News of Note
Income Tax Severed Letters 15 April 2020
Email this ContentThis morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Post-mortem tax planning should address the narrow scope of the comfort letter on s. 212.1(6)
A pipeline typically entails the estate selling its shares of Canco (whose ACB was stepped up on death) to a new Holdco for a Holdco note which, on its subsequent repayment, effectively extracts the corporate surplus of Canco. Although the new look-through rule in s. 212.1(6)(b) would otherwise generally generate a deemed dividend to the non-resident beneficiaries of the estate based on their proportionate share of the excess of the note over the paid-up capital of the transferred Canco shares, Finance has provided a comfort letter in which it disclosed a recommendation that the Act be amended to exclude, from the application of s. 212.1(6)(b), dispositions of shares by a Canadian resident graduated rate estate of an individual who was resident in Canada immediately before the individual's death, provided that those shares were acquired by the estate on and as a consequence of the individual's death.
As this proposal only applies to shares acquired on death:
If the Opco shares are exchanged (for example, for fixed-value preferred shares) after death and before the pipeline, relief may be lost.
More fundamentally, the comfort letter does not apply to life interest trusts (LITs)—such as alter ego, spousal, and joint partner trusts— even though LITs are in a materially identical position to GREs, so that the proposal does not address the same double taxation issue faced by them.
A suggestion:
Assume that the LIT transfers its shares of Opco for Holdco shares alone (that is, without receiving any non-share consideration). Paragraph 212.1(1.1)(b) suppresses the PUC of the Holdco shares, but no deemed dividend arises. On a subsequent repurchase or redemption of those shares, the LIT will realize a deemed dividend under subsection 84(2) or (3), but, critically, its POD will be reduced (see paragraph (j) of the POD definition in section 54). The result is a capital loss. Subject to the applicability of any stop-loss rules and the general three-year loss carryback period, the LIT can use that loss to offset its capital gain on death. Thus, only one layer of tax subsists.
Neal Armstrong. Summary of Kyle B. Lamothe and Alexander Demner, “Section 212.1 Post Mortem Pipeline Comfort Letter” Tax for the Owner-Manager, Vol. 20, No. 2, April 2020, p. 8 under s. 2261.
Lee – Court of Quebec finds deductible interest on a note that could be settled with property worth less than the amount owed and that the tax shelter definition is applied on a property-by-property basis
The ARQ did not lose heart with the victory by a representative investor in a tax shelter in Drouin (where CRA unsuccessfully argued that no business was carried on) and, for the same tax shelter and for the same year (as well as other years) was successful before the Court of Quebec in having most of the claimed deductions denied. For two of the years, there was a prescribed benefit in the form of limited recourse debt, which resulted in all the deductions being denied under the Quebec equivalent of ITA s. 231.7(6), as no tax shelter registration had been made. For two subsequent years, such registration had been made, but there nonetheless were tax shelter investments under Quebec equivalent of s. 143.2, so that the limited recourse nature of the debt again resulted in CCA denials under that provision and the equivalent of Reg. 1100(20.1). However, interest deductions on the limited recourse debt was allowed for those years, notwithstanding that the taxpayers could extinguish their obligations under the notes by surrendering their franchises (which in fact occurred, once the targeted deductions were claimed).
For some further taxation years, the promoters once again failed to file tax shelter registrations. The taxpayers argued that the franchises for those years did not satisfy the numerical tax shelter test because the cost of their acquisition of the property (being a single franchise property for these purposes comprised of the software licence and the membership right) included all the interest they had covenanted to pay. Fournier JCQ rejected this interpretation of “cost”, stating:
The term "cost" must therefore be assimilated to the price that the taxpayer agreed to pay to acquire the property, excluding other expenses incurred in respect of the property, including interest payable on money borrowed by the taxpayer to acquire the property.
He also rejected the single property argument, stating that the tax shelter definition “militates in favour of an individual analysis of the property in question in order to determine whether or not it qualifies as a tax shelter.” Accordingly, the Class 12 CCA claims for those latter years respecting the cost of the software were also denied, whereas the eligible capital amounts claimed for the membership right were deductible.
Neal Armstrong. Summaries of Lee v. Agence du revenu du Québec, 2020 QCCQ 780 under s. 20(1)(c)(ii) and s. 237.1(1) - tax shelter.
6 more translated CRA interpretations are available
We have published a translation of a CRA interpretation released last week and a further 5 translations of CRA interpretations released in November and October 2010. Their descriptors and links appear below.
These are additions to our set of 1,147 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 9 ½ years of releases of Interpretations by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall.
CRA confirms that the “cost” of call options closed out by their writer is nil, and that the “cost” of a short sale is the FMV of the borrowed shares
Box 20 of Form T5008 Statement of Securities Transactions that is prepared by investment dealers respecting the transactions conducted by them on behalf of their clients reports (in Box 20) the cost of such securities. CRA indicated that the cost of a call option that is sold by its writer on an exchange is nil, and that where the writer then terminates its obligations under that option by purchasing a matching option on the exchange, that purchase is treated as a separate transaction for T5008 reporting purposes.
