News of Note
CRA confirms that an IC-DISC qualifies as a U.S. resident for Treaty and surplus purposes
Email this ContentExempt earnings of a foreign affiliate include its net earnings from an active business carried on in a designated treaty country if it is resident in that country. Reg. 5907(11.2)(a) provides that it is deemed to not be resident in that country unless it is resident there for purposes of the relevant Treaty.
CRA confirmed its position that:
[W]here a person’s worldwide income is subject to a particular Contracting State’s full taxing jurisdiction but that Contracting State’s domestic law does not levy tax on the person’s taxable income … we will generally accept that the person is a resident of that Contracting State unless the arrangement is abusive … .
CRA then confirmed that an “Interest Charge Domestic International Sales Corporation,” so qualified, i.e., a U.S. subsidiary of a Canco that earned profit on an exempted basis on the sale of goods manufactured by another U.S. subsidiary for export. CRA’s discussion suggest that it is not confident that such an exempted U.S. corporation would be resident in the U.S. if its central management and control was in Canada (there perhaps is a concern that s. 250(5) only deems corporations to be non-resident generally rather than to be resident in a specific country).
Neal Armstrong. Summary of 24 May 2018 External T.I. 2017-0710641E5 under Reg. 5907(11.2).
CRA indicates that Canco may choose not to deduct interest expense of a CFA so as not to generate a FAPL
The sole activities of FA1, a wholly-owned foreign affiliate of Canco, are to use money borrowed from an arm’s length bank to buy all the shares of a corporation (FA2) carrying on an exclusively active business in a designated treaty country, and use exempt dividends from FA2 to service the bank interest and pay exempt dividends to Canco. CRA confirmed that FA1 would generate foreign accrual property losses equal to the bank interest.
Such FAPLs would generate a taxable deficit. When asked whether Canco could choose to not deduct these interest expenses (so as not to generate FAPLs), CRA responded, yes, the s. 20(1)(c) deduction is discretionary, but added that:
[I]f Canco does not deduct an amount of interest in computing FA1’s FAPI/FAPL for the year in which that interest is paid or payable, that interest may not be deducted in computing FA1’s FAPI/FAPL for any subsequent year.
Neal Armstrong. Summary of 5 June 2018 External T.I. 2017-0738081E5 under s. 95(2)(f).
CRA recommends that executors of non-resident estates that could have Canadian tax liabilities apply for a clearance certificate
A former resident of Canada (and after her death, her non-resident estate, which had exclusively non-resident beneficiaries) received CPP, interest and RRSP/RRIF payments from Canadian sources. Would the non-resident executors be required under s. 159(2) to apply (pursuant to a Form TX19 request) for CRA to issue a clearance certificate?
CRA responded with a somewhat generic answer that might have served equally for resident executors (i.e., they could face personal liability for unpaid taxes of the deceased if they did not do so).
CRA also reiterated its position that there is an obligation of the non-resident beneficiaries who are disposing of capital interests in the estate that are taxable Canadian property, as well as of the estate if it is distributing taxable Canadian property, to apply for a s. 116 certificate.
Summaries of 30 May 2018 External T.I. 2017-0717981E5 under s. 159(2) and s. 116(3).
Income Tax Severed Letters 8 August 2018
This morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Kau – Tax Court of Canada finds declaration of non-residency from a vendor to be insufficient to avoid s. 116(5) liability where there were indicators of a non-resident address
S. 116(5) indicates liability for failure to withhold under s. 116 on a purchase of taxable Canadian property from a vendor who in fact is non-resident unless “after reasonable inquiry the purchaser had no reason to believe that the non-resident person was not resident in Canada.” Russell J found that this standard was not met where the purchaser’s counsel was satisfied with a one sentence unsworn statement before a California notary public in Danville, Calif., U.S.A., in what was titled “affidavit”, containing the statement of the vendor (whose address for service was in California) that, “I am not a non-resident of Canada within the meaning of section 116 of the Income Tax Act (Canada) and nor will I be a non-resident of Canada at the time of closing.”
Russell J stated that, given the presence of “red flags:”
[W]hat happened in this case did not constitute “reasonable inquiry”. … Simple questions such as what was the Vendor’s permanent address as opposed to “address for service” and provision of a copy of the Vendor’s driver’s license, would have done much to bring clarity to this situation without undue further efforts. … [S]ubsection 116(5)(a), calls for and deserves more than a brief, baldly stated affidavit or solemn declaration when there are factual red-flags potentially suggestive of non-residency.
Neal Armstrong. Summary of Kau v. The Queen, 2018 TCC 156 under s. 116(5).
Pangaea - Tax Court of Canada finds that an agreement with another shareholder to enter into a share sale with a 3rd party was a restrictive covenant
A non-resident shareholder (“Pangaea”) of a Canadian corporation (“Public Mobile”) was required under the terms of the unanimous shareholder agreement to agree to any sale of the Public Mobile shares. A resident shareholder paid Pangaea a lump sum for its agreement to execute a share purchase agreement.
In confirming CRA’s view that this was a restrictive covenant payment that was subject to Part XIII tax under s. 212(1)(i), Smith J found that the agreement of Pangaea to waive its veto right was an agreement that “affected” the disposition of property (the Public Mobile shares), as contemplated under the restrictive covenant definition. He further rejected Pangaea’s submission that, as it had disposed of its veto right, the exclusion from the definition for an agreement that disposes of the taxpayer’s property applied, stating:
I find that there is no evidence of a conveyance or disposition of the Appellant’s veto right — even if it can properly be characterized as “property”. … [T]here was no evidence of an assignment of the veto right to a third party.
