News of Note
The revised stub-period FAPI rules raised a double-taxation issue
Email this ContentThe focus of both the currently-proposed stub-period foreign accrual property income rules and those proposed over a year ago was on the situation where the percentage interest (now referenced by the concept of participating percentage rather than surplus entitlement percentage) of a taxpayer in a foreign affiliate with FAPI decreases in a year, so that there is a deemed year end and recognition by it of its share of the FAPI that accrued up to that point. In the 2016 draft rule, draft s. 91(5) also provided elective relief in some situations where there was an increase in the percentage interest of another taxpayer in the foreign affiliate with FAPI, so that there could be an exclusion from its income for the portion of the FAPI of that FA that accrued in the stub period while it had a lower percentage interest. Subject to transitioning, draft s. 91(1.5) rule has been removed from the revised draft s. 91(1.1) et seq. rules. This was potentially problematic:
The technical notes say that the concept of connected corporation now includes non-arm's-length corporations as described above, which makes unnecessary subsection 91(1.5) in the 2016 draft. However, subsection 91(1.5) in that draft applied to all taxpayers, not just corporations. Hence, under the 2017 draft, the same stub-period FAPI is now taxed twice—in a taxpayer that has a PP decrease, and in another arm's-length non-corporate taxpayer (such as an individual or a trust) that has a PP increase.
However, as subsequently noted by the authors, the October 25, 2017 Notice of Ways and Means Motion likely addresses this issue by replacing the definition of "connected corporation" by "connected person" (defined in draft s. 91(1.3).)
Neal Armstrong. Summary of Paul Barnicke and Melanie Huynh, "Revised Stub-Period FAPI", Canadian Tax Highlights, Vol. 25, No. 10, October 2017, p. 3 under s. 91(1.2).
Scotia Mortgage Corp. v. Gladu – B.C. Supreme Court finds that it lacks jurisdiction to declare that a vendor was a Canadian resident for s. 116 purposes
Two banks which had foreclosed on properties of non-resident debtors, petitioned the B.C. Supreme Court for a declaration that a purchaser of the foreclosed properties would be considered to be acquiring them from the (resident) banks rather than from the non-residents (so that s. 116(5) would not apply.) Macintosh J found that he lacked the jurisdiction to make the requested declaration given that, as a practical matter, it related solely to a federal income tax issue.
Neal Armstrong. Summary of Scotia Mortgage Corporation v Gladu, 2017 BCSC 1182 under s. 220(1).
BT Céramiques – Quebec Superior Court finds that the mere suspicion of tax evasion and corrupting CRA officials is insufficient to invalidate audit information
Jarvis found that where the predominant purpose of a particular inquiry is the determination of a penal liability (e.g., under s. 239 of the ITA), CRA officials may not have recourse to the inspection and requirement tools in the ITA. In reversing the decision of the Court of Quebec to invalidate evidence obtained in a search and seizure of a Quebec registrant (BT Céramiques), which was believed to have fraudulently claimed input tax credits and corrupted CRA officials, Payette JCS stated:
When it commenced the audit, the CRA only had suspicions that BT Céramiques was engaged in tax evasion and that a “grand patron” in the CRA was assisting it. …
[T]he judge contrasted “auditing” and “investigation” … without noting that the audit powers themselves constitute powers of investigation, and without pausing to determine if the objective of the steps she described was to establish penal liability of the respondents.
Neal Armstrong. Summary of R. v. BT Céramiques Inc., 2017 QCCS 4262 under Charter s. 8.
Finance recognizes, as anomalous, the double deduction of the ACB of a corporate held life insurance policy in computing the CDA addition to two corporate beneficiaries of the proceeds
In 2017-0690311C6, Corporation A was the sole owner and premium payor for a life insurance policy with a death benefit of $1 million on the life of Mr. A. Corporation B and Corporation C were each designated as beneficiaries for 50% of the death benefit under this policy. Mr. A died after March 21, 2016 at a time that the adjusted cost basis of the policy to Corporation A was $200,000. CRA considered that the addition to the capital dividend account (CDA) of each of Corporation B and Corporation C was $300,000 (=$500,000-$200,000), not $400,000, i.e., the full ACB reduces the CDA addition for each rather than being prorated. Finance recognized that this result is anomalous, stating that:
The Department of Finance is prepared to address this issue as part of its ongoing review of the rules of the Income Tax Act.
Neal Armstrong. Summary of 6 October 2017 APFF Financial Strategies and Instruments Roundtable, Q.7 under s. 89(1) – capital dividend account – s. (d)(iii).
Finance indicates that extending s. 110.6(15)(a) to address disability coverage would raise potential policy issues
The two individual shareholders of a small business corporation agree that on the disability of either of them, his shares will be purchased out of the proceeds of a policy purchased by the corporation. What is the policy reason for not applying the s. 110.6(15)(a) cash-surrender-value rule so as to exclude the death benefit in determining whether the corporation qualifies as an SBC? Finance responded:
[T]he examination of such an issue could only be made in the context of a comprehensive review of the taxation of disability and critical illness insurance policies - unlike life insurance policies, the Act does not provide a comprehensive set of tax rules for disability and critical illness insurance policies. In addition, there may be significant differences between life insurance and disability or critical illness insurance, including the fact that an insured event under disability or critical illness insurance does not necessarily imply that the insured person ceases to participate in the corporation's business on a permanent basis.
