News of Note

Joint Committee notes that Pangaea is undercutting the ITA’s policy not to impose Part XIII tax on cross-border payments to arm’s-length debenture holders

In a 2020 submission, the Joint Committee expressed concerns that a broad reading of Pangaea could result in the imposition of Part XIII tax on commitment fees, and consent fees and restructuring fees, paid to arm's length non-resident lenders/ debt holders – which would run contrary to the policy choice made to reduce the cost of capital to Canadian businesses by eliminating the withholding tax payable to arm's-length lenders.

After Finance asked for information on the "real world" market implications of Pangaea in the above context, and after canvassing publicly available information on recent transactions in this context, the Joint Committee identified that the majority of such transactions have a risk factor disclosure as to the potential imposition of Canadian withholding tax on such fees.

Furthermore, the boards of directors of such issuers may well be concerned by their potential joint and several liability for unremitted Part XIII taxes of a restructuring issuer in financial difficulty, so that they may insist on withholding. For instance, in the Aleafia Health debt restructuring, there was withholding on the consent fees paid to the non-resident debenture holders.

Neal Armstrong. Summary of Joint Committee, “Impact of Pangaea case,” 10 January 2024 Joint Committee Submission under s. 212(1)(i).

The s. 94 rules contain potential traps for U.S. citizens

To provide a sampling of a broader coverage of s. 94 issues that U.S. citizens may face:

  • It is common for U.S. citizens to settle irrevocable trusts for the benefit of descendants and make gifts to those trusts in in amounts equal to the U.S. federal gift tax applicable exclusion amount (currently, $13.61 million per donor), thereby allowing for gifts to be made tax-free for the benefit of the trusts’ beneficiaries while maintaining the flexibility of using a trust.
  • However, the s. 94 rules potentially may apply to such a trust even if none of the beneficiaries was ever resident in Canada and the contributions to the trust by a resident contributor were immaterial. This would occur for instance if a U.S. resident and citizen who has never been resident in Canada established a discretionary U.S.-resident trust in 2010 for his U.S.-resident children and contributed an aggregate of $10 million to the trust over the following 10 years – but his brother, a U.S. citizen and Canadian resident, over the same 10-year period gave an aggregate of $100,000 cash to the trust to take advantage of his applicable credit (part of the $13.61 million amount) or his annual exclusion limit (currently, $18,000).
  • The adverse consequences of s. 94 applying can be ameliorated by making a resident portion election under s. 94(3)(f) – but this election cannot be made if the trust has already filed a return for a year in which it was deemed resident pursuant to s. 94.
  • Given that the definition of “contribution” includes transfers and loans that form part of a series of transactions that includes a transfer or loan of property by another person to the relevant trust, to the extent the transfer or loan to the trust can reasonably be considered to be made “in respect of” the transfer or loan at issue, an outright gift by a Canadian resident to a nonresident donee should be appropriately documented and care should be taken that any subsequent dealing with the donated property by such donee, such as a transfer to a U.S. trust for the benefit of that individual, is independent from the original gift.
  • No Canadian foreign tax credit is available to a U.S.-resident trust that is a grantor trust but is deemed to be a resident trust under s. 94 for the U.S. tax not paid by the trustee but instead paid by the grantor.
  • However, this mismatch can potentially be addressed by having a resident contributor elect to have s. 94(16) apply to the trust. For example, if a U.S. citizen and Canadian resident who is the sole contributor to a U.S.-resident grantor trust, elects to have s. 94(16) apply, all the trust’s income will be allocated, and the foreign tax credit will be available, to the individual regarding such foreign income designated to that individual pursuant to s. 94(16)(c).

Neal Armstrong. Summaries of Mark Brender and Marc Roy, “Canadian Tax Trap Arising from Cross-Border Gift Tax Planning,” Tax Notes International, Vol. 111, 4 September 2023, p. 1217 under s. 94(3), s. 94(1) – contribution, s. 94(16), s. 104(7.01), s. 94(2)(a) and s. 94(2)(k).

