News of Note
CRA applies a pro-rating approach to money borrowed from an affiliate to return capital used to fund both exempt and non-exempt activities
Email this ContentWhere FA1 borrows from a sister (FA3) to make a capital distribution on its Class A common shares, which had previously been issued solely to finance FA1’s active business, CRA would accept that the interest on this loan would be received as deemed active business income by FA3 under s. 95(2)(a)(ii)(B), on the basis that it was deductible in computing FA1’s earnings from an active business under Reg. 5907. This would be so even if FA1 had issued shares of another class (its Class B common shares), to finance the acquisition of shares which were not excluded property, at the same time as it issued the Class A common shares – so that even though CRA did not articulate it this way, a tracing approach evidently is accepted.
In the situation where FA1 was required to compute its income (pursuant to Reg. 5907(1) – earnings – (a)(iii)) under Part I of the Act, CRA indicated that the interest was deductible under s. 20(1)(c) “because the borrowed funds replaced capital that…had been used by FA1 for the purpose of earning income from an active business,” whereas in the situation where the earnings were computed pursuant to (a)(i) or (iii) of the earnings definition under local tax law and the interest was non-deductible under such law, CRA laconically stated that the interest would be deductible under Reg. 5907(2)(j) without explicitly indicating that it was applying the fill-the-hole approach here as well.
If instead, shares of only one class had been issued to fund the two (good and bad) uses of funds, as to 80% and 20%, respectively, CRA would consider that “the portion to which clause 95(2)(a)(ii)(B) applies should be determined on a pro-rata basis based on the current use of the capital (i.e., prior to its replacement with the borrowed funds)…[so that] 20% of the interest income of FA3 would not be recharacterize.” as active business income.
Neal Armstrong. Summary of 26 May 2016 IFA Roundtable Q. 8, 2016-0642041C6 under s. 95(2)(a)(ii)(B).
CRA has expressed concerns to Finance about products which technically skirt the LIA policy rules
CRA has identified leveraged insurance arrangements (which “technically escaping the LIA policy definition”) where products that form part of the arrangements are interdependent and would not have been otherwise issued without the others. These arrangements:
involve manipulating the terms of the products (including pricing) that form part of the arrangements and the issuance of products that would not have been otherwise issued on a stand-alone basis (including life insurance policies insuring non-insurable lives) to obtain unintended tax benefits.
In addition to potentially attacking these arrangements on the basis that interdependent products are one contract or under GAAR, CRA has brought its concerns to Finance.
Neal Armstrong. Summary of 3 May 2016 CALU Roundtable, Q. 1, 2016-0632601C6 under s. 248(1) – LIA policy.
CRA will issue a clearance certificate for a partial estate distribution
CRA will issue clearance certificates to an executor of an estate for partial distribution of the estate assets. This may be useful or necessary where a graduated rate estate wishes to make a gift to a qualified donee within what may be a 36-month deadline following the death of the testator.
Neal Armstrong. Summary of 3 May 2016 CALU Roundtable, Q. 5, 2016-0632641C6 under s. 159(2).
Element Financial butterfly spin-off of ECN Capital will be followed by a merger of ECN Capital with a 3rd (cash-rich) public company
Element Financial will be spinning off its commercial finance business as ECN Capital pursuant to a butterfly for which it did not apply for a ruling. It is contemplated that following the butterfly, ECN Capital will then acquire all the shares of a cash-rich recent IPO (IAC) in exchange for about 13% of its shares.
Holders of the Element stock options will exchange a portion of their options on the shares of the “Subco,” into which the to-be-distributed business has been dropped and then, immediately following the butterfly, exchange their Subco options for options on ECN Capital shares. The old exercise price will be prorated between the options on the post-spin-off Element (“Element Fleet”) and ECN Capital based on the relative 5-day VWAP for their share prices after giving effect to the butterfly.
Holders of about $534M of Element preferred shares will not participate in the butterfly exchange. Unlike the difficulties this would create on a cross-border butterfly (see Desjardins and Diksic), this is possible in a Canadian public-company butterfly spin-off.
Neal Armstrong. Summary of Element Circular under Spin-Offs & Distributions – Butterfly spin-offs.
