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CRA considers that in some circumstances it can require a taxpayer to disclose its uncertain tax positions
CRA indicated that it can seek the production of tax accrual working papers, provided that the request for such records is relevant to specific risks or items under audit, and it uses restraint in seeking the information. Factors considered before making such a request include the existence of large unexplained tax reserves.
CRA considers that (consistent with Atlas Tube) it may, in some circumstances, request a list from the taxpayer of its uncertain tax positions. Provided all relevant facts and transactions are included in the taxpayer’s uncertain tax positions, exclusions of the related advice and analysis may be accommodated. CRA recognizes the principle in BP that taxpayers are not required to self-audit.
2018-0744031C6 indicated that the shares of a corporation that did not generate business income (e.g., a corporation that generated rents that, given the level of activity, constituted income from property) cannot qualify as excluded shares, whereas in Examples 8 and 12 of the December 2017 CRA website Guidance, shares of a corporation earning income from passive investment assets qualified as excluded shares. How should these positions be reconciled?
CRA noted that if in the above example the corporation carried on a business, its shares could qualify as excluded shares. On the other hand, even if it did carry on a business, the amount received from the corporation by the specified individual would qualify as an excluded amount if it were not derived, directly or indirectly, from a related business in respect of the individual for the year.
This response is similar to 2018 APFF Financial Strategies and Instruments Roundtable, Q.2 and 2018 APFF Roundtable, Q.9(a).
CRA discusses the “derivation” for TOSI purposes of dividends from previously earned income from a related business
CRA provided two contrasting examples illustrating the timing of the related business determination for split-income purposes. In the first example, Mr. and Mrs. A (both over 25) are equal shareholders of ACo, which two years previously sold the “Old Business” in which Mrs. A had been actively engaged on a regular, continuous and substantial basis for many years – but Mr. A, not at all. Since then, ACo’s sole activity has been the investing of the proceeds.
After noting that if ACo’s current investment activities constituted a business, the excluded share exclusion from the split income (TOSI) rules would apply, CRA went on to indicate that if ACo’s investment activities did not constitute a business, a dividend declared in the current year to Mr. and Mrs. A would be considered to be excluded amount, given the winding up of the Old Business in a previous taxation year and there being no other related business of ACo.
In another scenario, Mrs. and Mr. A instead are the respective sole shareholders of Opco (carrying on a non-services operating business) and Serviceco (earning income in Year 1 from Opco, but without Mr. A being actively involved in its business). In Year 2, Serviceco does not render any services and its activities are insufficient to constitute a business. CRA indicated that, as Serviceco earned its Year 1 income from the provision of services to Opco (i.e., derived amounts from Opco’s business) and the dividend paid in Year 2 can also be said to have derived directly or indirectly from the provision of services to Opco in Year 1 (and thus to be derived directly or indirectly from Opco’s business, being a related business), the Year 2 dividends paid by Serviceco of its after-tax income from Year 1 would not be excluded amounts.
CRA confirms that s. 66.3(3) does not apply to the cost of shares received on a ss. 85(2) and (3) wind-up of a flow-through share partnership
S. 66.3(3) deems the cost of flow-through shares to be nil. CRA confirmed that where a flow-through LP transfers its flow-through shares under s. 85(2) to a mutual fund corporation for shares of the MFC, and then distributes those shares to its partners on its winding-up under s. 85(3), s. 66.3(3) would not apply to determine the cost to the limited partners of the distributed shares. That cost instead would be determined under s. 85(3)(f) to be equal to the ACB of their interests in the LP immediately before the LP winding-up, and would not necessarily be nil.
Neal Armstrong. Summary of 17 September 2018 External T.I. 2018-0751571E5 F under s. 66.3(3).
CRA indicates that where Parent acquired the net tax equity in Subco at a bargain price (low share ACB), avoiding a s. 88(1)(b) gain on wind-up through reducing PUC is abusive
CRA provided two examples of when it would apply GAAR where paid up capital (“PUC”) is reduced to nil in order to avoid a s. 88(1)(b) gain on a wind up.
Example 1. Subco was formed by Xco with an injection of capital of $1,000 (being the PUC of Subco’s shares). Parentco acquired Subco for $1. On the winding-up of Subco into Parentco, Subco had assets with a cost amount of $1,000, and no liabilities or retained earnings (nor were retained earnings realized by it after its acquisition by Parentco).
CRA noted that if the Subco shares instead were redeemed for $1,000, the $999 excess of the redemption proceeds over the shares' ACB would produce a capital gain given that the shares had full PUC. In particular, since the cost amount of the Subco assets was not increased by income earned or realized by Subco after its acquisition of control by Parentco, this indicated that Parentco has made a bargain purchase in the form of the tax attributes in those assets, so that the scheme of s. 88(1)(b) dictated that a gain be realized by Parentco on the winding up in the amount of $999. Thus, CRA would apply GAAR to a reduction of PUC without payment prior to the winding up.
Example 3. Parentco owned all Subco shares which have a PUC and ACB of $1,000. Subco used $2,000 borrowed from a third party to acquire assets with a cost amount of $3,000 – which subsequently lost all their value. Parentco claimed a s. 50(1) loss $1,000 (thereby reducing the shares’ ACB to nil) prior to winding up Subco and assuming Subco's debt.
CRA indicated that the net cost amount of the assets of Subco is $1000, and consequently Parentco should realize a capital gain of $1000 on the winding up of Subco, under s. 88(1)(b). Parentco would essentially have taken two deductions for the same loss of $1000 – first the $1000 loss on the Subco shares under 50(1), and an additional loss of $1000 on the assets of Subco. Thus, a PUC reduction to avoid the s. 88(1)(b) gain would be GAARable.
