News of Note
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
Email this ContentThe 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.
Complexities can arise in determining the contribution of foreign affiliates to safe income on hand
S. 55(5)(d) provides that the safe income of a foreign affiliate of a taxpayer is the lesser of its tax free surplus balance respecting the taxpayer (computed on a somewhat modified basis) and the fair market value of all its shares.
It may be possible to engage in transactions to increase a foreign affiliate’s TFSB by, for example, paying up interaffiliate dividends in order to blend the applicable excess hybrid underlying tax of one affiliate with a "low-taxed" hybrid surplus pool of another (having regard to the inclusion in TFSB of hybrid surplus of a particular foreign affiliate only if such surplus is "fully sheltered" by hybrid underlying tax.)
Reliance for safe income purposes on a computed TFSB balance may be problematic given the possibility of retroactive adjustments to surplus balances, for example, as a result of amending returns in the local jurisdiction, or as a result of retroactive adjustments to surplus pools arising from adjustments under Reg. 5907(1.1) to reduce (or increase) each group member’s surplus pools for local tax borne by (or refunded to) it.
The rule in s. 93.1(1) for looking through partnerships does not apply for purposes of s. 55(5)(d). This may not be as bad as it sounds. S. 55(2.1)(c) merely refers to the amount of the income earned or realized by any corporation, and Lamont Management concluded that the reference to “any corporation” can include a foreign non-affiliate.
Neal Armstrong. Summary of Jim Samuel, "Interaction of the Foreign Affiliate Surplus and Safe-Income Regimes: Selected Anomalies, Issues, and Planning Considerations", Canadian Tax Journal, (2018) 66:2, 269-307 under s. 55(5)(d).
The refreeze of a non-SBC may result in imputed income on a fictional amount
Mr. X effects an estate freeze on a non-small business corporation as a result of which he is subject to imputed income under s. 74.4(2) on the “outstanding amount,” being essentially under s. 74.4(3) the redemption amount of the preferred shares that he received on the freeze of, say, $15 million. If the corporation declines in value and he does a “refreeze” so that he now holds preferred shares with a redemption value of $3 million, the outstanding amount will remain at $15 million – or only be reduced to $12 million if those preferred shares are redeemed in full for cash.
Neal Armstrong. Summary of Manu Kakkar, Alex Ghani and Boris Volvofsky, “Corporate Attribution: Refreeze May Cause Unsolvable Corporate Attribution Problem,” Tax for the Owner-Manager, Vol. 18, No. 3, July 2018, p.6 under s. 74.4(3).
Moorthy – Court of Appeal of England and Wales finds that non-taxable receipts of an employee for “injury” included damages received for hurt feelings
The U.K. statute essentially deemed employment income to include any amount received as a consequence of a person’s employment – but had a specific exclusion for a payment provided "on account of injury to… an employee." After being terminated, an executive brought an action for damages on grounds that included unlawful age discrimination - and then settled his action for £200,000. Counsel to HMRC agreed that £30,000 was allocable to his age discrimination claim, if it could properly be termed "on account of injury.”
Underhill LJ held that it “would accord with the natural meaning of the language” to find that this exclusion applied to an amount received as compensation for the taxpayer’s injured feelings for having been terminated on the basis of his age - so that the taxpayer received the £30,000 tax free.
Neal Armstrong. Summary of Moorthy v Revenue and Customs, [2018] EWCA Civ 847 under s. 248(1) – retiring allowance.
2137691 Ontario v. Park – Ontario Superior Court finds that the residential complex HST exemption applied to the sale of a portion of a large home
The land for a large home in Oakville was divided by a corporation into three lots, so that the middle lot contained a pool house and hallway structure that connected to the rest of the home on the other two lots. The corporation then sold this middle lot to an individual purchaser coupled with a covenant that it would demolish this structure – which, however, it did not do until 45 days after closing. The sales contract provided that any HST was in addition to the sales price of $2.8M, but the vendor (the corporation) provided a statutory declaration that the property qualified for exemption as being used residential accommodation, so that no HST was collected on closing. A year later, it then brought a motion to recover HST from the purchaser.
After making the questionable statement that “the time of the supply is the time that the deal closes” (ETA s. 133 was not to be taken literally), Coats J found that the sale was exempt, stating:
[A]t the time of closing, the residence and pool structure were a complete structure which were suitable for living in. … It was clearly an appurtenance to the detached home.
… There is no requirement in ETA that the residential complex/residential unit exemption involve the transfer of an entire residential unit or a complete residency unit. This would be contrary to the “part thereof” language in section 123(1) … .
She went on to indicate that even if the sale had been subject to HST, ETA s. 194 would preclude the vendor from now charging such HST to the purchaser, as the purchaser’s reliance on the exemption certificate was not unreasonable.
Neal Armstrong. Summary of 2137691 Ontario Limited. v. Lucia Pessoa Park, 2018 ONSC 4218 under ETA s. 123(1) – residential complex, s. 194 and s. 224.
CRA finds that Canadian royalties received exempt of U.K. tax by a non-domiciled U.K. resident were ineligible for Treaty-reduced rate
A former Canadian author, who now was resident but not domiciled in the UK, was not subject to UK tax on royalties he received from a Canadian publisher because the royalties were not remitted to the UK. Art. 27(2) of the Canada-UK Convention effectively provides that where under the Convention “any income is relieved from tax in” Canada and that income is subject to tax in the UK only on a remittance basis, then “relief to be allowed under this Convention in [Canada] shall apply only to so much of the income as is taxed in” the UK.
CRA interpreted these words as indicating that the royalties that he thus received free of UK income tax were subject to Canadian withholding tax at 25% rather than the Treaty-reduced rate of 10%. CRA was not asked what would happen if that income was then taxed in the UK as a result of its subsequent remittance to the UK.
Neal Armstrong. Summary of 1 June 2018 External T.I. 2017-0723051E5 under Treaties – Income Tax Conventions – Art. 29.
Income Tax Severed Letters 1 August 2018
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.