News of Note
Income Tax Severed Letters 24 August 2022
Email this ContentThis morning's release of 14 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Blackrock Holdco – UK Upper Tribunal completely denies interest deductions under the UK transfer pricing rules because the loan was made without group support covenants
The structure for the acquisition by the BlackRock group of the target (“BGI”) entailed a BlackRock LLC (“LLC4”) lending US$4 billion to a wholly-owned LLC (“LLC5”) as well as injecting substantial equity into LLC5, with LLC5 using most of those proceeds to subscribe for preferred shares of the transaction Buyco (“LLC6” – which acquired all the shares of BGI). LLC6 was wholly-owned by LLC5 save for the common shares held directly by LLC4.
The UK transfer-pricing legislation (which was explicitly stipulated “to be read in such manner as best secures consistency” with the OECD’s Transfer Pricing Guidelines) required that the profits and loss of LLC5 be computed as if the transaction which would have been made between two independent enterprises (the “arm’s length provision”) had been made, instead of the “actual provision” between LLC5 and LLC4. After noting that, like Art. 9 of the OECD Model Convention, such legislation focused on the “two” enterprises to the transaction, rather than third parties, the Tribunal stated:
[T]he main concern of an independent lender of $4 billion to a company like LLC5 would be the risks around the fact that the borrower in the position of LLC5 had no control over the dividend flow to it and so its ability to repay the loan. In the actual transaction, LLC4 through its ownership of the LLC6 Common Shares, controlled LLC6 and so the dividend flow to LLC5. LLC4 did not therefore need covenants from LLC6 or BGI. In the hypothetical transaction however, the dividend flow would need to be secured so far as possible … .
In confirming the denial by HMRC of all of LLC5’s interest deductions on the basis that the loan transaction between the two enterprises (LLC4 and LLC5) was not one which would have been made by arm’s-length enterprises (i.e., it lacked covenants of LLC5 and BGI to ensure the flow of dividends from LLC5 to service the loan), the Tribunal stated:
Third-party covenants that were not given as part of or in support of the actual transaction cannot be considered to be part of the hypothetical transaction as this materially changes the surrounding circumstances and alters the economically relevant characteristics of the transactions in question. …
[A]n independent lender would not have made a $4 billion loan to LLC5 without such covenants being in place and that important finding should itself have determined that there was no comparable arm’s length transaction.
The “two enterprise” problem in this case, resulting in a complete interest denial, might not arise under ITA s. 247(2), which references the terms or conditions “between any of the participants” in the transaction or series.
Neal Armstrong. Summary of Revenue and Customs v Blackrock Holdco 5 LLC, [2022] UKUT 199 (TCC) under s. 247(2)(d).
MRPS found to be equity for Lux tax purposes
The highest Luxembourg tax court concluded that the mandatorily redeemable preferred shares (MRPS) issued by a Luxembourg company to its sole shareholder qualified as equity, rather than the dividends giving rise to interest deductions (based on their alleged economic substance). Although the MRPS had some debt-like features (10-year maturity, no voting rights except as provided under the Luxembourg commercial law, and cumulative and preferred fixed dividends), the court considered that the MRPS involved no evident mismatch between the legal form adopted (share capital) and the underlying economic reality of the provision of funds by a single shareholder to its subsidiary.
The court also emphasized that the preferred dividends depended on there being a net profit after payment of the company’s creditors (thus placing the MRPS holder on a different footing than a creditor) - and furthermore, the company had treated the MRPS as equity in its financial statements.
Neal Armstrong. Summary of Alex Pouchard and Paloma Nunez, “Luxembourg Court Rules on the Tax Treatment of MRPS,” International Tax Highlights (IFA Canada), Vol. 1, No. 2, August 2022, p. 5 under s. 113(1)(a).
We have translated 8 more CRA interpretations
We have published a further 8 translations of CRA interpretations released in June of 2004. Their descriptors and links appear below.
These are additions to our set of 2,183 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 18 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
Finance appears to be intent on introducing some sort of economic substance test into the GAAR rule
Comments of Finance in its discussion paper on GAAR include:
- It may be appropriate to provide that a “bona fide purpose” does not include foreign (or provincial) tax savings (contrary to what was suggested obiter by the TCC in Loblaw).
- The avoidance transaction definition could be expanded (from a "primarily" test) so that it applies where one of the main purposes (or one of the purposes) for undertaking the transaction (or series) is to obtain the tax benefit.
- Given the findings in Canadian Pacific and Spruce Credit, it may be appropriate to extend the meaning of “transaction” to include “the choice to effect a transaction in a particular way.”
