News of Note
Wickham Estate – Tax Court of Canada denies pro rata portion of an investment management fee based on the portfolio's RRIF portion
Email this ContentFees awarded by the Public Trustee to a retired investment manager (Sanders), who was the committee of the senile taxpayer (Ms. Wickham), qualified for deduction under s. 20(1)(bb) except for 20% thereof, which was denied under s. 18(1)(u) based on the 20% of her portfolio which was held in her RRIF. Although acting as committee was Sanders’ only relevant activity, it qualified as an investment management business under s. 20(1)(bb).
The income generated by the portfolio substantially exceeded his fees. Before turning to s. 20(1)(bb), Paris J stated: "since the management services provided by Mr. Sanders related to capital assets held by Ms. Wickham, the fees would be non-deductible capital expenditures unless otherwise provided." This is inconsistent with the deductibility of fees incurred in order to earn interest or dividends (Wilson).
The s. 18(1)(u) finding is problematic for any practice of paying investment advisor fees only out of the taxable portion of a portfolio, and deducting them in full rather than pro-rating based on the portfolio's RRSP portion.
Neal Armstrong. Summaries of Wickham Estate v. The Queen, 2014 TCC 352, under s. 20(1)(bb), s. 18(1)(u) and s. 18(1)(b) – capital expenditure v. expense – investment management.
The new back-to-back loan rule is an anti-conduit rule which undercuts legitimate Treaty benefits
The absence of a safe harbour in s. 212(3.1)(b), from the application of the back-to back loan rule for non-resident non-arm’s length intermediaries (who would not enjoy the statutory withholding tax exemption for arm’s length interest anyway), shows that an aspect of this rule is to be an anti-conduit rule that targets situations where that intermediary is fronting for a creditor with an inferior treaty standing. However, the rule operates mechanically.
This produces questionable results. For example, if the identified solution - to the application of the anti-hybrid rule in Art. IV(7)(b) of the Canada-U.S. Treaty to a loan by an LLC (with two "good" U.S. persons as partners) to a ULC subsidiary - is for the two U.S. partners to form a parallel financing LLC through which the debt financing is routed to the ULC, this rule would undermine that solution.
Neal Armstrong. Summary of Michael N. Kandev, "Canadian Interest Anti-Conduit Rule Soon to Be Law," Tax Notes International, December 15, 2014, p. 1027 under s. 212(3.1)(d).
Safe harbours in restrictive covenant rules do not accommodate the giving of a non-compete covenant by a terminated executive to corporate purchasers who are not a related group
The other two equal arm’s length shareholders of a corporation agree to pay $1 million to an executive who holds the other 1/3 of the shares, and who provides a covenant to them not to compete with the corporation and to sell his 1/3 shareholding to them equally. That payment will not be exempted under s. 56.4(6) or (7) from the requirement under s. 68 to allocate a reasonable portion thereof to the non-compete because inter alia he deals at arm’s length with them and the corporation is unrelated to them. The exemption in s. 56(2) will not be available for similar reasons.
Neal Armstrong. Summary of Kenneth Keung and Riaz S. Mohamed, "Restrictive Covenants for Departing Executives," Taxation of Executive Compensation and Retirement, Volume 23 Number 4, November 2012, p. 1604 under s. 56.4(6).
CRA considers that gambling winnings normally are exempt, ponzi scheme winnings generally are taxable and shareholder defalcations normally are non-deductible
Additions or changes in the new Folio on "Lottery Winnings, Miscellaneous Receipts, and Income (and Losses) from Crime" include:
- In a substantially expanded section on gambling, CRA shows significant deference to Leblanc, which it quotes for the proposition that gambling "by its nature is not generally regarded as a commercial activity except under very exceptional circumstances," and has dropped the statement in IT-334R2 that "it is clear…that earnings from…illegal gambling…are not exempt from tax."
- Without explicitly acknowledging Stewart, the statement in IT-334R2 that "in order for any activity or pursuit to be regarded as a source of income, there must be a reasonable expectation of profit" has been dropped – and curiously, the Folio also has dropped completely (rather than amending) the statement that if a "hobby or pastime results in receipts of revenue in excess of expenses, that fact is a strong indication that the hobby is a venture with an expectation of profit."
- A section on fraudulent investment schemes has been added, in which Johnson is cited for the proposition that "amounts paid to taxpayers that are a return on their investment should be included in…income."
- Crowdfunding receipts are taxable.
It has retained the assertion in IT-185R that losses from defalcations by partners or significant shareholders "are not normally deductible" because "in most cases, such losses…are sustained outside the normal income-earning activities of the business." This is at odds with the discrediting in the Egg Marketing case (65302) of the notion, supposedly based on the old Imperial Oil case, that deductible losses must result from "a normal and ordinary risk of the…operations."
Other retentions: a fraudster generally can reverse an income inclusion when it repays the funds; and, subject to statute-barring, in cases of hardship CRA generally will allow a taxpayer to recognize a loss in the year when its money was stolen rather than the year of discovery of this loss.
Neal Armstrong. Summaries of S3-F9-C1: Lottery Winnings, Miscellaneous Receipts, and Income (and Losses) from Crime under s. 3, s. 18(1)(a) income-producing purpose and s. 18(1)(a) – timing.
