News of Note
Foreign affiliate debt forgivenesses are not always benign
Email this ContentThe main distinctions between the ordinary and FAPI debt forgiveness regimes is that, under the former, an income inclusion can arise where the debtor does not have sufficient attributes to grind in the year, whereas under the latter, if the debtor has insufficient attributes in the year the debt is forgiven, the excess will be carried forward indefinitely to reduce future attributes rather than generating FAPI.
Although this sounds comforting, taxpayers should be cautious respecting forgiveness of shareholder loans owing by a foreign affiliate, as the s. 15 rule trumps the FAPI debt forgiveness rules.
Taxpayers have a preference to apply forgiven amounts to reduce FAPLs rather than FACLs.
The definition of foreign accrual tax requires that the relevant foreign income tax reasonably be regarded as applicable to the subsection 91(1) amount. It is not obvious whether this condition could be met if foreign tax is paid on a forgiven amount that reduces the debtor's FAPLs or FACLs in a particular year and the debtor realizes FAPI in a future year as a result.
Neal Armstrong. Summaries of Mark Coleman, Daniel A. Bellefontaine, "Forgiveness, Foreign Affiliates and FAPI: a Framework," Resource Sector Taxation (Federated Press), Vol. X, No. 1, 2015, p.694 under s. 95(2)(g.1), s. 95(1) – foreign accrual property income, s. 15(1.2), and s. 95(1) – foreign accrual tax.
CRA notes that “technically” s. 74.4(2) may be avoided through a stock dividend
CRA noted that s. 74.4(2) would likely apply to transactions in which a small business corporation (Opco) declares a stock dividend, consisting of high-low preferred shares, on its common shares held by an individual (Mr. X), with Mr. X rolling those prefs into a non-SBC (Holdco) held solely by his wife in exchange for Holdco prefs, and Opco then redeeming the prefs held by Holdco.
CRA then acknowledged (following 2014-0538041C6 F), that “technically” s. 74.4(2) would not apply if Opco instead was not a SBC and, following the high-low stock dividend by Opco to Mr. X, what instead happened was that his wife simply subscribed for common shares of Opco – and noted that CRA generally does not comment on GAAR in the context of a technical interpretation.
Neal Armstrong. Summary of 8 December 2015 T.I. 2015-0613401E5 F under s. 74.4(2).
CRA accepts that annual dividends by an SBC to a non-SBC are not an indirect transfer of property to the non-SBC by the individual who formed the SBC
An individual does an estate freeze on his small business corporation (“Opco”), so that all its common shares end up being held by a family trust, one of whose beneficiaries is “Holdco,” which is not an SBC. In order that Opco can maintain its SBC status, its earnings are annually dividended out to the Trust, which allocates them all to Holdco. CRA accepts that this annual transfer of property to Holdco does not represent an indirect transfer of property by the individual to a non-SBC (Holdco), so that s. 74.4(2) does not apply.
CRA takes a similar approach where the transaction instead is the individual incorporating his active business, the Holdco subscribing for a separate class of discretionary-dividend shares of the new SBC, and the new SBC annually paying dividends to Holdco on its shares, i.e., CRA again generally considers that this does not represent an indirect transfer of property by the individual to Holdco.
Neal Armstrong. Summary of 11 December 2015 T.I. 2015-0601561E5 F under s. 74.4(2).
CRA permits safe income to be allocated based on which class of discretionary shares receives dividends
Where a corporation has different classes of discretionary-dividend common shares, CRA effectively considers that the safe income on hand of the corporation can be allocated to whichever class of shares a discretionary dividend is paid on. For example, if Husband holds 99 Class A common shares of Opco and his estranged wife held 1 Class B common share (issued at the same time as the Class A shares, and entitled to only 1% of the remaining property on liquidation), which she has transferred under s. 85(1) to a new Holdco, CRA will accept that a dividend, which is paid only on the Class B share, comes 100% out of all of Opco’s safe income, so that the dividend is tax-free (subject to Part IV tax considerations). In particular, CRA accepts the proposition that the fair market value of the Class B share immediately before the dividend payment reflects the amount of the declared dividend, and also reflects the safe income that will imminently be distributed on the share.
At the 2015 annual CTF conference, CRA indicated (in Q.6(c)) that where a non-participating discretionary share (e.g., a non-cumulative preferred share) has no accrued gain, then a dividend paid thereon which violates the purpose test cannot benefit from safe income - but, where this occurs, CRA is prepared to accept that the safe income on the common shares of the same corporation will not be reduced. CRA has now essentially confirmed this position, but garnished with more detailed analysis.
CRA declined to express a view as to whether an $8,000 reduction in an accrued capital gain of $120,000 was significant. Probably not much should be read into this.
Neal Armstrong. Summary of 3 December 2015 T.I. 2015-0593941E5 F under s. 55(2.1)(c).
