News of Note
CRA indicates that exempt surplus calculations must be supported by records showing that the FA’s CMC was exercised in a Treaty country
Email this ContentIn order for the net earnings of a foreign subsidiary (FA) from an active business to be included under para. (d) of the Reg. 5907(1) definition of exempt earnings in respect of the Canadian parent (Canco), FA must be resident in a “designated treaty country” (an undefined term). CRA reiterated its position that for an FA to be so resident, it not only must be resident in the country for Treaty purposes under Reg. 5907(11.2)(a) (or under variants of that test in Regs. 5907(11.2)(b) to (d)), but its central management and control (CMC) must also be exercised there.
Furthermore, in addition to surplus calculations, Canco must keep records supporting that FA is resident in the Treaty country under the CMC test. Given that CRA considers that the situs of board meetings is not necessarily dispositive of satisfying the CMC test, such information in the records should:
include information relating to the whole “course of business and trading” of the FA and, thus, not be limited to the location of board meetings or where members of the board are resident.
Neal Armstrong. Summary of 17 May 2022 IFA Roundtable, Q.6, under Reg. 5907(1) – exempt earnings – (d).
CRA states that it will deny s. 113 deductions if there is insufficient documentation to support the FA’s surplus computations
The CRA position noted at 5 May 2019 IFA Roundtable Q.9, 2019-0798761C6 is that “[i]f complete surplus computations are not provided to the CRA, the current CRA general practice is to deny the deduction under subsection 113(1)” (even if the shares of the foreign affiliate had sufficient ACB (a.k.a., pre-acquisition surplus) to cover any deficiencies in its other surplus). At the 2022 IFA Roundtable, CRA went further and stated:
If documentation is not available to accurately support surplus account calculations at the time surplus is utilized, any deduction claimed based on surplus account balances will be denied and other adjustments may also be required. …
CRA went on to list various types of documentation that it “may” require, depending on the circumstances, including non-consolidated financial statements, minute books, and tax returns of the FA and supporting documentation illuminating the nature of its business and income and related to its transactions.
Neal Armstrong. Summary of 17 May 2022 IFA Roundtable, Q.5, under s. 113(1)(d).
Income Tax Severed Letters 25 May 2022
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Marin – Tax Court of Canada confirms that FTC domestic and Treaty provisions are applied re the particular year in which the subject income was earned
France started imposing income tax on rental income as it was earned rather than the tax being payable one year in arrears, as previously. However, the taxpayer (a Canadian resident with a French rental property), like others, was granted transitional relief so that in 2019 he received a tax credit from the French government equal to the French tax otherwise payable by him on his 2018 income – so that in 2019 he only had to pay the current tax on his 2019 rental income.
He nonetheless argued in Tax Court that he should be entitled to a foreign tax credit (“FTC”) for French income tax on the rental income for his 2018 taxation year (which clearly was subject to Canadian income tax) on the grounds that he was continuing throughout to pay French income tax on an annual basis.
In rejecting this and another argument, Lafleur J confirmed:
- The reference in s. 126(1) to an FTC for non-business income tax paid “for the year” refers to the taxation year (2018) in which the income was earned giving rise to the Canadian tax for which the FTC is claimed (he paid no net French tax for 2018).
- The statement in Art. 6 of the Treaty that "[i]ncome from immovable property ... may be taxed in the Contracting State in which such property is situated" did not accord an exclusive right on France to tax his French rental income, so that Canada was not precluded from taxing it.
- Art. 23 only dealt with issues of double taxation for income, and there was no double taxation of his rental income for 2018.
Neal Armstrong. Summaries of Marin v. The Queen, 2022 CCI 49 under s. 126(7) – non-business income tax, Treaties – Income Tax Conventions, Art. 6, Art. 24.
CRA indicates that condo inventory did not qualify as “goods” under s. 95(3)(b)
Where a foreign subsidiary (“FA”) provides services to its Canadian parent (“Canco”) for which the fees are deductible in computing Canco’s Canadian business income, the net fee income of FA therefrom generally will be deemed under s. 95(2)(b) to be foreign accrual property income (FAPI) of Canco. However, there is an exclusion from the application of s. 95(2)(b) under s. 95(3)(b) where the services of FA are “performed in connection with the purchase or sale of goods.”
CRA found that the s. 95(3)(b) exclusion was unavailable where FA was providing marketing services to Canco respecting the sale of Canadian residential condominiums by Canco in the course of its Canadian business, given its conclusions that real estate inventory did not qualify as “goods.”
Neal Armstrong. Summary of 17 May 2022 IFA Roundtable, Q.3 under s. 95(3)(b).
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
S. 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.