News of Note
CRA confirms that where a partnership with FA1 as a 40% partner pays interest to FA2, only 40% of the interest can be recharacterized as active under s. 95(2)(a)(ii)(B)(II)
Email this ContentCanco wholly-owns two non-resident corporations (“FA1” and “FALuxco”). FA1 is the 40% partner of “MLP,” whose other non-resident partners are not FAs of Canco. MLP borrows $200M from FALuxco, bearing interest of $10M per annum, for use in its active U.S. business.
CRA found that only 40% of the $10M interest received by FALuxco should be recharacterized as income from an active business under s. 95(2)(a)(ii)(B)(II) (resulting in FALuxco having FAPI of $6M - because only $4M of interest would be deductible in computing FA1’s earnings). CRA stated that from a policy perspective:
[S]ince a partnership is treated as a flow-through for Canadian tax purposes, for the purpose of subclause 95(2)(a)(ii)(B)(II) the interest paid by a partnership should be viewed as interest paid proportionately by each of its members. [Accordingly] to the extent that a portion of the interest paid to FALuxco by MLP is considered to be paid by a member that is not described in subclause 95(2)(a)(ii)(B)(I) [i.e., the non-FA members of MLP], that portion should not be recharacterized as income from an active business since it would not be so recharacterized if it had been paid directly by that member.
Neal Armstrong. Summary of 31 August 2017 Internal T.I. 2016-0680801I7 under s. 95(2)(a)(ii)(B)(II).
Income Tax Severed Letters 10 January 2017
This morning's release of five severed letter from the Income Tax Rulings Directorate is now available for your viewing.
Kenny – Tax Court of Canada finds that foreign government assistance scuppered the “substantially all” test in s. 118.94 (which did not violate a non-discrimination Treaty Art.)
In 2014, an Irish resident earned $32,728.52 in employment income from working for a few weeks in Fort McMurray, and also received $23,002.37 from the Irish government, mostly as means-tested assistance. C Miller J found that these assistance payments qualified under s. 56(1)(u) as “social assistance payment[s] made on the basis of … means,” notwithstanding that they were not income for Irish purposes and were foreign rather than domestic assistance. Accordingly, the taxpayer could not claim full Canadian credits of $28,717, as he did not satisfy the condition in s. 118.94 that “substantially all” of his income for the year was included in computing his taxable income earned in Canada for the year.
In this regard, C Miller J stated:
… [C]ases have relied on percentages as low as 76% to be considered substantially all. In Mr. Kenny’s case, I would be stretching “substantially all” beyond any measure of elasticity if I concluded that 60% represented “substantially all”.
In rejecting counsel’s submission that this result violated the prohibition in Art. 24(1) of the Canada-Ireland Treaty against subjecting nationals of Ireland to more burdensome taxation than for nationals of Canada (and vice versa), C Miller J stated:
I read this provision as applying to nationals, not residents, to ensure that a Canadian citizen residing in Ireland and receiving the same payments (employment from Canada and social assistance from Ireland) as Mr. Kenny would not be treated any differently. I do not find subsection 24(1) of the Treaty assists Mr. Kenny in this regard.
Neal Armstrong. Summaries of Kenny v. The Queen, 2018 TCC 2 under s. 118.94 and Treaties – Articles of Treaties – Art. 25.
CRA maintains its restrictive position respecting the GST/HST exemption for supplies of goods before their release
ETA s. 144 provides that “a supply of goods that have been imported … but have not been released [by the CBSA] before the goods are delivered … to the recipient of the supply, shall be deemed to be made outside Canada,” so that even if the vendor is a registrant, it is not required to charge GST/HST.
CRA considers that s. 144 does not apply if the goods were supplied by the vendor before they were imported and, in this regard, applies ETA s. 133, which deems goods to be supplied at the time that the sale agreement is entered into. Accordingly, in an example where a registered non-resident enters into a somewhat long-term agreement for the supply of fuel oil to Canco, and thereafter delivers the fuel oil to Canco at a Canadian port, CRA considers that s. 144 does not relieve the non-resident from the requirement to charge GST/HST notwithstanding that the fuel oil has not yet been released at the time of its delivery in Canada.
Neal Armstrong. Summary of 8 September 2017 Interpretation 180362 under ETA s. 144.
CRA indicates that a bad debt credit cannot be claimed for uncollectible GST/HST assessed on audit
ETA s. 231(1.1) provides that a supplier cannot claim a bad debt deduction unless “the tax collectible in respect of the supply is included in determining the amount of net tax reported in the reporting entity’s return … for the reporting period in which the tax became collectible.” CRA considers that the quoted language means that where a supplier is assessed on audit for failure to charge and remit the tax, no bad debt deduction is available for the uncollectible tax where, for example, the customer declared bankruptcy before the audit and resulting assessment.
Not a problem! CRA stated:
[S]ection 232 does appear to offer a solution where the consideration is reduced. Where the supplier issues a credit note to the customer (which is now bankrupt) to relieve it of that debt, the supplier would be entitled to claim a deduction if all conditions set out in paragraph 232(3)(b) are met.
The point appears to be that if the supplier is willing to give up its claim against the bankrupt estate for, say, $100, it can generate a bad debt deduction for the GST/HST (say, $13) provided it issues a credit note for the $100.
Neal Armstrong. Summary of 18 September 2017 Interpretation 176502 under ETA s. 231(1.1).