In the case of a short sale transaction, the cost of the shares sold short is the fair market value of the shares at the time they are borrowed for the purpose of being sold short – so that the cost of the sales sold short is not the cost of the shares subsequently purchased to cover the short.
S 49(1) deems the writing of a call option on capital account to be a disposition, with the implication that the call premium received by the writer is deemed to be proceeds of disposition. CRA confirmed its position “that expenses incurred in connection with the granting of an option may be deducted from the proceeds of disposition when calculating a taxpayer's gain.”
Neal Armstrong. Summaries of 22 January 2020 External T.I. 2014-0559281E5 F under Reg. 230(2), ITA s. 40(1)(a)(i) and s. 49(1).
Proposed Bitcoin Fund will be a long-term holder of bitcoin
The final long form prospectus for the Bitcoin Fund contemplates an Ontario trust whose units will be listed on the TSX and that will invest substantially all of its assets in bitcoin. It will acquire an initial bloc of bitcoin from another fund (with the same name as its manager) potentially on a s. 132.2 rollover basis, so that there was the potential for the acquired bitcoin to have an accrued gain.
It is contemplated that the bitcoin would not constitute non-portfolio property (no SIFT tax). Since the Fund intends to be a long-term holder of bitcoin, it is anticipated that it will treat its bitcoin as capital property. In addition to an annual redemption right at NAV (to be paid in U.S. dollars rather than in specie), there is a monthly redemption right (at a generally discounted redemption price) so that the Fund can qualify as a mutual fund trust. The disclosure notes that proposed s. 132(5.1) might effectively require the Fund to allocate capital gains realized by it on a redemption of unis to non-redeeming unitholders.
Neal Armstrong. Summary of 31 March 2020 Bitcoin Fund prospectus under Offerings – Commodity Funds – Cryptocurrency Funds.
Income Tax Severed Letters 8 April 2020
This morning's release of two severed letters from the Income Tax Rulings Directorate is now available for your viewing.
KIK – Federal Court finds that follow-up correspondence of the taxpayer’s accounting firm resulted in the transformation of a reversible CBSA decision into a reasonable one
Vavilov confirmed that decisions of the CRA (or, in this case, the CBSA) must satisfy requirements of justification, transparency and intelligibility. An adverse CBSA decision on the taxpayer’s request for a ruling that it was entitled to duty drawbacks on its imports did not meet this standard. However, the taxpayer’s accounting firm immediately contacted the officer involved by email for an explanation and made submissions, and as part of further email exchanges the officer clarified why the items were not considered to satisfy the conditions for the drawback. In finding that this email correspondence was effectively part of the decision under judicial review, Norris J stated:
The officer’s responses to the inquiries and further submissions from the applicant’s representatives are part and parcel of the justification for the decision that was given to the applicant. … The officer was not responding to an application for judicial review of the decision, something that had not yet been commenced at the time of the exchanges.
As the decision in this broader context was now rendered reasonable, Norris J declined to reverse it.
Neal Armstrong. Summary of KIK Custom Products Inc v. Canada (Border Services Agency), 2020 FC 462 under Customs Tariff Act, s. 89(1)(a).
CRA rules on pipeline transaction for marketable securities company that generates full dividend refunds and a s. 164(6) carryback
CRA provided standard rulings for a pipeline transaction respecting a CCPC, with a portfolio of public company shares and other marketable securities, whose common shares were stepped up to their fair market value on the death of the deceased. Preliminarily:
- ACo redeemed all of its preferred shares (having full paid-up capital and ACB) by issuing notes.
- ACo generated a refund of its eligible refundable dividend tax on hand, or its non-eligible refundable dividend tax on hand, balances, through the purchase for cancellation (in consideration for a promissory note) of a sufficient number of its common shares..
- The executors will carry back the resulting capital loss under s. 164(6), with s. 40(3.61) thereby precluding the application of the s. 40(3.6) stop loss rule.
The pipeline proper transactions were then to be implemented under which:
- The estate transfers the remaining ACo common shares to a Newco formed by it in consideration for a note and one Newco common share.
- A redacted number of months later, ACo is amalgamated with Newco, or wound up into it under s. 88(1).
- Thereafter the note issued in Step 1 begins to be repaid over a redacted period of time.
Between Steps 1 and 2, ACo (but not Newco) is permitted to partially repay the various notes issued by it.
Neal Armstrong. Summary of 2019 Ruling 2019-0822951R3 F under s. 84(2).
5 more translated CRA interpretations are available
We have published a further 5 translations of CRA interpretations released in November 2010. Their descriptors and links appear below.
These are additions to our set of 1141 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 9 1/3 years of releases of Interpretations by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall. You are currently in the “open" week for April.