News of Note
CRA confirms that expansions of non-residential buildings can qualify for enhanced CCA irrespective of their size
Email this ContentCanadian non-residential buildings acquired after the 2007 Budget date generally are eligible for enhanced capital cost allowance rates. CRA has confirmed that where a post-2007 addition is made to a non-residential building which itself does not qualify for the enhanced CCA (e.g., because a timely election was not made), the cost of the addition generally will qualify for the enhanced CCA irrespective of the quantum of the building expansion (provided that a timely election is made for the year of the addition). This is based on Reg. 1102(24), which deems "an addition to or an alteration of" the building to be a separate building.
This interpretation would have been more interesting if there instead were substantial repairs to the building without any area expansion.
Neal Armstrong. Summary of 10 June 2013 T.I. 2013-0489101E5 F under Reg. 1101(5b.1).
A sale of holding company shares is off-side CRA’s policy on earn-outs.
In IT-426R, CRA refers to earn-out clauses in share sale agreements where "the quantum of proceeds is determined by reference to future earnings generated by the underlying assets of the corporation," and it lists as one of the conditions, for the vendor being permitted to use the cost recovery method, that it is reasonable to assume that the earnout feature relates to "underlying goodwill."
CRA has indicated that the cost recovery method is not available where an individual sells, on an earnout basis, the shares of a holding company (Aco) whose only asset is shares of an Opco (Bco), because "the earnout clause is not tied to future amounts generated by underlying properties utilized in the course of a business carried on by Aco but rather to properties held by Bco."
Although ridiculous, this position may not be so bad. Stating that there is no relevant "underlying" property effectively is an acknowledgement that s. 12(1)(g) does not apply, and the future contingent amounts might be substantially discounted.
Neal Armstrong. Summary of 14 May 2013 T.I. 2013-0480561E5 F under s. 12(1)(g).
Burlington Resources - Tax Court accepts that it is "legitimate to ask" whether an NSULC should pay for a parent guarantee
The Minister challenged, under s. 247, the deduction by an NSULC of guarantee fees paid to its US parent (BRI). In response to a challenge of the Minister's relevant pleading, Hogan J stated that "it is legitimate to ask whether an arm's length person standing in the appellant's shoes would have been willing to pay the guarantee fees ... knowing that BRI was potentially responsible for the appellant's liabilities even without the guarantee."
Scott Armstrong. Summary of Burlington Resources Finance Company v. The Queen, 2013 TCC 231, under s. 247(2).
CRA finds that a partnership can enjoy qualifying interests in its non-resident subsidiaries for FAPI purposes notwithstanding that s. 95(2)(y) deems its Canadian parent to (also) own those shares directly for s. 95(2)(a) purposes
Where Canco holds foreign affiliates (Forco1, and its subsidiary, Forco2) through a partnership, s. 95(2)(a)(ii)(B) can still operate to deem interest paid by Forco2 to Forco1 to be active business income and not FAPI to the partnership. The partnership (which is a separate person for FAPI computation purposes) itself has a qualifying interest in Forco1 and Forco2 – notwithstanding that s. 95(2)(y) deems Canco to hold the shares of Forco1 directly for purposes of determining whether Forco1 and Forco2 are foreign affiliates of Canco for s. 95(2)(a) purposes.
Neal Armstrong. Summary of 12 July 2013 T.I. 2011-0415911E5 under s. 95(2)(m).
Income Tax Severed Letters 24 July 2013
This morning's release of 16 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA confirms that grandfathering generally will be lost if an RRSP redeems its prohibited investment shares rather than selling
The post March 22, 2011 prohibited investment rules for RRSPs effectively grandfathered the value of various prohibited investments which were held on March 22, 2011 by providing that generally only capital gains representing appreciation over the investment’s fair market value on that date would give rise to a taxable advantage.
CRA has confirmed that this grandfathering does not work where the RRSP subsequently redeems prohibited investment shares thereby giving rise to a deemed dividend – so that the full amount of the deemed dividend generally will be subject to a 100% tax. It is now too late to access further temporary relief in s. 207.01(4).
