News of Note
CRA finds that the distribution to a non-resident parent of assets of a subsidiary that had SERP obligations and the assumption of such obligations did not create an RCA
Email this ContentOpco, which formerly had an active business, but now is inactive, is obligated to pay supplemental executive pension benefits to former executive employees (the “Pensioners”). With the consent of the Pensioners, the non-resident “Parent” (which actually appears to be an Opco grandparent) assumes these “SERP Obligations” for no consideration. Immediately thereafter, Opco is wound-up into its immediate parent (Holdco), and Holdco uses its mostly cash assets to satisfy the liquidation entitlement of the Holdco shares held by Parent. The ruling letter stipulates that no portion of the assets distributed on the two windings-up are“ear-marked” or segregated to secure the SERP Obligations.
CRA ruled that no portion of the distributed assets will be considered a “contribution” made to a retirement compensation arrangement (or the subject property of an RCA for the purposes s. 207.6(1) respecting the SERP Obligations assumed by Parent. As stated by CRA in its summary:
[N]one of the proposed transactions involving the transfer of the SERP liability to Parentco would create an RCA.
Neal Armstrong. Summary of 2017 Ruling 2016-0655071R3 under s. 207.5(1) – refundable tax – (a).
Motter – Court of Quebec finds that a purported “tenant inducement payment” was a capital expenditure
An individual in the business of constructing and renting commercial real estate, entered into a lease agreement with Téléglobe respecting a building which he was to construct, that provided Téléglobe with “an initial Improvement Allowance” of $25.00 per square foot (or $2M). After construction, this was paid by way of partial set-off against the $2.7M cost of tenant improvements made by him in the course of constructing the building that he invoiced to Téléglobe. The $2.7M apparently was included in his income, but he sought to deduct what he styled as a $2M “tenant inducement payment” on income account.
After noting that in Canderel and Toronto College Park, the landlords made tenant inducement payments respecting already-constructed buildings in a market where there was a high vacancy rate, and in finding that the leasehold improvement payment of the taxpayer was a capital expenditure rather than deductible in computing his income, Lareau JCQ noted that the “lease provides that the budgeted amount must be devoted to the construction of the tenant improvements and consequently be assimilated to the building” and also that there was “no evidence that this amount was intended to deal with competition in a particularly difficult market,” and then concluded:
[T]here is no proof that links this expense to anything other than the construction of the building with a view to a future benefit arising from the collection of rents over the term of the lease.
Neal Armstrong. Summary of Motter v. Agence du revenu du Québec, 2018 QCCQ 3483 under s. 18(1)(b) – improvements v. repairs/running expense.
Toronto-Dominion Bank – Federal Court finds that the deemed trust for unremitted GST defeated the mortgagee’s priority on a voluntary sale of the mortgaged home
TD Bank made a mortgage loan to an individual who, unbeknownst to it, had unremitted GST collections. A year later the individual sold his home and repaid TD in full. TD found out about the unremitted GST two years later when it received a payment demand from CRA.
Grammond J found that TD was required to comply by virtue of the proposition that the deemed trust under ETA s. 222 for the unremitted GST followed the proceeds of the sale into TD’s hands. Among other arguments, he rejected a submission that (based on attempting to give the word “proceeds” a narrow construction) s. 222(3) did not apply to a voluntary sale as contrasted to a sale under a power of sale, and also rejected the proposition that a secured creditor could benefit from the equitable defence for “purchasers” (including lenders) for value. However, he stated:
I would add that the defence remains available to unsecured creditors, such as suppliers, landlords or public utilities, who receive payments from a tax debtor. In those cases, denying the defence would give rise to the concerns mentioned [in] ... First Vancouver – it “would have a general chilling effect on commercial transactions.”
Similar considerations arise under other statutes, e.g., ITA s. 227(4.1). It may become more common for loan agreements to require the regular provision by borrowers of statements of account with CRA, and for acceleration if this is not done.
Neal Armstrong. Summary of Canada v. Toronto-Dominion Bank, 2018 FC 538 under ETA s. 222(3).
Dusablon – Court of Quebec finds that a couple who renovated a house without moving in were ineligible for the principal residence exemption
Two individuals acquired a house in Montreal in a dilapidated condition for $695,000, spent $350,000 on having substantial renovations made, and put the property up for sale seven months after its acquisition at a price of $1,250,000, which was achieved in a sale two months later. The ARQ did not challenge the proposition that they had disposed of the house on capital account, but did deny the principal residence exemption. They had never moved into the property or even had any meals there, but stayed in a shared rented apartment.
In denying the exemption, Edwards JCQ noted that the taxpayers had not pleaded that they had “inhabited” the property but rather that they had "occupied" it by reason of their supervision of (and, in the case of one of the taxpayers, his participation in) the renovation work, and stated that the word “inhabit” “does not include the intention to inhabit a place, but is limited to in fact inhabiting there” (his emphasis).
Neal Armstrong. Summary of Dusablon v. Agence du revenu du Québec, 2018 QCCQ 3032 under s. 54 – principal residence – (a).
