News of Note
Income Tax Severed Letters 22 May 2024
Email this ContentThis morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Carter – Tax Court of Canada finds that s. 84.1 did not apply to a sale of the taxpayer’s Opco shares to her cousin’s holdco for cash funded by an Opco dividend
The appellant, her cousin (“McAllister”) and her father held 40%, 40% and 20% of the common shares of Brown’s Paving Ltd. (“BPL”), respectively, and her father also had voting control through special voting shares (representing over 90% of the voting rights). Both she and McAllister worked in the business. After McAllister had approached the appellant about purchasing her shares, the following occurred:
- BPL took out a $600,000 bank loan, secured by a charge on its assets and a secured guarantee of McAllister and his personal holding company (Corco).
- Corco purchased all of the appellant’s shares in consideration for issuing a $600,000 demand promissory note.
- BPL redeemed the shares held by Corco for $600,000 in cash, which was used by Corco to pay off the demand promissory note. Corco claimed the s. 112(1) deduction.
In finding that the sale in 2 above was a transaction between persons dealing with each other at arm’s length, so that s. 84.1 did not deem the appellant to receive a dividend, Graham J indicated that:
- “The Appellant and Corco engaged in hard bargaining regarding the terms of the sale.”
- “[T]he transactions were structured in the way they were to benefit Corco … [which] needed a way to finance the purchase.”
- “The parties only ended up in the position that they did because the Appellant, when asked, was willing to sell her shares to Corco”, and a transaction in which her shares instead were redeemed by BPL was not a realistic alternative.
Graham J stated:
Ultimately, for the Appellant and Corco to have been acting in concert without separate interests, there must be something more than sharing the same tax advisors and having a common interest in getting the deal done.
Graham J also found that BPL was not connected to Corco immediately after the sale, as required by s. 84.1(1). In particular, Corco (which held under 10% of the votes) also did not control BPL pursuant to s. 186(2) given that there was no evidence that Corco did not deal at arm’s length with the person (the appellant’s father) who held over 90% of the voting rights over the BPL shares.
Neal Armstrong. Summary of Carter v. The King, 2024 TCC 71 under s. 84.1(1).
CRA discusses when a cash pooling arrangement may be a notifiable transaction
The CRA list of notifiable transactions includes a non-resident (NR1) entering into an arrangement with a non-resident (NR2) to indirectly provide financing to the taxpayer who would file on the basis that it was not subject to the thin capitalization rules; or on the basis that the interest it pays under the arrangement is either not subject to withholding tax at all or is subject to a lower rate of withholding tax than the rate that would apply on interest paid directly by it to NR1.
A Canadian taxpayer is a participant in a global cash pooling arrangement (the “Cash PA”) involving an arm’s length non-resident intermediary. The other participants are non-resident entities with which the Canadian taxpayer does not deal at arm’s length, and the total amounts borrowed by participants cannot exceed total amounts deposited by other participants.
If the Canadian taxpayer is a debtor under the Cash PA, is the Cash PA a “notifiable transaction” if at least one non-resident participant resides in a jurisdiction that is subject to a higher Canadian withholding tax rate on interest than the rate applicable on interest paid by the Canadian taxpayer to the intermediary?
After noting that the definition of “substantially similar” in s. 237.4(2)(a) encompasses situations that are either factually similar, or informed by the same tax strategy and can be expected to yield similar tax consequences, CRA indicated that although the designated transaction does not specifically describe a cash pooling arrangement, such a cash-pooling arrangement would be substantially similar to a designated transaction.
On the other hand, if it is reasonably expected, at the time that the Canadian taxpayer first becomes a participant, that it would only be a creditor under the pooling arrangement, it would not be a notifiable transaction: as there was no financing of the taxpayer, different provisions than in the designated transaction would be potentially engaged, e.g., s. 15(2.16) or (2.17).
Furthermore, even if the Canadian taxpayer was participating as a debtor in the arrangement, it would not be a notifiable transaction if it was reporting on the basis of any relevant application of s. 18(4) and it withheld and remitted tax on the basis of any application of the back-to-back rules, so that no reduction in withholding tax rates was achieved.
CRA also indicated that since the cash pooling constituted a series of transactions, if it constituted a notifiable transaction:
- the reporting obligation would arise on the first transaction to occur after November 1, 2023, e.g., an interest payment; and
- the filing in respect of one element of the series would satisfy the filing requirement in respect of the whole series, provided that the filing describes the nature of the subsequent transactions, and whether they are recurring or not.
Whether there was a requirement for a professional services firm to report if the cash pooling arrangement was a notifiable transaction but it was not involved in the set-up of the arrangement and only undertook compliance services based on debt, interest and withholding figures provided by the taxpayer would turn on the reporting position of the taxpayer (for example, is it filing on the basis of the application of s. 18(4), and is there withholding and remitting as if the financing had come directly from NR1?) and on whether the firm had a professional obligation to validate or advise the client on the actual filing position or on the application of the Act to the client’s cash pooling arrangement.
Neal Armstrong. Summaries of 15 May 2024 IFA Roundtable, Q.3 under s. 237.4(2), s. 237.4(4) and s. 237.4(1) - advisor.
CRA comments on whether a société en commandite simple is a partnership
When asked as to the entity classification of a Luxembourg limited partnership (société en commandite simple (SCS)) or special limited partnership (société en commandite spéciale (SCSp)), CRA (without wishing to respond definitively to this question) noted:
- The fact of an SCS having separate legal personality under Luxembourg law is not determinative.
- CRA has viewed a French société en commandite simple as a partnership, irrespective of whether it has irrevocably elected to be taxed as a corporation in France – and similarly, the recent enactment of reverse hybrid rules in Luxembourg would not be determinative.
