News of Note
CRA rules on a gross asset butterfly
Email this ContentA simple butterfly concerns DC (whose assets, other than minor cash, consist solely of publicly-traded shares) which is owned equally by three siblings. Siblings 1 and 2 will each transfer his DC shares (being common shares) on a s. 85(1) rollover basis to TC1 and TC2, respectively (each incorporated by the respective Sibling) for TC1 or TC2 common shares, and DC will transfer, on a s. 85(1) rollover basis, 1/3 of each of its types of property in consideration solely for non-voting redeemable retractable special shares to each of TC1 and TC2. The shareholdings between DC and TC1, and between DC and TC2, will then be cross-redeemed for notes, and the notes set off.
This is to be done as a “gross asset” butterfly, i.e., each TC receives 1/3 of the total investment (and any cash) assets of DC, and any liabilities of DC (there are represented to be none) get left behind (and DC itself will remain in existence). If in fact there were liabilities, these would be borne by the 1/3 asset share of DC.
Although DC started with an ERDTOH balance, the transactions did not evince any concerns about Pt. IV tax circularity issues.
Neal Armstrong. Summary of 2022 Ruling 2021-0884331R3 under s. 55(1) – distribution and s. 86(1).
Income Tax Severed Letters 7 September 2022
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
The EIFEL rules create issues for the financing of CCPCs
From the perspective of a Canadian-controlled private corporation (CCPC) that has an active R&D program and financing needs (“Canco”), if a foreign investor is accorded an option to convert debt into equity representing at least 25% of votes or value, Canco would fall offside the para. (c) branch of the “excluded entity” definition in s. 18.2(2)(c) (and, in typical circumstances, would not fit within any of the other “excluded entity” categories.) This 25% threshold for (likely) engaging the (s. 18.2) EIFEL interest deductibility limitations is lower than the 50% threshold relevant to maintaining CCPC status and, therefore, may present additional challenges.
If Canco is a member of a larger (related or affiliated) group, the presence of a specified non-resident investor in any member of the group will impose EIFEL limitations on Canco.
A further concern is that any significant financing costs paid to non-residents (who are “tax-indifferent investors”) will also result in the loss of Canco’s excluded entity status – so that substantially all of Canco’s financing costs must be paid to other types of entities if it is to remain an excluded entity. Canco could structure returns on non-resident debt to be non-deductible (for example, making them participating payments), so as to ensure that payments to tax-indifferent investors are non-deductible, and so that it might thereby remain an excluded entity.
Neal Armstrong. Summary of Balaji Katlai and Hugh Neilson, “Canadian Inbound Investment: The EIFEL Trap?” International Tax Highlights (IFA Canada), Vol. 1, No. 2, August 2022, p. 7 under s. 18.2(1) – excluded entity – (c).
CRA confirms the cumulative application of the ETA change in use rules
Aco changes its use of a building, which had been used 100% in making exempt supplies, so that thereafter it is used 90% for making exempt supplies and 10% in the course of commercial activities. Two years later, the commercial use is further increased to 20%.
ETA s. 197 indicates that changes of “less than 10%” are not to be taken into account, suggesting that a change of 10% is to be recognized for purposes of the change in use rules. However, s. 141 indicates that a use of 90% (under CRA’s interpretation of “substantially all”) for exempt use is equivalent to 100% for exempt use, so that in Year 1, Aco could not claim an input tax credit based on a 10% change in use, whereas two years later, it could claim an ITC based on a 20% change in use.
CRA essentially confirmed this interpretation, stating:
While a change in use of 10% or more is normally considered to be a significant change in use (i.e. because section 197 considers any change of less than 10% to be insignificant), section 141 nevertheless considers that the entire use of the capital property is not commercial activities.
Accordingly, ETA s. 206(2) would only apply when the registrant (Aco) began to use capital property in commercial activities to an extent greater than 10% - which occurred two years later, permitting Aco at that time to claim an ITC based on a 20% change in use.
However, CRA went on to note that if Aco instead was a financial institution (to which the s. 141 rules do not apply), the rules in s. 206(2) could now apply to generate an ITC based on a 10% change of use in Year 1 and s. 206(3) would permit an ITC based on a further 10% change in use two years later.
