News of Note
Income Tax Severed Letters 14 March 2018
Email this ContentThis 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.
Six further full-text translations of CRA interpretations are available
The table below provides descriptors and links for a French technical interpretation released in November 2013 and five questions from the October 2013 APFF Roundtables, as fully translated by us.
These (and the other full-text translations covering the last 4 1/3 years of CRA releases) are subject to the usual (3 working weeks per month) paywall.
| Bundle Date | Translated severed letter | Summaries under | Summary descriptor |
|---|---|---|---|
| 2013-12-04 | 11 October 2013 Roundtable, 2013-0495801C6 F - Dividend Paid to Trust and Schedule 3 of T2 | Income Tax Act - 101-110 - Section 104 - Subsection 104(19) | s. 104(19) designation is not effective until year end of trust |
| Income Tax Act - Section 186 - Subsection 186(1) - Paragraph 186(1)(b) | s. 104(19)-designated dividend is not received for s. 186(1)(b) purposes until year end of trust | ||
| 11 October 2013 APFF Roundtable, 2013-0495811C6 F - De Facto Control | Income Tax Act - Section 256 - Subsection 256(5.1) | statutory right of chair to tie-breaking vote does not per se confer de facto control | |
| 2013-11-27 | 29 October 2013 External T.I. 2013-0489771E5 F - Internal Reorganization - 55(3)(a) | Income Tax Act - Section 55 - Subsection 55(3) - Paragraph 55(3)(a) - Subparagraph 55(3)(a)(v) | relief under s. s. 256(7)(a)(i)(C) or (D) is relevant to s. 55(3.1)(b)(ii), but not to ss. 55(3)(a)(i) to (v) |
| Income Tax Act - Section 248 - Subsection 248(10) | estate distribution of corporation followed by transfer of assets from related corporation could be part of same series | ||
| Income Tax Act - Section 55 - Subsection 55(3.2) - Paragraph 55(3.2)(d) | s. 55(3.2)(d) application to estate distribution of corporation to 3 sibling beneficiaries does not deem them to be related to each other | ||
| 11 October 2013 Roundtable, 2013-0495281C6 F - Question 9 - APFF Round Table | Income Tax Act - Section 146.3 - Subsection 146.3(6.1) | transfer of RRIF by executor to RRIF of surviving spouse | |
| Income Tax Act - Section 212 - Subsection 212(1) - lParagraph 212(1)(q) | direct transfer to RRIF of surviving non-resident spouse | ||
| Income Tax Act - Section 212 - Subsection 212(1) - Paragraph 212(1)(l) | transfer to RRSP or RRIF of surviving non-resident spouse: SIN required; payment can be made directly to RRSP/RRIF of surviving spouse in accordance with joint instructions even where no specific non-will designation is made | ||
| Income Tax Act - Section 146 - Subsection 146(8.1) | deemed receipt of refund of premiums for amount paid to executor, with deemed benefit to recipient spouse | ||
| 11 October 2013 APFF Roundtable, 2013-0493651C6 F - Affiliated persons and de facto control | Income Tax Act - Section 256 - Subsection 256(5.1) | holding of relatively large note where debtor has a iliquid business could give rise to de facto control | |
| Income Tax Act - Section 40 - Subsection 40(3.61) | exception unavailable for inter vivos trust | ||
| 11 October 2013 APFF Roundtable, 2013-0495781C6 F - GRIP Exceeds Safe Income | Income Tax Act - Section 89 - Subsection 89(1) - Excessive Eligible Dividend Designation | detailed review required to determine whether creation of preferred share dividend to flow out GRIP in excess of SIOH generatd EEDD |
Joint Committee identifies anomalies in the revised split income rules
In addition to broader questions about the scope and practicableness of the revised split income proposals, the Joint Committee has identified quite a number of technical anomalies and oddities respecting the rules, of which a sampling is listed below.
- The definition of an excluded shares excludes shares of a corporation which derives significant income directly or indirectly from a related business. This means that a holding company that annually receives its income as dividends from an Opco in whose business the parents are actively involved will be tainted (so that dividends paid by Holdco to their over-24 inactive child will also be tainted) whereas there likely would not be a problem it there were no Holdco and the family held all their shares in Opco directly.
- The exclusion in para. (b) of the excluded amount definition for spousal separation transfers described in s. 160(4) is quite narrow so that, for example, property transferred indirectly to the separated spouse through a s. 55(3)(a) spin-off transaction would not qualify, nor would an extraordinary discretionary dividend paid on one of her existing shares.
- The definition of “arm’s length capital” for adults who have not attained the age of 24 before the year excludes any borrowing by the specified individual under a loan or other indebtedness including from arm’s length sources – even where there is no security or guarantee provided by a “source individual” (related family member).
- The s. 120.4(1.1)(d)(iii) rule – which deems an amount to be derived from a business to include an amount that is “derived from an amount that is derived directly or indirectly from the business” – will be problematic if interpreted broadly. For example, an Opco dividend is received by a specified individual in respect of Opco’s business, who invests it in shares of Opco 2, which does not carry on any “related business” respecting the individual, with the shares subsequently generating income or a capital gain.
