News of Note
CRA finds that the C$5M threshold in s. 247(3)(b)(ii) is to be translated into a functional currency on the basis that it is not “in respect of a penalty”
Email this ContentA Canadian corporation (“Canco”) with an elected functional currency is subject to transfer pricing income adjustments respecting a functional currency year. What is the relevant spot rate to be used in converting the C$5,000,000 threshold in s. 247(3)(b)(ii) into the elected functional currency? S. 261(5)(b) generally requires that the relevant spot rate for the first day of the particular taxation year in issue be used in a converting a dollar amount, except where that amount is “in respect of a penalty or fine.”
CRA found that, in light of the quoted exclusion, the threshold amount was to be converted using the relevant spot rate for the first day of Canco’s particular taxation year in respect of which the transfer pricing income adjustments are made. In this regard, CRA noted that the C$5M threshold amount in s. 247(3)(b)(ii) was only one of the two components for establishing the threshold above which a penalty might be assessed, and that the penalty itself is equal to 10% of the amount determined under s. 247(3)(a), and does not take into account s. 247(3)(b). Thus, the C$5M threshold was in respect of determining whether a penalty might apply, but was not in respect of the penalty itself.
Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.3 under s. 261(5)(b).
CRA deferred a PPT ruling request until the Alta decision
Regarding whether CRA has issued any assessments based on the MLI principal purpose test (“PPT”), CRA noted that it was premature for any assessments to have been issued (the first deadline for NR4 filings for payments to which the PPT might apply was March 31, 2021; and the returns for the earliest 12-month taxation years to which the MLI could apply have a filing due date of November 30, 2021).
Regarding a query on any PPT ruling requests received by CRA, it indicated that it had received one pre-ruling consultation request involving the payment of a dividend by a Canco to a corporation, residing in a Treaty country, which was not engaged in commercial activities other than holding the Canco shares and managing assets, and which was wholly-owned by a resident of a non-Treaty country. CRA concluded that it would await the decision in Alta before entertaining a ruling request. that the Treaty reduced dividend withholding to 5%.
Neal Armstrong. Summary of 5 May 2021 IFA Roundtable, Q.2 under Treaties – MLI – Art. 7(1).
Finance provides pointers on the proposed earnings-stripping rules
Points made by Shawn Porter at the IFA Finance Roundtable on May 5, 2021 on the proposed earnings-stripping rules included:
- There is not contemplated to be a specific safe harbour for mostly Canadian firms – instead they likely will not be caught simply because their interest expense all fundamentally relates to the Canadian business and its earnings capacity and therefore comes in below the fixed ratio of 30% (or a higher group ratio rule applies).
- Part of the impetus for adopting these rules is that other countries are adopting them as well, and Canada wants to protect against more debt being pushed into Canada.
- The framework of the default 30% fixed ratio rule will be rooted in ITA concepts of what is a group and an entity.
- Each entity will determine whether it has net interest expense in a year, so that if that is less than 30% of its EBITDA, it has excess or unused capacity; if it is more, it has excess interest which would be denied.
- It is contemplated that what gets transferred within the group is the unused capacity of some members – rather than the excess interest being transferred, so that the interest can be deducted (if at all) only in the entity that incurred it.
- If excess interest remains in that group in the year after all unused capacity of other group members has been transferred within it, then the carryover rules come into play - the entity with the excess interest can look back three years to see whether it, or other group entities, have capacity in that time window to reduce the excess interest in the current year. If there is insufficient capacity looking back, then the denied interest can be carried forward for 20 years and deducted to the extent of the group’s unused capacity in those future years.
- “Net interest expense” is broader than the legal meaning of “interest,” and will includes interest expense, equivalents to interest expense, and financing expenses. This will only be partially informed by the concept of “equivalents” in BEPS Action 4.
- Capacity that emanates from net interest income of a group member would be eligible for transfer to other group entities – which would suggest that banks and insurers (if they have net interest income) would not be subject to these rules. In this regard, there potentially might be some sort of ring fencing around transfers of excess capacity by financial institution members to other members in a different business.
- The concept of EBITDA would start with taxable income, but it would make sense to provide for an add-back of deductions in computing taxable income, such as under s. 110(1)(k), for items that represent taxes rather that economic losses.
- The rules will accommodate tax loss transfer transactions according with CRA policies in that regard.
