News of Note
Income Tax Severed Letters 17 December 2014; Holiday Schedule
Email this ContentThis 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.
CRA continues a factually-based approach to the choice of currency for surplus account purposes
The amendment of Reg. 5907(6) to permit a foreign affiliate - rather than computing its surplus account balances in the country of its residence, or to do so in another foreign currency where this is reasonable in the circumstances – to also potentially use the Canadian dollar, has not changed CRA’s views as to the criteria to be applied to the reasonableness standard (and, it would appear, a related consistency standard). CRA states:
A number of criteria may apply in determining if it is reasonable to use the Canadian dollar…such as…the principal currency in which the corporation maintains its books and registers for purposes of presenting its financial results, the currency generally used in conducting its commercial transactions in the country in which it carries on business, and the currency which it uses for taxation purposes in the country of its residence. If an examination of these criteria, as well as others considered to be appropriate, permits a determination that use of the Canadian dollar presents a fair picture of the surplus account balances of the foreign affiliate, we will consider that such use is reasonable in the circumstances.
In the situation where the Canadian taxpayer now wants to use the Canadian dollar respecting the foreign affiliate and the reasonableness standard is satisfied, the published comment does not set an explicit deadline for starting to effect the conversion (which, when implemented, generally would use the 31 December 2009 spot rate, i.e., for the applicable FX trading day for 1 January 2010, being the commencement of the taxation year following the effective date of the amendment) - although perhaps some sort of clock started ticking once the amendment was passed on 26 June 2013, given that the comments refer to converting years that terminated before that June date.
Neal Armstrong. Summary of 10 October 2014 APFF Roundtable, Q. 24, 2014-0538181C6 F under Reg. 5907(6).
CRA accepts that s. 74.4(2) imputed interest can be avoided following an estate freeze by using a stock dividend of preferred shares
CRA considers that where an individual holding all the common shares of Opco (which is not a small business corporation) accomplishes an estate freeze through exchanging his common shares of Opco for preferred shares, with a trust for his minor children then subscribing a nominal amount for common shares, s. 74.4(2) will apply to impute interest to him on his preferred shares.
On the other hand, if he has Opco pay a stock dividend to him of preferred shares (thereby shifting most of the value from the common shares to the preferreds, which have nominal paid-up capital so there is only a nominal income inclusion to him), with the trust then subscribing for common shares, CRA accepts (consistently with 2003-0004125 F) that s. 74.4(2) will not apply. The safe income on hand previously attributable to his common shares will be apportioned between his preferred shares and his remaining common shares based on a comparison of the accrued gain on the common shares before the stock dividend with the accrued gain on the preferred shares after the stock dividend.
Neal Armstrong. Summaries of 10 October 2014 APFF Roundtable, Q. 19, 2014-0538041C6 F under s. 74.4(2), s. 55(2), s. 15(1.1) and Reg. 6205(2)(a).
CRA finds that the avoidance of s. 100(1.5) through paying down partner debt rather than making a dilutive partnership distribution is subject to GAAR
The published CRA responses to questions at the 2014 Annual CTF Conference include a discussion of the GAAR Committee approach to a situation where (using a simplified example) a building with accrued recapture of depreciation of $50,000 is transferred by a Canadian corporation on a s. 97(2) rollover basis to a subsidiary partnership in exchange for a note equal to the building’s undepreciated capital cost and units for the balance of the consideration. As the building is used in a business which is carried on outside (rather than inside) Canada, s. 100(1) would have applied, on a sale of half the resident’s partnership interest to a non-resident purchaser, to produce a fully taxable gain (of $25,000) on that sale – thereby producing a result comparable to realization of the accrued recapture of depreciation on half of the building. What occurs instead is that the non-resident subscribes $50,000 for a half interest in the partnership with that cash used to pay off the note – so that no immediate gain is recognized. CRA indicated that it "will challenge such an arrangement by applying the GAAR," given that there is "a misuse or abuse… having regard to the 2012 amendments to subsection 100(1) that extend its application to acquisitions by non-residents and the addition of the anti-avoidance dilution provisions contained in new subsections 100(1.4) and (1.5)."
