News of Note
CRA notes that services income earned from an arm’s length CCPC could be ineligible for SBC purposes under the “specified corporate income” rules
Email this ContentCRA commented on an example of the reduction to the small business deduction that may arise under the “specified corporate income” (SCI) rules. Mr. A owned 50% of a real estate management company (Hco), which derived substantially all of its income from providing services to a corporation owned by Mrs. A with a real estate business. Hco was 50% owned by an unrelated third party, and was not associated with Wco.
CRA noted that, absent an election under s. 125(3.2), the total active business income (ABI) derived by Hco from Wco would be excluded under s. 125(1)(a)(i)(B) from its income eligible for the SBD, notwithstanding that Hco and Wco were described as dealing with each other at arm’s length. This was because (applying the two conditions in s. (a)(i)(A) of the SCI definition): Mrs. W, who had an interest in Wco, did not deal at arm’s length with a shareholder of Hco (Mr. A); and it was not the case that substantially all of Hco’s ABI was from the provision of services (or property) to persons (other than Wco) with which Hco dealt at arm’s length.
However, the ABI otherwise carved out under the SCI definition could be restored under s. 125(1)(a)(ii.1) to the extent that Wco assigned all or a portion of its business limit to Hco under s. 125(3.2).
Neal Armstrong. Summary of 20 October 2022 External T.I. 2020-0869681E5 under s. 125(7) - “specified corporate income” - s. (a)(i).
CRA indicates that the daughter of the deceased, who is his sole beneficiary and the sole executor, is not related to the estate
A non-resident estate holding the Canadian condo of the Canadian deceased and cash, sells the condo for cash and utilizes the principal residence exemption to exempt the gain, and then distributes cash to the sole beneficiary who is the U-S.-resident daughter of the deceased (who also serves as the estate’s sole executor).
After noting its general position that “where a trust distributes assets in satisfaction of a non-resident beneficiary's capital interest in the trust, the beneficiary is considered to have disposed of that interest,” CRA indicated that, unlike the taxable Canadian property definition, the test under Art. XIII(3)(b)(iii) of the Canada-U.S. Treaty as to whether the value of an interest in a trust is derived principally from real property situated in Canada was a point in time test, so that it would not matter that the cash held by the estate at the time of the distribution was derived from Canadian real estate. Accordingly, s. 116(6.1)(a) would be met because the property would be “treaty-protected property” at the time of the distribution. Furthermore, a notice was not required to be given by the daughter beneficiary under s. 116(6.1)(b) because the estate of her parent (of which she was the sole executor) was not considered to be related to her. Thus, no s. 116 certificate would be required for the distribution.
Neal Armstrong. Summaries of 25 July 2022 External T.I. 2021-0905871E5 under s. 150(1.1)(b)(iii) and s. 116(6.1).
Kone Inc. – Court of Quebec finds that a cross-border repo was not an abuse of the s. 17 rule
The taxpayer (“KQI”), which was a Canadian operating subsidiary in a group ultimately controlled by a Finnish parent, used funds that had been borrowed by a Canadian holding company in the group and advanced to KQI as an interest-bearing loan and share subscription proceeds to purchase, for a cash purchase price of $394 million, cumulative preferred shares of “Kone USA” (a group company with an active business) from the non-resident affiliated company (“Kone BV”) to which such shares had recently been issued as a stock dividend. At the same time, KQI agreed to resell such preferred shares at pre-agreed higher prices, to Kone BV in three and five years’ time, which in fact occurred. The gain arising under this resale was deemed under s. 93 to be dividends coming out of exempt surplus of Kone USA. The funds so received by Kone BV were used indirectly to fund purchases by the Kone group of targets with complementary businesses.
The ARQ sought to impute interest income to KQI under TA s. 127.6, the Quebec equivalent of ITA s. 17(1), on the basis that the above “repo” transaction was a sham that should instead be characterized as an interest-free loan by KQI to Kone BV or, alternatively, that the repo transaction represented an abusive avoidance of such s. 17 equivalent for Quebec GAAR purposes.
