News of Note
Mony – Tax Court of Canada follows Gervais to find that avoiding capital gains attribution through ACB averaging abused ss. 73(1) and 74.2(1)
Email this ContentThe taxpayer, agreed to sell his shares of a Canadian-controlled private corporation, having a nominal ACB, to third parties. On the day of the closing of the sale, about two months later, the following transactions occurred:
- He donated ½ of his shares, having an FMV of approximately $1M, to his wife, with s. 73(1) applying for this to occur on rollover basis.
- He assigned the other ½ of his shares to her in consideration for a promissory note of approximately $1M, and elected out of the application of s. 73(1), so that he realized a capital gain of approximately $1M and her ACB increased by this amount.
- She completed the sale of all the shares to the purchaser and used ½ the proceeds to repay the note.
As a result of the ACB-averaging under s. 47(1), she realized a taxable capital gain (of around $250,000) on the sale of the ½ of the shares which she had purchased at full cost, so that the exception in s. 74.5(1) for FMV purchases allowed her to retain that half of the taxable capital gain and claim the capital gains deduction under s. 110.6(2.1), rather than such gain being attributed to him. The other half of the taxable capital gain realized by her (from her sale of the donated shares) was attributed to him pursuant to s. 74.2(1).
Favreau J found that the sale of ½ of the taxpayer’s shares to his wife for a note clearly was a tax avoidance transaction:
[T]he proceeds from the sale of the shares she purchased were used in full to repay the note ... . The appellant received the same amount by selling these shares to Ms. Vitté as if he had sold them directly to the third parties.
Favreau J went on to find that there was an abuse under s. 245(4), noting in this regard (at para. 56) that the facts were “very similar” to those in Gervais, where Noël CJ had stated that the result of the spouse retaining half of the capital gain realized by her due to ACB averaging was “contrary to the object, spirit and purpose of subsections 73(1) and 74.2(1), the purpose of which is to ensure that a gain (or loss) deferred by reason of a rollover between spouses or common-law partners be attributed back to the transferor.”
Accordingly, the s. 245(2) assessment of the taxpayer to include all (rather than ½) of the taxable capital gains in his hands was confirmed.
Neal Armstrong. Summary of Mony v. The King, 2022 CCI 120 under s. 245(3) and s. 245(4).
You may have a TOSI issue if your investment company receives interest from a company for which your brother is an active employee
Each of three resident siblings were the respective beneficiaries, along with their spouses and children, of three trusts each holding an equal number of voting common shares of Investco with FMVs equaling at least 10% of that of the Investco common shares. (The siblings also held preferred shares of Investco directly.) Only one of the siblings was actively involved in the Opco business (as its full-time manager).
In 2019, Opco (which did not carry on a services business) redeemed its shares held by Investco in consideration for an interest-bearing term note. In 2019 and 2020, the bulk of Investco's revenues were Note interest, and the balance was investment income from a portfolio acquired out of dividends that had been received over the years from Opco. The dividends received in 2020 and 2021 by the three trusts on their Investco common shares were distributed and designated to the respective siblings under s. 104(19).
Regarding the application of the tax on split income (TOSI) rules on the assumption that Investco was carrying on an investment business, and focusing on the common share dividends that were funded with the note interest, CRA indicated that the Opco business in the 2019 to 2021 years was a related business in respect of the inactive siblings based on the active involvement in that business of their sibling and that the s. 104(19) dividend amounts allocated to the inactive siblings (which, by assumption, were derived from the note interest) thus were derived indirectly from a related business. (Such dividend income would be from an excluded business in the case of the actively-involved sibling.)
The essential problem for the two inactive siblings might seem to be that the Investco common shares held by them “through” their family trusts did not qualify as excluded shares because they did not “own” those shares, as required by the excluded share definition. Could they solve their TOSI issue if such common shares instead were distributed to them by their respective family trusts before the dividends were declared?
CRA answered, “no.” Para. (c) of the “excluded share” definition was not satisfied given that: for the 2020 year, substantially all of Investco's income for the preceding year (2019) was derived, directly or indirectly, from Opco's business, a related business in respect of those two siblings (given their sibling’s involvement therein); and for the 2021 year, most of Investco's income for the preceding year (2020) was derived (in the form of the note interest), directly or indirectly from such business.
CRA closed by noting that the siblings could “depending on the circumstances, benefit from the general reasonable return exclusion” in s. g(ii) of "excluded amount."
Neal Armstrong. Summary of 5 August 2022 External T.I. 2021-0877051E5 F under s. 120.4(1) – related business.
CRA indicates that qualifying rent expense for CERS purposes did not include third-party liability insurance premiums
The application of the Canada emergency rent subsidy ("CERS") turned on the definition of “qualifying rent expense” which, in s. (b)(ii) thereof, included, in the case of a qualifying property owned by the eligible entity, “amounts paid for insurance on the qualifying property.” CRA indicated that this component refers “only to amounts paid as insurance for real or immovable property” and did not include third-party liability insurance.
Neal Armstrong. Summary of 10 January 2022 External T.I. 2020-0873921E5 F under s. 125.7(1) - qualifying rent expense - (b)(ii).
CRA indicates that the rental income from the smaller portion of a building not used in manufacturing could be assimilated to active business income
A CCPC (ABC Inc.) owns a building, 65% of which is used in its manufacturing business, and the remaining 35% is leased to a third party. Is the rental income excluded from income from property under the definition of “income” in s. 129(4)? Para. (b) of this definition assimilates to income from an active business, property income:
- that is incident to or pertains to that business (subpara. (b)(i)); or
- from property used or held principally for the purpose of gaining or producing income from that business (subpara. (b)(ii)).