Income Tax Severed Letter 10 January 2024

This morning's release of two severed letters from the Income Tax Rulings Directorate is now available for your viewing.

Glencore Canada – Federal Court of Appeal finds that a break fee was a capital receipt, but was includible under s. 12(1)(x)

An integrated nickel-mining public company (“Falconbridge”), entered into merger agreements with a more junior public company (“Diamond Fields”) which, through a 75%-owned subsidiary, held a valuable deposit at Voisey’s Bay in Newfoundland. The merger agreements provided for the immediate payment by Diamond Fields of a “Commitment Fee” of $28.2 million, and for the payment of a break fee of $73.3 million (calculated to bring the total of the two fees (the “Fees”) to 2.5% of the transaction value) on the completion by Diamond Fields of any competing offer. This occurred – the offer of another public company (Inco – the 25% minority shareholder) was accepted by the Diamond Fields shareholders, thereby triggering the payment by Diamond Fields of the break fee.

In reversing the Tax Court’s finding that the Fees were income from a business and that they instead were capital receipts, Woods JA found that the Fees were received on capital account because they were linked to a proposed acquisition of a capital asset (the Diamond Fields shares).

The break fee did not qualify as proceeds of disposition of a Falconbridge right to merge, as she did not consider there to be such a right: Diamond Fields could not promise the acceptance by its shareholders of the Falconbridge offer nor could it fetter the fiduciary obligations of its board – there was no capital gain.

Woods JA concluded that the fees (less a reduction for bid-related expenses pursuant to s. 12(1)(x)(vii)) were required by s. 12(1)(x) to be included in computing Falconbridge’s income from a business or property. Among other findings:

  • “Diamond Fields paid the Fees in order to entice Falconbridge to make an offer pursuant to the merger arrangements” so that it was “reasonable to consider that the Fees were received by Falconbridge as an inducement for the purposes of s. 12(1)(x)”;
  • “The Fees were linked to Falconbridge’s operations as a nickel mining company”, which “required access to ore deposits” so that they were received “in the course of” those activities (a phrase which she essentially equated with "in connection with"); furthermore, “the Fees were linked to an acquisition of shares that had the capacity to produce property income” so that they were “also received in the course of earning income from property”.

S. 12(1)(x) was enacted to ensure the recognition for tax purposes of tenant inducement payments and of the relocation allowances addressed in Consumers' Gas, i.e., in connection with assets used directly in the income-generating process. The above interpretation accorded to "in the course of" earning income from a business of property suggests that the scope of s. 12(1)(x) may be broader than what initially was principally targeted.

Neal Armstrong. Summaries of Glencore Canada Corporation v. Canada, 2024 FCA 3 under s. 9 – compensation payments, s. 248(1) – property and s. 12(1)(x).

Brookfield Renewable Power – Court of Quebec reduces the deductible interest on loss consolidation loans from 14% to 8.75%

In connection with a September 2009 loss consolidation transaction between a “Lossco” in the Brookfield group (“BRPI”) and its “Profitco” subsidiary (“BEMI”):

  • Two Newcos with nominal share capital were lent $2.25 billion and $0.525 billion by BRPI pursuant to unsecured demand notes bearing interest at 14%;
  • Each Newco used the loan proceeds to subscribe for non-cumulative preferred shares of BRPI;
  • On the same day, BEMI acquired the Newcos for a nominal amount and they were wound up into BEMI, so that BRPI held $2.275 billion of loans in its subsidiary, and BEMI held $2.275 billion of preferred shares of its parent; and
  • The loans were left outstanding for approximately five months, then: BRPI declared and paid a dividend on the preferred shares to fund the payment of all the accrued interest on the loans, and those shares and loans were redeemed and repaid by way of set-off.

The ARQ assessed on the basis that interest in excess of 6% was unreasonable.

