News of Note
Standard withholding tax gross-ups do not engage the mandatory tax disclosure rules
Email this ContentIt is suggested that the mere presence of contractual protection (CP) is not sufficient to engage the CP hallmark and that a “discernible link must exist between the CP and the avoidance transaction in question.” This is consistent with CRA’s example of an RRSP trustee receiving an indemnity regarding the RRSP acquiring non-qualified investments, as such indemnity “relates to transactions (for example, the making of non-qualified investments) that do not form part of the tax motivation that gives rise to the avoidance transaction” (establishing the RRSP).
To apply a similar approach in the context, for example, of a cross-border loan transaction with a gross-up clause, where the loan itself was not an avoidance transaction but was part of a series of transactions that included an avoidance transaction (e.g., a rollover transaction), an entirely appropriate conclusion would be that the usual indemnity and gross-up are not CP “in respect of” that avoidance transaction.
Furthermore, given that CP is defined in relation to a “tax benefit,” which, in turn, refers to a reduction, avoidance, or deferral of amounts payable under the ITA, because interest to an arm’s-length foreign lender generally is not taxable under the ITA, there is no identifiable “reduction, avoidance or deferral” that would make the existence of a tax benefit clear. A tax benefit may also be identified by referring to an alternative transaction that might reasonably have been carried out but for the existence of the tax benefit (Copthorne) - yet, in normal cross-border lending situations, no such reasonable alternative is likely to exist.
Accordingly, the absence of a tax benefit is a further potential basis for a standard gross-up and indemnity in an arm’s-length lending transaction not engaging the CP hallmark.
Neal Armstrong. Summary of Andrew Spiro and Jessica Charendoff, “Mandatory Disclosure Is Here: Now What?” Perspectives on Tax Law & Policy, Vol. 4, No. 3, September 2023, p. 1 under s. 237.3(1) – contractual protection.
Income Tax Severed Letters 20 September 2023
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Shawn Porter suggests that the identification of hallmarks should be informed by the legislative purpose “to identify potentially abusive transactions”
Shawn Porter, who was an Associate Assistant Deputy Minister, Tax Policy Branch during the design of the more recent mandatory reportable transaction (RT) rules, has co-authored an article providing perspectives on when these rules should be engaged.
The article suggests:
Hallmarks are intended to identify potentially abusive transactions on the basis that such transactions often exhibit a hallmark. …
[H]allmarks do not just exist in the ether; rather, they reveal themselves in circumstances where their presence may influence or cause a party to engage in the targeted riskier behaviour by entering into the potentially aggressive transaction.
In particular, since the contractual protection (CP) hallmark must be present by the time that the avoidance transaction was completed, it follows that “[p]rotection arising after the relevant avoidance transaction is consummated—and operating for the benefit of an arm’s-length person not involved with or interested in the earlier transaction that gave rise to the tax risk—is not the target.”
Thus, the Explanatory Notes “differentiate, appropriately, between (1) a situation where a purchaser obtains protection from pre-sale liabilities (including tax) and (2) a situation where insurance is obtained to cover specific identified tax risks in relation to avoidance transactions.”
Similarly, the CRA guidance indicates that protection relating to existing pre-closing tax issues, the quantum of existing tax attributes, and pre-sale safe income dividend transactions, do not bear the CP hallmark.
However, the CP hallmark would apply if CP were received after the fact, but the taxpayer seeking the benefit knew in advance that this would occur, or if the purchaser and vendor agreed to reduce the risk of a contemporaneous avoidance transaction under the guise of standard indemnities.
Neal Armstrong. Summary of Rob Jeffery and Shawn D. Porter, “Mandatory Disclosure: A Reasonable Balance Between Timely Information and Administrative Burden,” Perspectives on Tax Law & Policy, Vol. 4, No. 3, September 2023, p. 4 under s. 237.3(1) – contractual protection.
The s. 237.5 reporting rules lack a materiality threshold
Observations on the “reportable uncertain tax treatment” (RUTT) rules in s. 237.5 include:
- In contrast to the UK rules (which apply only if the company has UK turnover in excess of £200 million and assets on the balance sheet of more than £2 billion and only apply to uncertain tax treatments in excess of £5 million), the Canadian rules (including the penalties) apply irrespective of the materiality of the uncertain tax position, and the threshold for applying the rules is only $50 million of assets.
- A Canadian member of the group might need to report the uncertain tax treatment in a situation where there is only a nominal impact in Canada.
- In many situations, it might not even be aware of the uncertain tax treatment or have the requisite information to report its existence (the relevant documentation would likely be kept by other members of the group).
