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CRA goes along with new OECD transfer-pricing policy of overriding the legal characterization of transactions

The OECD 2017 Transfer Pricing Guidelines reoriented transfer pricing towards the concept of value creation, namely, of ensuring that profits are taxed where economic activities take place and value is created. This represents a significant departure from the Canadian jurisprudence, which generally respects the legal substance of arrangements rather than recharacterizing them in accordance with their underlying economic substance.

The 2017 Transfer Pricing Guidelines also essentially proposed that, in order to compare an (actual) transaction between associated enterprises with a comparable transaction entered into between independent parties, the actual transaction must be first "accurately delineated" in light of "economically significant characteristics," e.g., the conduct of the associated parties, the functions they perform, the assets they actually use and the risks they actually assume.

If an analysis of the above enumerated economically significant characteristics results in a delineation of a transaction that differs from that entered into under the contract between the associated enterprises, the accurate delineation principle would then ignore the contractual transaction in the comparability analysis, instead focusing on the "accurately delineated" transaction.

As an example of this recharacteriazation approach (even where the criteria in s. 247(2)(b) are not both satisfied), the OECD’s recent Discussion Draft on Financial Transactions provides an example of a purported loan being “accurately delineated” as equity, chiefly because of a low likelihood of repayment within the specified term.

In this context, it is problematic that the 2018 CTF Rouundtable, Q.4 indicated that CRA will apply the 2017 Transfer Pricing Guidelines to pre-2017 taxation years, as well as to the interpretation of treaties entered into post-2017. CRA does not consider such an application to be retroactive, due to CRA’s characterization of these Guidelines as merely an elaboration on the prior OECD guidance.

Neal Armstrong. Summary of Matias Milet and Jennifer Horton, “The Canada Revenue Agency’s Interpretation of the 2017 OECD Transfer Pricing Guidelines,” International Tax (Wolters Kluwer CCH), No. 103, December 2018, p.10 under s. 247(2).

Income Tax Severed Letters 9 January 2018

This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.

Thomson Reuters engaged in a U.S.$6.5B cash issuer bid under a modified Dutch auction

Prior to the s. 86 distribution of cash by Thomson Reuters described in a previous post, it made an issuer bid to purchase up to U.S.$9 billion of its shares for cash under a modified Dutch auction procedure. In fact, U.S.$6.5 billion in shares was tendered. Leaving aside s. 55(2), over ¾ of the purchase price was deemed to be a dividend.

The principal “modification” related to a desire of Woodridge, who held 62% of the Thomson Reuters shares, to not have its percentage interest change. Accordingly, there was added the concept of a “Proportionate Tender” under which a shareholder tendering its shares to Thomson Reuters under this alternative was deemed to have agreed to sell to Thomson Reuters, at the purchase price determined in accordance with the Dutch auction procedure, that number of shares that would result in its percentage shareholding remaining the same.

Shareholders also were offered a “Qualifying Holdco Alternative.” This entailed such a shareholder together with an affiliated “Preferred Holdco” transferring their Thomson Reuters shares to a Newco (potentially on a s. 85 rollover basis) in exchange for common and preferred shares of Newco. Newco (along with other Newcos) then amalgamating with a sub of Thomson Reuters under a triangular amalgamation in which the electing shareholder and Preferred Holdco received shares of Thomson Reuters. Such shares could then be tendered under the offer. Woodridge indicated that it would participate in the Qualifying Holdco Alternative, and it is unclear who else it might have been of interest to.

Neal Armstrong. Summary of Thomson Reuters Circular under Other – Issuer Bids – Share Offer.

CRA rules that a Luxembourg FCP was a co-ownership rather than a trust or partnership

Foreign pension funds invested in particular securities’ portfolios including, in some cases, Canadian securities through acquiring “units” in particular sub-funds of a Luxembourg FCP (“fonds commun de placement,” which might literally be translated as an “investment mutual fund”). Their units were stated to give them a proportionate ownership interest in the sub-fund. The portfolios were managed by a manager and held by separate custodians.

CRA ruled that the FCP including the constituent sub-funds would be treated as fiscally transparent for purposes of the Act so that, for example, dividends or interest paid by a particular Canadian investment in a sub-fund would be considered an amount paid directly to the unitholder “in proportion to its co-ownership interest in the assets and Gross Income of the particular Sub-Fund.” This ruling letter essentially constitutes the reissuance of a ruling letter given a decade previously.

Neal Armstrong. Summary of 2017 Ruling 2015-0605161R3 under s. 104(1).

7 further translations of CRA interpretations are available

We have released another 7 translations of CRA interpretations released in December 2012 including 5 from the 2012 APFF Roundtables.