- The Directorate will shortly be publishing an opinion that a société en commandite simple formed in Ivory Coast and Gabon most closely resembled a partnership under “Canadian law” (being the Quebec Civil Code given that the Ivory Coast and Gabon are civil law jurisdictions) notwithstanding its separate legal personality, given the unlimited liability of the general partner, as well as other characteristics.
Neal Armstrong. Summary of 15 May 2024 IFA Roundtable, Q.2 under s. 96.
CRA suggests that a non-resident’s increasing its voting shareholding in Canco to access the Treaty-reduced dividend withholding rate does not engage the PPT
A UK-resident corporation increased its voting shareholding of Canco the day before a dividend was paid so as to hold 10% of the shares. How would CRA apply the principal-purpose test (PPT) in Art. 7(1) of the MLI in this situation? CRA noted:
- Example E of the 2017 OECD Commentary on Art. 29 describes the similar situation of a shareholder who is slightly below the threshold for access to the lower dividend rate, and who acquires shares for the purpose of taking advantage of the reduced rate. The view in the Commentary is that such transaction would be in accordance with the object and the purpose of Art. 10(2), which provides the reduced rate.
- This OECD answer was conditional on the taxpayer’s acquisition "genuinely increas[ing]" its participation in the company. CRA understood “genuinely increasing” to suggest that there be no manipulation of the shareholding in the form of transitory acquisitions where, for example, a person, holding 8% of the shares, bought just enough shares to exceed the threshold for accessing the 5% reduced rate and, right after the dividend, returned to its initial 8% shareholding.
CRA indicated that the PPT had supplanted Art. 10(8) of the Canada-UK Treaty, so that this answer nullified the adverse position in 2019-0792651I7.
Neal Armstrong. Summary of 15 May 2024 IFA Roundtable, Q.1 under Treaties – Income Tax Conventions – Art. 10.
We have translated 7 more CRA interpretations
We have translated a CRA interpretation released in March 2024 and a further 6 CRA interpretations released in December of 2001. Their descriptors and links appear below.
These are additions to our set of 2,838 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 22 ½ years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
The 2024 IFA Roundtable is available
We have published the written questions which were posed, and a summary of the preliminary oral responses of CRA, at yesterday’s CRA Roundtable hosted by IFA in Montreal.
CRA indicates that the 3-month threshold for a drilling rig to be a PE under the Canada-US Treaty is counted based on days of consecutive or non-consecutive use including standby time
Art. V(4) of the Canada-U.S. Treaty provides that a permanent establishment exists in a Contracting State if the use of an installation or drilling rig or ship in that State to explore for or exploit natural resources is for more than three months in any twelve-month period. CRA indicated:
The three-month period is tested by counting the days of use, which need not be consecutive, provided they total to the three months.
Preparation time does not count as “use,” whereas standby time, i.e, “generally a temporary pause from operation that could be caused, for example, by severe weather, or shortage of labour” is counted as use on the basis that a “temporary interruption should not change the status that the installation or drilling rig or ship in question is being utilized in the business.”
Neal Armstrong. Summary of 23 November 2023 Internal T.I. 2020-0850381I7 under Treaties – Income Tax Conventions – Art. 5.
Income Tax Severed Letters 15 May 2024
This morning's release of four severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA indicates that dividend income that has not been subject to tax should not constitute safe income, and double taxation can be avoided with proper structuring
The starting structure in Example 30 of “CRA Update on Subsection 55(2) and Safe Income” is that Holdco owned the shares of Opco with an FMV, ACB and safe income of $500, 0 and 0; and Opco owned Subco1 (whose shares also had an FMV, ACB and safe income of $500, 0 and 0) and Subco2 (whose shares had no value, ACB or safe income). Then:
- Subco1 transfers its assets with an FMV and ACB of $500 and 0 on an s. 85(1) rollover basis to Subco2 for Subco2 shares.
- A third-party purchaser subscribes $500 for Opco shares.
- Subco2 redeems the shares of Subco1, Subco1 repurchases the shares of Opco, then Opco repurchases the shares of Holdco, in each case generating a $500 deemed dividend.
CRA indicated that although the deemed dividend from Subco2 to Subco1 is exempted under s. 55(3)(a) by virtue of s. 55(3.01)(g), the deemed dividend from Subco1 to Opco, and from Opco to Holdco, is subject to s. 55(2). In particular, the dividend from Subco2 is not subject to tax in the hands of Subco1 and none of the accrued gain on the assets has been realized, so that such dividend does not result in safe income to Subco1.
In response to a follow-up question, CRA indicated that the purpose of this example was merely “to illustrate the concept that a dividend income that has not been subject to tax should not constitute safe income for the benefit of a shareholder,” and stated:
The order of transactions described in the example would unlikely be implemented as such in the real world (for example, Subco1 does not need to redeem its shares held by Opco to achieve the results sought by Holdco) and a discussion on possible double-taxation in the scenario described is fruitless.
The double taxation issue was that, although “the capital gain realized by Opco on the redemption of shares of Subco1 would be included in the safe income of Opco and would not result in any double-taxation” (presumably because it would be there for potential future use), “[u]nfortunately, the deemed capital gain under subsection 55(2) would not be part of the safe income computed before the safe income determination time if all the transactions described are part of the same series of transactions” so that both Opco and Holdco would realize a capital gain. CRA further stated:
[W]e understand that transactions can be successfully implemented in a way to attract only one level of taxation if the ordering of transactions is carefully thought out … .
Neal Armstrong. Summary of 30 January 2024 External T.I. 2024-1005011E5 under s. 55(2.1)(c).