News of Note
Fiducie Claude Deragon – Tax Court of Canada finds that sales proceeds included contingent reverse earn-out amounts, but could be reduced by the operation a year later of a price adjustment clause
Email this ContentVendors agreed to sell shares for a sale price of $16 million, of which $2 million was payable in subsequent years only if an EBITDA condition respecting the sold companies was satisfied. The sales agreements contained a simple price adjustment clause based on the final audited shareholders’ equity of the sold companies. When a substantial deficiency in shareholders’ equity subsequently emerged, a negotiated Settlement Agreement concluded more than a year after the sale reduced the gross sale price by $0.5 million (to $15.5 million), increased the portion of the sale price payable under the reverse earn-out to $3 million – and provided that the vendors would reimburse a further portion of the sale price out of amounts received by them under the earn-out.
Favreau J respected the retroactive downward adjustment, pursuant to the Settlement Agreement, of the proceeds of disposition by $0.5 million but, by the same token, considered that the reverse earnout amounts of $3 million could not be excluded from the proceeds of disposition notwithstanding their contingent nature. However, somewhat paradoxically, he did not permit a downward adjustment to the proceeds of disposition for the contingent obligation to refund the sale price to the purchasers.
He also noted that the taxpayer had relied on IT-462, para. 9 to avoid income treatment of the proceeds under s. 12(1)(g). Consistently with this reverse earnout policy, the vendors presumably could have recognized a capital loss in subsequent years when they refunded the sale price, although those years were not before him.
Neal Armstrong. Summary of Fiducie Claude Deragon v. The Queen, 2015 CCI 294, under s. 54 - "Proceeds of Disposition" - para. (a).
Income Tax Severed Letters 2 December 2015
This morning's release of seven severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Discovery Trust and Boettger have not changed CRA’s application of the Fundy residency test to provincial trusts
CRA's views regarding the application of the "central management and control" test in determining the residency of a trust for provincial tax purpose (so as to determine whether such control is exercised by the settlor or beneficiaries rather than the named trustee) has not changed as a result of Discovery Trust and Boettger, so that it will continue to look at who makes the substantive decisions (being the high-level, strategic decision-making and governance rather than the day-to-day functions), where the power and discretion is really being exercised, and where the real business is carried on.
Neal Armstrong. 24 November CTF Annual Roundtable, Q.3.
Thibeault – Tax Court of Canada finds that a bare boat lease did not qualify as a business
D’Auray J applied a test derived by her from Oke, that a taxpayer’s activities must “surpass those which are usually provided under a lease,” to find that a bare boat lease by an individual of his boat to his company for use by it in operating whale-sighting cruises did not qualify as a business activity under Reg. 1100(17.3)(b), so that his CCA deductions were limited by the leasing property restriction rule. In particular, his distributing pamphlets, constructing a ticketing booth, landscaping around the booth and selecting a caterer, were effected in his capacity of shareholder of the company rather than of lessor.
Neal Armstrong. Summary of Thibeault v. The Queen, 2015 CCI 271, under Reg. 1100(17.3)(b) and 20(1).
Hôpital Santa Cabrini – Tax Court of Canada finds that a hospital which contracted for the services of nurses employed by a personnel-services agency was not being supplied an exempt supply of nursing services
Archambault J found that a hospital which paid outside personnel-services agencies to receive the services of salaried nurses employed by the agencies was not thereby receiving an exempt supply of nursing services under Sched. V, Pt II, s. 6 given that the nurses were providing their services under the direction and control of the hospital rather than of managers at the agencies. In fact, he even found that the agreement between the hospital and each agency only gave rise to rights which were property so that the object of the agreement was property rather than services.
Neal Armstrong. Summary of Hôpital Santa Cabrini v. The Queen, 2015 CCI 264 under ETA, Sched. V, Pt II, s. 6.
CRA considers that a member of an LLC is subject to U.S. income taxation on the LLC income for purposes of s. 95(2)(a)(ii)(D)(IV)(2) even though the net inclusion in its income is reduced by interest payable to a financing foreign affiliate
S. 95(2)(a)(ii)(D) may apply to deem interest payments received by FA #1 from FA #2 in a year on money borrowed by FA #2 to acquire shares of a foreign affiliate (Target) to be active business income. Among other conditions, s. 95(2)(a)(ii)(D)(IV) requires that in respect of both FA #2 and Target, either:
- the affiliate is subject to income taxation in a foreign country in the year; or
- the affiliate's shareholders are subject to income taxation in a foreign country on substantially all of the affiliate's income for the year.
