News of Note
The new s. 18.2 interest-limitation rules require careful consideration before their implementation
Email this ContentObservations on the draft s. 18.2 rules (supplemented by the elective rules in draft s. 18.21) for limiting a taxpayer’s interest and financing expenses net of its interest and financing revenues that are deductible in computing its income to a fixed ratio (ultimately 30%) of the taxpayer’s adjusted taxable income (“ATI”) (essentially, tax-basis EBITDA) include:
- It is unclear whether the rules apply to computing the income of a foreign affiliate, which is generally deemed by s. 95(2)(f) to be a Canadian resident for FAPI-computation purposes “except to the extent that the context otherwise requires.” If the rules did so apply, this could cause significant practical difficulties, such as conflicts with foreign interest limitation rules.
- Each year’s ATI is reduced by the non-capital loss and net capital loss generated for the current year – yet if these losses are applied in a future year, there is no consequential ATI adjustment for that subsequent year (except for the partial addback of the portion of a non-capital loss that reasonably relates to the taxpayer’s net interest and financing expense). “This results in these losses reducing ATI twice (once in the year incurred, and once in the year applied).”
- The definitions of interest and financing expenses and revenues, as supplemented by the Explanatory Notes, may be broad enough to include amounts arising under derivatives.
- Draft s. 18.2(3) deems amounts of previously capitalized interest that are otherwise deductible as CCA or resource pool deductions, but are denied as a deduction under s. 18.2(2), to have been allowed as deemed UCC or resource pool deductions - so as to prevent the taxpayer from receiving the “double benefit” of having a higher UCC or resource pool (potentially deductible in a future year) while at the same time having a restricted interest expense carryforward for future deduction. However, this deemed deduction also has the effect of increasing recapture to the taxpayer on a future disposition of such assets.
- The “excluded interest” rules depart from the 2021 budget (which stated that interest income and expense between Canadian members of a corporate group would be generally excluded) by requiring an election between two eligible group corporations. These rules (unlike the unused excess capacity rules) do not exclude financial institutions, but they are unavailable to trusts and partnerships.
- The group ratio rule in draft s. 18.21, which may enable taxpayers to access a higher fixed percentage than 30% where the group as a whole is bearing higher interest and financing expenses as a result of its external debt and as measured by the group GAAP financial statements, does not recognize any local European GAAP – so that the group ratio calculations could be unavailable for European-headed groups that do not consolidate using IFRS.
- This group ratio regime “requires information that may not easily be available to the Canadian group members, particularly in large conglomerate or private equity structures.”
- S. 18.2(4)(c), which effectively prevents a “relevant financial institution” from transferring any portion of its “cumulative unused excess capacity” for a year (as, for example, would typically be the case for a profitable bank with an excess of interest income over interest expense) to another member of its group having excessive interest and financing expenses, could cause significant difficulties for Canadian financial services groups, for example, where regulatory restrictions limit a regulated financial institution’s incurring of third party debt, leading other group members to incur such debt.
Neal Armstrong. Summaries of PwC, “Tax Insights: Excessive interest and financing expenses limitation (EIFEL) regime,” Issue 2022-06, 15 February 2022 under s. 18.2(1) – adjusted taxable income – A, excluded entity, excluded interest, interest and financing expenses – A – para. (d), s. 18.2(2), s. 18.2(3), s. 18.2(4)(c), s. 18.21(1) – acceptable accounting standards and s. 18.21(2).
Income Tax Severed Letters 16 February 2022
This morning's release of two severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Harding – Tax Court of Canada applies the Chopp principle that a s. 15 benefit is conferred where the shareholder ought to (but did not) know of the benefit
The taxpayer was the sole shareholder and director of a holding company which, in turn, was the majority shareholder of a logging company, which had been paying significant premiums on insurance policies (arranged by the taxpayer’s stepdaughter, a licensed insurance broker) on the life of the taxpayer and of his spouse and for which, at times, the beneficiaries were his spouse and stepchildren.
In confirming the reassessments of the taxpayer under s. 15(1) in the amounts of the premiums, St-Hilaire J stated:
… Chopp confirmed… that a benefit may be conferred without any intent or actual knowledge on the part of the shareholder if the circumstances are such that the shareholder ought to have known. I find that the circumstances in this appeal are such circumstances. The purchase of policies … for which significant premiums were paid and for which there were several changes to the beneficiaries over several years, is not and cannot be treated as a simple bookkeeping error.
Neal Armstrong. Summary of Harding v. The Queen, 2022 TCC 3 under s. 15(1).
De Geest – Federal Court of Appeal confirms gross negligence penalty where taxpayer’s legal argument had “no merit”
The taxpayer, who stated that he had formed the subjective activity to no longer carry on his work of installing windows and other construction work as a business, was assessed for failure to report $625,157 of business net income generated in three of his taxation years. In rejecting the taxpayer’s position, Webb JA stated:
[T]he appellant … acknowledged that the monies he received were used for his personal and living expenses. He therefore intended to receive monies in excess of the related expenditures … [I]n effect he did have the intention of earning a profit, i.e., the intention of receiving amounts in excess of his expenses.
Notwithstanding that the taxpayer was more coherent than the “natural person” cohort, Webb JA sustained the imposition of gross negligence penalties, stating that “there is no merit in the appellant’s interpretation of the Act.”
Neal Armstrong. Summary of De Geest v. Canada, 2022 FCA 22 under s. 163(2).