In rejecting the sham argument, Fournier JCQ noted that although the parties had agreed to treat the repo transaction as a secured loan by KQI to Kone BV for U.S. tax purposes, such characterization under the US “substance over form” tax doctrine did not detract from the “actual legal obligations agreed to between the parties in Canada and Quebec.”
In rejecting the application of the Quebec GAAR, he found that the required element of abuse of the s. 17-equivalent rule had not been established. He noted that such rule “contemplated blocking the exporting of income and preventing Canadian corporations from using their capital outside Canada by means of loans or advance not bearing a reasonable rate of interest and which remains unpaid for more than one year,” whereas here, no such loan or advance had occurred and KQI had “instead acquired from Kone BV the shares of Kone USA, which it had agreed to hold for a certain passage of time and to then resell them.”
Neal Armstrong. Summary of Kone Inc. v. ARQ, No. 500-80-028109-149 (Court of Quebec, 22 December 2022) under s. 245(4).
Income Tax Severed Letters 4 January 2023
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
The narrowing of the money-lending exception from the upstream loan rule may require taxpayers to take remedial action on existing upstream loans
S. 90(8)(b) provides one of the exceptions to the application of the upstream loan rule in s. 90(6), namely, for indebtedness that arose in the ordinary course of the creditor’s business (suggested to be, generally, trade accounts receivable rather than loans) or a loans made in the ordinary course of the creditor’s ordinary business of lending money, if bona fide arrangements were made, at the time the indebtedness arose or the loan was made, for repayment within a reasonable time.
The August 9, 2022 proposals would narrow the second, moneylending business, exception, while leaving the trade receivables exception intact. In particular, the proposed amendment would provide that if, at any time during which the upstream loan is outstanding, less than 90% of the aggregate outstanding amount of the loans of the business is owing by borrowers that deal at arm’s length with the lender/creditor, the money-lending business exception would not apply to the loan. (There is a similar narrowing of s. 15(2.3).)
Where there is intended reliance on the moneylending business exception, there will need to be a calculation of the percentage representing the moneylending to entities within the group, during all of the time in which the loan is outstanding – which could create difficulties if inter alia loan balances vary on a daily basis.
This amendment applies not only to loans made after 2022, but also to any portion of a particular loan made before 2023 that remains outstanding on January 1, 2023 as if that portion were a separate loan that was made on January 1, 2023 – so that taxpayers may be required to take remedial action in respect of pre-existing upstream loans.
Neal Armstrong. Summary of Audrey Dubois, “Upstream Loans: Limitation on the Scope of the Moneylending Business Exception,” International Tax Highlights, Vol. 1, No. 2 November 2022, p. 9 under s. 90(8)(b).
The scope for a suppression election is being narrowed, and a defect in the pack and sale rule is being corrected
The suppression election under s. 88(3.3) allowed a taxpayer to reduce the capital gain otherwise to be realized on the disposition of a share of a liquidating affiliate, upon a qualifying liquidation and dissolution, by electing lower proceeds of disposition on particular distributed capital properties of the liquidating affiliate.
It is proposed, effective for distributions occurring on or after August 9, 2022, that the distributed capital property for which the election may be made be limited solely to shares of another FA of the taxpayer. This amendment substantially reduces the effectiveness of the election.
Reg. 5907(2.01) potentially accommodates “pack and sale” transactions by allowing the recognition for surplus purposes of unrealized gain on a transfer from one foreign affiliate to another, newly incorporated, foreign affiliate where the shares of the new foreign affiliate are then promptly sold to a third party. A requirement for this relief is that the "only consideration received in respect of" the drop-down is shares of the new foreign affiliate.
2014-0550451E5 considered that this requirement will not be satisfied if the new foreign affiliate assumes any liabilities of the transferor FA as part of the purchase. In a delayed reaction to this interpretation, an amendment to Reg. 5907(2.01) will allow the consideration received to include “the assumption by the other affiliate of a debt or other obligation owing by the particular affiliate that arose in the ordinary course of the business of the particular affiliate to which the affiliate property relates.”
