News of Note
Joint Committee comments on the draft hybrid mismatch arrangements proposals
Email this ContentComments of the Joint Committee on the draft hybrid mismatch arrangements proposals include:
- Where a dividend is subject to the denial of the s. 113 deduction, by s. 113(5), for a dividend received from a foreign affiliate, no deduction is available under s. 113(1) for foreign withholding tax paid on the dividend, and the dividend remains “income from a share of the capital stock of a foreign affiliate of the taxpayer”, such that no foreign tax credit under s. 126(1) nor deduction under s. 20(12) is available for the foreign withholding tax paid on the dividend. It is recommended that relief be provided for foreign withholding tax paid on dividends that are subject to s. 113(5) by modifying it to allow grossed-up deductions for such withholding tax.
- Where, for example, a FAPI-earning controlled foreign affiliate has issued a financial instrument that is treated as debt from a Canadian perspective and as equity from a foreign tax perspective, it seems inappropriate to deny a deduction in computing such FAPI through an extension to such context of the proposed hybrid mismatch rules, given that if this instrument had instead been treated as equity from a Canadian perspective, such that there would not have been any deduction in computing FAPI for the “interest” payments, the existence of the instrument would have in any event resulted in a reduction of the Canadian taxpayer’s participating percentage in respect of the affiliate, and thus a corresponding reduction of attributed FAPI. It is recommended that s. 95(2)(f.11)(ii)(A) be expanded to exclude the application of ss. 12.7 and 18.4 in computing a foreign affiliate’s income from property, income from a business other than an active business and income from a non qualifying business.
- It should be clarified that there would not be considered to be a hybrid mismatch if, for example, a taxpayer borrows money at interest from a third party for the purpose of making an interest-bearing loan to a foreign subsidiary, i.e., the fact that the interest on this borrowing “shelters” the Canadian interest income should not be considered to give rise to a non-inclusion situation.
- There is potential double taxation under the draft rules through considering there to be a mismatch where the amount is deductible (but not actually deducted) in the foreign jurisdiction, e.g., under draft s. 18.4(9).
- S. 20(1)(yy) only relieves where the application of the hybrid mismatch rules results in the denial of a deduction under s. 18.4(4), and not where there is an income inclusion under s. 12.7(3), i.e., if a payment under a hybrid mismatch arrangement produces a foreign tax deduction in a particular foreign taxation year, and Canadian ordinary income in a taxation year beginning more than 12 months after the end of the particular year, the recipient of the payment is required to include an amount in its income under s. 12.7(3), notwithstanding that an amount is also included in Canadian ordinary income under the general Canadian income tax rules.
- Where s. 18.4(4) denies a deduction for an amount paid as interest, s. 214(18) deems such amount to have been paid as a dividend for Part XIII purposes. Where a deduction is subsequently provided under s. 20(1)(yy) (i.e., because such amount is demonstrated to be foreign ordinary income that has not previously been taken into account), the draft rules do not currently provide for any refund or reduction of the withholding tax that would result from such deemed dividend treatment.
Neal Armstrong. Summaries of Joint Committee, “Hybrid Mismatch Arrangements Proposals,” 30 June 2022 Submission of the Joint Committee under s. 113(5), s. 18.4(1) – Canadian ordinary income – (a)(iii), specified entity, s. 18.4(3), s. 18.4(9), s. 12.7(3) and s. 227(6.1).
CRA tries to make sense of the Bill C-208 provisions
CRA has adopted a number of interpretations of s. 84.1(2.3), which modifies the rule in s. 84.1(2)(e) for exempting, from the application of s. 84.1, certain transfers of QSBC shares or family farm or fishing corporation shares by the taxpayer to a purchaser corporation that is controlled by one or more adult children or grandchildren of the taxpayer.
