News of Note
Foix – Federal Court of Appeal confirms that s. 84(2) extends to the indirect distribution of liquid assets of the target through its sale to an arm’s length purchaser cum “facilitator”
Email this ContentThe shareholders of a private Canadian company (“W4N”) exploiting a valuable item of software had agreed in principle to sell W4N to a U.S. public company (“EMC”) for U.S.$50 million. However, EMC was amenable to a reorganization being implemented to permit the shareholders to extract the excess cash and investment type assets of W4N. What was implemented was a hybrid transaction in which there was both a sale of the software, goodwill and other business assets of W4N to EMC and a sale of shares of W4N (which continued to hold some Canadian business assets) by its shareholders to a Canadian subsidiary (“EMC Canada”) of EMC.
Although the steps to accomplish this and related safe-income, capital dividend and capital gains deduction planning were quite intricate, Noël C.J. focused for his purposes on the following five steps:
- Trusts for the families of the two principals (Souty and Foix) sold shares of W4N to EMC Canada for notes of EMC Canada, later paid in cash, with the resulting capital gains of $5 million (approximately equaling the proceeds) ultimately being distributed to various family beneficiaries.
- W4N sold its intellectual property, goodwill and some of its other business assets to EMC for consideration including two “capital dividend” notes totaling $22 million (which were later distributed) and a “Balance Note” for $19.75 million.
- Souty and the holding company for Foix (Virtuose) sold special voting shares of W4N to EMC Canada for nominal consideration so as to effect an acquisition of control of W4N.
- The balance of the shares of W4N now were sold directly, or through a sale of shares of Virtuose, to EMC Canada for cash consideration of around $14 million.
- EMC Canada, Virtuose and W4N amalgamated.
Noël C.J. essentially indicated that the final aggregate purchase price for the hybrid transaction had been increased by around the amount of the Balance Note but that the Balance Note was not repaid at any relevant time and that the payment of the cash sales proceeds in Step 4 essentially was funded by a diversion of cash resources of EMC that otherwise could have been used to repay the Balance Note.
In confirming the application of s. 84(2) to proceeds received under Step 2 that were distributed to a beneficiary of the Souty Trust and to some cash proceeds received by the two principals in Step 4, Noël C.J. first accepted the submission of the taxpayers “that the target corporation must be impoverished to the benefit of its shareholders for there to be a distribution or an appropriation,” but indicated that, here, there had been such impoverishment since the Balance Debt was not paid, and “the nonpayment of the debt in the course of the hybrid sale freed up the necessary funds to defray the cost of W4N’s and Virtuose’s shares.”
He went on to indicate that “the scope of subsection 84(2) is sufficiently broad to counter this type of distribution when the property being distributed is fungible and a third-party facilitator is involved in the extraction process” and that “it would be contrary to Parliament’s intention to turn a blind eye to the existence of a distribution or appropriation for the sole reason that, for example, the shareholder received the target corporation’s property as a creditor rather than as a shareholder … or, as in the present case, that the funds received by the shareholder originate directly from a third party but indirectly from the target corporation.” The presuppositions in McNichol and Descarries “that subsection 84(2) cannot apply to indirect distributions of property or funds because in such cases, the property distributed to the shareholders is not that of the target corporation, but property of the same quality and quantity” were incorrect. Furthermore, contrary to Robillard, the proper interpretation of s. 84(2) has not narrowed in its modern context.
He also confirmed that these indirect distributions had occurred on a “reorganization” of the business of W4N (its splitting into two pieces) and on a discontinuance of Virtuose’s business (it ceased to be a holding company).
Neal Armstrong. Summary of Foix v. Canada, 2023 FCA 38 under s. 84(2).
Income Tax Severed Letters 22 February 2023
This morning's release of five severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Ahamed TFSA – Tax Court of Canada finds that a TFSA is not exempted on profits of a business of trading in qualified investments
The self-directed TFSA of a professional investment advisor, which actively traded qualified investments (mostly, penny stocks listed on the TSX Venture Exchange), was assessed under s. 146.2(6) for its 2009 to 2012 taxation years (during which $15,000 in contributions grew to $564,483) on the basis that its net gains were income from carrying on a business.
The TFSA noted that s. 146(4)(b) effectively exempted from Part I tax any income earned by an RRSP from carrying on a business of trading qualified investments, and submitted that “there would have been no rational legislative purpose for Parliament to tax a TFSA trust carrying on a business of trading qualified investments while exempting an RRSP carrying on the very same business.”
