News of Note

CRA ruling describes a structure for MFT trailer fees to be funded out of increased management fees charged to an indirect real estate subsidiary LP of the MFT

CRA ruled respecting the creation of an additional class of “Class A” units of a mutual fund trust (the “Trust”) - which would essentially have identical attributes to those of the existing units except that they would indirectly bear all of the trailer fees paid to securities dealers, who would only sell the Class A units to further subscribers and not the existing units. CRA ruled that this amendment (which would be made by the trustee without unitholder approval on the grounds that there was no effect on the value of the existing units) would not result in a disposition at the trust or unitholder level, or in the application of s. 104(7.1).

The trailer fees respecting the Class A were to be funded out of additional management fees charged by the general partner of an indirect real estate subsidiary LP of the Trust to that LP, with the resulting reduction in distributions paid by that LP up the chain to the Trust being tracked so as to result in a pro tanto reduction in the distributions paid on the Class A units relative to the existing units. This general partner was controlled by the Trust corporate trustee. CRA did not comment on the trailer fees effectively being expensed at the operating LP level.

Neal Armstrong. Summary of 2016 Ruling 2015-0612931R3 under s. 248(1) – disposition.

The B2B connectivity tests do not require that the two legs of a B2B arrangement be put in place contemporaneously

The back-to-back loan rules attempt inter alia to catch situations where a particular non-resident indirectly funds a debt of a Canadian borrower by granting certain security interests or property rights to an intermediary (instead of lending to the intermediary). The concept of “specified right” which is used to this end now appears to target security interests and property rights that the intermediary can monetize and use to fund the particular debt to the taxpayer. However, if the Canadian subsidiary and foreign parent and sisters enter into a multiparty credit agreement where all parties guarantee the facility, pledge their assets and borrow, except that the subsidiaries do not guarantee the foreign parent's borrowings for foreign tax reasons, the requirements for the exception to the definition of "specified right" may not be satisfied.

The revised B2B rules catch a loan to the immediate funder by a partnership.

The B2B rules contain connectivity tests to link the particular loan made to the Canadian taxpayer by an intermediary to a loan or equity funding by (or royalty arrangement with) an intermediary.

[T]he connectivity tests do not require that the two legs of a back-to-back arrangement be put in place at or around the same time. Therefore, each time a Canadian entity receives funding of any sort, it will have to trace the historical origin of that funding, even if one leg of the back-to-back arrangement was put in place a long time ago and the funds in the intermediary have been reinvested a number of times.

Neal Armstrong. Summaries of Jason Boland and Christopher Montes, "A Detailed Review of the Back-to-Back Loan Rules," 2016 CTF Annual Conference draft paper under s. 18(5) – specified right, s. 18(6)(c)(i), s. 212(3.8) – relevant funder and specified share, s. 212(3.21), s. 212(3.6)(a), s. 212(3.91) and s. 15(2.18).

Sequencing the acquisition of control on a recapitalization can maximize tax attributes

A Canadian public company (Canco) will be recapitalized so that the provider of debtor-in-possession financing will end up holding 2/3 of the common shares having a fair market value equaling that of the DIP financing provided by it, and most of the balance of 1/3 of the common shares will be received by the holders of the U.S.-dollar bonds, who thereby will recognize a 90% loss in U.S.-dollar terms – or less than that in Canadian-dollar terms.

If the transactions are structured so that the acquisition of control by the DIP financier occurs first (or is deemed to occur first under s. 256(9)), Canco will realize the accrued FX loss on the bonds under s. 111(12). If the bonds are instead settled first, s. 80(2)(k) will effectively prevent realizing an FX loss on the 90% of the bonds that is forgiven, thereby resulting in fewer tax attributes recognized by Canco.

As background to the extension of the debt-parking rules by s. 39(2.01), many Canadian companies had substantial accrued FX gains on their U.S.-dollar debt, particularly debt originally issued in 2001 or 2002, and which matured in 2011 and 2012, when the Canadian dollar had appreciated to around parity.

Neal Armstrong. Summaries of Carrie Aiken and Johnson Tai, "Debt Restructuring Transactions – Issues, Strategies and Trends," 2016 CTF Annual Conference draft paper under s. 80(2)(k), s. 39(2.02) and s. 248(1) - disposition.

CRA states that a non-resident lender consent fee is not an administration fee and treats non-resident dealer board attendance as services rendered in Canada

Canco paid “consent fees” (calculated as a percentage of the amount owing) in order to obtain the consent of arm’s length non-resident lenders to a sale of its shares to a non-resident purchaser. Before finding that the fees were not subject to Part XIII tax as a management or “administration” fee or charge, or on any other ground, the Directorate noted that at the time of the original introduction of s. 212(1)(a), the Minister of Finance had stated (even before getting to the exclusions in s. 212(4)) that “a management or administration fee or charge is to be regarded as an amount paid for advice or direction pertaining to the operation or administration of a company, not including an amount paid for services to an independent firm.”