Lussier – Court of Quebec finds no taxable benefit in an insurance company employee attending a conference for insurance brokers in Cancun
The taxpayer, was designated by his employer (“BMO,” an insurance company) to attend a one-week conference for insurance brokers and financial advisors whom one of BMO’s managing general agents had identified as top “performers.” During his attendance, the taxpayer put on a 20-minute presentation, but spent most of the time on events, such as snorkeling and catamaran sailing, with the attendees and responding to messages from the BMO office.
In reversing the ARQ assessment to include 62.5% of the cost of the trip in the taxpayer’s income as a taxable benefit, Pilon JCQ stated:
The recreational activities were an opportunity to create or maintain relationships with advisors and brokers. …
… [T]he ARQ's … approach is somewhat penalizing and unfair to Mr. Lussier. His employer did not give him the choice to participate in a trip, on which he went alone, and where he was expected to work and develop business, which he did, both during business hours and beyond. …
[T]he ARQ's position stems either from a misunderstanding of what constitutes the steps required for business development where there is a legitimate growth objective, or from a desire to dictate to a business what its business model should be and how to achieve it. In either case, the ARQ's position is unjustified.
Neal Armstrong. Summary of Lussier v. Agence du revenu du Québec, 2022 QCCQ 9 under s. 6(1)(a).
We have translated 9 more CRA severed letters
We have published a translation of a ruling released by CRA last week and a further 8 translations of CRA interpretation released in July and June, 2005. Their descriptors and links appear below.
These are additions to our set of 1,924 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 16 2/3 years of releases of such items by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall.
CRA finds that an input to a financial institution that was on-supplied by it on a GST-taxable basis at a loss should also be treated as acquired as a financial services input
A listed financial institution acquired technology inputs for its own use and also for making taxable supplies of network services and related equipment to subcontractors to assist them in selling its financial products. However, such taxable charges to them were less than its pro rata cost of the technology package that was being on-supplied to them.
It had been filing its annual GST/HST returns on the basis of claiming ITCs respecting this on-supply equal to the GST/HST it collected from the subcontractors. It later changed its mind and started claiming a pro rata portion of the HST on its technology inputs as an ITC so that it, in effect, was asking CRA to share in the loss it took on that on-supply.
CRA first indicated that going back to change to the ITC method applied in the earlier years violated ETA s. 141.02(17), stating in this regard that “it is clear that the intention of the legislation is not to allow a retroactive ITC claim by a financial institution.” Furthermore, it did not consider the changed method to be acceptable even on a prospective basis, stating that it could be considered that the financial institution:
recognized that a portion of the technology package provided to [subcontractors] was related to its own business when it agreed to share the costs with [the subcontractors] instead of fully billing [the subcontractors] for the cost of the technology inputs. [The Financial Institution] would only incur such a loss on a continuing basis if its real purpose in acquiring the technology inputs was not to earn revenue from supplying the technology package but to earn revenue from the sale of its financial products that must be sold using the technology inputs.
In other words, the discounted pricing to the subcontractors reflected the reality that some of the pro rata cost of the technology inputs was being incurred by the financial institution for the purposes of its own financial services business, so that the previous method had properly capped the amount of the ITC claims.
CRA did not discuss whether this interpretive approach was consistent with the London Life decision (where the fact that an input was on-supplied on a taxable basis trumped the fact that such taxable supply indirected supported a financial services business).
Neal Armstrong. Summaries of 17 August 2020 GST/HST Interpretation 194307 under ETA s. 141.02(17) and ETA s. 141.02(12).
CRA notes that overheads may be direct rather than non-attributable inputs to financial institutions
In the context of general comments on whether a new ITC allocation method proposed by a financial institution for claiming its excluded, direct and non-attributable inputs would qualify as a "direct attribution" (i.e., permitted) method under the somewhat detailed input tax credit methodology rules in ETA s. 141.02, CRA noted that an input treated as an indirect input for cost allocation purposes (for example, certain overhead expenses) may nonetheless qualify as a direct input for s. 141.02 purposes, i.e., “overhead” expenses may often be regarded by CRA as contributing to the making of supplies.
Regarding the use of “causal” allocation of inputs (where tracking of inputs does not work), CRA indicated that “using an allocation base of the relevant employees’ time may be appropriate and could reflect the use of the input; however, an allocation base of employees time may not be used for an input unless the input is used equally amongst all employees included in that base.”
Neal Armstrong. Summary of 9 November 2020 GST/HST Interpretation 210124 under ETA s. 141.02(12).
CRA rules that lump-sum assistance paid to a member of a religious community, who had taken vows of poverty, on his return to secular life, is not income
A member of a religious order, who (along with all the other members) had taken vows of perpetual poverty, would receive a lump sum gift, upon his departure from the community after having decided to return to the secular world, as assistance to compensate for his lack of financial resources (resulting from such vow). The departure amount is determined as: a basic amount plus an additional amount for each year spent in the order; and an amount for each qualifying year the member did not contribute to a pension or retirement plan.
CRA ruled that the lump sum was not includible in his income
Neal Armstrong. Summary of 2021 Ruling 2021-0894621R3 F under s. 3(a).
GST/HST Severed Letters October 2021
This morning's release of 10 severed letters from the Excise and GST/HST Rulings Directorate (identified by them as their October 2021 release) is now available for your viewing.