News of Note
Custeau – Quebec Court of Appeal finds that Copthorne does not require the s. 248(10) “in contemplation of” test to be applied on a backwards-looking basis
Email this ContentWhen a family small business corporation (the “Corporation”) was in financial difficulty, two Quebec regional development funds agreed in 1997 and 1998 (with an objective of saving jobs) to inject equity capital in the Corporation on terms largely dictated by them. As a result of paid-up capital averaging that occurred in the 1998 transactions, the PUC of the common shares of the taxpayers (two brothers) was boosted by a significant amount. In 2003 and 2004, they engaged in capital gains crystallization transactions, which resulted in them holding their shares through respective Holdcos whose shares had a stepped-up ACB and a PUC that reflected the PUC that had effectively been transferred to them. The funds’ common shares of the Corporation were repurchased in 2005 (the Corporation had done quite well), and the taxpayers had their Holdcos distribute most of their PUC in cash during 2006.
The ARQ considered this to be abusive surplus-stripping, and applied the Quebec general anti-avoidance rule to treat most of the paid-up capital distributions as taxable dividends. Dortélus JCQ had found that the utilization by the taxpayers of their stepped-up PUC in 2006 was not part of the same series of transactions as the 1998 PUC-averaging transactions, stating that in order to analyze the nexus between the 1998 and 2006 transactions “it is necessary to place oneself in 1998, at the time of the first transaction and not to apply a backwards-looking analysis.” The ARQ submitted that this approach had erred by not recognizing that Copthorne had found that the assimilation to a series of transactions - of related transactions completed “in contemplation” of the series - included backwards-looking contemplation (i.e., the 2006 transactions were effected “in contemplation” of the previous PUC step-up in 1998.)
In rejecting this submission, Schrager JCA found that, consistently with Copthorne, the question of whether the “in contemplation of” test as to a series should be applied prospectively or retrospectively, depended “on the circumstances of the case.” In the circumstances of this case, including that “none of the players in 1998 could have foreseen that the business would generate sufficient cash six or eight years later to allow the shares to be redeemed,” Dortélus JCQ had not erred by applying the “in contemplation of” test looking forward from 1998 rather than backwards from 2006. It followed that the 1998 PUC-averaging transactions and the use of that PUC in 2006 were not avoidance transactions for GAAR purposes.
Neal Armstrong. Summary of Agence du revenu du Québec v. Custeau, 2020 QCCA 1496 under s. 248(10).
3295036 Canada – Quebec Court of Appeal finds that the use, in sales years later, of ACB that was stepped up in a “Quebec shuffle,” occurred as part of the same series
In October 1996, a Quebec-taxpayer company (“329”) acquired public company shares from its parent, on two separate days, in “Quebec shuffle” transactions. The parent realized no gain because federal and Ontario s. 85(1) elections were made. However, 329 acquired the shares at full cost for Quebec purposes because no Quebec rollover election was filed. Most of the shares were sold by 329 in 2000 at a capital loss for Quebec purposes, and it claimed some of those capital losses in its 2007 and 2008 Quebec returns.
A specific Taxation Act provision (s. 529.1) effectively denied 329’s use of its stepped-up cost if its two 1996 acquisitions occurred as part of a series of transaction that ended after 18 December 1996. The Court affirmed the finding of Fournier JCQ below, who found that the two 1996 share drop-downs were a “series of transactions” and applied Copthorne to find that the subsequent sales of the shares by 329 were transactions occurring “in contemplation” of that series and, thus, were assimilated to the series by the Quebec equivalent of s. 248(10). In this regard, the Court of Appeal stated:
[T]he transactions at issue … were not known at the time the tax planning was implemented, but were undoubtedly the type of transactions contemplated in order to benefit from the tax advantage resulting from the "Quebec shuffle".
The Court also confirmed Fournier JCQ’s finding that the ARQ was not precluded from reassessing 329’s 2007 and 2008 taxation years to deny the capital losses carried forward from 2000, notwithstanding that the 2000 year was statute-barred.
Neal Armstrong. Summaries of 3295036 Canada Inc. v. Agence du revenu du Québec, 2020 QCCA 1435 under s. 248(10) and s. 152(4).
