News of Note
CRA rules on the transfer of life insurance policies under a split-up butterfly
Email this ContentCRA ruled on a single-wing butterfly for the split-up of a farming corporation (DC) between (1) mother and Child 2 (who took the transferee corporation, TC), and (2) Child 1 (who stayed with DC, which kept inter alia the farm house). The assets of DC included life insurance policies on the lives of Mother and Child 1 and 2. The cash surrender value of these policies was treated as a near cash asset, whereas their fair market value in excess of their CSV was treated as investment property. All of the policy on Child 2, and a portion of the policy on mother’s life, was transferred to TC, with that portion calculated so as to help satisfy the butterfly percentage requirement.
The policies were not eligible for a s. 85(1) rollover, and as the consideration received from TC was a note equal to the transferred policy interests’ FMV, the proceeds of disposition to DC under s. 148(7) were equal to such FMV. The ruling letter stated:
None of DC, Mother, Child 1 and Child 2 expect that the Mother … or Child 2 Insurance Policy will be disposed of or that any benefits will be paid thereunder as part of the same series of transactions or events that include the Proposed Transactions.
Neal Armstrong. Summary of 2018 Ruling 2017-0714411R3 under s. 55(1) – distribution.
Six further full-text translations of CRA interpretations are available
The table below provides descriptors and links for six Interpretation released in April and March 2013, as fully translated by us.
These (and the other full-text translations covering all of the 633 French-language Interpretations released in the last 5 1/3 years by the Income Tax Rulings Directorate) are subject to the usual (3 working weeks per month) paywall. Next week is the “open” week for September.
| Bundle Date | Translated severed letter | Summaries under | Summary descriptor |
|---|---|---|---|
| 2013-04-24 | 20 March 2013 Internal T.I. 2013-0480201I7 F - Montants forfaitaires - XXXXXXXXXX | Income Tax Act - Section 6 - Subsection 6(3) - Paragraph 6(3)(d) | amounts paid to workers in wage-discrimination suit that were in excess of reasonable amount for rights’ violations or non-pecuniary damages would be employment income |
| Income Tax Act - 101-110 - Section 110.2 - Subsection 110.2(1) - Qualifying Amount | portion of wage discrimination award that related to loss of salary (based on days’ worked) would be qualifying amount | ||
| 29 November 2011 Roundtable, 2011-0426361C6 F - Price adjustment clause and redemption of shares | Income Tax Act - Section 84 - Subsection 84(3) | deemed dividend arising from preferred share price adjustment clause arises in the year of actual payment | |
| General Concepts - Effective Date | deemed dividend through operation of price adjustment clause arises in the adjustment rather than redemption year | ||
| 2013-04-17 | 27 March 2013 External T.I. 2012-0449661E5 F - Subparagraph 53(2)(c) ITA | Income Tax Act - Section 53 - Subsection 53(2) - Paragraph 53(2)(c) | effect of ss. 40(3.4) and 112(3.1) on partnership ACB where dividends paid to partnership before share disposition was currently under audit |
| 2013-04-10 | 18 February 2013 Internal T.I. 2013-0477821I7 F - Montants forfaitaires - XXXXXXXXXX | Income Tax Act - Section 3 | damages received in wage discrimination suit for pain and suffering were non-taxable |
| 2013-03-27 | 11 March 2013 External T.I. 2012-0432201E5 F - Payment of tax by an institute | Income Tax Act - Section 248 - Subsection 248(3) - Paragraph 248(3)(a) | application of testamentary trust rules to a substitution by testament |
| Income Tax Act - 101-110 - Section 108 - Subsection 108(1) - Testamentary Trust - Paragraph (d) | spousal beneficiary of substitution by testament does not taint the resulting deemed testamentary trust by paying the trust taxes | ||
| 21 February 2013 External T.I. 2012-0465711E5 F - Attribution Rules after Divorce | Income Tax Act - Section 74.2 - Subsection 74.2(1) | entire rather than only pro rata portion of a post-divorce capital gain is not subject to attribution |
PE fund investing in Canada gives rise to a range of issues
There has been a recent trend of third-party U.S. lenders pushing for a single U.S. borrower, even where the borrower group is primarily Canadian. This often will create thin cap problems, e.g., where both the U.S. borrower and the Holdco for the Canadian group are held by a private equity LP with a non-resident GP and there is a back-to-back loan from the U.S. borrower to the Holdco and from the Holdco to a Canadian Opco sub.
The “purpose of the [foreign affiliate dumping] rules is to deter foreign multi-nationals from … stuffing non-Canadian operating companies under Canada,” which is remote from the situation of non-resident controlled PE funds buying and continuing to operate a Canadian company. On the basis, there are good policy reasons why the FAD rules should not apply to the latter situation, it can be considered to not be an abusive avoidance of the FAD rules to structure around them by having no non-resident corporation control the CRIC (corporation resident in Canada) in question, e.g., having the general partner of the investing PE Fund be resident in Canada.
A PE fund will often expect management (and other co-investors such as non-management founders) to collectively hold a continuing stake in the acquired Canadian company which may result in the 10% threshold described under the bump-denial rules being exceeded.
