News of Note
Melman – Tax Court of Canada faults failure to review a tax return with a low amount payable
Email this ContentAn executive received a $15M dividend, deposited $4.7M to mature on the filing due date, did not read his return (omitting the dividend) and promptly redeployed the $4.7M. S. 163(2) applied.
Neal Armstrong. Summary of Melman v. The Queen, 2016 TCC 167 under s. 163(2).
Rio Tinto Alcan decision now available in English
The English version of Rio Tinto Alcan (summarized in Monday's post) is now available. It reads like it was drafted by Hogan J rather than a translator.
Slightly revised summaries of Rio Tinto Alcan Inc. v. The Queen, 2016 TCC 172 under s. 18(1)(a) – legal fees, s. 20(1)(g), s. 20(1)(bb), s. 20(1)(cc), 169(2.1), 20(1)(e), and s. 14(5) – eligible capital expenditure.
Income Tax Severed Letters 20 July 2016
This morning's release of 17 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Rio Tinto Alcan – Tax Court of Canada finds that investment dealer fees incurred respecting the advisability of making hostile takeover were fully deductible under s. 9 and 20(1)(bb) – and $17M in legal fees were deductible under s. 20(1)(cc)
Hogan J articulated a distinction between (currently deductible) “expenses linked to [board] oversight [,which] are current expenses since they relate to the management of the process of producing income of the corporation,” and (capital-account) “expenses incurred in the course of implementing a transaction leading to the acquisition of capital property.” Accordingly, he found that the substantial portion of investment dealer fees incurred by the Alcan board that represented input to its decision to launch a hostile bid for a French public company (i.e., 65% of the Morgan Stanley fee and 35% of the Lazard Frères fee) was currently deductible, whereas the balance of the fees relating to assistance in the bid was a capital expenditure and addition to the ACB of the acquired shares. The same fees also were fully deductible in the alternative under s. 20(1)(bb) as being fees relating to advice on the advisability of acquiring the shares of the target (Pechiney).
The same principles applied to investment dealer fees incurred respecting a subsequent butterfly spin-off transaction, so that the portion of Lazard Frères fees that related to advice on various divestiture options up to the time of the final board decision to effect a butterfly spin-off was fully deductible. The alternative deductibility of these same fees under s. 20(1)(bb) was based on the proposition that the butterfly mechanics entailed the sale (on a rollover basis) of the shares of the Opco in question to the new public company (Novelis) in consideration for the acquisition of (subsequently redeemed) preferred shares of Novelis – so that the fees related to advice culminating in the sale or purchase of shares, as required by s. 20(1)(bb). The balance of the Novelis fees (including professional fees) were deductible as disposition expenses under s. 40(1)(a).
$19M in fees paid to a French lobbyist firm related only to smoothing the Pechiney bid and were capital expenditures (i.e., ACB additions).
Legal fees of around $17M incurred in getting various regulatory (e.g., competition, securities) approvals for the Pechiney takeover were fully deductible under s. 20(1)(cc).
As noted, the portions of the fees on capital account which were not deductible under s. 20(1)(cc) were additions to the cost of the Pechiney shares (or s. 40(1)(a) disposition expenses incured in the butterfly) rather than being eligible capital expenditures. S. 20(1)(e) was not sufficiently advanced in the Alcan Notice of Objection and, in any event, Alcan did not provide any evidence as to how the fees incurred on capital account should be allocated between the cash and share consideration for its Pechiney bid.
Neal Armstrong. Summaries of Rio Tinto Alcan Inc. v. The Queen, 2016 CCI 172 under s. 18(1)(a) – legal fees, s. 20(1)(g), s. 20(1)(bb), s. 20(1)(cc) and s. 14(5) – eligible capital expenditure.
CRA provides s. 55(3)(a) rulings conditional on the U.S. parents receiving, and waiving the right to object to, GAAR assessments to reduce outside Canadian basis that they “paid for” by paying 5% Canadian withholding tax
In connection with a s. 55(3)(a) distribution of a Canadian subsidiary (Canco3) to a sister chain of companies held by U.S. parents, Canco3 redeemed all but one of its common shares held by its immediate Canadian parent in consideration for a promissory note, thereby resulting in a step-up in its outside basis. The proposed transactions required that this additional basis be vapourized (namely, through a subsequent amalgamation which resulted in such note disappearing by operation of law).
Before getting to that vapourization, part of the mechanics for subsequently transferring Canco3 over to the sister chain of U.S. companies entailed the U.S. parent (XXXco1) of the Canadian corporation (Canco1) at the top of the stack above Canco3 transferring a portion of its Class A common shares of Canco1 to a U.S. subsidiary (USco3) of XXXco1, and then having Canco1 pay a stock dividend on its Class A common shares (now held on a pro rata basis by XXXco1 and USco3) consisting of a new class of Class B common shares, so that the existing Class A common shares were diluted down to a nominal value, and the value of the newly issued Class B common shares (now embedding most of the value in the stack) being subject to 5% withholding tax. CRA ruled that s. 15(1.1) would not apply to this stock dividend. However, focusing on the fact that the Class A common shares of Canco1 held by XXXco1 and USco3 still had significant basis notwithstanding that they now had nominal value, CRA ruled that s. 245(2) would apply to deny the tax benefit arising from such ACB to USco3 and XXXco1, and made its rulings conditional on XXXco1 and USco3 receiving a GAAR assessment under s. 152(1.11) to reduce their ACB to a nominal amount and waiving under s. 165(1.2) there right to object thereto.
Finally, s. 212.3(2) rulings were granted based on very extensive representations about arm’s transactions not occurring as part of or before the series.
