News of Note
ENMAX Energy – Alberta Court of Queen’s Bench finds that an 11.5% interest rate on unsecured intercompany debt was reasonable under s. 20(1)(c) notwithstanding that this exceeded an arm’s length rate of around 8.5%
Email this ContentAn Alberta utility (EEC) was required to make payments to the province equal to the provincial and federal income tax to which it would have been subject had it not been tax-exempt. In order to minimize this pseudo-tax liability of EEC, EEC's parent capitalized it mostly with a subordinated note bearing interest at 11.5%, whereas the Alberta government denied the interest deduction over 5.42% as being in excess of the “reasonable amount” referenced in s. 20(1)(c).
After listening to a slew of expert evidence on credit ratings and capital markets, Poelman J concluded that an arm’s length interest rate likely would have been in the range of 7.97% to 8.77% - so that you might have expected him to deny interest expense in excess of 8.77%.
Instead he applied a Gabco-derived test as to “whether no business would have contracted to pay that amount, having only its business considerations in mind and under the form of transaction pursuant to which the obligation was incurred,” and concluded that the interest was fully deductible. He also stated:
[I]ntercompany debt is not rated… . Further… the intercompany notes [here] were burdened with a number of conditions, such as the level of debt and stripping of cash flow to the parent, which would have made them very difficult to sell on the market without significant changes. These observations reinforce the weakness of putting too much emphasis on artificially constructed arm’s length comparators… .
Neal Armstrong. Summaries of ENMAX Energy Corp. v. Alberta, 2016 ABQB 334 under s. 20(1)(c) and s. 67.
CRA substantially rewrites its Bulletin on “Fringe Benefits”
CRA’s new Folio on Benefits and Allowances Received from Employment replaces IT-470R entitled “Employees’ Fringe Benefits” (a phrase which CRA no longer uses). Although there are extensive and substantial changes as compared to IT-470R, this Folio nonetheless does not represent much new. Although the Folio also states that it replaces Income Tax Technical News No. 40, most of the policies in ITTN No. 40 are continued. In addition, various topics which were dealt with in ITTN No. 40 or IT-470R are not brought forward to the Folio and are instead dealt with in referenced web pages on the CRA site. The emphasis in the Folio has shifted somewhat to statements of broader principle, often as enunciated in decisions of the Federal Court of Appeal, including:
- Benefit recognition generally requires generally requires receipt of an economic advantage measurable in monetary terms of which the employee is the primary beneficiary (Lowe)
- “something…provided to an employee primarily for the benefit of the employer…will not be a taxable benefit if any personal enjoyment is merely incidental to the business purpose” (McGoldrick)
- the value of a benefit is its fair market value (Spence)
However, CRA is silent on its judicial authority for a restrictive statement of when a shareholder may receive a benefit qua employee.
Neal Armstrong. Summaries of S2-F3-C2, Benefits and Allowances Received from Employment under s. 6(1)(a), s. 6(1)(a)(iv), s. 6(1)(a)(vi), s. 6(1)(b) and s. 6(1)(b)(v).
Baker – Tax Court of Canada notes that CRA assessed under s. 160 so as to give credit for Quebec tax paid under the Quebec equivalent
On the intestacy of her deceased brother, the taxpayer received property whose value was less than tax debts owing by him to CRA as well as to the ARQ. Smith J adverted to the fact that, technically, the taxpayer could have been assessed by each of CRA and the ARQ under s. 160 and its Quebec equivalent so that, depending on the numbers, she could have been assessed for taxes equalling double the value of the property devised to her. However, such double taxation did not arise here, as CRA only assessed for the difference between the value of her brother’s property received by her and the amount she paid to the ARQ.
Neal Armstrong. Summary of Baker v. The Queen, 2016 TCC 120 under s. 160(1).
Income Tax Severed Letters 13 July 2016
This morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Deluca – Ontario Superior Court finds that CRA has no duty to protect taxpayers from participating in tax shelters
The taxpayer’s claim against CRA for negligence in failing to revoke the registration of a charity on a timely-enough basis (so that he suffered losses as a result of making supposedly valuable donations to the charity) was struck by Dunphy J in its entirety. Among other grounds, he stated:
The ITA cannot be construed to impose a duty on the Minister or his or her officials to administer the registration and supervision of registered charities in order to protect taxpayers from the risk of dealing with them…
Tax shelters are an instance where the private good competes directly with the public good. … [T]he risk of such deductions being disallowed ought most efficiently to rest with those seeking to benefit from the scheme rather than with taxpayers at large. …
Neal Armstrong. Summaries of Deluca v Canada, 2016 ONSC 3865 under s. 171(1), General Concepts – Negligence, Charter s. 15.
LLLPs may be partnerships on the basis of being governed by a contract for carrying on business in common
At 2016 IFA Roundtable, Q. 1, CRA orally indicated that Florida and Delaware limited liability partnerships and limited liability limited partnerships are corporations for ITA purposes, given their separate legal personality and that all the members (even the GP) have limited liability.
Joel Nitikman suggests that an LLLP or an LLP is a partnership for ITA purposes given that has the following hallmarks of partnership:
(a) it has at least two members;
(b) its members are carrying on business with a view to profit; and
(c) there is in force a contractual agreement, express or implied, in writing orally, or by conduct, between or among its members to carry on the business with a view to profit.
Adoption by CRA of this view presumably would entail repudiation of its position that Quebec limited partnerships which do not carry on business can be partnerships (see 2011-0411911C6, see also Folio S4-F16-C1, para. 1.18). (See also Matias Milet respecting the more flexible Wittgenstein approach of identifying "family resemblances" within a class of entities.)
