Subsection 246(1) - Benefit conferred on a person

Suppose that two brothers resident in Canada each have a Holdco owning 50% of Opco and that, in order to fund the buy-sell agreement on the death of an ultimate shareholder, each Holdco has purchased insurance on the life of its sole shareholder, with Opco as the revocable or irrevocable beneficiary of both insurance policies. Suppose further that (a) both Holdcos pay the insurance premiums out of their after-tax accumulated profits without reimbursement by Opco, or (b) that Opco reimbursed the Holdcos for the premiums. Would s. 246(1) apply?

CRA indicated, consistently with 2010-0359421C6, that “subsection 246(1) could apply in the situation where a parent corporation owns and pays the premiums on a life insurance policy and its subsidiary is designated as the beneficiary” so that, here, “the provisions of subsection 246(1) could apply in respect of Opco, subject to a review of the specific facts of a particular situation.” However, if the two brothers dealt with each other at arm’s length, s. 246(1) would not apply if the other conditions in s. 246(2) were satisfied.

CRA further stated:

In the situation where Opco, as (revocable or irrevocable) beneficiary of the life insurance policies, reimburses the Holdcos, the policyholders, for the related premiums, it would be necessary to examine all the relevant facts and documentation to be able to determine whether the reimbursement should be included in the income of the Holdcos pursuant to section 9 or paragraph 12(1)(x).

A Canadian REIT (the “Fund”) holds the units and notes of a subsidiary unit trust (“Sub-Trust”), whose principal asset is most of the partnership interests, other than exchangeable LP units, in a subsidiary LP (“Partnership”) which holds real estate and a corporate subsidiary (“Opco”).

The Fund first eliminates Sub-Trust by setting up a unit trust (“MFT”), transferring its assets to MFT under s. 107.4, distributing just enough units of MFT to its unitholders for MFT to qualify as a mutual fund trust, and then instigating a s. 132.2 merger of MFT into the Fund.

The Fund does not wish for Opco to pay corporate income tax. Had the Fund now held Opco directly, this would have been accomplished by incorporating a subsidiary (“MFC”), distributing relatively modest shareholdings in MFC to its unitholders sufficient to qualify MFC as a mutual fund corporation, amalgamating MFC and Opco so that Amalco MFC also qualifies as a mutual fund corporation, and then instigating the merger of Amalco MFC into the Fund under s. 132.2 – so that the former assets of Opco are now held directly by a REIT (the Fund).

A complicating factor is that Opco is held by the Partnership. Accordingly, the Partnership first transfers its Opco shares to MFC under s. 85(2) in consideration for most of the shares of MFC (so that Opco then can be vertically amalgamated with MFC). On the s.132.2 merger of Amalco MFC into the Fund, the Partnership renounces the receipt of the Fund units that otherwise would be receivable by it on the merger. CRA ruled that the Partnership will not realize any gain or loss on the disposition of its Fund units as a result of the renunciation because their proceeds of disposition should be equal to their ACB pursuant to s. 132.2(3)(g)(vi)(C)(I), and that none of the conferral-of-benefit provisions in the Act would apply.

Opco is held somewhat equally by three holding companies, each wholly-owned by an individual (A, B or C) who is unrelated to the others. Opco sells an asset to B’s child for 1/2 its fair market value. CRA found that:

• If the benefit conferred by Opco on B’s child was not also indirectly conferred by B’s holding company (Holdco B) on B or B’s child, then such benefit would be deemed by s. 15(1.4)(c) to be a benefit conferred on Holdco B by Opco, so that it would be included in Holdco B’s income.
• On the other hand, if the benefit had been indirectly conferred by Holdco B on B or B’s child (which CRA would generally infer if Holdco B influenced Opco’s conferral of the benefit), s. 246(1) could apply to include the benefit in B's income.
• If Holdco B had concurred in the benefit conferral, s. 56(2) could be an alternative basis for including the benefit in Holdco B’s income.

CRA did not discuss what criteria it would apply to determine whether it would assess Holdco B, or B, for the benefit (or even do both).

The only issued and outstanding share of Opco (which has retained earnings of $500,000) is 1 Class A common share, with a fair market value of $1,000,000 owned by Mr. A. Opco issues to Mrs. A, for nominal consideration, 1 non-voting Class B preferred share, which is redeemable and retractable “for the fair market value for which it is issued” and entitled to discretionary dividends as and when declared.

In Scenario 1, Opco immediately declares and pays out a $100,000 dividend on the Class B preferred share, which would have the effect of reducing the FMV of Opco and the 1 Class A common share by the same amount.

In Scenario 2, Opco does not declare and pay the $100,000 dividend until after it has earns an additional $100,000 of income, and the FMV of Opco after the dividend is at least $1,000,000.