Yellow Point – Federal Court of Appeal confirms that an ecological gift was made in the year before it was certified as such
A taxpayer, who donated an interest in ecologically sensitive land to two qualified donees in 2008, unsuccessfully argued that the gift was not made until 2009 for purposes of computing the five-year (now 10-year) carryforward period described in s. 110.1(1)(d)(iii), because it was not until 2009 that he received the certification from the Minister of the Environment as to the land's ecologically sensitive nature and value that was required under that provision. In confirming that the ecological gift instead was made in 2008 when the gifted property was transferred, Noël CJ stated:
[W]hen property is gifted … the disposition takes place when ownership of the gifted property is transferred from the donor to the donee …
… There is no doubt that the appellant’s entitlement to the capital gain exemption and the related deduction did not arise until 2009 when all the conditions set out in paragraph 110.1(1)(d) and subsection 110.1(2) were met, but this does not alter the time when the “gift was made”.
Noël CJ also effectively found that the word “peut” (may) in the French version of s. 118.1(11) meant the same thing as the word “shall” in the English version, stating in this regard:
[T]he use of the word “peut” in the French version illustrates how “an official who is permitted to do a thing may, in addition, be obliged to do it” (Ruth Sullivan, Sullivan on the Construction of Statutes …).
Neal Armstrong. Summary of Yellow Point Lodge Ltd. v. Canada, 2020 FCA 195 under s. 110.1(1)(d) and s. 118.1(11).
Income Tax Severed Letters 11 November 2020
This morning's release of two severed letters from the Income Tax Rulings Directorate is now available for your viewing.
MDA Systems – Court of Quebec finds payments made by the federal government under a contract where it mostly had the risks and benefits were SR&ED “contract payments”
MDA contracted with the Government of Canada to provide computer systems engineering work on a satellite system to perform radar imaging from space. The ARQ denied tax credits for the wages cost of work performed on the contracts by MDA on the basis that the consideration received by MDA from the Government was “contract payments” – whose definition (similarly to the federal definition in ITA s. 127(9)) relevantly referred to “an amount in respect of an expenditure of a current nature … of a taxpayer … payable by the Government of Canada … or other public authority … for scientific research and experimental development to be performed for the authority.”
Before agreeing with the ARQ position, Bourgeois JCQ found that:
- “the SR&ED work was carried out because of the requirements in the contracts between the Government of Canada and MDA”
- “the Government of Canada bore the major risks of the … Program”
- “the intellectual property developed by MDA in the space component of this project was transferred from MDA to the Government of Canada”
- it was a contract for services rather than for the sale of goods (although Bourgeois JCQ agreed with a CRA Policy Statement that “a contract for the sale of a good does not necessarily mean that the SR&ED work was not being performed on behalf of the payer”)
More generally, “[a]lthough the contracts were not drafted specifically for doing SR&ED work, analysis of the contract terms tends to show that ultimately the SR&ED work was undertaken on behalf of the Government of Canada.”
Neal Armstrong. Summary of MDA Systems Ltd. v. Agence du revenu du Québec, 2020 QCCQ 4190 under s. 127(9) - contract payment - para. (b).
CRA reaffirms that there potentially can be a safe income pick-up from a corporation over which there is no significant influence
CRA reaffirmed its position dating back to the 1984 Hiltz paper that:
One can consolidate safe income of a corporation over which there is no significant influence if it can be clearly demonstrated that the safe income of such corporation contributes to the gain on the shares … .
CRA went on to note that this position:
- extended to the consolidation of income from foreign corporations that were not foreign affiliates (citing Lamont)
- generally would not extend to portfolio investments in public corporations (given that “what would be considered to contribute to the value of the shares held by the shareholder is not the income of the public corporations but rather the trading value of its shares on the stock exchange”)
CRA also stated:
… [T]he negative safe income of corporations would reduce the safe income of a holding corporation only to the extent that it can be considered to result in a reduction of the value of the shares of the holding corporation, for example, either because of a guarantee made by the holding corporation, or because of an actual payment for the losses by the holding corporation [citing Brelco].
Neal Armstrong. Summary of 27 October 2020 CTF Roundtable, Q.2 under s. 55(2.1)(c).
CRA expands on why it views a UK LLP as a corporation
CRA has provided its written responses to the questions posed at the October 27, 2020 CTF Roundtable. In its written response as to why it views a UK LLP as a corporation for ITA purposes, it set out its lists of what it considers to be salient attributes that led it to this conclusion under its two-step approach:
- A UK LLP has a legal existence separate from its members.
- A UK LLP, and not its members, carry on the business.
