News of Note
Fowler – English Court of Appeal finds that a domestic provision deeming employment income to be from trade rendered it business profits for Treaty purposes
Email this ContentA U.K. domestic income tax provision deemed the diving activities of a South African resident in the North Sea to be the carrying on of a U.K trade, notwithstanding that in fact he was an employee. The majority of the Court of Appeal of England and Wales found that this meant that his earnings were business profits for purposes of Art. 7 of the U.K-South Africa Treaty (rather than employment income under Art. 14) so that they escaped U.K. taxation (as he had no U.K. permanent establishment.)
Both Lord Justices in the majority treated the domestic deeming provision (which merely deemed the underlying activity to be a trading activity rather than explicitly deeming the resulting income to be “profits” of an enterprise) as having effect for Treaty purposes. However, each of the three Lord Justices had a different view of the scope of Art. 3(2) of the Treaty (which, in the standard OECD form, provided that any term not defined in the Treaty “shall, unless the context otherwise requires, have the meaning that it has …under the law of [the U.K.]”).
Baker LJ in his concurring reasons stated:
The term "employment" is not defined in the treaty and, under article 3(2), is ascribed the meaning that it has under UK tax law. Under that law … Mr Fowler is deemed not to be in employment but rather carrying on a trade.
Henderson LJ (also in the majority) stated:
My approach does not depend to any significant extent on the provisions of article 3(2) … however, I would accept … that the purpose of article 3(2) is to anchor the provisions of the treaty … to the domestic tax law of the Contracting State which is applying the treaty.
In the course of his dissenting reasons, Lewison LJ stated that Art. 3(2) permitted reference to the common law of England to determine the meaning of “employment,” and further stated:
I cannot extract from [a South African] case the general proposition that a word used in a double tax treaty to describe a particular source of income or gain necessarily encompasses a domestic deeming provision, particularly where the word in question is defined in domestic tax law … .
Neal Armstrong. Summary of Fowler v HM Revenue and Customs [2018] EWCA Civ 2544 under Treaties – Income Tax Conventions – Art. 3(2).
CRA confirms that Class 14.1 “property” need not be property
Class 14.1 depreciable property references “property” of the taxpayer. CRA confirmed that this does not have the effect of disqualifying capital expenditures that did not give rise to property rights (such as legal costs of an aborted acquisition , see 2017-0727041E5). The reason is that s. 13(35) provides that such expenditures incurred for the purpose of gaining or producing income from a business are deemed to be the cost of property that is goodwill, and the s. 248(1) definition of “property” has been amended to clarify that goodwill is property.
Neal Armstrong. Summary of 27 November 2018 CTF Roundtable, Q.15 under s. 13(35)(a).
CRA indicates that accrued interest under both ss. 20(14)(a) and (b) is translated at the transfer date spot rate
CRA indicated that where an FX-denominated debt is assigned between interest coupon dates, the amount of the accrued interest translated at the spot rate on the transfer date is what is used both in determining the transferor’s income inclusion under s. 20(14)(a), and the transferee’s deduction under s. 20(14)(b).
Neal Armstrong. Summary of 27 November 2018 CTF Roundtable, Q.14 under s. 261(2)(b).
Over 700 full-text translations of CRA interpretations are available
The table below provides descriptors and links for five Interpretations released in January 2013 (from the 2012 APFF Roundtables), and a Technical Interpretation released last week, all as fully translated by us.
These are additions to our set of 702 full-text translations of French-language Rulings, Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers the last 5 3/4 years of releases by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall. You are currently in the “open” week for December.
CRA indicates that interest on money borrowed by parent for use in connection with a triangular amalgamation to redeem preferred shares issued by Target can be deductible
In a triangular amalgamation, the proceeds of a third party loan are used by ParentCo to redeem preferred shares issued by TargetCo as part of the transaction.
CRA responded that interest on the borrowed money would be deductible under s. 20(1)(c), to the extent that the borrowed amount did not exceed the capital of the shares, computed prior to the redemption of such shares, and provided that the capital replaced by the borrowing was previously used for eligible purposes. The interest rate also would be required to be reasonable.
Neal Armstrong. Summary of 27 November 2018 CTF Roundtable, Q.13 under s. 20(1)(c)(i).
CRA considers that in some circumstances it can require a taxpayer to disclose its uncertain tax positions
CRA indicated that it can seek the production of tax accrual working papers, provided that the request for such records is relevant to specific risks or items under audit, and it uses restraint in seeking the information. Factors considered before making such a request include the existence of large unexplained tax reserves.
CRA considers that (consistent with Atlas Tube) it may, in some circumstances, request a list from the taxpayer of its uncertain tax positions. Provided all relevant facts and transactions are included in the taxpayer’s uncertain tax positions, exclusions of the related advice and analysis may be accommodated. CRA recognizes the principle in BP that taxpayers are not required to self-audit.
Neal Armstrong. Summary of 27 November 2018 CTF Roundtable, Q.11 under s. 231.1(1).
CRA comments on the TOSI excluded share and excluded amount exclusions
2018-0744031C6 indicated that the shares of a corporation that did not generate business income (e.g., a corporation that generated rents that, given the level of activity, constituted income from property) cannot qualify as excluded shares, whereas in Examples 8 and 12 of the December 2017 CRA website Guidance, shares of a corporation earning income from passive investment assets qualified as excluded shares. How should these positions be reconciled?