Neal Armstrong. Summary of 25 March 2021 CBA Commodity Taxes Roundtable, Q.19 under ETA s. 206(2).
CRA rules on 2-year pipeline transactions
Preliminary transactions to pipeline transactions on which CRA ruled entailed the subject corporation (a portfolio investments company) using its CDA account (which had been increased through the receipt of life insurance proceeds on the life of A) to pay a capital dividend to the estate of A, thereby reducing the FMV of the estate’s shares.
Then:
- The estate transferred all its shares of the corporation to Newco in consideration for four notes maturing 3, 6, 9 and 12 months after the amalgamation below (and in consideration for voting common shares of Newco, with an election filed under s. 85(1),) - and with the resulting capital loss (which was not denied under ss. 40(3.61) and (3.6)) being carried back under s. 164(6).
- Newco will be amalgamated with the corporation (presumably after a year) and the notes will thereafter commence to be repaid consistently with their maturity dates.
The transfer to Newco in 1 above had been completed by the time of the ruling letter.
Neal Armstrong. Summary of 2021 Ruling 2021-0895631R3 under s. 84(2).
We have translated 9 more CRA severed letters
We have published a translation of a CRA ruling released last week and a further 8 translations of CRA interpretations released in May and April of 2004. Their descriptors and links appear below.
These are additions to our set of 2,200 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 ½ years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
Ristorante a Mano – Federal Court of Appeal finds that net tips on restaurant credit card sales distributed to the servers were pensionable wages and insurable earnings for CPP/EI purposes
The appellant, which operated a restaurant, paid “due-backs” to its servers representing the tips on sales processed on credit and debit cards (“electronic tips”) minus deductions made by it as a processing charge and amounts to be paid to kitchen staff, and further deductions based on the amount of cash sales collected by the servers. Monaghan JA indicated that the question of whether a due-back constituted pensionable wages and insurable earnings for CPP and EI purposes turned on the question whether the amount “is paid by the employer to the employee in respect of their employment.”
The due-backs were amounts in respect of the servers’ employment:
But for their employment with the appellant, the servers would not have received the due-backs from the appellant.
Furthermore, the due-backs were paid by the appellant to the servers:
[T]here is no dispute the electronic tips came into possession of the appellant or that the appellant transferred the due-back, representing a portion of those electronic tips, to the servers.
Neal Armstrong. Summaries of Ristorante a Mano Limited v. Canada (National Revenue), 2022 FCA 151 under General Concepts – Payment and Receipt and s. 6(1)(a).
CRA confirms that, under the ETA s. 182 rules, a payment by a guarantor can generate an ITC to the defaulter
Aco (a corporate registrant) agreed to make taxable supplies in Canada of tangible personal property to Bco (a registered partnership). A corporate partner of Bco (Cco) agreed to guarantee the obligations of Bco under the contract. As a result of Bco’s default on its obligations, Cco is required to pay liquidated damages to Aco.
CRA indicated that, under ETA s. 182, Aco is deemed to have collected the GST/HST as part of the liquidated damages amount, which is deemed to be consideration for a taxable supply by it, and Bco would be deemed to have paid that GST/HST (notwithstanding that Cco is the actual payer) – so that Bco (not, Cco) would be able to claim an ITC for the deemed GST/HST payment if the usual conditions in s. 169 were satisfied.
Neal Armstrong. Summary of 25 March 2021 CBA Commodity Taxes Roundtable, Q.18 under ETA s. 182.
CRA confirms that an employee cannot access the 2019 business use by a predecessor of a car to generate standby-charge relief under s. 6(2.3) in 2020/2021
Although an employee must use the employer-provided automobile over 50% in the course of the employment in order for a reduction under the standby formula in s. 6(2) to be available, the COVID-relief rule in s. 6(2.3) deemed an employee who used an automobile more than 50% of the distance driven for business purposes in 2019 to have done the same in 2020 and 2021. CRA confirmed that where a position was filled by a replacement employee in 2020, the 2019 business usage by the predecessor could not be used by the current employee to access the relief under s. 6(2.3).
Neal Armstrong. Summary of 13 January 2022 External T.I. 2021-0900691E5 under s. 6(2.3).
Income Tax Severed Letters 31 August 2022
This morning's release of two severed letters from the Income Tax Rulings Directorate is now available for your viewing.