News of Note
Emergis – Tax Court of Canada finds that U.S. withholding tax applicable to a tower structure did not generate a s. 20(12) deduction
Email this ContentEmergis financed a U.S. acquisition through a tower structure under which:
- it made an interest-bearing loan to a subsidiary Canadian partnership (“USGP”);
- USGP funded such interest payments out of dividends received from a wholly-owned Nova Scotia ULC (“NSULC”);
- NSULC, in turn, received dividends out of the exempt surplus of a wholly-owned LLC; and
- the LLC received s. 95(2)(a)-recharacterized interest on the acquisition-financing loan made to “US Holdco”.
Emergis’ 99.9% effective share of the interest deduction of USGP for the loan largely offset its interest income from that loan and, in addition, it claimed the s. 112(1) deduction for its effective share of the dividend income from NSULC. From a U.S. perspective, the interest on the loan owing by USGP was deductible interest paid by a U.S. corporation (USGP) to a Canadian resident (Emergis), and was subject to U.S. withholding tax.
Before concluding that Emergis could not claim the s. 20(12) deduction for such withholding taxes, on the basis that they were “taxes … that can reasonably be regarded as having been paid by a corporation [Emergis] in respect of income from a share of the capital stock of a foreign affiliate of the corporation [the LLC],” Favreau J stated:
[T]he words “in respect of” are very broad … .
Given the flow of funds in this tower structure, there is some connection between the interest income paid by USGP and the dividends paid by LLC to USGP, which were reclaimed and reported by Emergis through its partnership interest in USGP.
After stating that the s. 20(12) exclusion at issue was “intended to restrict the availability of foreign tax relief where the provisions that deal with foreign affiliates can be said to have provided sufficient relief,” he noted that additional connecting factors between the interest payments and the underlying dividend from the LLC included:
- the interest deduction on the upper-tier loan was “dependent on a purpose of earning income which in this case is the dividend flowing from LLC and on from NSULC”
- “the only cross-border source of income recognized by the Act is the income from a share of LLC, which can reasonably be regarded as the income on which foreign tax was levied, since the interest income [itself] is seen as paid by a Canadian resident to another"
Neal Armstrong. Summary of Emergis Inc. v. The Queen, 2021 TCC 23 under s. 20(12).
CRA rules on a pipeline bump transaction
CRA ruled on pipeline transactions respecting common shares of Opco which the deceased held on death, in which:
- the estate redeems common shares of Opco on which the capital gains exemption was claimed, resulting in a deemed dividend and a capital loss, which is carried back under s. 164(6)
- the estate transfers its common shares of Opco to the Newco newly-incorporated by it mostly in consideration for a demand note of Newco
- Opco continues to carry on its business for at least 12 months thereafter, and is then permitted to amalgamate with Newco
- in connection with the amalgamation, Amalco designates, in its return of income for its first taxation year, an amount under ss. 87(11) and 88(1)(c) and (d) to bump the ACB of land that had been held continuously by Opco from before the date of the death until immediately prior to the amalgamation
- the Newco note is gradually repaid over a period of at least one year after the amalgamation, with Amalco continuing to carry on the business.
Neal Armstrong. Summaries of 2020 Ruling 2020-0860231R3 under s. 84(2) and s. 88(1)(d.3).
CRA indicates that the CEWS may be passed along by an outsource staffing company to its clients
Where an outsource staffing company provides its services to a client, it will be that company rather than the client who generally may be eligible to receive the CEWS (wage subsidy). CRA appeared to indicate that the eligibility of the staffing company for the CEWS would not be lost if it passed its receipt of the CEWS along to the client by providing a matching discount on the fees charged by it.
Neal Armstrong. Summary of 20 October 2020 External T.I. 2020-0856781E5 under s. 125.7(1) – eligible remuneration.
We have translated 10 more CRA Interpretations
We have published a translation of a CRA interpretation released last week, and a further 9 translations of CRA interpretation released in January 2009, and in October and September, 2008. Their descriptors and links appear below.