S. 84.1(2.3)(a) provides that, for the purposes of s. 84.1(2)(e):
(a) if, otherwise than by reason of death, the purchaser corporation disposes of the subject shares within 60 months of their purchase:
(i) paragraph [84.1](2)(e)] is deemed never to have applied, [and]
(ii) the taxpayer is deemed, for the purposes of [s. 84.1], to have disposed of the subject shares to the person who acquired them from the purchaser corporation … .
Regarding the meaning “by reason of death,” CRA stated that it:
would look for a causal link between the death and the subsequent disposition of the shares by the purchaser corporation. For example, the death of an individual may make it impractical or difficult to continue under the current ownership and may precipitate the subsequent sale of the subject shares.
It indicated that, for example, this causal link likely could be established if, following the death of the child wholly-owning the purchaser corporation, her estate sold the QSBC shares back to the taxpayer within the 60-month period.
Regarding how to apply 84.1(2.3)(a)(ii) if the “by reason of death” exclusion did not apply, CRA indicated that it would then determine whether s. 84.1 applied to the initial disposition to the child or grandchild corporation on the basis of whether s. 84.1 would have applied to the subsequent purchaser. Thus if the subsequent purchaser was a third party who dealt at arm’s length with the taxpayer or (to return to the example above) was the taxpayer himself, so that s. 84.1 could not have applied to such a purchaser, s. 84.1 will be considered not to have applied to the disposition by the taxpayer to the child or grandchild corporation.
CRA confirmed that the purported numerical limitation on the s. 110.6(2) or (2.1) capital gains deduction (based inter alia on the level of the corporation’s taxable capital employed in Canada) set out in s. 84.1(2.3)(b) is meaningless and has no application because it is stated to apply only for the purposes of s. 84.1(2)(e).
Regarding s. 84.1(2.3)(c), which provides that the taxpayer must provide the Minister with an independent assessment of the FMV of the subject shares and an affidavit signed by the taxpayer and a third party attesting to the disposal of the shares, CRA stated:
[T]he documentary requirements are integral to the application of paragraph 84.1(2)(e) of the Act. That is, these requirements must be met for paragraph 84.1(2)(e) to apply.
Neal Armstrong. Summaries of 3 May 2022 CALU Roundtable Q. 3, 2022-0928721C6 under s. 84.1(2.3)(a), s. 84.1(2.3)(b) and s. 84.1(2.3)(c).
We have translated 8 more CRA interpretations
We have published a further 8 translations of CRA interpretations released in October of 2004. Their descriptors and links appear below.
These are additions to our set of 2,125 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 ¾ years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
Sabex (a.k.a., 3295940) – Tax Court of Canada finds that a circular use of capital dividends abused s. 55(2) and the purpose of the CDA
The taxpayer (3295940) was a holding company holding a shareholding in a Target with a low ACB (even after using safe income on hand to step up such ACB), whereas the holding company (Micsau) holding shares in 3295940 had a high ACB for its shares. Unfortunately, the third-party purchaser (Novartis) was unwilling to acquire the shares in the capital of 3295940 (due to potential liabilities), and was only interested in acquiring shares from 3295940 itself.
Under the plan to try to address this:
- Micsau created a sister company (4244) to 3295940 to which it transferred newly-created pref shares of 3295940 having full ACB in exchange for full-ACB shares of 4244.
- 3295940 then transferred its Target shares to 4244 on a partial s. 85 rollover basis, so that it effectively realized a capital gain corresponding to high-ACB prefs received by it from 4244, and also took back common shares of 4244 with a high FMV and nominal ACB.
- 3295940 redeemed the prefs held by 4244 for a $31.5M note, and elected for the resulting $31.5M deemed dividend to be a capital dividend paid to 4244.
- 4244 redeemed $31.5M of the low-ACB common shares that it had issued to 3295940 in Step 2 for a $31.5M note, and elected for the resulting $31.5M deemed dividend to be a capital dividend paid to 3295940.
- Then the two notes were set off, Micsau transferred its shares of 4244 to 3295940, and 3295940 sold the shares of 4244 to Novartis at no further capital gain.