Neal Armstrong. Summary of Joel Nitikman, "Is an LLP a Corporation for Canadian Tax Purposes? A Reply to the CRA," Tax Topics, (Wolters Kluwer), No. 2313, July 7, 2016, p.1 under s. 96.
CCPCs can choose to forego the small business deduction so as to maximize their GRIP
CRA accepts that a corporation may choose not to take the small business deduction so as to increase its general rate income pool account, thereby increasing the amount that may be distributed as eligible dividends.
Neal Armstrong. Summary of 20 June 2016 T.I. 2016-0648481E5 Tr under s. 89(1) - adjusted taxable income.
CRA states that limited partners carry on the trading business of their LP for purposes of the s. 39(4) capital gains election
A hedge fund, which is a limited partnership, engages in trading of Canadian securities which would cause it to be considered to be a trader or dealer in securities – but its trading gains are allocated to its Canadian limited partners. If they have made the s. 39(4) election, are those gains deemed to be capital gains? CRA responded:
[A] limited partner of an LP will be considered to be carrying on the business of the LP in applying subsections 39(4) and 39(5). … [P]aragraph 11 of… IT-479R … could be useful in determining…whether a limited partner of an LP in the described situation is a trader or dealer in securities for the purposes of subsection 39(5).
This might be saying that because the LP is carrying on a trading business, each limited partner thereby would be considered to be a trader or dealer in securities respecting the trading gains allocated to it, so that the election would not be available. Such a view would be debatable, given that s. 39(4.1) only deems the partners to own and dispose of the LP securities and does not deem them “to be carrying on the business of the LP” as asserted by CRA. Furthermore, although s. 96(1)(f) deems trading income of the LP to be trading income of the partners, it does not go on to deem the partners to be traders.
Neal Armstrong. Summary of 20 June 2016 T.I. 2014-0559961E5 Tr under s. 39(4.1).
Oil Search consideration for InterOil shares would include a substantial contingent cash payment based on how big InterOil’s natural gas resource turns out to be
Oil Search, a Papua New Guinea (“PNG”) corporation listed on the Australian Stock Exchange and whose ADSs trade over the counter in the U.S., is proposing to use a newly-incorporated Yukon subsidiary to acquire (under a Yukon Plan of Arrangement) InterOil, which is a Yukon corporation listed on the NYSE but essentially all of whose assets are natural gas assets held in a PNG subsidiary. The consideration incudes not only Oil Search shares or cash (subject to a U.S.$770M cap) but also “contingent value rights,” which will trade on the ASX and will entitle the holder to a cash payment based on the extent to which an interim resource assessment of a PNG natural gas project of InterOil shows a resource of greater than 6.2 trillion cubic feet equivalent ("tcfe"). For example, if the resource is measured at 10 tcfe, the CVRs would pay U.S.$1.17 billion in total.
The Canadian tax disclosure indicates that the proceeds of the InterOil shares likely would include the estimated fair market value of the CVRs at the time of the Arrangement, and suggests that although the CVRs are legally described as “notes,” they might not be subject to the prescribed debt obligation rules given that the amount payable is “uncertain and unlimited.” There likely is no discussion of the Budget rules applicable to Reg. 7000(1)(d) obligations, as this would not affect the broader statement that whether any gain would be on income or capital account is uncertain.
The U.S. tax disclosure waffles even on the issue whether the holders can get the benefit of their basis in the CVRs, and indicates that Code s. 483 imputed interest rules likely would apply.
The Australian tax disclosure is crisply Australian.
Neal Armstrong. Summary of InterOil Booklet for its acquisition by Oil Search under Mergers & Acquisitions – Cross-Border Acquisitions – Inbound – Canadian Buyco.
Polycom acquisition by Mitel is anticipated to avoid Mitel becoming a U.S. corporation
The acquisition of Polycom, a NASDAQ-listed U.S. corporation by Mitel in a Delaware merger (in which an indirect Delaware sub of Mitel (“Merger Sub”) is merged into Polycom, with Polycom as the survivor) is being structured so that it will be treated for accounting purposes as a purchase by Mitel and as not causing Mitel to be deemed to be a U.S. corporation under Code s. 7874 – even though the market cap of Polycom is almost 50% greater than that of Mitel. This is being accomplished by a portion of the cash consideration for the public’s shares of Polycom being paid in cash (with much of the cash coming from Polycom itself.)
Mitel and Polycom intend to treat the merger as divided for Code purposes into two transactions: (1) the redemption of a portion of the shares of Polycom stock held by each Polycom stockholder for the portion of the cash consideration that is funded by Polycom (including any borrowing by Merger Sub and Polycom and any cash distributions from subsidiaries of Polycom (collectively, the "redemption cash")), and (2) the exchange of a portion of the shares of Polycom stock held by each Polycom stockholder for Mitel common shares and the cash which is funded by Mitel (the "merger cash.") The shares of Polycom stock held by each Polycom stockholder will be divided between these transactions based on the relative fair market values of the merger consideration exchanged for such shares.
The payment of the redemption cash will be treated as a distribution in redemption of shares of Polycom stock. The receipt of the merger cash (but not the Mitel common shares) by U.S. Holders is expected to be subject to Code s. 304 so that the Polycom stockholders will be treated as if they received additional Mitel common shares in the merger equal in value to the merger cash, and then Mitel redeemed such shares for such merger cash.
Presumably for Canadian basis reasons, the merger agreement provides for the issuance, on the merger, of shares by Polycom to Mitel (or Merger Sub’s immediate Delaware parent) in consideration for Mitel's payment of the aggregate consideration to the Polycom shareholders.
Neal Armstrong. Summary of Polycom Proxy Statement under Mergers & Acquisitions – Cross-Border Acquisitions – Outbound – Delaware Mergers.