News of Note
Brian Ernewein expresses hope that the IRS rather than CRA can serve a surrogate parent role for US multinationals in 2016
Email this ContentAlthough the U.S. issued a draft Regulation (REG-109822-15 - see IRS Bulletin: 2016-14) to implement country by country reporting, the likely effective dates will be such that there will be a substantial number of US multinationals in 2016 that will not yet be subject to such reporting requirements. This means that a large U.S. multinational with subsidiaries in, say, 50 different countries, would be subject to a requirement to provide the required OECD-mandated reporting to the local tax authorities for each of the 50 countries – unless the multinational can find a country which will treat its subsidiary in that country as a “surrogate parent” to accept the required filing on behalf of it, the US parent and the other 49 subsidiaries (with the tax administration for that country then being responsible for filing the report with the other countries).
It has been suggested that such U.S. multinationals might choose their Canadian subs as their surrogate parents. However, this would generate a huge workload for CRA for the one year. In this regard, Brian Ernewein stated:
One of the things that has been frequently raised is the possibility of the US itself serving as a surrogate country for the US multinationals for 2016 - if the IRS was prepared to accept those country by country returns, and if other countries are prepared to accept that that works in terms of cutting off the local filing obligation if the US uses itself as a surrogate. There is nothing settled on this but work is being done on this, and I am hopeful (given the desirability of a practical approach) that we will get somewhere on this.
Neal Armstrong. Brian Ernewein on BEPS under “Country-by-Country reporting” - 2016 Annual IFA Conference.
CRA considers that U.S. taxes paid by a Canadian resident individual on business income of LLCs held through a ULC are deductible under s. 20(12) as being in respect of his ULC shares as a source of property income
CRA considered that U.S. taxes paid by a U.S. citizen resident in Canada on income which for U.S. purposes was considered to be earned by him as a “partner” of a Canadian ULC which carried on a U.S. business through LLCs was deductible by him in computing his Canadian income under s. 20(12). CRA reasoned that such U.S. taxes were “in respect of” potential income on his shares of the ULC (being his only source of income from a Canadian perspective, albeit one that was not currently generating income):
There is a logical connection between the income from ULC and the U.S. taxes paid by Taxpayer because if Taxpayer did not own such shares, no U.S. taxes would have been paid [citing Smidth].
Neal Armstrong. Summary of 15 December 2015 Memo 2014-0560371I7 under s. 20(12).
CRS draft legislation contains some departures from FATCA
The OECD model common reporting standard (which is reflected in the Canadian draft legislation released on April 15, 2016 to add Part XIX of the ITA) is heavily influenced by FATCA and the associated Model 1 Intergovernmental Agreement on which the Canada-US Intergovernmental Agreement (Canada-US IGA) is based. However, there are some differences:
First, the CRS applies to reportable persons on the basis of their residence for tax purposes, with no reference to individuals with foreign citizenship, as with FATCA. Second, the Canada-US IGA provided for a de minimis exemption from a review of pre-existing accounts whose balance or value was less than US$50,000. Proposed part XIX does not include such a de minimis exemption for an account held by an individual, but instead provides that varying levels of review apply depending upon the account value.
Neal Armstrong. Summary of Kyle B. Lamothe, "Common Reporting Standard: Draft Legislation", Canadian Tax Highlights, Vol. 24, No. 5, May 2016, p. 6 under s. 273(3).
Income Tax Severed Letters 1 June 2016
This morning's release of six severed letters from the Income Tax Rulings Directorate is now available for your viewing.
New Delaware corporate rectification procedure permits various corporate slips to be rectified without a court proceeding, if uncontested
As the Performance Industries and Shafron decisions of the Supreme Court are non-tax, contract cases, the narrower scope given by them to the rescission doctrine - as contrasted to the Juliar line of cases - is justified. The principal concern in such cases is unjust enrichment as between the parties to the instrument. In these contractual cases, “rectification is designed to prevent a written instrument from being used as an engine of fraud or of misconduct equivalent to fraud. The remedy restores the parties to an original oral bargain so that one party cannot rely on the strict terms of a written instrument that contravenes the true arrangement between the parties.” In tax cases, the injustice of mistake-based taxation trumps the policy that underlies the sanctity of contracts. In the successfully contested tax cases, “the Crown, which lacks privity of contract, reaps an undeserved windfall, yet strives to rely on the strict terms of the instrument to justify its enrichment.”
The Delaware corporate law was recently amended to allow various types of corporate slips consisting of defective corporate acts that arise from a failure of authorization, including those found in both public records and private instruments, to be rectified without a court proceeding being required in the first instance. If adopted in Canadian corporate legislation, the process could for example have fixed the mistake in Dale – and since the Crown does not oppose that type of correction, the solution could proceed privately.