Bitton Trust – Quebec Court of Appeal finds that the ARQ did not exceed its Quebec-based audit authority when it issued a s. 231.2 demand to a Calgary bank branch
The ARQ, which was seeking to establish that the central management and control of an Alberta trust was in Quebec, issued a requirement to a Calgary branch of the Banque Nationale du Canada (“BNC”) for various bank records respecting the trust under the Quebec equivalent of ITA s. 231.2(1). The requirement was sent directly to the branch rather than to the BNC head office because this was required under s. 462(2) of the Bank Act. In finding that the ARQ had not exceeded its territorial competence in making this requirement, Hogue JCA stated:
Here we are not concerned with … a seizure outside of Quebec which, it is true, could require the seizing party to approach an authority of the foreign State with a view to obtaining its collaboration in order to proceed. …
The communication of the requirement to BNC through one of its branches situated outside Quebec is the sole external element that is present here. However, such communication is purely accessory and is insufficient to conclude that the ARQ exercised its powers of taxation or of audit outside of Quebec or exceeded its competence.
Neal Armstrong. Summary of 1068754 Alberta Ltd., trustee of DGGMC Bitton Trust v. ARQ, No. 500-09-025203-159, 8 January 2018 (Queb. CA) under s. 231.2(1).
Six further full-text translations of CRA technical interpretations are available
The table below provides descriptors and links for the French technical interpretation released last week and five technical interpretations released in February of 2014, as fully translated by us.
These (and the other full-text translations covering the last 3 ¾ years of CRA releases) are subject to the usual (3 working weeks per month) paywall.
Dynamic hedging might be on capital account
A dynamic hedge, for example, where a taxpayer has written a call option on a number of shares of X Co, involves the taxpayer continually buying or selling shares of X Co in predictable numbers and at predictable times based on changes over time in the market price of the X Co shares.
[B]ased on George Weston … a compelling argument can be made that gains and losses resulting from a dynamic hedging strategy to hedge a capital asset should also be on capital account despite the fact that there may be numerous transactions. … [T]he relevant issue is the character of the risk that is being hedged (depreciation in value of a foreign-currency-denominated capital asset), not the number of transactions.
The derivative forward arrangement definition was amended in response to concerns that it could apply to conventional currency forwards. However, there are concerns that the new wording does not adequately deal with currency forwards that hedge foreign-currency denominated borrowings (as contrasted to investments).
Under hedge accounting, recognition of income or loss on the hedge of a trading-account item can be deferred until the year of recognition of loss or income on the underlying hedged item. A company,
having chosen hedge accounting, could argue on the basis of Kruger that hedge accounting provided a more accurate picture of income; it matched the results of the hedged item with the results of the hedging item, thus producing a better match of profit and related loss than the realization principle.
Neal Armstrong. Summaries of Nigel P.J. Johnston and Roger E. Taylor, "Taxation of Hedges and Derivatives: Recent Developments," 2016 Conference Report (Canadian Tax Foundation), 13:1-36 under s. 9 - timing, s. 9 – capital gain v. profit – futures/forwards/hedges, and s. 248(1) – derivative forward agreement – s. (b)(iii).
CRA rules that the purchase of an IP royalty gives rise to non-creditable GST/HST to the investor unless there is a specified minimum royalty
A Canadian registrant (Investor) enters into an agreement with a Canadian corporation (Corporation 1) under which it pays lump sums in consideration for the right to receive monthly royalties calculated as a percentage of intellectual property (IP) related revenue streams of Corporation 1. CRA ruled that the lump sums so paid are consideration for the taxable supply to Investor of intangible personal property (the right to the royalty payments). However, CRA ruled that Investor is not making any taxable supply in exchange for the royalty payments when Corporation 1 makes the subsequent royalty payments – so that Investor would not be entitled to claim input tax credits for the GST/HST paid or payable on related inputs. Apparently, this means that the GST/HST charged to it on its lump sum investment is non-creditable. This analysis could be troubling to the companies which invest in Canadian resource or other royalties.
A second agreement with Corporation 2 was similar, except that a minimum monthly royalty was specified. CRA ruled that because the Investor now had a non-contingent right to receive money, the right to the royalties qualified as a “debt security” (defined in ETA s. 123(1) as “a right to be paid money”), so that the purchase of the royalty agreement was now the exempt purchase of a financial instrument. This seems to suggest that the revenue potentially payable under a “debt security” can be highly variable provided that there is a specified minimum.
Neal Armstrong. Summaries of 10 February 2017 Ruling 162056 under ETA s. 123(1) - debt security, s. 169(1) and s. 182(1).
CRA finds that a corp. held 50-50 by two 100% grandchildren of A was closely related for ETA purposes to A and to another 100% grandchild of A
One of the requirements for the ETA s. 156 nil consideration election is that the parties be closely related. The basic building block for the closely-related definition is the concept of a “qualifying subsidiary,” which references the holding of 90% or more of the value and number of the issued and outstanding shares, having full voting rights under all circumstances, of the mooted subsidiary. There is a somewhat ambiguous reference in ETA s. 128(1)(a)(v) to the 90% closely-related test being satisfied by a “combination” of corporations.
This did not give CRA pause, and it found that a corporation which was held on a 50-50 basis by two wholly-owned grandchildren of A was closely related to A as well as to another wholly-owned grandchild of A held through another chain.
Neal Armstrong. Summary of 11 October 2017 Interpretation 181628 under ETA s. 128(1)(a)(v).