News of Note

Canadian residents generally are better off investing in a portfolio that may include Canadian companies through a partnership rather than an LLC

Where an LLC with both Canadian- and US-resident members receives a dividend from a Canadian corporation, the US members may benefit from Art. IV(6) of the Treaty so as to reduce the dividend withholding tax rate to 15% or 5% - but there is no Treaty reduction to the Canadian withholding tax rate regarding the indirect interest in that dividend of the Canadian members.

Contrast this with the receipt of the same dividend by a partnership with US and Canadian partners - form NR302 generally provides for look-through treatment of the partnership so that, with proper documentary support, withholding tax may not apply to the portion of the dividend allocated to the Canadian-resident partners.

Neal Armstrong. Summary of Nakul Kohli and Jiani Qian, “Canadian Residents Earning Income Through Non-Resident US LLCs,” Canadian Tax Focus, Vol. 12, No. 1, February 2022, p. 10 under Treaties – Income Tax Conventions – Art. 4.

Paywall Changes

Starting March 1st, Tax Interpretations' paywalled content (e.g. case and administrative policy summaries, translations of severed letters and systematic scraped copies of current and historical CRA websites) will be open-access to the public on the 1st-5th of each month, and paywalled for the remainder. The decisions and severed letters themselves, and News of Note posts, will continue to be open-access at all times.

We will also continue to expand the free content on the site. For example, we have recently added a substantial volume of income tax severed letters from 1979-1993, and court decisions from 1980-1999.

Income Tax Severed Letters 23 February 2022

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

Fiducie Immobilière J.P. – Tax Court of Canada accepts that maintaining rental income could be a good s. 40(2)(g)(ii) purpose

A family trust, which made non-interest-bearing loans to two companies owned directly or indirectly by its sole trustee and another family trust, was prohibited by s. 40(2)(g)(ii) from recognizing capital losses when the loans went bad because, unlike Byram, it did not have any direct or indirect shareholding in the companies. As for an alternative argument that the loans were made for the (income-producing purpose) of preserving rental income (rather than dividend income) from the two companies, St-Hilaire J stated (at para. 29):

[T]here is no reason to exclude rental income from the test of subparagraph 40(2)(g)(ii), which provides that the deduction is nil unless the debt obligation was acquired for the purpose of earning income from a business or property. [emphasis in original]

However, the evidence failed to establish that the trust in fact was leasing property to the two companies.

Neal Armstrong. Summary of Fiducie Immobilière J.P. v. The Queen, 2022 CCI 7 under s. 40(2)(g)(ii).

Fyfe – Tax Court of Canada rejects a CRA position that a taxpayer who regularly reported business income was not carrying on a business

The taxpayer spent approximately six months per year doing work for one client (mostly construction and repair work), and the balance of the year sailing in the Bahamas. He reported annual income (of around $11,000) that was just below the level at which the Working Income Tax Benefit (“WITB”) (now the Canada Workers Benefit) began to be reduced. He kept no business records.

CRA denied his WITB claims on the surprising basis that he had no source of income and, therefore, no income – rather than on the basis that he was under-reporting his income. Masse DJ allowed his appeal, stating:

Although he was only carrying on a small business and only for 6 months of the year and had essentially only one client, this does not mean that he was not carrying on a business. The appellant's testimony is corroborated by his client, Mr. Huet, and I accept their testimony.

Neal Armstrong. Summary of Fyfe v. The Queen, 2022 CCI 20 under s. 122.7(1) – working income – para. (c).

Dominelli – Federal Court accepts that an agreement to compromise a s. 231.7 compliance procedure would have been binding if complied with by the taxpayer

Before judgment had been rendered in an application by the Minister for a s. 231.7 compliance order regarding failure of Mr. Dominelli (who had claimed $139 million in deductions from two leveraged insurance annuity arrangements) to provide related documents, Dominelli and the Minister made a written agreement that Dominelli would provide an affidavit with appended documents that was to certify with particulars that he and his advisors had canvassed their records for the requested documents – and that if the Minster was not satisfied with the affidavit, she would ask that judgment be delivered on the compliance application (until then, held in abeyance).

The Minister indicated dissatisfaction with the affidavit, whereupon Dominelli brought this motion before Pentney J to enforce the settlement agreement.

Pentney J stated (at para. 59) that he agreed “with Dominelli that the scope of the Minister’s discretion to determine that she is not satisfied that he has discharged his obligations under the agreement must be limited by the terms of their agreement … .” However, he went on to find that Dominelli’s affidavit did not demonstrate that he had met his obligations under the agreement, stating (at para. 79):

[T]he gap between what Dominelli promised to do and what his affidavit states is striking. … [H]is evidence does not establish that he has met the specific and detailed terms of the agreement and the Undertaking that he negotiated, and thus his motion cannot succeed.

Neal Armstrong. Summary of Canada (National Revenue) v. Dominelli, 2022 FC 187 under s. 231.7(1).

We have translated 8 more CRA severed letters

We have published a further 8 translations of CRA interpretation released in June, 2005. Their descriptors and links appear below.