- A taxpayer may make a single entry for uncertain tax treatments to account for multiple interdependent potential adjustments, e.g., the reasonableness of a royalty may be considered in light of inter-affiliate charges for tangible goods. If the taxpayer were required to report the individual uncertain tax treatment even where an offsetting adjustment nets against the liability, excessive reporting would be the result – failing which, s. 237.5(5) penalties might be assessed on each uncertain treatment that was not reported.
Neal Armstrong. Summary of Dean Landry and Colin Mowatt, “The Uncertainty Surrounding Uncertain Tax Treatments,” Perspectives on Tax Law & Policy, Vol. 4, No. 3, September 2023, p. 13 under s. 237.5(2).
We have translated 7 more CRA interpretations
We have translated a CRA interpretation released last week and a further 6 CRA interpretations released during December of 2002. Their descriptors and links appear below.
These are additions to our set of 2,584 full-text translations of French-language Technical Interpretation and Roundtable items (plus some ruling letters) of the Income Tax Rulings Directorate, which covers all of the last 20 ¾ years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
| Bundle Date | Translated severed letter | Summaries under | Summary descriptor |
|---|---|---|---|
| 2023-09-13 | 11 September 2017 External T.I. 2017-0706851E5 F - Changement partiel d'usage - Immeuble locatif | Income Tax Act - Section 45 - Subsection 45(1) - Paragraph 45(1)(c) - Subparagraph 45(1)(c)(i) | partial change-of-use rules applied when a non-resident with a s. 216 rental triplex immigrates to Canada and moves into one of the units |
| Income Tax Act - Section 216 - Subsection 216(1) | previous s. 216 use of property taken into account, following immigration to Canada, under ss. 13(7)(d)(ii) and 45(1)(c)(i) | ||
| 2002-12-20 | 23 December 2002 Internal T.I. 2002-0176087 F - LIMITE APPLICABLE TRANSFER DANS REER | Income Tax Act - Section 146.3 - Subsection 146.3(6.1) | deemed benefit under s. 146.3(6.1) included in amount referred to in s. 146.3(5) |
| Income Tax Act - Section 146.3 - Subsection 146.3(6.11) - Paragraph 146.3(6.11)(b) - Variable C | Variable C included the deemed benefit under s. 146.3(6.1) | ||
| 12 December 2002 External T.I. 2002-0146175 F - Losses Incurred by a Taxpayer ect...... | Income Tax Act - Section 39 - Subsection 39(1) - Paragraph 39(1)(c) - Subparagraph 39(1)(c)(iii) | usual s. 50(1)(b)(i) and SBC qualification rules applied to shares of a cooperative corporation that became bankrupt | |
| 11 December 2002 Internal T.I. 2002-0173007 F - Observation aux commentaires (OCDE) | Treaties - Income Tax Conventions - Article 12 | Canada’s withdrawal of its observation on Art. 12 on March 28, 2002 was prospective, and did not affect its right to impose withholding tax on payments for use of a secret process prior to that date | |
| 2002-12-06 | 16 December 2002 External T.I. 2002-0138195 F - ALLOCATION POUR FRAIS DE DEPLACEMENT | Income Tax Act - Section 6 - Subsection 6(1) - Paragraph 6(1)(b) - Subparagraph 6(1)(b)(vii.1) | travel allowance for travel 40% of the employment days between home and a more remote employer situs was for personal travel |
| Income Tax Act - Section 81 - Subsection 81(3.1) | amalgamation of 2 part-time employers ended the s. 81(3.1) exclusion so that travel allowance was for personal travel | ||
| 17 December 2002 External T.I. 2002-0158165 F - REPAS DE FETE OFFERTS PAR L'EMPLOYEUR | Income Tax Act - Section 67.1 - Subsection 67.1(2) - Paragraph 67.1(2)(f) | monthly restaurant event for only those employees whose birthday month it was would not qualify/ restaurant implicitly the employer’s place of business | |
| 20 December 2002 External T.I. 2002-0159365 F - REMUNERATION NON MONETAIRE | Income Tax Act - Section 153 - Subsection 153(1) - Paragraph 153(1)(a) | no source deduction or remittance obligations where all remuneration is non-monetary |
The mandatory-disclosure rules do not comply with the constitutional requirement to place a disclosure obligation on lawyers only when “absolutely necessary”
Chambre des notaires found that a limitation imposed on solicitor-client privilege (SCP) that was “not absolutely necessary to achieve the purposes of the ITA” thereby infringing on s. 8 of the Charter, and further found that there it was “not absolutely necessary … to rely on notaries or lawyers rather than on alternative sources in order to obtain the information or documents being sought.”
