News of Note
CRA accepts that a significant arm’s length investment in a related corporation that will purchase the assets retained under a s. 55(3)(a) spin-off did not occur as part of the series
Email this ContentMother along with an arm’s length business associate (“Investor”) wanted to use some of the assets of the family business corporation (“Amalco”) to engage in some sort of development project, whereas her daughter did not want any part of this. Accordingly, it was agreed that one of the two businesses would be spun off to the Daughter’s Newco under s. 55(3)(a). It was also contemplated that thereafter the business retained by Amalco would be sold by Amalco at fair market value to a recently formed development company (XCo) which was controlled by Mother but in which Investor had made a significant equity investment.
This investment by Investor would have jettisoned s. 55(3)(a) treatment of the spin-off by virtue of s. 55(3)(a)(ii) if it had been considered to have occurred as part of the same series of transactions. However (before giving a s. 55(3)(a) ruling of sorts), CRA accepted a representation that:
The Acquisitions [including Investor's equity investment] did not rely on the Proposed Transactions in order to produce a given result. The Proposed Transactions will not rely on the Acquisitions to produce a given result.
In addition ... the Acquisitions ... would have been undertaken irrespective of whether any of the Proposed Transactions will be implemented..
Neal Armstrong. Summary of 2018 Ruling 2017-0683941R3 under s. 55(3)(a)(ii).
Solar Power. v. ClearFlow - Ontario Court of Appeal confirms that a daily discount fee had the 3 attributes of interest
A typical loan made by the lender (ClearFlow) to the borrower bore base interest rate of 12% p.a. compounded monthly, an administration fee that was charged when the Loan was initially advanced, and each time it renewed (of, say, 1.81% of the loan balance), and a “discount fee” of 0.003% per day of the outstanding principal. Sharpe JA confirmed the finding of the application judge that the administration fee was not interest, as well as his finding that the discount fee was interest, stating:
[T]he amount of the fee did not vary according to the administrative work required by the loan as in the case of the administrative fee, and the fee was charged at a daily fixed rate unrelated to any ongoing or specific events… [It] bore all the hallmarks of the test for interest: it was consideration or compensation for the use of money, it related to the principal amount, and it accrued over time.
He went on to find that the disclosure of the “rate” of such interest through the provision of a simple formula complied with s. 4 of the Interest Act. For this and other reasons the borrower was unsuccessful in its arguments that the total interest under the loan was subject to a 5% cap imposed under s. 4.
For a borrower whose business in not money-lending or something similar, the distinction between a fee and interest informs whether deductibility of a lender's charge is to be analysed under s. 20(1)(e) or (e.1), or under s. 20(1)(c).
Neal Armstrong. Summary of Solar Power Network Inc. v. ClearFlow Energy Finance Corp., 2018 ONCA 727 under s. 20(1)(c).
Custeau – Court of Quebec finds that GAAR did not apply where individuals used PUC thrust upon them by an arm’s length investor (through PUC averaging) to subsequently strip surplus
When the taxpayers’ corporation (“Opco”), a small business corporation, was in financial difficulty, a Quebec regional development fund agreed to inject equity capital in Opco on terms dictated by the fund – which entailed the fund investing in the common shares of Opco, so that the paid-up capital of the taxpayers’ shares was boosted from a nominal amount to $1.45 million. About five years later, the taxpayers engaged in capital gains crystallization transactions in which they transferred most of their common shares of Opco to personal holding companies, realizing capital gains of $1 million, and took back preferred shares with a correlative adjusted cost base and also a paid-up capital that reflected the earlier step-up in the transferred shares’ PUC. Following the repurchase of all of the fund’s common shares of Opco, the taxpayers’ had their Holdcos distribute most of the PUC of their preferred shares in cash.
The ARQ considered there to have been 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 found both that there had been no avoidance transaction (with his focus being on the boosting of the paid-up capital of the taxpayers’ shares), and that there was no abusive tax avoidance.
