News of Note

CRA treats hedging book of Canadian parent in respect of subsidiary's business as being held on income account

A Canadian parent assumed the commodities hedging book of a foreign subsidiary and then realized gains and losses on closing out that hedging book over a number of years.  CRA found that as this assumed hedge book was not linked to an underlying capital transaction of the parent, those gains and losses were on income account (as reported by the Canadian parent).

Neal Armstrong.  Summary of 10 July 2012 Memorandum 2011-0418541I7 under s. 9 - Commodities, and commodities futures and derivatives.

Income Tax Severed Letters for 17 October 2012

This morning's release of 14 severed letters by the Income Tax Rulings Directorate is available for your viewing.

Johnson - Federal Court of Appeal decision might (or might not) require taxpayers to waive privilege in connection with a statute-barring defence

The taxpayer's gains from investing with the perpetrator of a ponzi scheme were not statute-barred because she had failed to check the story of the rogue - that he was making tax-paid capital distributions out of a trust to her - with an independent advisor. This finding is problematic if it is interpreted as indicating that (notwithstanding that in this context, the onus is on the Crown rather than the taxpayer) there somehow is an onus on a taxpayer to testify that he or she in fact had received legal advice on the otherwise statute-barred transactions that have purportedly been assessed by CRA.  There is a judicial doctrine that once a taxpayer advances a defence that legal advice was received on a point in issue, all solicitor-client privilege respecting that  communication, and perhaps surrounding communications, with or from that advisor is lost.  See, for example, Bentley v. Stone, Verney v. Great-West Life, Toronto-Dominion Bank v. Leigh Instruments, and Softsim Technologies.

Neal Armstrong.  Summaries of Johnson v. The Queen, 2012 FCA 253 under s. 152(4)(a)(i) and s. 3 -general.

Surrey City Centre Mall - Tax Court decision suggests that intercompany debt reductions following a settlement can give rise to double GST taxation

A settlement payment received by the grandparent company of a project company as a result of the termination of contracts for the construction of a B.C university facility otherwise likely would have been subject to GST under s. 182 of the Excise Tax Act both in its hands (in light of the impairment of its indirect investment in the project company and its various direct contractual rights and obligations under the project agreements) and to the project company (given that its debt to its parent was written down following the settlement - so that under s. 182 it had enjoyed a debt reduction "as a consequence" of the settlement).  In fact, there was no GST payable on the settlement payment as the only relevant assessment was of the project company, and the deemed supply made by it enjoyed the Crown immunity of the province (notwithstanding that the province did not provide the usual certification of Crown immunity).

This case illustrates that care should be taken if any intercompany or other debts are settled in connection with a contractual settlement.

Neal Armstrong.  Summaries of Surrey City Centre Mall Ltd. v. The Queen 2012 TCC 619 under ETA s. 182(1) and Constitution Act, 1867, s. 125.

Guindon - Tax Court deguts the professionals' penalty provision (s. 163.2)

The taxpayer, who was a family lawyer, was assessed penalties of $546,747 under s. 163.2(5) (i.e., before taking into account any parallel Ontario assessment), calculated as 50% of the purported federal tax savings of all 134 participants in a charitable donation scheme in relation to which she, in her capacity of president of the charity, issued false receipts.  Bédard J. found that this sanction was essentially criminal in nature given its potential materiality and unlimited amount (it incresed with the number of taxpayers involved and their tax savings), as well as likely collateral damage to her professional reputation, so that it was invalid as not having been imposed pursuant to proper criminal proceedings (e.g., with a requirement for proof beyond a reasonable doubt).

If correct, this finding has the likely effect of eviscerating s. 162.5, given the significantly higher burden on the Crown in successfully applying a criminal provision.  It is not clear what other income tax or HST/GST penalty provisions this reasoning might apply to (other than, of course, the "twin" Excise Tax Act provision (s. 285.1)).

Neal Armstrong  Summaries of Guindon v. The Queen, 2012 TCC 287 under s. 163.2(5) and s. 163.2(4).

