News of Note

Comments of Yves Moreno and Annie Mailhot-Gamelin (both with the Income Tax Rulings Directorate) on the proposed s. 55(2) rules included:

• The integration principle is key to CRA’s thinking about safe income and s. 55(2) (so that the role of s. 55(2) is “is to ensure that corporate tax is paid, but that at the same time that there is no duplication of corporate taxes”) and, conversely, “the concept of safe income is one of the pillars of integration.”
• The changes to s. 55(2) were meant to address the type of planning raised by D & D Livestock, where ACB is created (without being caught by existing s. 55(2) because there was no gain on the shares in question). In particular, new s. 55(2) “now would address circumstances where the purpose of the dividend is to either reduce the value of a share…or to increase the cost of the property in the hands of the dividend recipient…” (with both elements being present in the D&D-style planning).
• For the new rules to apply, there is no requirement that a sale occur as part of the same series of transactions. In this regard, the policy is similar to the boot rules, where excess boot will produce an immediate gain even if there is no plan to use the additional basis.
• CRA previously provided comfort (in 2015-0613821C6) on the non-application of s. 55(2.1)(b) to dividends paid as part of a corporation’s standard practice of paying regular quarterly or annual dividends. CRA has now indicated that the rationale is that “it is doubtful that the dividend would significantly reduce the fair market value or the gain on shares,” and that, in any event, “it is difficult to imagine that one of the purposes of the dividends would be to achieve that.” CRA rejected calling this position a “safe harbour,” stating that “the analysis of every dividend will involve its own set of facts and circumstances.” Similarly, there can be no automatic exemptions for other common dividend transactions such as funding general current expenses of a parent or settling intragroup debt resulting from cash pooling arrangements.
• CRA considers it to be appropriate from a policy perspective for safe income to be correspondingly lower where incentive deductions have lowered a corporation’s income for ITA purposes.
• CRA cannot confirm in the context of a butterfly that the pro-rata requirement in s. 55(1) is met where the shares issued are discretionary, and might ask that the terms of those shares be changed in order to be able to issue a favourable ruling under s. 55(3)(b).

Neal Armstrong. 8 June 2016 CTF Technical Seminar: Update on s. 55(2).

CRA briefly concluded (after the obligatory nod to its two-step approach to foreign entity classification) that a Dutch Co-op was a corporation for purposes of the Act. (See also 2010-0373801R3.)

Neal Armstrong. Summary of 21 June 2016 Memo 2015-0581151I7 under s. 248(1) – corporation.

Application of the plain wording of ss. 132.11(4) and 132.11(5)(c) can produce an odd result. Where, in the last 16 days of December, a mutual fund trust, which has elected a December 15 year end under s. 132.11(1), acquires some units of another mutual fund trust that also has elected a December 15 year end, an income distribution payable by the acquired trust on December 31 (presumably out of post-December 15 earnings) will be deemed to have been received by the top trust in its year that had already ended on December 15, notwithstanding that it was not a beneficiary of the acquired trust at that time.

Neal Armstrong. Summaries of 17 May 2016 T.I. 2014-0546831E5 under s. 132.11(4) and s. 132.11(3).

A simplified description of a “structured transaction” is that Opco used proceeds of a daylight loan to redeem shares of Holdco, which used those proceeds to purchase a life insurance policy (or, to be more precise, to purchase an annuity to fund the premiums on the acquired policy) from an accommodating offshore insurance company, with those funds making their way back, through a series of equally accommodating intermediaries, to the sole individual shareholder of Holdco (“Paul Sr.”) as a loan. This loan was guaranteed by Holdco, with the guarantee secured by Holdco’s life insurance policy. The loan terms limited the lender’s recourse thereunder to realization of such security.

In finding that most of the loan amount was a shareholder benefit, given that “Holdco has agreed to use insurance proceeds from a policy it owns to pay off its shareholder’s debt,” C. Miller J stated

The transactions were structured such that there would be no sensible reason for Paul Sr. to repay the loan. Everyone’s understanding was the annuity and insurance were the only manner in which the obligation of the… loan would be met… .

He did not consider it necessary, in order to reach the above conclusion, to consider that there had been an absolute assignment of the insurance policy by Holdco to the lender at the time of the loan – but considered that, in any event, the purported non-absolute assignment of the policy was a sham, which further buttressed his finding of a shareholder benefit. However, in referring to a clause in the purchased annuity contract which incorrectly indicated that there was a potential investment return on the annuity, he stated that

Although there has been a misrepresentation, my view is that to void the entire transaction as a sham transaction because of a misrepresentation that is not fundamental to the nature of the annuity extends the concept too broadly.

He also found that the 8% interest on the loan (which he appeared to consider to be in excess of a reasonable rate of 5.5%) was deductible in full, but that there was an offsetting shareholder benefit to the extent this interest was capitalized, so that Paul Sr. only received a net interest deduction for the portion of the interest (equivalent to about a 1.33% rate) paid by him in cash.

Paul Sr. used the loan proceeds to acquire shares of Opco with full paid-up capital, with Opco paying off the daylight loan. C Miller J found that if it had been necessary to rely on GAAR, he would have found “there is an abuse of the underlying policy of subsection 84(1).”

Neal Armstrong. Summaries of Golini v. The Queen, 2016 TCC 174 under s. 15(1), s.20(1)(c), s. 245(4), General Concepts – Sham.