News of Note
CRA makes some additions in its new Folio on interest deductibility
Email this ContentChanges going from IT-533 to the new interest-deductibility Folio include:
- a reference to Midwest (respecting interest not having been deductible in any year due to the "in respect of" requirement) has been dropped
- an acknowledgement that Ludco indicates that an ancillary purpose to produce gross income is sufficient for deductibility, while CRA at the same time insists on a positive spread in the context of loss shifts
- an addition of a statement of the long-standing policy that interest on borrowings to fund PUC distributions is non-deductible unless the proceeds are used for an eligible purpose
- an expanded discussion of interest-free loans including a nostalgic reference to interest being denied in a cross-border contribution of capital in Mark Resources
- the section on loss shifts merely states that "the transactions that are undertaken must not be blatantly artificial," and does not require more explicitly that the amounts used are not in excess of what could be borrowed from the bank (see also 2014-0525441R3)
- an additional statement that "where accrued interest is added to the outstanding principal amount of an existing loan resulting in a new obligation or novation, an interest payment will not be considered to have been made."
Neal Armstrong. Summaries of S3-F6-C1: "Interest Deductibility" under s. 20(1)(c), s. 9 – exempt receipts, s. 16(1), s. 248(1) -10/8 policy, s. 18(1)(b) – capital expenditure v. expense – financing expenses, s. 67.1(1).
CRA finds that a taxpayer's failure to file returns was a “misrepresentation” entitling CRA to open up a statute-barred year
A taxpayer failed to file a tax return notwithstanding a s. 150(2) demand to do so, CRA assessed under s. 152(7) without the return and then, more than three years later, discovered some income which it had missed. In finding that it was not now statute-barred from assessing this additional income, CRA stated that by virtue of not filing the return "the taxpayer has made a misrepresentation by virtue of wilful default."
This accords with common sense, but not with the meaning of "misrepresentation:" the taxpayer quite clearly had not made any representation.
Neal Armstrong. Summary of 4 December 2014 Memo 2014-0526451I7 F under s. 152(4)(a)(i).
CRA finds that warrants distributed under s. 84(2) have a cost equal to their (estimated) FMV
A Canadian public corporation, which holds some foreign exploration companies indirectly through a Canadian holdco which it mostly has capitalized with debt, will convert a portion of that debt into common shares and common share purchase warrants, and then make a paid-up capital distribution of the shares and warrants to its shareholders under s. 84(2) – but with only the distributed common shares being subsequently listed.
Although no section states this, CRA considers that common shares received on a s. 84(2) distribution have a cost equal to their fair market value at that time. Not surprisingly, CRA extended this position to the cost of the warrants. More surprisingly, the ruling letter boldly states what will be the approximate respective FMVs of the distributed shares and warrants.
Neal Armstrong. Summary of 2014 Ruling 2014-0537161R3 under s. 84(2).
CRA confirms a full step-up of properties distributed in satisfaction of an estate’s capital interest in an inter vivos personal trust
S. 107.4(4) deems an indefeasibly-vested capital interest in an inter vivos personal trust to have a fair market value equal to a proportionate share of the trust’s net asset value. This means that where such an interest passes on death (thereby resulting in a deemed FMV cost to the estate of such interest as so computed), the estate upon receiving a distribution of trust property in satisfaction of its capital interest generally can step up the cost of such distributed property to an amount equal to such FMV.
Neal Armstrong. Summaries of 12 December 2014 T.I. 2013-0511391E5 under s. 107(2) and s. 70(5).
CRA position implies that dissolving a partnership can have the effect of postponing indefinitely the recognition of a suspended capital loss
The postamble to s. 40(3.4) provides that, for purposes of the suspended loss release events listed in s. 40(3.4)(b), a dissolved partnership is deemed to continue to exist and its partners to continue to be partners until immediately before the occurrence of such a release event. CRA considers that this means that if a capital loss, which was suspended on the disposition of a partnership interest to an affiliated corporation, will continue to be suspended after the dissolution in a subsequent year of the partnership and thereafter until the transferor and transferee cease to be affiliated, or there is an acquisition of control of the transferor – or perhaps some more obscure release event occurs.