Very briefly, Example 2 indicated that where the net tax equity in the Subco assets was matched by safe income, avoidance of s. 88(1)(b) would not be abusive.
What did CRA conclude in its review of questions regarding the impact of s. 55(2) on the computation of cost and CDA and the application of s. 112(3)? CRA indicated:
- Where a dividend in kind paid by a corporation is subject to s. 55(2), the dividend recipient will be considered to have acquired the distributed property at a cost under s. 52(2) equal to its fair market value.
- Since Finance’s intent is to give cost to the portion of the stock dividend that is supported by safe income, and also to a portion of the stock dividend that is technically subject to the application of s. 55(2), cost will be recognized under s. 52(3) for the amount of a stock dividend to which s. 55(2) has applied. (This and the above position reverse 9830665.)
- A dividend arising on a paid-up capital increase to which s. 55(2) applied remains a dividend for s. 53(1)(b)(i) purposes but such dividend was not permitted a deduction under s. 112(1), for purposes of the application of the basis reduction under s. 53(1)(b)(ii). Conversely, there is a reduction of cost under s. 53(1)(b)(ii) to deny cost on the amount of the dividend that exceeds safe income, and on which a deduction under s. 112(1) was obtained. Thus, cost will not be denied when a dividend on a paid up capital increase has been subject to s. 55(2).
- CRA will ensure that the taxpayer will not be penalized in the capital dividend account calculation where a stock dividend or paid-up capital increase was previously subject to s. 55(2). Thus, CRA will restrict the exclusion of 53(1)(b)(ii), and the similar provision found in s. 52(3)(a), in the CDA calculation, to situations where s. 55(2) did not apply to the stock dividend or the PUC increase.
CRA will now only provide guidance on safe income allocation to discretionary dividend shares in ruling letters
We have now published the questions posed at the CRA Roundtable at the annual 2018 CTF Conference and our summaries of the oral responses of the Income Tax Rulings Directorate.
In response to Q.1 as to the allocation of safe income where a corporation has discretionary dividend shares, CRA indicated that:
- It stands by all positions on this matter that it has expressed since the 2015 CTF Annual Conference.
- On a going-forward basis the CRA is willing to provide assurance on the tax treatment of the discretionary dividend shares, but only in the context of a ruling request – and thus will no longer express its views on this matter in Technical Interpretations or Roundtable responses.
CRA finds that a lower tier internal spin-off transaction accompanied by an upper-tier sale by a minority shareholder was subject to s. 55(2)
Holdco A has wholly-owned Opco spin off Opco’s real estate to a newly-formed subsidiary of Holdco A (and sister of Opco), namely, to Realco. The spin-off entails a cross-redemption of shares and resulting s. 84(3) dividends. In the course of the spin-off transactions, an unrelated shareholder of Holdco A (Holdco C) with a direct and indirect equity interest in Holdco A of around 16% sells its interest at fair market value (giving rise to gain) to arm’s length purchasers. Does s. 55(2) apply to the s. 84(3) dividends?
CRA indicated that assuming (as appeared to be the case) that the sale by Holdco C was part of the same series as the spin-off, and that the shares of Opco and Realco represented more than 10% of the value of what Holdco C was selling, then ss. 55(3)(a)(iii)(B) and 55(3)(a)(iv)(B) would “technically apply” to oust the s. 55(3)(a) exemption. Was CRA troubled that the deemed dividends at the Opco and Realco level did not affect the capital gains arising on the share sales by Holdco C? It stated:
[P]aragraph 55(3)(a) is intended to provide an exemption from the application of subsection 55(2) for certain dividends received in the course of related-party transactions. … [S]ince the other direct or indirect shareholders of Holdco A are not related persons, and the transactions … include a sale of Holdco A shares as part of the same series as the deemed dividends … the application of subsection 55(2) is operating as intended.
This approach illuminates why advisors sometimes seek s. 55(3)(a) rulings on internal spin-off transactions beneath a public company.
Neal Armstrong. Summary of 10 September 2018 External T.I. 2018-0772501E5 under s. 55(3)(a)(iii)(B).
Ntakos Estate – Tax Court of Canada finds that reassessments at the request of a taxpayer lacking mental capacity were void
An accountant got the taxpayer (Anna – who at that point was mentally failing), months before her death, to file T1 adjustment requests in 2003 for her 1998, 2001 and 2002 taxation years to allocate increased management fees and employment income to her by the family companies. This apparently had the effect of improving the tax position of one of Anna’s brothers, for whom the accountant was also acting. Over 10 years after the resulting reassessments of Anna (i.e., well beyond the s. 166.1(7)(a) deadline), her estate filed notices of objections or applications for an extension of time to file a notice of objection. Bocock J found:
Non est factum is available where a person is not capable of both reading and sufficiently understanding a document. …
… Anna from and after her diagnosis date, lacked mental capacity to execute or did not execute and file the 2003 filings… . Therefore, the notices of reassessments responsive to the 2003 filings … were void. … [T]he reassessments were consequential to invalid or unlawful filings and issued by the Minister under innocent mistake of fact. Accordingly, no objection was required to the void reassessments. …
Bocock J went on to vacate those reassessments.
He was striving for an equitable result. He did not explain how lack of mental capacity to make or adjust a return for a taxation year invalidates an assessment of that year.
Neal Armstrong. Summary of Ntakos Estate v. The Queen, 2018 TCC 224 under s. 166.