News of Note
CRA considers that a QROC distribution by a foreign affiliate to its Canadian shareholder of ECP results in ECE to the shareholder of the property’s FMV
Email this ContentCRA considers that property contributed for no consideration to a corporation by its shareholder, or received by a Canadian corporate shareholder from its wholly-owned foreign affiliate on a return of capital (or other upstream transfer), generally will have a cost to the transferee equal to the property’s fair market value.
CRA has extended this position to a return-of-capital distribution by the foreign affiliate of a Canadian corporation of eligible capital property (in this case, intellectual property with an unlimited life), so that the distribution gave rise, for purposes of applying the eligible capital expenditure definition to the Canadian shareholder, to an expenditure incurred by it equal to the FMV of the property at the time of distribution.
Neal Armstrong. Summaries of 2013-0506561I7 under s. 14(5) – eligible capital expenditure, s. 69(1)(c) and s. 69(4).
Income Tax Severed Letters 18 May 2016
This morning's release of 10 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Montminy – Tax Court of Canada finds that the exercise of employee stock options and immediate sale of the acquired shares to the controlling shareholder following an asset sale did not generate a s. 110(1)(d) deduction
When a third-party purchaser agreed to acquire all the assets of Opco, the management employees agreed with the 100% shareholder of Opco (“Holdco”) that when the asset sale closed, they would exercise their options to acquire common shares of Opco and immediately sell their newly-acquired shares to Holdco for an agreed cash sale price.
The Crown accepted that this right to sell their shares to Holdco was a fair market value liquidity right described in Reg. 6204(2)(c), so that the shares were not prevented from being prescribed shares under Regs. 6204(1)(a)(iv) and (vi) (re right for their shares to be acquired by a specified person, i.e., Holdco). However, D’Auray J accepted the Crown’s submission that the shares were tainted under Reg. 6204(1)(b). In addition to noting the text of Reg. 6204(1)(b), which on its face referenced a reasonable expectation of the shares being acquired by a specified person within two years rather than legal rights and obligations, she also noted that:
The underlying tax policy of paragraph 110(1)(d)…and paragraph 6204(1)(b)…is to ensure that the stock option regime does not become disguised remuneration and that the employees who subscribe for the shares are subject to a certain level of risk.
Accordingly, the employees were not able to reduce their employee stock option benefits by the s. 110(1)(d) deduction.
Neal Armstrong. Summary of Montminy v. The Queen, 2016 CCI 110 under Reg. 6204(1)(b) and General Concepts – FMV - shares.
Herbalife – Delhi High Court finds that an Indian domestic provision denying the deduction of technical services fees paid to a non-resident where there was a failure to withhold back-up withholding violated the non-discrimination provision in the U.S.-India Treaty
Art. 26(3) of the U.S.-India Treaty, which is similar to Art. XXV(6) of the U.S.-Canada Treaty, provided that:
Except where the provisions of paragraph 1 of Article 9 (Associated Enterprises), paragraph 7 of Article 11 (Interest), or paragraph 8 of Article 12 (Royalties and Fees for included Services) apply, interest, royalties, and other disbursements paid by a resident of a Contracting State to a resident of the other Contracting State shall, for the purposes of determining the taxable profits of the first-mentioned resident, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State.
The Delhi High Court applied Art. 26(3) to override a domestic provision, which denied the deduction of technical service fees paid to a non-resident (in this case, a U.S. affiliate) where the Indian payer had failed to withhold back-up withholding. (This domestic provision applied even where, as here, the fees were exempt from Indian tax under the business profits/PE Articles of the Treaty.) Muralidhar J saw the matter quite simply:
[T]he condition under which deductibility is disallowed in respect of payments to non-residents, is plainly different from that when made to a resident. … The lack of parity in the allowing of the payment as deduction is what brings about the discrimination.
Neal Armstrong. Summary of CIT v. Herbalife International India PVP. Ltd., ITA 7/2007, 13 May 2016 (Delhi HC) under Treaties – Art. 25.
Revised s. 212.1(4) rule generates anomalous results
The exception in s. 212.1(4) from the application of the surplus-stripping rule in ss. 212.1(1) permits the unwinding of a sandwich structure resulting from a Canadian corporate purchaser having acquired a non-resident corporation holding a Canadian subsidiary – so that such non-resident corporation can transfer the shares of the Canadian subsidiary to the Canadian purchaser. The 2016 federal budget proposed a significant narrowing of s. 212.1(4), so that it will not apply where, at any time as part of the series of transactions, a non-resident who did not deal at arm’s length with the Canadian purchaser owned directly or indirectly any share of the purchaser.
Even accepting the general policy of this proposal, it could produce inappropriate results. For example:
- The proposed rule could penalize a Canadian shareholder of the Canadian purchaser if a non-resident shareholder of the purchaser does not deal at arm’s length with the purchaser.
- If a Canadian corporation (with no non-resident shareholders) had previously acquired the purchaser from a non-resident vendor, and the purchaser corporation now is used to acquire a non-resident corporation holding an underlying Canadian corporation, the s. 212.1(4) exception will not be available if the prior acquisition occurred as part of the same "series" - even though no non-resident now indirectly holds any interest in the acquired corporation.
- Similarly, if a Canadian corporation (with no non-resident shareholders) had previously acquired the purchaser from a non-resident vendor, and the purchaser already held a non-resident corporation that, in turn, held an underlying Canadian corporation, s. 212.1(4) will not apply to permit the sandwich to be unwound into the purchaser.