Income Tax Severed Letters 13 June 2018
This morning's release of 11 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Wild – Federal Court of Appeal finds that surplus-stripping transactions were not subject to GAAR before the surplus had in fact been stripped
Mr. Wild stepped up the adjusted cost base of his investment in a small business corporation (PWR) by transferring his PWR common shares to two new Holdcos for him and his wife in exchange for preferred shares of the Holdcos, and electing under s. 85 at the right deemed proceeds amount to use up his capital gains exemption. However, the paid-up capital of those preferred shares was ground down to essentially nil under s. 84.1.
The solution was for PWR to then transfer high basis assets to the Holdcos in consideration for preferred shares of the same class, so that the PUC of the preferred shares held by Mr. Wild personally could be bumped due to the class-averaging rule in s. 89(1).
Dawson JA reversed the finding of the Tax Court that there was an abuse under s. 245(4) that should be remedied by grinding the PUC of Mr. Wild’s preferred shares down to what his starting (nominal) PUC had been. She stated:
Because the tax-free distribution of retained earnings section 84.1 is intended to prevent has not occurred section 84.1 has not, to date, been mis-used or abused.
In other words, positioning for future abuse is not abuse.
This was a pyrrhic victory for Mr. Wild. The Tax Court was wrong, very wrong, to take away the PUC of his shares. However, now he is effectively being told that he can keep that PUC but never use it (lest he be subject to a deemed dividend under s. 245(2).) Will Mr. Wild wait 20 years until CRA has forgotten about this case and where his PUC came from?
Neal Armstrong. Summary of Wild v. Canada (Attorney General), 2018 FCA 114 under s. 245(4).
Proposed s. 231.8 may deter taxpayers from challenging s. 231.2 requirements
Proposed s. 231.8 will extend the normal reassessment period by the period of time during which an s. 231.2 requirement or an s. 231.7 compliance order is being contested. The stop-the-clock period begins (1) re a requirement, when the taxpayer applies for judicial review; and (2) re a compliance order, when the taxpayer opposes the application. The period ends on the day the relevant application is “finally disposed of.”
[T]he stop-the-clock suspension operates in respect of all audit issues, not just those to which the requirement or compliance application relates. In effect, proposed section 231.8 may deter taxpayers from challenging a requirement through the judicial review process because the challenge would result in extending the life of all issues to which the reassessment period relates.
Neal Armstrong. Summary of Nick Pantaleo and Marisa Wyse, “Power to Lengthen Assessment Period,” Canadian Tax Highlights, Vol. 26, No. 5, May 2018, p. 1 under s. 231.8.
Wolf – Tax Court of Canada finds that revenues earned by an individual through an LLC could be included in determining what were his business revenues for services-PE purposes
A U.S. engineer provided services to Bombardier in Canada over a 188-day period (straddling the 2011 and 2012 years). He would have been considered to have a services permanent establishment in Canada under the Canada-U.S. Treaty but for the requirement in Art. V, 9(a) of the Treaty that “more than 50 percent of the gross active business revenues of the enterprise consists of income derived from the services performed in [Canada] by that individual.”
The taxpayer derived most of his income through a New York LLC. Although Ouimet J recognized that the LLC was a separate taxpayer for Canadian purposes, he nonetheless found that the U.S.-source revenues received by the taxpayer as an LLC member qualified as active business revenues from the same enterprise as that for the earning of engineering fees from Bombardier. His reasoning appears to be that the LLC’s revenues (from U.S. manufacturing and licensing of a patent generated by the taxpayer) all arose from the same expertise and design work of the taxpayer respecting aircraft fuel lines as were also being exploited in the 2011/12 work for Bombardier – and that the LLC was merely a passive vehicle for divvying up the profits generated from this enterprise engaged in by the taxpayer in conjunction with a third party.
Thus, the taxpayer came close to establishing that he did not have a services PE. However, he lost on an evidentiary point. The figures that he had provided to Ouimet J for the active business revenues generated through the LLC were for calendar 2012, whereas the 50% test was to be applied to the 188 day period straddling the two years. As there was no evidence of what the U.S.-source business revenues were for that precise period, the taxpayer failed to meet the onus on him.
Neal Armstrong. Summary of Wolf v. The Queen, 2018 TCC 84 under Treaties, Art. 5.
CRA confirms that the claiming of a capital gains reserve on a s. 84.1 transfer can result in a s 84.1 deemed dividend on a subsequent transfer
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.
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.
Neal Armstrong. Summary of 29 May 2018 STEP Roundtable, Q.17 under s. 84.1(2.1).
Six further full-text translations of CRA interpretations are available
The table below provides descriptors and links for five Technical Interpretation released in August and July 2013, as fully translated by us and a further Technical Interpretation released in December 2010 (which we translated somewhat out of sequence given increasing interest in the s. 249(3.1) election.)
These (and the other full-text translations covering all “French” Interpretations released in the last 4 3/4 years by the Income Tax Rulings Directorate) are subject to the usual (3 working weeks per month) paywall.