Neal Armstrong. Summaries of Samantha D’Andrea, “Packing and Unpacking Proposed Amendments,” International Tax Highlights, Vol. 1, No. 2 November 2022, p. 6 under s. 88(3.3) and Reg. 5907(2.01).
CRA rules on a post-mortem pipeline where the estate is paid off over 3 years commencing 1 year after its transfer of the subject portfolio company to Newco
CRA ruled on a post-mortem portfolio under which:
- some of the preferred shares of the subject portfolio company (Holdco) were redeemed in its hand in order to generate the recovery of Holdco’s ERDTOH and NERDTOH and a capital loss to be carried back to the deceased’s terminal year pursuant to s. 164(6)
- the estate transferred, to a “Newco” formed by it, preferred shares of Holdco in consideration for a demand note ("Note 2") of Newco and a Newco common share (apparently, its only issued and outstanding share), electing under s. 85(1).
- after a period of at least one year following such transfer, Newco may progressively repay the note at the rate of 1/3 of its principal per year, with such repayments funded through Holdco redeeming preferred shares.
- after the expiry of a specified period of years, Newco will be wound up.
Neal Armstrong. Summary of 2021 Ruling 2021-0877011R3 under s. 84(2).
We have translated 7 more CRA severed letters
We have published a translation of a ruling released by CRA two months ago and of two interpretations released by CRA two weeks ago, and a further 4 translations of CRA interpretations released in December and November of 2003. Their descriptors and links appear below.
These are additions to our set of 2,312 full-text translations of French-language Technical Interpretation and Roundtable items (plus some ruling letters) of the Income Tax Rulings Directorate, which covers all of the last 19 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
| Bundle Date | Translated severed letter | Summaries under | Summary descriptor |
|---|---|---|---|
| 2022-12-21 | 7 December 2022 External T.I. 2020-0846891E5 F - SSUC - Revenu admissible
2021-0878941E5 F is similar
|
Income Tax Act - Section 125.7 - Subsection 125.7(7) | limited partner’s share of LP revenues cannot be qualifying revenue |
| 12 December 2022 External T.I. 2021-0878941E5 F - SSUC - Revenu admissible
2020-0846891E5 F is similar
|
Income Tax Act - Section 125.7 - Subsection 125.7(1) - Qualifying Revenue | partner’s share of qualifying revenue is not qualifying revenue | |
| 2022-10-26 | 2021 Ruling 2021-0877011R3 - Post-mortem Hybrid Pipeline | Income Tax Act - Section 84 - Subsection 84(2) | note issued on post-mortem pipeline effected on portfolio company paid off over 3 years commencing 1 year after transfer by estate to Newco |
| 2003-12-05 | 14 November 2003 External T.I. 2003-0013445 F - Application de 94(1) et 128.1(1)
Also released under document number 2003-00134450.
|
Income Tax Act - Section 128.1 - Subsection 128.1(1) - Paragraph 128.1(1)(a) | application of s. 94 subject to prior to application of s. 128.1(a)(a) |
| 29 September 2003 External T.I. 2003-0013435 F - Pension Belge
Also released under document number 2003-00134350.
|
Treaties - Income Tax Conventions - Article 18 | Belgian National Pensions Office was a Belgian government instrumentality for purposes of the former Art. 18(2) exemption | |
| 2003-11-28 | 19 November 2003 Internal T.I. 2003-0047687 F - Interest Calculation T/P Adjustment RQST
Also released under document number 2003-00476870.
|
Income Tax Act - Section 161 - Subsection 161(7) - Paragraph 161(7)(a) - Subparagraph 161(7)(a)(iv) | substitution of NCL carrybacks with CCA claims for nil assessment taxation years does not generate s. 161(1) interest |
| Income Tax Act - Section 161 - Subsection 161(1) | substitution of NCL carrybacks with CCA claims for nil assessment taxation years does not generate s. 161(1) interest | ||
| 18 November 2003 External T.I. 2003-0181195 F - REGLEMENT STRUCTURE
Also released under document number 2003-01811950.