Potential changes to the application of the abuse or misuse test in s. 245(4) could include:
- the inclusion of preambles and purpose statements in income tax legislation or greater emphasis on purpose statements in extrinsic aids such as Explanatory Notes
- amending s. 245(4) "to ensure that general schemes that can reasonably be established upon reviewing the Act as a whole [e.g., a presumption against surplus stripping?] are taken into consideration (and given appropriate weight) in the GAAR analysis, notwithstanding that a misuse of specific provisions of the Act cannot be identified”
- including an interpretative rule which, in contrast to Alta Energy, would shift the balance more to fairness to the tax system as a whole and de-emphasize certainty and predictability, and also address application issues, e.g., providing (again contrary to Alta Energy) that GAAR applies to foreseen as well as unforeseen tax planning
- reversing the Canada Trustco burden on the Crown, e.g., presuming “that abusive tax avoidance has occurred unless the taxpayer can establish to an appropriate standard that the provision or provisions being used to provide the tax benefit were used in the manner that Parliament intended them to be used” – although perhaps this burden shift would only occur where the transactions lacked economic substance
Finance repeatedly laments that Canada Trustco had not adopted the Finance statement accompanying GAAR’s introduction that it “would apply together with the … other provisions [of the Act] to require economic substance in addition to literal compliance with the words of the Act.”
The government intends to add an explicit economic substance rule to the GAAR, so that it applies more appropriately. In this regard [:] … First, it is necessary to define economic substance so that it is possible to determine when it is lacking. Second, an economic substance rule would need to be integrated into the GAAR analysis. Third, the appropriate consequences associated with a lack of economic substance would need to be determined.
Alternatives for testing for economic substance include:
- introducing a sole or dominant purpose test (under which, for example, “[w]here a taxpayer has no bona fide commercial or other non-tax purpose (or almost no such purpose), the relevant transactions could be considered to be sufficiently lacking in economic substance”
- determining whether a transaction has the potential for pre-tax profit after taking into account the costs of the transaction, which might then be compared to the tax savings
- determining whether the transfers of rights and assumptions of obligations under the transaction affected the economic positions of the participants in the transaction (so that "[i]f the economic exposure of the participants to a transaction is not materially affected by the transfers of rights and obligations under the transaction, then the transaction can be said to be lacking in economic substance”
- assessing whether the legal form of the transactions differs significantly from the accounting treatment of the transactions
Alternatives for utilizing the concept of economic substance include:
- Reworking the avoidance transaction test, so that “where a transaction resulting in a tax benefit is primarily tax motivated but not entirely (or almost entirely) tax motivated, the current scheme would continue to apply (i.e., the transaction will be subject to the GAAR unless the current misuse or abuse exception is met)” – but “where such a transaction or series is entirely (or almost entirely) tax motivated” under an economic substance test, different tax consequences would apply, “for example, the misuse or abuse exception could be made unavailable or the misuse or abuse burden could be reversed”
- An interpretive rule could provide in the GAAR context that “tax benefits are intended to be conferred only in the context of transactions with economic substance” – although it would be necessary to "ensure that transactions which appear to lack economic substance but are not objectionable from a policy perspective” are excepted
- More simply, the misuse or abuse test could be amended by adding an explicit requirement to take into account the economic substance of the relevant transactions
- Transactions could be deemed to be abusive where they lack economic substance or the misuse or abuse exception could become unavailable where the economic substance test is failed, although, again, there would need to be an exception for transactions that were not objectionable on policy grounds
- Alternatively, where transactions lacked economic substance, “the misuse or abuse exception would apply only where the taxpayer clearly demonstrates that the use made by the taxpayer of the provisions relied upon to obtain the tax benefit was specifically contemplated and intended by Parliament.”
In order to increase the deterrent effect, penalties or increased interest charges could be added where GAAR was applied, and the period for reassessing under GAAR could be extended.
Neal Armstrong. Summaries of “Modernizing and Strengthening the General Anti-Avoidance Rule,” Department of Finance Consultation Paper, 11 August 2022 under s. 245(3), s. 245(4) and s. 245(1) – transaction.
CRA confirms its protocol for referrals by Appeals back to Audit
CRA indicated that where specific documents or information was requested by the auditor, but only provided by the taxpayer at the objection stage, the appeals officer is required (with the exception of the GST/HST Refund Integrity Program) to make a referral to audit. In other situations, a referral to Audit is discretionary, for example, where the new information provided for review is substantial, or where an on-site visit is warranted for factual verification.
Upon the referral by the appeals officer, Appeals will so inform the objector or representative and assure them that the review decision remains with Appeals. Upon receipt of audit findings, Appeals will discuss them with the objector or representative, and may share the second auditor’s report, addressing the submission of the supplemental documentation, with the taxpayer.
