News of Note
CRA indicates that extracting exempt surplus through cash dividends rather than a s. 93 election in a sale scenario may be GAARable
Email this ContentAn arm’s length shareholder (NR1) of a 2nd-tier foreign affiliate of Canco (Cco) purchased an asset from Cco, with Cco then paying a dividend on one of its classes of shares (namely, Class D shares) held by the 1st-tier foreign affiliate of Canco (Bco) and with NR1 waiving its right to the dividend on its Class D shares. Cco then redeemed the Class D shares of Bco at a loss to Bco. There was a further indirect sale transaction that looked even more peculiar.
The Rulings Directorate noted that if (1) Bco was able to access more exempt surplus through the payment of dividends by Cco rather than by selling the shares and using the s. 93(1) election, and (2) its shares of Cco were not excluded property, so that accessing more exempt surplus meant reducing the recognition of foreign accural property income to Canco by reducing a taxable gain which would have been recognized by Bco on the direct sale scenario, then the auditor should consider the application of the general anti-avoidance rule.
Neal Armstrong. Summary of 10 September 2013 Memorandum 2010-0387631I7 under Reg. 5902(1).
CRA finds that the Treaty exclusion for participating interest applies to oil-index linked interest paid by a Canadian oil exploration company to a U.S. resident even though it owns no oil
Although interest paid paid by a Canadian resident to a U.S. resident normally is exempt from withholding tax, Art. XI, para. 6(b) of the Treaty provides that the exemption does not apply where the interest "is determined with reference to…any change in the value of any property of the debtor." CRA has found that this exclusion applies to interest paid by a Canadian exploration company with valuable oil and gas properties, where the interest is computed by reference to a public index tracking the price of oil and gas, even though it does not have any oil or gas inventory.
Neal Armstrong. Summary of 26 August 2013 Memorandum 2013-0494211I7 under Treaties – Art. 11.
Income Tax Severed Letters 25 September 2013
This morning's release of 11 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Acquisition of control on a single-wing butterfly helps address RDTOH circularity issue
Where the distributing corporation (DC) in a butterfly is a Canadian-controlled private corporation which earns investment income and has refundable dividend tax on hand, a circularity complication arises, relating to the fact that that the butterfly mechanics entail a cross-redemption of shares between DC and the transferee corporation (TC), resulting in each receiving a deemed dividend from the other: (1) the deemed dividend paid by DC generates a dividend refund to it which, in turn, generates Part IV tax to TC under s. 186(1)(b), thereby generating RDTOH to TC; (2) this RDTOH of TC means that it generates a dividend refund on the deemed dividend paid by it to DC; which (3) generates Part IV tax and an increase to the RDTOH account of DC, thereby increasing its dividend refund in step 1; and so on until following the reaching by at least one of them of the 1/3 dividend refund limit in s. 129(1)(a)(i) – which could produce asymmetrical results if the paid-up capital of the cross-shareholdings differs.
A single-wing butterfly conveniently (from the standpoint of this circularity issue) resulted in an acquisition of control of DC by its remaining shareholder when the common shares in DC of TC were redeemed. This meant that DC had a deemed year end immediately before the cross redemptions started (as no s. 256(9) election was made). This, in turn, meant that DC (which had sufficient safe income on hand vis-à-vis both shareholders) could flush out its existing RDTOH account in its pre-butterfly taxation year through s. 84(1) deemed dividends.
This was not a complete solution, as DC and TC could still earn investment income post-butterfly (and TC still had a full taxation year, so that its "flush out" RDTOH could bounce back to DC in DC's second taxation year). However, rather than transferring the pro rata portion of its properties to TC directly, DC made this transfer to a sub of TC, so that it received a deemed dividend on a subsequent share redemption by the sub (which was immediately wound up into TC, and did not generate any RDTOH) rather than receiving a deemed dividend from TC. This eliminated circularity issues for DC's 2nd taxation year as well.
Neal Armstrong. Summary of 2013 Ruling 2012-0449611R3 under s. 55(1) – distribution. See also Michael N. Kandev and Alan Shragie, "RDTOH on Butterfly", Canadian Tax Highlights, Volume 16, Number 11, November 2008, p. 2.
NRT Technology – Federal Court of Appeal confirms the application of REOP tests in a loss-streaming case
Although the reasonable expectation of profit doctrine has been largely defunct since Stewart and Walls in the context in which it was originally most often applied by CRA (businesses financed as tax shelters and losses of part-time "farmers"), its existence has been preserved in various statutory provisions, including the GST definition of "commercial activity," and the loss-streaming rule in s. 111(5)(a).
The Federal Court of Appeal has briefly affirmed a decision of Campbell Miller J, where he applied the criteria developed in the pre-Stewart cases for determining the existence of "REOP" (e.g., Tonn) to find that a loss business of a purchased corporation was not carried on with a REOP, as required by s. 111(5)(a) (and, in fact, the business was essentially dormant following the acquisition). Accordingly, the losses could not be utilized.
Neal Armstrong. Summary of NRT Technology Group v. The Queen, 2013 DTC 1021, 2012 TCC 420, briefly aff’d 2013 FCA 221, under s. 111(5)(a).