Regarding subpara. (b)(i), CRA indicated that “rental income may constitute incidental income of a business if, for example, the excess space was rented on a temporary basis, i.e., with the intention of using that portion of the building for the very near future expansion of the business's activities, or because the rental is related to the business's activities,” but thought that the facts here did not fit that pattern.
CRA stated that, in determining whether, under subpara. (b)(ii), the rental income was derived from property that was used or held principally for the purpose of gaining or producing income from an active business:
[T]here are arguments to support the contention that the building used 65% by ABC Inc. in its manufacturing activities could be a property used or held primarily to earn income from its manufacturing business for the purposes of subparagraph (b)(ii) … . In such case, the rental income of ABC Inc. would qualify as "income of the corporation for the year from an active business" within the meaning of subsection 125(7).
Neal Armstrong. Summary of 7 October 2022 APFF Federal Roundtable, Q.12 under s. 129(4) – “income.”
Income Tax Severed Letters 26 October 2022
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA indicates that common or affiliated trustees do not by themselves cause entities to be affiliated
S. 251.1(4)(c) provides that for the purposes of the definition of affiliated persons in s. 251.1:
notwithstanding subsection 104(1), a reference to a trust does not include a reference to the trustee or other persons who own or control the trust property;
CRA indicated that this reading rule is not restricted to the provisions of s. 251.1(1) that refer expressly to a “trust” (i.e., it is not limited to ss. 251.1(1)(g) and (h)). Instead, the rule “should be taken into account when interpreting subsection 251.1(1) regardless of whether there is a specific reference to a trust in the paragraph being examined.”
Perhaps an example of what is meant by this is in the application of s. 251.1(1)(c)(i) (whereunder two corporations are affiliated if they are controlled by the same person, or by respective persons who were affiliated with each other) - so that, under this CRA interpretation, two corporations would not be affiliated merely because, for instance, they were each owned by a trust for a different family but the two trusts happened to have the same trustee.
Neal Armstrong. Summary of 9 June 2022 External T.I. 2022-0930081E5 under s. 251.1(4)(c).
CRA indicates that a corporation cannot change its year end by objecting to the 1st year’s initial assessment
2020-0874951I7 indicated that if a request for a retroactive change to a taxation year is made after the corporate tax returns are filed but before the first Notice of Assessment for that year is issued, it will generally be granted – but not if such request is made after such issuance.
What if, after such initial assessment of the first year, a timely objection is filed to request cancellation of the initial assessment pursuant to s. 165(3), so that the taxpayer is now free to file a fresh first-year return with a changed year end? In rejecting this approach, CRA stated:
For the purposes of subsection 165(3), an assessment may generally be vacated upon receipt of a Notice of Objection if a taxpayer submits additional facts or compelling arguments that were not before the Minister at the time the assessment was made and that demonstrate that the assessment is either invalid … or was unfounded … .
[Here] … the mere fact that the corporation wishes to change the timing of its fiscal period end after tax has been assessed for the year corresponding to the fiscal period, even if it is the corporation's first fiscal period, does not, in and of itself, invalidate or render unfounded the [initial] assessment … .
Neal Armstrong. Summary of 7 October 2022 APFF Federal Roundtable, Q.11 under s. 249.1(7).
CRA states that it lacks jurisdiction to determine whether a trust can elect under Art. XIII(7) of the Canada-U.S. Treaty to avoid double taxation of a s. 104(4)(b) gain
CRA indicated that it considered that it was within the IRS’s jurisdiction and not its jurisdiction to determine whether the trust is eligible to elect pursuant to Art. XIII(7) the Canada-U.S. Treaty to have a notional sale and repurchase of the U.S. real property occur for U.S. purposes in the same year as that of the s. 104(4)(b) deemed disposition.
In also indicating that there would be no relief under Art. XXIV(2)(a) of the Treaty from the double taxation arising if there was no U.S.-source income for s. 126(1) purposes in the year of disposition for U.S. purposes, it noted that Art. XXIV(2)(a) is expressly “subject to the provisions of the law of Canada regarding the deduction from tax payable in Canada of tax paid in a territory outside Canada,” and stated that “this means that a Canadian resident is subject to the limitations on claiming a foreign tax credit found in the Canadian legislation, and more specifically in section 126, including a timing restriction on when a foreign tax credit may be claimed (see … 2015-0601781E5 … .)
Neal Armstrong. Summaries of 3 February 2022 Internal T.I. 2021-0922301I7 under Treaties – income Tax Conventions – Art. 13, Art. 24.
We have translated 8 more CRA interpretations
We have published a further 8 translations of CRA interpretations released in February and January of 2004. Their descriptors and links appear below.
These are additions to our set of 2,257 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 18 ¾ years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
CRA indicates that there is no change in the regular use under s. 45(1)(c) where a property regularly alternates between personal and rental use
An individual owns a chalet that is personally occupied for six months of the year (May to October) and is rented out to others for the remaining six months of the year. CRA essentially appeared to indicate that there would be no deemed dispositions every six months at FMV each time there was such a (temporary) change in use since, for purposes of s. 45(1)(c), there was no change in the use regularly made of the property.
Based on this apparent conclusion, it would be unnecessary for the individual to make a s. 45(2) election to deem the property not to have a change of use to an income-producing use each November when it commenced to be leased. However, CRA indicated that if there were such a change of use and the election was made, there would be no further deemed disposition at FMV when the chalet commenced again to be used for personal use in May, as the s. 45(2) election effectively deemed it to have been used for personal use prior to this change.
Neal Armstrong. Summaries of 7 October 2022 APFF Federal Roundtable, Q.10 under s. 45(1)(c) and s. 45(2).