News of Note
CRA confirms that outside basis is not lost on a horizontal short-form amalgamation
Email this ContentCRA noted that its position in S4-F7-C1, para. 1.74 that
Where shares of a predecessor corporation are cancelled for no consideration pursuant to a short-form horizontal amalgamation, the adjusted cost base of such cancelled shares to the shareholder will be added to the cost of the common shares of the new corporation which are deemed to have been received by the shareholder on the amalgamation under subsection 87(1.1).
is based on a 1999 Technical Interpretation (9830205).
Neal Armstrong. Summary of 15 August 2018 Internal T.I. 2018-0749931I7 under s. 87(4).
Tournier – Tax Court of Canada finds that file storage fees incurred after business cessation were deductible
A retired member of Nova Scotia bar was permitted to deduct $1200 of annual storage fees for client files notwithstanding that her practice had ceased two years’ previously. After noting that retention of the client files was professionally recommended, Bocock J stated that deductibility was “consistent with the notion of unavoidable expenses necessarily expended in future years referable to previous income contemplated in … Poulin, Raegele and Langille.”
Neal Armstrong. Summary of Tournier v. The Queen, 2018 TCC 229 (Informal Procedure) under s. 18(1)(a) - start-up and liquidation costs.
Income Tax Severed Letters 21 November 2018
This morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Mazraani – Supreme Court of Canada finds that the Tax Court’s pressuring witnesses to speak in English, not French, required a new hearing
A laid-off “independent contractor” (Mazraani) appealed to the Tax Court on the basis that he had instead been employed in insurable employment for EI purposes. At the hearing, his alleged employer (Industrial) was an intervenor and called witnesses whose testimony in French would not have been understood by Mazraani. Rather than providing Mazraani with an interpreter, the Tax Court Judge exerted pressure on Industrial's witnesses to testify in English, which counsel for Industrial communicated was problematic. Industrial’s counsel also had to make his legal arguments in English, even though this was difficult.
Before affirming the decision of the Federal Court of Appeal ordering a new hearing before a different judge in response to these violations of the witness’s and counsel’s language rights under s. 133 of the Constitution Act, 1867, s. 19 of the Charter and s. 14 and 15 of the Official Languages Act, Gascon and Côté JJ stated:
[E]ven if there was no error in the decision on the merits, the language rights in question would be compromised if no remedy was granted
… [A] new hearing will generally be an appropriate remedy for most language rights violations. …
The judge’s insistence that [Industrial’s counsel] speak English during most of his argument constitutes a flagrant violation of the lawyer’s language rights.
… [T]he order for a new hearing was fully justified. … The violations were numerous and, in some cases, serious and repeated, and they brought the administration of justice into disrepute.
Neal Armstrong. Summary of Mazraani v Industrial Alliance Insurance and Financial Services Inc. et al, 2018 SCC 50 under Charter s. 19.
The B2B loan rules can render funding received from a non-resident bank subject to withholding tax
A borrowing by Canco directly from a non-resident bank would not give rise to Part XIII tax on the interest. However, if the bank lends to a non-resident corporation in the group (NR1), and NR1 in turn on-lends to group companies including Canco, Canco’s borrowing may now become subject to withholding tax.
In particular, suppose that CA and NR2 (another group company) pledged assets to secure NR1's borrowing, so that the bank has a right to sell the pledged assets on default. If the bank has a "specified right" granted by NR2 which secures repayment of NR1's borrowing, then the bank would not be an "ultimate funder". As the grantor of a specified right, NR2 would become a "relevant funder."
The NR2 pledge supports NR1’s borrowing, and not CA’s borrowing, and such NR1 borrowing does not appear to be an amount described in the relevant exclusions from the “specified right” definition. Accordingly, the B2B rules would apply, and withholding tax would generally apply.
Had the bank lent the funds directly to Canco, with NR2 provided security for that borrowing, the carve-outs from specified right likely would have applied.
Neal Armstrong. Summaries of Nik Diksic and Sabrina Wong, “Cross-Border Lending Practices,” 2017 CTF Annual Conference draft paper under s. 212(3.6)(a), s. 212(3.8), s. 212(3.1)(c)(ii), s. 212(3.1)(d) and s. 20(1)(c)(i).
