News of Note
CRA requires the allocation by arm’s length parties of a royalty between copyright and trademark to be “reasonable and realistic” for Pt. XIII purposes
Email this ContentS. 68 only applies to the allocation of proceeds of disposition, fees or restrictive covenant payments for Part I purposes. Therefore, CRA is bound, for Part XIII tax purposes, by the apportionment of a royalty payment between copyright (exempted under s. 212(1)(d)(vi)) and trademarks agreed to by arm’s length parties in a royalty agreement respecting property that is protected by both trademark and copyright (a “mixed contract”)?
CRA stated:
An apportionment of a royalty payment agreed to by arm’s length parties under a mixed contract, to the extent that it is reasonable and realistic, in the sense that it is reflective of the actual consideration paid for a copyright described under subparagraph 212(1)(d)(vi), will generally be accepted by the CRA. …
In determining if an apportionment provided under a mixed contract is reflective of the obligation of the parties under subsection 212(1), consideration would be given, amongst others, to the terms of the mixed contract and to whether the parties have divergent interests in respect of this apportionment. Where the payor is economically indifferent to the apportionment, the apportionment provided under the terms of the mixed contract might not be reasonable, realistic and reflective of the tax obligation of the recipient under subsection 212(1)(d) and the CRA might determine that a different portion of the payment is subject to withholding tax.
Neal Armstrong. Summary of 17 May 2022 IFA Roundtable, Q.2 under s. 212(1)(d)(vi).
We have translated 8 more CRA interpretations
We have published a further 8 translations of CRA interpretation released in December of 2004. Their descriptors and links appear below.
These are additions to our set of 2,047 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 17 1/3 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
Finance notes areas of potential change to the EIFEL rules
At Tuesday's IFA Finance Roundtable, Finance did not have time to list all the areas where it is considering (or has decided) to recommend changes or refinements to the “EIFEL” (interest-deductibility) rules.
Before getting to those areas, Finance indicated that it had a distinct preference for not providing sector-specific exemptions, e.g., for real estate, infrastructure, utilities, or P3 projects. It also indicated skepticism that deferral of the implementation date by one year was needed.
Potential changes listed were:
- Finance is considering requests to increase, under the “excluded entity” rules, the threshold limit for CCPCs that are exempted from the EIFEL rules from the existing limit of $15 million of taxable capital employed in Canada to $50 million - and also to increase the de minimis threshold for application of the rules from the proposed annual group-wide net interest expense limit of $250,000 to something higher that would be more in line with the de minimis threshold in other countries under their Action 4 regimes.
- Finance is aware that the draft “excluded entity” exemption from the EIFEL rules for domestic entities or groups is quite narrow, e.g., the requirement that all or substantially all of the interest and financing expenses of an entity be paid to persons other than tax-indifferent investors, and is exploring some ways that they could be potentially relaxed without compromising the integrity of the rules – and is also interested in exploring whether most of the requests for specific carve-outs, for sectors or types of businesses, could be appropriately dealt with, through an expansion of the excluded entity definition, and of the availability of the group ratio rule.
- Regarding requests for relief regarding the haircut that applies in the case of ratios over 40% under the group ratio rules, Finance noted that the haircut was intended to address inflated ratios that can result where there are loss or negative entities in a consolidated group, and indicated that it will explore whether that particular concern can be addressed in a more targeted way.
- It is considering how financial institutions might potentially be permitted to transfer their excess capacity to other group entities in some circumstances.
- Finance is amenable to providing some guidance in the Explanatory Notes as to transactions targeted by the specific EIFEL anti-avoidance rules, and also recognizes the need to clarify that certain transactions are not intended to be caught, such as typical loss consolidations.
- Finance is now considering potentially providing an add-back in respect of resource expense pool deductions in determining adjusted taxable income.
- Finance has received helpful submissions on potential design options for the application of the EIFEL rules in relation to foreign affiliates and indicated that it was always its intention to add specific rules addressing this issue in the final legislation, and is now working on this.
- The draft EIFEL rules were not intended to interfere with a group borrowing from an arm’s length lender at the parent level, and on-lending to, e.g., a foreign subsidiary to fund the subsidiary’s active business, with the resulting interest income reducing the parent’s net interest expense. Draft s. 18.2(12) had an unintended result in this regard, which Finance intends to correct.
Paletta – Federal Court of Appeal finds that straddle trading, with an appearance of commerciality but not engaged in for profit, was not a business
In order that he could shelter most or all of his income for an extended period of years, Paletta entered into an FX straddle-trading program, with each straddle entailing both a “long leg”, and a matching “short leg” that established a short position (under which he agreed to sell the same currency on a slightly different (future) value date), so that he was almost completely hedged - and then, near each year end, realized the targeted loss by closing out whichever of the long and short legs at that time was the loss leg of the straddle. The corresponding gain leg was closed out at the beginning of the next year. In that following year, the same trading pattern was repeated but on a larger scale, given that the entire gain from closing out, in that year, the gain leg from the previous year’s trading needed to be offset in addition to his other taxable income for that year.
