News of Note
R & S Industries – Federal Court appears to interpret a s. 97(2) drop-down agreement as preventing a re-allocation of boot to avoid gain
Email this ContentAn agreement for the drop-down under s. 97(2) of assets by the taxpayer (R & S) to a subsidiary LP specified that the elected amounts in a joint s. 97(2) election, and the respective portions of the Purchase Price allocated to the transferred assets, would be the minimum agreed amounts permitted under the Act, “provided …that in respect of the Goodwill, the elected amount shall, unless otherwise agreed be equal to $2,502,600.” The reasons for judgment are unclear, but CRA apparently reassessed on the basis that the election form effectively allocated excess boot to the non-goodwill assets, so that gain was required to be recognized under the excess boot rules. R&S then sought to amend the election, apparently (although again this is unclear) to re-allocate this excess boot to the goodwill (which might have produced a better result as the stipulated $2.5M agreed amount presumably was above the goodwill’s cost amount).
When CRA rejected the request for an amended election, 15 months passed before R & S sought judicial review of this decision in the Federal Court. One of the grounds for refusing an extension of the normal 30-day deadline for this application was that the application lacked substantive merit. Diner J appears to have interpreted the above clause, which fixes the elected amount for the goodwill at $2.5M “unless otherwise agreed,” as preventing the boot from being reallocated to the goodwill.
Neal Armstrong. Summaries of R & S Industries Inc. v. MNR, 2016 FC 275 under Federal Court Act, s. 18.1(2) and ITA s. 97(2).
CRA indicates that Amalco (successor to Buyco) is free to allocate assumed debt to retained rather than distributed Target assets for interest-deductibility purposes
After Buyco acquires Target (funded in part through the assumption of debt of the vendor – in this case, a non-arm’s length vendor), Buyco amalgamates with Target and then immediately makes a paid-up capital distribution of a portion of the acquired assets (being shares of FA) to its parent. CRA stated:
[T]aking into consideration the flexible tracing approach mandated… in Ludco…Amalco would be entitled to allocate the entire amount of the Assumed Debt to its assets other than the FA shares. Thus, the interest payable by Amalco on the Assumed Debt would be deductible under subparagraph 20(1)(c)(ii) after the distribution of the FA shares to the extent that the remaining assets are capable of producing income from property or from a business.
Neal Armstrong. Summary of 5 February 2016 Memo 2014-0555291I7 under s. 20(1)(c).
Income Tax Severed Letters 9 March 2016
This morning's release of eight severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA requires detailed property listings on the ETA s. 167 election form
The ETA s. 167 election form requests a listing of all the types of property acquired. A generic description such as “substantially all the property” is not acceptable. CRA states:
[A] detailed list of all property acquired should be provided in order for CRA to make a determination that all or substantially all of the business has been acquired.
Neal Armstrong. Summary of May 2015 CPA Roundtable, GST Q.4 under ETA s. 167(1).
The ITRD and LAS respectively interpret the ITA and assist in applying those interpretations to the audit facts
The Legislative Application Section (LAS) “provides technical assistance to large case auditors in the application of the ITA to specific facts and issues identified in the context of an income tax audit,” whereas the Income Tax Rulings Directorate “focuses on interpretive issues” - but the two consult frequently.
The LAS issues its memoranda directly to the auditor with that memo being distributed at the discretion of the auditor. However, the taxpayer may formally request a severed copy of the memo under the Access to Information procedure or (preferably) informally request a copy.
Neal Armstrong. Summary of May 2015 CPA Roundtable, Plenary Q.2 under s. 152(1).
CRA responds to allegations it is soft on off-shore tax evasion or aggressive tax avoidance
Perhaps in response to today’s stories in the Press (see “Canada Revenue offered amnesty to wealthy KPMG clients in offshore tax 'sham': Federal authorities demanded secrecy in no-penalty, no-prosecution deal to high net worth Canadians,”) CRA issued a Press Release today indicating inter alia:
- It is actively pursuing the KPMG case referenced in the press including auditing and reassessing those clients identified to date and taking “legal action to obtain the identities of all remaining KPMG LLP clients who have not been identified to date.”
- CRA will pursue penalties or prosecution against tax professionals who “who offer, assist or create opportunities for clients to participate in offshore tax evasion… to the fullest extent possible, based on the law and the facts of each case.”
- “Early dispute resolution [i.e., settlement], where appropriate, is in the public interest.”