Where, for example, there is a desired amalgamation of Acquireco, Target and one or more of Target's subsidiaries holding a non-resident subject corporation, there is no explicit relief from the FAD rules for an amalgamation not described in s. 87(11), and the reorganization rule in s. 212.3(18) may be of no help.
It appears unlikely that the “more closely connected business” exception in “should be read so narrowly as to be virtually meaningless in all but the most extreme, and commercially impractical, of factual circumstances.” Having said that, the PE sponsor may have key transactional skills such as negotiating a purchase agreement or credit facility which, if brought to bear, could increase the risk of an adverse FAD result.
Determining a fair market value exercise price for stock options granted to management of the Canadian investee of a PE fund can be challenging because of the "waterfall" return that PE investors expect, whereby they are entitled to a repayment of their original investment plus a specified hurdle rate of return before other stakeholders (including management, through their management incentives) begin to participate in profits. The point-in-time rigidity of the employee stock option rules can also be problematic where PE sellers “expect that optionholders be treated exactly the same as selling shareholders in terms of escrows, post-closing working capital and other price adjustments and indemnities.”
Neal Armstrong. Summaries of Peter Lee and Paul Stepak, “PE Investments in Canadian Companies” draft 2017 CTF Annual Conference paper under Treaties – Income Tax Conventions – Art. 10, s. 95(2)(b)(i)(B), s. 18(5) – equity amount – (a)(iii), s. 212.3(1)(b), s. 88(1)(c)(vi)(B)(II), s. 212.3(18)(a)(ii)(B), s. 212.3(16)(b), s. 7(1)(b), s. 6(1)(a), s. 256(9) and s. 110(1)(d)(ii)(A).
Alta Energy Luxembourg – Tax Court of Canada finds no abuse in non-resident investors using a s.à r.l. to avoid capital gains tax on a new Canadian exploration company
A Blackstone LP and a U.S. shale company held their investment in a Canadian subsidiary (Alta Canada), that was to develop a shale formation in northern B.C., through a Luxembourg s.à r.l. About two years after the acquisition by Altas Canada of the exploration licences, it was sold to Chevron Canada at a significant gain. The s.à r.l. relied on the exclusion in Art. 13(4) of the Canada-Luxembourg Treaty, which provided that the Alta Canada shares were not deemed immovable property (and thus not subject to Canadian capital gains tax) if the Alta Canada licences qualified as property of Alta Canada “in which the business of the company … was carried on.”
The Crown contended that this exclusion should be applied on a licence-by-licence basis, so that virtually all of the property would not be excluded as only six wells had been drilled by Alta Canada by the time of the sale to Chevron. In rejecting this submission, Hogan J noted that Alta Canada, by starting off slowly in its drilling of the formation, was being consistent with its approach of “the development of its working interest on a systematic and commercially prudent basis” and stated:
Since the purpose of the carve-out is to attract foreign direct investments, it is reasonable to assume that the treaty negotiators wanted the exception to be granted in accordance with industry practices.
The Crown also sought to apply the general anti-avoidance rule to deny use of the Treaty exclusion. It was bothered that the capital gain was taxed in neither jurisdiction, whereas the purpose of the Treaty was only to prevent double taxation. Hogan J stated:
[I]f Canada wished to curtail the benefits of the Treaty to potential situations of double taxation, Canada could have insisted that the exemption provided for under Article 13(5) be made available only in the circumstances where the capital gain was otherwise taxable in Luxembourg. Canada and Luxembourg did not choose this option. It is certainly not the role of the Court to disturb their bargain … .
More generally, he considered that, as “the significant investments of the Appellant to de-risk the Duvernay shale constitute an investment in immovable property used in a business,” the rationale for the exclusion had been satisfied.
Accordingly, the gain was Treaty-exempt.
Neal Armstrong. Summaries of Alta Energy Luxembourg S.A.R.L. v. The Queen, 2018 TCC 152 under Treaties – Income Tax Conventions – Art. 13 and s. 245(4).
CRA confirms that aborted target acquisition expenses may qualify as Class 14.1 additions
IT-143R3, para. 23 states:
Since an outlay or expense is an eligible capital expenditure only if it is incurred for the purpose of gaining or producing income from a business, legal and accounting fees incurred in an abortive attempt to acquire shares of a corporation would normally not qualify. Where, however, the taxpayer can demonstrate that he or she proposed to make the business of the corporation part of a similar business which the taxpayer already operated, the fees may qualify as eligible capital expenditures.
CRA confirmed that this policy continues to apply respecting additions to Class 14.1. No mention was made of Rio Tinto, which carves out from acquisition expenditures those made before the decision to acquire is made.
Neal Armstrong. Summary of 19 July 2018 External T.I. 2017-0727041E5 under Schedule II, Class 14.1.
Devon – Tax Court of Canada finds that payments made to target’s employees for surrendering their options on target’s acquisition were mostly deductible by it
Two public-companies made cash payments for the surrender by employees of their options previously granted to them under employee stock option plans, with the surrenders occurring on the closing of their acquisition by other public companies.