These are additions to our set of 1,440 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 12 1/2 years of releases of Interpretations by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall.
Savics – Federal Court of Appeal finds that s. 152(5) permits the restoration of an initial assessment of income that had been previously reversed by reassessment
To present simplified facts, a taxpayer reported losses from a film distribution LP of $300 per year in Years 1 through 3 and also reported (and was initially assessed for) the $100 of income-account gains that was allocated to him by the LP for Year 4. On audit, CRA determined that the LP did not exist and reversed all of the above amounts in Year 7 (i.e., within the normal reassessment period.) In Year 19, CRA implemented a settlement agreement by inter alia reversing the Year 7 reassessment and restoring the originally-reported income allocation to the taxpayer.
The taxpayer then argued that the Year 19 reassessment was invalid because it did not satisfy s. 152(5), which prohibits the Minister from reassessing beyond the normal reassessment period to include income that “was not included in computing the taxpayer’s income for the purposes for an assessment, reassessment or additional assessment made … before the end of [that] period.” His point was that the Year 4 reassessment nullified the initial assessment, so that the latter ceased to exist for purposes of satisfying the s. 152(5) requirement.
In rejecting this argument (and thus finding that the Year 19 restoration of the initially assessed income was valid), Webb JA stated:
Abrahams, Bowater Mersey and TransCanada Pipelines do not stand for the proposition that when a subsequent reassessment is issued it is as if the prior assessment or reassessment had never been made. Rather, the prior assessment or reassessment would still have been made and would have been valid for the period from the date it was issued until the subsequent reassessment was issued. Therefore, even though Mr. Savics was reassessed in [Year 7], the initial assessment … was still an assessment that was made before the end of his normal reassessment period. …
I do not accept that the purpose of subsection 152(5) … is to prevent the Minister, in reassessing a taxpayer under subsection 165(3) … from restoring a taxpayer to their original filing position by reinstating a particular source and amount of income that had been reported by the taxpayer, assessed as filed, and then subsequently deleted as a result of a reassessment.
Neal Armstrong. Summaries of Savics v. Canada, 2021 FCA 56 under s. 169(3) and s. 152(5).
CRA is now effectively prohibiting the avoidance of contribution holidays or designated plan status through using hybrid defined benefit/money purchase provisions
S. 147.1(5) gives Minister the discretion to impose reasonable conditions on one or more registered pension plans. CRA has now announced two blanket conditions.
First, some employers who sponsor individual pension plan and designated plans (with fewer than four members, at least one who is related) with excess surplus try to avoid the requirement under s. 147.2(2)(d) for a contribution holiday by amending the plan to suspend defined benefit accruals for members and add a money purchase provision under which the employer would then continue contributions.
CRA has now imposed a condition, effective March 16, 2021, that prohibits employers and members from contributing to a money purchase provision of an IPP or to a designated plan if actuarial surplus under the defined benefit provision of the plan is more than the surplus limit – so that any required contributions to the plan’s money purchase provision are permitted only if they are made from the surplus.
A second condition is aimed at plans that in substance are designated plans but that avoid that status by providing that past service benefits are provided on a defined benefit basis while current service benefits are provided strictly on a money purchase basis, and with members having the option to convert their money purchase benefits into defined benefits at regular intervals. Such plans would typically then generate much higher defined benefit contributions than would otherwise be permitted if the plan was subject to the funding restrictions for a designated plan.
CRA is now imposing a condition that deems such plans to be designated plans. The condition is applicable to “employer contributions made pursuant to an actuary’s recommendation contained in an actuarial valuation report that is filed with us after [March 16, 2021]”.
Neal Armstrong. Summary of Newsletter 21-1, Additional Conditions Applicable to Individual Pension Plans and Designated Plans, 16 March 2021 under s. 147.1(5).
