News of Note
CRA confirms that the use of s. 69(5) in post-mortem planning to realize a trust capital loss is not abusive
Email this Content2012-0456221R3 concerned a spousal testamentary trust which held all the shares of a Canadian investment holding company (Holdco) on the death of the surviving spouse, so that the trust realized gain and an ACB step-up under s. 104(4)(a)(iii). A portion of the Holdco shares were to be transferred by the trust to a newly-incorporated unlimited liability company (Newco 2), with Holdco then redeeming its shares held by Newco 2 for cash and with Newco 2 then to be wound-up under s. 69(5) to realize a capital loss which would be carried back by the trust to reduce the s. 104(4)(a) gain. The s. 84(2) deemed dividend arising on the wind-up was to be allocated and distributed to the US trust beneficiaries, subject to the Treaty-reduced withholding of 15% pursuant to Art. XXII(2) of the Canada-US Treaty, and the corresponding distribution of paid-up capital distributions received by the trust was to be allocated and distributed to the Canadian-resident beneficiary.
In confirming that this position regarding the realization of the s. 69(5) loss was still valid in the context of such post-mortem planning, even if legal and commercial constraints prevent the winding-up of the corporation within three years of the death of the beneficiary spouse (although, of course, this would not be as good a result), CRA stated:
Where the conditions and technical parameters of subsection 40(3.6) apply, the Trust finds itself in a situation of immediate double taxation (capital gain on the death of the beneficiary spouse and deemed dividend on the redemption of the corporation's shares). … The CRA does not consider that the use of post mortem transactions to eliminate the capital gain arising on the death of the beneficiary spouse in order to limit double taxation at the trust level results in a situation of [GAAR] abuse … .
In 2013-0480361C6, CRA confirmed that s. 129(1.2) did not apply in the above situation. In also confirming this position, CRA stated:
Generally, where, in light of the facts and circumstances of a particular situation, post mortem planning is undertaken primarily to prevent the application of the loss limitation rule in subsection 40(3.6) to limit double taxation and, to the extent that the integration principle is respected, i.e., a corresponding tax is ultimately paid by the Trust on the deemed dividend received, the CRA would be of the view that the specific anti-avoidance rule in subsection 129(1.2) should not apply in those circumstances.
Neal Armstrong. Summaries of 10 October 2024 APFF Roundtable, Q.13 under s. 69(5) and s. 129(1.2).
The October 10, 2024 APFF Financial Strategies and Instruments Roundtable is now available in English
We have uploaded our translation of the written questions posed at the 10 October 2024 APFF Financial Strategies and Instruments Roundtable held in Gatineau and of the Income Tax Ruling Directorate’s provisional written answers. We have also made some minor corrections to our summaries of the questions posed, and of our translation of the full text of the provisional answers given, at the (regular) 10 October 2024 APFF Roundtable.
CRA finds that the testing of a NAL relationship regarding the ACB grind under ss. 84.1(2)(a.1) and 84.1(2)(a.1)(ii) occurs when the shares are acquired, rather than when transferred as described in s. 84.1
In 2020, Mr. X married the daughter of Mr. Y and also acquired the shares of PME Inc. from Mr. Y (who claimed the capital gains exemption). In 2022, Mr. X ceased to be related to Mr. Y by virtue of the death of his spouse or the rupture of their marriage.
If in 2024, Mr. X transferred his shares of PME Inc. on a s. 85 rollover basis to his holding company, would s. 84.1 reduce the ACB of his shares of PME Inc., or is the determination of the non-arm’s length relationship under s. 84.1 to be made, not in 2020, but at the time it is engaged (in 2024 in this rollover transaction)? CRA stated:
At the time Mr. X acquired the shares of the capital stock of PME Inc., there was a non-arm's length relationship between Mr. X and Mr. Y, and the CGD was claimed by Mr. Y in respect of that disposition. There was therefore a non-arm's length relationship both at the time referred to in paragraph 84.1(2)(a.1) and at the time referred to in subparagraph 84.1(2)(a.1)(ii). Consequently, for the purposes of applying section 84.1 to the sale to his holding company, the ACB of the shares of the capital stock of PME Inc. held by Mr. X must be reduced by the CGD claimed by Mr. Y.
Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.12 under s. 84.1(2)(a.1)(ii).
CRA confirms that where a vehicle is used both personally and for business by a self-employed worker, there is a choice between a simplified method, and that under ss. 13(7)(c) and (d)
CRA considers that the CCA deduction for the motor vehicle of a self-employed worker that is used for both business and personal use can be computed by determining the amount of CCA in respect of the motor vehicle as if it were used entirely for business purposes, while deducting annually only the proportion of CCA corresponding to the business use in the particular year.
