News of Note
Income Tax Severed Letters 3 June 2015
Email this ContentThis morning's release of six severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Kruger – Tax Court of Canada decision calls into question the use of mark-to-market accounting by financial institutions for derivatives
Kruger engaged in extensive trading of FX options, mostly writing European style puts and calls, although it also purchased FX options. It was not a financial institution or subject to oversight of a financial regulator, so that CRA’s policy of letting those entities use mark-to-market a tax accounting for derivatives (which are not covered by s. 142.2) did not apply. Rip J held that "the realization principle is basic to Canadian tax law," so that’s what Kruger was required to follow. An exception was made in the case of purchased FX options, which qualified as inventory, so that accrued losses could be recognized under s. 10. However, as noted, most of the options were ones where Kruger was the writer, which Rip J viewed as liabilities rather than inventory. Rip J also was troubled that because these were European-style options, which were difficult to value, they essentially were being "marked to model" rather than marked to (any) market – although it is not clear if he would have come to any different conclusion if the options were more liquid.
At para. 115 of his reasons there appears to be an implied criticism of CRA for not applying the law (i.e., realization principle) to the banks and other financially regulated enterprises. In 2012, CRA indicated (in 2008-0289021E5) that it may no longer accommodate non-statutory mark-to-market accounting, and this case will not help.
Neal Armstrong. Summaries of Kruger Inc. v. The Queen, 2015 TCC 119, under s. 9 – timing, s. 10(1) and s. 4(1)(a).
CRA’s view of the acting-in-concert doctrine may be overly broad
CRA’s statement in Folio S1-F5-C1 that "Even when there are two distinct parties (or minds) to a transaction, but these parties act in a highly interdependent manner (in respect of a transaction of mutual interest), then it can be assumed that the parties are acting in concert and therefore are not dealing with each other at arm's length" may very well be an overly expansive reading of the acting-in-concert jurisprudence. The Joint Committee expressed scepticism as well.
Neal Armstrong. Summary of Sandra Mah and Mark Meredith, "Factual Non-Arm's Length Relationships," draft version of paper for CTF 2014 Conference Report, under s. 251(1)(c).
CRA rules on a pipeline transaction for the estate of a minority shareholder of a portfolio investment company
CRA has also issued a ruling on some more complex pipeline transactions involving a minority shareholding of an estate in a portfolio investment company ("Holdco"). The other shareholders are the three surviving siblings, and trusts for the extended family. In order that the Newco used to extract the estate’s share of corporate surplus will be connected to Holdco for Part IV tax purposes, the trust which controls Holdco will acquire the voting common shares of Newco.
Neal Armstrong. Summary of 2015 Ruling 2014-0541261R3 F under s. 84(2).
CRA issues a pipeline ruling providing for the complete extraction of corporate surplus in under two years
CRA has provided a ruling on a "pipeline" transaction in which an estate holding the common shares of a portfolio investment company, whose adjusted cost base had been stepped-up on death, sells those shares to a Newco for a Newco Note, with "Investmentco" then being wound-up into Newco one year later so that the corporate assets of Investmentco can be used to pay down the Newco Note.
In addition to the fact that Investmentco only has liquid assets (which may raise greater surplus-stripping issues – see 2011 STEPs Roundtable, Q. 5 2011-0401861C6, although CRA has ruled on portfolio investment companies before – see 2013-0503611R3), what is interesting is that the ruling specifies that the note will be paid off in four quarterly instalments commencing right after the wind-up - whereas most previous rulings as published have been vague or indefinite as to the repayment schedule. (The ruling expressed the times in alphabetic form - "one year" and "each trimester" - rather than in Arabic form, which seems to be automatically redacted.)
Neal Armstrong. Summary of 2015 Ruling 2014-0559481R3 F under s. 84(2).
CRA treats the activities of a corporation as being transparent for Indian Act purposes
CRA found that the portion of capital gains realized by status Indians on their sale of shares of a corporation - whose head office and management were based in a reserve – that was exempt, should be determined by the portion of the management and other income-generating activities located on the reserve.
Neal Armstrong. Summary of 4 February 2015 Memo 2014-0520721I7 under Indian Act, s. 87.
Vine Estate – Federal Court of Appeal leaves open the question whether neglect for statute-barring purposes must be that of the taxpayer itself rather than its accountants
The general sense of a complex reporting and audit history is suggested by indicating that an estate filed what it later alleged was an amended return correcting a previous failure to report recapture of depreciation - but which hid this element of that "amending" return from CRA’s attention (so that it did not reassess for the recapture within the normal reassessment period).
Not a winner case. Webb JA found that even if CRA had been able to discover the correction in the "amended" return, this would not have had the effect of clearing the negligent misrepresentation in the original return – so that the estate could be reassessed for the missing recapture beyond the normal reassessment period. This might be regarded as the flip side of a mooted proposition that if a return is filed without neglect, there is no obligation to file an amended return for a subsequently discovered error.
Webb JA indicated that as the estate should have noticed that the property to which the recapture related was not listed in the original return, it was not necessary for him to decide whether he agreed with Campbell J below (who, in turn, followed Aridi) that neglect etc. (for purposes of opening up statute-barred years) had to be that of the taxpayer (the estate) rather than only of its accountants.