Although, at first glance, this looks reasonable, it seems to imply that the loss will remain suspended even if the former partnership business is sold to a third party.
Neal Armstrong. Summary of 27 October 2014 Memo 2014-0534981I7 F under s. 40(3.4).
CRA finds that a cross-border restrictive covenant payment was not eligible for Treaty-reduced withholding
After CanCo had sold shares of a partly-owned subsidiary (SubCo), it made a payment to the other share vendor (LuxCo) pursuant to what was assumed to be a "restrictive covenant" in a related agreement, and withheld and remitted 25% of the payment. Luxco was unsuccessful in a refund claim based on Art. 7 (business profits with no PE) or 21 (other income) of the Canada-Luxembourg Treaty: the restrictive covenant payment did not qualify as business profits given that LuxCo was stated as having held the shares of SubCo as a capital investment; and the payment was not subject to reduced withholding under Art. 21 as it was considered to be derived from Canada (Canadian payer; subject shares were Canadian shares; and Canadian governing law).
Neal Armstrong. Summaries of 20 November 2014 Memo 2014-0539631I7 under Treaties - Art. 22, and s. 56.4(1) - restrictive covenant.
CRA comments on the eligibility of a foreign partnership interest as excluded property
Paras. (d) and (e) of the excluded property definition deem the units of a foreign partnership held by a foreign affiliate of a Canadian taxpayer to be foreign shares for purposes of determining whether the partnership is a deemed foreign affiliate of the taxpayer under the excluded property definition. However, CRA does not consider that this permits one to conclude that such partnership interest is excluded property, even where the partnership is engaged exclusively in an active business, if the equity percentage of the Canadian taxpayer in the partnerships (viewed as a deemed foreign corporation) is under 10% (say, 5%) and a further 5% interest in the partnership is held directly by a related Canadian corporation. The reason is that the paras. (d) and (e) deeming rule only applies to partnership interests held by a foreign affiliate rather than by a (related) Canadian person – so that the partnership interest does not qualify as shares of a foreign affiliate (because the required 10% threshold under the foreign affiliate definition has not been achieved). This, in turn, means that the partnership interest cannot qualify as excluded property notwithstanding the active business.
The factually unusual and narrow character of this point may imply that the paras. (d) and (e) deeming rule works quite well in circumstances where an active foreign partnership is held largely within a wholly-owned group. For instance, there was no quibbling that paras. (d) and (e) do not explicitly go on to deem the active business assets of the partnership to be active business assets of the fictional non-resident corporation, so this would appear not be a sticking point.
Neal Armstrong. Summary of 15 January 2015 T.I. 2014-0546581E5 under s. 95(1) – excluded property.
Income Tax Severed Letters 4 March 2015
This morning's release of eight severed letters from the Income Tax Ruling's Directorate is now available for your viewing.
AUSPICE commodity index ETFs are structured for capital gains treatment to unitholders
The proposed AUSPICE Canadian Crude Oil Index ETF and Canadian Natural Gas Index ETF will each track its designated (Canadian crude or Canadian natural gas) "Underlying Index" by entering into forward agreements with NBC, and pledging cash raised from its Unit offerings to secure its obligations thereunder. Although the forwards will have terms of five years, they will be extended annually with the consent of the parties – which presumably will occur in order that no income in excess of expenses (to be funded with partial settlements) will be realized. Accordingly, unitholders likely will anticipate capital gains treatment on their units, so that the introduction of the derivative forward agreement rules (requiring income account treatment on the forwards) has not had a significant impact.
Neal Armstrong. Summary of Preliminary Prospectus for Units of AUSPICE Canadian Crude Oil Index ETF and Canadian Natural Gas Index ETF under Offerings – Forward Sales/TRS Funds.
The TPSM is often inconsistent with the Canadian transfer-pricing rules
Unlike Art. 9 of the OECD Model Treaty and Code s. 482, which permit consideration of the overall commercial or financial relations between related entities, the focus in ss. 247(2)(a) and (c) on individual transactions renders it quite difficult to utilize the transactional profit split method in a Canadian context.
Neal Armstrong. Summary of Ilana Ludwin, "Application of the Transactional Profit Split Method in Canada," Tax Management International Journal, 2015, p. 98 under s. 247(2).