News of Note
Income Tax Severed Letters 9 October 2019
Email this ContentThis morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Paletta – Tax Court of Canada denies a film marketing partnership loss on the basis that an alleged option was a sham
A taxpayer used U.S.$82M that had largely been indirectly financed by Twentieth Century Fox to fund, as partner, prints and advertising expenses (“P&A expenses”) respecting a film that Fox allegedly had sold to the partnership for US$128.3M, but with Fox having an alleged option to repurchase the film. The second related taxpayer, engaged in a quite similar transaction.
In denying the claimed losses, Hogan J stated:
[T]he Appellants invested in the … Partnerships solely to avail themselves of the tax savings that the promoters led them to believe they could expect and that they felt secure in the knowledge that Fox had agreed to reacquire the films prior to their commercial release.
Accordingly, I conclude that the options were shams designed to mask the parties’ agreement that Fox would reacquire the films prior to their commercial release.
Consequently, the P&A expenses allegedly borne by the partnerships were not incurred for the purpose of earning income. Likewise, the financing and other expenses incurred by the Appellants with respect to their partnership interests are not deductible.
Hogan J went on to find, in the alternative, that even if his finding on sham was wrong (i.e., the “options” were something less than binding purchase obligations of Fox), s. 231.7(6) of the tax shelter rules precluded the deduction of the losses given inter alia that no tax shelter registration had been made, the P&A expenses had been represented to be deductible and the taxpayers’ expectation of the exercise of those options gave rise to a prescribed benefit under Reg. 231(6).
Neal Armstrong. Summaries of Paletta v. The Queen, 2019 TCC 205 under General Concepts – Sham and Reg. 231(6).
Weaver – Quebec Court of Appeal applies the REOP doctrine to a “gentleman farmer”
A full-time engineer also maintained two horses, which his two daughters rode in equestrian competitions. He had visions of his elder daughter competing in the junior Olympics and making a career of her riding. Revenues from the operation averaged less than 10% of claimed expenses. In reversing the finding below that this “gentleman farmer” was entitled to his claimed losses, the Court stated:
[T]he judge did not analyze the activities of the respondent in relation to the objective factors laid out … in Stewart, namely, (1) the profit and loss experience in past years; (2) the taxpayer’s training; (3) the taxpayer’s intended course of action; and (4) the capability of the venture to show a profit.
… [I]t is difficult to conclude that the predominant intention of the respondent was to derive profit from the equestrian activities of his daughters and that he showed serious businesslike conduct.
Neal Armstrong. Summary of Agence du revenu du Québec v. Weaver, 2019 QCCA 1687 under s. 3(a) – business source.
Income tax issues for pension real estate corporations can arise when investing in LPs or real estate joint ventures
Observations on income tax considerations relevant to s. 149(1)(o.2) corporations include:
- A s. 149(1)(o.2)(iii) corporation is precluded from issuing “bonds, notes, debentures or similar obligations.” Hudson’s Bay v. OMERS indicates that there is no legal relationship between a limited partner (e.g., an (o.2) corp) and 3rd parties who have contracted with the limited partnership (i.e., the general partner thereof). In any event, comfort is provided by s. 253.1, which indicates that such limited partner is not considered to be carrying on any “activity” of the LP (including presumably its borrowing activities).
- Where the (o.2)(iii) corp has guaranteed debt of the LP, the guarantee likely would not be considered to be a similar obligation because there is no creditor-debtor relationship under which the guarantor is primarily liable.
- In order that a s. 149(1)(o.2)(ii) real estate corporation can avoid issues arising out of a CRA position that its activities respecting co-owned real estate should be proportionate to the interest held by it (or other quailed entities), it may headlease its interest to a headlessee which carries on the activities in question.
- Borrowing to fund a tenant inducement payment should generally satisfy the borrowing restrictions under s. 149(1)(o.2)(ii)(C), since the purpose of the borrowing is to earn rental income from the real property being leased. However, borrowing to lend money to a tenant to fund tenant improvements is not permitted, since any income earned from the loaned money will be interest income earned on the loan, not income earned from real property.
