News of Note
CRA considers that making a s. 107(2) distribution to a corporate beneficiary held by a new trust is an abusive circumvention of the s. 104(4) 21-year rule
Email this ContentA discretionary resident trust that is approaching its 21st anniversary distributes property with an unrealized gain to a corporate beneficiary that is wholly owned by a newly-established discretionary trust.
When this transaction was presented to it in a ruling request, the GAAR Committee observed that the new trust technically would start afresh under the 21-year deemed realization rule, and considered that it inappropriately circumvented this rule, which works hand in hand with the s. 70 rule for deemed realizations on death, to prevent indefinite deferrals of capital gains. CRA further indicated that a distribution to a corporate beneficiary will generally be acceptable if the individual shareholders of that corporation are resident in Canada, and that, as for non-resident individual beneficiaries, it will look to see that there will be taxation within Canada in their lifetime.
Neal Armstrong. Summary of 2016 CTF Annual Roundtable, Q.1 under s. 104(5.8).
2016 CTF Roundtable Answers
Our summaries of the questions and answers at the 2016 CTF Conference CRA Roundtable are now posted. Only the first 10 questions were answered. The official answers (including to questions 11-15) may be published in several weeks.
Over the next few days, we will be releasing a number of News of Note posts to highlight points of interest.
Barejo – Federal Court of Appeal states that determining whether the notes in Barejo were debt for purposes of the ITA rather than s. 94.1 would be “an improper use of judicial resources”
The Federal Court of Appeal has dismissed the Barejo appeal – but on the grounds that the Rule 58 question posed to the Tax Court was whether the “notes” in question were debts for purposes of the Act rather than for purposes of s. 94.1 thereof. As it did “not appear as though the answer to the question asked will resolve anything in the context of the underlying appeal which turns on the meaning of the word ‘debt’ in section 94.1,” it followed in the view of Noël C.J. “that endeavouring to dispose [of] the appeals on the merits would serve no useful purpose and give rise to an improper use of judicial resources.”
Neal Armstrong. Summary of Barejo Holdings ULC v. The Queen, 2016 FCA 304 under s. 94.1(1).
Income Tax Severed Letters 30 November 2016
This morning's release of 32 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA rules on addition of preferred units to a listed MFT’s capital
CRA ruled that the amendment of the trust deed for a listed mutual fund trust to add preferred units (also to be listed) would not result in the application of s. 104(7.1) or any disposition of trust property or existing units.
Similarly to other published rulings along this line, the amended Declaration of Trust was to provide that ITA income of the trust would be allocated among the different classes in proportion to their respective distributions. Assuming that the yield of a preferred unit as a percentage of its liquidation (or redemption) entitlement was different than that for a common unit, it would have a different percentage entitlement to trust property than its percentage entitlement to income – so that effectively the ruling (similarly to the others) affirmed that this result was not one of the main purposes of the trust terms.
Neal Armstrong. Summary of 2015 Ruling 2015-0578051R3 under s. 104(7.1).
CRA rules that s. 75(2) does not apply to trust fund where the income therefrom but not the capital can be distributed to the settlor, and no encroachment decision occurs during his lifetime
CRA ruled that s. 75(2) did not apply to property settled on a trust where during the settlor’s lifetime, no capital distributions could be made and income could only be distributed to the settlor or the settlor’s spouse. Only following the settlor’s death could the (numerous) trustees determine to distribute income and capital to the second-generation beneficiaries.
CRA also opined that s. 104(4) would not apply to the new trust 21 years later on the basis of a trust deed provision providing for the vesting (but not necessarily pay-out) of all trust interests before then.
Neal Armstrong. Summary of 2015 Ruling 2015-0610391R3 under s. 75(2).