These are additions to our set of 747 full-text translations of French-language Rulings, Roundtable items and Technical Interpretations of the Income Tax Rulings Directorate, which covers the last 6 years of releases by the Directorate. These translations are subject to the usual (3 working weeks per month) paywall. You are currently in the “open” week for January.

Bundle Date Translated severed letter Summaries under Summary descriptor
2012-12-24 5 October 2012 Roundtable, 2012-0453161C6 F - RRIF, prohibited investment, minimum amount Income Tax Act - Section 146.3 - Subsection 146.3(1) - Retirement Income Fund payout of transitional prohibited investment benefit may be taken into account as satisfying the minimum amount
5 October 2012 APFF Roundtable, 2012-0454171C6 F - Taxable Pref. Shares and Short-Term Pref. Shares Income Tax Act - Section 248 - Subsection 248(1) - Taxable Preferred Share - Paragraph (f) para. (f) tests applied at time of payment and receipt of dividend
5 October 2012 APFF Roundtable, 2012-0453891C6 F - Price Adjustment Clause General Concepts - Effective Date operation of freeze price adjustment clause depends on share actually being adjusted and can apply for s. 75(2) purposes
Income Tax Act - Section 75 - Subsection 75(2) price adjustment clause that is implemented potentially can prevent s. 75(2) application to estate freeze
2012-12-12 20 November 2012 External T.I. 2012-0440031E5 F - Quebec Tax Credit for Production of Performances Income Tax Act - Section 12 - Subsection 12(1) - Paragraph 12(1)(x) - Subparagraph 12(1)(x)(iv) Québec Credit for the Production of Performances includible under ss. 12(1)(x)(iii) and (iv) rather than s. 9
2012-12-05 7 November 2012 External T.I. 2012-0437821E5 F - Registered Plan - Advantage Income Tax Act - Section 207.01 - Subsection 207.01(1) - Advantage - Paragraph (b) advantage from swap transaction includes 100% of resulting value increase, income on transferred property and income on income
5 October 2012 APFF Roundtable, 2012-0454091C6 F - GRIP and deemed dividend pursuant to 84.1(1)(b) Income Tax Act - Section 84.1 - Subsection 84.1(1) - Paragraph 84.1(1)(b) unnecessary in s. 89(14) for s. 84.1 to have deemed dividend to be paid on shares
Income Tax Act - Section 89 - Subsection 89(14) s. 84.1 deemed dividend paid to an individual could be an eligible dividend notwithstanding him not being a shareholder of the payer
5 October 2012 APFF Roundtable, 2012-0454111C6 F - Power of attorney and acquisition of control Income Tax Act - Section 251.2 power of attorney in event of capacity is an external docuement which, when judically approved, does not effect a change of control

Thomson Reuters distributed US$2.3 billion in cash pursuant to a s. 86 reorg with opt-out rights

On November 27, 2018, Thomson Reuters distributed US$2.3 billion to its shareholders (being a portion of the US$17 billion realized earlier in the year on an asset sale), using a s. 86 distribution. In order to avoid potentially adverse tax consequences for some shareholders in foreign jurisdictions, Thomson Reuters gave non-exempt shareholders in non-Canadian jurisdictions the right to opt out of the cash distribution so that, rather than receiving such cash, their percentage equity interest in the Corporation would increase by an appropriate amount.

To accomplish this result, the “Participating Shareholders” (i.e., those who did not elect to be “Opting Out Shareholders”) had each of their old common shares exchanged under a s. 86 reorg for US$4.45 of cash and 0.9070 of a new common share, whose attributes were the same as for an old common share, except that it was convertible on a one-for-one basis for an old common share. All their new common shares were then converted into old common shares. The Opting Out Shareholders continued to hold the same number of old common shares as before. Given the paid-up capital per old common share of C$13.36 per share, no deemed dividend arose.

This “Return of Capital Transaction” was effected pursuant to on Ontario Plan of Arrangement, whose terms effectively indicate that the Corporation is potentially willing to entertain letting Participating Shareholders elect under s. 85(1) or (2) respecting the above exchange.

Neal Armstrong. Summary of Thomson Reuters Circular and Press Release under Spin-offs & Distributions – S. 86 cash distributions.

Walsh – Federal Court of Appeal confirms denial of interest relief for a taxpayer who held off paying an assessment pending the resolution of a similar (departure trade) case

In 1998, the taxpayer implemented a “departure trade transaction” under which he borrowed $695 million from CIBC so as to generate an interest deduction for the period prior to his departure from Canada, with that money simultaneously being reinvested with CIBC – but with the return thereon not being taxable to him prior to his departure due to the reinvestment occurring “through” intermediate Caymans companies who issued preferred shares rather than debt to him.

