News of Note
Income Tax Severed Letters 7 February 2018
Email this ContentThis morning's release of six severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA has published all its answers at the 2017 Annual CTF Roundtable
Although we commented on most of the answers provided at the 2017 Annual CTF CRA Roundtable at the time, for convenience the table below provides brief descriptors for the final published CRA responses as well as links to those responses and our summaries thereof.
The split income rules do not apply to salaries
The split income rules, including in their proposed form, do not apply to salaries. Under the Gabco test, a salary is unreasonable if “no reasonable businessman would have contracted to pay such an amount having only [his] business considerations … in mind." This implies that:
[I]t may be justifiable and reasonable to pay a non-arm's-length person an amount in excess of an amount that would be paid to an arm's-length person if the non-arm's-length person exhibits, for example, a degree of loyalty and commitment that an arm's-length person could not….
Neal Armstrong. Summary of Alex Klyguine, "Income Splitting After the New Private Corporation Proposals: Salaries Paid to Family Members," Canadian Tax Focus (Canadian Tax Foundation), Vol. 8, No. 1, February 2018, p.2 under s. 67.
A preferred/common unit structure in a Canadian partnership holding foreign affiliates can result in the loss of s. 113 deductions to the Canadian corporate partners
Although s. 93.1 provides a look through rule where Canadian corporations hold significant indirect interests in foreign corporations “through” a partnership, their ability under s. 93.1(2) to claim a deduction under s. 113(1) (e.g., for an exempt surplus distribution) is based on the relative fair market value of their partnership interest rather than the share of the dividend that in fact is distributed to them under the terms of the partnership agreement. This can result in a portion of the dividend not being deductible under s. 113 where the Canadian corporations hold units with differing dividend-sharing attributes, e.g., where the partnership has preferred and common units.
Neal Armstrong. Summary of Karthika Ariyakumaran and Michael Spinelli, "Holding a Foreign Affiliate Through a Partnership," Canadian Tax Focus (Canadian Tax Foundation), Vol. 8, No. 1, February 2018, p.14 under s. 93.1(1).
Six further full-text translations of CRA technical interpretations are available
The table below provides descriptors and links for six French technical interpretation released in January of 2014, as fully translated by us.
These (and the other full-text translations covering the last 4 years of CRA releases) are subject to the usual (3 working weeks per month) paywall. You are currently in the “open” week for February.
Oxford Properties – Federal Court of Appeal finds that using the s. 88(1)(d) bump on newly-formed rental property LPs to avoid indirect recapture income under s. 100(1) was abusive
When Oxford Properties was sold to an OMERS subsidiary, the purchaser first negotiated that Oxford would drop various properties down into LPs on a s. 97(2) rollover basis, with those partnership interests subsequently being bumped under s. 88(1)(d) (which, in 2001, did not prohibit bumping interests in partnerships holding appreciated buildings). After the acquisition, those bumped costs were then pushed down onto the cost of interests in property-specific LPs (which had been formed following the acquisition), by winding-up the upper-tier LPs under s. 98(3) and using the s. 98(3)(c) bump. After the three-year s. 69(11) period, some of the property-specific LPs were then sold to tax exempts.
Noël CJ reversed the findings of D’Arcy J that these transactions did not abuse ss. 97(2) and 100(1). Respecting s. 97(2), he stated that “the only reason why Parliament would preserve the tax attributes of property that is rolled into a partnership is to allow for the eventual taxation of the deferred gains and latent recapture,” so that a series of transactions that instead ensured “that deferred gains and recapture will never be taxed frustrates the object, spirit and purpose of subsection 97(2).” Somewhat similarly, he stated, respecting s. 100(1):
Parliament wanted tax to be paid on the latent recapture which would otherwise go unpaid on a subsequent sale of the depreciable property by the tax-exempt purchaser.
Given this, the inevitable conclusion is that the object, spirit and purpose of subsection 100(1) was frustrated by the result achieved in this case as the latent recapture in the depreciable property … will forever go unpaid.
Most interestingly, he found that the same broad brush that was applied in determining that the transactions were abusive insofar as they avoided recognition in taxable hands of recapture should also be applied to determine that GAAR should be applied only to recognize a taxable capital gain (effectively under s. 100(1)) equal to that recapture (of $116M) and not a taxable capital gain equal to the accrued capital gain on the buildings of $21M and the accrued capital gain on the land of $11M – i.e., “the Crown cannot have it both ways” and be able to apply s. 100(1) in a technical manner once, on broader grounds, it had been found to be abused. In this regard, he stated:
[F]ailure to recognize a cost that has been actually incurred but which would disappear on a vertical amalgamation or a partnership dissolution goes against the integrity of the capital gains system because it allows for the subsequent realization of a capital gain in circumstances where there has been no economic gain.