Respecting his first finding, he noted that the increase in the taxpayers’ PUC was not their doing but was a result of terms imposed by the fund, and that at that time it was “financially inconceivable” that Opco would be able to turn around within six years so as to both redeem out the fund at a large gain to it and fund the distribution of the taxpayers’ PUC.
Respecting his second finding, he accepted the taxpayers’ submission that Pomerleau and 1245989 were distinguishable on the basis that in those two decisions “the surpluses were stripped as part of ‘internal’ transactions between individuals and corporations not dealing at arm’s length, which is not the case here, as there is an arm’s length relationship between the plaintiffs and [the fund].”
Neal Armstrong. Summaries of Custeau v. Agence du revenu du Québec, 2018 QCCQ 5692 under s. 245(3) and s. 245(4).
Where an LLC has a Canadian business, it may be advantageous for U.S. members to hold their membership interests through S Corps
Art. IV(6) of the Canada-U.S. Treaty does not provide Treaty benefits to non-U.S. residents (including Canadians) investing through an LLC. This extends to the situation where the LLC carries on business in Canada but does not have a Canadian permanent establishment, so that only the income allocable to the LLC's U.S. resident members would be exempted under Art. VII. Where U.S. resident individuals invest through an LLC, CRA considers that the pro rata share of branch earnings attributable to them should be subject to branch tax at the statutory 25% rate rather than the Treaty-reduced 5% rate, since the relieving provisions in Art. X(6) are only applicable to corporations. This might be addressed by interposing S Corps (viewed by CRA as Treaty residents notwithstanding their U.S. tax transparency) as the members of the LLC.
Neal Armstrong. Summary of Julie Colden and Éric Lévesque, “An In-Depth Look at the Hybrid Rules in the Fifth Protocol,” 2017 Annual CTF Conference draft paper under Treaties – Income Tax Conventions – Art. 4.
Care should be taken in structuring an inbound PE investment or in implementing post-acquisition restructuring so as to avoid FAD-rule application
As a result of an amendment enacted on December 2017, the foreign affiliate dumping (FAD) rules have been expanded to apply where the Canadian corporation (CRIC) making the investment in the non-resident subject corporation is not itself controlled by a non-resident corporation but a non-arm’s length Canadian resident corporation is, and the subject corporation is a foreign affiliate of that other Canadian corporation but not of the CRIC. This expanded rule might apply, for example, where the CRIC is a 9% shareholder of Canco with the other 91% held by Canco’s non-resident parent and the CRIC lends to a non-resident subsidiary of Canco – provided that the CRIC does not deal at arm’s length with Canco as a factual matter.
It is suggested that the s. 212.3(25) deeming rule likely supplements rather than supplants the regular de jure control test, so that if there is an acquisition by a limited partnership, a determination as to whether the FAD rules apply should take into account both the residence of the general partner and also, having regard to the s. 212.3(25) look-through rule, whether there is any control of the CRIC by a limited partner.
Application of the FAD rules where there is an inbound investment through a private equity LP with a non-resident general partner could be avoided, for example, through the use of subsidiary buyco LP having a Canadian-resident general partner. Given that the drafting of those rules chose foreign corporate control rather than foreign economic ownership as the tripping point for their engagement, such avoidance “appears to be consistent with the object and spirit of the FAD rules.”
The supposed safe harbour in s. 212.3(18)(a)(i) for transfers of shares or debts of subject corporations between Canadian-resident corporations operates in a capricious manner having regard to any reasonable policy rationale for the scope of this exception. To mention only one example, if an acquisition of control of a foreign parent (“FP”) holding Canco1 (which, in turn, holds Canco2) is followed as part of the series of transactions by a transfer of a foreign affiliate between the two Cancos, the safe harbour is unavailable – unless, following such acquisition of FP, FP first transfers the Canco1 shares it owns to a new Canadian corporation and a new Canadian company is also inserted between Canco1 and Canco2.
Neal Armstrong. Summaries of Dean Kraus and John O’Connor, “Foreign Affiliate Dumping: Selected Issues,” 2017 Annual CTF Conference draft paper under s. 212.3(1)(a)(ii), s. 212.3(1)(b) and s. 212.3(18)(a)(i).