- Where the s. 212.1(4) exception is not available because there is a non-resident corporation atop a double-decker sandwich structure, the unwinding of that structure could result in double withholding tax.
- Purchasers who are Canadian public corporations with non-resident shareholders, or private-equity funds with non-resident partners, may have difficulty in demonstrating satisfaction of the arm’s length test.
Neal Armstrong. Summary of Angelo Nikolakakis, "Cross-Border Surplus Stripping – Stripping Bona Fide Non-Resident Purchasers," International Tax (Wolters Kluwer CCH), No. 87, May 2016, p.4 under s. 212.1(4).
0741449 B.C. Ltd. – Federal Court grants a s. 164(1.2) order based on taxpayer’s low net worth and poor payment history
A corporation had a refund claim of $1.2 million respecting its previous payment of income taxes that were still in dispute. In granting a jeopardy order under s. 164(1.2) that the refund claim not be paid, Hughes J referred to the corporation’s principal asset being subject to a foreclosure order and to its shareholder having “a history of non-payment of taxes and bankruptcy.”
Neal Armstrong. Summary of Canada (National Revenue) v. 0741449 B.C. Ltd., 2016 FC 530 under s. 164(1.2).
Rice – Quebec Court of Appeal finds that status Indians were required to collect sales tax on sales to non-Indians
Status (Mohawk) Indians selling gasoline on the Kahnawake Reserve to non-Indian purchasers were not exempted by s. 87 of the Indian Act from the requirement to collect and remit GST, QST and Quebec fuel tax, given that these taxes were designed to be borne by the ultimate purchasers and the retailers’ obligations were merely those of statutory collection agents. (Various constitutional arguments also were rejected by Hesler CJQ.)
Similar issues can arise respecting whether crown agents or non-residents can be required to collect or withhold tax on payments collected or paid to counterparties.
Neal Armstrong. Summaries of Rice v. ARQ, 2016 QCCA 666 under Constitution Act, 1982, s. 35(1), s. 25, Indian Act, s. 87, Constitution Act, 1867, s. 91(24).
CRA should adhere to the OECD transfer-pricing guidelines on “reasonable efforts”
If a taxpayer satisfies the contemporaneous documentation requirements of s. 247(4), s. 247(3) provides a safe harbor from its penalty provisions if the taxpayer made “reasonable efforts” to determine an “arm’s length transfer price.”
The following statement in TPM-09 is generally consistent with the 1995 OECD Guidelines which inspired this safe harbor (and which referred to "prudent business management principles that would govern the process of evaluating a business of a similar level of complexity and importance:"
What is reasonable is based on what a reasonable business person in the taxpayer's circumstances would do, having regard to the complexity and importance of the transfer pricing issues that arise in the taxpayer's case. …
However, the authors note that “regardless, we have seen the CRA assert penalties in circumstances where it ought to be uncontroversial that reasonable efforts were made.”
Neal Armstrong. Summaries of Michael Colborne, Michael McLaren, Mark Barbour, "Subsection 247(3): What are "Reasonable Efforts"?", Canadian Tax Journal, (2016) 64:1, 229-43 under s. 247(3) and s. 247(4).
CRA considers that the debt parking rule can apply even if no capital loss is recognized
If a corporation disposes of debt of a subsidiary at a substantial loss to another corporation which is related to it (and the subsidiary) by virtue only of s. 251(5)(b), the loss nonetheless is denied by s. 40(2)(e.1) and added to the adjusted cost base of the debt in the acquirer’s hands under s. 53(1)(f.1). However, the debt parking rule in s. 80.01(8) also applies to the acquisition, and deems that debt to be settled for an amount equal to its ACB to the acquirer.
CRA considers that the debt forgiveness rules could thereby apply to the debt because the deemed settlement under s. 80.01(8) occurs at the time of the acquisition, whereas the s. 53(1)(f.1) bump to the acquirer’s ACB occurs only immediately after that time, i.e., the debt apparently is deemed to be settled for an amount equal to the acquirer’s cost rather than its post-bump ACB.
Neal Armstrong. Summary of 31 March 2016 T.I. 2014-0524391E5 Tr under s. 80.01(8).
CRA seemingly reverses a previous position that s. 20(12) applies on a source-by-source basis, so that taxes paid on business income are not eligible where the Canadian taxpayer only earns property (dividend) income
In 2011-0394631I7, CRA indicated that a Canadian corporation (“Canco”), holding shares of disregarded LLCs through a US LP that was a corporation for Code purposes, was not entitled to a s. 20(12) deduction for its share of the U.S. corporate income taxes of the US LP, on the grounds that those US taxes were paid in respect of business income (as the LLCs were carrying on active businesses) rather than property income, whereas the only source of income of Canco was property income, namely, the LLC dividends.
Without mentioning it, CRA, in a laconic recent technical interpretation, appears to have reversed this 2011 interpretation. On essentially the same facts, except that the taxpayer was a Canadian-resident individual holding his interest in the US LP through a Canadian LP, CRA indicated that the taxpayer could claim an s. 126(1) foreign tax credit, or a deduction under s. 20(11) or (12), provided the usual conditions were satisfied. The relevant development since 2011 may be that in Smidth (affirmed on different ground by the FCA), Paris J stated, with apparent approval, that in 2008-0284351I7 “the CRA accepted that the 20(12) deduction was available where the U.S. tax was paid on income from a source that is different from the taxpayer’s source of income under the Act” (as well as referring with approval to 1999-0010295).
Neal Armstrong. Summary of 2015-0572461I7 under s. 20(12).