Neal Armstrong. Summaries of The Queen v. Oxford Properties Group Inc., 2018 FCA 30 under s. 245(4), s. 69(11), s. 88(1)(d) and s. 171(1).
Joint Committee asks Finance to review the s. 55(2) issues previously raised with CRA
In April, the Joint Committee provided approximately 90 pages of slides to the Income Tax Rulings Directorate on s. 55(2) issues. CRA was able to deal only with some of the issues, which were subsequently discussed at the 2017 Annual CTF Roundtable, and the Joint Committee has now asked for Finance’s consideration of these issues.
Neal Armstrong. Summary of Joint Committee, “Subsection 55(2) Amendments – Follow-Up to Our Meeting with Canada Revenue Agency,” 19 January 2018 Joint Committee Submission to Finance respecting s. 2015 s. 55(2) Amendments including appended 20 April 2017 letter to Randy Hewlett on such amendments under s. 55(2).
The Joint Committee suggests that there are preferred approaches for the inevitable Finance response to Green
The Joint Committee has suggested that, under the Finance response to Green (respecting the flow-through of lower-tier LP losses to upper-tier partners), there be an ability to carry over unused limited partnership losses to future years in which the upper-tier partnership has an at-risk amount respecting the lower-tier partnership. For example, a provision could be added to allow partnerships to claim a deduction in computing their income in circumstances similar to where a taxpayer is allowed a deduction in computing taxable income under s. 111(1)(e).
Although s. 40(3.12) is intended to address the problem of negative ACB arising from interim distributions before ACB is increased by year-end income, it is not an ideal solution. The Committee suggests that the s. 40(3.111) relief accorded to professional partnerships be extended.
Neal Armstrong. Summaries of Joint Committee, “Response to Green case” 19 January 2018 Joint Committee Submission to Finance respecting the Green case under s. 111(1)(e) and s. 40(3.12).
FTQ – Tax Court of Canada finds that a “gift” that relieved the taxpayer of an obligation to invest the gifted funds was not a gift
The corporate taxpayer agreed with the City of Chandler that it would no longer use any loan repayment proceeds received by it from a City-owned corporation - that had failed in an costly attempt to restart a paper mill close to the City – to invest in a prospective replacement economic-development LP to be sponsored by the City, but would instead make a “gift” of the loan repayment proceeds (which ended up totalling $9.3 million) to the City, for which it received charitable receipts. From a CRA perspective, what might have been troubling about this was that, broadly speaking, this $9.3 million was not really the taxpayer’s money as, in the absence of its “gift,” it would have been received subject to an obligation to “invest” in what might likely be or become a worthless enterprise with ugly financial statements.
Ouimet J found that there was no “gift” and, thus, no s. 110.1(1)(a) deduction, stating:
Since the payment of the sums … to the City of Chandler had the effect of freeing the appellant of its obligation to negotiate in good faith to create a limited partnership, the consideration received by the appellant in exchange for such payment was the amount by which that obligation was extinguished.
He also rejected the taxpayer’s alternative argument that the payments qualified for current deduction consistently with the s. 18(1)(a) income-producing purpose test given that their purpose instead was to avoid involvement in the proposed LP and to leave to the City alone the responsibility of using the sums to economically develop the region.
Neal Armstrong. Summary of Fonds de solidarité des travailleurs du Québec (F.T.Q) v. The Queen, 2018 CCI 3 under s. 110.1(1)(a) and s. 18(1)(a) – income-producing purpose.
The new split income rules rest on a conceptually flawed foundation
The concept under the expanded split-income rules of linking business income or gains to individual contribution based on a “reasonable return” thereon is inherently intractable:
Returns are random, often yielding unintended results, from large gains to bankruptcy. There's often no demonstrable way to connect the results back to the contributions of specific people. The notion that one can do so is closely related to the … Marxist … labour theory of value – an intuitive notion that has since been thoroughly debunked… .
Paradoxically, the rules do not accommodate family members adjusting their relative gains to accord with the new normative standard. Suppose that a corporation that is owned 50-50 by two spouses is sold, and that their relative contribution to the success of the company is considered to be 60-40:
In this scenario, 20 per cent of one spouse's gain is split income, and taxed at the highest rate. There is no way around this, except to manipulate the price paid by the vendor to each spouse. That tax-guided manipulation may not be acceptable, or even possible because of the attribution rules.
Neal Armstrong. Summary of Kevyn Nightingale, "Private Company Income-Splitting Proposal Part 3: The Government Responds", Tax Topics (Wolters Kluwer), No. 2389-90, December 21, 2017, p. 1 under s. 120.4(1) – reasonable return – para. (b).