Considering the number of parties simultaneously subject to the MDR disclosure obligations, and considering that subjecting lawyers to an MDR disclosure obligation creates a high-risk situation for the clients to whom the SCP belongs, it does not seem “absolutely necessary” to rely on lawyers “rather than on alternative sources in order to obtain the information or documents being sought.”
Other jurisdictions instead place the primary disclosure obligation on the promoter.
Relying (as contemplated under ss. 237.3(17) and 237.4(18)) on lawyers to raise SCP would place an “inappropriate burden” on them (see Chambre des notaires, at para. 44) and, in particular, they would be caught between their duty to assert SCP and the potentially severe sanctions for failing to report all relevant information, thereby putting them in a position of direct conflict with their clients’ interests.
Neal Armstrong. Summary of Élisabeth Robichaud and Marie-Emmanuelle Vaillancourt, “An Avoidable Threat to the Protection of Solicitor-Client Privilege,” Perspectives on Tax Law & Policy, Vol. 4, No. 3, September 2023, p. 11 under s. 237.4(18).
Preston – Tax Court of Canada finds that the taxpayer’s substantial expenses in trying to launch his daughter’s singing career were deductible
The taxpayer entered into a personal management contract with his daughter (Chantal), an aspiring singer/ songwriter, under which he would incur promotional expenses up front and receive a 5% or 10% commission if Chantal achieved a major milestone, such as signing with a major record label. CRA disallowed his related business deductions of $52,046 for his 2017 taxation year on the basis that he was not engaged in the business of artist management.
In allowing the appeal, Wong J indicated that, although there was clearly a personal element involved, the taxpayer nonetheless had established the presence of an activity carried on in a sufficiently commercial manner. For instance, Chantal had produced an album in Ontario from which one song received radio play and produced some royalties from SOCAN, a second album was recorded in Nashville in 2017 (though it had not received radio play), Chantal eventually signed a licence agreement with a Toronto record label in 2019 and, meantime, the taxpayer had engaged an accountant with an understanding of the music industry.
Neal Armstrong. Summary of Preston v. The King, 2023 TCC 136 under s. 3(a) – business source.
CRA would apply the partial change-of-use rules when a non-resident with a s. 216 rental triplex immigrates to Canada and moves into one of the units
Shortly after immigrating to Canada, a non-resident individual, who had been renting out the three identical units in a Canadian triplex and reporting the net rental income (after CCA deductions) based on a s. 216 election, moved into one of the three units in the triplex for use as his principal residence. CRA treated this as a partial change of use (i.e., the triplex was one property, not three), so that recapture of depreciation and taxable capital gain could be realized on a proportionate (1/3) basis pursuant to ss. 13(7)(d)(ii) and 45(1)(c)(i). Thus, the property’s use by him as a s. 216 filer and then by him as a resident was integrated for purposes of applying those rules.
Neal Armstrong. Summary of 11 September 2017 External T.I. 2017-0706851E5 F under s. 45(1)(c)(i).
Vefghi Holding – Tax Court of Canada disagrees with the CRA position that connected-corp. status must be tested at the (trust year-end) effective date of a s. 104(19) designation
Partway through its calendar taxation year, a family trust received a dividend from a family corporation (Consultant Inc.), paid that dividend to a corporate beneficiary (Vefghi Corp., also with a calendar year end) and in its return for that taxation year, made a s. 104(19) designation. CRA applied its published position (e.g., in 2020-0845821C6 F) that, since the two corporations had ceased to be connected between the time of the dividend and the effective time of the s. 104(19) designation (the December 31 trust year end), the dividend was subject to Part IV tax. However, D’Arcy J stated:
I agree with the Respondent that the determination of the application of subsection 104(19) can only be made at the trust’s year-end. However, I do not agree that this results in the relevant point in time for determining whether corporations are connected being the trust’s year-end.
Instead, he found that, since s. 104(19) was silent as to when in Vefghi Corp.’s taxation year it received the dividend, it should be treated as having received the dividend on the same day as it in fact was received by the trust. Although the case was in the form of a Rule 58 query, this effectively signified that the dividend received by Vefghi Corp. was exempt from Part IV tax because Consultant Inc. was connected with it on that day.
A second situation presented to him was similar, except that a new taxation year of the corporate beneficiary started after the date of the payment of the dividend (on June 30, shortly preceding the dividend payer and beneficiary ceasing to be connected) and before the (December 31) effective date of the s. 104(19) designation by the trust, so that on no day in that taxation year of the corporate beneficiary was the dividend payer connected to it. It followed from the wording of s. 104(19) that the connected-corporation exemption from Part IV tax was not available.
Neal Armstrong. Summary of Vefghi Holding Corp. v. The King, 2023 TCC 135 under s. 104(19).
Income Tax Severed Letters 13 September 2023
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.