News of Note
CRA substantially expands on its Bulletin on capital dividends
Email this ContentThere are various comments in the CRA Folio on capital dividends which did not appear in IT-66R6, including:
- A recipient of a capital dividend need not be a shareholder provided it was a shareholder on the record date.
- Negative ACB gains of partners are not added to their CDA.
- A partner adds its share of a capital dividend to its CDA at the time of partnership receipt “if the partnership agreement provides that [such] partner is entitled to a share of a capital dividend at the time the dividend is received by the partnership.”
- Where a death benefit is paid pursuant to a creditor’s group life term policy, the full amount of the death benefit (as opposed to the net proceeds) can be added to the debtor’s CDA - whereas only the net proceeds of a life insurance policy owned by the debtor as policyholder may be added to the debtor’s CDA.
- CRA provides a numerical example illustrating that Amalco has a memory of the excess capital losses of a predecessor, which do not reduce the other CDA components, but which must first be filled before there is a component (a) to Amalco’s CDA.
- After describing various ways in which a CDA deficiency relative to a capital dividend can arise, CRA notes its policy in 2013-0504951E5 that an election to convert an excessive capital dividend into a taxable dividend can be held in abeyance until an objection respecting whether there, in fact, should have been a reduction to the CDA has been dealt with.
- CRA agrees with Groupe Honco that, under s. 83(2.1), a person can have more than one main reason for the acquisition of shares.
Neal Armstrong. Summaries of S3-F2-C1 under s. 83(2), s. 89(1) – capital dividend account – para. (a), s. 89(1) – capital dividend account – para. (b), s. 89(1) – capital dividend account – para. (d), s. 87(2)(z.1), s. 184(3) and s. 83(2.1).
CRA indicates that insurance assets transferred to a subsidiary in consideration for assuming obligations of the insurance business could qualify as “reinsurance premiums”
In the context of a tax-deferred transfer under s. 138(11.94) of an insurance business carried on in Canada to a corporation within the same wholly-owned group, s. 138(11.5)(m) provides that a reinsurance premium paid or payable by the transferor to the transferee respecting the assumed or reinsured obligations will be included or deducted, as the case may be, only to the extent that doing so may reasonably be regarded as necessary to determine the appropriate amount of income of both the transferor and the transferee.
After noting that whether s. 138(11.5)(m) can apply depends, in part, on whether the drop-down occurs under a reinsurance arrangement, CRA stated that “the assets transferred by the transferor to the transferee in exchange for assuming the transferred obligations may be a ‘reinsurance premium’” (although that term could also extend to “any amounts paid or payable to the transferee as consideration for the assumed obligations in respect of the transferred insurance business.”)
Neal Armstrong. Summary of 15 November 2016 External T.I. 2015-0597921E5 under s. 138(11.5)(m).
The mammoth Folio on the general CCA rules carries forward most of the positions in predecessor Bulletins
The new Folio on the general capital cost allowance rules is in many respects a consolidation of various IT Bulletins which it replaces (285R2, 418, 220R, 190R2, 128R and 478R2). CRA has been very conservative about changing the previous positions even where subsequent developments might justify changes. For example, it has carried forward the statement in IT-128R that “where the building is used to earn income for only a short time prior to demolition, it is likely that the building will not be regarded as depreciable property unless the taxpayer can clearly establish that the prime intention on acquiring the building was for the purpose of gaining or producing income,” notwithstanding the Ludco ancillary purpose doctrine (see also Rich: subordinate purpose; and Hickman Motors: 5 days’ rental use.)
CRA also maintains some positions that it likely would not adopt if it were starting afresh, e.g., that the taxpayer has the choice of treating the cost of demolishing an old established rental building as a current expense or as a cost of the new building. Consistently with this conservatism, its new policy on assessing recapture for the first non-statute-barred year following statute-barred years in which there were proceeds received in excess of UCC, applies only to properties acquired after December 31, 2015.
A helpful discussion has been added on the more recent available-for-use rules, and briefer discussions of some other newer rules such as in s. 16.1 also are provided. Some illuminating numerical examples have been added, e.g., on the operation of the rules under s. 13(21.1) for allocating between land and building, and the s. 13(7.5) rule re access properties.
Neal Armstrong. Summaries of S3-F4-C1 under s. 18(1)(b) – capital expenditure v. expense – improvements v. repairs or running expenses, s. 13(21) – UCC – A, s. 13(21) – depreciable property, s. 16.1(1), s. 13(28), s. 13(27), Reg. 1100(2.2). 18(3.1), s. 13(7.5), s. 261(2), s. 68, s. 13(21.1)(a), s. 13(21.1)(b), s. 8(2), s. 13(9), s. 152(4), s. 13(5), and s. 13(6).
A purported transfer of goodwill or knowhow separately from the related business may not be effective
Given a judicial view that goodwill is inseparable from the business to which it adds value, it would appear that the accrued gain on goodwill cannot be realized apart from a disposition of the business.
Knowhow might be considered to have been disposed of only if the transferor can no longer avail itself of the knowledge in question—for example, where it sells the business to which the knowledge relates. An exception may exist if the knowhow is of a type that can be clearly documented and separated from the employees who developed it.
Neal Armstrong. Summary of Alison Spiers, "ECP Planning: Some Practical Considerations", Canadian Tax Focus, Vol. 6, No. 4, November 2016, p 1 under s. 248(1) – disposition.