[I]t seems particularly inappropriate for the rule to apply in situations such as [this], where amounts could be deemed to be derived from a related business “through” amounts that have already been received by, and taxed in the hands of an individual.
- The definition of “related business” does not exclude listed corporations or mutual fund trusts or corporations. For example, a specified individual is a beneficiary of a trust holding shares of a listed arm’s length corporation of which a Canadian-resident sibling is a full-time employee, such that this public corporation is carrying on a “related business” in respect of the specified individual, and so that any income or taxable capital gain of the specified individual included under s. 104(13) or 105(2) in respect of the trust would seem to be subject to the tax.
Neal Armstrong. Summaries of Joint Committee, “Legislative Proposals to Address Income Sprinkling Released December 13, 2017,” 8 March 2018 Joint Committee Submission under s. 120.4(1) – “excluded shares,” “excluded amount,” para. (b), para. (a), “arm’s length capital,” “related business” - para. (c), “excluded business,” and s. 120.4(1)(d)(iii), and s.120.4(3).
Parliamentary Budget Office estimates that most TOSI revenues will be generated in Ontario and Alberta
The Parliamentary Budget Officer has estimated that the split income proposals will generate $589M in additional tax revenues for the 2018-19 fiscal year, of which $356 million will go to the federal government. Families in Ontario, Alberta and Quebec would pay $224M (or 63%), $46M (or 13%) and $23M (or 6.5%) of this amount, respectively. This estimate is based on a scenario where all spouses over 24 would not be subject to the new rules:
The rationale behind this scenario is that it is likely that most spouses have assumed some risk in the family business (for example, using the house as collateral for a bank loan to start the business). Therefore, we assume they would pass the reasonableness test and see the dividends they received as being exempt from the TOSI.
Neal Armstrong. Summaries of Govindadeva Bernier and Tim Scholz, “Income Sprinkling Using Private Corporations,” Office of the Parliamentary Budget Officer (with thanks to “Finance Canada officials for their helpful technical discussions”), 8 March 2018 under s. 120.4(3) and s. 120.4(1) - Excluded Amount - para. (g).
Bacanora Canada effectively will migrate to the UK through a 3-party share exchange
Bacanora Canada, whose key assets are Mexican subsidiaries holding lithium properties, is listed on the TSX, but its shares mostly trade on the AIM. It will effectively migrate to the UK under an Alberta Plan of Arrangement under which there will be a triangular exchange of shares with a newly-formed UK company (Bacanora UK) and a wholly-owned Alberta sub of Bacanora UK (Acquireco), so that the Bacanora Canada shareholders transfer their shares to Acquireco, Acquireco issues shares to Bacanora UK and Bacanora UK issues shares to the Bacanora Canada shareholders – with Bacanora Canada and Acquireco then amalgamating.
This exchange will occur on a taxable basis for Canadian purposes – and the AIM qualifies as a designated exchange for RRSP eligibility purposes. The U.S. tax disclosure indicates that there is substantial uncertainty as to whether the transaction qualifies as a s. 351 reorg given that there is a plan for Bacanora UK to do a substantial equity raise.
The corporation tax rate applicable to Bacanora UK’s taxable profits is currently 19% and from April 2020, will reduce to 17%. The UK rate of capital gains tax on disposal of Bacanora UK shares by basic rate taxpayers will be 10% and, for upper rate and additional rate taxpayers, will be 20% (I vaguely recall rates in Ontario being higher.)
Neal Armstrong. Summary of Bacanora Canada Circular under Other – Continuance/Migrations – New Non-Resident Holdco.
CRA finds that an estate gift of sales proceeds of s. 70(5) property can be carried back to the terminal return – and s. 38(a.1)(ii) zeroes post-death appreciation on estate-donated shares
S. 118.1(5.1)(b) applies to most gifts made by a graduated rate estate of property that was acquired by it on and as a consequence of the deceased’s death “or is property that was substituted for that property.” CRA indicated that this substituted property concept applied where the deceased held appreciated mutual fund units whose cost was stepped up on the death under s. 70(5) and with the executors then determining to sell some of the units and gift the cash proceeds to a registered charity. The significance of this was that the donation credit could be claimed under s. (c)(i)(C) of the definition of “total charitable gifts” in s. 118.1(1) in the deceased’s terminal return, thereby helping to offset some of the tax on the s. 70(5) gain.
There also is a look-back under s. 118.1(5.1) for purposes of s. 38(a.1)(ii), so that if the executors instead donated the MFT units in kind, the terminal return would then be amended to eliminate the s. 70(5) gain on the MFT units and have the gain treated as nil. Furthermore, this would be the case even if the MFT units had substantially appreciated between death and their donation by the executors.
Neal Armstrong. Summaries of 24 July 2017 External T.I. 2017-0698191E5 under s. 118.1(5.1)(b) and s. 118.1(1) - “total charitable gifts”- s. (c)(i)(C).