News of Note

Hunt – Tax Court of Canada finds that the advantage tax is a tax, not a penalty

S. 207.05 imposes the 100% advantage tax on the controlling individual of a registered plan, and s. 207.06 authorizes the Minister to waive such tax having regard to listed criteria. The following Rule 58 question was posed to Bocock J:

Is the charge imposed by either or both of sections 207.05 and 207.06 of the Act in law a penalty or a tax?

Bocock J appeared to accept that the relevant context for this question was that “[i]f section 207.05 were a penalty, a due diligence defence applies, and a successful defence renders non-qualified income free of tax,” i.e., if the provision imposed a penalty there would be a due diligence defence rather than any relief being confined to that potentially provided under s. 207.06. However, he went on to find that the provisions did not impose a penalty given inter alia that the “tax” was labelled as such and given that although “a tax may have characteristics so clearly coercive and disproportionate that one concludes it is a penalty … this case does not meet that standard.”

He also found that the discretion accorded to the Minister under in s. 207.06 (being a constrained rather than unfettered discretion) did not have the effect of improperly delegating to the Minister a tax-rate setting discretion contrary to s. 53 of the Constitution Act, 1867.

Neal Armstrong. Summaries of Hunt v. The Queen, 2022 TCC 672022 TCC 67 under s. 207.05(2) and Constitution Act, 1867, s. 53.

CRA accepts that interest-free loans by a limited partner to the LP, or to wholly-owned subs which directly or indirectly hold such LP, can be a good s. 20(1)(c)(i) current use

Folio S3-F6-C1, para. 1.55 states that, generally, a deduction for interest will be allowed if borrowed money is used to make an interest-free loan to a wholly-owned corporation or in cases of multiple shareholders, where shareholders make an interest-free loan in proportion to their shareholdings and the proceeds of the interest-free loan have an effect on the corporation's income-earning capacity. CRA has acknowledged extensions of this policy, for instance where a corporation uses proceeds of a bank loan to make an interest-free loan to limited partnerships carrying on business of which it is the 99.9% limited partner and a wholly-owned subsidiary is the general partner (provided it is shown that such loans “to the LPs affect [its] ability to earn income from the LPs”).

Second, regarding where the bank loan is received by a corporation at the top of a stack of corporations (e.g., by Aco, which holds Bco, which holds Cco, which holds Dco, the holder of the limited partnership interests) and Aco uses the loan proceeds to directly or indirectly make an interest-free loan to the LPs (e.g., making such loan to Dco which, in turn, makes interest-free loans to the LPs, or to Bco, with back-to-back interest free loans made all the way down the stack), CRA stated:

[I]n light of … Canadian Helicopters, the fact that the taxpayer's income is derived from dividends from stacked corporations should not be a factor that … prevents a taxpayer from relying on the direct use of borrowed funds exception to make an interest-free loan.

[I]t would be necessary to assess … whether the interest-free loans made by Aco to the LP, Bco or Dco … affect Aco's ability to earn income.

Neal Armstrong. Summary of 10 February 2022 External T.I. 2021-0912581E5 F under s. 20(1)(c)(i).

CRA indicates that a s. 164(6) amendment must be made through filing an amended return, not a T1 Adjustment Request

The conditions for allowing capital losses of a graduated rate estate in its first taxation year to be considered capital losses of the deceased pursuant to s. 164(6) include that an election is filed, and the legal representative amend the deceased’s final T1 return of income. CRA indicated that to make the election, s. 164(6)(e) requires the legal representative to file an amended final T1 return of income for the deceased taxpayer to give effect to the election made under s. 164(6)(c). Filing a T1 adjustment request is not sufficient.

Neal Armstrong. Summaries of 15 June 2022 STEP Roundtable, Q.13 under s. 164(6)(e) and s. 164(3).

CRA finds that allowable capital losses are not grossed up when applied against capital gains that are grossed up under s. 100(1)(b)

It was suggested to the Directorate that where taxable capital gains had been increased to 100% of the capital gains amount pursuant to s. 100(1)(b), allowable capital losses that were carried back or forward to be deducted from such taxable capital gains pursuant to s. 111(1)(b) should also be effectively increased to 100% of the capital losses that had generated them. The Directorate disagreed, stating:

While paragraph 100(1)(b) deems a higher amount of a taxable capital gain from the disposition of a partnership interest to be included in income, it does so by ignoring and not adjusting the fraction under section 38 for purposes of determining the allowable capital loss (or taxable capital gains). The amount of the allowable capital loss … is then still determined under the ordinary rules in section 38.

Neal Armstrong. Summary of 21 September 2021 Internal T.I. 2021-0907861I7 under s. 111(1.1)(a)(ii).

Income Tax Severed Letters 13 July 2022

This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.

CRA indicates that the s. 73(1) rollover can apply to a sale for cash proceeds at a gain over ACB

After having previously settled an alter ego trust, the settlor sells non-depreciable capital property to the Trust for cash proceeds exceeding the property’s adjusted cost base. CRA indicated that such receipt of cash sale proceeds would not preclude the s. 73(1) rollover from applying – and that the answer would not change if the settlor subsequently gifted the cash proceeds to an adult child.

Neal Armstrong. Summary of 15 June 2022 STEP Roundtable, Q.12 under s. 73(1).