The CRA analysis appears to be informed by two, or perhaps three, alternative transactions:
- a sale of ½ of the resident’s partnership interest (along with half of the note) to the non-resident, which would give rise to a fully taxable gain of $25,000 under s. 100(1);
- the $50,000 cash subscription from the non-resident (applied as to $25,000 for partnership units and a partnership note, respectively) is used to make a capital distribution of $25,000 to the resident so that its partnership interest is reduced in value from $50,000 to $25,000 (with the other $25,000 used to pay off ½ of the resident's note), in which case s. 100(1.5) would apply to deem the resident to realize a fully taxable gain under s. 100(1) of $25,000; and
- a direct sale of a ½ interest in the building for $50,000, which would result in the resident’s UCC being reduced from $50,000 to nil (so that the UCC of $25,000 relating to the resident’s retained ½ interest would be eliminated).
The first (and a fortiori the third) transaction appear to not have a lot of GAAR traction since (leaving aside whatever one might make of Stursberg) there appears to be a fundamental distinction between sales and subscriptions, and "where it can be shown that an anti-avoidance provision has been carefully crafted to include some situations and exclude others, it is reasonable to infer that Parliament chose to limit their scope accordingly" (Landrus – see also Inter-Leasing).
The second comparative transaction is more interesting. Immediately receivable partnership distributions following a s. 97(2) roll have been characterized as boot, i.e., as an obligation (see Haro, Vantem, MDS). If a right to an almost immediate capital distribution is effectively characterized in some contexts as cognate with partner debt (assuming that the partner debt is not recharacterized as equity under general principles – see Skingle), can this somehow be turned on its head so that a repayment of partnership debt should be characterized for purposes of applying the policy of s. 100(1.5) for GAAR purposes as if it were an obligation to make a dilutive capital distribution?
Neal Armstrong. Summary of 2 December 2014 CTF Roundtable, Q. 6 under s. 100(1).
A related group can consist of corporations whose respective controlling shareholders are not all related to each other
A is related to his wife’s brother (B), and B is related to his wife’s parent (C), but A is unrelated to C. If A, B and C each holds 1/3 of the shares of Dco through his respective holdco (Aco, Bco or Cco), each of Aco, Bco and Cco will be considered to be related to Dco (given inter alia that Aco and Cco is each related to Bco and they thus are deemed to be related to each other), and Dco will also be considered to be related to a subsidiary of Aco.
Neal Armstrong. Summary of October 2014 APFF Roundtable, Q. 17, 2014-0538071C6 F under s. 251(3).
CRA applies the connected corporation tests on the basis of numbers of voting shares
CRA has confirmed that for purposes of the connected corporation tests, having 10% or 50% of the "issued share capital" of a corporation with full voting rights means owning voting shares whose relative number exceeds the percentage threshold – so that (leaving GAAR aside) a CCPC would be "controlled" by a Holdco if for example the Holdco held 100 shares of CCPC with 1 vote per share and an arm’s length shareholder held one share bearing 1000 votes.
Neal Armstrong. Summary of October 2014 APFF Roundtable, Q. 18, 2014-0538081C6 F under s. 186(2).
Black – Federal Court of Appeal affirms a finding that Treaty residence in the U.K. did not stop CRA from treating Conrad Black as a Canadian resident
In 2002, Conrad Black was resident in Canada under general principles but was resident in the U.K for Treaty purposes under the tie-breaker rules. He made an unsuccessful argument before Rip CJ to the effect that s. 250(5) (which was not yet applicable to him) was enacted for greater certainty, so that (it was argued) he was deemed because of his Treaty status not to be resident in Canada. Accordingly, Conrad Black was subject to Canadian tax on his world-wide income.
If he instead had been successful on this argument, he would have faced a further difficulty in Art. 27, para. 2 of the Treaty, which provided that income, which otherwise was "relieved" from Canadian income tax under the Treaty but was subject to tax in the U.K. only on a remittance basis, would only be subject to such relief to the extent it was so remitted. Rip CJ found that this provision was not restricted to income which arose in Canada, so that it would have permitted Canada to tax Black’s U.S.-source employment income (which had not been remitted to the U.K.)
This decision has been briefly affirmed, including the Art. 27 findings.
Neal Armstrong. Summary of Black v. The Queen, 2014 DTC 1046 [at 2882], 2014 TCC 12, briefly aff’d 2014 FCA 275, under Treaties – Art. 4, Art. 29, Stat. Interp. – Other/Conflicting Statutes, and Interp. Act - 45(2).