News of Note
Persepolis – Tax Court of Canada declines to infer the existence of an agency arrangement
Email this ContentA company (“Persepolis”), which had been incorporated to do renovation work on a cost plus 15% basis on a building owned by a corporation whose shareholder was friends with its sole shareholder, was found not to have incurred its renovation costs as agent for that owner in the absence of convincing evidence that the owner “had implicitly accepted an agency relationship with respect to the renovations.” Accordingly, Persepolis had been correctly assessed for failure to charge HST to the owner on the costs incurred by it.
Neal Armstrong. Summary of Persepolis Contracting Inc. v. The Queen, 2017 TCC 89 under General Concepts – Agency.
Hybrid sales transactions still may be worthwhile
Although hybrid sales transactions (in which individual shareholders of a target Canadian –controlled private corporation utilize the capital gains exemption by exchanging a portion of their shares for preferred shares, which then are sold to the arm’s length purchaser, with the purchaser retracting the prefs and effecting an asset purchase payable in part by set-off against the redemption note) are less attractive following the repeal of the eligible capital property regime, they can still offer significant benefits if the vendor CCPC has sufficient funds or high-basis assets. The authors provide a numerical example showing an integrated tax rate of 26.0% on a hybrid sale in Alberta v. 29.5% for an asset sale, and state:
If the vendor has enough cash on hand or high-basis assets, it can successfully recover its RDTOH balance and retain the full benefit of hybrid sales (on an integrated basis)….
[In this example] the full recovery of RDTOH is possible because the vendor has $2 million of high-basis capital assets….
In Alberta, if one assumes that there is no recapture on the depreciable property, a rule-of-thumb breakeven point is one dollar of basis or cash per dollar of CGE claimed. For example, if a single exemption of $835,000 is claimed, the vendor should fully recover RDTOH if it has cash or basis in its capital assets of at least $835,000….
Neal Armstrong. Summary of Matthew Clark, Josh Proulx and Rami Pandher, "Hybrid Sales," Canadian Tax Highlights (Canadian Tax Foundation), Vol. 25, No. 5, May 2017, p. 4 under s. 110.6(2.1).
CRA considers that the capital portion of annuity payments made to a Turkish resident are subject to withholding
The definition of “annuity” in Art. 18 of the Canada-Turkey Treaty excludes “any annuity the cost of which was deductible for the purposes of taxation in the Contracting State in which it was acquired.” Where a resident of Turkey has acquired a prescribed annuity contract, it could be argued that the portion of each annuity payment that would be treated in the hands of a Canadian resident as a capital payment comes within the quoted exclusion. However, CRA considers that this is not the case given inter alia that the capital portion does not represent a deduction for the cost of the annuity that is available when the annuity is acquired, so that each annuity payment is subject to the (Treaty-reduced) Part XIII tax of 15%.
In the case of an RRSP annuity, the RRSP contributions were deductible, so that the quoted exclusion from “annuity” would apply. However, the Income Tax Conventions Interpretation Act deems all payments out of an RRSP to be pension payments (where “pension” is not specifically defined in the Treaty), so that RRSP payments made to a Turkish resident are also subject to (Treaty-reduced) withholding as pension payment.
Neal Armstrong. Summaies of 30 March 2017 External T.I. 2015-0609951E5 Tr under Treaties - Art. 18 and Income Tax Conventions Interpretation Act, s. 5 - pension.
Professional firms may only be required to recognize the payroll costs (not the dockets) of salaried professional staff and not partners’ time in their WIP
Most professionals subject to the new 2017 Budget rule will choose to value their work-in-progress at the lower of cost and fair market value. In the December 18, 1981 Notes of the Department of Finance dealing with the similar proposal in the 1981 Budget, it stated that the cost of WIP would not include: fixed or indirect overhead costs, such as rental, secretarial, and general office expenses; and the cost of the time of partners or proprietors.
A longer transitional period than two years may be warranted given that many of the primary beneficiaries of the WIP deferral may no longer be with the firm and so that the current partners, who may have had limited benefit from the deferral, will bear the entire cost of unwinding the deferral.
Given that s. 10(4)(a) would appear to contemplate that the valuation of WIP should be determined based on what the professional can reasonably expect will be collected under a fee arrangement in a subsequent year, rather than on what is collectible at year end, the legal basis for the CRA position for not requiring the recognition of WIP associated with contingent fee arrangements is unclear.
Neal Armstrong. Summaries of 31 May 2017 Submission of the Joint Committee on Professionals’ Work in Progress under s. 10(5)(a) and s. 34.
Hart – Federal Court of Australia finds that summarizing legal tax advice received in a submission to the tax authority resulted in loss of privilege over the opinion letter
The taxpayer argued that he was not subject to the application of the Australian general anti-avoidance rule given that he had relied on two legal opinions. The taxpayer’s counsel had voluntarily provided a précis to the Commissioner of one of two legal opinions in some considerable detail.
Bromwich J found that this amounted to waiver of legal professional privilege over the letters.
A similar dilemma was avoided in Inwest, where it was sufficient, in helping to establish that the taxpayer’s filing position did not reflect carelessness, to indicate that it had consulted with counsel, without the specific advice received being put in evidence – so that there was no waiver of solicitor-client privilege.