CRA indicates that the s. 73(1) rollover applies to non-jointly contributed property of a spouse to a joint spousal trust, and that s. 75(2) does not apply to 2nd-generation income

CRA confirmed that once a joint spousal or common-law partner trust is created with a contribution of jointly-owned property by an individual and the individual’s spouse or common-law partner, a subsequent contribution to that trust can be made solely by one of the spouses or partners and still be eligible for the s. 73(1) rollover.

Where each spouse/partner is a discretionary capital beneficiary such that s. 75(2) applies to both, CRA went on to indicate that s. 75(2) does not apply to second-generation income, because this income is not earned on property that was contributed to the trust, or property substituted therefor. For example, if the property received by the trust from a person is cash, and that cash is deposited by the trust into a bank account, the interest on the initial deposit would attribute to that person; but any interest earned on the interest left to accumulate in the bank account would not attribute.

Neal Armstrong. Summaries of 15 June 2022 STEP Roundtable, Q.11 under s. 73(1.01)(c)(iii) and s. 75(2).

Jackman – Tax Court of Canada finds that the use of corporate yacht for marketing involving socializing did not generate a shareholder benefit

The individual shareholder of a corporation (“C.A.B.”), that owned a marina on Vancouver Island, used a 36-foot yacht to stay at other marinas and at boat shows, where he would mingle socially with the boaters and promote the use of the C.A.B. marina (as well as operating a promotional booth, when at a boat show). Personal use (e.g., taking friends or family out for whale watching) was only occasional, and Boyle J found that the personal use was around 5%, so that the charge paid by the taxpayer for such personal use of $18,000 per annum was reasonable. There was no shareholder benefit.

Boyle J stated:

Once it is established that business marketing activities were bona fide and primarily undertaken for business purposes, and that the expenses were themselves reasonable, it does not matter that the marketing involves socializing with clients, potential clients and/or other persons or entities relevant to its business.

Boyle J appeared to be critical of Crown counsel for not having conceded after the evidence was in, stating:

Even after the evidence was all before the court, unchallenged even as to credibility, this appeal carried on into its second day for argument. This all appears to have been driven by one or more CRA officials who did not attend for any of the evidence. It is the Department of Justice that represents the respondent Her Majesty the Queen. CRA is not Justice’s client in a solicitor-client relationship.

Neal Armstrong. Summary of Jackman v. The Queen, 2022 TCC 73 under s. 15(1).

Soulliere – Federal Court of Appeal finds that an incorporating director’s resignation was invalidated because he was not replaced

The taxpayer was named as the sole incorporating director of an Ontario corporation, and a few weeks later he submitted a written resignation as director without any replacement director having been appointed, as required by s. 119(2) of the OBCA, so that such resignation was invalid. However, the taxpayer submitted that there had been a deemed appointment of a replacement pursuant to s. 115(4) of the OBCA (so that s. 119(2) did not nullify his resignation). S. 115(4) provided:

Where all of the directors have resigned or have been removed by the shareholders without replacement, any person who manages or supervises the management of the business and affairs of the corporation shall be deemed to be a director for the purposes of this Act.

In rejecting this submission, Gleason JA stated, inter alia:

On its plain meaning, a deeming provision does not constitute an “election” or “appointment” … .

[T]hose who are deemed to be directors by virtue of subsection 115(4) of the OBCA may often be unaware that they have been deemed to hold that office. If incorporating directors were allowed to resign before the first meeting of the corporation’s shareholders where permanent directors are elected, the person deemed to be a director could well be unaware of their fiduciary obligations to the corporation and the steps mentioned in subsection 117(1) of the OBCA [respecting the appointment of the continuing directors] may not be completed.

Accordingly, the taxpayer’s appeals from assessments under ITA s. 227.1 and ETA s. 323 was dismissed.

Neal Armstrong. Summary of Soulliere v. Canada, 2022 FCA 126 under s. 227.1(4) and Statutory Interpretation - Consistency.

St. Benedict Catholic Secondary School Trust – Federal Court of Appeal finds that a taxpayer is precluded from changing previous CCA claims

The taxpayer, over the course of its 1997 to 2003 taxation years, claimed capital cost allowance and generated non-capital losses. When CRA denied the carryforward of these losses to the taxpayer’s 2014 to 2016 taxation years (they had expired), the taxpayer claimed that it incurred a terminal loss in 2017 that could be carried back to those years. This terminal loss was computed by reversing a portion of CCA claims it had made in its 1997 through 2003 taxation years (so as to reduce the losses in those years to nil), and adding these amounts to the undepreciated capital cost of the property it had disposed of in 2017.

In finding that such CCA claims could not be treated as having been revised, Webb JA indicated that the “administrative practice [in IC 84-1] is not binding on this Court, nor can it amend the Act, noted that “Nassau Walnut … drew a distinction between an election and a designation” and found that “the comments in Nassau Walnut with respect to an election, and the inability of a taxpayer to change an election absent a specific provision in the Act permitting such a change, are applicable in this case.” He further stated:

If the Trust is permitted to revise its earlier claims for CCA, this would defeat the purpose chosen by Parliament of having non-capital losses only available for a particular period of time. Having chosen to claim the amounts of CCA as it did in each of the years, the Trust must accept the consequences that flow from having made those choices. The Trust is attempting to revive non-capital losses that it cannot otherwise claim by converting these non-capital losses into a terminal loss in 2017.

Neal Armstrong. Summary of St. Benedict Catholic Secondary School Trust v. Canada, 2022 FCA 125 under s. 13(21) - UCC – E.

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