News of Note
CRA has rejected the Goldilocks taxable Canadian property interpretation?
Email this ContentYou 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).
Income Tax Severed Letters 19 June 2013
This morning's release of 10 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Oops. I forgot to mention the consideration
Private investors have financed and constructed public projects such as hospitals and contracted for a stream of regular future payments (e.g., management or operating fees) from the government until maturity, when the financing is paid off. Following a favourable ruling, many such projects have been structured on the basis that, in consideration for the agreement of the consortium to construct the facility and operate it during the term to maturity, it is granted a licence to use the property, which qualifies as a Class 14 depreciable property.
When asked what happens when the participants forget to state that the construction costs are incurred in consideration for the grant of the licence, CRA expressed incredulousness that "such an important matter" could be missed; and stated that it was "possible" that some other evidence could be found establishing the cost of the licence.
Neal Armstrong. Summary of 30 May 2013 T.I. 2013-0487301E5 under Sched. II, Class 14.
Lehigh comment: s. 95(6) was intended to deal only with manipulations of CFA/FA status
Nat Boidman suggests that the scope accorded to s. 95(6) by Lehigh is significantly broader than the tax community's understanding of the provision's historical purpose and scope: it was intended only to deal with contrived avoidance of controlled foreign affiliate status or contrived qualification as a foreign affiliate.
Neal Armstrong. Summary of Nathan Boidman, "The Troubling Effects for Canadian MNEs of the Decision in Lehigh," Tax Notes International, 17 June 2013, p. 1211 under s. 95(6).
CRA indicates that the addition by a trustee/beneficiary of a discretionary trust of further beneficiaries can give rise to a taxable disposition by him of part of his beneficial interest
In a 2008 letter addressed to the Aggressive Tax Planning Audit Division which was not released until this week, CRA found that the addition by the sole trustee of a discretionary family trust, who also was one of the beneficiaries, of a group of unrelated persons to the trust beneficiaries, represented a disposition of part of his beneficial interest in the trust for proceeds of disposition that were deemed by s. 69(1)(b)(ii) (respecting "gifts") to be equal to its fair market value.
Given that, as acknowledged by the letter, the property represented by the interest of a beneficiary in a discretionary trust is merely "a right ... to be considered by the trustee as to whether or not any trust property ... should, in the trustee's discretion, be distributed," this advice isn't practical.
Neal Armstrong. Summary of 20 November 2008 Memorandum 2008-0281411I7 under s. 69(1)(b)(ii).
Guindon - Court of Appeal indicates that the Act's administrative penalties are not criminal even when large
The Court of Appeal reversed the Tax Court's decision in Guindon (see previous post) - which vacated a s. 163.2 (professionals') penalty on the basis that the taxpayer had not been given the procedural protections appropriate for the imposition of a criminal penalty. Although the reversal occurred principally on procedural grounds, Stratas JA also indicated that the s. 163.2 penalty (like other such penalties in the Act) was not criminal in nature even though it could be quite large (as happened in this case). Although the penalty was mechanically calculated, the Minister was required on a s. 220(3.1) relief application to take the "fairness purpose" of that provision into account - however here, no timely (within 10 years) application was made.
Scott Armstrong. Summary of Guindon v. The Queen, 2013 FCA 153, under ss. 163.2(5), 220(3.1) and Charter ss. 11 and 12.
Serabai Gold acquisition of Kenai Resources (holding CFAs) will use a Canadian Buyco
Serabi Gold, a UK public company, is proposing to acquire all the shares of Kenai Resources, a BC micro-cap company with a gold property held in a Brazilian subsidiary. The acquisition is proposed to occur under a three-way exchange pursuant to a plan of arrangement under which the Kenai shareholders will transfer their shares to a BC Newco subsidiary of Serabi (Subco), Serabi will issue ordinary shares to them, and Subco (which has one class of shares) will issue common shares with full stated capital to Serabi. Subco and Kenai will then amalgamate.
The normal PUC suppression rule in s. 212.3(7) applies to the PUC of the shares of the CRIC (i.e., Subco) "immediately before" the investment time, whereas here the Subco shares are to be issued immediately afterwards. A dividend substitution election may be planned (see IFA 2013 Round Table, Q. 6(h)), as the same timing rule is not stated to apply in that situation.
As noted in a previous post, CRIC vertical amalgamations are problematic, but presumably Finance will fix that.
Neal Armstrong. Summary of Kenai Resources Circular under Mergers and Acquisitions – Inbound – Other.