In dismissing the TFSA’s appeal, Spiro J stated:
So long as the business is one that may be “carried on” (i.e., not an “adventure in the nature of trade”) all businesses — without statutory exception — fall within the scope of subsection 146.2(6) of the Act, including a business of trading qualified investments.
Had one of Parliament’s purposes been to extend the scope of the tax exemption to TFSA trusts carrying on a business of trading qualified investments, Parliament would have said so. It had already done so in the context of a different statutory scheme when it amended the RRSP legislation in 1993 to make such an exception for RRSPs.
Neal Armstrong. Summaries of Canadian Western, Trustee of Ahamed TFSA v. The King, 2023 TCC 17 under s. 146.2(6) and s. 146(4)(b).
Joint Committee comments on August 2022 FA technical amendments
Some of the comments of the Joint Committee on some foreign affiliate measures included in the August 2022 draft technical amendments include:
Regarding the proposed expansion of the anti-avoidance rule in s. 85.1(4) (and a similar draft s. 87(8.3) rule, given the breadth of the “series of transactions” concept, the proposed elimination of the purpose test could result in significant uncertainty.
Relevant subsequent dispositions should not extend to dispositions of foreign affiliate shares by a Canadian taxpayer (even if such shares derive value from the shares of the first affiliate) - nor to dispositions of shares of the Canadian taxpayer or of shares further up the chain, since these would be taxable transactions.
Further, proportionality should apply, so that a disposition of shares of another foreign affiliate deriving any of their FMV from the shares of the first affiliate (or substituted property) should only lead to a denial of rollover treatment on a proportionate basis.
The excluded property test should be applied regarding the excluded property status of the property that is disposed of on the subsequent disposition, and the (existing) requirement to test the excluded property status of the property of the first affiliate at the time of the initial transfer should be eliminated.
The s. 95(2)(b)(i)(B) amendments address that, under current legislation, a disproportionate amount of FAPI can arise where the participating percentage in the payee affiliate is higher than the participating percentage in the payer affiliate. However, inequitable results can arise where partnerships are involved, and it is suggested that there could be, for instance, a look-through rule for partnership structures.
Although proposed s. 95(3.03) regarding relief where inter-affiliate services fees are paid by FA Holdco rather than by the underlying FA Opco is modelled on the provision of relief in existing s. 95(2)(a)(ii)(D) where inter-affiliate interest is paid by an FA Holdco rather than being paid by the underlying FA Opco, it is problematic that the various ancillary rules applying for the purposes of s. 95(2)(a) do not extend to proposed s. 95(3.03) to ensure its proper operation, including inter alia regarding the “throughout the year” requirement (ss. 95(2.2) and (2.01)), qualifying interest status (s. 95(2)(n)), and deeming rules for intervening partnerships (ss. 95(2)(y) and 93.1(5) and (6).)
It is problematic that para. (c) of proposed s. 95(3.03) requires that the services fees be paid or payable “by the second affiliate,” since services fees that are paid or payable by a holding partnership in which a FA is a member can be subject to s. 95(2)(b) (i.e., if they are deductible in computing the FAPI of the FA member). Accordingly, a corresponding rule to s. 93.1(4) should be introduced (although “the requirement in subsection 93.1(4) that all members of the partnership be foreign affiliates should not be extended to paragraph 95(2)(b), given that the latter only applies to the extent that the amounts are deductible by a foreign affiliate.”)
While the “subject to tax” requirement in s. 95(3.03) is modelled on the requirements of existing s. 95(2)(a)(ii)(D), there appears to be no policy rationale to base the application of subsection 95(3.03) on whether the payer affiliate and its directly held subsidiaries are subject to tax.
Neal Armstrong. Summaries of Joint Committee, "August 2022 legislative proposals relating to the Income Tax Act and the Income Tax Regulations", 16 February 2023 Joint Committee Submission under s. 85.1(4), s. 95(2)(b)(i)(B) and s. 95(3.03).
We have translated 6 more CRA interpretations
We have published a further 6 translations of CRA interpretations released in October of 2003. Their descriptors and links appear below.