In 2022, a self-employed worker acquired a passenger vehicle at a cost of $50,000, so that $34,000 was included in Class 10.1. The business-use percentage in 2022 was 40%, and the individual designated the property as designated immediate expensing property, giving rise to a CCA claim of $13,600 for 2022.
In 2023, he sold the passenger vehicle for $38,000. Since the cost to him of the passenger vehicle (a designated immediate expensing property per Reg. 1104(3.1)) was higher than the Reg. 7307(1) limit, s. 13(7)(i) provided that the proceeds of disposition were computed as: $38,000 X $34,000/ $50,000 = $25,840, resulting in recapture of depreciation. However, multiplying this amount by the increased business-use percentage for 2023 of 60% produced an inclusion $15,504, which exceeded the previous CCA claim.
In agreeing with this calculation, CRA confirmed that, in using the above method, recapture of depreciation was to be included in the proportion corresponding to the business use in the year of disposition (i.e., 60%). However, CRA seemed to effectively indicate that the individual had the choice between the above simplified administrative method and the method actually contemplated by ss. 13(7)(c) and (d), provided that such choice was consistently applied. In this example, there presumably would have been a better result applying s. 13(7)(d)(i) since it would have deemed there to be a capital cost increase based on the increased 20% business use at the beginning of 2023, so that there would have been a larger UCC pool to partially absorb the subsequent business proceeds.
Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.11 under s. 13(7)(d).
CRA indicates that an early lease termination fee might potentially be an “actual lease charge” for purposes of the s. 67.3 lease-payment deductibility limit
In 2023, a self-employed individual leased an automobile, which he used in the course of his business, but several months later, terminated the lease and paid a lease termination fee of $10,000, in order to lease a different make of car.
2008-0285361C6 dealt with a car lease early termination payment by an employee (claiming employment expenses therefor) and stated that if the termination fee represented “actual lease charges” under the automobile lease, it could be deducted pursuant to s. 8(1)(h.1) subject to the limitations in s. 67.3, i.e., the termination fee was to be added to the other lease costs that were subject to the s. 67.3 numerical limit (of generally close to $13,000 per year).
CRA confirmed that a generally similar approach applied if the individual was self-employed, i.e., again, it would be a question of fact as to whether the lease termination fee constituted an “actual lease charge” and, if it did, it would be added to the more usual lease charges – and if the taxpayer's total annual lease charges exceeded the limit allowed under s. 67.3 including this addition, he would not be able to deduct the excess amount in computing his income under s. 9.
Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.10 under s. 67.3.
CRA confirms that compensatory payments made by a US C-corp to LLC subsidiaries were FAT pursuant to Regs. 5907(1.3) and (1.5)
A corporation resident in Canada wholly owns a US “C” corporation (“Holdco”), which earns foreign accrual property income (“FAPI”) and is the sole member of two fiscally-transparent LLCs. In each relevant taxation year (the “FAPI Year”), Holdco both uses losses incurred by the LLCs to fully offset its taxable income for the U.S. tax purposes and makes compensatory payments under a group tax sharing agreement to the LLCs (“Loss LLC 1” and “Loss LLC 2”) for the utilization of their losses (the “Compensatory Payments”). The loss of Loss LLC 1 is a “foreign accrual property loss” (“FAPL”); and the loss of Loss LLC 2 is neither a FAPL, nor a “foreign accrual capital loss” (“FACL”).
Do the Compensatory Payments made to the two LLCs qualify as foreign accrual tax (FAT) pursuant to Reg. 5907(1.3); and, if so, do Regs. 5907(1.4) to (1.6) apply to the Compensatory Payments made to Loss LLC 2?
In finding that Reg. 5907(1.3)(b) would be satisfied, CRA noted that, as a result of the two LLCs being treated as fiscally transparent, in computing its income or profits subject to tax in the U.S. for the FAPI Year, Holdco deducts the losses incurred by the LLCs, which are losses of other corporations. Holdco, as the particular affiliate, pays the Compensatory Payments to the loss transferors and such payments may reasonably be regarded as being in respect of income or profit tax that would otherwise have been payable by Holdco. Thus, Reg. 5907(1.3)(b) would deem the Compensatory Payments made to Loss LLC 1 and Loss LLC 2 to be FAT, subject to the application of Reg. 5907(1.4).
Reg. 5907(1.4) will deny the amount prescribed to be FAT of Holdco under Reg. 5907(1.3)(b) to the extent it relates to the Compensatory Payment made to Loss LLC 2 - on the basis that the Compensatory Payment cannot reasonably be considered to be in respect of a FAPL or a FACL. However, Regs. 5907(1.5) and (1.6) would reinstate the FAT if for the subsequent 5 years, Holdco earns active business income in excess of its losses, and any losses of Loss LLC 2 for the FAPI Year, as well as their losses that can be carried back and used in those five years.
