News of Note
Singapore Telecom – Federal Court of Australia, Full Court finds that an independent enterprise would have agreed to allow cross-border interest to be capitalized, but not to make it contingent on cash flow
Email this ContentThe taxpayer (“STAI”) - a wholly-owned Australian subsidiary of a Singapore public company - purchased in June 2002 all the shares of an Australian telecommunications company from a Singapore sister company (“SAI”). SAI provided $5.2 billion of vendor financing pursuant to a note facility that had a term of 10 years and provided for interest at the one year bank bill swap rate from time to time plus 1%. However, SAI had the right to choose to defer the payment of the interest, which it did for the first tax year given the initial low cash flow of STAI.
Under a loan amendment made at the end of the first taxation year (on March 31, 2003), the accrued interest was forgiven, a profitability benchmark was introduced so that no interest would be payable unless that benchmark was met and the (now contingent) rate of interest was increased by a further 4.552% per annum of the principal. A further amendment made on March 30, 2009 replaced the variable interest rate with a fixed rate of 13.2575% for the balance of the loan term.
The Commissioner applied the Australian transfer-pricing rules (which referenced the related-person Article of the Singapore-Australia Treaty, and tested whether conditions operated between the two enterprises (STAI and SAI) in their commercial or financial relations which differed from those which might be expected to operate between independent enterprises dealing wholly independently with one another) to substantially reduce the interest claims of STAI for its tax years ending on 31 March 2011, 2012 and 2013.
The primary judge had found that independent enterprises in the positions of SAI and STAI might have been expected to have agreed at the time of the notes’ issuance that the interest rate applicable to the notes would be the rate actually agreed (the swap rate plus 1%) and that such interest rate could be deferred and capitalized. This interest rate took into account that, in such circumstances, there would be a guarantee by the parent, given that it would not be commercially rational to bear the significantly higher interest rate that would have been required without such a guarantee, and it would have been reasonable for a party like SAI to seek security. Furthermore, no guarantee fee should be imputed as there was no evidence that under the hypothetical conditions the parent would have charged such a fee.
In addition, an independent party in the position of SAI would not have agreed to make the changes contained in the two amendments.
The Full Court found no reversible error in the findings of the primary judge. It rejected the contention of STAI that the amount of interest actually paid over the 10 year period was equal to or less than that which might be expected to have been paid between independent parties in similar circumstances over the same period, as the transfer-pricing standard was required to be met on a tax year by tax year basis – and the Commissioner had the discretion to adjust the interest for earlier years upwards. Regarding the 2003 amendment, it noted the primary judge’s finding that there did not appear to be any commercial rationale for it, and that it had been implemented to avoid withholding tax. It noted that it was consistent with applying the independent enterprises hypothesis having regard to the circumstances of each enterprise to impute that the creditor (SAI) would have required a parent guarantee for a $5.2 billion loan.
Neal Armstrong. Summary of Singapore Telecom Australia Investments Pty Ltd v Commissioner of Taxation [2024] FCAFC 29 under Treaties – Income Tax Conventions – Art. 9.
We have translated 6 more CRA interpretations
We have translated 6 further CRA interpretations issued in April of 2002. Their descriptors and links appear below.
These are additions to our set of 2,774 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 22 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
CRA will not change its GAAR positions in IC 88-2 and the Supplement as a result of the GAAR amendments
Regarding the impact of Bill C-59 on the GAAR positions in IC 88-2 and IC 88-2 Supplement 1, CRA stated:
[T]he application of the amended section 245 must be in accordance with the object, spirit and purpose of such provision and of the other provisions that are relied upon by the taxpayer as well as, ensure that economic substance receives proper consideration.
That being said, our general view is that the conclusions reached in the examples provided in IC 88-2 and IC 88-2 Supplement 1 should remain the same under the amended section 245.
Neal Armstrong. Summary of 28 February 2024 Internal T.I. 2024-1008251I7 under s. 245(4).
CRA concludes that a Liechtenstein stiftung was a trust for ITA purposes
A Liechtenstein stiftung was formed in order to invest its funds and make distributions to beneficiaries as determined in the discretion of its foundation council. It had legal personality and owned the property allocated by the founder.
CRA first noted that “[d]escribing a trust by reference to dual ownership or equity in an international context would have the result of ignoring all civil law arrangements that have adopted the trust idea of the administration of assets for the benefit of others.” It concluded that the stiftung had more in common with a trust than a corporation (and, thus, should be treated as a trust for ITA purposes) given inter alia that:
- it had no form of “share capital” or other ownership interests which conveyed a right to distributions of earnings or capital
- it was created by an endowment from a founder much like a trust settlement
- it had beneficiaries, named in its by-laws
- its executive bodies administered and used the property transferred by the founder for the benefit and advantage of the beneficiaries similarly to a trustee
- unlike a corporation, it was restricted to investing rather than carrying on a commercial business.
These conclusions were consistent with 2008-0266251I7 and 2010-0388611I7.