These are additions to our set of 2,382 full-text translations of French-language Technical Interpretation and Roundtable items (plus some ruling letters) of the Income Tax Rulings Directorate, which covers all of the last 19 1/3 years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
| Bundle Date | Translated severed letter | Summaries under | Summary descriptor |
|---|---|---|---|
| 2003-10-17 | 25 September 2003 External T.I. 2002-0180905 F - Cessation de résidence-Conséquences fiscales
Also released under document number 2002-01809050.
|
Income Tax Act - Section 128.1 - Subsection 128.1(4) - Paragraph 128.1(4)(b) | overview of consequences of emigration to Switzerland |
| 3 October 2003 External T.I. 2003-0004575 F - ASSURANCE-INVALIDITE
Also released under document number 2003-00045750.
|
Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(a) - Income-Producing Purpose | premiums paid by corporation for disability policy on shareholder-employee are non-deductible | |
| Income Tax Act - Section 3 - Paragraph 3(a) | disability benefits received by corporation for disability policy on shareholder-employee are not income | ||
| 3 October 2003 External T.I. 2003-0028385 F - EXONERATION DU REVENU IMPOSABLE
Also released under document number 2003-00283850.
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Income Tax Act - Section 149 - Subsection 149(1) - Paragraph 149(1)(d.3) | non-share corporations do not have shares | |
| 6 October 2003 External T.I. 2003-0040145 F - TRANSFERT D'UNE POLICE D'ASSURANCE-VIE
Also released under document number 2003-00401450.
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Income Tax Act - Section 148 - Subsection 148(7) | loss on transfer of universal life policy to wholly-owned subsidiary not recognized | |
| Income Tax Act - Section 148 - Subsection 148(9) - Adjusted Cost Basis - Element A | no taxable benefit when life insurance policy transferred to wholly-owned corporation at less than its FMV | ||
| Income Tax Act - Section 246 - Subsection 246(1) | no taxable benefit when life insurance policy transferred to wholly-owned corporation at less than its FMV | ||
| 3 October 2003 External T.I. 2003-0030585 F - PENSIONS ETRANGERES
Also released under document number 2003-00305850.
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Treaties - Income Tax Conventions - Article 18 | degree of exemption for social security pension payments from Germany, Belgium or France | |
| 2 October 2003 External T.I. 2003-0033415 F - FRAIS D'ACCES INTERNET
Also released under document number 2003-00334150.
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Income Tax Act - Section 6 - Subsection 6(1) - Paragraph 6(1)(a) | reimbursement of high-speed internet access fees to employees who must work from home likely not a taxable benefit |
Taxpayers who have filed under s. 216 face uncertainties under the EIFEL rules
It is uncertain whether a s. 216 filer will be a person resident in Canada for purposes of the draft excessive interest and financing expenses limitation (EIFEL) rules.
If, by virtue of s. 216(1)(a) (providing that such filer is liable to pay Part I tax as if it were a person resident in Canada), the answer is yes, the filer would be treated as resident for the purposes of provisions that were likely intended to apply only to actual Canadian residents. For instance, the taxpayer could qualify as an “excluded entity” under para. (b) of that definition (regarding the $1 million “de minimis” net interest test). If the taxpayer was a “fixed interest commercial trust” and was considered resident, it could potentially transfer and receive excess capacity from other eligible group entities.
Being an eligible group entity could also be relevant under the group ratio rules in s. 18.21.
Conversely, if the s. 216 filer is to be treated for EIFEL purposes as non-resident, it would have no “adjusted taxable income” (ATI) because it would have no “taxable income earned in Canada” for the year (as required under para. D(a) of the ATI definition), as that term applies only to taxpayers filing under s. 115. Furthermore, since, by virtue of s. 216(1(c), a s. 216 filer cannot claim any deductions in computing taxable income, restricted interest and financing expenses (RIFE) for a year cannot be claimed as a deduction in any subsequent year even if the taxpayer had excess capacity.
Neal Armstrong. Summary of Ken Griffin, “The EIFEL Rules and Section 216 Filers,” International Tax Highlights, Vol. 2, No. 1, February 2023, p. 7 under s. 216(1)(a).
Buhler Versatile – Tax Court of Canada finds that increasing the horsepower of a tractor by 20% was SR&ED
Wong J allowed the claim of the taxpayer, which was the only Canadian manufacturer of agricultural tractors, respecting a project to build a four-wheel drive tractor with 85 horsepower (or about 20%) above the current industry maximum.