Scheuer – Federal Court of Appeal indicates that investors in a gifting tax shelter might be better off suing their own advisors – rather than CRA for issuing a tax shelter number
The taxpayers, who participated in the same gifting tax shelter as Ficek, sued CRA for negligence in issuing a tax shelter registration number to the promoter and in not warning them of potential problems. In finding that their statement of claim should be struck “for failing to assert a cognizable cause of action,” Dawson JA noted that issuance of a tax shelter number was not discretionary (i.e., was required if the specified information was submitted) and that the “written warning tax shelter promoters are mandated by paragraph 237.1(5)(c)… to display” (that the number does not confirm any tax benefits)
is consistent with Parliament’s intent that taxpayers should participate in a tax shelter at their own peril, not at the peril of Canadian taxpayers generally. … The issuers of [the related] opinions, who benefited financially from the provision of their professional advice, are better placed to indemnify the plaintiffs in the event of negligence in the exercise of their professional responsibilities.
…The above conclusions … reflect that the performance of statutory duties does not generally give rise to private law duties of care.
Neal Armstrong. Summary of The Queen v. Scheuer, 2016 FCA 7, under General Concepts – Negligence.
The Aggressive Planning section manages "sham" assessments
Before a GST assessment based on “sham” is made, an auditor must prepare a position paper explaining that position and send it to the Aggressive GST/HST Planning Section - HQ for review, which then “works closely with the TSO in ensuring the two elements of sham are demonstrated” (i.e., deceit, as broadly defined in Antle, and actual legal rights which are different), and also approves the final assessment.
Neal Armstrong. Summary of 26 February 2015 CBA Roundtable, Q. 6 under General Concepts – Sham.
CRA continues to consider that costs incurred respecting capital raises to fund an operating subsidiary are not creditable under ETA s. 186(1)
Memorandum 8.6, para. 11, Example 3, indicates that “HoldCo” may not claim input tax credits under ETA s. 186(1) for legal and accounting costs incurred in connection with raising money through issuing shares, even where the issuance proceeds are used to purchase additional shares in “OpCo,” all of whose property is acquired for consumption, use or supply in widget manufacturing - on the basis that the services are acquired for consumption or use in relation to the first order supply (the share issuance) and not in relation to the shares of OpCo. Although this approach was rejected by the Tax Court in Stantec, CRA will not revise this example, stating that the Tax Court decision was an informal procedure case and that its approach on this issue was not dealt with on the appeal to the Federal Court of Appeal.
Neal Armstrong. Summary of 26 February 2015 CBA Roundtable, Q. 17 under ETA s. 186(1).
Income Tax Severed Letters 20 January 2016
This morning's release of 12 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Birch Hill – Ontario Superior Court of Justice refuses to rectify stock option transactions on the basis that the s. 110(1)(d) deduction was peripheral to the larger sale transaction
Ten executives who were denied the ½ s. 110(1)(d) deduction for their $17 million stock option benefit on the basis inter alia that they had sold the shares acquired by them on exercise of their options to a specified person (who on-sold to the arm’s length purchaser of the corporation, namely, Rogers), rather than directly to Rogers, were denied a rectification of the sales agreement to add them as parties to it and to provide for the transfer by them of their optioned shares directly to Rogers. Dunphy J found that there was “insufficient evidence… of an initial mutual ‘mistake’ as to a dominant or even important issue to the [sale] transaction itself,” noting that “I cannot characterize as a mistake a matter which was simply too insignificant to the parties to make its way on to the radar screen when they were negotiating their $425 million transaction.”
Although CRA did not contest the rectification application, it also took the position that the shares were not prescribed shares because the Board on liquidation had the discretion to establish a fixed liquidation amount for the shares, and reserved the right to maintain its denial of the s. 110(1)(d) deduction on this alternative basis . This was a further ground for denying rectification, i.e., the proposed “fix” might not be effective.
Neal Armstrong. Summaries of Birch Hill Equity Partners Management Inc. v Rogers Communications Inc., 2015 ONSC 7189, under General Concepts - Rectification and Reg. 6204(1)(a).
Green – Tax Court of Canada finds that limited partnership losses flow through a 2-tier LP structure
Paris J found that the business losses of a limited partnership allocated to an upper-tier partnership in excess of its at-risk amount continue to be business losses in its hands, so that such losses can, in turn be allocated to the partners in the upper-tier partnership – so that, if the at-risk amount rules apply, it is only to restrict the losses that are allocated to the partners in the upper-tier partnership. This runs contrary to CRA positions (2012-0436521E5, 2004-0107981E5, 2004-0062801E5 and 5-94077) that business losses generated in a lower-tier limited partnership effectively can be extinguished.
Paris J thought that the Crown was reading too much into s. 96(2.1)(c), which provides that a business loss in excess of the at-risk amount “shall not be deducted in computing the taxpayer’s income for the year.” The upper-tier partnership (like other partnerships) only computes income for purposes of allocating it to its partners and is not itself a taxpayer for computing income under s. 3, so that s. 96(2.1)(c) does not apply to deny the recognition of business losses in the hands of the upper tier partnership for such computation purposes. Conversely, s. 96(2.1)(e), which deems the excess business loss to be a limited partnership loss, is intended to operate only at the level of a taxpayer who is required to compute income and taxable income, i.e., only at the level of the partners in the upper-tier partnership.
Neal Armstrong. Summary of Green v. The Queen, 2016 TCC 10, under s. 96(2.1).