These are additions to our set of 1,932 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.

Bundle Date Translated severed letter Summaries under Summary descriptor
2005-06-17 9 June 2005 Internal T.I. 2004-0105421I7 F - Déductibilité des frais juridiques et d'intérêts Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(b) - Capital Expenditure v. Expense - Damages legal fees to defend against claim for unpaid construction fees on building addition were on capital account
Income Tax Act - Section 13 - Subsection 13(21) - Undepreciated Capital Cost - A legal fees to defend against claim for unpaid construction fees on building addition were not a capital cost addition
Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) - Subparagraph 20(1)(c)(ii) interest paid pursuant to a judgment requiring payment of construction fees would be deductible but for s. 18(3.1)
Income Tax Act - Section 18 - Subsection 18(3.1) interest paid pursuant to a judgment requiring payment of construction fees would be capitalized to the construction costs to the extent of accrual during construction period
2005-06-10 11 May 2005 Roundtable, 2005-0127081C6 F - États financiers - Impôt de la Partie I.3 Income Tax Act - Section 181 - Subsection 181(3) GAAP refers to Canadian GAAP
9 June 2005 External T.I. 2004-0092001E5 F - Droits indivis dans les actions Income Tax Act - 101-110 - Section 110.6 - Subsection 110.6(1) - Qualified Small Business Corporation Share undivided interests in SBC shares on s. 98(3) winding up could qualify as shares of QSBC shares
Income Tax Act - Section 248 - Subsection 248(1) - Share undivided interests in QSBC shares qualify as shares
24 May 2005 External T.I. 2005-0121291E5 F - Processing in Canada of ore Income Tax Regulations - Regulation 1204 - Subsection 1204(1) - Paragraph 1204(1)(b) - Subparagraph 1204(1)(b)(iii) - Clause Subparagraph 1204(1)(b)(iii)(A) second crushing of nickel ore at the surface generated gross resource profits
Income Tax Regulations - Schedules - Schedule II - Class 10 - Paragraph 10(k) mobile plant of subcontractor used at mine surface level to further crush ore before its transport qualified under 10(k)
Income Tax Act - Section 125.1 - Subsection 125.1(3) - Manufacturing or Processing - Paragraph (f) - Subparagraph (f)(i) second crushing of nickel ore at the surface is excluded processing
19 May 2005 External T.I. 2005-0113681E5 F - Dédommagement pour congédiement injustifié Income Tax Act - Section 5 - Subsection 5(1) court-ordered reinstatement order gives rise to employment income
11 May 2005 Roundtable, 2005-0118691C6 F - Certificat américain d'actions étrangères Income Tax Act - Section 181.2 - Subsection 181.2(4) - Paragraph 181.2(4)(a) ADR holder holds shares if such holder has all the attributes of ownership of the shares
31 May 2005 External T.I. 2005-0122641E5 F - Intérêts courus Income Tax Regulations - Regulation 7000 - Subsection 7000(2) - Paragraph 7000(2)(c.1) Reg. 7000(2)(c.1) applied on December 31 of each year to investment contract issued on January 1
Income Tax Act - Section 12 - Subsection 12(11) - Anniversary Day anniversary day for an investment contract issued on January 1 is December 31
11 May 2005 Roundtable, 2005-0118731C6 F - Contrat avec une société d'affacturage Income Tax Act - Section 181.2 - Subsection 181.2(3) - Paragraph 181.2(3)(f) characterization as “loans and advances” and “all other indebtedness” based on legal character

Hong Kong Style – Tax Court of Canada indicates that a CRA program to detect “zapped” sales did not alter the taxpayers’ burden to displace the Minister’s assumptions

Two incorporated restaurants were alleged by the Minister to have used “zapping” software to delete a portion of their sales, with the proceeds for the deleted sales being appropriated by their individual shareholder. The taxpayers argued that the CRA program (the “Algorithm”) used to identify missing line items in the raw point-of-sale data was exclusively within the knowledge of the Minister, and argued that the difficulty they would face in “disproving” the Algorithm somehow meant that Bocock J should now grant their pre-trial motion to delete the Minister’s pleaded assumptions of fact that appeared to rely on the Algorithm.

Bocock J dismissed the motion essentially on the basis that it was within the trial judge’s bailiwick, not his, to deal with the evidence at trial and related questions of burden.

Before so concluding, he volunteered his views on the likely irrelevance of the Algorithm to the matter of the burden on the taxpayers to displace the Minister’s assumptions as to unreported income, stating:

The Appellants are under no obligation to prove that the … Algorithm is deficient or unreliable. Rather, their burden of proof will be discharged by disproving the Minister’s core assumed facts through the presentation of evidence at trial to substantiate, on balance, what were the correct sales, revenue and reportable income.

Neal Armstrong. Summary of Hong Kong Style Café Ltd. v. The Queen, 2022 TCC 9 under General Concepts – Onus.

The new s. 18.2 interest-limitation rules require careful consideration before their implementation

Observations 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.

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