News of Note
Income Tax Severed Letters 23 December 2019
Email this ContentThis morning's release of two severed letters from the Income Tax Rulings Directorate is now available for your viewing.
FCR is converting to a REIT using an exchangeable unit structure
The shareholders have approved a conversion of First Capital Realty Inc. into a REIT to occur on December 30, 2019 under a Plan of Arrangement. The shareholders will transfer their shares of FCR on a taxable basis in exchange for units of a newly-formed Ontario unit trust (the REIT) – except that those who legitimately seek rollover treatment can elect to receive exchangeable units of a newly-formed subsidiary Ontario LP of the REIT (FCR LP). The number of exchangeable LP units that may be issued is capped at 20% of the currently outstanding number of FCR common shares. The REIT and FCR LP then transfer (under s. 85(2) in the case of FCR LP) their common shares of FCR to a Newco in consideration for notes and shares of Newco. In addition to other tidying-up steps, Newco then amalgamates with FCR.
The final structure portrayed in the Circular is of the REIT holding Amalco directly and through FCR LP. The exchangeable units of FCR LP must be exchanged by December 23, 2023.
As part of the steps, the REIT will become bound by the terms of the FCR’s Debenture Indenture, with FCR (then Amalco) remaining as a co-principal debtor, but being released from numerous covenants. The common shares held by FCR LP and the REIT in Amalco will be retractable.
Neal Armstrong. Summary of First Capital Realty Circular under Offerings – REIT and LP Offerings – Domestic REITs.
Latulippe – Quebec Court of Appeal finds that subdividing a rental property to substantially enhance the sales proceeds did not entail conversion to inventory
Three individuals who had purchased an eight-unit rental property in co-ownership, determined around 4 ½ years later to sell the property due to a change in personal circumstances of one of them. A real estate broker advised that they could achieve a higher price if they instead sold the eight units separately. This was accomplished by entering into an “indivision agreement,” which meant that each purchaser purchased as a co-owner but with rights of exclusive access to a particular unit. As a result of effectively subdividing the property, they increased their aggregate proceeds by around 25%.
They reported capital gains. The ARQ (but not CRA) reassessed on the basis that the gain that arose after the indivision agreement was business income (i.e., on the basis that the property at that time had been converted to inventory).
In finding that the taxpayers realized capital gains, Rochette JCA noted the absence of any connection between the taxpayers’ employment and real estate or of prior dealings in real estate, their initial intention of generating additional income on retirement and the decision to sell being brought on by changed circumstances, the low cost in dividing into co-ownership units and the low commercial risk associated with this step, and the sale of all the units occurring within the same year.
Neal Armstrong. Summary of Latulippe v. Agence du revenu du Québec, 2019 QCCA 2177 under s. 9 - Capital Gains v. Profit - Real Estate.
Atlas Tube (on no privilege for tax due diligence reports) could be overturned
In Atlas Tube, the Federal Court found that a tax due diligence report - that EY had prepared on a target in advance of its acquisition – could be required to be provided to CRA. Southcott J found inter alia that, as the report’s “dominant purpose when commissioned and generated was to inform the decision whether to proceed with the transaction and at what price” rather than to assist Stikeman in structuring the acquisition, it was not protected by solicitor-client privilege.
Arguments before the Federal Court of Appeal challenging the correctness of this decision may include the following:
- There was no requirement that legal advice be the due diligence report’s dominant purpose. Gower v. Tolko Manitoba Inc. (2001 MBCA 11) stated:
Nowhere in the definition of legal advice privilege is there any requirement that the communications between the lawyer and his/her client be for the dominant purpose of litigation. Rather, what must be present is the provision of legal advice as one of the purposes of the document….
- The characterization of the primary purpose of the report as being to inform the buyer’s business decision as to whether to buy the target (and at what price) is questionable. Instead, tax due diligence reports are an input to the commercial terms of the purchase agreement so as to inform what representations and indemnities are sought.
- Commercial use of legal advice (for which a tax due diligence report is an input) does not detract from it being legal advice.
Neal Armstrong. Summary of Steve Suarez, “FCA To Hear Atlas Tube Appeal,” Canadian Tax Highlights, Vol. 27, No. 12, December 2019, p. 2 under s. 232(1) – solicitor-client privilege.
Alberta Queen’s Bench finds that an executor had no right of implied indemnity from the beneficiaries for estate taxes that should have been withheld
After litigation as to what, if anything, the separated spouse (Ms. Muth) of the deceased was entitled to receive under his estate, a mediated settlement was reached pursuant to which she applied for probate and distributed the estate 55% to her and 45% to her nieces and nephews. However, she withheld an insufficient amount for estate taxes before distributing without an indemnity, and subsequently sued her nieces and nephews for 45% of the deficiency.
After noting that under ITA s. 159 “Parliament could have chosen to make all beneficiaries of the estate liable as well but chose not to do so,” Little J found that the nieces and nephews were under no obligation to indemnify Ms. Muth for these taxes, stating:
… Ms. Muth had a statutory obligation to obtain a clearance certificate and failed to do so.
