpayer, an indirect wholly-owned subsidiary of Loblaws, wholly-owned a Barbados subsidiary (GBL), that was licensed in Barbados as an international bank and that used funds mostly derived from equity injections by the taxpayer to invest in U.S.-dollar short-term debt obligations, loans to several thousand independent U.S. distributors of Weston baked goods and intercorporate loans – and entered into cross-currency and interest rate swaps with an arm’s length bank to effectively convert much of its income stream into fixed rated Canadian-dollar interest. CRA assessed the taxpayer on the basis that GBL had realized $473 million of foreign accrual property income (FAPI) between 2001 and 2010.

C Miller J found that GBL met the requirement, in the exclusion from the investment business definition, of being a foreign bank given that it was licensed in Barbados as an international bank. GBL also satisfied the further test, for the exclusion to apply, that the business employ the equivalent of more than five full-time employees in its active conduct (given that some time spent by its employees in servicing related affiliates, as described in s. 95(2)(b)(i), was not sufficient to reduce the equivalent number to below this threshold). However, he nonetheless confirmed the assessments on the basis that such business was conducted principally with the Loblaw group (i.e, it was not conducted principally with arm’s length persons.) “In looking at both aspects of a foreign bank’s business [namely] the receipt of funds and use of funds, there should be emphasis on the receipt side as that is where one would expect to find the completion element.” GBL clearly flunked on the receipt side (its funds came from Loblaw - although no authority was cited for the proposition that equity funding was part of the conduct of a business) and, even on the fund use side, the purchases of the short-term debt were impressed with their character of researching the best return for a non-arm’s length party, the distributor loans “were effectively handed over to GBL by Loblaw,” the intercompany loans clearly were with non-arm’s length persons and “even the swap activity has a considerable element of conducting business with non-arm’s length person, as the swaps were subject to Loblaw derivative policies.”

In finding that GBL realized foreign exchange gains and losses under s. 95(2)(f) on its U.S.-dollar denominated short-term debt portfolio on income account, he stated:

The acquisition of the short term securities, taking their yield and funding a derivatives program to produce a greater yield is … using these short term securities in a manner akin to inventory in an income producing scheme.

Now, for some obiter. He found that CRA would have been statute-barred from applying the general anti-avoidance rule (GAAR) to the pre-2008 taxation years of the taxpayer and that, even for the 2008-2010 years, GAAR would not have been applicable had he concluded that the GBL income was not FAPI. He appeared to consider that CRA could only assess those open years if there was a relevant avoidance transaction that occurred in those (rather than the earlier statute-barred) years. The only mooted transaction in those years was the renewal of GBL’s international banking licence. Was this renewal part of a “series of transactions” that constituted an avoidance transaction? In this regard, C Miller J focused most on the hiring of three employees by GBL in 1994, which appeared to be motivated by the legislative adoption of the investment business definition containing the five full-time employees test, and stated that this was “a one-off transaction that has no bearing beyond the year in which it occurred.” Instead the relevant series was that of the taxpayer engaging in an offshore investment strategy “in a low tax jurisdiction with a recognized international financial infrastructure” with a view to avoiding FAPI, and the bona fide commercial purpose therein outweighed the FAPI-avoidance objective.

It thus would have been unnecessary to consider “misuse" or "abuse” under s. 245(4). However, he indicated (in what you might term 2^nd-tier obiter) that there would have been such misuse:

The policy, or underlying rationale, of the exemption … is to promote competition of affiliates operating in international markets. …

[I]t follows that Loblaw Financial was misusing this exemption as it was not competing in any manner in any international market. It basically managed an investment portfolio for Loblaw.

Neal Armstrong. Summaries of Loblaw Financial Holdings Inc. v. The Queen, 2018 TCC 182 under s. 165(1.11), s. 95(1) – foreign bank, investment business, para. (a), para. (c), s. 9 – capital gain v. profit – foreign exchange, s. 152(4.01)(a)(ii), s. 245(3), s. 248(10), s. 245(4), s. 95(2)(l).