News of Note

Income Tax Severed Letters 4 December 2013

This morning's release of 13 severed letters from the Income Tax Rulings Directorate is now available for your viewing.

Versteegh – UK First-tier Tribunal finds no benefit to the parent from a downstream loan with the in-kind interest thereon paid to a sister subsidiary

A UK group of companies engaged in a childishly vacuous scheme to generate an interest deduction in one group company (the borrower) without a corresponding income inclusion to the lender or any other group company.  The parent lender made a loan to a subsidiary borrower on the basis that under the loan the borrower would be required to pay interest in the form of issuance of shares to a sister company.

It was held that the shares received by the sister company were income from a source (being the loan agreement) notwithstanding that it was not a party to the loan agreement.

Another issue was whether interest should instead be imputed to the parent on the basis that its exclusion of imputed interest from its accounts did not accord with GAAP. The Tribunal accepted the characterization of the taxpayer’s accounting expert, which was that the parent had made the loan in consideration for the right to receive back the principal plus the right to require a transfer of value between its wholly-owned subsidiaries, which latter right was of no incremental value to it, so that there should be no corresponding recognition of accounting income.  This sort of thinking would be helpful from a Canadian perspective if one were to worry (by broad analogy to the Vine case) about whether there was a shareholder benefit by virtue of the borrower issuing shares to the sister rather than to the parent.

Neal Armstrong.  Summary of Versteegh Ltd & Ors v. Commissioners, [2013] UKFTT 642 (TC), under s. 15(1) and s. 9 – exempt receipts.

Tradehold - Supreme Court of Appeal of South Africa finds that an “alienation” for Treaty purposes includes a deemed disposal

A South African public company shifted its place of effective management to Luxembourg in 2002 (so that it became a Luxembourg resident for purposes of the Treaty with South Africa) but did not cease to be a South African resident for domestic purposes until 2003, when a domestic amendment provided that its Treaty status determined its residency status for domestic purposes.

This then triggered a deemed capital gain on its assets under the South African exit tax provisions, subject to the standard exemption in Art. 13(4) of the Treaty for "alienations" by a resident of Luxembourg of most types of property.

The Court rejected the South African Commissioner’s argument that "alienations" did not include deemed disposals (so that the company was not subject to the exit tax).  This is consistent with the interpretation elsewhere of "alienation" (e.g., 84 C.R. – Q. 40).

Neal Armstrong  Summary of Commissioner for South African Revenue Service v. Tradehold Limited, [2012] ZASCA 61 (Supreme Court of Appeal of South Africa) under Treaties - Art. 13.

PGNX will use its PUC in advance of its final liquidation distribution

PGNX Capital Corp. has sold all its assets and has or will distribute the net proceeds in three tranches: a stated capital distribution on November 15, 2013; a distribution that will only partly be a stated capital distribution (as there is estimated to be insufficient remaining stated capital of all of it to be a capital distribution) on December 19, 2013; and a distribution pursuant to liquidation proceedings.

The tax disclosure indicates that even if a shareholder resolution is not passed to authorize the applicable portion of the second distribution to occur as a stated capital distribution, there may still only be a deemed dividend arising under s. 84(2) on the second distribution to the extent of the Corporation’s remaining paid-up capital.

Due bills attached to the PGNX shares would effectively mean that trades in the shares after the record date and before the payment time would entitle the purchaser to receive the second cash distribution.

Neal Armstrong.  Summary of Circular of PGNX Capital Corp. under Spin-Offs and Distributions - Liquidations.

Testamentary trusts will be tainted if they become “beneficially interested” in an inter vivos trust

CRA has confirmed its position in 2011-0417391E5 F that any testamentary trust which becomes beneficially interested in a Quebec inter vivos trust (including it would appear by virtue of a mere potential to be named as a beneficiary by the trustees of the inter vivos trust from amongst a larger class of potential beneficiaries) will cease to qualify as a testamentary trust under s. 108(1) because the beneficial interest in the inter vivos trust represents property which has been contributed to it other than by testator as a consequence of the testator's death.

Neal Armstrong.  Summary of 11 October 2013 APFF Round Table, Q. 5, 2013-0493671C6 F under s. 108(1) – testamentary trust.

Conocophillips - Federal Court finds that it rather than the Tax Court had the authority to reverse a CRA decision that the taxpayer’s objection was out of time

The taxpayer claimed that it did not find out about a notice of reassessment which allegedly had been mailed to it on November 7, 2008 (the "date of mailing" notation on the reassessment – although the reassessment was actually dated April 26, 2010!) until April 2010.  The taxpayer promptly objected, and the CRA official rejected the objection on the basis that it was out of time.