Lareau JCQ reviewed various case on the meaning of “reasonable” under ITA ss. 67 and 20(1)(c) as well as the ENMAX and Gervais Auto decisions. He also referred to the evidence of the two ARQ experts indicating that BRPI had been borrowing from arm’s length lenders at around that time at rates ranging between 6.00% and 8.75%; and to a written concession of counsel for the ARQ that an interest rate as high as 8.75% could be justified as reasonable. He then referred the appeal back to the ARQ for reassessment on the basis of allowing the interest deduction at an 8.75% rate.

Neal Armstrong. Summary of Brookfield Renewable Power Inc. v. Agence du revenu du Québec, 2023 QCCQ 10239 under s. 20(1)(c).

FOOi Inc. – Tax Court of Canada declines to treat a letter to CRA enclosing an SR&ED claim that CRA had lost as a de facto request for an extended period to object, and as an objection

The taxpayer, a CCPC, was found by MacPhee J to have filed its SR&ED claim for its taxation year ending on June 30, 2018 on a timely basis on December 20, 2019. However, CRA lost this filing and, on January 21, 2021, somewhat over a year from the date of initial assessment of the 2018 return, the taxpayer’s accountants wrote to the CRA SR&ED division, explained that no response had been received to the December 2019 SR&ED claim filing and provided a duplicate copy of the 2018 return along with the SR&ED claim. On March 8, 2021, CRA informed the taxpayer that the SR&ED expenditures claim was denied as it had been filed more than 12 months after the 2018 return was due.

The taxpayer submitted that the letter dated January 21, 2021 should be regarded as both an application for an extension of time with the Minister (as the 90-day period to file a notice of objection had elapsed) and a Notice of Objection. MacPhee J rejected these submissions as the letter was not sent to the Chief of Appeals, and it did not clearly indicate that it was intended as an application to extend time, or even as a notice of objection.

Neal Armstrong. Summary of FOOi Inc. v. The King, 2023 TCC 176 under s. 166.1(2).

We have translated 6 more CRA interpretations

We have translated 6 further CRA interpretations released during June of 2002. Their descriptors and links appear below.

These are additions to our set of 2,688 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 21 ½ 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
2002-06-07 11 June 2002 External T.I. 2001-0104075 F - DEDOMMAGEMENT Income Tax Act - Section 54 - Adjusted Cost Base damages award not part of cost if subject to an appeal
Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(e) damages award not recognized until appeal thereof heard
17 June 2002 Internal T.I. 2001-0111717 F - BFT ET CONSTRUCTION MAISON EN USINE Income Tax Act - Section 125.1 - Subsection 125.1(3) - Manufacturing or Processing - Paragraph (c) fabricator of manufactured homes was not excluded for engaging in “construction”
18 April 2002 Internal T.I. 2002-0118827 F - DEBENTURES CONVERTIBLES
see also 2002-0130177 F

Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(f) no s. 20(1)(f)(ii) deduction on conversion of convertible debentures notwithstanding attempt in resolution to fix the issued shares’ stated capital at their market value
Income Tax Act - Section 89 - Subsection 89(1) - Paid-Up Capital PUC of shares issued on debenture conversion equal to consideration stated in debenture indenture and in financial statements, rather than the FMV of shares stated in resolution
Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(b) - Capital Expenditure v. Expense - Financing Expenditures premium on redemption of convertible debentures was not deductible on current account
Income Tax Act - Section 18 - Subsection 18(9.1) straight-line or present value method may be used in amortizing premium, and must relate to interest
20 June 2002 External T.I. 2002-0120245 F - CREDIT D'IMPOT PERSONNELS Income Tax Act - Section 118 - Subsection 118(1) - Paragraph 118(1)(b) general requirements
31 May 2002 Internal T.I. 2002-0131647 F - REPORT CREDITS FRAIS SCOLARITE Income Tax Act - Section 118.61 - Subsection 118.61(1) deductible credits which are not used cannot be carried forward
20 June 2002 External T.I. 2002-0140895 F - PRESTATION AU DECES Income Tax Act - Section 248 - Subsection 248(1) - Death Benefit amount was not a taxable death benefit and was in substance insurance proceeds