6 further translations of CRA French-language interpretations are available
The table below provides descriptors and links for six Interpretations released in January 2013 (including three 2012 APFF Roundtable items), all as fully translated by us.
These are additions to our set of 690 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.
2763478 Canada - Federal Court of Appeal finds that value shift transactions abused the basic capital gains regime – and notes missing s. 245(6) request
An individual (Jobin) did not sell his shares of an operating company (Groupe AST) directly to a third-party purchaser, but instead transferred them on s . 85(1) rollover basis into a holding company (276), following which some internal transactions occurred in which the adjusted cost base of the Groupe AST shares was stepped up to fair market value - including a non-rollover drop-down of those shares to a subsidiary (9144) in exchange for high-basis common shares - with 276 realizing corresponding capital gains. The Groupe AST shares were then sold to the purchaser at no additional gain.
Nine months later in the same year, 276 engaged in “value shift” transactions, i.e., a stock dividend of high-low preferred shares was paid on the high-ACB common shares that 276 held in 9144, thereby rendering those common shares almost worthless, and then the capital loss was realized by selling those common shares for $1 to a corporation owned by Jobin’s son.
The internal gain recognition transactions effected at the beginning of the year ensured that the capital gain was recognized in the same hands (those of 276) as the ones realizing the mooted capital loss through the value shift transactions. 276 argued that the former transactions were not part of the same series of transactions as the value shift transactions as they were separated by nine months and the purpose of the value shift transactions (which were not identified until after the initial transactions) was to effect an estate freeze in favour of Jobin’s son. In rejecting these arguments, Noël CJ noted that the nine-month gap did not negate a series of transactions, and that an estate freeze could have been accomplished conventionally (using a s. 85(1) or 86(1) rollover) rather than through realizing (allegedly offsetting) gain and loss.
With that out of the way, it entailed a straightforward application of Triad Gestco to find that the value shift transactions were abusive as per s. 245(4), i.e., “permitting a real gain to be absorbed by a paper loss goes against the raison d’être of [the capital gains] regime.”
276 argued that the resulting denial of its capital loss under s. 245(2) was unreasonable because of the corresponding gain that Jobin would be deemed to realize on his death under s. 70(5). Noël CJ noted various obstacles to this argument including that the quantum of any such gain on death was speculative and that, in any event, Jobin had failed to apply under s. 245(6) within 180 days of the s. 245(2) reassessment of 276 to increase the adjusted cost base of his shares by the amount of the denied capital loss of 276.
Neal Armstrong. Summaries of 2763478 Canada Inc. v. Canada, 2018 CAF 209 under s. 245(3), s. 248(10), s. 245(6) and s. 245(4).
There is a policy incoherence between Holdco redeeming or selling its Opco shares
The bifurcation rules in s. 55(5)(f) (or s. 55(2.3) for high-low stock dividends) frustrate the creation of capital dividend account to the extent that the built-in capital gain in shares is attributable to safe income on hand of the dividend payer – but only in the context of s. 55. On the other hand, a holding company that realizes a capital gain on a disposition of its shares of an operating company (Opco) by other means, such as a sale, can still increase its CDA respecting its capital gain, irrespective of whether any portion thereof derives from appreciation in the shares caused by after-tax retained earnings.
This policy incoherence can be illustrated by the situation where 1/3 of the shares of Opco, having nominal paid-up capital and adjusted cost base, and safe income on hand of $30 as compared to their fair market value of $100, are held by Holdco A.
If Holdco A sells its shares to another corporation (Holdco B), although there is safe income of $30, the bifurcation rules do not apply because Opco did not pay a taxable dividend to Holdco A. Thus, Holdco A's capital gain increases its CDA by $100. Holdco A can distribute its sale proceeds to A as a capital dividend and an ineligible dividend so as to achieve an effective combined tax rate approximating that applicable to capital gains realized directly by Mr. A.
In contrast, if Opco redeems its shares held by Holdco A, s. 55(5)(f) bifurcates the resulting deemed dividend into a safe income dividend of $30 and a non-safe income dividend of $70 for s. 55 purposes. S. 55(2) recharacterizes the non-safe dividend as a deemed capital gain in the amount of $70. Only this smaller $70 amount increases Holdco A's CDA. As the safe income dividend reduced the quantum of the deemed capital gain, Opco's safe income on hand that is attributable to its redeemed shares cannot be surplus stripped. This is a punitive result.