CRA indicates that where there has been a s. 125.7(4.1)(e) election, the asset purchaser picks up all rather than part of the seller’s qualifying revenues for the prior reference period
On October 11, 2020, i.e., part-way through the September 27 to October 24, qualifying period, there is an arm’s length purchase by an acquiror of the assets (along with employees) of an operation of the seller. They jointly elect under s. 125.7(4.1)(e), and meet all other conditions to qualify for the CEWS (wage subsidy).
CRA rejected the suggestion that, in determining the acquiror’s qualifying revenue for the previous prior reference period (October 2019), the qualifying revenue attributable to the assets for that prior reference period (the “assigned revenue”) should be pro-rated, based on the number of days in the current reference period for which the acquiror (21 days) and the seller (10 days) used the acquired assets in carrying on business, for purposes of computing the revenue reduction percentage. Instead, “the assigned revenue described in paragraph 125.7(4.2)(a) … refers to the qualifying revenue of the seller for the entire prior reference period that is reasonably attributable to the acquired assets.”
As for the current reference period, in determining its qualifying revenue for that period, the acquirer would include the assigned revenue of the seller, which amount would be subtracted from the seller’s qualifying revenue for that period.
Both the seller and acquiror could potentially make CEWS claims for the current qualifying period based on “their” respective weeks falling before or after the acquisition time.
Neal Armstrong. Summary of 28 January 2021 External T.I. 2020-0870981E5 under s. 125.7(4.2).
Income Tax Severed Letters 17 March 2021
This morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.
4053893 Canada – Federal Court finds that a disclosure by a company was reasonably treated by CRA as not voluntary given enforcement action against its sole shareholder
An individual was contacted by CRA by letter and in a phone call about his failure to file returns for 10 years, his company (which also had not filed returns for 20 years) then made a voluntary disclosure (VDP) application, following which the individual filed his delinquent returns. McHaffie J found that it was reasonable for CRA to determine that the company’s disclosure was not voluntary given the close connection between that disclosure and the enforcement action being taken against the individual, including that his returns would disclose his income from the company, and in the telephone conversation with CRA, it had been informed that the company was still active.
The company had been successful at 2019 FC 51 on the basis of a failure in the Minister’s decision to address how the enforcement action against the individual would likely have uncovered the disclosed corporate information, but his time around the reasons of the Minister’s delegate, although brief, were adequate, and McHaffie J found the decision to deny admission to the VDP to be reasonable.
Neal Armstrong. Summary of 4053893 Canada Inc. v. Canada (National Revenue) 2021 FC 218 under s. 220(3.1).
Unidisc – Quebec Court of Appeal treats master recordings as intangible (Class 14.1) rather than tangible (Class 8) property
Unidisc bought master recordings of music, i.e., the magnetic tapes containing the original recordings of the music for the purpose of having them reproduced in order to make and sell song compilations. Before reversing the decision below that the masters were Class 8(j) tangible capital property, and agreeing with the ARQ that they instead were eligible capital property (now Class 14.1 property), Schrager JA referenced s. 18 of the Copyright Act, which provided that “the maker of a sound recording has a copyright in the sound recording, consisting of the sole right to … [inter alia] reproduce it in any material form,” and then stated (at para. 31):
There are intangible rights … as described in section 18 … which were purchased in association with the physical tapes. It is not credible that an experienced business person would pay in excess of one million dollars for tapes without the right to make and sell copies (albeit subject to the composer’s and the publisher’s copyrights). The value is found in what is recorded on the plastic or cellulose and what Respondent can do with it – i.e. make and sell good quality copies … .
Since Unidisc had not presented any evidence as allocation of the value between the tangible and intangible property, it had failed to meet its burden of demonstrating that the ARQ reassessment (allocating all of the property value to the intangible rights) was incorrect, so that on these grounds, 100% of the capital cost, rather than some lesser amount, was allocated to the intangible property (i.e., eligible capital property).
Neal Armstrong. Summary of Agence du revenu du Québec v. Unidisc Musique Inc., 2021 QCCA 393 under Class 14.1, s. 152(8) and General Concepts – Onus.