News of Note
CRA indicates that a passive real estate company would not generate TOSI to its equal significant shareholders
Email this ContentMany years ago, three Canadian-resident brothers pooled their savings and incorporated a corporation, whose only class of shares is owned equally by them and which owns three rental properties of equal value. The brothers live primarily on the dividend income on the shares and have never been active in the corporation, which instead is managed by an arm’s length property management company.
CRA indicated that, where the level of activity in the corporation was enough to constitute a business, and the other conditions in the excluded share definition were met, those shares would be excluded shares. Conversely, if it was determined that the corporation did not carry on a business, the excluded share exception would not apply – but s. (e)(i) of the excluded amount definition would apply to prevent the taxable dividend from being subject to TOSI.
The analysis would be similar following any split-up butterfly.
Neal Armstrong. Summary of 15 June 2021 STEP Roundtable, Q.4 under s.120.4(1) – excluded amount – s. (e)(i).
CRA indicates that the reasonable return TOSI exclusion can apply to interest-bearing promissory notes issued in satisfaction of family trust distributions
Where a family trust distributes its income to an adult beneficiary with no involvement in a related business owned directly or indirectly by the trust, would the beneficiary be able to rely on the “reasonable return” exception in either s. (f)(ii) or (g)(ii) of the “excluded amount” definition where interest accrued and paid on the note is equivalent to that which would have been charged between arm’s length parties?
After noting that the interest income did not appear to qualify as an excluded amount under s. (f)(ii) since the note did not appear to be “arm’s length capital,” CRA stated, regarding the reasonable return exceptions in s. (g)(ii):
In a situation where the individual has not assumed any risk, whether an arm’s length rate of interest charged is a reasonable return is a mixed question of fact and law … .
In determining whether something constitutes a reasonable return, the CRA does not intend to generally substitute its judgment about what would be considered a reasonable amount where the taxpayer has made a good faith attempt to do so based on the reasonableness factors set out in the definition of “reasonable return."
Neal Armstrong. Summary of 15 June 2021 STEP Roundtable, Q.3 under s. 120.4(1) – reasonable return.
CRA indicates that it can be acceptable to cap the kilometres for which a car allowance is paid
An employer pays a fixed per-kilometre allowance to its employees for their motor vehicle use in the course of employment – except that if the kilometres driven during a particular period exceed a cap, no allowance is paid for the excess kilometers. Is such allowance unreasonable by virtue of s. 6(1)(b)(x), which deems a motor vehicle allowance not to be reasonable
where the measurement of the use of the vehicle for the purpose of the allowance is not based solely on the number of kilometres for which the vehicle is used in connection with or in the course of the office or employment [?]
CRA responded:
In general … the mere presence of a capping policy such as the one at issue here is not sufficient to conclude that an allowance paid to an employee is deemed not to be reasonable by virtue of paragraph 6(1)(b)(x). …
An allowance not being deemed to be unreasonable by s. 6(1)(b)(x) does not necessarily mean it is reasonable for purposes of s. 6(1)(b)(vii.1), which generally excludes a reasonable allowance for employment driving from inclusion under s. 6(1)(b). CRA went on to state:
The situation described in your request is unique in that it presents the possibility that an employee may, for a portion of the total distance travelled in the performance of employment duties, receive no allowance. In such a case, the allowance may not be high enough in relation to the expenses that the employee is expected to incur in a specific situation and thus may not be reasonable for the purposes of subparagraph 6(1)(b)(vii.1). If so, the allowance would be a taxable benefit that the employee would have to include in employment income under paragraph 6(1)(b).
It seems odd that a car allowance would be taxable because it is unreasonably low. Maybe you should advise your employer to increase your allowance to reduce tax risk.
Neal Armstrong. Summary of 5 March 2021 External T.I. 2017-0713041E5 F under s. 6(1)(b)(x).