|
Income Tax Act - Section 56 - Subsection 56(1) - Paragraph 56(1)(d) | CCRA position on exemption of structured settlements (as described) extends to court-ordered personal injury payments | |
| Income Tax Act - Section 3 - Paragraph 3(a) | summary of CCRA position on structured settlements |
The proposed version of s. 85.1(4) is overly broad
The current version of s. 85.1(4) avoids deferral of the capital gain that would otherwise be realized on the outright sale of a directly held FA (the first affiliate) through transferring it under s. 85.1(3) to a second affiliate, which then sells the first affiliate shares to a subsequent acquiror – where the first affiliate shares are excluded property so that such sale occurs on a deferred basis.
Under the proposed expanded version of s. 85.1(4) released on August 9, 2022, its application will extend to a subsequent disposition of any property that is substituted for the share of the first affiliate, as well as any other property any of the FMV of which is derived, directly or indirectly, from the first affiliate shares is inappropriately broad.
For example, the transfer of the first affiliate from a Canadian corporation to a second affiliate followed by an outright sale of the second affiliate by the Canadian corporation is caught, even where such subsequent disposition is fully taxable in Canada.
Second, the transfer of the first affiliate by a Canadian corporation to a second affiliate, followed by an outright sale of the Canadian corporation by its shareholders, is caught because the FMV of the Canadian corporation’s shares is derived, in part, from that of the first affiliate shares.
Third, if all of the first affiliate shares are transferred to the second affiliate for 100 shares of the second affiliate, and then to the third affiliate for 100 shares of the third affiliate, following which only one share of the second affiliate is sold to a subsequent acquiror, rollover treatment would be denied for all (rather than only 1/100) of the first affiliate shares because the single share derived a portion of its FMV from each first affiliate share.
The current purpose test is eliminated under proposed s. 85.1(4). Instead, there is simply a requirement that the initial transfer be part of a series of transactions that includes another disposition of the first affiliate shares (or certain other properties that derive a portion of their value from such shares.) This means that reference must now be made to the fraught concept of a series under Copthorne.
Neal Armstrong. Summary of David Bunn and Mark Dumalski, “Proposed Amendments to Subsection 85.1(4),” International Tax Highlights, Vol. 1, No. 2 November 2022, p. 6 under s. 85.1(4).
The new s. 95(3.03) safe harbour from s. 95(2)(b)(i) raises issues as to which FA is the recipient of the inter-FA management services
Draft s. 95(3.03) would provide an exception to the application of s. 95(2)(b)(i), which otherwise would deem, say, a management fee paid by one FA to another FA in which the taxpayer also has a qualifying interest to be FAPI to the recipient FA if it was deductible in computing the payer FA’s FAPI. S 95(3.03) sets out conditions that are largely analogous to those in s. 95(2)(a)(ii)(D), so that one of the requirements is that the recipient FA of the management fee provide the related services to the FA paying the fee.
Draft s. 95(3.03) appears to arise out of a comfort letter addressing the situation where an FA (“FA 1”) of a taxpayer provides management services “in respect of” another FA of the taxpayer (“FA Opco”) carrying on an active business and whose shares are held by the taxpayer through “FA Holdco.” The management fee received by FA 1 for its services is paid by FA Holdco rather than FA Opco, because other shareholders of FA Opco are unwilling to bear the fee.
Rather ironically, s. 95(3.03) would not provide relief in the comfort letter situation if FA 1 were regarded as providing its management services to FA Opco rather than to FA Holdco. (The ITA does not, at least explicitly, have a rule similar to the ETA rule that the “recipient” of a supply generally is the person who has agreed to pay for it.)
Neal Armstrong. Summary of Silvia Wang and Clara Pham, ‘The Amended Service FAPI Rule: New Relief Available,” International Tax Highlights, Vol. 1, No. 2 November 2022, p. 8 under s. 95(3.03).