CRA considers that use of s. 212.1(4) to step-up cross border PUC (or debt) is abusive
A non-resident corporation (NR Target) holding shares of a Canadian sub (CanOpco) with nominal paid-up capital will be prohibited by s. 212.1 from stepping up the cross-border PUC by transferring its CanOpco shares to a new Canadian holding company (CanAc) in consideration for CanAc shares with a high stated capital. However, leaving the general anti-avoidance rule aside, a PUC step-up can be accomplished where, in connection with a purchase of NR Target by an arm’s length buyer (Foreign Parent), Foreign Parent capitalizes its CanAc with the purchase price, NR Target (post-acquisition) sells CanOpco to CanAc for a note (which avoids s. 212.1 because CanAc still controls NR Target, thereby engaging the s. 212.1(4) safe harbour) and NR Target is then distributed to Foreign Parent – so that CanAc now owes the note (which could now be converted into high-PUC shares) "upstairs." If you add the smoking gun that, in fact, CanOpco distributed its surplus to its Canadian parent (CanAc) for distribution offshore under the note, CRA considers that GAAR should be applied. The transactions misuse s. 212.1(4), which provides an exemption from s. 212.1(1) on the premise that there is "no increase in the ability to strip surplus tax-free out of Canada," whereas that is what happened here.
This view is broadly consistent with the CRA comments in a domestic context (on Descarries) that it generally is contrary to the scheme of the Act to directly or indirectly distribute corporate surplus otherwise than as dividends. It also represents a hardening of position from the 2013 IFA Roundtable, Q. 4, where CRA was noncommittal as to whether "pre-acquisition" cross-border PUC planning (somewhat similar to that described above) was subject to GAAR.
Neal Armstrong. Summary of 2 December 2014 CTF Roundtable, Q. 4 under s. 212.1(4).
CRA considers that s. 95(6)(b) can extend beyond status manipulation to transitory foreign FA positions to access dividends
CRA considers that Lehigh Cement established that s. 95(6)(b) "generally" is targeted at manipulation of status of non-resident corporations for subdivision i purposes (cf. Boidman: the FCA confirmed that the provision is "a precise instrument for very precise issues, namely, attempts to create FA status where none would otherwise exist and de-control what would otherwise be CFAs"). However, CRA considers that the provision could still be applied in some other contexts, for example, where share ownership in the non-resident corporation is intentionally transitory in order to extract one-off s. 113(1)-deductible dividends.
Neal Armstrong. Summary of 2 December 2014 CTF Roundtable, Q. 9 under s. 95(6)(b).
Income Tax Severed Letters 17 December 2014; Holiday Schedule
This morning's release of five severed Letters from the Income Tax Rulings Directorate is now available for your viewing.
Severed letter releases in the next two weeks will be on Tuesdays - December 23 and 30.
CRA will seek judicial confirmation that indirect distributions of corporate surplus otherwise than as dividends are contrary to the scheme of the Act
Although it did not appeal Descarries (as it won on grounds that the surplus stripping in that case was abusive having regard to the policy of s. 84.1), CRA thinks it also should have won on s. 84(2) grounds. It considers that the reference in s. 84(2) to an appropriation to the shareholders "on" the winding-up of the corporate business includes a distribution "as a result of" the winding-up, and that it should not especially matter that the distribution occurs indirectly by means of an interim loan through an intermediate company.
It also considers that Hogan J’s GAAR analysis was too narrow, stating that there is a range of provisions "whose purpose is to prevent individual shareholders from indirectly accessing the surplus of a corporation otherwise than as a dividend" and that the Descarries transactions were "an abuse of the integration system." CRA reiterated (see also 2012-0433261E5) that it "will seek a decision of the Federal Court of Appeal or the Supreme Court of Canada…confirming the broad scope of subsection 84(2)… and on whether...there is a specific scheme under the Act for taxing any direct distribution of surplus of a Canadian corporation as a taxable dividend in the hands of individual shareholders; as well as a specific scheme under the Act against indirect surplus stripping."
Neal Armstrong. Summaries of 10 October 2014 APFF Roundtable, Q.21, 2014-0538091C6 F under s. 84(2) and s. 245(4).
CRA treats exchangeable shares and units equivalently under the DFA rules
CRA considers that an exchangeable share (e.g., of a Canadian subsidiary of a foreign parent) generally is not a derivative forward agreement "because the risk of loss and opportunity for profit associated with the exchangeable shares will generally be very similar to the risk of loss and opportunity for profit associated with the second securities," e.g., of the parent – and not because the embedded exchange right might not be an "agreement." CRA also states that where there instead is a separate intermediate-term or long-term agreement to sell the shares of the subsidiary for a price based on the shares of the parent, this safe harbour test will not be satisfied, without really explaining why in the final written response.
It is difficult to develop a logically coherent and convincing rationale for this position. What CRA may be saying is: (i) we don’t want to acknowledge that embedded rights cannot give rise to DFAs, as this might provide an opening for playful taxpayers; and (ii) Finance said exchangeable shares are OK, so we will go along, albeit without any coherently articulated theory in support.
CRA will apply the same "analysis" to exchangeable partnership units.
Neal Armstrong. Summary of 2 December 2014 CTF Roundtable, Q. 1 under s. 248(1) – derivative forward agreement.
CRA confirms that a reverse earnout obligation of Buyco for Target shares continues to be an excluded obligation for debt forgiveness purposes following their amalgamation
A Buyco for a purchaser acquires the shares of a Target for consideration including a deferred purchase price (representing a "real" legal obligation), with the unpaid balance subject to reduction pursuant to a reverse earnout clause. Such reduction occurs after the amalgamation of Target with Buyco.
CRA generally considers that by virtue of the contingent amount rule in s. 143.3 applying to reduce the cost to Buyco of its Target shares in the amount of the reverse earnout contingent obligation, that obligation would represent an "excluded obligation" under s. 80(1), so that the debt forgiveness rules would not apply to the extinguishing of the earnout obligation.
Although not mentioned, this interpretation is consistent with s. 87(2)(l.5), which deems Amalco to be a continuation of Buyco and Target for s. 143.4 purposes.
Neal Armstrong. Summary of 10 October 2014 APFF Roundtable, Q. 15, 2014-0538151C6 F under s. 80(1) – excluded obligation.