Although CRA was responding in a GST Roundtable, the underlying referenced 2016 Protocol also applies to income tax appeals (i.e., from the ILBD, SMED, and SRED Directorates or the Offshore Compliance Division)..
Neal Armstrong. Summary of 25 March 2021 CBA Commodity Taxes Roundtable, Q.13 under ETA s. 301(3).
Libfeld – Tax Court of Canada does not permit a new home purchaser to resile from the vendor’s certification that it was an exempt sale
Libfeld claimed the $24,000 Ontario new housing rebate on his purchase in 2018 of an unoccupied and sparsely-furnished home. He provided indirect evidence that the individual vendor was a builder of the home, including a Toronto Life promotional article (admitted to be hearsay) titled “House of the Week: $7 million for a newly built mini-mansion in Forest Hill” and explaining that the vendor had torn down a pre-existing house and built this one in its place.
In finding that Libfeld had not established that the vendor was a builder, as required by s. 254(2)(a), so that the rebate was unavailable, Smith J noted that “the Court does not have the benefit of any direct evidence from the Vendor or other independent witness as to the frequency of similar transactions, what her intention was when she acquired the Property or what her motive was for selling” and that, on the closing of the purchase, Libfeld had accepted the sworn declaration of the vendor that the sale was not a taxable supply. There also was not much evidence to establish, as required by ss. 254(2)(f) and (g), that the vendor had not, at some point, occupied the “new” home prior to its sale.
Neal Armstrong. Summary of Libfeld v. The Queen, 2022 TCC 91 under ETA s. 254(2)(a).
CRA ruling confirms that a s. 149(1)(o.2)(ii)(A) permitted activity can include an implied activity
A corporation which was otherwise exempted under ss. 149(1)(o.2)(ii) and (iv) will borrow money from an arm’s length lender on the security of a mortgage on some of its existing real estate, and use the loan proceeds to acquire, on an unencumbered basis, Canadian income-producing real property, or invest in real estate partnerships described in s. 149(1)(o.2)(ii)(A)(II).
CRA ruled that such borrowing and acquisition will not, by themselves, cause the corporation to fail to comply with s. 149(1)(o.2)(ii). The CRA summary stated:
The use of existing real property to secure additional borrowing, where such borrowed money is used for activities described in subclause 149(1)(o.2)(ii)(A)(I) or (II), is part of acquiring and investing in real property for the purposes of subparagraph 149(1)(o.2)(ii).
Apparently, someone was concerned that the list of permitted activities in s. 149(1)(o.2)(ii)(A) did not include the granting of a security interest on real property that was not itself being acquired, and the answer was that this was part and parcel of the acquisition of the further real estate.
Neal Armstrong. Summary of 2021 Ruling 2020-0872241R3 under s. 149(1)(o.2)(ii)(A).
CRA notes uncertainties as to whether two condos functionally used as one residence are a single residence for ETA purposes
A couple (A and B) along with others purchased a property in trust for development as a condominium complex. On completion of construction, A and B took title to two of the units jointly, with a view to using them (as the first occupants) functionally as a single place of residence (with sleeping quarters in one unit and living quarters in the other).
After noting uncertainties as to whether the two units constituted two, or a single, residential complex and place of residence, CRA noted that even if each was a residential complex (and each of A and B, a builder) then the personal use exception in s. 191(5) to the self-supply rule in s. 191(1) would apply to each unit if either A or B, or both A and B, used the unit primarily as a place of residence.
CRA did not discuss the income tax jurisprudence (e.g., Salama and Boulet) as to whether duplex units or basement apartments are separate residences.
Neal Armstrong. Summary of 25 March 2021 CBA Commodity Taxes Roundtable, Q.12 under ETA s. 191(5).
CRA indicates that a health spending account for a single shareholder/employee likely does not qualify as a PHSP
S. 6(1)(a)(i) excludes a taxable benefit from the employer’s funding of a private health services plan (PHSP) for its employees, including in the case of a health spending account (HSA) (under which an employer agrees to reimburse its employees’ hospital and medical expenses incurred during the year up to a pre-determined limit).
However, CRA considers that an HSA established for a single shareholder/employee (and family members) likely does not qualify as a PHSP. This is based on its view that “for a plan to be a PHSP … the plan must be a plan of insurance” and, here, “[e]ffectively, the sole employee-shareholder is paying for the personal hospital and medical expenses for themselves and their family members through their solely owned corporation without any risks being assumed by the corporation.”
Neal Armstrong. Summary of 3 May 2022 CALU Roundtable Q. 10, 2022-0928901C6 under s. 248(1) – PHSP.