Campbell J agreed with the taxpayer that the correct procedural remedy was for the taxpayer to apply to the Federal Court for an order to set aside the official’s decision to reject its objection (there was no indication that he had really reviewed the evidence that the reassessment had not been received) rather than to appeal to the Tax Court under s. 169(1)(b).  That decision was set aside.

Neal Armstrong.  Summary of Conocophillips Canada Resources Corp. v. MNR, 2013 FC 1192, under s. 169(1).

CRA found that an estate's holding of a debt claim to essentially all the NAV of an investment company was mostly irrelevant to de facto control

Although IT-64R4, para. 23 indicates that the holding of a large demand note is relevant to de facto control, CRA found in an internal technical interpretation (referenced, with a redacted document number, in a subsequent APFF Round Table) that this factor was "of little importance ... where the debt represented virtually all the net value of a corporation but all its assets consisted of readily marketable securities which could serve to repay the debt held by an estate without imperiling its investment operations."

Neal Armstrong.  Summary of 11 October 2013 APFF Round Table, Q. 4, 2013-0493651C6 F under s. 256(5.1).

AES and Riopel – Supreme Court of Canada declines to reconcile the Juliar and Shafron lines of cases on rectification

In Riopel, a tax plan which contemplated a sale of shares followed first by an amalgamation, and then by the redemption of shares and repayment of a note by Amalco, was not properly implemented.  Among other problems, the amalgamation occurred before any sale.  LeBel J found that under art. 1425 of the Quebec Civil Code, the Court had the jurisdiction to declare that the written instruments did not give effect to the "the agreement of wills" reached by the parties when (before any documents were drafted) they were presented with the fully-articulated tax plan.

The simpler AES facts entailed a s. 86 exchange of shares for shares and a note, where the amount of the note was too high due to a miscalculation of the ACB of the old shares.  LeBel J found that there was an agreement of wills for there to be a s. 86 rollover by taking back note only up to the ACB.  Therefore, a declaration could be made under art. 1425 that the self-help documents which the parties entered into (after the filing of a notice of objection to the assessments of capital gain) - to reduce the note and issue (retroactively created) preferred shares - reflected that agreement.

The result in both cases is reasonably generous in the Quebec context as the articles of the corporations effectively were amended retroactively.

After referring to the argument of the Attorney General of Canada as intervener, that the Juliar line of cases was inconsistent with Shafron and Performance Industries, LeBel J stated (at para. 55) that the cases now before him were "governed by Quebec civil law and are not appropriate cases in which to reconsider the common law of rectification."

Neal Armstrong.  Summary of Agence du Revenu du Québec v. Services Environmentaux AES Inc. and Agence du Revenu du Québec v. Riopel, 2013 SCC 65 under General Concepts - Rectification and Interpretation Act, s. 8.1.

2013 CTF Round Table

The questions posed to CRA at the Round Table held yesterday at the annual CTF conference, together with brief notes of the responses, are now available for your viewing.  Some highlights:

  • Q1.  CRA has published its new practices on pre-ruling consultations.
  • Q2(b).  Where there is a mismatch in the loans amounts comprising a back-to-back loan to which s. 90(7) applies, the pay-down in the larger loan amount is treated as not going first to reduce the notional upstream loan.
  • Q3.  CRA will not follow the purported expansion in CAE of when the change-in-use rules apply, and will stick with IT-102R2 and IT-218R.
  • Q4(c).  Repetitive reporting on T1134s of tiered structures is no longer required.
  • Q6.  CRA accepts Daishowa.
  • Q8.  S. 214(7) deemed interest on a "regular" convertible debenture is not participating interest.
  • Q11.  CRA's policy of allowing 3-party agreements to get around s. 55(3.2)(h) in cross-border butterflies is now well-established.
  • Q15.  CRA did not accept using stock dividends to accomplish the approximate equivalent of a s. 85.1(3) drop-down.
  • Q16(a).  Will CRA incentivize its auditors by paying 25% of all reassessments?

Neal Armstrong and K.A. Siobhan Monaghan.  2013 CTF Round Table.

S. 69(11)(b) does not undercut the s. 85.1(3) rollover

Where Canco drops FA1 into FA2, prior to a sale of FA1 by FA2 to an arm’s length non-resident purchaser, s. 69(11)(b) will not apply to deny s. 85.1(3) rollover treatment on the drop-down transaction: FA2 is not "exempted" from tax under the Act on its sale of FA1, but simply is not subject to tax under the Act in the first place.

Neal Armstrong.  Summary of 21 October 2013 Memorandum 2013-0505831I7 under s. 69(11).