News of Note
CRA confirms that amounts derived from a related business do not include capital gains from the passive investment of the dividends therefrom
Email this ContentS. 120.4(1.1)(d) provides that an amount derived directly or indirectly from a business includes an amount that:
- is derived from the provision of property or services to, or in support of, the business, or
- arises in connection with the ownership or disposition of an interest in the person or partnership carrying on the business, or
- is derived from an amount described [above]
Notably, it does not reference an amount arising from the disposition of property whose acquisition was funded with dividends from the business.
CRA confirmed that this is so in a simple example. In Year 1, Opco pays a $1M dividend to its wholly-owning Holdco (Investco, which is owned equally by Mr. and Mrs. A, but with Mrs. A not involved in the Opco business). Investco invests in shares of publicly-traded corporations; then in Year 2, Investco pays a dividend-in-kind to Mrs. A of its entire stock portfolio which, at that time, has an aggregate FMV of $1.1M (for an accrued gain of $0.1M).
Before concluding that only $1.0M of the $1.1M dividend-in-kind received by Mrs. A would be derived from the related business of Opco in respect of Mrs. A (so that if Investco did not have a related business in respect of Mrs. A, $0.1M of the amount would not be derived from such a business), CRA stated:
The portion of the FMV of the distributed stock portfolio that represents the initial investment of the dividends paid by Opco to Investco would be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A. However, gains earned by Investco as a result of the investment of those dividends would not be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A.
Neal Armstrong, Summaries of 2 November 2018 External T.I. 2018-0771861E5 under s. 120.4(1.1)(d) and s. 120.4(1) – excluded amount – (e)(i).
Income Tax Severed Letters 14 November 2018
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Morrison – Tax Court of Canada finds that the taxpayers had the burden of disproving the Minister’s assumptions about their gift tax shelter about which they knew virtually nothing
The taxpayer, who participated in a charitable gifting program that generated receipts well in excess of the amount contributed by him, had no familiarity with how the program “worked.” He argued that since he (and the other participants) did not have knowledge of most of the factual matters assumed by the Minister in assessing him, as a matter of procedural fairness he should not be required to demolish such assumptions and the Minister should instead bear the burden of proof with respect to them. In rejecting this submission, Owen J stated:
The Appellants consciously chose to participate in the Programs with little or no knowledge of what went on behind the curtain, so to speak. In such circumstances, it is not unfair to the Appellants to allow the Minister to assume what went on behind the curtain.
… By participating in the Programs without further inquiry, the Appellants accepted the risk that the facts behind the curtain were not what they expected them to be.
Before so disposing of the taxpayers’ arguments on burden of proof, with the result that there was no credit for the donated certificates, Owen J essentially noted that he agreed with the comments of Webb JA in Sarmadi on this topic, and indicated that comments of L’Heureux Dubé J in Hickman to a different effect (respecting the burden potentially shifting to the Minister) “were obiter dicta.”
However, Owen J went on to find that the taxpayer could get a tax credit for the cash that he had donated. He did not receive any collateral benefit under the non-cash part of the program (it was essentially bogus), nor was the cash donation to be characterized as a fee for participating in the program.
Neal Armstrong. Summaries of Morrison v. The Queen, 2018 TCC 220 under General Concepts – Onus and s. 118.1(1) – total charitable gifts.
6 further translations of CRA French-language interpretations are available
The table below provides descriptors and links for six Interpretations released in January 2013, all as fully translated by us.
These are additions to our set of 684 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.
Iberville Developments – Quebec Court of Appeal finds that it is abusive to use rollover provisions to avoid rather than defer tax
Three affiliated Quebec corporations avoided (or so they thought) most of the Quebec tax on the sale of Quebec real estate at a gain of around $800M (including some recapture) by using a “Quebec year-end shuffle.” In particular, they transferred the properties on a rollover basis to subsidiary LPs, and then transferred their units of those LPs to two numbered companies, also on a rollover basis. The two numbered companies selected February 28, 2006 as their taxation year-end for federal (and Ontario) tax purposes, but March 19, 2006 for Quebec taxation purposes. On March 1, the two numbered companies then acquired units in two Ontario LPs with business income, which had the effect of most of their income being allocated to Ontario for Quebec purposes in accordance with the inter-provincial income allocation formula, so that virtually no Quebec tax was payable on the above gains, which were realized in March between the two year ends.
