News of Note

This morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.

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.

Two individuals acquired a rental property, consisting of a duplex and triplex, in 2004. In 2009, they decided to enlarge the duplex and convert it to an open-plan single-unit dwelling. After receiving the required approval from the City of Montreal in April, 2010, a declaration of co-ownership was registered, permitting the effective severance (pursuant to a co-ownership, or “indivision,” agreement) of the triplex and the former duplex, which was sold the next year following its renovation.

Quenneville JCQ found that, in light of the taxpayers’ other increased real estate activity at the around the same time, and in contrast to Latulippe, the application for division of the property evinced a conversion of the property from capital property to inventory.

In assessing the gain on the renovated unit, the ARQ had applied the methodology in IT-218R, para. 15, which was to calculate a notional capital gain at the time of seeking approval from the City for the division, based on the estimated FMV of the duplex at that time, and treating the excess of the gain in 2011 over that capital gain as being a business property. However, consistently with IT-218R, the resulting taxable capital gain was not recognized until the year of the actual sale in 2011. In the course of rejecting the taxpayers’ submission that the CAE decision should instead be applied to treat the taxable capital gain as only being includible in the taxpayers’ income in 2010, Quenneville JCQ stated:

It can be seen that this argument is attractive to the plaintiffs, allowing them to argue that the capital gain should have been taxed in 2010 and to argue that this is a statute-barred year. However, in all other cases, mainly where the sale of the property occurs years later, the taxpayer would be at a distinct disadvantage in the scenario proposed by the plaintiffs.

Neal Armstrong. Summary of Polonovski v. Agence du revenu du Québec, 2020 QCCQ 8943 under s. 9 – capital gain v. profit – real estate, computation of profit.

CRA has announced its approach (which it indicates is generally informed by that in the OECD Commentary to allocating cross-border stock option benefits) on the allocation of RSU benefits between Canada and a foreign jurisdiction:

The following methodology generally applies [after 2020] in sourcing RSU Benefits between Canada and foreign jurisdictions (the “Hybrid Methodology”):

i. Separate the “in the money” portion of RSU Benefits at the date of grant (the “ITM Portion”) and the portion of RSU Benefits relating to the increase in fair market value of the underlying shares from date of grant to date of vesting (the “FMV Portion”).

ii. The ITM Portion at the date of grant generally pertains to past services, and is sourced to the jurisdiction in which the employment services were rendered in the year in which the RSUs were granted (if multiple jurisdictions, in proportion to the employment period exercised in each jurisdiction in that year).

iii. The FMV Portion generally pertains to services rendered during the vesting period, and is sourced according to the OECD Guidance (that is, in proportion to the employment period exercised in each jurisdiction from date of grant to date of vesting).

For example, an employee, who was resident and exercised his employment in a foreign country (“FC”) up until December 31, 2021 and thereafter was resident in and exercised his employment in Canada, was granted 300 RSUs (to be settled in employer shares) on December 31, 2020, when his employer’s shares were trading at $10. The RSUs vest 1/3 each on December 31 of 2021, 2022, and 2023.

Focusing, for instance, on December 31, 2023, when he receives 100 shares with an FMV of $34 each, the ITM Portion for those shares, of $1,000, is sourced to FC (where his services were performed before the grant date); and the FMV Portion, of $2,400, is sourced 1/3 to FC and 2/3 to Canada (in proportion to the respective periods of employment in each country during the vesting period).

The individual recognizes an employment benefit of $3,400 in 2023 under s. 7(1)(a) (assume no Treaty). However, he is entitled to claim a foreign tax credit under s. 126(1) for any income tax paid to FC on the portion of the employment benefit that is sourced to FC (i.e., $1,800 = $1,000 + $800).

Neal Armstrong. Summary of 20 January 2021 Internal T.I. 2019-0832211I7 under s. 126(1).