CRA accommodates the s. 90(2) “pro rata” requirement in a foreign divisive reorganization
Canco holds, say, 25% of the shares of FA1 directly and 75% of its shares through a grandchild foreign affiliate (Forsub2). In using a foreign divisive reorganization to create a new Finco for the group ("Newco"), 25% of FA1’s assets (being loans to other FAs) are transferred by operation of law to Newco and Canco’s shares of FA1 become shares of Newco. CRA confirmed that s. 90(2) deems there to be a dividend on the FA1 shares in the amount of the transferred loans.
Although somewhat similar to Q.2 at the 2013 IFA Round Table (where in effect Forsub2 started off as a 100% rather than 75% shareholder of FA1), this one requires mental gymnastics: a transfer of the loans effectively 100% in favour of Canco is treated as a pro rata distribution on the shares of FA1 held by both shareholders.
Neal Armstrong. Summary of 2013 Ruling 2012-0463611R3 under s. 90(2).
CRA indicates that a Canadian-resident trust was eligible for a full FTC notwithstanding its gain was lower for Canadian than foreign purposes
Where a non-resident trust was deemed to be resident in Canada under s. 94 and a gain which it realized on the disposition of marketable securities was lower for Canadian than U.S. purposes (due to a previous step-up in the securities’ adjusted cost base under s. 128.1(1)(c)), there was no resulting reduction of the foreign non-business income tax credit of the trust – i.e., it got full credit for the U.S. tax paid.
CRA’s reasoning suggests that the same result could obtain for an individual who is resident in Canada on ordinary principles.
Neal Armstrong. Summary of 28 May 2013 Memorandum 2013-0476381I7 under s. 94(3)(b).
CRA takes pragmatic approach to meaning of “regularly traded” under the Canada-U.S. Treaty?
A "U.S. Holdco" which was the parent of a ULC and was not a qualifying person for purposes of the Canada-U.S. Treaty was able to access the Treaty-reduced rate on a deemed (s. 84(1)) dividend received by it from the ULC on the basis of the derivative benefits rule in Art. XXIX A, para. 4. Both the immediate parent and grandparent of U.S. Holdco were entitled to full benefits under the Treaty between Canada and their country of residence, which was not the U.S. (with the dividend withholding tax rate under that Treaty presumably being no higher than under the Canada- U.S. Treaty); the common shares of the ultimate parent traded on recognized stock exchanges; and U.S. Holdco was represented to satisfy the "base erosion test" (re expenses paid to non- qualifying persons).
The ruling contains no explicit representations respecting the requirement that the shares of the ultimate parent be "regularly traded" on the recognized stock exchanges. After a screed on the U.S. meaning of this requirement (which CRA may have adopted - see 8 December 2009 TEI Round Table, Q. 4, 2009-0347701C6), the 2007 U.S. Technical Explanation states that "subject to the adoption by Canada of other definitions, the U.S. interpretation of ‘regularly traded’ and ‘primarily traded’ will be considered to apply, with such modifications as circumstances require, under the Convention for purposes of Canadian taxation."
The usual 2-step (increase PUC, then distribute it) was used to deal with the hybrid status of the ULC.
Neal Armstrong. Summaries of 2013 Ruling 2012-0471921R3 under Treaties, Art. 4 and 29A.
Geoff Turner points out that the proposed safe-harbour for Canadian parent guarantees is too narrow
Draft s. 247(7.1) provides relief from the application of the Canadian transfer pricing rules to a guarantee of debt of a controlled foreign affiliate by the Canadian parent if the borrowed funds were used in the specific active business manner described in s. 17(8)(a) or (b).
The draft s. 247(7.1) exception is unduly narrow. For example, if the CFA is generating foreign accrual property income, the savings generated to the corporate group by accessing the parent's credit rating through a guarantee will be captured in the Canadian tax base irrespectively of the charging (or not) of a guarantee fee.
Having said that, were CRA consistent with its position in the General Electric cases, it would not require a guarantee fee even where the draft s. 247(7.1) exception did not apply.
Neal Armstrong. Summary of Geoffrey S. Turner, "Downstream Loan Guarantees and Subsection 247(7.1) Transfer Pricing Relief," CCH Tax Topics, No. 2166, September 12, 2013, p.1 under s. 247(7.1).
CRA rules that the unwinding of a sandwich structure avoids the application of the upstream loan rule
A US marketing subsidiary (US Salesco) has lent to an indirect Canadian parent (Can Opco 1) which, in turn, is ultimately indirectly owned by a non-resident parent. Can Opco 1 repays this payable, the sandwich structure is unwound (so that US Salesco now is a "sister" rather than indirect sub of Can Opco 1), and US Salesco then relends the same amount back to Can Opco 1.
CRA ruled that this avoids the application of the upstream loan rule in s. 90(6). It also ruled on routine applications of the reorganization exemption rules in s. 212.3(18) to the "de-sandwiching" transactions, including a mildly interesting illustration of the dovetailing of those rules with the partnership look-through rule in s. 212.3(25).
Neal Armstrong. Summary of 2013 Ruling 2013-0491061R3 under s. 90(8)(a).