Six further full-text translations of CRA interpretations are available
The table below provides descriptors and links for six Interpretation released in March 2013, as fully translated by us.
These (and the other full-text translations covering all of the 639 French-language Interpretations released in the last 5 1/2 years by the Income Tax Rulings Directorate) are subject to the usual (3 working weeks per month) paywall. You are currently in the “open” week for September.
De Vries – Tax Court of Canada finds that a corporate creditor’s oral agreement to postpone collection of his loan defeated a RTP encompassing that loan
The two individual shareholders (husband and wife) of a corporation (“IPG”) were assessed under s. 160 regarding a dividend they had received from IPG on the basis that, at the time of the dividend, IPG had been assessed for failure to comply with a s. 224(1) requirement to pay (“RTP”) effectively requiring it to pay to CRA a demand loan owing by it to a former employee and business associate (“Houweling”).
Paris J accepted testimony that Houweling had orally agreed, prior to the receipt by IPG of the RTP, to postpone his right to receive repayment of the loan until the conclusion of a significant suit brought by IPG against a third party. He further found that “there has been an evolution in the doctrine of consideration in the context of contract modifications,” so that now “when parties to a contract agree to vary its terms, the variation should be enforceable without fresh consideration, absent duress, unconscionability, or other public policy concerns.”
As the oral agreement of Houweling to postpone payment was contractually binding, the assessment of IPG for its purported failure to honour the RTP was invalid, so that there was no corporate liability to flow through to the taxpayers under s. 160.
Neal Armstrong. Summaries of De Vries v. The Queen, 2018 TCC 166 under s. 224(1) and s. 160(1).
CRA rules on the use of s. 107.4 transfers of debt to a new fixed investment trust in order to increase cross-border leverage of a REIT U.S. sub
The units of a REIT were stapled to those of another mutual fund trust (Finance Trust), so that they traded on a stock exchange together. Finance Trust held interest-bearing notes of the indirect U.S. commercial real estate subsidiary of the REIT (U.S. Holdco). Finance Trust qualified as a fixed investment trust for Code purposes, so that its unitholders were treated as if they held such notes directly. This avoided the U.S. earnings stripping limitations on the level of permitted interest deductions by U.S. Holdco. However, subsequently to this structure being implemented, U.S. acquisitions by U.S. Holdco were funded with loans from REIT, which were subject to the earnings stripping rules.
In order that much of this additional debt could access the benefits of the stapled structure, Finance Trust made a s. 107.4 transfer of its notes of U.S. Holdco to the REIT and, following the replacement of those notes and some of the newer debt with amended notes, and the effective distribution to the unitholders of units of a new fixed investment trust with nominal assets (the F17 Trust), the amended notes were transferred by the REIT under s. 107.4 to the F17 Trust. Thus, there was a replacement stapled structure similar to what was there before, except that the new Finance Trust (F17 Trust) held more U.S. Holdco debt.
The only ruling requested and granted (other than on GAAR) was that the disposition of the Finance Trust loans to the REIT and of the amended loans to F17 Trust constituted “qualifying dispositions” under s. 107.4(1).
Neal Armstrong. Summary of 2017 Ruling 2017-0720591R3 under s. 107.4(1)(a).
Income Tax Severed Letters 29 August 2018
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
U.S. shares in your Canadian brokerage account may not be foreign property
Shares of a U.S. corporation credited to an account with a Canadian broker may not constitute “specified foreign property” given that in all the Canadian provinces “securities entitlements” are now governed by legislation that is modelled on Article 8 of the Uniform Commercial Code, the Commentary to which states that a securities entitlement is in large part merely a claim against the broker or other intermediary.
Neal Armstrong. Summary of David H. Sohmer, “Do Shares of an American Company Credited to an Account with a Canadian Broker constitute ‘Specified Foreign Property’?”, The Canadian Taxpayer, August 10, 2018, Vol. xl, No 16, p. 121 under s. 233.3(1) – specified foreign property – (c).