News of Note
CRA indicates that a limited partnership cannot use a cost recovery earnout
Email this ContentWhere a limited partnership with resident and non-resident partners sells shares subject to an earnout, it is difficult to comply with the conditions in paras. 2(e) and (f) of IT-426R respecting use of the cost-recovery method given that the limited partners generally will not have access to the sale contract and they do not declare the capital gain on their own returns in the capacity of vendor. CRA stated:
The conditions of application provided in paragraph 2 of IT-426R were not designed for limited partners of a limited partnership in a situation as described above.
Consequently, the cost recovery method could not be used by a limited partnership in such a situation.
Neal Armstrong. Summary of 8 October 2021 APFF Roundtable, Q.8 under s. 12(1)(g).
CRA states that financial dependence is indicative but not dispositive of a non-arm’s length relationship
Is financial dependence of one party on another sufficient in itself to create a non-arm’s length relationship? CRA stated:
If the facts and circumstances of a specific case demonstrate that the financial dependence of one party on another is such that it is possible for the CRA to conclude that a transaction or series of transactions was entered into between persons not dealing with each other at arm's length under any of the criteria listed in … S1-F5-C1, [para. 1.38, respecting a common mind directing the bargaining, acting in concert or de facto control], then such dependence may be sufficient to conclude that the parties are not dealing at arm's length.
CRA further indicated that, in determining whether there was financial dependence, it would be guided by the jurisprudence, as to which it stated:
[T]he following factual elements have been considered by the courts in determining whether a party is financially dependent on another party: all or substantially all of the income earned by one party came from the other party; one party was the sole customer or supplier of the other party; the sole customer or supplier would be very difficult to replace; the integration of the activities of one party with those of the other party; the involvement or control of one party in the financing of the other party; and the contractual and commercial arrangements between the parties did not reflect terms and conditions normally agreed upon by independent parties according to commercial practices of the industry.
Neal Armstrong. Summary of 8 October 2021 APFF Roundtable, Q.7 under s. 251(1)(c).
CRA will honour incorrect AMT carryforward balances that arose due to an error in the CRA form
S. 120.2(3) computes the “additional tax” alternative minimum tax liability for the year (i.e., the excess of the minimum tax over the Part I tax otherwise payable for the year, as adjusted) that may be carried forward for up to seven years for deduction under s. 120.2(1) if the minimum tax levels fall below the adjusted Part I taxes otherwise payable in those carryforward years.
Form T691 currently provides that the tax on split income (TOSI) for the year is to be deducted in computing the adjusted Part I tax that is compared to the minimum tax in computing the additional tax. This has the effect of making TOSI for that year a tax that increases the “additional tax” for the year that thereby can be carried forward to be deducted from future years’ excesses of ordinary Part I tax over the minimum tax for those future years.
This is an error – and has been such since 2013, when s. 120.2(3)(b) was amended to exclude TOSI from the downward adjustments to the adjusted Part I ordinary tax liability for the year that is used in computing the additional tax (although, of course, it was only recently that the scope of TOSI was increased).
After acknowledging this error, CRA stated:
The CRA does not have a general administrative policy on the implications of a correction to a CRA form that may result in a reassessment for prior taxation years. … With respect to the amendment to Form T691, the CRA will correct the application of subsections 120.2(1) and 120.2(3), but will not issue reassessments for taxation years prior to 2021 changing the amount of tax payable that relates to that correction. System changes are being implemented so that additional tax amounts are computed using line 113 of Form T691 for taxation years prior to 2021 only and the unused additional tax balance resulting from line 113 for those years is available for the 2021 and subsequent taxation years.
In other words, CRA is grandparenting not only prior taxation years where an erroneously high carryforward amount was applied, but also unutilized carryforward balances that were erroneously calculated in 2020 and prior years’ returns and can still be erroneously claimed in future taxation years within the seven-year carryforward period.
Neal Armstrong. Summary of 8 October 2021 APFF Roundtable, Q.6 under s. 120.2(3)(b).
Glencore – Tax Court of Canada finds that a break fee was income from a business
An integrated nickel-mining public company (“Falconbridge”), entered into merger agreements with a more junior public company (“DFR”) which, through a 75%-owned subsidiary, held a valuable deposit at Voisey’s Bay in Newfoundland. The merger agreements provided for the immediate payment by DFR of a “Commitment Fee” of $28.2 million, and for the payment of a break fee of $73.3 million (calculated to bring the total of the two fees to 2.5% of the transaction value) on a failure of DFR to complete the merger. In fact, another public company (“Inco” – the 25% minority shareholder) made a subsequent offer that was accepted by DFR, thereby triggering the payment by it of the break fee.
In finding that the fees were income from a source, namely, a business, Favreau J drew an analogy with the findings in Ikea that payments received in the day-to-day conduct of a business, namely, tenant inducement payments received as “necessary incidents” of the conduct of that business in rented premises, were income receipts. He stated:
The potential acquisition of the Voisey’s Bay deposit was part of Falconbridge’s strategy for earning income from its business.
Falconbridge was carrying on its business when it negotiated the Merger … Agreement[s], … which provided for the fees in dispute. … The … Fees were ancillary business income received by Falconbridge in the course of earning income from business.
Neal Armstrong. Summary of Glencore Canada Corporation v. The Queen, 2021 TCC 63 under s. 9 – compensation payments.
Income Tax Severed Letters 20 October 2021
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA indicates that the Pt. IV and safe income exclusions under s. 55(2) can now be doubled up
9711005 indicated, before the bifurcation of RDTOH into the eligible refundable dividend tax on hand (“ERDTOH”) and non-eligible refundable dividend tax on hand (“NERDTOH”) accounts, that it was not possible to use both the Part IV tax exception to s. 55(2) and the safe income exclusion.