In 2002, his 1998 return was reassessed to deny his $47 million interest deduction and to increase the reported capital gain arising under s. 128.1(4). In May 2006, his 1999 return was reassessed to add $54 million of income based on the in-the-alternative view that he had not ceased to be a Canadian resident in 1998 – which, of course, was inconsistent with the earlier reassessment of the departure tax for that year. In June 2006, a similar departure trade case (Grant – subsequently affirmed), denied the interest deduction. In a 2010 settlement, the appellant accepted the denial of the interest.

Near JA affirmed the decision below that the decision of the Minister’s delegate to deny relief of the assessed interest had not been established to be unreasonable, noting that:

Telfer stated that a taxpayer who knowingly fails to pay a tax debt pending a decision in a related case “normally cannot complain that they should not have to pay interest” … .

He also indicated that the inconsistent reassessment did not preclude the taxpayer from taking steps to reduce his interest exposure (and that the taxpayer had been slow in providing CRA with information to sort out when he had ceased to be a Canadian resident).

Neal Armstrong. Summary of Walsh v. Canada (Attorney General), 2018 FCA 229 under s. 220(2.1).

Ihama-Anthony – Tax Court of Canada indicates that an objection can be made after the proposal letter and before the notice of reassessment – but must state “I object”

Sommerfeldt J found that a fax sent by the taxpayer to CRA could have qualified as notices of objection even though it may have been sent before the issuance of the notices of reassessment in question, stating:

Like Justice Woods in Persaud, I am of the view that a notice of objection prepared in response to a proposal letter, which informs a taxpayer that a reassessment is about to be issued, may, if validly served on a Chief of Appeals, constitute a valid notice of objection in respect of the reassessment when it is subsequently issued.

However, the fax in question did not so qualify because it was not addressed to the Chief of Appeals, and did not state “I object to the expense disallowance” or words to that effect, and instead only provided missing documents.

Neal Armstrong. Summaries of Ihama-Anthony v. The Queen, 2018 TCC 262 under s. 165(1) and s. 166.2(5)(a).

Loblaw Financial – Tax Court of Canada finds that the Crown should not receive a costs award

CRA prevailed in assessing a Loblaw subsidiary for the realization of $473 million of foreign accrual property income between 2001 and 2010 through a wholly-owned Barbados international bank (GBL), but only on the basis that GBL’s business was not conducted principally with arm’s length persons. The taxpayer had made a settlement offer on what C Miller J had described as a principled basis, namely, that CRA would apply GAAR to GBL’s 2006 to 2013 years – but not to the earlier years on the basis that they were not covered by waivers provided. CRA rejected this offer and made its own offer (which was made too close to trial to qualify under Rule 147(3.2), and was also rejected) that provided a concession on the characterization of foreign exchange gains and losses realized by GBL

C Miller J found that no costs should be awarded to CRA, notwithstanding its total success, since it had lost on most of the issues raised by it. Respecting CRA’s submission that it should receive an award of 30% of solicitor-client costs incurred after its counteroffer, he agreed (at para. 19) with the taxpayer that this offer “was neither a compromise nor a good faith attempt to settle, given the relative insignificance of the [FX] issue.”

Neal Armstrong. Summary of Loblaw Financial Holdings Inc. v. The Queen, 2018 TCC 263 under Tax Court Rules, Rule 147(3).

CRA requires that a transfer of an FA with exempt earnings by FA Holdco to Can Subco occur at less than the shares’ FMV

A foreign affiliate (New FA) of a Canadian corporation (ACo) transferred all the shares of FA1 to a Canadian-resident subsidiary (BCo) of ACo in consideration for a note of BCo whose amount equalled the sum of the relevant cost base of the FA1 shares and the net surplus (being exempt surplus) of FA1 (such sum, the “Transfer Amount”). BCo then used share subscription proceeds received by it from ACo to repay the note, with New FA then distributing that cash to ACo and with ACo electing under Reg. 5901(2)(b) for the distributions to come out of New FA’s pre-acquisition surplus. CRA ruled inter alia as to the application of s. 93(1.11) to effectively convert part or all of the capital gain of New FA otherwise realized on its disposition of its FA1 shares into an exempt surplus dividend.

The ruling letter states:

The purpose for the transfer by New FA of its FA1 Shares to BCo … occurring at the Transfer Amount as opposed to occurring at their FMV, was not to confer a benefit on a person, but rather to address certain policy concerns of the CRA by restricting BCo’s aggregate ACB of its FA1 Shares to the Transfer Amount.

Having insisted that the transfer of the FA1 shares by New FA to BCo occur at the Transfer Amount rather than the higher FMV, CRA obligingly issued rulings that none of the usual conferral-of-benefit provisions applied.

Neal Armstrong. Summaries of 2016 Ruling 2016-0630761R3 under s. 93(1.11) and Reg. 5901(2)(b).