News of Note

Observations on the revised draft EIFEL rules include:

• Under the excluded entity definition, the test of all or substantially all of the businesses, undertakings and activities of each eligible group entity in respect of the taxpayer being carried on in Canada throughout the entity’s taxation year appears to apply on an entity-by-entity basis, so that the failure of the test by even an insignificant group entity will cause the whole group to not qualify for the domestic exception.
• Also under the excluded interest definition, the test of the total fair market value of all property of a foreign affiliate of the taxpayer or of an eligible group entity in respect of the taxpayer not exceeding $5 million applies irrespective of whether the taxpayer has a 10% interest or 100% interest in the foreign affiliate – and even an insignificant interest in a special class of shares causing a non-resident corporation to be a foreign affiliate, would require the fair market value of its property to be considered in applying the $5 million threshold.
• The anti-avoidance rule in s. 18.2(9) would be engaged where a Canadian-resident subsidiary with a foreign business or holding of a significant foreign affiliate was sold by the taxpayer so that the excluded entity test could be met, whereas a direct sale by the subsidiary of its non-Canadian business or of its shares of the foreign affiliate would not engage s. 18.2(9).
• The inclusion under para. (g) of the interest and financing revenues definition of the relevant affiliate interest and financing revenues (“RAIFR”) of a controlled foreign affiliate of the taxpayer, is generally reduced by any deduction under s. 91(4) in respect of foreign accrual tax to the extent that it relates to the RAIFR, even where there is a deduction under s. 91(4) in a subsequent taxation year – so that taxpayers may be required to estimate their foreign accrual tax deductions that will be claimed in subsequent years.
• Any over-designation, including an immaterial one, will invalidate a transfer of excess capacity under s. 18.2(4). An amended transfer election may be filed, but only as provided in s. 18.2(4)(i).
• Under s. 18.21(2), if an election is made that allocates an amount greater than the specified limits, the allocated group ratio amount will be deemed to be nil – a potentially punitive result for what might be a small error.

Neal Armstrong. Summaries of Saira Bhojani and Eivan Sulaiman, “EIFEL Rules,” Draft 2022 CTF Annual Conference paper under s. 18.2(1) – excluded entity – (c)(i), (c)(ii), (c)(iii)(A). s. 18.2(9), s. 18.2(1) – interest and financing revenue – (g), excess capacity, s. 18.2(4), and s. 18.21(2).

Under the rule against accumulations in Ontario (and other provinces), any trust income after a specified period (“surplus income”) may not be accumulated in or added to the capital of the trust and must go to the person(s) who would have been entitled to it had the accumulation not been directed. A trust established for a dependent mentally-infirm child (the “Dependent Beneficiary”) in such a province could address the rule by directing the surplus income to be paid to a designated beneficiary (a “designated beneficiary clause”) or stipulate that the surplus income be paid to the person(s) entitled to receive that income (an “accumulation clause”). Such a clause would cause the trust not to meet the requirements under s. 60.011(1)(b) for being a lifetime benefit trust (“LBT”) if (as might normally the case, due to the mental infirmity of the Dependent Beneficiary) someone other than the Dependent Beneficiary was named in a designated beneficiary clause or the accumulation clause was drafted to have a similar effect.

Absent such a clause, the surplus income would become part of the residue of the estate and be distributed in accordance with the residuary clause, so that the recipient of the surplus income would receive it by operation of law. However, using this operation-of-law approach would not solve the desire to avoid having the surplus income distributed to the Dependent Beneficiary.

CRA did not suggest any solutions to this dilemma, and stated:

[T]he mere possibility that pursuant to the terms of the trust or will, or by operation of law, a person other than the Dependent Beneficiary can receive the surplus income will cause the trust not to comply with the conditions of subsection 60.011(1). Therefore, such a trust will not qualify as an LBT from the time that the trust is created.

Neal Armstrong. Summary of 14 October 2022 External T.I. 2021-0913801E5 under s. 60.011(1)(b).

CRA indicated that an employee life and health trust (ELHT) can qualify as such under s. 144.1(2) even where the trustee in accordance with the terms of the plan requires participating employers to pay premiums directly to the insurance carriers providing benefits under the plan rather than having the employers make contributions into the plan to fund such premiums. Indeed, CRA stated:

[A] trust established to provide [designated employee benefits] to employees and certain related persons may qualify as an ELHT absent employer contributions. For example, a trust established by a union may qualify an ELHT where the union or participating employees have the legal obligation to fund the entire cost of DEB’s (i.e., an employee-pay-all plan).

Neal Armstrong. Summaries of 29 June 2020 External T.I. 2018-0782541E5 under s. 144.1(2) and s. 144.1(4).

The August 9, 2022 proposals would amend s. 212(13.1)(a) to deem a partnership to be a person resident in Canada in respect of the portion of payments made by the partnership to a non-resident person that is deductible in computing a partner’s share of the partnership’s income or loss, to the extent that the partner’s share is taxable under Part I of the Act. This reference to Part I taxability extends to a partner with Part I income resulting from a s. 216 election.

This amendment contemplates a partnership having withholding tax obligations when making payments to a non-resident even if the partnership does not have Canadian-source income.

As an example, a foreign private equity partnership with one or more partners that are resident in Canada may now have a withholding tax obligation on management fees paid to a non-arm’s-length foreign manager if Treaty relief is not available.

Where a foreign fund partnership owns subsidiary foreign partnerships which pay interest to it in order to reduce foreign-country taxation, Part XIII tax will apply to the extent that one or more partners of the fund partnership are Canadian residents.

Neal Armstrong. Summaries of Cynthia Morin and Suhaylah Sequeira, “Withholding Tax Obligations: Proposed Amendments to Subsections 212(13.1) and 212(13.2),” International Tax Highlights, Vol. 1, No. 2 November 2022, p. 2 under s. 212(13.1)(a) and s. 212(13.2).