Canco had also paid fees of a non-resident dealer for assistance in structuring the transaction, finding purchasers, evaluating their offers and coordinating due diligence. Regarding Reg. 105 withholding, CRA stated that “it would appear that at least some of the services, particularly meeting with the Board of Directors would be provided in Canada,” and referred to its comment in IC 75-6R2, para. 32 that “The portions allocated to the services to be performed inside and outside Canada must be clearly expressed either within the contract or through the related information and documents.”

Neal Armstrong. Summaries of 30 March 2017 Internal T.I. 2016-0636721I7 under s. 212(1)(a) and Reg. 105.

Montminy – Federal Court of Appeal finds that employees enjoyed the ½ deduction on exercising their stock options notwithstanding an immediate sale of the acquired shares to the controlling shareholder

When a third-party purchaser agreed to acquire all the assets of Opco, the management employees agreed with the 100% shareholder of Opco (“Holdco”) that on the asset sale closing date, they would exercise their options to acquire common shares of Opco and immediately sell their newly-acquired shares to Holdco for an agreed cash sale price.

The Crown accepted that this right to sell their shares to Holdco was a fair market value liquidity right described in Reg. 6204(2)(c), so that the shares were not prevented from being prescribed shares under Regs. 6204(1)(a)(iv) and (vi) (re right for their shares to be acquired by a specified person, i.e., Holdco). However, D’Auray J in the Tax Court had accepted the Crown’s submission that the shares were tainted under Reg. 6204(1)(b).

In allowing the taxpayers’ appeal, Noël CJ found that Reg. 6204(2)(c), by providing that the taxpayers’ right to sell their shares to Holdco was to be ignored for purposes of Reg. 6204(1), had the effect of also deeming there to be no reasonable expectation under Reg. 6204(1)(b) of such an acquisition occurring within two years of the options’ exercise. He also found that providing the ½ deduction under s. 110(1)(d) to the taxpayers accorded with the broader context of the stock option rules. In particular, the taxpayers had been fully at risk during the lengthy period of their holding of their options to fluctuations in Opco’s value.

Neal Armstrong. Summary of Montminy v. Canada, 2017 FCA 156 under Reg. 6204(1)(b).

CRA considers the possibility that a portion of redemption proceeds could be treated as a dividend under Barbados corporate law

The s. 90(2) rule, which deems a pro rata distribution received on a foreign affiliate share to be a dividend, does not apply to a “distribution made…on a redemption …of the share.”

Canco held the preferred, but not the common, shares of a Barbados International Business Company (“FA”), and its preferred shares were redeemed. Although the relevant facts are mostly redacted, it would appear that the resolution pursuant to which FA redeemed the shares provided that a portion of the proceeds paid on the redemption was a dividend, and Canco apparently relied on this wording rather than making a s. 93(1) election. The Directorate stated:

If there is only, as a matter of law, a redemption and cancellation of shares, or if there is no conclusive evidence as to whether there is, in part, a dividend, we would generally view all such amounts as having been received as proceeds from the disposition of the… Shares, and no amount as having been received as a dividend.

This seems to imply that the Directorate was amenable to the possibility that, with the right corporate-law treatment, the proceeds could in part be a dividend even though they were all paid “on a redemption …of the share[s].”

The Directorate also stated:

If there is, in part, a dividend… to the extent the purpose of issuing the...Shares is to skew exempt surplus to the Canadian shareholder…consideration [should] be given as to the potential application of subsection 95(6) and/or subsection 245(2).

Neal Armstrong. Summary of 11 April 2017 Internal T.I. 2016-0670541I7 under s. 90(2).

Income Tax Severed Letters 19 July 2017

This morning's release of eight severed letters from the Income Tax Rulings Directorate is now available for your viewing.

Ontario Ministry of Finance proposes to end the transparency of mutual fund trusts and SIFT partnerships for LTT purposes

The Ontario Ministry of Finance has released (with a comments-due date of August 28, 2017) a proposed modification to the Ontario land transfer tax rules for dispositions of beneficial interests in Ontario real estate by some trusts and LPs and their unitholders.

“Group 1” vehicles will themselves be treated as separate LTT taxpayers and, thus, be required to pay LTT on their beneficial acquisitions – and conversely acquisitions or redemptions of interests in Group 1 vehicles will no longer trigger LTT. Group 1 vehicles are:

  • SIFT trusts and partnerships as defined for ITA purposes;
  • mutual fund trusts the units in which are eligible for the MFT unit exemption (as described in the current Regulation); and
  • pension trusts which are exempt under ITA s. 149(1)(o).

No exemption for REIT mergers is mentioned.