Neal Armstrong. Summary of 8 March 2016 CRA Press Release under s. 152(1).
S. 49 option rules only are expected to apply to the Slate REIT rights offering
Slate Retail REIT is making a rights offering to the holders of its units (including the holders of exchangeable units in subsidiary LPs) to acquire REIT units at a discount to their pre-announcement trading price. The rights will be tradeable on the TSX.
In the unlikely event that the rights were to trade at a significant value, there would be a technical concern that their value represented a taxable benefit under s. 105(1). However, the disclosure indicates that CRA likely would accept that there would be no consequences of the distribution of the rights to the unitholders other than under the s. 49 rules.
Neal Armstrong. Summary of Circular of Slate Retail REIT for rights offering under Offerings – Rights Offerings – Units.
TransForce is making an issuer bid under a modified Dutch auction with a specified amount in the lower part of the potential range of purchase prices
TransForce is proposing to repurchase approximately 11% of its outstanding common shares under a modified Dutch auction at a price of between $19.00 and $22.00 per share. Deemed dividends will result, as the paid-up capital per share is around $8.00. Consistently with other issuer bids, the safe harbour from Part VI.1 tax for repurchase amounts paid up to the "specified amount" is considered to be available even where the specified amount is meaningless from a commerical standpoint. The Offer has a stand-alone statement that: “For the purposes of subsection 191(4) of the Income Tax Act (Canada), the "specified amount" in respect of each Share will be $19.61.”
Neal Armstrong. Summary of Offer of TransForce Inc. under Other – Issuer Bids – Share Offer.
TDL Group – Federal Court of Appeal sticks with the direct use test, so that interest on money borrowed to acquire (non-dividend producing) common shares of a subsidiary was deductible
The Canadian taxpayer ("TDL") used money, which it had indirectly borrowed from its U.S. parent ("Wendy’s"), to subscribe for common shares of its wholly-owned U.S. subsidiary ("Tim's U.S.") which, in turn, lent the money back to Wendy’s – initially on a non-interest-bearing basis until it was changed to interest-bearing seven months later (upon being contributed to a new U.S. subsidiary of Tim's U.S.). Pizzitelli J had denied an interest deduction to TDL on its borrowing during the seven-month period, finding that TDL did not have "any reasonable expectation of earning non-exempt income of any kind" on its common share investment in Tim’s U.S.
Dawson JA noted the “paradox” of finding that “there was no income-producing purpose during the first seven months…but an income earning purpose thereafter” given that the same common shares were held by TDL throughout, indicated that there was no requirement that the Tim's U.S. shares generate income during the first seven months of their holding, and stated:
[T]he temporary use of the subscription proceeds by Tim’s U.S. did not detract from the appellant’s income earning purpose behind its acquisition of additional shares in Tim’s U.S.
The interest was deductible.
Neal Armstrong. Summary of TDL Group Co. v. The Queen, 2016 FCA 67 under s. 20(1)(c).
Canadian private equity investors often prefer to invest in a parallel Canadian fund to that used by foreign investors
A non-Canadian private equity fund that expects to have significant investor capital sourced in Canada and to invest in Canadian portfolio companies should consider forming a separate fund restricted to Canadian investors that would invest in parallel with the main fund. If the Canadian fund sells taxable Canadian property, it will not be subject to the s. 116 withholding requirements. In addition, it will not be subject to Part XIII withholding, which might be a concern where an exit strategy entails an asset sale which would give rise to a substantial dividend or deemed dividend. CRA has indicated that no amount in respect of the portion of such payments allocable to a Canadian resident partner of a non-Canadian fund would be required to be withheld by a Canadian portfolio company.
“However, this policy, for which there is no legislative basis, does not expressly supersede past contrasting published positions. Some Canadian investors have expressed uneasiness with this uncertainty and are not receptive to investing jointly with non-Canadians in a fund that is subject to Canadian withholding tax.” Where there is a resulting insistence on the use of a parallel fund, “this is typically easier for Canadian private equity fund sponsors to accommodate than for non-Canadian sponsors, who would otherwise not consider forming a Canadian partnership having a Canadian resident general partner.”
Neal Armstrong. Summaries of Timothy Hughes, Matias Milet and Marc Richardson-Arnould, "Private Equity Funds – Selected Canadian Tax Issues,” Tax Management International Journal, 2016, p.84 under Treaties - Art. 10, s. 115.2(2)(b) and s. 248(1) - taxable Canadian property.