CRA noted that if in the above example the corporation carried on a business, its shares could qualify as excluded shares. On the other hand, even if it did carry on a business, the amount received from the corporation by the specified individual would qualify as an excluded amount if it were not derived, directly or indirectly, from a related business in respect of the individual for the year.
This response is similar to 2018 APFF Financial Strategies and Instruments Roundtable, Q.2 and 2018 APFF Roundtable, Q.9(a).
Neal Armstrong. Summaries of 27 November 2018 CTF Roundtable, Q.10 under s. 120.4(1) - excluded share.
CRA discusses the “derivation” for TOSI purposes of dividends from previously earned income from a related business
CRA provided two contrasting examples illustrating the timing of the related business determination for split-income purposes. In the first example, Mr. and Mrs. A (both over 25) are equal shareholders of ACo, which two years previously sold the “Old Business” in which Mrs. A had been actively engaged on a regular, continuous and substantial basis for many years – but Mr. A, not at all. Since then, ACo’s sole activity has been the investing of the proceeds.
After noting that if ACo’s current investment activities constituted a business, the excluded share exclusion from the split income (TOSI) rules would apply, CRA went on to indicate that if ACo’s investment activities did not constitute a business, a dividend declared in the current year to Mr. and Mrs. A would be considered to be excluded amount, given the winding up of the Old Business in a previous taxation year and there being no other related business of ACo.
In another scenario, Mrs. and Mr. A instead are the respective sole shareholders of Opco (carrying on a non-services operating business) and Serviceco (earning income in Year 1 from Opco, but without Mr. A being actively involved in its business). In Year 2, Serviceco does not render any services and its activities are insufficient to constitute a business. CRA indicated that, as Serviceco earned its Year 1 income from the provision of services to Opco (i.e., derived amounts from Opco’s business) and the dividend paid in Year 2 can also be said to have derived directly or indirectly from the provision of services to Opco in Year 1 (and thus to be derived directly or indirectly from Opco’s business, being a related business), the Year 2 dividends paid by Serviceco of its after-tax income from Year 1 would not be excluded amounts.
Neal Armstrong. Summaries of 27 November 2018, Q.9 under s. 120.4(1) – excluded amount – (e)(i), and excluded share – (c).
CRA confirms that s. 66.3(3) does not apply to the cost of shares received on a ss. 85(2) and (3) wind-up of a flow-through share partnership
S. 66.3(3) deems the cost of flow-through shares to be nil. CRA confirmed that where a flow-through LP transfers its flow-through shares under s. 85(2) to a mutual fund corporation for shares of the MFC, and then distributes those shares to its partners on its winding-up under s. 85(3), s. 66.3(3) would not apply to determine the cost to the limited partners of the distributed shares. That cost instead would be determined under s. 85(3)(f) to be equal to the ACB of their interests in the LP immediately before the LP winding-up, and would not necessarily be nil.
Neal Armstrong. Summary of 17 September 2018 External T.I. 2018-0751571E5 F under s. 66.3(3).
CRA indicates that where Parent acquired the net tax equity in Subco at a bargain price (low share ACB), avoiding a s. 88(1)(b) gain on wind-up through reducing PUC is abusive
CRA provided two examples of when it would apply GAAR where paid up capital (“PUC”) is reduced to nil in order to avoid a s. 88(1)(b) gain on a wind up.
Example 1. Subco was formed by Xco with an injection of capital of $1,000 (being the PUC of Subco’s shares). Parentco acquired Subco for $1. On the winding-up of Subco into Parentco, Subco had assets with a cost amount of $1,000, and no liabilities or retained earnings (nor were retained earnings realized by it after its acquisition by Parentco).
CRA noted that if the Subco shares instead were redeemed for $1,000, the $999 excess of the redemption proceeds over the shares' ACB would produce a capital gain given that the shares had full PUC. In particular, since the cost amount of the Subco assets was not increased by income earned or realized by Subco after its acquisition of control by Parentco, this indicated that Parentco has made a bargain purchase in the form of the tax attributes in those assets, so that the scheme of s. 88(1)(b) dictated that a gain be realized by Parentco on the winding up in the amount of $999. Thus, CRA would apply GAAR to a reduction of PUC without payment prior to the winding up.
Example 3. Parentco owned all Subco shares which have a PUC and ACB of $1,000. Subco used $2,000 borrowed from a third party to acquire assets with a cost amount of $3,000 – which subsequently lost all their value. Parentco claimed a s. 50(1) loss $1,000 (thereby reducing the shares’ ACB to nil) prior to winding up Subco and assuming Subco's debt.
CRA indicated that the net cost amount of the assets of Subco is $1000, and consequently Parentco should realize a capital gain of $1000 on the winding up of Subco, under s. 88(1)(b). Parentco would essentially have taken two deductions for the same loss of $1000 – first the $1000 loss on the Subco shares under 50(1), and an additional loss of $1000 on the assets of Subco. Thus, a PUC reduction to avoid the s. 88(1)(b) gain would be GAARable.
Very briefly, Example 2 indicated that where the net tax equity in the Subco assets was matched by safe income, avoidance of s. 88(1)(b) would not be abusive.
Neal Armstrong. Summary of 27 November 2018 CTF Roundtable, Q.5 under s. 88(1)(b).