Schrager JA agreed with the findings in the Court of Quebec that the Quebec GAAR applied on the basis that:
- establishing different year ends for provincial and federal purposes was contrary to the purpose of the Quebec definition of “fiscal period” which, in copying the federal definition, did not show any intention to allow different year ends for federal and Quebec purposes as well as contrary to the interprovincial allocation rule, whose purpose was to ensure that 100% of a corporation’s income is taxed collectively by the provinces (with Schrager JA disagreeing with a Veracity comment that how the provinces tax the income allocated to them “is beyond the purpose, object and spirit of the Allocation Rules”)
- the rollover transactions abused the legislative intent of the rollover provisions, which was to defer and not to eliminate tax.
In the latter regard, he stated:
[T]he Appellants transferred their business to Ontario knowing that because of the creation of two fiscal periods, tax would not be paid there …[and] knew that no tax would be payable in Quebec because (theoretically) it was payable in Ontario upon application of the allocation formula, but because of the different fiscal periods, no tax would ultimately be paid in Ontario.
Thus, the rollover provisions have been used, as in OGT Holdings, to avoid the payment of tax and not simply defer its payment. ln this manner, the Appellants have acted contrary to the object and spirit of [the rollover provisions].
One of the companies had wanted to acquire 10 million square feet to build a shopping centre, but the vendor had insisted that the sale be of the whole 30 million square foot tract, with the zoning of the balance of 20 million square feet expected to be residential. Schrager JA confirmed the trial judge’s finding that the two portions of the property were acquired on capital and income account, respectively. Bifurcating an acquisition in this manner is quite unusual.
Neal Armstrong. Summaries of Les Développements Iberville Ltée v. Agence du Revenu du Québec, Quebec Court of Appeal No. 500-09-026184-168 (November 12, 2018) under s. 245(4), s. 9 – capital gain v. profit – real estate and s. 18(1)(b) – capital expenditure v. expense – improvements v. running expenses.
Rousseau – Court of Quebec finds that no penalty was payable by a Quebec individual with Alberta work and a Quebec home for not filing in Quebec
An individual (Mr. Rousseau) who had worked in Quebec as a heavy machinery operator, started working in Alberta in 1999 but, in addition to renting a room in Edmonton, he kept his house in Quebec, where his wife and children stayed and where he stayed as well on vacation or longer leave periods. In finding that Mr. Rousseau continued to reside in Quebec for the taxation years in issue (2003 to 2011), Allen JCQ stated:
The entirety of the evidence demonstrates that Mr. Rousseau left Quebec solely for work purposes and that he never had the intention to sever his connections with Quebec, which was the place with which he maintained his strongest links between 2003 and 2011.
However, in finding that Mr. Rousseau had made out a due diligence defence to the imposition of penalties under the Quebec equivalent of ITA s. 162(1) for failure to file Quebec income tax returns for those years, Allen JCQ stated that Mr. Rousseau “relying on the independent opinion provided by his accountant, believed sincerely and in good faith that he was resident in Alberta.”
The taxpayer was assessed for the 2003 to 2011 taxation years by the ARQ on October 24, 2013. They were not statute-barred as he had not filed Quebec returns for them until returns were demanded by the ARQ. The reasons of Allen JCQ do not disclose whether the taxpayer applied for reassessments of the earlier years to vacate the Alberta tax within the 10-year time period described federally in s. 152(4.2).
After noting that he lacked jurisdiction to do anything more than this respecting the Alberta taxes, Allen JCQ stated:
[T]he Court is of the view the Minister should, in all equity, take steps under the agreements between the federal government and the other provinces, including Alberta so as to avoid this double taxation.
Neal Armstrong, Summaries of Rousseau v. Agence du revenu du Québec, 2018 QCCQ 7340 under s. 2(1), s. 162(1) and s. 152(4.2).
CRA finds that a suspended loss on the sale of CFA1 to CFA2 was not de-suspended on the s. 95(2)(e) wind-up of CFA1 into CFA2
Canco realized a suspended loss when it contributed its shares of a controlled foreign affiliate (CCo) to another CFA (BCo), and then took the position that such loss was de-suspended when CCo was then liquidated into BCo. This position turned on the proposition that s. 40(3.5)(c)(i) did not apply because such liquidation did not satisfy two requirements in order for s. 40(3.5)(c)(i) to apply: the liquidation (a.k.a., winding-up) was not a "merger" of the loss corporation (CCo) with another corporation (BCo); and such "merger" resulting in the formation of a corporation (BCo).
CRA inferred from the somewhat loose meaning of the term “merger” and the fact that various provisions (but not s. 40(3.5)(c)(i)) exclude a winding-up from a merger, that the winding-up of CCo into BCo was a merger of the two corporations, and then took the even more questionable position that it could be inferred from the fact that s. 40(3.5)(c)(i) is stated not to apply to mergers referred to in s. 40(3.5)(b) - which refers to rollover transactions, some of which do not result in a new legal entity being formed - that BCo (which, of course, was already in existence) nonetheless was to be regarded as having been formed on the liquidation.