Having an individual hold a CFA earning FAPI through a Canco produces a modest reduction in the overall level of tax on the income distributed up to the individual
Where an Ontario individual has a 100% interest in a controlled foreign affiliate earning property income (i.e., foreign accrual property income) at a high foreign rate of tax, there will be a modest reduction in the overall rate of tax on income distributed up to him if he holds the CRA through a Canco rather than directly – and a significant deferral if funds received from the CFA by the Canco are reinvested rather than distributed to him.
Neal Armstrong. Summary of Jonah Bidner, "An Individual's Direct Ownership of a CFA," Canadian Tax Focus, Vol. 6, No. 4, November 2016, p. 12 under s. 91(1).
[corrected table] Further full-text translations of French severed letters are available
The table below links to full-text translations of the balance of the 2016 APFF Financial Strategies and Instruments CRA Roundtable questions and answers (Q.5 to Q.9) as well as of the French severed letters which were released on December 21, 2016, January 20, 2016 and January 13, 2016.
The translations are paywalled in the usual (3 work-weeks per month) manner. However, all of next week will be an “open” (non-paywalled) week.
Income Tax Severed Letters 28 December 2016
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Grimes – Tax Court of Canada finds that holding company shares should not be discounted for shareholder level exit taxes, and applies a minority discount re a NAL party’s voting control
In determining the fair market value of a trust’s shares of a Holdco wholly-owning an Opco, the Tax Court found that there should be no discount to the FMV of the Holdco shares to reflect income taxes that would be payable by the trust on a redemption by it of its Holdco shares.
One of the two individuals who was a trustee of the trust also held special voting preferred shares of Holdco in her personal capacity that represented 69% of the total Holdco voting rights. Lafleur J found that it was appropriate to apply a 12.5% minority discount to the Holdco common shares held by the trust in this light, stating that she was required to assume in the valuation exercise that only the non-controlling shares of the trust were being sold, and not the special voting shares not held by it. She also applied a further 15% “marketability discount” to the common shares’ valuation.
Finally, advances made by Opco to an individual director were treated as having a nil value because of a regular practice of eliminating such advances by way of annual bonuses.
Neal Armstrong. Summary of Grimes v. The Queen, 2016 TCC 280 under General Concepts – FMV.
Debt conversions and assumptions can operate asymmetrically as between debtor and creditor
The conversion (after addition of a conversion right) of an appreciated USD debt into prefs appears to operate in an asymmetrical manner, so that the creditor enjoys rollover treatment under s. 51, whereas the debtor realizes an FX loss under s. 39(2). Similarly, a conversion into shares on a s. 51 rollover basis nonetheless would give rise to a repayment for s. 15(2.6) purposes.
Two rulings suggest that an internal assumption (e.g., by a sub of its parent’s FX debt but without the parent being released) would give rise to a s. 39(2) gain or loss to the parent even though there would be no disposition to the creditor.
The s. 51.1 rollover requires that the principal amounts of the exchanged obligations be the same. In two rulings given after the enactment of s. 261(2)(b), CRA indicated that s. 51.1 applied to the conversion of US-dollar-denominated non-interest-bearing notes into US-dollar-denominated interest-bearing notes with the same principal amount in US dollars (but not the Canadian-dollar equivalent).
When an FX-denominated debt is repaid by issuing a replacement debt denominated in the same currency, there is an argument that no s. 39(2) gain or loss is realized. It also is unclear whether a deemed dividend arises on redemption of preferred shares having a USD-denominated stated capital.
Although CRA has considered that substitutions for s. 93(2.1) purposes are not limited to share-for-share transactions, “there seems to be a reasonable interpretation that a taxable disposition of the shares for cash (or a promissory note) should break the chain of substitutions, such that dividends paid on the original shares should no longer be relevant.”
Neal Armstrong. Summaries of Didier Fréchette and Ryan Rabinovitch, "Current Issues Involving Foreign Exchange" 2015 CTF Annual Conference paper under s. 51(1), s. 39(2), s. 51.1, s. 80(2)(k), s. 84(3), s. 84(4), s. 93(2.01), s. 93(2.1) and s. 112(3).
The expansion under s. 55(2.1)(b) of the scope of s. 55(2) has resulted in potential anomalies
Prior to the introduction of the new s. 55(2.1)(b), a Holdco could create a Subco with common shares having a fair market value equal to their adjusted cost base (by having Opco pay a stock dividend of pref shares with full paid-up capital and transferring those prefs to Subco for high basis shares of Subco) – and then have Subco declare a dividend to it of the Opco prefs, which reduces the FMV of Subco’s shares below their ACB but was not caught by the old s. 55(2) because the purpose of the dividend could not be to reduce a capital gain on the Subco shares. This increased basis in Holdco’s investment could reduce the capital gain realized by it on a subsequent arm’s length sale. New S. 55(2.1)(b)(ii)(B) would likely catch this basis creation as its purpose likely was to increase the total cost amount of Holdco’s property.
A somewhat odd result of the new s. 55(2.1)(b) is that where the FMV of the shares of Opco have temporarily declined below their ACB, the safe-income exception will not apply to a cash dividend paid by Opco, so that it is necessary to address the FMV-reduction purpose test in s. 55(2.1)(b)(ii)(A).
The legislative definition of "sate-income determination time" (which references the beginning of a series of transactions) was designed for a share sale transaction. and has not been amended to align better with the new rules. For example, if a corporation establishes a policy to distribute each year's earnings, it would be unreasonable if the dividend paid to distribute the first year's earnings triggered a safe-income determination time, thereby preventing the subsequent years' earnings from being added to safe income.
Neal Armstrong. Summaries of Rick McLean, "Subsection 55(2): What Is the New Reality?" 2015 CTF Annual Conference paper under s. 55(2.1)(b), s. 55(1) – safe income determination time, s. 55(2.3).