News of Note
Income Tax Severed Letters 26 June 2013
Email this ContentThis morning's release of 12 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA appears to find that a limited partner’s status as a trader does not affect the capital gains character of its partnership allocations
CRA found that a capital gain realized by a partnership from a real estate sale retained its character as such when allocated to a limited partner, even (it would appear) where the latter was a trader.
This position presumably also would apply to a securities dealer which was a minority limited partner in an investment partnership.
Neal Armstrong. Summary of 25 April 2013 Memorandum 2013-0478511I7 F under s. 96(1)(f).
WHA - UK Supreme Court finds that an insurance claims handler for vehicle breakdowns did not receive a supply for VAT purposes of repair services from the mechanics
For British VAT purposes, an insurance claims processor was merely providing third party consideration rather than consideration for repair services received by it when it paid mechanics for repair work on cars that were insured under vehicle break-down insurance provided by an affiliated insurer. The repair services instead were supplies made to the insured drivers. Among other considerations, the drivers had direct implied contracts with the mechanics under which they authorized the repair work and agreed to cover any shortfall between the repair cost and the insurance cover.
Neal Armstrong. Summary of WHA Ltd. v. Revenue and Customs Commissioners, [2013] UKSC 24, [2013] 2 All ER 908 under ETA - s. 169(1).
New Gold friendly merger with Rainy River is not utilizing a Plan of Arrangement
New Gold is offering to acquire Rainy River Resources shares (and related shareholder rights plan rights) for per share consideration of $3.83 in cash or (at the option of the Rainy River shareholder) 0.5 of a New Gold share – but with the total consideration (including on a subsequent squeeze-out transaction) fixed at $198 million in cash and 25.8 million New Gold shares, so that some proration is highly likely.
Although this acquisition is supported by the Rainy River board, it is not proceeding by way of a plan of arrangement (which avoids US share registration requirements) as the issuance of the New Gold shares will occur pursuant to a registration statement under the US Securities Act of 1933.
The tax disclosure is not affected by SRP rights also being acquired. Similarly to the recent Plazacorp offer for KEYreit units, Rainy River shareholders desiring s. 85 rollover treatment are given only 45 days after take-up to provide the election forms to New Gold.
Neal Armstrong. Summary of New Gold offer under Mergers & Acquisitions – Friendly Corporate Offers – Shares for Cash and Shares.
Gastar Exploration – IRS is demanding the payment of a toll charge in exchange for giving a continuance ruling
Gastar Exploration, which is an Alberta corporation with a U.S. natural gas business, is proposing to continue to Delaware pursuant to an Alberta Plan of Arrangement. The continuance is regarded from a U.S. tax perspective as entailing a transfer by Gastar of all its assets to the new Delaware corporation (Gastar Delaware), followed by a distribution by Gastar of Gastar Delaware to its shareholders. This distribution step is potentially problematic as Gastar Delaware will be a United States real property holding company for FIRPTA purposes.
The IRS has ruled that Gastar will qualify for an exemption from the FIRPTA tax that otherwise would be payable on this distribution if Gastar pays a "toll charge" equal to the FIRPTA taxes that would have been imposed on its shareholders since its incorporation 10 years ago had it been a domestic corporation all along - plus interest. Management estimates that this toll charge will be only around $500,000 (the Gastar share price has been in a somewhat steady decline from $25 10 years ago to $2.50 today.)
CRA likely would not engage in this sort of horse trading given the perceived strictures of the Cohen and Galway doctrine.
Notwithstanding a deemed disposition of all its property (s. 128.1(4)(b)) and an exit tax calculated at 5% of NAV minus PUC (s. 219.1), management does not anticipate any material Canadian income tax on the continuance.
Neal Armstrong. Summary of Gastar Exploration Proxy Statement under Other – Continuances.
FLSmidth - Court of Appeal confirms that foreign taxes of a partnership are paid for Canadian purposes by the partners
The taxpayer utilized a tower structure: a hybrid partnership atop a hybrid Nova Scotia ULC atop an LLC, which made loans to a C-Corp subsidiary of the partnership. For U.S. purposes, the partnership was subject to US corporate tax on interest income (net of 3rd-party interest expense) considered to be received directly from the C-Corp. For Canadian purposes, the taxpayer was considered to receive dividends from the ULC ("through" the partnership) eligible for the intercorporate dividend deduction (and effectively deducted the partnership-level interest expense from that income); and the ULC received exempt surplus dividends from the LLC.
The taxpayer unsuccessfully sought to deduct its 98.9% share of the US taxes paid by the hybrid partnership under s. 20(12) on the basis that those taxes: (i) were paid by it in respect of its income; and (ii) could not be reasonably regarded as having been paid by it in respect of income on foreign affiliate shares (i.e., the LLC). Two problems: (1) its income for Canadian purposes was its (98.9%) share of dividends from the ULC, and US taxes were not imposed on that dividend income (contrary to the requirement in (i)); and (2) if the US taxes nonetheless could be considered to have been paid by it "in respect of" that income (a broad phrase), this entailed looking further down the tower structure and recognizing that it got such income via dividends on the LLC shares (contrary to the requirement in (ii)).