Favreau J noted that the total capital gain realized by 3295940 (on Step 2) was $31.5M lower than if 3295940 had simply sold its shares of Target outright to Novartis. He considered that, normatively, 3295940 should have been caused by s. 55(2) to have realized a capital gain of $31.5M on Step 4. However, this result was avoided because the resulting deemed dividend paid to 3295940 was a capital dividend (representing a recycling of CDA that had originated with it) rather than a taxable dividend that would then have been converted by s. 55(2) to a capital gain. This represent a GAAR abuse of ss. 55(2) and the capital dividend system. He stated:
The capital dividend was used in a way that is not consistent with its purpose: instead of allowing tax-free amounts to flow upwards in the corporate group, the amount circulated back to its starting point, in the hands of 3295940.
This recycling of the capital dividend prevented subsection 55(2) from applying and converting the deemed dividend paid by 4244 to 3295940 into a capital gain. The application of subsection 55(2) would have allowed the entire appreciation in value of the Holdings shares to be taxed, thereby preserving the integrity of the capital gains tax regime.
Regarding the taxpayer’s submission that it was appropriate for it to effectively access the high ACB of Micsau in the shares of 3295940, Favreau J noted that, in light of s. 88(1)(d.2), Micsau could not have used s. 88(1)(d) to bump the low ACB of the shares of Holdings to 3295940, and stated that 3295940 “reached the same result as if there had been a bump of the shares held by it, but without having to satisfy the required conditions.”
Regarding the submission of the taxpayer that (but for commercial roadblocks) it could have achieved a similar result by more directly using the high ACB of Micsau in 3295940, he stated:
[I]t was demonstrated that the sale of [the Target] shares was paramount. That being the case, the alternative transactions involving the sale of 3295940 shares cannot be submitted for comparison … .
Neal Armstrong. Summary of 3295940 Canada Inc. (formerly, Sabex Inc.) v. The Queen, 2022 CCI 68 under s. 245(4).
Grewal – Federal Court of Appeal confirms that a voluntary disclosure which included loans did not stop CRA from later applying s. 163(2) for failure to include them in income
A voluntary disclosure included a description of various loans, but did not volunteer that they gave rise to taxable benefits. After the voluntary disclosure was accepted through reassessments, a subsequent audit of one of the taxpayer’s companies caused CRA to conclude that these loans gave rise to additional income under s. 246(1) of over $14M to the taxpayer for years that had been covered by the voluntary disclosure, and CRA not only reassessed for these s. 246(1) benefits, but also for significant gross negligence penalties.
In confirming the Federal Court’s dismissal of the taxpayer’s application for judicial review of the decision to impose the penalties, Laskin JA stated:
[T]he appellant’s submissions, if accepted, would place this taxpayer in a better position than that of other taxpayers who did not avail themselves of the VDP. When a taxpayer makes use of the VDP, the taxpayer can still be audited and the taxpayer’s filings can still be assessed like those of any other taxpayer. Additional tax, interest, and penalties arising from the failure to disclose income may be due. The appellant’s submissions, if accepted, would restrict the Minister’s ability to assess penalties in these circumstances. …
Neal Armstrong. Summary of Grewal v. Canada (Attorney General), 2022 FCA 114 under s. 163(2).
CRA confirms that splitting long hours between many companies can result in loss of the s. 120.4(1.1)(a) TOSI safe harbour
A husband and wife owning a number of corporations, each of which has its own business and full-time staff, work on a full-time basis for the various companies (whose shares are not excluded shares), but do not work for any particular company at least 20 hours a week. Would dividends above a reasonable amount be subject to the tax on split income (“TOSI”)?
After confirming that neither spouse would thus satisfy the 20-hour test in s. 120.4(1.1)(a), CRA turned to the “excluded business” safe harbor, and indicated that the greater the involvement in the management or current activity of the business, the more likely it is that the individual will be considered to participate in the business on a regular, continuous and substantial basis; and that the more an individual’s contributions are integral to the success of the business, the more substantial they would be.