Hersh Joshi and Jack Silverson, “Understanding and Doing Business with Tax-Exempt Entities,” 2018 Conference Report (Canadian Tax Foundation), 29:1 – 35 under s. 149(1)(o.2)(iii)(C), s. 149(1)(o.2)(iii)(B), s. 149(1)(o.2)(ii)(A), s. 149(1)(o.2)(ii)(C) and Reg. 8501(2)(a).
Kurnik – Tax Court of Canada finds that legal costs of defending against of countersuit by the employer could be deducted under s. 8(1)(b)
After the former CFO of a company (Mr. Kurnik) sued the successor of his employer (“RJM56”) for reneging on its agreement to pay him a $1.5 million closing bonus on the sale of the company to a venture capitalist, RJM56 then responded by suing Mr. Kurnik in his personal capacity and as trustee of a family trust for the recovery of bonuses paid to him during his employment and distributed to him and beneficiaries of the trust. All such litigation was ultimately settled with Mr. Kurnik receiving a release and a cheque for the full $1.5 million - out of which Mr. Kurnik paid $364,442 in legal fees, including $55,552 in legal fees of trust counsel.
CRA allowed the deduction of the full amount under s. 8(1)(b) (which permitted the deduction of legal fees incurred “to establish a right to” an amount of employment income) other than the $55,552. In allowing the deduction of the latter amount as well, Bocock J stated:
[T]here is no question that the initial lawsuit spawned the subsequent one. … The primary issue within that second lawsuit is the entitlement and quantum of remuneration payable by the employer to the employee. This falls squarely within the wording of paragraph 8(1)(b) … .
Neal Armstrong. Summary of Kurnik v. The Queen, 2019 TCC 206 under s. 8(1)(b).
CRA accepts that a large employer contribution on compassionate grounds to an employee’s crowdfunding campaign to cover a child’s therapeutic requirements was not taxable
An employee, whose recently-born child had a condition that required costly therapy, established a donation-based crowdfunding campaign to help fund such costs. CRA accepted that a contribution by the employer, which was likely the largest contribution to the campaign, was received by the individual on compassionate grounds qua individual rather than qua employee and, thus, did not represent a taxable benefit.
Neal Armstrong. Summary of 23 August 2019 External T.I. 2018-0779191E5 under s. 6(1)(a).
Clevor Technologies – Tax Court of Canada accepts that using metaheuristics is not SR&ED
The taxpayer’s systematic process of trying different combinations of coding changes to its software to eliminate problems of integrating that software with that of a third party (Oracle), which had made poorly documented coding changes, was characterized by Russell J as a “trial and error” procedure that was “routine engineering” and not SR&ED.
Russell J also accepted the view of the Crown’s expert that a second mooted “SR&ED” effort to enhance the ability of the taxpayer’s software to calculate optimal timelines for concurrently run projects used an established methodology termed "metaheuristics, which in essence search the solution space based on some algorithms and converge to a solution … [and] did not involve experimentation or analyses to resolve scientific or technological unknowns,” so that for this activity as well, the claimed SR&ED credits were denied.
Neal Armstrong. Summary of Clevor Technologies Inc. v. The Queen, 2019 TCC 166 under s. 248(1) - SR&ED.
6 more translated CRA interpretations are available
We have published a further 6 translations of CRA interpretations released in July, 2011. Their descriptors and links appear below.