Neal Armstrong. Summaries of Vine Estate v. The Queen, 2015 FCA 125 under s. 152(4)(a)(i) and General Concepts – Onus.
CRA surmounts technical hurdles and provides favourable responses at the 2015 IFA Roundtable
Highlights from the CRA Roundtable held at the 2015 IFA Conference include:
Q.1 CRA accepts that GWL confirms that there can be a hedge of a net investment where a sufficient linkage can be demonstrated with the underlying hedged assets. CRA will defer providing more comprehensive comments until cases in the pipeline are decided.
Q.2 The GAAR Committee recently approved the application of GAAR to some Treaty shopping cases.
Q.3 CRA recently has been considering whether Florida Limited Liability Limited Partnerships and Florida Limited Liability Partnerships are partnerships under its standard two-step approach, given that their limitation of liability goes beyond that available to Canadian limited partners, and they can convert into an LLC without any change in the ownership of their property.
Q.4 In an extension of its favourable approach in 2013-0488881E5, CRA considers that surplus balances can be apportioned between application to notional dividends made for purposes of eliminating income inclusions under s. 90(9) and application to actual dividends (or deemed pre-acq dividends due to s. 5901(2)(b) elections).
Q.5 CRA will be guided by the policy of the back-to-back loan rules in determining whether a particular debt (by Canco to an intermediary) became owing because an intermediary debt (of the intermediary to a suspect non-resident) was entered into or kept outstanding.
Q.6 CRA, in reversing 2013-0496841I7, concluded that an interest-bearing note was acquired for the purpose of earning income from shares, as required by s. 95(2)(a)(ii)(D), as the note was acquired in order to immediately contribute it to a foreign subsidiary, thereby enhancing the dividend-earning potential of the shares held in that subsidiary.
Q.7 CRA is prepared to interpret the combined operation of Regs. 5905(7.2) and (3), in the situation where FA2, with an exempt deficit and holding FA2 with exempt surplus, is merged into FA1, which has exempt surplus and is the survivor of the merger, so that the exempt deficit of FA2 is not deducted twice in computing the exempt surplus of the merged FA.
Q.8 Where Canco makes a functional currency election before 2016 (the expiry of the s. 39(2.1) rule for letting upstream loans be repaid without giving rise to FX gains), CRA considers that FX gains arising under s. 261(10), respecting the portion of an FX gain on the loan that had accrued before the beginning of the first functional currency year, can also be eliminated under the s. 39(2.1) rule provided that the two companies have the same year end.
Q.9 The s. 95(2)(i) rule is not restricted to money borrowed by the foreign affiliate in question, and also can apply to a note that it issued to acquire qualifying property, or to debt assumed by it on such a purchase.
Q.10 CRA considers that when there is an acquisition of control of a CRIC’s non-resident parent, so that the CRIC steps up the cost of its shares of a foreign affiliate under s. 111(4)(e)(ii), this will represent an investment under the foreign affiliate dumping rules – but as no property would thereby be transferred to the FA, the deemed dividend arising under s. 212.3(2) would be nil.
Q.11 Interest on money borrowed by FA1 (whose only activity is an active business) from FA2 in order to distribute accumulated profits will qualify under s. 95(2)(a)(ii)(B).
Q.12 In a situation where the meaning of the English and French versions of the Swiss-Canada Treaty differs, the version which produces the most favourable result to the taxpayer should be applied.
Neal Armstrong. Summaries under 2015 IFA Roundtable.
Former Finance analyst intimates that the Canadian thin cap rules may be expanded in light of the BEPS process
In an IFA-conference presentation this morning on BEPS by Phil Halvorson, who was seconded to Finance until 1 May 2015, but was speaking in a non-representative capacity, he indicated that the topic that the greatest attention should be paid to by the Canadian tax community was that of interest deductibility. Finance has an interest in expanding and modernizing the scope of the Canadian thin cap rules and is "keenly" interested in how this is being addressed under BEPS.
Neal Armstrong. Summary of Halvorson presentation under Roundtables – 2015 IFA Conference.
Joint Committee makes submissions on proposed s. 55 amendments
In a further comment on the 2015 Budget proposals, the Joint Committee has submitted that the proposed s. 55(2.1)(b)(ii) will create significant uncertainty respecting routine cash movements within Canadian corporate groups, a concern which has been magnified by the narrowing of the s. 55(3)(a) safe harbour to cover only s. 84(3) deemed dividends. Leaving aside suggestions to change the rules’ broader thrust, they recommend that s. 55(2.1)(b)(ii) apply only to "loss shares" (consistently with the primary motivation to override D&D planning), that the amendments clarify that routine intra-group cash transfers are not subject to the proposals, and that s. 55(3)(a) revert to covering all dividends. A detailed suggested redraft is appended.
The proposed removal of s. 55(2)(b) could result in over-inclusions in income or double taxation. For example, if a share with and FMV, ACB and PUC of $100, $60 and $10 is redeemed, under the proposals it would have a capital gain of $90 rather than $40. Other recommendations in the excellent submission include that the stock dividend proposals not apply to a stock dividend paid in shares of the same class (which would avoid brain damage in normal public company stock dividends).
Neal Armstrong. Summary of 2015 Budget s. 55 rules under Joint Committee Submissions.