Neal Armstrong. Summary of 22 July 2023 Internal T.I. 2021-0883241I7 under s. 104(1).
3295940 Canada – Federal Court of Appeal finds no abuse in a tax plan producing the same gain as if the ultimate shareholder had directly used its high outside basis for its investment
The taxpayer (3295) was a holding company with a minority shareholding in a target company (Holdings) with a low ACB, whereas 3295’s parent (Micsau) had a high ACB for its 3295 shares. Unfortunately, the majority shareholder of Holdings (RoundTable) negotiated the initial terms of the sale without Micsau’s involvement, which provided for a sale of the shares of Holdings to Novartis by its two shareholders. However, Micsau subsequently contacted Novartis, and negotiated that it could sell its shares of Holdings through a Newco (4244 referred to below).
Under that plan:
- Micsau created a sister company (4244) to 3295 to which it transferred newly-created preference shares of 3295 having an ACB (of $31.5M) equal to their redemption amount in exchange for full-ACB shares of 4244.
- 3295 then transferred its Holdings shares to 4244 on a partial s. 85 rollover basis in exchange for Class D and common shares, and realized a capital gain corresponding to the capital gain (of $53M) that it would have realized had it sold its 3295 shares to Novartis; this capital gain was reflected in the full-ACB (of $57M) Class D shares which it received from 4244, whereas its common shares of 4244 had a high FMV (of $31.5M) and nominal ACB.
- 3295 redeemed the preference shares held by 4244 (see 1 above) for a $31.5M note, and elected for the resulting $31.5M deemed dividend to be a capital dividend paid to 4244.
- 4244 redeemed $31.5M of the low-ACB common shares that it had issued to 3295 in Step 2 for a $31.5M note, and elected for the resulting $31.5M deemed dividend to be a capital dividend paid to 3295.
- Then the two notes were set off, Micsau transferred its shares of 4244 to 3295, and 3295 sold the shares of 4244 to Novartis at no further capital gain.
Goyette JA found that in determining “whether transactions forming part of a series are abusive, one must consider the ‘entire series of transactions’ or its ‘overall result’” and that, here, the overall result of the series was the same as if Micsau had sold its 3295 shares to Novartis.
Furthermore, the Tax Court had erred in considering that the cross-redemption capital dividend (Steps 3 and 4) reduced the capital gain that 3295 would have realized from disposing of its commons shares in 4244 immediately before the dividend. Thus, the “series’ overall result [was] consistent with the object, spirit and purpose of the capital gains regime as previously identified by this Court—that is, to tax real economic gains: Triad Gestco … “.
In addition, "courts consider alternative transactions’ tax consequences when determining whether tax avoidance is abusive”. The Tax Court had erred in failing to consider four alternative transactions which would have produced the same tax result (of using the high outside tax basis in 3295 shares) as those implemented, such as a tuck-under transaction, or having RoundTable purchase the 3295 shares, and bump the Holdings’ shares under s. 88(1)(d) on winding-up 3295.
Goyette JA stated that these transactions were relevant because they were: available under the Act; realistic alternatives; commercially similar to the subject transactions and with similar tax results; and reflecting a similar absence of abuse, i.e., they “would have enabled Micsau to realize its high ACB without attracting the application of the GAAR.”
Neal Armstrong. Summary of 3295940 Canada Inc. v. Canada, 2024 FCA 42 under s. 245(4).
CRA states that it will continue to issue post-mortem pipeline rulings following the GAAR amendments, but will not rule on surplus stripping by individuals
Regarding the status of post-mortem pipeline transactions following the amended GAAR rule, the Directorate stated:
The Directorate does not consider the use of a pipeline transaction as a means to preserve the capital gain arising on the death of a shareholder while limiting double taxation on the subsequent distribution of Opco’s assets to be a … [GAAR] abuse … . Accordingly, the Directorate will continue to issue favourable Rulings on the non-application of the amended GAAR in the context of post-mortem pipeline transactions that meet our existing administrative guidelines described in document 2018-0748381C6.
However, the Directorate noted the example provided in the Explanatory Notes of a surplus-stripping transaction of Jane in which she realized a capital gain on a dirty s. 85 exchange of her Opco shares, transferred her stepped-up Opco shares to another corporation controlled by her (Buyco) in consideration for a Buyco note, with Opco then dividending its earnings to Buyco for application in repaying the note. It indicated that it will not provide Rulings in respect of transactions of this type or “in similar circumstances where an individual shareholder proposes to engage in non-arm’s length transactions, one of the main purposes of which is to create cost basis to extract retained earnings.”
Neal Armstrong. Summary of 29 February 2024 Internal T.I. 2023-0987941I7 under s. 245(4).
