News of Note
6 further translations of CRA French-language interpretations are available
Email this ContentThe 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.
CRA confirms that amounts derived from a related business do not include capital gains from the passive investment of the dividends therefrom
S. 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.