Neal Armstrong. Summary of 6 October 2017 APFF Financial Strategies and Instruments Roundtable, Q.3 under s. 110.6(15)(a).
Finance “will consider situations where the application of [s. 220(3.5)] late-filing penalties creates a disproportionate burden on low-income taxpayers”
When queried about the onerous impact on middle-class individuals of being required under s. 220(3.5) to pay a late-filing federal penalty of $100 per month for a late-filed election, e.g., under s. 50(1), 86.1 or 45(2), Finance stated:
As part of the ongoing review of the ITA rules, the Department of Finance Canada will consider situations where the application of late-filing penalties creates a disproportionate burden on low-income taxpayers.
Neal Armstrong. Summary of 6 October 2017 APFF Financial Strategies and Instruments Roundtable, Q.12 under s. 220(3.5).
Finance states that the B2B rules in s. 15(2.16) are intended to apply mechanically irrespective whether s. 15(2) has been circumvented
Respecting the back-to-back loan rules in s. 15(2.16) et seq., Finance confirmed that “a right should not be considered a ‘specified right’ simply because the right secures debts that the shareholder of the corporation and the corporation itself owe to a financial institution.” Finance also stated:
Where the criteria set out in subsection 15(2.16) are satisfied, the shareholder benefit rules apply to an arrangement or mechanism, even if the facts and circumstances do not actually reveal an intention to circumvent the application of subsection 15(2). The rules are simply a function of the source of funds. This approach is consistent with the underlying technical approach of subsection 15(2), which is not articulated around a "purpose" test.
Neal Armstrong. Summaries of 6 October 2017 APFF Financial Strategies and Instruments Roundtable, Q.13 under s. 18(5) – specified right and s. 15(2.16).
Finance has no plans to rectify the potential double recognition of a loanback benefit under s. 118.1(16)
2009-0307941E5 dealt with two donors (not dealing with each other at arm’s length) who each made a cash gift to the same donee, and with one of the donors using part of the gift (as a result of the loan-back to it of gifted cash) as described in s. 118.1(16)(c)(ii). This resulted under s. 118.1(17) in a reduction not only in the amount of the gift made by that donor, but also by the other. In commenting on this situation, Finance stated:
[I]f two or more persons not dealing at arm’s length make a donation to the same charity, the use of the property donated by one of them will reduce the value of each one's gift, even if one of them does not use the property. These provisions clearly evince a demarcation between a property owned and used by a charity and a property owned and used by a donor. Adding a rule to apportion the reduction in the value of the gift would add a great deal of complexity to the tax rules surrounding charitable giving while opening the door to new opportunities for abuse of the provisions of the ITA.
Neal Armstrong. Summary of 6 October 2017 APFF Financial Strategies and Instruments Roundtable, Q.15 under s. 118.1(17).
CRA indicates that the s. 162(7) penalty for late-filing of a T1135 will be imposed automatically
In 2015-0588971C6, CRA indicated that the proposition that “the late-filing penalty of $2,500 under subsection 162(7) applies automatically… is currently under study.” Having completed that study, CRA is:
still of the opinion that [this penalty] applies automatically where all the conditions of that subsection are satisfied. …
CRA went on to acknowledge the six-year normal reassessment period under s. 152(4)(b.2), and referenced the exception thereto for neglect etc.
There will be circumstances where a taxpayer has a due diligence defence, for example, a reasonable view (albeit mistaken) that the situs of the property in question was in Canada. CRA’s answer appears to indicate that any such defence will be ignored at the initial assessment stage, and does not mention that is can be raised at the Notice of Objection stage.
Neal Armstrong. Summaries of 6 October 2017 APFF Financial Strategies and Instruments Roundtable, Q.14 under s. 162(7) and s. 152(4)(a)(i).
CRA indicates that (in the absence of counter indicators) a statutory declaration of residence is sufficient for s. 116(5)(a) purposes
S. 116(5)(a) (and similarly s. 116(5.3)) indicates that a purchaser is not liable for a failure to withhold under s. 116 on a purchase of taxable Canadian property from a non-resident if “after reasonable inquiry” it “had no reason to believe that the non-resident person was not resident in Canada.” When asked whether this requirement was met if the purchaser obtains a statutory declaration from the vendor that the vendor is not a non-resident of Canada, and the purchaser has no reason to believe this to be false, CRA indicated that “obtaining such declaration would generally qualify as a reasonable inquiry” – and referred to “a known mailing address outside of Canada or any other indication of the vendor’s residence being outside Canada in the transaction documentation” as examples of circumstances that should put the purchaser on notice.
This question is odd as usually there is only a written representation of residency in the sale agreement, and no statutory declaration to that effect.
Neal Armstrong. Summary of 25 August 2017 External T.I. 2017-0703351E5 under s. 116(5)(a).