CRA indicates that the quantum of offshore investment fund property income earned through a CFA is unaffected by dividends paid by that CFA
A wholly-owned non-resident subsidiary (“CFA”) of Canco owned 50% of the common shares of a non-resident corporation (“FA”) which were assumed to constitute offshore investment fund property (“OIFP”). CFA received annual dividend distributions from the OIFP. Headquarters rejected Canco’s argument that a dividend paid by CFA to Canco generated a deduction pursuant to s. 94.1(1)(g) from the imputed income inclusion to Canco under the OIFP rules pursuant to s. 94.1(1)(f). The effect of C of the FAPI formula was that the OIFP rules generated FAPI to CFA, and Canco then picked up its share of such FAPI – and this combined operation of the FAPI and OIFP rules was not affected by dividends paid by FA to the CFA (inter-FA dividends are excluded form FAPI) nor was it affected by any dividends paid by CFA to Canco.
Neal Armstrong. Summary of 23 August 2023 Internal T.I. 2021-0882371I7 under s. 94.1(1)(g).
Income Tax Severed Letters 6 March 2024
This morning's release of five severed letters from the Income Tax Rulings directorate is now available for your viewing.
DEML Investments – Tax Court of Canada finds that the generation of a capital loss on a partnership interest representing a successful investment was a GAAR abuse
In early 2008, the sale of petroleum and natural gas (PNG) rights by an arm’s length vendor (Transglobe) to the parent (Direct Energy) of the taxpayer (DEML) was structured on the basis that Transglobe transferred 99% and 1% of the PNG rights, at a nominal s. 85(1) elected amount, to two wholly-owned Newcos (137 and 138, respectively), which then transferred the rights on an s. 97(2) rollover basis to a newly-formed partnership (DERP2). Direct Enery then acquired the shares of 137 and 138 for $51 million and $0.5 million, respectively.
A year later, Direct Energy transferred the shares of 137 to DEML on an s. 85(1) rollover basis, with 137 then distributing its partnership interest in DERP2 to DEML on its winding up, with the ACB of that partnership interest being bumped under s. 88(1)(d).
DERP2 then distributed its resource properties to DEML as a return of capital, thereby increasing the COGPE balance of DEML and reducing the ACB of DEML’s partnership interest by the FMV of the rights (higher than the value a year earlier) – but with these items effectively being approximately reversed at the partnership year end as a result of DERP2’s proceeds of the distribution of the PNG rights being allocated to its partners.
After then reseeding DERP2 with a small resource property that was of interest to a third-party purchaser, DEML sold its partnership interest to that purchaser, thereby realizing a capital loss. In confirming CRA’s GAAR assessment to deny the capital loss, Russell J stated:
Here the substantial Capital Loss was claimed where there was no economic loss or impoverishment, thus per Triad Gestco breaching the OSP [object, spirit and purpose] of the Act’s capital loss provisions, including paragraph 39(1)(b). …
As the purpose of the capital loss provisions is to recognize real losses, there is clear abuse where artificial losses are deducted. That is even more so when those losses are based on non-capital CRP [Canadian resource property], that will also be deducted through CCOGPE pools at a 100% inclusion rate thus creating a double deduction.
Similarly, regarding the use of the s. 88(1)(d) bump to effectively create most of the quantum of the loss, he stated:
[I]t seems incomprehensible that an artificial loss would signal misuse of capital loss provisions of the Act without equally indicating misuse of the very “bump” provisions of the Act used to achieve the artificial loss through the “bumping” of an ACB.
Neal Armstrong. Summary of DEML Investments Limited v. The King, 2024 TCC 27 under s. 245(4).
CRA discusses the different treatment of losses under Pt. XIV, and Art. X(6) of the Canada-US Treaty
The Directorate confirmed the position in 9408985 that in light of the branch profits limitation under Ar. X(6) of the Canada-US Treaty of 10% of cumulative untaxed "earnings," a two-step process should be followed under which branch tax is first computed in accordance with Part XIV, then the upper limit is computed under Art. X(6) which, if applicable, reduces the branch tax computed under the first step.
Regarding the effect on “earnings” under Art. X(6) where a non-resident corporation applied a loss carryback to reduce its taxable income earned in Canada in the prior year, the Directorate noted that, in contrast to the Part XIV rules, the Art. X(6) earnings for a particular year are not reduced by the carryback of losses to that year from a subsequent year, so that such loss only reduces the cumulative earnings for Art. X(6) purposes in the loss year. Furthermore, although Art. X(6)(b) contemplates the deduction of Part I federal, and provincial income tax in computing earnings, when there is a loss carryback to a prior year which reduces such taxes for that year, the impact of such tax reduction on earnings for Art. X(6) purposes should be to reduce the loss for the current year rather than to increase earnings for the prior year.
The Directorate further stated:
[T]he amount of Allowance for Investment Property in Canada claimed in the prior year and that is being added back to the branch tax base under paragraph 219(1)(g) should not be added back in the same manner in computing “earnings” under Article X(6). Instead, the amount of Allowance for Investment Property in Canada for the current year, calculated under Regulation 808, would be deducted in the “earnings” calculation in accordance with subparagraph (c) of Article X(6).
Neal Armstrong. Summary of 21 October 2021 Internal T.I. 2020-0872281I7 under Treaties – Income Tax Conventions – Art. 10.