Neal Armstrong. Summary of 6 June 2013 T.I. 2012-0451801E5 F under s. 207.01(1) – Advantage.
QSBC purification transactions must respect the FIFO rule in s. 110.6(14)(a)
In order that shares of a Canadian-controlled private corporation will qualify for the enhanced capital gains exemption, taxpayers may engage in "purification" transactions so that the CCPC does not have excess cash at the time of sale to the purchaser.
A technical interpretation points out a trap. The individual taxpayers transfer recently-purchased shares of their CCPC (the "new shares") on a rollover basis to a Holdco, with Holdco then redeeming those shares to extract the excess CCPC cash. The taxpayers then sell their "old" shares of the CCPC to the purchaser, thereby satisfying the 24-month holding period requirement in the qualified small business corporation share definition.
Wrong! S. 110.6(14)(a) deems identical shares to have been disposed of on a FIFO basis for QSBC purposes, so that the taxpayers will be deemed to have disposed of all of their new shares to the purchaser, thereby flunking the 24-month holding period test for those shares.
Neal Armstrong. Summary of 2 May 2013 T.I. 2013-0481361E5 F under s. 110.6(14)(a).
Morgan - Tax Court vacates a s. 163(1) penalty where the taxpayer had a reasonable misunderstanding of the Act
The taxpayer was assessed a s. 163(1) penalty (repeated failure to report income) for the portion of a pension plan withdrawal that he had transferred to his wife's RRSP. Woods J found that the penalty should be vacated under the due diligence defence notwithstanding a "troubling" lack of evidence. This admittedly represented a "generous interpretation of the facts," but it was not intuitively obvious that funds transferred from one tax-exempt vehicle to another would give rise to income.
As stated by Woods J, the due diligence defence "can apply to [reasonable] mistakes of fact or if all reasonable measures have been taken to prevent the failure." Given the absence of "reasonable measures" evidence, the taxpayer in effect got relief for a mistake of law.
Scott Armstrong. Summary of Morgan v. The Queen, 2013 TCC 232, under s. 163(1).
CRA considers that there’s no rollover to the extent that a trust property distribution satisfies debt owing to the beneficiary
CRA interprets the preamble to s. 107(2) as establishing that there is a rollover under s. 107(2)(a) only for that portion of the property distributed by a personal trust to a beneficiary which satisfies the beneficiary’s capital interest in the trust. Accordingly, if a personal trust distributes an appreciated parcel of real estate to a capital beneficiary, and 10% of the property repays debt owing by the trust to the beneficiary, with only the balance of 90% satisfying the beneficiary’s capital interest, the trust will realize a capital gain on the distribution of the 10% portion.
Neal Armstrong. Summary of 2 July 2013 T.I. 2013-0488061E5 under s. 107(2).
Horizons Leveraged Commodity ETFs will replace share sale forwards with cash-settled forwards in response to Budget character conversion rules
The Horizons Leveraged Commodity ETFs have made s. 39(4) elections and entered into forward sales of their Canadian portfolio share investments to a Canadian bank at prices which are tied to the performance of notional long or short rolling futures positions in the underlying commodity rather than on the value of the shares, thereby achieving capital gains treatment. The March 2013 federal budget provided that this type of "derivative forward agreement" will now give rise to income account gains, subject to transitional relief (with modest additional transitional relief announced on July 11, 2013).
After running through the applicable transitional periods, the ETFs will now replace the existing forward contracts with cash-settled forward contracts, and will use any new unit issuance proceeds to invest in cash equivalents (to be pledged under the cash-settled forwards) rather than in Canadian equities.
Any gains on the new contracts will be on income account. This may not be a concern to taxable investors (who for other reasons are encouraged to trade rather than invest in their units) if they do not hold units on the record date for any distribution of any net annual gains.
Neal Armstrong. Summary of Prospectus for Leveraged Horizons Commodity ETFs under Forward Sale Funds.