Holdco holds all the shares of Opco having attributable safe income of $1,000,000 and a fair market value of $5,000,000. Opco has a general rate income pool of $1,000,000 and a NERDTOH balance of $70,000. Before Holdco’s sale of the Opco shares, Opco first pays a $1,000,000 dividend (designated as an eligible dividend) - and then pays a non-eligible dividend of $182,608, which generates a refund of the $70,000 of NERDTOH.
CRA seemed to indicate that Holdco can take advantage of both the $1,000,000 safe income exclusion and of the Part IV tax exclusion.
In particular, it noted that the $1,000,000 dividend is not subject to s. 55(2) as it does not exceed the $1,000,000 of safe income. Furthermore, since Opco is entitled to a dividend refund of its $70,000 in NERDTOH, Holdco is liable for $70,000 of Part IV tax on that dividend, so that such dividend is not subject to s. 55(2) under the Part IV tax exclusion in the s. 55(2) preamble, to the extent that such Part IV tax is not refunded as part of the same series.
Neal Armstrong. Summary of 8 October 2021 APFF Roundtable, Q.5 under s. 55(2).
CRA states that using a foreign corporation with Canadian CMC to produce a lower tax rate on investment income could be GAARable
A corporation which will generate investment income is incorporated outside Canada (and, thus, is not a Canadian corporation, as per s. 89(1) and, therefore, is not a Canadian-controlled private corporation under s. 125(7)), but has its central management and control (CMC) in Canada. As a non-CCPC, it is not subject to the refundable tax under s. 123.3, and is entitled to the s. 123.4(2) deduction. Would s. 245(2) apply?
CRA noted that the foreign incorporation produces a tax benefit consisting of the “avoidance” of the refundable tax under s. 123.3, and the generation of the s. 123.4(2) deduction, and then stated:
… If the purpose of such a transaction were to avoid CCPC status in order to defeat the purpose and intent of various anti-avoidance rules applicable to investment income, including section 123.3 and subsection 123.4(2), the CRA would consider, depending on the circumstances, application of the GAAR … .
Neal Armstrong. Summary of 8 October 2021 APFF Roundtable, Q.4 under s. 123.3.
CRA finds that delegating property management to an independent property manager does not affect whether a trust is carrying on its rental operation as a business
CRA confirmed that it was not relevant to the determination, of whether a personal trust that had a portfolio of residential and commercial rental buildings was carrying on a business rather than earning income from property, that all its property management services were carried out through an independent third-party property manager rather than by its own employees or dependent agents.
CRA reiterated its position in IT-434R that “the renting of real property by an individual … will be regarded as a business operation only when the landlord supplies or makes available to tenants services of one kind or another to such an extent that the rental operation has gone beyond the mere rental of real property,” and that, accordingly, other factors such as “[t]he size or number of properties being rented” and “the extent to which their management or supervision occupies the owner's time” are not “to be taken into account in determining if the operation is a business.” Accordingly, CRA appears to continue to consider that a trust, such as a REIT, with a substantial rental operation, will not be considered by it to be carrying on a business, if it only provides basic and customary services to its tenants.
Here, CRA noted that the trust was described as providing cleaning and security services to the commercial tenants, which the Bulletin characterized as being non-basic services, so that a more detailed understanding of the facts might make it possible for CRA to conclude that the trust was carrying on a business.
Neal Armstrong. Summary of 8 October 2021 APFF Roundtable, Q.3 under s. 216(1).
CRA notes that unreasonable returns are bifurcated for TOSI purposes, and that loans to individuals do not generate split income
In an APFF question, CRA addressed the application of the tax on split income rules (TOSI) on strategies described to it as being intended to recover alternative minimum tax (planning which CRA addressed more directly in a subsequent question).
In the first scenario, Mr. X lent $100,000 to his spouse, Ms. X (also aged 30), at the 1% prescribed rate of interest. She then lent that amount as an unsecured loan to his wholly-owned personal holding company at a 5% rate of interest.
CRA noted that in these circumstances (e.g., she was essentially lending back to his company money that she got from him), it was “difficult to see how the factors enumerated in the definition of ‘reasonable return’ in subsection 120.4(1) could be satisfied.” Regarding what would be the impact if the holding company instead was equally owned by them, CRA stated that “the dividends received by Mr. X and Ms. X should also be considered in relation to Mr. X's and Ms. X's contributions to the related business, in order to determine whether the amount of interest income is otherwise a reasonable amount to Ms. X.”
However, if the interest at 5% was not a “reasonable return,” the split income amount of Ms. X would not be the total interest amount but, rather, only the excess over the reasonable return – so that, for example, if the reasonable return was 3%, her split income inclusion would be interest of 2%. (The statutory authority for this position appears to be the “to the extent of” language in the preamble of the excluded amount definition, so that this same approach could apply to other branches of the definition.)
In response to two other scenarios, CRA noted that, at least as a technical matter, the TOSI rules did not apply to loans by a specified individual at an unreasonably high rate of interest (including of funds derived from a related business) to a related individual (para. (d) of the split income definition only refers to loans to specified types of corporations, trusts and partnerships) or the payment of excessive salary by one spouse’s company to the other spouse (the specified individual) although, depending on the circumstances, it might review a GAAR application or (in the case of excessive salary) apply s. 67 or the benefit-conferral provisions.
Neal Armstrong. Summaries of 8 October 2021 APFF Roundtable, Q.2 under s. 120.4(1) – excluded amount – (g)(ii), split income – (d).
We have published 10 more translations of CRA interpretations
We have published a further 10 translations of CRA interpretation released in September, 2006. We also published a translation of a ruling released last week. Their descriptors and links appear below.
These are additions to our set of 1,766 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 15 years of releases of such items by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall.