News of Note
Income Tax Severed Letters 5 August 2015
Email this ContentThis morning's release of 12 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
The foreign-affiliate dumping rules could apply currently, or year-by-year, to earnout clauses, and commercial conflicts can arise re whose PUC (the non-resident parent’s or an arm’s length 3rd-party shareholder’s) is reduced under those rules
There are two interpretations of how to apply an earnout clause in an agreement for the acquisition of a subject corporation by the CRIC: there are successive transfers of property by the CRIC each time a payment obligation is crystallized under the earnout (so that there are successive deemed dividends subject to the PUC offset rules); or the deemed dividend (or PUC offset) is determined only once at the investment time.
The first interpretation produces the peculiar result that the value of the subsequent deemed dividends are measured based on the fair market value of the transferred property at the investment time rather than at the times of their actual subsequent transfers (which might, for example, entail valuing shares at a time that the issuer had not yet been incorporated.) However, this approach nonetheless may be preferable to the second approach, which "would require the contingent obligation to be valued at the investment time and necessitate an analysis of the likelihood of the CRIC being required to make future earnout payments as well as the quantum of such payments."
Potential conflicts can arise between a non-resident parent of the CRIC and an arm’s length 3rd party who holds all of the shares of one class of shares of the CRIC. Where the CRIC "can demonstrate" that all of the PUC of that class arose as a result of property transferred to the CRIC which was all used to make the investment in the subject corp, the PUC of that class will be automatically reduced under the offset rule in s. 212.3(7)(a). Thus, from the perspective of the non-resident parent, it could reduce the reduction to the PUC of its share investment by causing the CRIC to demonstrate that none of the transaction costs reduced the amount of the investment traceable to the share subscription proceeds of the 3rd party. Should the 3rd party get the CRIC to agree that it will not demonstrate that the s. 212.3(7)(a) requirements are satisfied?
S. 227(6.2) generally requires the CRA to accept late-filed forms under s. 212.3(7)(d) for the offset of a deemed dividend otherwise arising under the foreign affiliate dumping rules and refund the Part XIII tax paid on the deemed dividend. However, s. 227(6.2) does not retroactively rescind the deemed dividend so that, even after the s. 212.3(7)(d) form is late-filed, the CRIC is still deemed to have paid a dividend to the non-resident parent for purposes of other provisions, e.g., ss. 129(1), 112(3) and Part IV.
Neal Armstrong. Summaries of Brett Anderson and Daryl Maduke, "Practical Implementation Issues Arising from the Foreign Affiliate Dumping Rules," draft version of paper for CTF 2014 Conference Report under s. 212.3(2), s. 212.3(7)(a), s. 227(6.2), s. 212.3(14)(a), s. 212.3(19) and s. 212.3(1.1).
Turcotte – Quebec Court of Appeal finds that an estate could not “double dip” for a testamentary gift
An estate which, under the Quebec equivalent of s. 118.1(5), had claimed a charitable credit in the terminal return of the deceased for a gift directed to be made in the will, also claimed a deduction under the equivalent of s. 104(6)(b) in the estate return on the basis that paying the gift to the charity in question was a distribution of estate income. Vézina JCA found that this deduction represented impermissible "double dipping," and that it made no difference that the gift was clearly funded out of proceeds of an RRSP, which had been included in the estate’s income.
Neal Armstrong. Summary of Turcotte v. ARQ, 2015 QCCA 396 under s. 104(6).
Guindon – Supreme Court of Canada finds that “culpable conduct” under s. 163.2 must be at least as bad as gross negligence under s. 163(2)
Before finding the preparer’s penalty under s. 163.3(4) is not a criminal penalty so that the preparer does not benefit from procedural protections under s. 11 of the Charter, Rothstein J quoted the definition of "culpable conduct" and stated:
"[W]ilful, reckless or wanton disregard of the law" refers to concepts well-known to the law, commonly encountered as degrees of mens rea in criminal law… . [T]he standard must be at least as high as gross negligence under s. 163(2)… .
A family lawyer and president of a charity was liable for penalties (of $547,000, before add-ons) for issuing charitable receipts to 134 different investors in a charitable donation scheme after falsely representing in a tax opinion that that she had looked at the implementing documents (which did not exist).
Neal Armstrong. Summaries of Guindon v. The Queen, 2015 SCC 41 under s. 163.2(4) and s. 163.2(1) – culpable conduct.
Public Television Association of Quebec – Federal Court of Appeal finds that PTAQ was a conduit for a U.S. public TV station
In order for a Quebec-based corporation with educational TV objects (PTAQ) to qualify as a "charitable organization" under s. 149.1(1), it was required to itself carry on charitable activities rather than merely disbursing funds to a non-qualified done, in this case, a Vermont public TV station (VPT). Accordingly, agreements were carefully crafted to require VPT to produce non-commercial television as agent for and at the direction of PTAQ and engage in fund-raising for PTAQ.