CRA accepts a loss shift through a lump sum irrevocable prepayment of contingent future royalties
In order that the non-capital losses of Lossco would not expire, an affiliated licensee of a licence to manufacture and sell a product made a purported prepayment of the royalties (which were calculated as a function of sales), but with the prepaid royalty being non-refundable. CRA found that this payment likely was not a royalty (given its non-contingent nature) and that the full amount was business income to Lossco either under s. 12(1)(a) (on the basis, applying Ellis Vision, that it “could be considered as an amount paid in advance for the use of chattels,” or under s. 9.
It was not necessary for CRA to “resolve the issue of which of these two provisions prevails because [Lossco] does not wish to benefit from a deduction under paragraph 20(1)(m).” If the s. 20(1)(m) reserve weres relevant, it would have been necessary for CRA to engage with the finding in Doteasy that the s. 20(1)(m) reserve is available for an amount even if it is included under s. 9 rather than s. 12(1)(a), so long as it is described in s. 12(1)(a).
Neal Armstrong. Summary of 12 December 2014 Internal T.I. 2014-0524751I7 Tr under s. 9 - timing.
Pomerleau – Tax Court of Canada finds that GAAR applied to converting soft ACB (generated from crystallizing the capital gains deduction) into pseudo-hard ACB under s. 53(1)(f.2) for use in extracting surplus
An individual taxpayer engaged in a surplus-stripping transaction similar to transactions in a ruling which CRA had resiled from following Descarries. He held shares of a holding company whose adjusted cost base reflected the step-up of predecessor shares’ ACB in capital gains crystallization transactions by him and other family members. Such additional “soft” ACB would have been ignored under s. 84.1 if those shares had been transferred to a personal holding company in exchange for the issuance of shares with a purported paid-up capital equal to the transferred shares’ soft ACB.
Instead, he retracted his own soft ACB shares (as well as soft ACB shares that had been gifted to him by family members), which resulted in a capital loss under s. 40(3.6) that was added to the ACB of his common shares of the corporation under s. 53(1)(f.2). This s. 53(1)(f.2) bump was not caught by s. 84.1(2), so that he could transfer the bumped common shares to a personal holding company, taking back high PUC shares which he promptly redeemed.
Favreau J agreed with CRA that this conversion of soft ACB into hard ACB, in order to receive a tax-free return of capital, contravened GAAR, stating:
This series of transactions permitted the appellant, on the redemption of the Class G shares of [his new holding company], to extract as a tax-free return of capital, $994,628 derived from the surplus of his corporation by virtue of utilizing his capital gains deduction and that of his mother and sister. …
Neal Armstrong. Summary of Pomerlau v. The Queen, 2016 CCI 228 under s. 84.1(2)(a.1).
Francoeur – Cour du Québec finds that a somewhat quick flip by a builder was eligible for the principal residence exemption
Aubé, JCQ found that an entrepreneur who had followed a pattern of building and selling residences, realized a capital gain eligible for the principal residence exemption where he built a home to the exacting requirements of his spouse, and then sold it at a gain somewhat over three years after having purchased the vacant lot. She stated:
The financial situation motivated the sale of the property. Mr. R. F. stated that… his lines of credit had reached their limit. …
Although Mr. RF works in the construction industry, this does not deprive him of the right to acquire and sell his principal residence if circumstances make it unavoidable or desirable, even if the transactions occur over a relatively short period of time.
Neal Armstrong. Summary of Francoeur v. Agence du revenu du Québec, 2016 QCCQ 11906 under s. 9 – capital gain v. profit – real estate.
The replacement property rollover for voluntary dispositions of ECP has not been replaced
The rollover in s. 14(6) for the acquisition of replacement eligible capital property following a voluntary disposition of ECP (e.g., of farm quota) is not being replaced. The somewhat equivalent provisions of ss. 13(4) and 44(1) only apply to former business properties, i.e., real property.
The ITA historically has accommodated farmers, so that this may not be a targeted result.
Neal Armstrong. Summary of 4 November 2016 External T.I. 2016-0666901E5 - New Class 14.1 and replacement property rules under s. 13(4).