.. [I]f the beneficiaries did not instigate or request the breach, they cannot be obligated to indemnify the trustee. In a fiduciary relationship such as that between a trustee and a beneficiary, the logic of that corollary is that as between the two parties, one who had the obligation to perform a duty and failed and one who had neither the obligation nor the means to satisfy it, it is the former who should bear the consequences of the action or inaction.
Little J denied Ms. Muth’s motion for summary judgment and “caution[ed] the Applicant that if she continues the lawsuit, she may face a significant costs award if another judge comes to the same conclusion at the end of the suit.”
Neal Armstrong. Summary of Muth Estate, 2019 ABQB 922 under s. 159(3).
Loyer Succession – Federal Court allows review application for failure of CRA to consider a penalty-waiver agreement of the ARQ for the same unreported income
The estate of a suspected drug dealer, who had been murdered, was assessed by the ARQ for income that he had not reported. CRA followed suit with assessments made on the same basis – but CRA did not follow the ARQ’s lead when the latter agreed with the estate to waive all gross negligence penalties - and did not even mention the Agreement to this effect between the estate and the ARQ in its second level review of the estate’s request under s. 220(3.1) for relief. Before remitting the matter to another delegate for redetermination, LeBlanc J stated:
[The estate] has the right to see the Agreement considered and to know why it was not applied in this case, if that was the CRA viewpoint. The failure to do neither … had the effect… of “depriving the process of justification, transparency and intelligibility,” to adopt … Telfer … .
Neal Armstrong. Summary of Loyer (Succession) v. Canada (Attorney General), 2019 CF 1528 under s. 220(3.1).
CRA indicates that supplier documentary deficiencies can be remedied for GST/HST purposes by the recipient’s internal records
Observations of CRA on the documentary requirements for supporting input tax credit claims included:
- It is not necessary that an invoice have the supplier’s registration number. That number can be obtained in any other document.
- Deficiencies in the supplier’s documents can be remedied by the recipient’s internal records. For example, if there is only a cash register receipt that does not list the recipient’s name, that deficiency can be remedied by “sufficient evidence” in the internal records of the recipient that identify itself as the recipient.
- Invoices etc. can be issued in the name of the recipient’s agent provided that the agency arrangement is properly documented and established.
Neal Armstrong. Summaries of 19 June 2019 GST/HST Interpretation 197123 under Input Tax Credit Information (GST/HST) Regulations, s. 3(b)(i) and s. 3(c(ii).
Adélard Soucy – Court of Quebec finds that a building for warming equipment qualified as “manufacturing or processing machinery or equipment”
The taxpayer custom-fabricated pieces of heavy specialized equipment at the northern mining site of one of its mining customers. In order that its soldering work did not fracture (which required that the soldering be carried out at close to room temperature), it needed to house its operation in a pre-assembled shelter (the “Econox”) which it installed at the site. Whether the Econox qualified for Quebec investment tax credit purposes turned on whether it constituted a Class 29 property which, in turn, rested on whether it was a property described in Class 8. In finding that the Econox was a “a structure that is manufacturing or processing machinery or equipment” as per para. (a) of the Class 8 description, Popescu JCQ stated:
[T]he manufacturing and processing activities of the taxpayer could only be carried out within the Econox, which was closely linked to this activity.
The Econox also was fixed equipment which permitted the plaintiff to manufacture and process industrial and mining items.
… In default of being able to speak of permanent physical integration, one can certainly speak of a functional integration as the plaintiff could not carry out its operations in the Great North without the Econox.
Neal Armstrong. Summary of Adélard Soucy (1975) Inc. v. Agence du revenu du Québec, 2019 QCCQ 6956 under Schedule II – Class 8(a).
Patrie – Tax Court of Canada found that a value-enhancing home renovation could qualify for home accessibility tax credit purposes
The house of the taxpayer and his wife had rickety stairs leading down to the yard. To address increasing mobility issues of his wife, the taxpayer replaced these with a deck with a 5-foot wide stairway and aluminum railing – and claimed the $10,000 home accessibility tax credit. CRA was bothered that, with the exception perhaps of the railing, this was what anyone who was trying to improve his home might have built. The definition of “qualifying expenditure” excluded an outlay or expense “made or incurred primarily for the purpose of increasing or maintaining the value of the eligible dwelling.”
In the course of allowing the taxpayer’s appeal, Bocock J stated:
The intention to add or maintain value must be primary. Absent some evidence that the taxpayer foremost sought to improve or maintain the value of the property and only secondarily solve accessibility, the exclusion in sub-paragraph (g) of being “primarily undertaken” to increase or maintain value cannot be sustained.
Neal Armstrong. Summaries of Patrie v. The Queen, 2019 TCC 276 under s. 118.041(1) - “qualifying renovation”, “qualifying expenditure” - (g).
Income Tax Severed Letters 18 December 2019
This morning's release of 10 severed letters from the Income Tax Rulings Directorate is now available for your viewing.