Planning can increase post-compromise tax attributes of a company in CCAA proceedings
It may be desirable for a company that is going through a CCAA restructuring to reduce its non-capital losses (for example, by reversing previous CCA claims) given that it may be better to instead realize income under s. 80(13) (reflecting only half of the unapplied forgiven amounts arising on the CCAA implementation), keeping in mind that with other planning there may be substantial pools to shelter that income, and it can be recognized (under s. 61.4) over five years.
Embedded capital losses in the shares of subsidiaries might be triggered in the year preceding the year of debt settlement so that they would become net capital losses, thereby soaking up the forgiven amount (after first being applied to non-capital losses) before the use of more valuable attributes such as UCC.
It may also be desirable to wind-up a wholly-owned subsidiary under s. 88(1.1) shortly before the CCAA implementation, given that the non-capital losses will be protected from a s. 80(3) grind as they would not be considered NOLs of the parent until after the compromise.
An alluring proposition, if valid, is that contractual claims, whose amount was fully deducted when incurred, will not give rise to a forgiven amount (or other inclusion) when forgiven.
Neal Armstrong. Summaries of Marie-Andrée Beaudry and Dean Kraus, "Selected Income Tax Considerations in the Court-Approved Debt Restructurings and Liquidations," Draft 2015 Annual CTF Conference paper under s. 80(13), s. 80(4), s. 80(3), s. 20(1)(c), s. 80(1) - commercial debt obligation, s. 18(1)(e), s. 224.1, s. 222(2), s. 80(2)(h).
Use of Holdcos may prevent accessing the farming capital gains exemption
The use of holdcos can scupper access to the deduction under s. 110.6(2) for dispositions of qualified farm or fishing property. This would be the case where an interest in an unrelated Farmco is held through a Holdco, or where an interest in a farming partnership is held through a 2-tier corporate structure.
Henry Shew and Jody Wong, "Multi-Level Farming Structures and the Capital Gains Exemption", Canadian Tax Focus, Vol. 6, No. 3, August 2016, p. 10 under s. 110.6(1) – share of the capital stock of a family farm or fishing corporation.
Donald Bowman suggests that a bare trust is not a trust
Former Chief Justice Bowman thinks that “a ‘bare trustee’ is an agent, not a trustee,” and that “no one can legally be a trustee and an agent at the same time,” so that the statement adopted in Trident Holdings that “a person may be both agent of and trustee for another,” was incorrect (although the same passage went on to acknowledge that in a bare trust “it is the agency relation that predominates.”) Accordingly, “judges, when faced with something called a ‘bare trustee’, have to make up their minds and decide which side of the line the entity falls on” and can’t say "maybe both".
Neal Armstrong. Summary of Donald G.H. Bowman, “Bare Trusts and Nominee Corporations,” Tax Topics (Wolters Kluwer), August 11, 2016, No. 2313, p. 1 under s. 104(1).
CRA considers that an exempt foreign charitable trust must satisfy the Canadian common law tests
The definition of an exempt foreign trust in s. 94(1) includes a charitable trust described in para. (d) thereof, which is required to have been created and operated exclusively for charitable purposes. In interpreting this, CRA considers many of the tests applied by it to Canadian registered charities to be applicable:
- One of the four Pemsel charitable purpose tests must be satisfied.
- “When the charitable activities are carried out by an intermediary…the activities and the underlying resources provided must be subject to the direction and control of the trust.”
- “A charitable trust may conduct commercial activities to the extent that they remain incidental to and only serve as a means of furthering the exclusive charitable purposes of the organization.”
- “An exempt foreign trust may accumulate and invest funds, so long as the accumulation and investments are incidental to and serve as a means of furthering the exclusive charitable purposes of the organization, rather than being an end in themselves.”
Neal Armstrong. Summary of 14 June 2016 T.I. 2016-0647951E5 under s. 94(1) – exempt foreign trust – para. (d).
CRA recognizes that failure to file a T1135 may not indicate carelessness or neglect
CRA considers that a s. 162(7) penalty for failure to file a T1135 form can be assessed beyond the normal reassessment period (or, under s. 152(4)(b.2), beyond the normal reassessment period plus three years where the taxpayer did not report income from specified foreign property in the relevant return) but, in such a case, CRA would have to “prove” that “although that error may have been made in good faith, it was an error that a prudent and conscientious person would not have made.”
Neal Armstrong. Summary of 26 May 2016 Alberta CPA Roundtable, 2016-0645001C6 under s. 152(4)(a)(i).
Income Tax Severed Letters 17 August 2016
This morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.