Neal Armstrong. Summary of Hart v Commissioner of Taxation (No 3) [2017] FCA 571 under s. 232(1) – solicitor-client privilege.
MP Western Properties – Tax Court of Canada states that the Crown must produce all documents “considered by officials involved in or consulted during” a GAAR-related audit
Predecessors of the taxpayers had been acquired for their losses in transactions where less than 50% of their voting shares, but more than 90% of their non-voting participating shares, had been acquired. The Minister had reassessed to deny the acquired losses primarily on the basis that there had been an acquisition of control, but secondarily through applying the general anti-avoidance rule.
In discussing the scope of the obligations of CRA and Finance to provide correspondence relating to loss utilization schemes that had been requested by the taxpayers, V.A. Miller J stated:
… It is my view that in a GAAR appeal, draft documents prepared in the context of a taxpayer’s audit or considered by officials involved in or consulted during the audit and assessment of the taxpayer should be disclosed. They inform the Minister’s mental process leading up to an assessment. They may also inform the Minister’s understanding of the policy at issue.
Neal Armstrong. Summaries of MP Western Properties Inc. v. The Queen, 2017 TCC 82 under Tax Court Rules, Rule 95 and ITA s. 245(4).
CRA is now willing to apply the Trans-Prairie indirect use test to the safe harbour in s. 17(8)(a)(i)(A)
S. 17(8)(a)(i)(A) provides an exception to the imputed interest rule under s. 17(1) for outbound low-interest loans where the loan was used by a controlled foreign affiliate for the purpose of earning income from an active business, as defined. In a change of position, CRA has now indicated that it is willing to apply the (Trans-Prairie “fill the hole”) indirect use test described in the interest-deduction Folio in this context as well, so that such a loan used to fund a return of capital or accumulated profits that had funded an active business would fit the exception.
Neal Armstrong. Summary of 15 May 2017 External T.I. 2016-0676701E5 under s. 17(8)(a)(i)(A).
Income Tax Severed Letters 31 May 2017
This morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Green – Federal Court of Appeal states that an upper-tier partnership should not compute its income
CRA considered that business losses incurred by lower-tier partnerships (the PSLPs) were deemed to be limited partnership losses of an upper-tier LP (MLP) – which meant that they were effectively trapped in MLP given that s. 111 (and, thus, the ability to deduct limited partnership losses under s. 111(1)(e)) was only available to a taxpayer and not to a partnership such as MLP. Webb JA rejected this interpretation and considered that the PSLP business losses were also business losses rather than limited partnership losses in the hands of MLP, so that such losses could be allocated to the MLP partners in the same manner as if they had been generated in a single-tier LP. In the course of a detailed discussion, he stated:
Since the computation of income for a partnership that is a member of another partnership will cause problems when that top-tier partnership attempts to allocate its income on a source basis to its partners, in my view, Parliament did not intend for a partnership that is a member of another partnership to compute income. Rather, Parliament intended for the sources of income (or loss) to be kept separate and retain their identity as income (or loss) from a particular source as they are allocated from one partnership to another partnership and then to the partners of that second partnership (and so on as the case may be). [emphasis added]
Since MLP was not supposed to compute its income, does this mean that the adjusted cost base of its units do not reflect the income or loss earned by it (but still reflect the distributions made by it out of those earnings) – or in the post-Green world, is the ACB of interests in an upper-tier partnership now an irrelevancy since the partnership is transparent?
Webb JA also stated that the Crown’s concern, “that the at-risk rules could be avoided entirely if the top-tier partnership (MLP) were a general partnership,” was outweighed by other considerations.
Neal Armstrong. Summary of The Queen v. Green, 2016 FCA 107 under s. 96(2.1) and s. 102(2).
Turgeon - Federal Court of Appeal affirms that an accommodation party was not dealing at arm's length
In the Turgeon case (usually referred to by the name of the other taxpayer, Poulin), CRA successfully applied s. 84.1 to a transaction in which one of the two major shareholders of a Quebec CCPC (Mr. Turgeon) agreed to sell some preferred shares of the CCPC to a newly formed Holdco of its comptroller (“Hélie Holdco”) in consideration for a promissory note bearing interest at 4% and which was to be repaid over a number of years out of dividends or redemption proceeds received by Hélie Holdco from the CCPC. D’Auray J noted that this employee had no risk, and Hélie Holdco had no upside as its only assets and liabilities were the prefs and the note, both with frozen values – so that Hélie Holdco essentially was just an accommodation party. She stated:
Hélie Holdco served only to participate in the transaction for the benefit of Mr. Turgeon, thereby permitting him to strip the surplus of [the CCPC] free of tax by virtue of utilizing the capital gains deduction.
Mr. Turgeon appealed this decision on the sole ground that he was dealing at arm’s length with Hélie Holdco. Boivin JA dismissed his appeal, stating that D’Auray J had followed the principles stated by the Supreme Court in McLarty.
Neal Armstrong. Summary of Poulin v. The Queen, 2016 TCC 154, briefly aff’d sub nomine Turgeon v. The Queen, 2017 CAF 103 under s. 251(1)(c).