Neal Armstrong. Summary of Jeff Oldewening, Rachel A. Gold and Chris Sheridan, "Statutory Ratification", Canadian Tax Journal, (2016) 64:1, 293-325 under General Concepts – Rectification.
CRA considers that the s. 95(2)(c) rollover can apply on a dropdown of shares made to an LLC as a contribution of capital rather than for “share” consideration
FA1 transfers all of its shares of FA2 to another non-resident subsidiary of FA1, viz., a non-share corporation (“FA3”), as a capital contribution, i.e. no new member interests are issued by FA3. S. 93.2(3)(a) deems FA3 to have issued shares to FA1 in respect of the transfer if the fair market value of a class of its shares (i.e., the FMV of its membership interest) is increased as a result of the transfer.
In a brief oral response, CRA indicated that s. 93.2(3) is sufficient to permit the rollover under s. 95(2)(c) to be available, notwithstanding the absence of an actual share issuance.
Neal Armstrong. Summary of 26 May 2016 IFA Roundtable, Q.10 under s. 93.2(3).
CRA finds that 25% Part XIII tax applies to interest paid by a transparent ULC sub to an S-Corp
Where an S-Corp (described by the questioner as fiscally transparent for U.S. purposes, so that its income is taxable in the hands of its U.S. shareholders) makes an interest-bearing loan to a Nova Scotia ULC (held by it through a qualified Subchapter S subsidiary), the interest paid on the loan will not be eligible for Treaty benefits under the anti-hybrid rule in Art. IV, 7(b): the interest will be disregarded for U.S. purposes, given the fiscally transparent nature of the ULC and QSSS, whereas the interest would be regarded for such purposes if the ULC were not transparent, i.e., the hybrid status of the ULC affects the Code treatment of the interest.
The answer implicit
Neal Armstrong. Summary of 26 May 2016 IFA Roundtable, Q. 9 under Treaties – Art. 4.
CRA accepts a tracing approach to determining whether interest on money borrowed to return capital is considered for s. 95(2)(a)(ii)(B) to be deductible in computing exempt earnings
Where 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). This signifies that the “fill the whole” approach to determining a source of business income under s. 20(1)(c) is portable to s. 95(2)(a)(ii)(B)(I). It also signifies a tracing approach is at work, as CRA indicated that this result 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.
If instead, shares of only one class had been issued to fund the two (good and bad) uses of funds, CRA “could consider that the appropriate method would be to apply clause 95(2)(a)(ii)(B) on a pro rata basis.”
Neal Armstrong. Summary of 26 May 2016 IFA Roundtable, Q. 8 under s. 95(2)(a)(ii)(B).
CRA considers a contribution of shares to a subsidiary causes the subsidiary shares to be substituted property for s. 93(2.01) purposes
The stop-loss rule in s. 93(2.01) applies to grind the capital loss realized on the disposition of a share of a foreign affiliate by the amount of exempt dividends previously received on that share “or on a share for which [it] was substituted.”
CRA considered that this stop loss rule applied where Canco made a contribution of capital to a foreign subsidiary (FA2) of its shares of a non-resident Finco subsidiary which had paid dividends out of its deemed active business income to Canco – so that s. 93(2.01) denied a subsequent capital loss realized on an arm’s length sale of the FA2 shares to the extent of such dividends. This was so even though the contribution did not entail any exchange of property and even though the Finco shares likely would never have generated an accrued loss.
However, CRA stated:
[W]e may be prepared to develop administrative solutions to the extent this could result in double-counting, or the same dividends being counted, or producing two or more losses.
Neal Armstrong. Summary of 26 May 2016 IFA Roundtable, Q. 7 under s. 93(2.01).
CRA considers that profit transfer payments made by a German sub to its German parent are s. 90(2) deemed dividends and not FAPI
Under an “Organschaft,” a German parent (“Parentco”) and its German subsidiary (“Subco”) can enter into an agreement under which Subco agrees to annually transfer its entire profit determined in accordance with German (statutory) GAAP to Parentco, and Parentco agrees to compensate Subco for any loss incurred under German GAAP. CRA has confirmed that, at least in the simple case where Parentco wholly-owns Subco through ownership of a single class of shares, the annual profit transfers will be deemed to be dividends under s. 90(2) and, thus, not foreign accrual property income to the direct or indirect Canadian parent of Parentco.
This will supplant an earlier position (e.g., 2001-0093903) that a profit transfer payment made by Subco to Parentco could be re-characterized as income from an active business of Parentco under s. 95(2)(a) to the extent that Subco had earnings from an active business before taking into account the profit transfer payment – so that this previous position will only apply to profit transfer payments made before 2017.
Neal Armstrong. Summaries of 26 May 2016 IFA Roundtable, Q. 6 under s. 90(2) and s. 53(1)(c).