7 October 2016 APFF Roundtable Q. 19, 2016-0655841C6 F - Reimbursement of attributed income -- translation

Principal Issues: Does income that is attributed or allocated to another taxpayer, under certain specified provisions of the Act, need to be reimbursed to the taxpayer?

Position: No.

Reasons: These provisions neither require such a reimbursement nor do they provide rules that specify the treatment of such a reimbursement.

7 OCTOBER 2016 APFF FEDERAL ROUNDTABLE - 2016 CONFERENCE

Question 19

Income Allocation Rules and Income Payment

The Income Tax Act provides for a number of circumstances in which the income received by a taxpayer will be attributed and taxed in the hands of another taxpayer, including inter alia, under the provisons of 15(1), 51(2), 69(1)(b), 74.1(1) and (2), 74.2, 74.3, 74.4(2), 75(2), 85(1)(e.2), 86(2), 103 and 103(1.1).

In addition, none of these provisions requires payment or reimbursement, by the taxpayer who received the income, of the income so attributed to the other taxpayer under the provisions of the Income Tax Act (to the extent that the application of an adjustment clause is not required, where applicable).

Situation 1

A spouse ("Spouse A") transfers $100,000 to his or her spouse ("Spouse B"). With this sum of $100,000, Spouse B purchases a term deposit with a Canadian bank ("Bank"). The Bank annually pays interest on this deposit to Spouse B and the spouse is taxed annually on these amounts for the 2012 and 2013 taxation years. In 2014, the CRA attributes all of such interest income generated on the term deposit and paid by the Bank to Spouse A under the provisions of subsection 74.1(1).

In these circumstances, we are of the view that if the interest income paid by the Bank to Spouse B is attributed to Spouse A by the CRA under subsection 74.1(1), Spouse A will be subject to his or her own tax rate on this income and Spouse B who received the full payment of the interest income will not be subject to any obligation to reimburse that income to Spouse A.

Situation 2

A limited partnership ("SENC") has two (2) partners. As provided in the partnership agreement, for 2012 one of the partners, an individual ("Partner A"), is allocated 90% of the taxable income of the SENC, while the other partner ("B"), a share corporation, is allocated 10% of the SENC's taxable income. In 2014, the CRA re-allocates 40% of the taxable income that was paid to Partner A to Partner B under section 103. Partner B must therefore be taxed on the additional income (40%) so attributed to him, while Partner A has received the payment of the income from the initial allocation.

In these circumstances, we are of the view that if the taxable income allocated and paid to Partner A is reallocated to Partner B by the CRA pursuant to section 103, Partner B will be subject to its own tax rate on that additional income and Partner A who has received the full payment of such income will not be subject to any obligation to reimburse such income to Partner B. In addition, as Partner A has the exclusive ownership of the income, the provisions of subsections 15(1) or 15(2) would not be applicable. On the other hand, as confirmed in Erb v. The Queen, 1999 203 (TCC), the payment by a partnership of distributions in excess of a partner's share does not create an indebtedness of the partner to the partnership and therefore subsection 15(2) cannot be applicable even if the partnership had a share corporation among its partners.

Situation 3

A share corporation ("Taxpayer A") holds preferred shares and an individual ("Taxpayer B") holds common shares in the capital stock of a Canadian-controlled private corporation ("Corporation C"). Taxpayer A exchanged the preferred shares (the "Exchanged Shares") with a fair market value ("FMV") of $100,000 for new common shares in the capital stock of Corporation C ("Shares Received in Exchange"). In 2014, Taxpayer B sells the common shares he holds in the capital stock of Corporation C for $100,000. The CRA assesses Taxpayer A under subsection 51(2) or paragraph 69(1)(b) of the Act for a capital gain of $99,990 on the basis that (i) the Exchanged Shares had a FMV of $100,000 and (ii) the Shares Received in Exchange had a FMV of $10.

In these circumstances, we are of the view that B does not have to repay to A the proceeds of the sale of the common shares of Corporation C received by him, or $100,000, in whole or in part. In addition, as such income is the exclusive property of Taxpayer A, the provisions of subsections 15(1) or 15(2) would not be applicable.

Questions to the CRA

(a) Can the CRA confirm that income attibuted to another taxpayer in Situations 1 and 2 above pursuant to subsection 74.1(1), 103(1) or 103(1.1) does not have to be reimbursed, by the taxpayer who actually received the payment of the income, to the other taxpayer who was taxed on those sums, to the extent that an adjustment clause is not required to be applied, if applicable?

(b) Can the CRA confirm in Situation 2 that the payment by the SENC of distributions in excess of Share A's share, as established pursuant to the reallocation by the CRA under section 103, does not create indebtedness of Shareholder A to the SENC or Shareholder B and that subsections 15(1) and 15(2) would not apply?

(c) Can the CRA confirm in Situation 3 above that Taxpayer B, who received the proceeds from the sale of the common shares, does not have an obligation to reimburse Taxpayer A who has been subject to a capital gain resulting from the exchange of the Exchanged Shares for the Shares Received in Exchange?

(d) Would the CRA's response respecting reimbursement of the reallocated income be the same where the income was reallocated to another taxpayer by virtue of the provisions of 15(1), 74.1(2) , 74.2, 74.3, 74.4(2), 75(2), 85(1)(e.2) or 86(2) (to the extent that the application of any adjustment clause is not required)?

CRA response to Q.19(a), (c) and (d)

At the APFF Congress in 2015, a similar question was put to the CRA (question 15). In response to that question, the CRA indicated that the Income Tax Act is an accessory statute that is applied to the effects arising from the rights, obligations and contracts between parties. Thus, the question whether a person is legally obliged to repay another person is a matter of civil law or common law. Moreover, the provisions of the Income Tax Act referred to in questions 19(a), (c) and (d) do not provide for a reimbursement obligation by a taxpayer where a benefit was allocated or where income was attributed to another taxpayer.

CRA response to Q.19(b)

In Situation 2, if under civil law or common law, as applicable, partner A did not obtain a loan nor become the debtor of the partnership or of partner B by reason of distributions in favour of partner A under the partnership agreement, the conditions for the application of subsection 15(2) of the Act would not be satisfied.

Moreover, there is not enough information to reach a conclusion as to the application of subsection 15(1) in a situation similar to Situation 2.

Marc Séguin
(514) 620-8562
October 7, 2016
2016-065584