CRA recharacterizes a portion of the lease payments under a lease with a bargain purchase option as consideration for the option
Regarding a lease of a truck tractor with a term of 48 months and a bargain purchase option at maturity, CRA indicated that the monthly rental payments should be allocated between deductible rental payments for the use of the vehicle and consideration for the option, which would be added to the adjusted cost base of the option. (For the same policy applied to a realty lease, see 2010-0370561E5 F.) Given its acceptance of Shell, the bargain purchase option would not cause it to recharacterize the lease as a purchase by the lessee of a depreciable asset under a secured loan.
Neal Armstrong. Summaries of 17 February 2021 External T.I. 2018-0768051E5 F under s. 20(1)(c)(ii), s. 68, s. 16.1(1) and s. 13(5.2).
CRA indicates that services income from multiple investee private corporations can be bad income for purposes of the specified corporate income - s. (a)(i)(B) safe harbour
The definition "specified corporate income" is used in the rule indicating that the portion of the income of a Canadian-controlled private corporation (say, Opco B) from an active business from the provision of services or property to a private corporation is not eligible for the small business deduction (SBD) if Opco B or one of its shareholders (or a person who does not deal at arm's length with the corporation or one of its shareholders) holds a direct or indirect interest in the private corporation, except to the extent that the private corporation assigns a portion of its own business limit to Opco B. However, s. (a)(i)(B)(I) of that definition indicates that such income is excluded from being specified corporate income for such SBD purposes if “it is not the case that all or substantially all of [Opco B]’s income for the year from an active business is from the provision of services or property to … persons (other than the private corporation) with which [Opco B] deals at arm's length.” Thus, services income from “the private corporation” does not count towards being good income for purposes of this substantially-all test even if the private corporation deals at arm’s length with Opco B.
What if Opco B derives all of its active business income from the provision of services to arm’s length third parties, except that it derives 20% of its services income from two private corporations with the degree of connectedness described above: 15% from Opco D, with which it deals at arm’s length; and 5% from Opco C with which it does not deal at arm’s length?
CRA indicated that the above exclusion for services income from “the private corporation” should be interpreted under s. 33(2) of the Interpretation Act (references to the singular included the plural) as applying to the services income from both private corporations (Opco D and C). CRA indicated that since “this means that at most only 80% of Opco B's income is derived from the supply of property or services to persons (other than the private corporations Opco C and Opco D) with which it deals at arm's length,” the safe harbour was not available, so that the income from both private corporations was bad income.
Neal Armstrong. Summary of 23 February 2021 External T.I. 2018-0769891E5 F under s. 125(7) - specified corporate income - s. (a)(i)(B)(I).
CRA indicates that a loan made, on arm’s length terms to a trust, that is motivated partly by who the beneficiaries are, is not an arm’s length transfer
Father, a resident Canadian, makes a loan on arm’s length terms to a factually non-resident trust for the benefit of his resident children. This loan will not be considered to be a contribution by him (so that it will not cause the trust to be resident for various purposes under s. 94(3)(a)) if it is an “arm’s length transfer,” whose definition relevantly requires that it reasonably be considered “that none of the reasons … for the transfer is the acquisition at any time by any person or partnership of an interest as a beneficiary under a non-resident trust.”
CRA indicated the quoted words did not establish a test that the beneficiary’s interest must be acquired as a result of the particular transfer, and the definition instead seeks to ensure that there is no connection between the transfer, and the person or partnership that already has (or will have) an interest in the non-resident trust.
Accordingly, it must be reasonable to conclude that none of the reasons for Father making the loan was his children being trust beneficiaries. CRA indicated that such a conclusion would be highly unlikely given his relationship to them – so that his loan would be considered to be a contribution to the trust causing him to be a resident contributor and the trust to come within s. 94(3)(a).
Neal Armstrong. Summary of 15 June 2021 STEP Roundtable, Q.2 under s. 94(1) – arm’s length transfer.
CRA explains that it generally requires LCs to secure exit tax
We have published the questions posed, and a summary of the answers given, at the 2021 STEP Roundtable held yesterday.