- In contrast to the 30% default fixed ratio, consolidated GAAP measures will be used for both the numerator, and denominator in determining whether external leverage permits using a higher ratio. Design issues include the choice of the appropriate ultimate parent (including the related issue of the provision of credit-support to the consolidated group, as so defined, by someone outside of the group), distortions to the extent that the group is loss-making overall, and different kinds of distortions if there are constituent entities within the group that are loss-making, as well as averaging effects for diversified multinationals in very different business-lines.
Neal Armstrong. 5 May 2021 IFA Finance Roundtable.
CRA notes that on the transition to the ERDTOH/NERDTOH regime there can be an anomalous addition of Part IV tax on a connected corporation dividend to the recipient’s NERDTOH
CRA has confirmed that the eligible refundable tax on hand (“ERDTOH”) definition applies in an anomalous manner where a corporation that has transitioned to the ERDTOH and non-eligible refundable tax on hand (“NERDTOH”) regime receives a dividend in its taxation year beginning after 2018 from a connected corporation whose taxation year began before 2019. In particular, Part IV tax payable on the dividend will always be added to the recipient corporation’s NERDTOH even where normatively it should have been added to its ERDTOH. The reason is that (a)(ii) of the ERDTOH definition only adds the Part IV tax if it generated a dividend refund to the connected payor out of its ERDTOH – and since the connected payor by assumption had not yet transitioned to the ERDTOH/NERDTOH regime, this would not be possible.
CRA stated:
This outcome does not appear to be consistent with the policy objectives of the transition rules and, therefore, we have brought this potential unintended consequence to the attention of the Department of Finance.
Neal Armstrong. Summary of 9 December 2020 Internal T.I. 2020-0856521I7 under s. 129(4) - ERDTOH – s. (a)(ii).
CRA rules on a superficial gain transaction to transfer losses to a Profitco owned directly by the non-resident parent
CRA ruled on transactions for Profitco, which is an indirect wholly-owned Canadian subsidiary of a non-resident parent, to utilize the non-capital losses of Lossco, which is a direct wholly-owned Canadian subsidiary of the non-resident parent. Profitco transferred Class 12 property on a s. 85(1) rollover basis to Lossco in consideration for redeemable preferred shares of Lossco, then Lossco transferred the properties back to Profitco in consideration for redeemable preferred shares of Profitco having a paid-up capital equaling their redemption amount, with a joint s. 85(1) election being made at the estimated FMV of the properties, so that Lossco realized recapture of depreciation. The two preferred shareholdings were then redeemed for notes, and the notes set off.
In its summary, the Directorate stated:
The proposed subject transaction conforms with the CRA's policy to not apply subsection 55(2) of the Act to internal reorganizations within a related group for loss consolidation purposes and recognizing that property retains its character on a rollover transaction between related parties is consistent with the CRA’s position in … 2014-0553731I7 that depreciable property should retain its character on wind-up.
Neal Armstrong. Summary of 2020 Ruling 2019-0834901R3 under s. 9 – capital gain vs. profit – equipment.
Income Tax Severed Letters 5 May 2021
This morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Blue Bridge – Federal Court of Appeal finds that CRA was not responsible for analyzing whether information requested by France could be used contrary to the French Treaty
Art. 26(1) of the Canada-France Convention provides for exchanges of “such information as is foreseeably relevant … to the administration or enforcement of the domestic laws concerning taxes of every kind … imposed on behalf of the Contracting States, insofar as the taxation thereunder is not contrary to the Convention.”
CRA issued requests for information (RFIs) to the appellant (“Blue Bridge”), which was the trustee of some trusts, as a result of a request made by the French tax authorities pursuant to Art. 26 for various particulars regarding the trusts, including the identity of the beneficiaries and financial information.
Blue Bridge argued that it was the Minister’s responsibility to ensure that the “taxation … not contrary to the Convention” condition in Art. 26 was met before transmitting the requested information to France, whereas here, France was seeking to impose tax under a French wealth-tax statute which attributed all foreign trust assets to a French settlor or beneficiary in order to subject them to the tax, which in its view raised the possibility of the information being used to levy tax contrary to the Convention.