CRA considers that the 2nd test above will be satisfied, in the situation where Target is an LLC that is treated for U.S. purposes as a partnership in which FA #2 has a 95% partnership interest, if substantially all (i.e., 95% in this example) of the Target income is included in the computation of the income of FA #2, even though that computed income is reduced by the interest expense payable by FA #2 to FA #1 on the borrowed money that had been used to acquire Target.
Neal Armstrong. 24 November 2015 Annual CTF Roundtable, Q. 9.
DMWSHNZ Ltd. – English Court of Appeal finds that the repayment of a note does not entail its disposal to the debtor
Lewison LJ rejected a U.K. taxpayer’s submission that when a debtor repays a note, there is a disposal of the note to the debtor given that following such repayment the debtor is still required to cancel the note (stating that “In the real world when the debt was repaid the obligation to pay was discharged; and there were no remaining creditor's rights that could have been transferred to the Issuer.”)
The correctness of this view is even more apparent in Canada, given that s. 84(9) deems the cancellation of a security to entail its disposition to the issuer only in the case of a share, although CRA professes (e.g., in 2010-0385771E5) that a trust distribution to capital beneficiaries in satisfaction of their interest entails an acquisition of property by the trust.
Neal Armstrong. Summaries of DMWSHNZ Ltd. v. Commissioners for Her Majesty's Revenue and Customs, [2015] BTC 32, [2015] EWCA Civ 1036, under s. 69(1)(b) and Statutory Interpretation – Purpose.
CRA considers that s. 94(10) can impose a retroactive obligation on a non-resident trust to file returns for up to five previous taxation years
In its published version of Q.7 at the 2015 STEP Roundtable, CRA has provided an extended example illustrating that where a previous long-term Canadian resident left Canada, made a contribution more than five years later (say, in 2010) to a non-resident trust with Canadian beneficiaries, and then returned to Canada in 2015, less than 60 months later, s. 94(10) would then apply retroactively to all the post-contribution years, i.e., 2010 through to 2015, to deem the trust to be resident in Canada in those years. Consequently, it would be retroactively delinquent for having failed to file (and pay) the requisite returns (and tax) for those years. If he instead made the contribution to the trust in 2010 when he had been a non-resident for less than five years (and again returned to Canada in 2015 less than 60 months after that contribution), the Trust would be deemed fron the time of his contribution to be resident in Canada (i.e., from 2010 onwards) - rather than s. 94(10) applying retroactively at the time of his return to Canada to deem this result.
Neal Armstrong. Summary of 19 September 2015 STEP Roundtable, Q.7(b), 2015-0572141C6, under s. 94(10).
Amos-Yeo – England and Wales High Court finds parties' intention to distribute enough shares to trust beneficiaries to access a reduced capital gains rate was sufficient to rectify a miscalculation of the shares’ number
In order that some trust beneficiaries could access a reduced U.K capital gains rate on a share sale, they were required to hold over 5% of the nominal share capital of the company before they sold their shares. Accordingly, the trusts distributed over 5% of the shares to them more than one year before a sale closed. However, due to the trust advisor overlooking the higher nominal capital of some of the other shares, the shares which were so distributed to them represented only 4.97% of the company’s share capital.
The intention of the parties to transfer enough shares to access the reduced rate of tax was found to be a sufficiently specific intention to permit rectification of the number of shares transferred, even though the parties had left the determination of the precise number to their advisor.
Neal Armstrong. Summary of Prowting 1968 Trustee One Limited v. Amos-Yeo, [2015] EWHC 2480 (Ch), under General Concepts – Rectification.
Bueti – Tax Court of Canada seems to imply that s. 70(5)(b) cannot apply to property acquired by a residuary beneficiary
Owen J made a factual finding that a particular property (a house in the estate of the taxpayer’s father) was purchased for cash consideration by her and her husband, as joint tenants, rather than being devised to her under her father’s will. Accordingly, it was clear that her and her husband’s cost of the property was their cash purchase price rather than being deemed by s. 70(5)(b) to be its higher fair market value at the time of their purchase.
Before so concluding, he made the interesting observation that, under the laws of Ontario, residuary beneficiaries do not acquire an interest in any specific property in the residue of the estate and it is instead the executors who acquire the property in the residue – with a possible implication that s. 70(5)(b) cannot apply to property acquired by a residuary beneficiary (as contrasted to property acquired by specific devise or bequest). Neither counsel mentioned s. 248(8)(a), which deems property acquired “as a consequence of the terms of the will” to be acquired “as a consequence of the death” (being the triggering phrase in s. 70(5)(b).)
Neal Armstrong. Summary of Bueti v. The Queen, 2015 TCC 265, under s. 70(5).