Q.1 dealt with a Canadian-resident inter vivos personal trust that realized gain under s. 128.1(4) as a result of its central management and control moving to outside Canada, and wishes to post security to defer the payment of the exit tax.
CRA indicated that the required terms for security agreements are based on the nature of the security provided and do not typically differ for trusts and individual taxpayers. However, it would not normally relax its requirements to receive a letter of credit or a letter of guarantee, and considers a secured line of credit to not be adequate security given that its typical features do not provide CRA with sufficient certainty of future payment, if required.
Neal Armstrong. Summary of 15 June 2021 STEP Roundtable, Q.1 under s. 220(4.5).
Income Tax Severed Letters 16 June 2021
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA provides a more comprehensive description of its policies on secondary and repatriation adjustments
CRA has substantially expanded its Transfer Pricing Memorandum on secondary adjustments, and relief therefrom where there is an acceptable repatriation agreement. Where a Canadian taxpayer (including for these purposes, a partnership) is subject to a “primary adjustment” under s. 247(2) regarding its participation in a transaction or series with a non-arm’s length non-resident, (other than a CFA) a secondary adjustment (usually, a deemed dividend) is generally required to account for the benefit conferred on the non-arm’s length non-resident, namely, the excess amount paid to, or insufficient amount received from, such non-resident. However, if there is a repatriation agreement that is acceptable to CRA (that promptly refunds the benefit that otherwise gave rise to the secondary adjustment), CRA generally will not assess the deemed dividend.
Since the time of the original memorandum, ss. 212(12) and (13) were enacted to provide statutory authority for secondary adjustments and repatriation adjustments in the case of taxpayers who are resident corporations. However, this makes less of a difference than one might think. Where the taxpayer (e.g., a resident individual or trust) is not deemed to pay a dividend under s. 247(12), CRA will get to the same result by applying s. 15 (for a non-resident shareholder) or s. 56(2) (where the non-resident is not a shareholder) in order to impose withholding tax on the secondary adjustment under s. 214(3) – except that it may instead consider invoking s. 246(1)(b).
Similarly, although the potential relief for repatriation adjustments under s. 247(13) only applies to Canadian corporate taxpayers, CRA as an administrative matter applies the same policy to Canadian trusts and individuals.
However, CRA states that it will not provide relief from Part XIII tax on secondary adjustments, where there is repatriation, in the following cases:
- the Transfer Pricing Review Committee has approved the application of paragraphs 247(2)(b) and (d) of the ITA;
- the General Anti-Avoidance Rule Committee has approved the application of the general anti-avoidance rule under subsection 245(2) as an assessing position;
- other anti-avoidance provisions of the ITA are applicable to the transaction(s) or series of transactions (for example, subsections 17(2), 247(9), etc.);
- the taxpayer or a non-arm’s length non-resident has failed to honour a requirement or compliance order issued under the ITA relating to the transaction(s) or series of transactions; or
- any other circumstance in which the Minister does not concur with the repatriation.
These conditions for relief are expressed with greater rigidity than one would have expected for an appropriate exercise of Ministerial discretion.
Neal Armstrong. Summaries of TPM-02R Secondary Transfer Pricing Adjustments, Repatriation and Part XIII Tax Assessments 1 June 2021 under s. 247(12), s. 247(13) and s. 247(14).
CRA indicates that it will not issue rulings or TIs on what is normal accounting practice for CEWS purposes
Regarding a question as to the timing of recognition of qualifying revenue for CEWS purposes, CRA noted that, per s. 125.7(4), the qualifying revenue of an eligible entity is generally determined in accordance with its normal accounting practices, and stated:
In situations involving an opinion on accounting or commercial principles, practices, or guidelines, we will not issue a ruling or a technical interpretation.
Neal Armstrong. Summary of 26 October 2020 External T.I. 2020-0856791E5 under s. 125.7(4).