In rejecting this argument, Rivoalen JA determined that the Federal Court did not have expert evidence of French law so as to be able to conclusively address this argument, and that this argument was based on facts that had not been verified, and could not be verified at this stage, by the Minister. She stated:
The judge rightly concluded that a requirement for thorough research and analysis of the facts and the law of the requesting State would impede the proper and effective operation of the Convention’s provisions … .
She concluded that the Federal Court had not erred in finding that the requirements for issuing a compliance order under ITA s. 231.7(1) had been met.
Neal Armstrong. Summary of Société de fiducie Blue Bridge Inc. v. Canada (National Revenue), 2021 CAF 62 under Treaties – Income Tax Conventions – Art. 27.
Gervais Auto – Quebec Court of Appeal finds that 10% interest on unsecured loans from shareholders was not unreasonable
The taxpayer financed its inventory of used automobiles held for resale through unsecured loans from the family Holdcos that were its shareholders. When the ARQ reviewed the deductibility of the loan interest of 10% p.a., the taxpayer provided a very brief letter from Desjardins stating that for an unsecured “cash flow” loan the interest rate in 2015 would fall in the range of 9% to 12%, and then a more detailed letter from its accountants (Deloitte) that, based on Moody’s metrics, concluded that an interest rate for such loans should fall in the range of 7.89% to 12.39%. The ARQ reassessed to deny the claimed interest in excess of 7.89%, having regard to the Quebec equivalent of ITA s. 67 (TA s. 420).
Before reversing the decision below to confirm these reassessments, the Court of Appeal stated (at para. 13, TaxInterpretations translation):
The appellant was not required to make out a prima facie case that the 7.89% rate was unreasonable but, rather, that the assumption, on which the respondent relied in assessing it, that the 10% interest rate deducted from its income for the taxation years in issue was not "reasonable in the circumstances," … was prima facie … unsound.
Since the 10% rate actually used fell within what the above evidence indicated was a reasonable range, such a prima facie case had been established – so that the onus shifted to the ARQ, which had “failed to demonstrate by a preponderance of the evidence that the 10% interest rate was unreasonable within the meaning of TA section 420.”
Neal Armstrong. Summaries of Gervais Auto Inc. v. Agence du revenu du Québec, 2021 QCCA 459 under s. 20(1)(c) and General Concepts – Onus.
Our translations of CRA Interpretations go back over 13 years
We have published a further 10 translations of CRA interpretation released in May and April, 2008. Their descriptors and links appear below.
These are additions to our set of 1,516 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 13 years of releases of Interpretations by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall. You are currently in the “open” week for May.
Zeifmans LLP – Federal Court finds that an RFI issued to an accounting firm re named clients could extend to unnamed offshore entities if the latter were not being audited
An accounting firm (Zeifmans) unsuccessfully argued that the Minister should have sought prior judicial authorization under s. 231.2(3) of a requirement to provide information (RFI) issued in the course of a CRA audit of three related resident individuals (the “Named Persons”) who were Zeifman clients. The RFI (which was issued after various attempts by CRA to obtain the information directly from the Named Persons and from the records of Canadian banks) set out a long and detailed list of required information and documents in relation to the Named Persons and all “entities owned, operated, controlled or otherwise connected to [such] individuals” (the “Unnamed Persons.”)
In responding to this argument, Walker J first stated the principle:
If a Canadian taxpayer organizes their affairs through corporate or other entities, the CRA is entitled to obtain information related to those entities for the purpose of auditing and verifying the taxpayer’s compliance with the ITA. If the entities’ books and records are placed in the possession of third parties, the Minister is entitled to require the third party to provide the information requested if the unnamed persons are not subject to audit. The information is required to verify the compliance of the taxpayer being audited and no application for judicial authorization is required … . [emphasis added]
In rejecting the argument, she then stated:
There is no evidence in the record that the Unnamed Persons are a current investigation target. I find that the possibility that one or more of the Unnamed Persons may be subject to audit in the future is not sufficient to require judicial authorization for the RFI and the Minister’s reliance on subsection 231.2(1) was justified.
In also rejecting an argument that the RFI had not been issued to a “person” as required by s. 231.2(1) because it was issued to a partnership (Zeifmans), she stated that “the effect of subsection 244(20) is that the RFI was addressed to each partner for purposes of the ITA.”
Neal Armstrong. Summaries of Zeifmans LLP v. Canada (National Revenue), 2021 FC 363 under s. 231.2(1) and s. 244(20).