These are additions to our set of 981 full-text translations of French-language Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers all of the last 8 ¼ 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 October.
| Bundle Date | Translated severed letter | Summaries under | Summary descriptor |
|---|---|---|---|
| 2011-07-29 | 6 July 2011 Internal T.I. 2010-0357461I7 F - CII RS&DE | Income Tax Act - Section 127 - Subsection 127(8.3) | proportionate ITCs allocated to specified member in proportion to capital can then be reallocated under s. 127(8.3) to non-specified member |
| 27 June 2011 External T.I. 2009-0350501E5 F - Gains et pertes sur change étranger | Income Tax Act - Section 39 - Subsection 39(2) | s. 39(2) gain or loss on USD-denominated purchase arises between acquisition and payment date | |
| Income Tax Act - Section 89 - Subsection 89(1) - Capital Dividend Account - Paragraph (a) | s. 39(2) gain or loss does not affect CDA until year end | ||
| 18 July 2011 External T.I. 2010-0370561E5 F - Location avec option d'achat | Income Tax Act - Section 49 - Subsection 49(1) | where lease is coupled with bargain purchase option, a portion of the rents must be allocated to option proceeds | |
| General Concepts - Substance | lease is a lease in the absence of sham | ||
| Income Tax Act - Section 68 | where lease is coupled with bargain purchase option, a portion of the rents must be allocated to option proceeds | ||
| 26 May 2011 External T.I. 2010-0354921E5 F - 212(1)d)(vi) - Exemption redevance droit d'auteur | Income Tax Act - Section 212 - Subsection 212(1) - Paragraph 212(1)(d) - Subparagraph 212(1)(d)(vi) | there now is a blanket exemption for all royalties (including lump sum advances for performances of a play) respecting copyright | |
| 2011-07-22 | 11 July 2011 External T.I. 2010-0367021E5 F - Cotisations excédentaires au REER | Income Tax Act - Section 204.2 - Subsection 204.2(1.2) | a taxable RRSP withdrawal reduces undeducted RRSP premiums and, as a result, the cumulative excess amount in respect of RRSPs |
| Income Tax Act - Section 204.1 - Subsection 204.1(2.1) | s. 204.1(2.1) tax ceases when, at the end of the month, there is no cumulative excess amount in respect of RRSPs | ||
| 13 July 2011 External T.I. 2011-0400951E5 F - Alinéa 73(1.01)b) - régime de séparation de biens | Income Tax Act - Section 73 - Subsection 73(1.01) - Paragraph 73(1.01)(b) | s. 73(1.01)(b) can apply to a transfer occurring pursuant to an ancillary agreement |
CRA states that shares subscribed for out of a joint bank account should not be treated as having been funded by a passive spouse in applying the reasonable return TOSI exception
An individual (Spouse B) who, quite unlike Spouse A, was not involved in the business of Opco, received distributions of s. 104(19) dividends from a discretionary family trust following their declaration and payment by Opco to Holdco, and by Holdco to that trust. These dividends could not qualify in Spouse B’s hands as being from excluded shares, and CRA also found that they could not qualify under the “reasonable return” exception in the “excluded amount” definition for exclusion from split income, notwithstanding that all the shares of Opco originally had been issued to Spouse A for cash subscription proceeds that came out of a joint bank account of Spouses A and B.
CRA stated:
[A]lthough the cash used to fund Spouse A’s initial share investment … was stated to be from cash that came from a joint account … the legal form of these transactions strongly suggests that Spouse B has not made any direct or indirect contribution of property to Opco. …
[T]aking an overly broad interpretation that a specified individual has made an indirect financial contribution to a business such that the reasonable return exception in subparagraph (g)(ii) of the definition of excluded amount would apply to prevent the amount from being split income would appear to frustrate the underlying tax policy of the TOSI rules.
Neal Armstrong. Summary of 7 August 2019 External T.I. 2019-0814161E5 under s. 120.4(1) - reasonable return.
Miller – Tax Court of Canada accepts that software was to be valued at its purchase price
A PhD purchased software from a promoter entity in 2003 for $7,000 and immediately donated it to a registered charity, and was issued a tax receipt for $42,000. In confirming CRA’s reduction in the gift amount to $7,000, Owen J applied the dictum in Nash that “where the dates of acquisition and disposition are very close in time, barring evidence to the contrary, the cost of acquiring the asset will likely be a good indicator of its fair market value.”
Neal Armstrong. Summary of Miller v. The Queen, 2019 TCC 204 under s. 118.1(1) – total charitable gift.