Respecting the second problem, taxpayer's counsel argued that the US taxes were paid by a partnership (the US taxpayer), whereas they had to be paid by a corporation (namely, the taxpayer) in order for the foreign affiliate exclusion in (ii) to apply. Noël JA disagreed, finding that it was the partners who should be considered to have paid the US taxes for Canadian purposes. This point may be the broader significance of the case.
Neal Armstrong. Summary of FLSmidth v. The Queen, 2013 FCA 160 under s. 20(12).
CRA has rejected the Goldilocks taxable Canadian property interpretation?
You and other non-resident investors indirectly invest in the equity of a Canadian real estate partnership having a value of $100 by forming a non-resident partnership which invests $70 in interest bearing loans of a non-resident Newco (Foreign Subsidiary) and $30 in common shares of Foreign Subsidiary, which then uses the $100 to acquire the units of the Canadian partnership.
You could argue that your units of the non-resident partnership are not taxable Canadian property. It holds the loans which in a normal (Goldilocks) range of circumstances will not fluctuate in value irrespective of the value of the underlying real estate and represent more than 50% of its assets (i.e., the underlying Canadian real estate will not depreciate below $70 or appreciate above $140).
On a slightly more complicated structure, CRA ruled that the units of the non-resident partnership were taxable Canadian property. CRA did not seem to be especially interested in what percentage the loans represented of the total assets, so this may represent an implicit rejection of the above Goldilocks interpretation.
CRA also ruled that the units of the non-resident partnership represented treaty-protected property under four of the relevant treaties (but not the fifth). This may relate to an exception for non-rental Canadian real estate in which a business is carried on, such as a hotel. See, for example, Art. 13(4) of the Lux and German treaties, and 20 August 2007 T.I. 2005-011115.
Neal Armstrong. Summaries of 2013 Ruling 2012-0444431R3 under s. 248(1) – taxable Canadian property and Treaties – Art. 13.
CRA appears to accept its inability to recharacterize a cross-border obligation as equity in a transfer-pricing context
In the interpretation described in the post immediately below, the Rulings Directorate went on to indicate that if the local CRA office determined that the interest rate payable by Canco to its non-resident parent departed from the arm’s length transfer pricing standard (i.e., there was a departure described in Article IX of the applicable Treaty from the "conditions" that would have been made between independent enterprises), then a resulting reassessment of Canco to deny some of the interest deduction would be subject to the time limitation contained in Article IX.
The Directorate went on to indicate that if the applicable intercompany instrument
were a commercially common instrument which would be classified as an equity investment even if it were entered into between independent enterprises…such a reassessment would not be subject to the time limitation period in [Article IX] because it would not be as the result of conditions made or imposed between the two enterprises in their commercial or financial relations which differed from those which would be made between independent enterprises.
The italicized words (referring to calling something equity only if it essentially is equity) suggest that CRA accepts that it does not have any significant ability to recharacterize the instrument the parties entered into as contrasted to requiring that the terms chosen be arm’s length terms. See Brian Bloom and François Vincent, "Canada's (Two) Transfer-Pricing Rules: A Tax Policy and Legal Analysis."
Neal Armstrong. Summary of 3 June 2013 Memorandum 2012-0468131I7 under Treaties - Article 9.
CRA concludes that amounts paid on a hybrid instrument to the taxpayer’s parent were deductible interest
CRA has concluded that "amounts" (to use a neutral word) paid by a Canadian subsidiary to its non-resident parent, on a "Contract" that had been issued by it for the purchase of a parent subsidiary, were deductible as interest (to the extent they were reasonable in amount) notwithstanding that the amounts were not treated as income under the domestic tax laws of the parent. The features of the Contract which were somewhat equity-like were: it was subordinated and convertible at the parent’s option into common shares; the percentage returns included a variable component which went to nil if the taxpayer had no income; there apparently was a long term (perhaps 30 years); and the returns were called "amounts" rather than "interest," and could be paid at the taxpayer’s option through the issuance of preferred shares.
Neal Armstrong. Summary of 3 June 2013 Memorandum 2012-0468131I7 under s. 20(1)(c).
CRA notes that basis averaging can adversely affect the bump under the new s. 88(1)(d) bump rules
Suppose that Parent wishes to "bump" the cost of 3,000 shares of a public company which Target held at the time of Parent’s acquisition of control of Target. CRA notes that as a result of the revised bump limit in draft s. 88(1)(d)(ii), a purchase of additional shares of the public company by Target at a high cost before Target is wound-up will reduce the bump limit for the 3,000 shares because their cost amount will be increased under the (s. 47) basis averaging rules.
Neal Armstrong. Summary of 23 April 2013 T.I. 2012-0461741E5 under s. 88(1)(d)(ii).