This structure was ignored by them. PTAQ merely purchased programming from VPT that had been assembled without input or control by it. Indeed, PTAQ was merely a "conduit" for VPT, i.e., VPT allocated its Canadian donors to PTAQ, PTAQ issued receipts to them, and paid the proceeds over to VPT in amounts that always matched VPT’s programming charges.
Neal Armstrong. Summary of Public Television Association of Quebec v. M.N.R., 2015 FCA 170 under s. 149.1(1) - charitable organization.
Folio reference to Mark Resources fails to acknowledge its obsolescence
In Folio S3-F6-C1, CRA indicates (perhaps somewhat contrary to TDL and Swirsky) that it is only in quite limited circumstances that it will consider investments in common shares to not be an eligible use of borrowed money. However, it then notes that in Mark Resources, where borrowed money was used to fund a cross-border investment in a U.S. Lossco, the interest deduction was denied because "the real purpose of the borrowing was to enable the Canadian corporation to absorb into its income the losses of its foreign subsidiary."
This reference is "puzzling." Leaving aside that the scheme would no longer work anyway, "Mark Resources is a clear outlier" as it departs from the s. 20(1)(c) (largely direct) use test as subsequently clarified by the Supreme Court of Canada (e.g., in Singleton).
Neal Armstrong. Summary of Nathan Boidman, Héléné Gagné, and Michael Kandev, "Interest Deductibility in Canada: What's the Fuss?", Tax Notes International, July 13, 2015, p. 16 under s. 20(1)(c).
CRA treats the cost of gift cards redeemable at a supermarket as food and beverage expense
S. 67.1(1) denies the deduction of 50% of the cost of food and beverages, and an exemption from this rule in s. 67.1(2)(a) appears to be restricted mostly to restaurants, bars and caterers rather than to any purchase made in the ordinary course of business.
CRA considers that the cost of gift cards purchased for promotional purposes (e.g., to thank customers who attend marketing presentations) will be treated as a food and beverage expenditure subject to the 50% limitation if the cards are "exchangeable for merchandise in an establishment that is primarily engaged in selling foods and beverages," e.g., a supermarket (unless the business can establish that in fact the cards were exchanged for something else).
Neal Armstrong. Summary of 4 November 2014 T.I. 2014-0521211E5 F under s. 67.1(1).
Income Tax Severed Letters 29 July 2015
This morning's release of eight severed letters from the Income Tax Rulings Directorate is now available for your viewing.
North American Palladium will be recapitalized through debt being exchanged for common shares
It is proposed that $345M of the debt of North American Palladium (including a fair amount of interest that accrued at a 19% rate) be exchanged under a Plan of Arrangement for treasury common shares, with the existing common shareholders thereby being diluted down to 2%. 10 days later, but also under the same Plan of Arrangement, the common shareholders will be issued rights (which will be listed on the TSX) to acquire further common shares. The two principal former debt holders (Brookfield and Polaris) will "backstop" the rights offering (so as to effectively guarantee that the target equity will be raised), but in a manner so as to comply with the s. 15(1)(c) safe harbor for rights offerings. Ineligible (non-North American) holders will not be permitted to exercise rights, which instead will be sold on their behalf.
No tax risk factors are disclosed (the debt forgiveness rules are too boring for words).
The exchanged debt would include an exchange of debentures (for which there is tax disclosure) and should qualify as a tax-free recapitalization for U.S. federal income tax purposes.
Neal Armstrong. Summary of under North American Palladium Circular under Other – Recapitalizations.
Where a corporation confers a benefit on the wife of a shareholder, CRA will apply the s.15(1.4)(c) inclusion to that shareholder rather than the other shareholders (his brothers)
S. 15(1.4) extends the operation of s. 15(1) by assimilating benefits conferred on an individual who does not deal at arm's length with, or is affiliated with, a shareholder of a corporation, to benefits conferred on the shareholder – except where the benefit is (already) included in the income of the individual or another person. Where the corporation, with four equal shareholders who are siblings, confers a benefit on the spouse of Sibling 4, CRA arguably has a choice as to which sibling will have the s. 15(1.4)(c) income inclusion, given that the spouse is related to each sibling. Not surprisingly, CRA will include the benefit in Sibling 4's income only. CRA was not asked, and it might not always be clear, whether the same approach would apply where the other shareholders are instead parents, children or personal holding companies.
Neal Armstrong. Summaries of 24 June 2015 T.I. 2015-0575911E5 F under s. 15(1.4)(c), s. 56(2) and s. 246(1).