CRA did not reach any conclusion, but this sounds encouraging.
Neal Armstrong. Summaries of 15 June 2022 STEP Roundtable, Q.8 under s. 120.4(1.1)(a) and s. 120.4(1) - excluded business.
Income Tax Severed Letters 29 June 2022
This morning's release of 10 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA takes an expansive view of what constitutes “double non-taxation” in its revised TPM on s. 247(10)
CRA has replaced TPM-03 (regarding downward adjustments under s. 247(10)) by TPM-03R. It added the following statement of general principle, along with elaborations thereof:
Downward transfer pricing adjustments are not intended to serve as a vehicle for taxpayers to implement retroactive tax planning or base erosion and profit shifting strategies, nor are they intended to achieve double non-taxation.
It was inferable from the position taken by CRA in Dow Chemical that it considers there to be “double non-taxation” even if the downward adjustment requested of it corresponds to an income inclusion in the foreign jurisdiction which is now statute-barred. CRA provides a more elaborate example in TPM-03R indicating that it also considers there to be double non-taxation if the downward adjustment requested of it corresponds to an income inclusion in the foreign jurisdiction that is sheltered by a loss created through a corporate reorganization.
As compared to TPM-03, CRA has removed a number of examples regarding repatriations and secondary adjustments. This topic is now principally addressed in TPM-02R. CRA has also elaborated on who within CRA has the authority to decide on requested downward adjustments of various types.
Neal Armstrong. Summary of Memorandum TPM-03 "Downward Transfer Pricing Adjustments, 21 June 2022 under s. 247(10).
CRA indicates that an alter ego trust, with planning, can use s. 88(1)(d.3) for post-mortem bumps
2009-0350491R3 ruled on the usebyf an alter ego trust of the s. 88(1)(d) bump following the death of its settlor and life beneficiary (Mr. X). At the time of his death, the trust held a holding company (Xco) with a number of subsidiaries. In the absence of some advance planning, the trust would not have been able to take advantage of the step-up in the ACB of the shares of Xco on the death of Mr. X by transferring its Xco shares to a Newco formed by it, and causing Xco to be wound-up with a view to having the tax basis of the subsidiaries’ shares bumped under s. 88(1)(d). The reason: ss. 88(1)(d.2) and 88(1)(d)(ii)(A) would generally (assuming typical circumstances) deem the ACB of the Xco shares to instead equal their historical cost.
The planning solution: the trust deed for the alter ego trust directed that such sale to Newco followed by Xco’s winding-up would occur following Mr. X’s death. On this basis, the parent (Newco) acquired the subsidiary (Xco) as a consequence of Mr. X’s death, so that s. 88(1)(d.3) relieved from the above provisions and permitted the bump rules to use the stepped-up ACB of the Xco shares. The CRA ruling summary stated:
Shares of subsidiary are acquired as a consequence of death pursuant to the directions of the settlor in the terms governing the alter ego trust, trustees of the alter ego trust under equitable obligation to transfer shares of subsidiary to parent on the death of the settlor.
CRA now confirmed that it “has not modified its views on the application of s. 88(1)(d.3) in the circumstances described in that document.”
It also indicated that the deemed reacquisition, pursuant to s. 104(4), of the Xco shares on the death of the settlor of the alter ego trust (Mr. X) would not have resulted in an acquisition of control of the corporation by the alter ego trust as “a consequence of the death of [the] individual,” stating that such deemed re-acquisition would not detract from the shares continuing to be legally owned by the trust, so there would be no transfer of the legal ownership of those shares that would result in an acquisition of control.
Neal Armstrong. Summaries of 15 June 2022 STEP Roundtable, Q.7 under s. 88(1)(d.3) and s. 104(4)(a.4).
We have translated 8 more CRA interpretations
We have published a further 8 translations of CRA interpretation released in October of 2004. Their descriptors and links appear below.
These are additions to our set of 2,117 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 2/3 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).