News of Note

On the non-arm’s length transfer of shares by an individual to a corporation, s. 84.1 prevents the use by the transferor of adjusted cost base in the transferred shares that reflects the previous claiming of the capital gains exemption (“CGE”). However, s. 84.1(2.1) indicates that for purposes of the ACB reduction under s. 84.1(2)(a.1)(ii)) respecting the non-arm’s length transfer, where a capital gains reserve is claimed under s. 40(1)(a)(iii) by the transferor or a non-arm’s length individual and it is possible for the transferor to claim the CGE, the CGE is deemed to have been claimed in the maximum amount irrespective of whether it is in fact claimed and whether in fact there is no intention to claim it.

For example, Father transfers shares of Opco (a small business corporation whose shares are eligible for the CGE) to his children in consideration for a note that is payable over 10 years, claims the capital gains reserve, but does not claim the CGE. The children transfer the Opco shares to a new Holdco in consideration for a note of Holdco, with a view to Opco dividends funding note repayments.

At the 2018 STEP Roundtable, CRA confirmed that this is how s. 84.1(2.1) operates, so that in this example, the children are deemed to receive a dividend on their receipt of the Holdco note. It is irrelevant that the transferor may have CGE room that he wishes to retain for future use - all the available room effectively is deemed to be used.

In its official response, CRA added three examples illustrating the interrelationship between the s. 84.1(2) ACB adjustment, the amount of CGE actually claimed and the amount of unutilized CGE at the end of the year of the transfer.

For example, if Father realized a $100,000 capital gain, claimed a $50,000 reserve, claimed a $25,000 CGE while still having $10,000 unclaimed CGE at the year end, he would be deemed to have claimed a CGE (of $35,000) re $70,000 of the capital gain.

Neal Armstrong. Summary of 29 May 2018 STEP Roundtable, Q.17 under s. 84.1(2.1).

In May 2008, the Quebec taxpayer (ST Productions) agreed to pay another company with which it was affiliated in some manner (Hybride) approximately U.S.$6 million in eight monthly instalments for producing special effects for a film production. The amount of the Quebec film tax credit which ST Productions could claim turned on when its expenses “arose” under the Quebec equivalent of ITA s. 261(2)(b). The taxpayer claimed that the expense arose only when the work was completed and it was invoiced for it (at which time the U.S. dollar had appreciated), rather than as the work was performed and paid for.

After noting that, although the contract provided for adjustments to the contract price in the event of specified changes to the costs of performing the work, no such adjustments occurred, Massol JCQ stated that “the percentage-of-completion method [which] takes into account the work effected as it occurs … should be considered … the method to be adopted,” and that “the foreign currency conversion arose at the time of each due date.”

Neal Armstrong. Summary of 9189-7397 Québec Inc. v. Agence du revenu du Québec, 2018 QCCQ 4692 under s. 261(2)(b).

Under the split income proposals, dividends or gains from “excluded shares” are excluded from the tax on split income. Subpara. (a)(i) of the excluded share definition requires that less than 90% of the corporation’s "business income" be from the provision of services, and para. (c) requires that "all or substantially all of the income" of the corporation be not derived directly or indirectly from related businesses.

CRA has now provided to STEP Canada its official responses to the questions posed to it at the May 2018 STEP Roundtable. In its response to Q.5 on the above definition, CRA confirmed its previous oral response that references to “business income” and “income” are to gross income rather than net income.

It also expanded (as compared to its oral response) on its views on when it will regard product sales as “real” for purposes of the 90% business income test, stating:

Where a corporation has income from the provision of both services and non-services (including a service business that also involves a sale of property such as a business carried on by plumbers, mechanics or other contractors that sell replacement parts or building materials), the income from the provision of services and non-services should be computed separately and the non- service income should generally be taken into account in determining whether shares of a corporation are excluded shares of an individual unless such income can reasonably be considered to be necessary but incidental to the provision of the services (for instance as would be the case in an office cleaning service if it billed separately for the cleaning supplies used).

The distinction between the plumber who sells a replacement toilet and an office cleaning service that purports to charge separately for its cleaning supplies may indicate that CRA will ignore separate product charges when they are contrived.

Neal Armstrong. Summary of 29 May 2018 STEP Roundtable, Q.5 under s. 120.4(1) – excluded share.

A British taxpayer (Leekes) carrying on a retail trade through four stores acquired, for nominal consideration, all the shares of another company (Coles) carrying on a similar retail trade through three stores, and then effectively wound-up Coles so as to carry on the operations of the three former Coles’ stores directly. At issue was whether a provision - which provided that Leekes (viewed as the successor to the Coles’ trade) could deduct any amount for which the predecessor (Coles) would have been entitled to relief if it had continued to carry on the trade - permitted Leekes to deduct its losses from continuing to carry on the three former Coles’ stores from its profits from operating its four “old” stores.

In finding that such relief was unavailable, Henderson LJ stated:

[T]he words "the trade" can only refer to the trade previously carried on by Coles. They cannot refer to the enlarged trade carried on by Leekes, because that trade had never been carried on by Coles, and Coles cannot therefore be deemed to have continued to carry it on. … [I]t is necessary to ascribe a deemed continuity to the former trade of Coles, although it now forms part of the merged business carried on by Leekes, and relief may only be obtained if and to the extent that Leekes then derives trading income from the former Coles trade.

ITA s. 111(5)(a)(ii) provides a somewhat generous test for carrying forward losses from a streamed business and deducting them from profits from a similar business as described in s. 111(5)(a)(II)(B). In most circumstances, an expanded business would qualify as a similar business, so that it would be unnecessary to address any relevance of the distinction drawn in the above case between the core of the business that is a continuation of that which was previously carried on, and the expanded component of that business (that had been a separate person's business).

Neal Armstrong. Summary of Leekes Ltd v HM Revenue & Customs, [2018] EWCA Civ 1185 under s. 111(5)(a)(ii).