News of Note
CRA rules on pipeline transfers of shares with both “soft” and “hard” ACB
Email this ContentCRA has ruled on a pipeline involving Opco shares inherited by an individual whose ACB consisted of both “soft” ACB (attributable to V-Day value basis of the deceased and the deceased’s use of the capital gains deduction immediately before death) and “hard” ACB (attributable to the further step-up in the shares’ ACB under s. 70(5).) The proposed transactions entailed the s. 85(1) transfer by him to a Newco of his Opco shares for notes in an amount close to the transferred shares’ hard ACB and preferred shares as to the balance – followed by an amalgamation (or wind-up) of the Opcos over a year later and gradual repayment of the notes on a redacted timetable.
Neal Armstrong. Summary of 2017 Ruling 2016-0629511R3 under s. 84(2).
CRA rules that the merger of two segregated funds held by the same insurer would occur on a s. 107.4 rollover basis
CRA ruled that the s. 107.4 rollover applied to the “transfer” of all the property of one segregated fund to another segregated fund held by the same insurer. The insurer was the legal and beneficial owner of both funds’ properties both before and after, so that the transfer consisted in the insurer starting to book the securities of the first fund as being securities of the second fund, and adjusting the notional units of the policyholders accordingly. Thus, the rulings essentially turned on the proposition that these book entries were sufficient to effect a transfer of property from one fund (which was deemed by s. 138.1 to be a trust) to the second such deemed trust, notwithstanding the absence of specific language in s. 138.1 to that effect.
As it happened, the property of the two funds was essentially identical (units of a mutual fund trust), but the logic in this ruling would appear to extend to situations where the two funds had different property.
Neal Armstrong. Summary of 2017 Ruling 2016-0625301R3 under s. 107.4(1).
CRA finds that the s. 6(1)(a)(ii) exclusion for employer RCA contributions was effectively allocated between Cdn and US employment income of an athlete
40% of a non-resident athlete’s $2 million compensation package from a Canadian team was in the form of annual team contributions to his retirement compensation arrangement. Upon retirement or loss of employment, the athlete would receive a lump sum cash-out payment from the RCA that would be subject to 25% Part XIII tax.
CRA indicated that the $800,000 annual team RCA contribution was excluded from employment income under s. 6(1)(a)(ii) and that the (net) employment income of $1,200,000 should be allocated as to 40% (or $480,000) to Canada based on the higher number of games played in the U.S. Thus a submission that the athlete’s Canadian employment income under s. 115(1)(a)(i) was nil through allocating the s. 6(1)(a)(ii) exclusion wholly to the Canadian income ($2 million x 40% - $800,000) was unsuccessful.
A variant of these facts entailed the athlete and team each annually contributing $400,000 to the RCA. In finding that the employee contributions would not qualify for deduction under s. 8(1)(m.2), which refers inter alia to deduction of “an amount contributed by the taxpayer in the year to a pension plan in respect of services rendered by the taxpayer … where the plan is a [RCA],” CRA stated:
[A] plan will not be a pension plan where the only payment provided for under the terms of the plan is a single lump sum payable on retirement or loss of employment. … [A] plan that is excluded from being a salary deferral arrangement (“SDA”) by virtue of the special exception for professional athletes in paragraph (j) of the SDA definition in subsection 248(1) [also] will not be a pension plan, regardless of the form of benefits provided.
The first reason for denial focuses on the implausible situation of a plan providing only for the payment of a lump sum on retirement or termination, rather than providing for a retirement pension but with provision for commutation on specified events. The second reason appears to be an exercise in policy making rather than statutory interpretation.
Neal Armstrong. Summaries of 21 February 2018 External T.I. 2017-0702061E5 under s. 115(1)(a)(i) and s. 8(1)(m.2).
CRA elaborates on the relationship between Part IV tax and s. 55(2) and related amended return filings
2017-0724071C6 indicated that where Holdco receives a dividend of $400,000 that was subject to Part IV tax of $153,333 (38.33% of $400,000) equalling the connected payer’s dividend refund and, in turn, pays a dividend to its individual shareholders resulting in a dividend refund (DR) of the Part IV tax – so that the dividend received by Holdco was subject to s. 55(2) there should be two returns filed by Holdco – one reporting the Part IV tax, and a second one reporting the capital gain under s. 55(2), thereby giving rise to refundable tax and an addition to Holdco’s RDTOH account which could only be used prospectively. CRA has now provided six detailed numerical examples going through variants on this scenario.
Respecting scenarios where Holdco did not pay a full dividend to its individual shareholder, CRA stated:
[A]ny future payment of a taxable dividend by Holdco that resulted in a refund of Part IV tax could result in the potential application of subsection 55(2) to the extent that this payment was part of the same series of transactions. The CRA would consider any future DR as a result of the payment of a dividend by a corporation, where the payment was part of the same series of transactions, as coming first from the Part IV tax paid on the taxable dividend.
Respecting when the amended return of Holdco should be filed, CRA indicated a preference for Holdco to wait until its original return was assessed. If Holdco wanted to avoid interest charges by paying at the time of the first return an amount that took into account its s. 55(2) liability to be reported in the second return, CRA described the procedures for avoiding having this overpayment refunded in the interim.
Neal Armstrong. Summary of 18 December 2017 External T.I. 2017-0714971E5 F under s. 55(2).