Sommerfeldt J accepted the taxpayer submissions that the surrender payments were deductible as to 75% under s. 111(5.2) (since supplanted by s. 111(5.1).) Among other considerations, he determined that the surrender payments were made for the purpose of gaining or producing income from the acquired companies’ business given that under this test “it will suffice if the income-gaining purpose is [only] one of the purposes of the outlay or expense” and that, similarly to Imperial Tobacco, the surrender payments had “an employer-compensation-related purpose.”
Furthermore, the exclusion in para. (f) of the definition of eligible capital expenditure for “the cost of … a right to acquire [a share]” did not apply given that “the word ‘cost’ contemplates an acquisition of an asset or other property,” whereas “when a stock option is surrendered to the issuing corporation, the rights represented by that option [instead] are extinguished.”
The latter finding likely is authority for the proposition that (notwithstanding e.g., 2017-0717981E5) there is no liability under s. 116(5) where no clearance certificate has been obtained for the disposition by a non-resident beneficiary of a capital interest (that is taxable Canadian property) in a resident trust by virtue of the extinguishing of that beneficiary’s entitlements thereunder.
Neal Armstrong. Summaries of Devon Canada Corporation v. The Queen, 2018 TCC 170 under s. 14(5) - eligible capital expenditure and s. 20(1)(e)(i).
Income Tax Severed Letters 22 August 2018
This morning's release of three severed letters from the Income Tax Rulings Directorate is now availabel for your viewing.
CRA rules on cross-border butterfly including steps to come within “permitted exchange”
CRA ruled on a cross-border butterfly which entailed assets of the “Transferred Business” being transferred indirectly to a wholly-owned non-resident subsidiary (Foreign Spinco) of a non-resident public company (Foreign Parentco) or to a wholly-owned non-resident subsidiary of Foreign Spinco (Foreign Spinco Sub) – with a view to the shares of Foreign Spinco being dividended out to the shareholders of Foreign Parentco at the transactions’ completion. One of the indirect assets of Foreign Parentco was a Canadian corporation (DC) which held the Canadian portions of both the Transferred Business and the “Retained Business” – hence the need for a cross-border butterfly.
Preliminary transactions included the drop-down of the Canadian Transferred Business by DC to a Newco and the transfer of DC by its direct holder (a non-resident subsidiary of DC) to DC.
Following a s. 86 reorg of DC to split its share capital into special and new common shares, there then is a four-party exchange under which Foreign Parentco transfers its special shares of DC to a newly-formed Canadian sub of Foreign Spinco Sub (TCo), TCo issues common shares to Foreign Spinco Sub, Foreign Spinco Sub issues shares to Foreign Spinco and Foreign Spinco issues shares to Foreign Parentco.
On the butterfly proper, DC transfers Newco to TCo in consideration for preferred shares and the assumption of liabilities – except that in order to ensure that the transfer of cash (under the consolidated look-through approach) represented by the transfer of Newco is in the same proportion as the transfer of business assets, there also is a transfer of cash made as of the date of this butterfly distribution but that, in fact (and similarly to 2012-0459781R3 and 2014-0530961R3), is transferred a redacted number of days thereafter in order to accommodate a more accurate computation of the required amount. The sole investment property (a rental property) is valued at nil due to encumbrances.
Thereafter, there is a cross-cancellation of the shareholdings between DC and TC, and TC thus becomes an indirect wholly-owned subsidiary of Foreign Spinco.
Foreign Parentco had first acquired direct ownership of 100% of DC in order that the ensuing exchange by Foreign Parentco of its shares of DC for shares of Foreign Spinco under the four-party exchange arrangement would qualify as a “permitted exchange.”
The butterfly ruling was conditional on the Foreign SpinCo shares never deriving 10% or more of their fair market value from the TCo shares or DC special shares.
Neal Armstrong. Summaries of 2017 Ruling 2017-0699201R3 under s. 55(1) – distribution, s. 55(1) – permitted distribution – para. (b) and s. 143(3).
Six further full-text translations of CRA interpretations are available
The table below provides descriptors and links for six Interpretation released in May and April 2013 (including one 2012 APFF Financial Strategies and Instruments Roundtable item), as fully translated by us.
These (and the other full-text translations covering all of the 627 French-language Interpretations released in the last 5 1/3 years by the Income Tax Rulings Directorate) are subject to the usual (3 working weeks per month) paywall.
Soucy - Court of Quebec finds that a double gift was not an avoidance transaction
A direct gift of a vehicle to the taxpayer by her ex-husband would have been subject to Quebec sales tax as they were now unrelated persons. From this perspective, QST was avoided as a result of the vehicle being gifted by her ex-husband to her daughter, and then by her daughter to her – both of them, related-person transfers. In finding that these were not avoidance transactions for Quebec GAAR purposes, Poirier JCQ accepted the taxpayer’s testimony that the transactions had to happen this way in order for her to get the vehicle – her ex was only prepared to give the vehicle to her daughter.
He also stated that "utilizing the exemptions provided by the Act cannot constitute an abuse within the meaning of the Act."
Neal Armstrong. Summary of Soucy v. Agence du revenu du Québec, 2018 QCCQ 4845 under ETA s. 274(3).