- A UK LLP, and not its members, acquires and owns property in its own name for use in its business, and is responsible for any debts or obligations incurred as a result of carrying on its business.
- The capital of a UK LLP serves the same function as the share capital of a corporation.
Neal Armstrong. Summary of 27 October 2020 CTF Roundtable, Q.9 under s. 248(1) - corporation.
We have translated 7 more CRA Interpretations
We have published translations of the 2 CRA interpretations that were released last week, as well as of a further 5 CRA interpretation released in November, 2009. Their descriptors and links appear below.
These are additions to our set of 1,315 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 11 years of releases of Interpretations by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall.
Glencore – Full Federal Court of Australia finds that it accorded with arm’s length transfer pricing for an Australian sub to agree to pricing that gave up some price upside for less volatility
An Australian subsidiary (“CMPL”) of Glencore Switzerland (“GIAG”), which had a high-cost copper mine, agreed with GIAG (who was the sole purchaser of the mine output) to amend its supply contract in early 2007 after there had been a surge in world copper prices. The Commissioner argued that CMPL had acted “irresponsibly” by agreeing in these amendments to “price sharing” which meant that CMPL would participate less in a high copper price over the 2007 to 2009 period, but with the benefit of less volatility in price.
The majority reasons found that for the transfer–pricing purposes at issue, it was posing the wrong question to ask “whether an arm’s length party would have agreed to the amendments, given the pre-existing terms of trade”, and that the correct question was simply whether “the pricing formula established by those [amended] terms did not differ from those formulae which might be expected to have operated between independent enterprises dealing wholly independently with one another in the copper concentrate market at the time”. In this regard, the majority concluded, in light inter alia of the evidence of the taxpayer’s expert witness as to industry contracting practice:
[T]he taxpayer has established that independent parties dealing at arm’s length with each other for the sale of the copper concentrate in fact sold by C.M.P.L. to G.I.A.G. from 2007 to 2009 might reasonably be expected to have agreed to a price sharing clause at the rate of 23% as part of the calculation of [the mooted aspect of the pricing formula].
Regarding an alternative pricing approach advocated by the Commissioner’s expert witness, they stated:
[H]is opinion that the parties should have adopted benchmark T.C.R.C.s [i.e., closer to spot pricing] appears to us to represent another possible position that arm’s length parties might reasonably be expected to have adopted. But the existence of this possibility does not negate our finding that price sharing using a 23% rate was also an arm’s length outcome.
Before so concluding, the majority made numerous observations on transfer pricing principles, as they bore on the determination of an arm’s length price, including:
- “one should include all of the objective circumstances of the actual ... mine” and the “objective circumstances of the copper concentrate market as at February 2007”
- however, “it would be appropriate to exclude any considerations that are the product of C.M.P.L.’s non-arm’s length relationship with G.I.A.G. and the broader Glencore Group” which “would include whatever attitude or policy C.M.P.L. had formed about the issue of risk when selling to G.I.A.G”
- “C.M.P.L. … could legitimately adopt a more conservative approach to risk so long as it was commercially rational to do so, and it is what an independent party dealing at arm’s length might reasonably be expected to have done”
- “the possibility of a range of arm’s length outcomes, each of which would be sufficient to answer the statutory test, is supported by authority”
Neal Armstrong. Summary of Commissioner of Taxation v Glencore Investment Pty Ltd [2020] FCAFC 187 under s. 247(2)(a).
Mokrycke - a CRA decision, refusing to recommend FAA relief for reassessments that the taxpayer had failed to appeal, is set aside by the Federal Court
The taxpayer sought a remission order to reverse assessments which he stated were unjustified - but which were not reversed at the notice of objection and were not appealed to the Tax Court allegedly due to his personal circumstances and deficient performance by his accountant. Before setting aside the CRA Remission Committee’s decision and remitting it for consideration by a different decision maker, Norris J stated that the Committee’s decision was “lacking in justification, transparency and intelligibility.”
The decision referenced the taxpayer’s failure to demonstrate the incorrectness of the assessments, whereas the taxpayer’s request for reconsideration in this regard was “the very point in issue.” As for the Committee’s stated position that a taxpayer is responsible for the failures of the professional to whom he entrusts his affairs, “it is insufficient to simply state the rule without also explaining why an exception should not be made in this case.”
Neal Armstrong. Summary of Mokrycke v. Canada (Attorney General), 2020 FC 1027 under Financial Administration Act, s. 23(2).