CRA finds that lacunae in the s. 87 rules do not deny the s. 22 election to an Amalco
Immediately after its formation, Amalco dropped the business of a predecessor down to a partnership under s. 97(2) – except that it used the s. 22 election for the transferred trade receivables. The Directorate found that as a technical matter the s. 22 election was not available – effectively because s. 87(2)(g), which deemed Amalco to be a continuation of the predecessor for purposes of the ss. 20(1)(l) and (p) reserve provisions, did not go further to deem the Amalco receivables to have been includible in its income. Furthermore, it was at least somewhat doubtful that Amalco carried on the predecessor’s business given that the drop-down occurred within minutes of the amalgamation.
The Directorate nonetheless concluded that the s. 22 election was valid as denying the election “runs against the legislative scheme of section 87.”
Neal Armstrong. Summary of 24 October 2017 Internal T.I. 2017-0719531I7 under s. 22(1).
Income Tax Severed Letters 14 March 2018
This morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA indicates that non-flow through shares can be part of a flow-through share class
Where a taxpayer otherwise has realized a nil taxable capital gain under s. 38(a.1)(i) on the donation of shares, s. 40(12) provides that if those shares were included in a “flow-through share class,” then the taxpayer is deemed to have a capital gain generally equal to “exemption threshold” in respect of that flow-through share class (generally, the pool of actual (commercial) costs of flow-through shares issued to the taxpayer).
CRA indicated that non-flow through shares issued to a taxpayer are tainted as being part of a flow-through share class if any share in that class held by another person is a flow-through share. Although this sounds ominous, CRA went on to indicate that the taxpayer’s exemption threshold in this situation would be nil “it is necessary for the taxpayer to have acquired a flow-through share (or certain partnership interests …) in order for a taxpayer to have an exemption threshold in respect of a flow-through share class of property to which subsection 40(12) of the Act would apply.” Thus the capital gain on the donation of such shares to a registered charity would not be increased under s. 40(12).
Neal Armstrong. Summary of 19 January 2018 External T.I. 2017-0683501E5 under s. 40(12).
Hughes – Tax Court of Canada finds that care of a child with severe and stringent dietary requirements qualified for the disability tax credit
The taxpayer spent 13.5 hours per week carefully monitoring the amount of a particular amino acid (Phe) consumed by her daughter (who had been born with phenylketonuria (“PKU”)) in order to avoid severe brain damage. Boyle J rounded this up to meet the requirement in s. 118.1(1)(a.1)(iii) of 14 hours per week of “therapy,” stating that this treatment was “much more like administering a medication than it is like managing a diet.” There also clearly was “life‑sustaining therapy” supporting a “vital function,” so that he granted the disability tax credit.
Neal Armstrong. Summary of Hughes v. The Queen, 2018 TCC 42 under s. 118.3(1)(a.1).
CRA finds a lump sum paid to a non-resident for granting an exclusive right to distribute its product in Canada was subject to s. 212(1)(i) (“restrictive covenant”) withholding
In consideration for a lump sum, a non-resident in a Treaty country (NRco) granted an arm’s length Canadian company (Canco) the exclusive right to distribute its product in Canada, with Canco agreeing not to acquire or sell competitive products. The Directorate found that the lump sum was not a royalty on general principles and, in light of Farmparts (which stated that an exclusive right to buy and sell could, “under no circumstances, be said to constitute the use or the right to use” the product) likely also was not caught by s. 212(1)(d)(i), nor did the Directorate recommend challenging the characterization under the agreement of the licence of a trademark as being gratuitous (as the “Distribution Agreement does not contemplate an extensive use of the trade-mark, but only limited use in connection with the distribution, promotion and advertising of the product.”) However, the exclusivity of the distributorship right granted by NRco was a “restrictive covenant,” so that the lump sum would be subject to Part XIII tax under ss. 56.4(2) and 212(1)(i).
But there was the Treaty, whose Royalty Article was similar to the OECD Model, the Commentary on which stated that that payments made in consideration for obtaining the exclusive distribution rights of a product in a given territory do not constitute royalties within the meaning of the Model Tax Convention as they are not made in consideration for the use of, or the right to use, an element of property included in the Royalty definition. Hence, the lump sum was withholding-tax exempt.
Neal Armstrong. Summaries of 16 August 2017 Internal T.I. 2017-0701291I7 under s. 212(1)(d)(i), s. 212(1)(d), s. 56.4(1) – restrictive covenant and Treaties – Art. 12.
CRA finds that an Alberta coniferous tree-harvesting right was a timber resource property
Rather than reviewing the quite complex jurisprudence on what is a timber resource property, CRA looked at a timber removal right that was effectively a renewal of some timber removal rights that had been granted by the Alberta government in 1967 and 2004, and simply stated:
Based on jurisprudence … and the facts and assumptions described above, the New Quota (whether it is viewed as a single property or a combination of two properties) would qualify as a timber resource property pursuant to the definition of that term in subsection 13(21).
As such, its sale would give rise to full income-account treatment rather than the potentially more favourable treatment accorded to timber limits or eligible capital property (or Class 14.1 properties).
Neal Armstrong. Summary of 6 February 2018 External T.I. 2017-0732151E5 under s. 13(21) – timber resource property.