Procon – Federal Court of Appeal doubts that “losses incurred by disposing of property that is ‘inextricably linked’ to the ongoing operation of the business are on income account”

The appellant, a mining contractor, subscribed for shares of two junior mining companies in connection with being awarded mine development work by each company. It later realized losses on sales of those shares to a related corporation after the companies failed to proceed with the mines, which the Tax Court found to be capital losses.

Monaghan JA found no reversible errors in the following findings of the Tax Court:

[T]he shares “were acquired and held …in connection with [the appellant’s] business”, “were not acquired for trading purposes”, and “constituted an investment …in the equity of the [mining companies]… intentionally [made]…with a view to further strategically enhancing its future growth, and recoveries/cash flow generated from its business.”

Furthermore, she did not find significant support for the proposition advanced by the appellant that “losses incurred by disposing of property that is ‘inextricably linked’ to the ongoing operation of the business are on income account”.

Neal Armstrong. Summary of Procon Mining and Tunnelling Ltd. v. The King, 2024 FCA 1 under s. 18(1)(b) – capital loss v. loss.

Maverick Oilfield – Federal Court quashes a CRA decision not to provide full interest relief for companies’ failure to make tax remittances due to their CEO’s incompetence and deception

The applicants were an Alberta oilfield service company and a trucking company, each owned equally by Mr. Schnell and his spouse, and directed by him. In order to semi-retire, in 2012 he hired a Mr. Challis as the CEO of both companies, and a CFO. Mr. Challis ran those successful companies into the ground within a few years. Furthermore, employees, including the accountant and the CFO, deceived Mr. Schnell in order to conceal emerging problems and Mr. Challis’ incompetence. Mr. Schnell did not become aware of the companies’ failures to make the required remittance until May 2018, whereupon he fired the CEO and CFO, retook control of the companies, and entered into a payment arrangement with CRA in April 2018, and used his personal resources to make full payment by January 2020.

CRA denied the companies’ applications for relief from interest and penalties accrued during their 2014 through 2020 taxation years, made on the basis of “extraordinary circumstances leading to … financial hardship.” CRA granted relief only from interest assessed during the CRA approved payment arrangements, and took the view inter alia that “the director [Mr. Schnell] remained responsible to take the necessary measures … to ensure that all obligations [were] met when required” and failed to do so.

Zinn J found this decision to be unreasonable, so that it was quashed and the requests for relief remitted to a different decision maker. First, the CRA finding that it was within the control of Mr. Schnell as director to avoid the late remittances did not address the active concealment by Mr. Challis and other employees of the late remittances.

Second, regarding a CRA finding “that extraordinary circumstances cannot persist over several years”, Zinn J stated that “[t]here is no temporal limitation on extraordinary circumstances”.

Third, it was evident that the consequences of Mr. Challis’ actions did not immediately end with his firing (the companies simply did not have the financial resources to make the necessary payments after such firing) and CRA’s finding to the contrary was unreasonable.

Neal Armstrong. Summary of Maverick Oilfield Services Ltd. & Latigo Trucking Ltd. v. Canada 2023 FC 1728 under s. 220(3.1).

9331-0688 Québec – Tax Court of Canada finds that three corporations wholly-owned by an individual could not make an ETA s. 156 election

Jorré J found that three corporations were ineligible to make the ETA s. 156(2) nil consideration election because they were not “closely related,” i.e., their mutual shareholder was an individual rather than a corporation.

Neal Armstrong. Summary of 9331-0688 Québec Inc. v. The King, 2023 CCI 173 under s. 156(1) – qualifying group.

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