Neal Armstrong. Summary of Pangaea One Acquisition Holdings XII S.À.R.L. v. The Queen, 2018 TCC 158 under s. 56.4(1) – restrictive covenant.
Ludmer – Quebec Superior Court considers equity-linked notes held in BVI company were reasonably viewed as portfolio investments held with a tax avoidance purpose, but were not reasonably viewed as being subject to 7000(2)(d) interest accrual
The Canadian-resident taxpayers were shareholders of a BVI company (“SLT”) which, in turn, held notes issued by two foreign subsidiaries of two Canadian banks. The notes were payable in 15 years’ time and the amount payable was calculated by reference to the performance of a reference portfolio of equities or bonds.
CRA considered that there was a requirement to recognize deemed interest income on the notes under Reg. 7000(2)(d) given that, in contrast to the usual equity-linked notes that were available to investors at the time, these notes had “internal puts,” i.e., SLT had the right to terminate the notes at any time, on 367 days’ notice, at the market value of the reference assets. On this basis, it considered that the “the maximum amount of interest thereon that could be payable thereunder in respect of that year” was the difference between the maximum value of the reference assets at the end of the year and the maximum value in the prior years, and assessed accordingly, to treat such annual increase as foreign accrual property income of SLT under element C of the s. 95(1) FAPI definition.
Hamilton JCS rejected the taxpayers’ submissions that it was unreasonable of CRA to assess on the basis that the notes were “portfolio investments” within the meaning of s. 94.1 (given that they were held by SLT as passive investments and they tracked portfolio investments) and also considered it reasonable to consider that tax motivation figured significantly in the structure – but then went on to find that these assessments were unreasonable, given that in its previous published positions, CRA had “never suggested that the [mere] possibility of locking-in the bonus means that an amount can be accrued based on the highest value of the index in the year.” It was also unreasonable for CRA to assess all of the increase in value of the notes in the taxation years prior to 2005 (which were statute-barred) in its reassessments for the 2005 taxation year.
In light of these and other failings by CRA, Hamilton JCS awarded the taxpayers approximately $4.8 million in damages comprised principally of interest that the large corporations were required to pay on the reassessments before they were reversed, a portion of the professional fees that were incurred in connection with the audit and, in the case of two of the individual taxpayers, $250,000 for damages to reputation (respecting a false statement made to the Bermuda authorities that CRA was conducting a "criminal" investigation) and for stress, trouble and inconvenience. Additional failures included making the unreasonable reassessments with the knowledge that they were contrary to advice received from Rulings, offering in a settlement offer to settle elements that it knew it was going to abandon, failing to honour a commitment to give notice of the reassessments and delaying disclosures under the Access to Information Act process.
Neal Armstrong. Summaries of Ludmer v. Attorney General of Canada, 2018 QCCS 3381 under s. 94.1(1), Reg. 7000(2)(d), s. 56(2), s. 152(4)(a)(i), s. 152(1) and General Concepts – Negligence.
Six further full-text translations of CRA interpretations are available
The table below provides descriptors and links for six Interpretation released in May 2013, as fully translated by us.
These (and the other full-text translations covering all of the 615 French-language Interpretations released in the last 5 1/4 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 August.
CRA rules on a pubco spin-off of a U.S. business using s. 86
CRA has ruled that a spin-off by a Canadian public corporation (Parent”) to its shareholders of a Canadian Newco indirectly holding a U.S. business qualified as a s. 86 reorg. Under the Plan of Arrangement, the articles of Parent are amended to provide that the existing common shares of Parent are changed into Class A common shares (carrying two votes per share) and, at the same time, “New Common Shares” are added to the authorized capital with identical attributes to the former common shares. There then is an exchange of the Class A common shares for Newco shares and New Common Shares.
CRA ruled that s. 86 applied to the exchange, and that the previous change of the common shares into Class A common shares was not a disposition.
Neal Armstrong. Summaries of 2016-0679281R3 under s. 86(1) and s. 248(1) – disposition.
CRA rules that USco’s use of a Canadian affiliate for substantial marketing support for web-delivered services did not constitute carrying on business in Canada
As a small part of its business, a U.S. resident who is not registered for GST/HST purposes (“USco”) supplies information services to Canadian businesses and individuals, who subscribe by credit card through a website hosted on a U.S. web server and with the information services being delivered electronically to them from that server. USco, whose personnel for the most part do not visit Canada, will now receive expanded assistance respecting marketing to its Canadian customers from its Canadian resident affiliate ("Canco"), which heretofore has only provided it with customer address and contact information and other data. The "New Services" include most of the leg work involved in marketing including strategy development, weekly “prospecting” of accounts, assistance in the preparation of term sheets and proposals for delivery to prospective clients and in the negotiation of contract terms and drafting contracts, use of the Canco website as a portal in communicating with current and prospective purchasers and attending key trade events to promote the USco information services.
The Services Agreement between Canco and USco stipulates that Canco is not acting as agent of USco; and Canco does not have contact with the customers.
There is no statutory definition of carrying on business in Canada for ETA purposes. CRA ruled that USco, following the New Services addition, is not carrying on business in Canada for GST/HST purposes – and also ruled that the supply of the New Services by Canco to USco is zero-rated pursuant to Sched. VI, Pt. V, s. 5 (arranging for, procuring or soliciting orders for supplies made outside Canada).
Neal Armstrong. Summary of 16 March 2018 Ruling 158124 under ETA s. 240(1) and Sched. VI, Pt. V, s. 5.