News of Note

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

A Canadian-controlled private corporation (ACo) held a minority interest in another corporation (BCo) in the form of two classes of shares, one of which had been held on V-day (December 31, 1971), so that the accrued capital gain on the V-day shares represented potential pre-1972 CSOH which could be distributed under s. 88(2) as a capital distribution on the winding-up of ACo.  CRA ruled, based on previous GAAR committee deliberations, that it was acceptable for ACo to distribute this incipient surplus to its individual shareholders without itself being wound-up.  This was to be accomplished by ACo spinning-off the V-day shares to a Newco held by its shareholders, with BCo then being wound up in the hands of its shareholders including Newco and ACo (which until then continued to hold the post-72 shares of BCo), and with Newco itself then being wound up (so that the Newco shareholders accessed 100% of the pre-1972 CSOH under s. 88(2).)

The spin-off mechanics entailed ACo and Newco receiving equal deemed dividends from each other.  This gave rise to a RDTOH circularity problem, as ACo had a RTOH balance.  The Rulings Directorate stated that the district CRA offices "will have to be consulted in order to determine which corporation will receive the dividend refund and which corporation will be subject to the Part IV tax liability under paragraph 186(1)(b)."

Neal Armstrong.  Summary of 2013 Ruling 2012-0443081R3 ("Distribution of pre-72 Capital Surplus on Hand") under s. 186(1).

Some surplus-stripping transactions involved a company (Opco) paying a dividend to Trust 1, which distributed the dividend to a related corporation (Holdco) qua beneficiary which, in turn, paid the same dividend amount to Trust 2 (the taxpayer).  The "trick" was that Holdco had previously undergone an estate-freeze style of reorg so that Trust 2 had been able to purchase all of Holdco’s common shares from Opco for their nominal fair market value.  Therefore (the taxpayer argued), s. 75(2) applied to deem the dividend received by it from Holdco to instead be dividend income of Opco, which was eligible for the s. 112 intercorporate dividend deduction.

However, Sommerer was decided before judgment – so that Bocock J found that s. 75(2) did not apply to the dividend income on the Holdco common shares, as they had been sold, rather than contributed, to the taxpayer.  Hence, GAAR was moot.

He did not comment on new (draft) s. 75(2).

Neal Armstrong.  Summary of Brent Kern Family Trust v. The Queen, 2013 TCC 327, under s. 75(2).

Several cases (e.g., RMM, see also Livingston) suggest that if a normally independent (and unrelated) person agrees to act as an accommodation party for the taxpayer, then it and the taxpayer are not dealing at arm's length in the resulting transaction.  The most recent example is a friend of the taxpayer who let the taxpayer deposit funds with his corporation to be held by the corporation on behalf of the taxpayer, in order to defeat a bank claim (the friend didn't know about the taxpayer's tax debt).

Noël JA also found that because this arrangement was a "simulation" under the Civil Code (i.e., a contract availed of by third parties notwithstanding that it was contrary to the parties' "secret contract" - i.e., the funds in fact were held on behalf of the taxpayer rather than having been truly divested by him), CRA could treat the funds as if they had been transferred to the corporation for s. 160 purposes.  Although there is no doctrine that CRA can rely on the terms of a purported common law contract which is a sham, a taxpayer in a common law province unsuccessfully argued (in 1524994 - see also Gurd's Products) that a contract should be disregarded for tax purposes because it was "merely" entered into in order to deceive a third party for non-tax reasons.

Neal Armstrong.  Summaries of The Queen v. 9101-2310 Québec Inc., 2013 FCA 241 under ss. 160(1) and 251(1)(c).