She found in particular that here “the integration of non-trivial combinations of established (well-known) technologies and principles carried a major element of technological uncertainty” and that “with a horsepower increase of this magnitude, the obvious problems might not have had obvious solutions.” She also found that the scientific method had been followed – and documented well enough, although only marginally so.
The costs for this qualifying project were pooled with two others involving developing models with horsepower close to that of competitors’ models, which did not qualify as SR&ED. Since the cost allocation amongst the three projects was not established, Wong J allowed one-third of the pooled costs of $2.9 million, even though the qualifying project entailed the most work.
Neal Armstrong. Summary of Buhler Versatile Inc. v. The King, 2023 TCC 18 under s. 248(1) – SR&ED.
Income Tax Severed Letters 15 February 2023
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
The combined operation of the EIFEL rules on a Canco and CFA with FAPI is illustrated
A simple example has been provided to illustrate how the revised draft excessive interest and financing expenses limitation (EIFEL) rules operate in a somewhat consolidated manner where a Canadian corporation has a controlled foreign affiliate (CFA) that generates foreign accrual property income (FAPI).
Canco, which has business income of $1,100 after deducting interest expense of $1,400, also has a wholly-owned CFA that has income from property of $400 after deducting interest expense of $600, and pays no tax – so that Canco’s income including FAPI is $1,500. The interest and financing expense (IFE) of Canco is $1,400 plus its share of the relevant affiliate IFE (RAIFE) of the CFA of $600, or $2,000. Its adjusted taxable income (ATI) is its income of $1,500 plus the IFE of $2,000, or $3,500.
A percentage EIFEL denial is determined by comparing the IFE of $2,000 to 30% of ATI (0.3*$3,500), resulting in an aggregate denial of $950, being 47.5% of the $2,000 IFE. 47.5% of Canco’s $1,400 interest expense, or $665, is denied under s. 18.2(2). 47.5% of the RAIFE of $600, or $285, is denied under s. 95(2)(f.11)(ii)(D), increasing the FAPI inclusion accordingly. These two additions of $665 and $285 increase Canco’s income by $950 from $1,500 to $2,450.
The $950 of denied interest is added to the restricted interest and financing expense (RIFE) of Canco, which can be carried forward indefinitely and deducted by Canco, generally having regard to its capacity to deduct interest under the EIFEL rules in those future years.
If the CFA had incurred a foreign accrual property loss (FAPL) instead of FAPI, the RAIFE of the CFA would nonetheless be included in the IFE of Canco – even though that FAPL might never be deducted in computing Canco’s income.
Neal Armstrong. Summary of Nat Boidman and Eivan Sulaiman, “The EIFEL Proposals and Controlled Foreign Affiliates,” International Tax Highlights, Vol. 2, No. 1, February 2023, p. 5 under s. 95(2)(f.11)(ii)(D).
CRA applies its GST/HST policies to the UHTA concepts of primary residence and continuous occupancy
There is an exemption under s. 6(8) of the Underused Housing Tax Act regarding a home of a non-resident/non-citizen individual that is the “primary place of residence” of that individual or spouse thereof for the year in question, or of a child occupying it in connection with qualifying studies – subject to an obligation of a couple to share this exemption where there is more than one such home. CRA has indicated that it will apply its GST/HST policies in P-288 as to what is meant by “primary place of residence” – so that it cannot be secondary (determined generally by the relative degree of use in the year) to another home. Thus, the quoted term is narrower than the ITA concept of “principal residence.”
Ss. 6(1) and (9) generally provides an exemption for a corporate or individual non-resident where there is “continuous occupancy” of the home by an arm’s length individual under a written lease for specified periods amounting to at least about half the year – with a more intricate variant of this test applying where the occupant is not at arm’s length. Here, as well, CRA is applying its GST/HST policy, which is to consider that an “individual’s continuous occupancy of the dwelling unit for a period is not necessarily interrupted by the individual’s physical absence from the dwelling unit at a time in the period if … the individual still has the right to occupy the dwelling unit throughout their physical absence [and] the right to occupy the dwelling unit is not given to another individual for any period during the physical absence.” In other words, occupancy can include constructive occupancy.
Neal Armstrong. Summary of Underused Housing Tax Notice UHTN6 “Exemption for Primary Place of Residence” January 2023 under UHTA, s. 6(8) and summary of UHTN7 “Exemption for Qualifying Occupancy” under UHTA, s. 6(1).