News of Note
New Delaware corporate rectification procedure permits various corporate slips to be rectified without a court proceeding, if uncontested
Email this ContentAs 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).
CRA indicates it would not apply s. 90(7) to a back-to-back loan made to avoid an anomalous application of the s. 90(9) surplus deduction rule
Where Canco holds FA1 with an exempt deficit of $20M, which holds FA2 with exempt surplus of $100M, Canco can take advantage of the surplus deduction rule in s. 90(9) on an upstream loan of, say, $10M from FA2. This is by having FA2 lend that sum to FA1 for on-loaning to Canco. This permits the elevation of the exempt surplus of FA2, so that FA1 is considered to have ample surplus for purposes of accessing the s. 90(9) deduction on the $10M loan to it from FA1 – whereas this result would not obtain if FA2 made the $10M loan directly to Canco.
However, this planning confronts the back-to-back loan rule in s. 90(7) which, applied literally, would deem FA2 to have made its loan directly to FA1. However, having regard to the policy of the provisions, CRA would not apply s. 90(7) in a situation such as this.
Neal Armstrong. Summary of 26 May 2016 IFA Roundtable, Q. 5 under s. 90(8).
CRA indicates that the replacement of an “2nd-tier” upstream loan to a non-resident parent by a PLOI will not occur as part of the same series
Canco indirectly distributed $10M to its non-resident parent (NRco) in 2010 through a capital contribution to a new foreign subsidiary (FA) and a loan of the $10M by FA to NRco. In order to unwind this upstream loan structure by the August 19, 2016 deadline for doing so, NRco will repay the $10M loan owing to FA, FA will pay a $10M dividend to Canco out of pre-acquisition surplus and Canco will make a fresh (direct) loan to NRco, which it will elect to be a “pertinent loan or indebtedness.”
CRA confirmed that the new PLOI loan will not cause the old loan to be considered to have been “repaid…otherwise than as part of a series of loans or other transactions and repayments,” so that a $10M income inclusion to Canco under the upstream loan rules will be avoided.
Neal Armstrong. Summary of 26 May 2016 IFA Roundtable, Q. 4 under s. 90(8)(a).
CRA indicates that a Canadian corporation with a USD functional currency can be subject to Part XIII withholding obligations on its USD prefs resulting from FX fluctuations
CRA considers that a Canadian corporation which has the U.S. dollar as its elected functional currency nonetheless is required to keep track of the paid-up capital of its shares, so that if it issued U.S.$100,000 of shares when the Canadian dollar was at par and redeemed those shares when their Canadian-dollar equivalent was $125,000, there would be a resulting deemed dividend to its shareholder (unless the shareholder was a Canadian corporation that also had the U.S. dollar as its functional currency for the relevant period.) However, there would be no Part VI.1 tax, as that would relate to the tax results of the corporation rather than its shareholder.
Neal Armstrong. Summary of 26 May 2016 IFA Roundtable, Q. 3 under s. 84(3).
CRA continues to not accept the deduction of notional expenses from the profits of PEs of (non-U.S.) non-residents
Notwithstanding a somewhat revised OECD approach, CRA continues to consider (in light of Cudd Pressure and s. 4(b) of the Income Tax Conventions Interpretations Act) that notional expenses are not deductible in computing the profits attributable to a Canadian permanent establishment for Treaty purposes – with the exception of PEs of qualifying U.S. residents, as to which there is an overriding agreement with the U.S. competent authority.
Neal Armstrong. Summary of 2016 IFA Roundtable, Q. 2 under Treaties – Art. 7.