Neal Armstrong. Summaries of 22 February 2024 External T.I. 2016-0667251E5 under Reg. 5907(1.3) and Reg. 5907(1.5).
Income Tax Severed Letters 23 October 2024
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA confirms the conversion of vehicle lease payments into recapture on option exercise and vehicle sale
An individual, after having paid $12,500 in lease expenses during the first 48 months of an automobile lease, exercises the option under the lease to acquire the automobile for $15,000, at a time that its FMV is $20,000, then immediately sells it for $20,000.
CRA confirmed that if the individual had been using the vehicle in the course of carrying on a business then, by virtue of s. 13(5.2), the capital cost would be deemed to be $20,000 (i.e., the lesser of the vehicle’s FMV, and the sum of the actual cost of $15,000 and the lease expenses), and the individual would be deemed to realize recapture of depreciation of $5,000 on the sale, rather than a capital gain.
On the other hand, if there was no business use of the automobile, s. 13(5.2) would not apply. Assuming that the relationship between the parties was legally that for a vehicle lease and that no part of the leasing costs was reasonably attributable to the acquisition of the purchase option, the ACB of the purchase option under the s. 49 rules would be nil. If so, the ACB of the vehicle was equal to the exercise price of $15,000 plus the nil ACB of the option, for a total of $15,000, so that there would be a $5,000 capital gain on the sale.
Neal Armstrong. Summaries of 10 October 2024 APFF Roundtable, Q.9 under s. 13(5.2) and s. 49(3).
CRA indicates that the exclusions under (e) of the “automobile” definition, in the case of a leased vehicle, are to be applied in the year of lease signing
The conditions in (e)(i) to (iii) for exclusion from the “automobile” definition specify that such conditions must be satisfied “in the taxation year in which it is acquired or leased.” In the case of a leased vehicle, is the referenced taxation year the year of the signing of the leasing contract, or does it apply to each of the years within the lease term?
CRA responded:
With respect to leased vehicles, the CRA is of the view that the use tests apply in the taxation year in which the lease agreement comes into effect, i.e., generally in the taxation year in which the lease agreement is signed.
Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.8 under s. 248(1) - automobile.
CRA comments on the potential conversion of ERDTOH to NERDTOH through inter-corporate dividends
CRA was provided with the following example to illustrate a potential erosion of the eligible refundable dividend tax on hand (ERDTOH) account where a corporation with a ERDTOH and NERDTOH accounts pays an eligible and non-eligible dividend in the same year to two connected shareholders.
Aco has two connected shareholders, each held by the same resident individual (the “Shareholder”): Bco holding all its common shares; and Cco holding all its preferred shares.
At the end of the applicable taxation year, Aco has ERDTOH and NERDTOH balances of $38,333 and $100,000, respectively.
In the course of that taxation year, it paid an eligible dividend to Bco of $100,000, generating a dividend refund (DR) of $38,333 from its ERDTOH account; and it redeemed the preferred shares held by Cco, generating a deemed dividend of $500,000 for which Aco received a DR of $100,000 from its NERDTOH account.
Bco and Cco were subject to Pt. IV tax on such dividends based on the total DR received by Aco, in accordance with s. 186(1)(b):
Bco: $100,000/$600,000 X $138,333 = $23,055;
Cco: $500,000/$600,000 X $138,333 - $115,278.
For Bco, as the dividend received permitted Aco to receive a DR from its ERDTOH, the $23,055 was added to its ERDTOH account. For Cco, as the dividend received did not generate a right to a refund from its ERDTOH, the $115,278 was added to its NERDTOH account.
Thus, there was a conversion of a $15,278 amount from ERDTOH to NERDTOH for the corporate group.
After noting that this ERDTOH-NERDTOH shift resulted “from the fact that paragraph 186(1)(b) makes no connection between the type of RDTOH account entitling Aco to the DR and the type of dividend received by Bco and Cco,” CRA indicated that, here, “the conversion of an amount of ERDTOH into an amount of NERDTOH results in an increase in the tax payable by the Shareholder … but only at … the stage where the amount of dividends paid is limited to the amount necessary to give entitlement to the DR of the ERDTOH and the NERDTOH of Bco and Cco totalling $138,333.” However, CRA indicated that this “conversion of an ERDTOH amount into a NERDTOH amount … does not ultimately result in additional tax to the Shareholder once all of the dividends received from Aco are paid to the Shareholder by Bco and Cco.”
Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.7 under s. 129(4) - NERDTOH.