News of Note

A 50% limited partner (Ms. X) funded her investment in an LP jointly owned with her husband through a $3M bank loan that was secured by a pledge to the bank of a $3M term deposit held by a corporation (Corporation B) equally owned by her and her husband. In finding that the back-to-back loan rules in s. 15(2.6) et seq. deemed her to owe $3M to Corporation B, CRA indicated that:

• Ms. X had an amount outstanding ($3M) to an “immediate funder” (the bank),
• the bank held an amount (the $3M term deposit) owing to an “ultimate funder” (Corporation B), and
• "the condition in clause 15(2.16)(c)(i)(B) would be satisfied" (e.g., the $3M loan was permitted to remain outstanding because the term deposit was outstanding).

CRA also stated that the term deposit might also be a “specified right.”

Neal Armstrong. Summaries of 31 October 2017 External T.I. 2017-0690691E5 F under s. 15(2.16)(c)(i)(B) and s. 15(2.16)(c)(ii).

The (corporate) shareholders of Holdco (a Canadian-controlled private corporation) wish to accommodate the purchase of shares of the Holdco for an operating subsidiary (Opco) by an Opco key employee on an earnout basis and with the key employee’s purchase being governed by the s. 7 rules. (This cannot be accommodated by issuing treasury shares of Holdco or Opco to the key employee on an earnout basis as the governing Business Corporations Act requires that shares be fully-paid on issuance.) Under the ruled-upon transactions:

1. The Holdco shareholders transfer a portion of their Holdco common shares on a s. 85(1) rollover basis to Opco in consideration for tracking preferred shares of Opco;
2. The key employee immediately purchases those Holdco common shares from Opco in consideration for five annual instalments, with each annual instalment based on the most recent year’s earnings (plus, in the case of the first instalment, the opening shareholders’ equity), with adjustments to the purchase price on any IPO or business acquisition; and
3. Each instalment payment is immediately dividended by Opco to the Holdco shareholders on the tracking preferred shares.

Re 2, CRA rules that the cost-recovery method in IT-426R was to be used by Opco.

Re 3, s. 55(2) deemed the tracking dividends to be capital gains to the holders of the tracking preferred shares.

There’s more. Before the implementation of the above transactions, Holdco and Opco adopted a policy of dividending out all of their operating earnings – but deferred paying any of these dividends until the rulings were granted. CRA ruled that the dividend determination time for the “Second Annual Dividends” (i.e., dividends payable based on the annual income for the Opco taxation year ending after the sale of the Holdco common shares by Opco to the key employee) is the time immediately before their payment rather than the time immediately before the payment of the previous dividends, so that the safe-income exception in s. 55(2.1)(c) could access the more recent earnings.

Neal Armstrong. Summaries of 2015 Ruling 2015-0589471R3 under s. 12(1)(g), s. 55(1) – safe income determination time and s. 85(1).

CRA considers that:

In a situation where a corporation provides a self-insured HCSA for its only employee who is also its sole shareholder … it is likely that the sole employee-shareholder would be reimbursed for the full amount allocated to him or her annually.

On this basis, CRA would view the arrangement as not being a plan of insurance and, thus, not a private health services plan, so that there would be a taxable benefit to the employee-shareholder, even where the benefits were comparable to those available to non-shareholder employees performing similar services for similarly-sized businesses.

Neal Armstrong. Summary of 14 September 2017 CPA Alberta Roundtable, Q.9, 2017-0703871C6 under s. 248(1) - private health services plan.

Comments on the s. 55(2) rules include:

• Given that CPL Holdings found that a creditor-proofing transaction, which had the effect of significantly reducing the capital gain that would have been realized on the disposition of shares, did not have that purpose, the position of CRA in 2015-0623551C6, that creditor-proofing transactions offend the new purpose tests, is questionable.
• The mechanics of the amendment to the Part IV tax exception (so that it is not available even if the Part IV tax is refunded as a consequence of the payment of a dividend to an individual) create a host of issues that may not have been anticipated by the Department of Finance (including over-integration or under-integration). “However, the department is now fully aware of these issues and has indicated that it currently has no intention of making any further amendments to the provision, as suggested in the submissions by the joint committee.”
• In 2015-0610681C6, CRA indicated that it would challenge a preliminary transaction segregating pre-existing ACB from shares to be subsequently redeemed (i.e., shunting ACB away from shares that are being redeemed in reliance on the s. 55(3)(a) exception). However, what if a dirty s. 85 reorg had resulted in common shares of Opco, with an FMV of $1,000,000 and an ACB of $100,000, being converted into preferred shares with an ACB and FMV of $100,000 and new common shares with a nil ACB and an FMV of $900,000? Quaere whether it would be acceptable to engage in a preliminary cost base consolidation transaction to ensure that a redemption of the preferred shares would result in the disappearance of only $90,000 of ACB.
• CRA has not made any specific comments regarding the potential application of the new s. 55 to PUC-streaming transactions. In its simplest form, PUC of the class of shares to be redeemed, in reliance on the s. 55(3)(a) exception, can be reduced with a corresponding increase in the PUC of another class.

Neal Armstrong. Summaries of Doron Barkai and Alexander Demner, "Dealing with New Subsection 55(2): Issues and Strategies", 2016 Conference Report (Canadian Tax Foundation), 6:1–56 under s. 55(2.1)(b), s. 55(2.1)(c), s. 55(2.3), s. 55(2), s. 55(3)(a), s. 248(10) and s. 55(1) – safe income determination time.