After noting the Tax Court’s factual findings that the taxpayer had no intention to profit from these “trades” and that their only purpose was the realization of the losses for tax purposes, Noël C.J. found that the taxpayer’s straddle trading activity was not a business or other source of income, so that the claimed losses were not deductible. In this regard, he indicated that “where as is the case here, the evidence reveals that, despite the appearances of commerciality, the activity is not in fact conducted with a view to profit, a business or property source cannot be found to exist.”
Noël C.J. went on to confirm the imposition of gross negligence penalties. He noted that although Paletta had informally consulted on three separate occasions with three well-known tax lawyers, it appeared that “Mr. Paletta … presented the plan as not being materially different from the one that was in issue in Friedberg” whereas “the facts in Friedberg were fundamentally different as Mr. Friedberg was conducting his trading activities for profit whereas Mr. Paletta’s sole purpose was tax avoidance.” Indeed, “no minimally competent tax lawyer could have sanctioned Mr. Paletta’s plan to portray his trades as a business, if informed that he was making these trades not for profit but for the sole purpose of generating tax losses in order to avoid paying taxes.”
Neal Armstrong. Summaries of Canada v. Paletta, 2022 FCA 86 under s. 3(a) – business source, s. 163(2), s. 248(1) - business and s. 152(4)(a)(i).
Income Tax Severed Letters 18 May 2022
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA indicates that “habitual abode” is determined in context based inter alia on relative stays and nature of activities
We have published a summary of today’s IFA Roundtable.
Q.1 was on how CRA applies the test of an in individual’s “habitual mode” under the “tie breaker” rules in most treaties. CRA responded that length of stays, and the nature of the activities, of the individual in each jurisdiction would have to be considered, to determine whether the individual usually lives in one state as compared to the other, and that the relevance of particular lengths of time would need to be considered in the circumstances: no set periods of time were applied as tests.
Neal Armstrong. Summaries of 17 May 2022 IFA Roundtable, Q.1 under Treaties - Income Tax Conventions – Art. 4 and ITA s. 2(1).
Jefferson – Federal Court of Appeal indicates that a taxpayer had not “demolished” the Minister’s assumption where it is demonstrated to be somewhat incorrect
The taxpayer relied on a statement in Hickman that the “initial onus of ‘demolishing’ the Minister’s exact assumptions is met where the appellant makes out at least a prima facie case.” He argued that since he had established that around ¼ of the payments received by him as cheques from a corporation, with which he did not deal at arm’s length, properly reimbursed him for business expenses, he had demolished the Minister’s “exact” assumption made in assessing him under s. 160 that the taxpayer had “provided no consideration for the cheques.”
In rejecting this position, Monaghan JA stated that the taxpayer “places far too much emphasis on the word ‘exact’ and gives insufficient weight to the word ‘demolish’ in … Hickman.” and further stated that “establishing some consideration for the cheques is not sufficient to demolish the Minister’s assumption,” noting in this regard that the “purpose of pleading the assumption is to provide the appellant with notice of the case the appellant has to meet” and here, the taxpayer knew that, in the context of a s. 160 assessment, he needed to establish that he had provided fair market consideration for the cheques, “not merely some consideration.”
Neal Armstrong. Summary of Jefferson v. Canada, 2022 FCA 81 under General Concepts – Onus.
We have translated 9 more CRA interpretations
We have published a translation of a CRA ruling released last week and a further 8 translations of CRA interpretation released in December of 2004. Their descriptors and links appear below.
These are additions to our set of 2,039 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 17 1/3 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
CRA rules on a pipeline involving a deferred distribution of portfolio assets from the corporation held on death
CRA labelled it a “post-mortem hybrid pipeline,” so that must have been what it was despite an unusual form.
An individual died holding shares of a portfolio investment company (“Investments”) directly and through a holding company (“Newco”), so that the estate acquired those shares with their basis stepped up under s. 70(5). Investments redeemed various shares held by the estate for a note (giving rise to deemed dividends and capital losses which were carried back under s. 164(6)), and the estate then disposed of all its shares of Investments to Newco in consideration for a further note. Investments then sold its stock market investments to the estate beneficiaries (four testamentary trusts) for four trust notes.
It was now proposed that Investments be wound-up into Newco under s. 88(1), and that the estate distribute, to its beneficiaries, most of the Newco notes owing to it by Newco, with the beneficiaries (the four trusts) then presumably using these notes as the currency to settle the trust notes owing by them to Newco. Newco would then by wound-up into the estate pursuant to s. 88(2).
Neal Armstrong. Summary of 2021 Ruling 2020-0865901R3 F under s. 84(2).
National R&D – Federal Court of Appeal confirms the need for use of the scientific method in SR&ED
Rennie JA confirmed that, as set out in Northwest Hydraulic, the scientific method was required to be followed in order for work to qualify as SR&ED. The Tax Court judge “did not take a narrow or restrictive approach to what evidence might be encompassed by the scientific method,” and she had “noted that ‘what is important’ is there be the formulation of hypothesis, testing of those hypotheses and recording of results in a systematic manner.”
In contrast, here, the taxpayer “did not conduct its work in a methodical manner and did not keep adequate records.” The denial of its investment tax credit claims was confirmed.
Neal Armstrong. Summary of National R&D Inc. v. Canada, 2022 FCA 72 under s. 248(1) - SR&ED.