Finance …sought, through its withdrawn proposed section 246.1, to deny CDA created on an internal reorganization that was not caught by subsection 55(2) but which could have facilitated surplus stripping. Upon the abandonment of that measure, there is no clear tax policy against surplus stripping achieved through realizing the economic value of a corporation's safe income on hand by a sale of shares that does not invoke the bifurcation rules. Further, withdrawal of proposed section 246.1 indicates that there is no abuse from surplus stripping through so-called "mixing-and-matching" distribution.
Neal Armstrong. Summaries of Rick McLean, Jeff Oldewening and Jonas Lau, "Capital Gains Stripping and Surplus Stripping," 2017 Annual CTF Conference draft paper under s. 55(5)(f), s. 89(1) – CDA – (a)(i), s. 52(3)(a)(ii) and s. 53(1)(b)(ii).
Callidus Capital – Supreme Court of Canada finds that the deemed Crown statutory trust for unremitted GST/HST lapses on a bankruptcy of the tax debtor
ETA s. 222(3) provides that payments received by a secured creditor out of property that is subject to the deemed statutory trust under s. 222(1) for collected but unremitted GSTHST is itself subject to a deemed trust in favour of the Crown. However, s. 222(1.1) provides that s. 222(1) “does not apply, at or after the time [the debtor] becomes a bankrupt…to any amounts that, before that time, were collected…by the [debtor] as or on account of tax….”
In the Federal Court of Appeal, the majority had found that, although s. 222(1.1) causes the deemed trust to disappear on bankruptcy, it does not eliminate the liability of a creditor for having received payments prior to bankruptcy that should have been subject to the Crown’s (at that point, still extant) priority under the s. 222(1) deemed trust so that such “personal liability … can be pursued by the Crown in a cause of action independent of any subsequent bankruptcy proceedings.”
The Supreme Court has now adopted, as its own, the reasons given by Pelletier JA in his dissent. Pelletier JA found that the bankruptcy effectively had the same result as a deemed repayment of the s. 222(1) deemed trust amount, so that there no longer was any subject matter for the s. 222(3) trust to attach to.
In addition to more textual and technical reasons for this conclusion, he referred to s. 67(2) of the Bankruptcy and Insolvency Act as reflecting that “Parliament put the Crown on the same footing as unsecured creditors” in a bankruptcy – with an exception for employee source deductions, which “is explained by the fact that source deductions are amounts which belong to the employee in question … [and] this money does not belong to the employer anymore.”
Neal Armstrong. Summary of Callidus Capital Corp. v. Canada, 2018 SCC 47 under ETA s. 222(1.1).
CRA confirms that start-up risk that has now been eliminated can be taken into account in applying the TOSI reasonable return exception
Mr. and Mrs. X (both over 25) incorporate XCo, subscribe a nominal amount for non-voting and voting common shares, respectively and lend the proceeds of a mortgage on their home to XCo as start-up capital (the “Loan”). Mr. X has no involvement in XCo’s business, which is highly speculative. Several years later, XCo repaid the Loan and they repaid the mortgage.
Notwithstanding such repayment, can Mr. X continue to look to the reasonable return exception under the split income rules in s. 120.4 having regard to the risks he initially assumed on the start-up of XCo’s business? CRA stated:
If the terms and conditions of the Loan were not sufficient to adequately compensate Mr. X and Mrs. X for the risk they assumed when mortgaging their home and providing the Loan to XCo, the relative risk that was assumed by each of them in mortgaging their home and providing the Loan could be taken into account in determining whether a dividend received by Mr. X after the repayment of the Loan is a reasonable return in respect of Mr. X (among the other factors noted above). (emphasis added)
More generally, CRA stated that it “does not intend to generally substitute its judgment of what would be considered a reasonable amount where the taxpayers have made a good faith attempt to do so.”
Neal Armstrong. Summary of 2 November 2018 External T.I. 2018-0771851E5 under s. 120.4(1) – reasonable return.