This CRA internal Interpretation is more detailed than 2018-0745501C6, where CRA took essentially the same approach to a suspended loss transaction followed by a s. 88(3) wind-up (rather than s. 95(2)(e) wind-up) of the loss corporation. In particular, CRA discussed its view of the policy of the suspended loss rules (perhaps by way of explanation for why the textual part of its "textual, contextual and purposive" analysis was forced), including a statement that:
[T]he purpose of the stop-loss rules in subsections 40(3.3), 40(3.4) and 40(3.5) is to defer the recognition of losses incurred in an affiliated-party. Such purpose becomes especially evident or useful in circumstances that reveal there to be no true economic loss incurred by the transferor or by the affiliated group as a whole.
Neal Armstrong. Summary of 26 January 2018 Internal T.I. 2017-0735771I7 under s. 40(3.5)(c)(i).
CRA indicates that parental leave need not detract from satisfying the regular, “continuous” and substantial TOSI test
A specified individual will be deemed under paragraph 120.4(1.1)(a) to have been actively engaged on a regular, continuous and substantial basis in the activities of a business in a taxation year of the individual if the individual works in the business at least an average of 20 hours per week during the portion of the year in which the business operates. Finance’s Explanatory Notes state:
An average work commitment of less than 20 hours per week could qualify as regular, continuous and substantial where, for example, an individual works 30 hours per week in a year-round business up to the start of July, after which they are unable to continue working throughout the remainder of the year (e.g., because of injury, illness or the birth or adoption of a child).
CRA essentially adopted this statement and stated:
[T]here are certain situations where the average work commitment could be considered as being “regular, continuous and substantial” even if the bright-line deeming rule is not met. Accordingly, the fact that an individual was unable to work for a portion of a year in which the business operated due solely to the adoption or birth of a child would not, in and by itself, mean that the individual was not otherwise considered to meet the regular, continuous and substantial requirement for that year.
Neal Armstrong. Summary of 26 September 2018 External T.I. 2018-0770911E5 under s. 120.4(1.1)(a).
Chao – Tax Court of Canada finds that a judgment issued based on a legally unsupportable concession of Crown counsel could not be varied
The taxpayer appealed the denial of employment expenses and a GST rebate. Crown counsel, on the basis that the taxpayer had now provided a properly completed GST rebate form, indicated to the Court that the rebate issue was no longer in issue. In reliance on this concession, Jorré DJ dismissed the appeal respecting the employment expenses but allowed the GST rebate amount. However, if the employment expenses were nil, it was a legal impossibility for there to be a GST rebate, and the Crown applied for the judgment to be varied to dismiss the appeal in its entirety.
Jorré DJ refused, stating:
The reasons and the judgment both deal with the rebate issue. Clearly the rebate issue has not been overlooked and has been adjudicated.
Neal Armstrong. Summary of Chao v. The Queen, 2018 TCC 202 under Tax Court Rules, s. 168.
Atlas Tube – Federal Court finds that CRA could compel disclosure of an EY tax due diligence report discussing uncertain tax filing positions of a target
The U.S. parent (JMC) of the Canadian taxpayer (Atlas) acquired another Canadian company (LSI), following which some of the pieces of LSI ended up in Atlas’ hands in a post-closing reorganization. CRA requested, pursuant to s. 231.1, a copy of a tax due diligence report - that EY had prepared on LSI in advance of the LSI acquisition - on the grounds that it might be relevant to its audit of Atlas.
The EY report included an analysis of the tax filing positions taken by LSI and their risk of successful challenge by CRA. Atlas argued that compelling disclosure of the report was contrary to BP, which found that tax accrual working papers setting out uncertain tax positions were protected. In rejecting this argument, Southcott J stated:
BP is to be read as precluding general and unrestricted access to TAWPs on a prospective basis, outside the context of an audit of particular issues. …
… Unlike in BP, the Minister’s request for access to the Report in the present case is made in the context of an active audit of particular issues. …[T]he information in the Report sought by the Minister meets the applicable threshold of relevance in that context. I therefore find that compelling Atlas to provide the Report would not offend the principle described in BP that a taxpayer is not required to self-audit.
He also found that, as the report’s “dominant purpose when commissioned and generated was to inform the decision whether to proceed with the transaction and at what price” rather than to assist Stikeman in structuring the acquisition, it was not protected by solicitor-client privilege.
Neal Armstrong. Summaries of Canada (National Revenue) v. Atlas Tube Canada ULC, 2018 FC 1086 under s. 231.1(1) and s. 232(1) – solicitor-client privilege.