A "Group 2" vehicle is an ITA s. 108 unit trust, or a partnership that has filed (or is required to file) a declaration under the Ontario Limited Partnerships Act (and not the Act for any of the other provinces) - which, in either case, has had over 49 arm's length unitholders or partners. Unitholders or partners of Group 2 vehicles will have the same substantive liability for direct or indirect beneficial transfers as before. Although the Group 2 vehicle itself will continue to be a flow-through for such purposes, it will become an LTT collector and be required to collect and remit LTT calculated at the unitholder or partner level - and will be authorized to collect such amounts from them through withholding from distributions. If it collects an insufficient amount, it will be subject to a penalty of at least the amount it failed to collect. (It is not clear whether this is intended to be effectively a double imposition, so that the Ministry might still go after the unitholders as well.)

No changes are proposed in the treatment of other trusts or partnerships.

At the time of title registration, nominees will be required to disclose the legal names and business registrations numbers of the partnerships or trusts for whom they now hold title.

Neal Armstrong. Summary of Ontario Ministry of Finance Proposal 17-MOF010, posted 14 July 2017 “Facilitating the Payment and Administration of the Land Transfer Tax under Section 3 of the Land Transfer Tax Act” under Ontario Land Transfer Tax Act, s.3(1).

Six further full-text translations of CRA technical interpretations/Roundtable items are available

Full-text translations of the three French technical interpretations released last week, and of the three (APFF) Roundtable item released on December 30 and 23, , 2015 are listed and briefly described in the table below.

These (and the other translations covering the last 31 months of CRA releases) are subject to the usual (3 working weeks per month) paywall.

Bundle Date Translated severed letter Summaries under Summary descriptor
2017-07-12 6 April 2017 External T.I. 2016-0658841E5 F - Purpose tests and Allocation of safe income Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) safe income was allocated between 2 classes of participating shares pro rata to their dividend entitlements
Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(b) s. 55(2) did not apply to dividends paid only for asset protection and QSBC-status purposes
21 November 2016 Internal T.I. 2016-0675761I7 F - Obligation de produire un T4A Income Tax Regulations - Regulation 200 - Subsection 200(1) artists’ union must issue T4A slips to incorporated artists respecting benefits received from the union
6 June 2017 External T.I. 2015-0617331E5 F - TFSA - Exempt Contribution Income Tax Act - Section 207.01 - Subsection 207.01(1) - Exempt Contribution - Paragraph (b) payment of family-law debt out of TFSA to surviving spouse would occur as a consequence of the deceased’s death
Income Tax Act - Section 248 - Subsection 248(23.1) - Paragraph 248(23.1)(a) payment of family-law obligation of deceased to surviving spouse out of deceased's TFSA could qualify
Income Tax Act - Section 248 - Subsection 248(8) - Paragraph 248(8)(a) legacy of residue (which included the residence) could be satisfied with TFSA of deceased
2014-12-30 10 October 2014 APFF Roundtable, 2014-0538241C6 F - 75(2) and definition of "earned income" in 146(1) Income Tax Act - Section 75 - Subsection 75(2) character preservation of attributed income/basis adjustment for denied capital loss at trust level
Income Tax Act - Section 146 - Subsection 146(1) - Earned Income character preservation of s. 75(2) attributed income
Income Tax Act - Section 40 - Subsection 40(3.6) basis adjustment for denied capital loss (otherwise subject to s. 75(2) attribution) at trust level
2014-12-23 10 October 2014 APFF Roundtable, 2014-0538261C6 F - Disposition of capital interest/personal trust Income Tax Act - 101-110 - Section 107 - Subsection 107(2) issuance of note by trust is not distribution of trust property
Income Tax Act - 101-110 - Section 108 - Subsection 108(1) - Cost Amount note issuance is not trust property distribution to a beneficiary
Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) non-deductible interest on note issued to beneficiary
10 October 2014 APFF Roundtable, 2014-0538221C6 F - Day Trading in RRSP Income Tax Act - Section 146 - Subsection 146(4) RRSP/RRIF day-trading of qualified investments is exempt

Mullings – Tax Court of Canada finds that time spent administering special “medical formula” foods to a child counted as therapy administration and not as dietary control

The taxpayer’s ability to claim the disability tax credit in respect of her young child, who suffered from an inability to digest a common amino acid (“Phe”), turned on whether she was spending at least 14 hours per week on therapy, which was defined in s. 118.3(1.1)(d) to exclude “time spent on dietary…restrictions or regimes.”

Keeping such a child’s bodily levels of Phe within a narrow range (failing which there will be severe brain damage) requires that “medical formula [food] is given in very precise doses four times a day and administering it is no different from administering any other prescription medication.” Since “measuring and controlling Phe intake is properly characterized as administration of the therapy and not as control of X’s diet,” the time so spent counted towards the 14 hours. The taxpayer got the credit.

Neal Armstrong. Summary of Mullings v. The Queen, 2017 TCC 133 under s. 118.3(1.1)(d).

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