News of Note

CRA ruled on routine transactions between two Lossco subsidiaries and one Profitco subsidiary of an immediate Canadian parent company involving Lossco loans to the Profitco and Profitco subscriptions for Lossco cumulative preferred shares. The ruling contemplated that the daylight loan to the immediate parent could be in a somewhat small amount borrowed from a group company, with the funds used in setting up the loss shifting structure moved in a circle up to five times. Using a re-circulating in-house daylight loan would not only likely be cheaper and more expedient, but also could make it easier to give the representation that the daylight loan amount was consistent with that parent’s borrowing capacity.

The rulings included that Profitco could use any non-capital loss arising from these transactions for carryback (for up to 3 years) back to a prior year.

Neal Armstrong. Summary of 2023 Ruling 2023-0964601R3 under s. 111(1)(a).

The taxpayer (“KQI”), a Canadian operating subsidiary in the Kone multinational group, used group funds advanced to it by a group company (Kone Canada), in part as an interest-bearing loan, to purchase, for a cash purchase price of $394 million, cumulative preferred shares of a US affiliate (Kone USA) from the non-resident affiliated company (Kone BV) to which such shares had recently been issued as a stock dividend. At the same time, KQI agreed to resell such preferred shares at pre-agreed higher prices, to Kone BV in three and five years’ time, which in fact occurred. The gain arising under this resale was deemed under s. 93 to be dividends coming out of exempt surplus of Kone USA.

The ARQ sought to impute interest income to KQI under TA s. 127.6, the Quebec equivalent of ITA s. 17(1), on the basis that the above “repo” transaction was a sham that should instead be characterized as an interest-free loan by KQI to Kone BV or, alternatively, that the repo transaction represented an abusive avoidance of such s. 17 equivalent for Quebec GAAR purposes.

After rejecting the sham argument, the Court also rejected the application of the Quebec GAAR, stating:

One cannot ignore the fact that financing transactions that are not loans will not generate interest but may provide for other forms of return. … A repo with a reasonable return in the form of dividends does not defeat the OSP [object, spirit and purpose] of Section 127.6.

… KQI is taking advantage of … a mismatch between the tax treatment of its income (the dividends from Kone US are not taxable because they are paid out of its exempt surplus) and its expense (the interest in pays to Kone Canada is deductible). …

However, the mismatch arises from the Taxation Act and the policies underlying it … . The exempt surplus in Kone US is made up of its earnings from an active business on which it has already paid income taxes.

Neal Armstrong. Summaries of ARQ v. Kone Inc., 2024 QCCA 678 under s. 245(4) and General Concepts - Sham.

After giving effect to some preliminary transactions, a U.S. corporation which was a qualifying person for purposes of the Canada-US Treaty (the “Treaty”) wholly-owned four stacked corporations in Country 1. The “bottom” Country 1 corporation, in turn, wholly-owned a resident of Canada (Canco). The shares of Canco and of the above Country 1 corporations were taxable Canadian property (TCP).

The proposed transactions include:

1. The US corporation will contribute its shares of a Country 1 corporation to a newly-formed wholly-owned US corporation (Taxpayer 6), which is a qualifying person.
2. Three downstream absorptive mergers of Country 1 corporations will occur.
3. In addition, there will be an upstream merger of a Country 1 corporation which is a subsidiary of one of the above Country 1 corporations but whose shares are not TCP (because it is not “above” the Canco) into its Country 1 parent as the survivor.

Where there is a downstream absorptive merger under the Country 1 corporate law of a parent into its wholly-owned subsidiary: the subsidiary as the surviving entity does not dispose of its assets or liabilities (other than amounts owing between it and the parent); all of the assets and liabilities of the parent (other than such intercompany amounts and the shares of the subsidiary) are transferred to the subsidiary; the shares in both parent and subsidiary are cancelled; and the subsidiary allocates new shares to the current shareholder(s) of the parent.

An upstream absorptive merger is similar (in reverse) except that the shares of the subsidiary are cancelled and the current shareholder(s) of the parent continue to hold their shares of the parent.

CRA ruled that the disposition in 1 above will be exempted under Art. XIII(4) of the Treaty (presumably, because the transferred TCP was not shares of a company resident in Canada).

CRA gave rulings based on the mergers qualifying as absorptive mergers under s. 87(8.2) (so that the s. 87(4) rollover, and the para. (n) of “disposition” exclusion, applied). For instance, on each downstream merger, the shareholder of the parent will dispose of its shares of the parent for their ACB and will have an ACB for its shares of the surviving subsidiary for the same amount, and the parent will be deemed by para. (n) not to have disposed of its shares of the subsidiary.

Neal Armstrong. Summaries of 2023 Ruling 2022-0958521R3 under s. 87(8.2) and Treaties – Income Tax Conventions – Art. 13.

A physician and status Indian who lives off the reserve and is the sole shareholder of a corporation that is managed from an office on the reserve spends 70% of his time as employee on the reserve (mostly on patient care) and 30% off the reserve performing hospital duties. CRA indicated that although this was a question of fact, it might be considered that since 70% of the corporation's business income was located on a reserve, 70% of the physician’s salary from his corporation should be exempted.

Neal Armstrong. Summary of 4 April 2024 External T.I. 2023-0996201E5 F under Indian Act - s. 87.