Neal Armstrong. Summary of 2015 Ruling 2015-0604051R3 under s. 55(3)(a)(iii).
CRA considers that a dividend distributed by a trust to a connected corporation can be subject to Part IV tax due to the delayed implied effective date of s. 104(19) designations
A dividend is received by a family trust from a Canadian-controlled private corporation with only operating assets (Opco) and immediately distributed to a corporate beneficiary (Holdco) that is connected at that time with Opco - but ceases to be connected by the end of that calendar year due to an in intervening sale of Opco by the trust. CRA considers that the trust will not enjoy the connected-corporation exemption from Part IV tax even if a timely s. 104(19) designation is made by the trust. The reason is that it considers the s. 104(19) designation to not be effective until the end of the year, at which time Holdco no longer is connected.
This is a potential trap on CCPC sales.
Neal Armstrong. Summary of 3 June 2016 T.I. 2016-0647621E5 Tr under s. 104(19).
Vessels or mobile drilling rigs might be “fixed” places of business if they move around within the same oil field
The starting point for considering whether a vessel or other piece of oil and gas equipment is a permanent establishment is to ask whether it is a fixed place of business through which the enterprise’s business is carried on. If a vessel or mobile drilling rig operates in an area that is considered to be geographically and commercially coherent, it may be considered to satisfy the “fixed place” aspect of this test. This could be the case for platform supply vehicles plying the same route repeatedly, or construction support vehicles working on only one subsea installation in the same oil field. It has been suggested this issue should be approached by considering each oil field to be one geographical area, so that a floating platform or rig moving around in the same oil field would, therefore, satisfy the geographically fixed criterion, though it is not fixed to the ground.
Whether a lessor carries on its business through the piece of equipment turns in part whether it is providing crew or other significant services - so that this question might turn on whether the lease is a time charter or bareboat charter.
Furthermore, “if a vessel is contracted to support the installation or removal of pipelines, subsea constructions or drilling rigs, this could be covered by the construction and installation provision in article 5(3) of the OECD Model.”
Neal Armstrong. Summary of Maja Stubbe Gelineck, "Permanent Establishments and the Offshore Oil and Gas Industry – Part 1," Bulletin for International Taxation, April 2016, p. 208 under Treaties – Art. 5.
CRA rules that two properties to be used in an expanded farming business will be replacement property for a single former property
CRA has ruled that where the expropriation proceeds of a farm will be used to purchase two nearby farms (with the scale of the farming business also to be expanded), the two new farms would qualify as replacement properties for s. 44 purposes. This acceptance (consistent with IT-259R4, para. 28) that there can be more than one replacement property, and of some forms of business expansion, are not new.
Neal Armstrong. Summary of 2016 Ruling 2016-0632001R3 under s. 44(5).
ENMAX Energy – Alberta Court of Queen’s Bench finds that an 11.5% interest rate on unsecured intercompany debt was reasonable under s. 20(1)(c) notwithstanding that this exceeded an arm’s length rate of around 8.5%
An Alberta utility (EEC) was required to make payments to the province equal to the provincial and federal income tax to which it would have been subject had it not been tax-exempt. In order to minimize this pseudo-tax liability of EEC, EEC's parent capitalized it mostly with a subordinated note bearing interest at 11.5%, whereas the Alberta government denied the interest deduction over 5.42% as being in excess of the “reasonable amount” referenced in s. 20(1)(c).
After listening to a slew of expert evidence on credit ratings and capital markets, Poelman J concluded that an arm’s length interest rate likely would have been in the range of 7.97% to 8.77% - so that you might have expected him to deny interest expense in excess of 8.77%.
Instead he applied a Gabco-derived test as to “whether no business would have contracted to pay that amount, having only its business considerations in mind and under the form of transaction pursuant to which the obligation was incurred,” and concluded that the interest was fully deductible. He also stated:
[I]ntercompany debt is not rated… . Further… the intercompany notes [here] were burdened with a number of conditions, such as the level of debt and stripping of cash flow to the parent, which would have made them very difficult to sell on the market without significant changes. These observations reinforce the weakness of putting too much emphasis on artificially constructed arm’s length comparators… .
Neal Armstrong. Summaries of ENMAX Energy Corp. v. Alberta, 2016 ABQB 334 under s. 20(1)(c) and s. 67.
CRA substantially rewrites its Bulletin on “Fringe Benefits”
CRA’s new Folio on Benefits and Allowances Received from Employment replaces IT-470R entitled “Employees’ Fringe Benefits” (a phrase which CRA no longer uses). Although there are extensive and substantial changes as compared to IT-470R, this Folio nonetheless does not represent much new. Although the Folio also states that it replaces Income Tax Technical News No. 40, most of the policies in ITTN No. 40 are continued. In addition, various topics which were dealt with in ITTN No. 40 or IT-470R are not brought forward to the Folio and are instead dealt with in referenced web pages on the CRA site. The emphasis in the Folio has shifted somewhat to statements of broader principle, often as enunciated in decisions of the Federal Court of Appeal, including:
- Benefit recognition generally requires generally requires receipt of an economic advantage measurable in monetary terms of which the employee is the primary beneficiary (Lowe)
- “something…provided to an employee primarily for the benefit of the employer…will not be a taxable benefit if any personal enjoyment is merely incidental to the business purpose” (McGoldrick)
- the value of a benefit is its fair market value (Spence)
However, CRA is silent on its judicial authority for a restrictive statement of when a shareholder may receive a benefit qua employee.
Neal Armstrong. Summaries of S2-F3-C2, Benefits and Allowances Received from Employment under s. 6(1)(a), s. 6(1)(a)(iv), s. 6(1)(a)(vi), s. 6(1)(b) and s. 6(1)(b)(v).