Meranex Energy uses more recent corporate structure for investing in U.S. business

Meranex Energy Trust is proposing a structure for investing in a U.S. oil and gas business that essentially is identical to that used in Argent Energy Trust and other more recent offerings:  it will use a corporate structure, i.e., investing in a Canadian holding corporation which will hold a US Opco, as well as investing in notes of the US Opco.  This contrasts to the earlier Eagle Trust offering, which used a hybrid structure (i.e., holding units and interest-bearing notes of a Canadian sub trust that is a corporation for US tax purpose which, in turn, holds a Delaware LP that is disregarded for US tax purposes).

Accordingly, issuers may now be starting to vote in favour of this corporate structure for this type of cross-border business.  However, note that the new kid on the block is the Crius offering, which uses a similar corporate structure to Meranex, except that the Canadian mutual fund trust elects to be a partnership for U.S. purposes and contributes the cross-border debt to a subsidiary sub trust - perhaps in order to maximize potential U.S. interest deductions.

Neal Armstrong.  See summary of Meranex Energy Trust preliminary prospectus under Foreign Asset Income Funds and LPs.

CRA reconfirms that receipt of a capital distribution on a share can result in a loss of interest deductions

Comments of CRA in IT-533, para. 31, indicate that where a taxpayer borrows at a negative spread (e.g., borrowing to acquire preferred shares with a dividend rate lower than the interest rate), the interest generally will be deductible in full.  However, CRA has also indicated that where there is a paid-up capital distribution on shares acquired with borrowed money, there will be a proportionate loss of the interest deduction to the extent that the capital distribution is used for personal purposes.  See 1993 A.P.F.F. Round Table, Q.3.

Both propositions have recently been confirmed.  The second proposition is somewhat questionable where the quantum of the capital distribution is not sufficient to significantly impair the income-producing potential of the shares in question.

Neal Armstrong.  Summary of 15 August 2012 T.I. 2012-0446741E5 under s. 20(1)(c).

9098-9005 Québec Inc. - Tax Court comments on the legal impossibility of a salaried partner

An individual who managed a partnership for a fixed fee "through" a corporation of which he was the sole officer and shareholder would have been an officer of the partnership but for the interposition of his corporation - so that the corporation was found to be carrying on a personal services business (with a resulting loss of the small business deduction).

Before reaching this conclusion, Bédard J. noted that the same individual could not have been viewed as an employee (as contrasted to the holder of an office) of the partnership as (at both common law and Civil Law) it was "well established that a partner cannot be an employee in his own partnership."  This legal proposition is in part the basis for a CRA position that fixed partnership draws paid to a "salaried" partner cannot give rise to a deductible loss to the other non-salaried partners.  See Income Tax Technical News, No. 30.

This case also may indicate that in some circumstances, "fees" paid to an individual partner-manager of a partnership are exempt from GST/HST under s. 272.1 of the Excise Tax Act.

Neal Armstrong  Summaries of 9098-9005 Québec Inc. v. The Queen, 2012 TCC 324 under s. 125(7) - personal services business and s. 248(1) - office.

Crius Energy Trust offering uses a double-hybrid structure

Crius Energy Trust, which will be a listed Canadian mutual fund trust, proposes to elect for US purposes to be a partnership.  It will indirectly invest in an LLC (carrying on an energy distribution business in the U.S.) which will be a partnership for US purposes but a US corporate subsidiary for Canadian purposes.  The US anti-inversion rules are expected not to apply as it will initially acquire only a 1/3 interest in the LLC.

Neal Armstrong.  Summary of Crius Energy Trust preliminary prospectus under Foreign Asset Income Funds and LPs.

CRA provides transitional relief for 2-tier joint ventures

When CRA withdrew its position allowing joint ventures to compute income as if they had a separate fiscal period, it also indicated that it would allow transitional relief by allowing the deferred income to be brought into income over a period of up to five years (similar to the rule in s. 34.2).

CRA has indicated that this administrative transitional relief also will apply to the the full amount of the deferral of 22 months' worth of income that was deferred as a result of a two-tier joint venture (e.g., the corporate taxpayer is a member of a joint venture with a fiscal period ending one month later which, in turn, is the member  of a second joint venture with a fiscal period ending yet a further one month later).

Neal Armstrong.  Summary of 28 August 2012 T.I. 2012-0454811E5 under s. 249.1(1).