What would be the consequences for Opco and its shareholders of such issuance and dividend? CRA appeared to indicate that it could be difficult to seek to apply s. 56(2) in light of Neuman, but it was more likely that s. 15(1) could be applied “particularly if the amount that is being paid by Mrs. A as consideration for the share does not represent the fair market value of such share at the time of subscription.” CRA then stated:

Alternatively, it may be possible that the circumstances of a particular situation would suggest that Mr. A rather than Opco is conferring the benefit to Mrs. A. If it could be demonstrated that there was a transfer of economic interest in Opco from Mr. A to Mrs. A similar to the situation...Kieboom...Mr. A would be considered to have disposed of a right, interest or right to dividends in Opco to Mrs. A. Under these circumstances, because Mr. A and Mrs. A are spouses, the automatic rollover provision in subsection 73(1) would apply such that the disposition of Mr. A’s economic interest would be at cost.

In…2011-0411491E5, CRA commented on an interest in a United States Limited Liability Corporation (LLC) held by an Alberta Unlimited Liability Corporation (AULC) owned by a Canadian resident individual. …[T]he individual would be subject to US taxation on…LLC income attributed to the AULC. CRA indicated that payment of these taxes on the individual's behalf would constitute a taxable benefit, either under S 15(1) if paid by AULC or under S 246(1) if paid by LLC. Can CRA explain the economic enrichment of the individual which it perceives to arise through the ownership structure? CRA responded:

[A]n amount paid by a corporation to its individual shareholder as a reimbursement of that shareholder's personal tax liability would result in an impoverishment of the corporation and an enrichment of the shareholder for purposes of subsection 15(1). A similar enrichment would result for purposes of subsection 246(1) where the shares are held by that individual indirectly through another corporation.

Corporation A, is wholly owned by Holdco, which has equal unrelated Shareholders 1, 2, 3 and 4. Corporation A disposes of a capital property to the spouse (who is not herself a shareholder) of Shareholder 4 at a price which is determined to be less than the property's fair market value. What are the consequences? After discussing the potential application of ss. 15(1.4)(c) and 56(2), CRA stated (TaxInterpretations translation):

…[Respecting s. 246(1)], it appears that if Holdco had made a payment directly to Shareholder 4, such payment would be required to be included in computing the income of Shareholder 4 pursuant to subsection 15(1). Accordingly, to the extent that subsection 246(1) was applicable, the value of the benefit that Holdco indirectly conferred on Shareholder 4 (through Corporation A) would be included in computing the income of the latter pursuant to paragraph 246(1)(a).

See summaries under s. 15(1.4)(c) and s. 56(2).

In a wholly-owned stacked structure of three Corporations (C holding D, holding E), Corporation E acquired an aircraft for business use but with some percentage use by Mr. A, the sole shareholder of Corporation C, and by his father (Mr. B), who also was the director of Corporations D and E. Was CRA required (as submitted by the taxpayer) to apply IT-160R3 (which was archived for the years under review, and then cancelled in September 2012), under which the taxable benefit to Mr. A was computed on the basis of the cost of a first class ticket for an equivalent trip or should the benefit be based on the quantum of the denied expenses of Corporation E (based on application to those expenses of the personal-use percentage)?

The Directorate stated (TaxInterpretations translation, para. 23) that " we agree with you that section 246(1) applies to your file” (at para. 30), and that "the benefit for the personal use of the Aircraft is conferred on Mr. A in his capacity as shareholder and on Mr. B. in his capacity as being related to shareholder Mr. A.” and that "subsection 15(1) do not apply to a situation where a benefit is conferred…on an indirect shareholder” Although "it does not seem clear … considering that Corporation E conferred the benefit, that it is possible to justify an inclusion in income under subsection 246(1). However, … subsection 246(1) may apply … if it were established that Corporation C conferred the benefit for the personal use of the Aircraft.”(para. 32)." In particular (paras. 33, 34):

… Although it can be shown that Corporation E conferred a benefit on Mr. A, the value of the benefit would not be included in computing Mr. A’s income … if it was a payment made directly to Mr. A, since Mr. A is not a shareholder of Corporation E. From that perspective, subsection 246(1) does not apply to a benefit conferred by Corporation E on Mr. A …

However, in … Masicotte the judge concluded that subsection 246(1) could apply when a corporation confers a benefit on an indirect shareholder.

In order to consider that:

Corporation C confers directly or indirectly a benefit on Mr. A…it imust be shown that Corporation C has an influence on Corporation E. (para. 35)

This condition was satisfied in light of the control of Corporations C and E by Mr. A.

[T]he value of the benefit conferred on Mr. B cannot be included in his income under subsection 246(1), because…if Corporation C had made a payment directly to Mr. B, this payment would not have been included in computing the income of Mr. B by virtue of subsection 15(1) or paragraph 6(1)(a)… .

Under paragraph 15(1.4)(c), the benefit conferred on Mr. B by Corporation B would instead be a benefit conferred on Mr. A, who is a shareholder of Corporation C, since Mr. B is not dealing at arm’s length with Mr. A. Therefore, for this benefit, subsection 246(1) should be applied because Corporation C conferred a benefit on Mr. A.

However, for a benefit conferred on Mr. B before November 1, 2011…it would not be possible to include [it] in the income of Mr. B or Mr. A… (paras. 36-38).

After discussing Youngman, Fingold, Schroter and Anthony (and before discussing Spence to the same effect), the Directorate stated (at para. 57):

[T]he value of the benefit for Mr. A and Mr. B for the personal use of the Aircraft should correspond to the FMV and not to the cost to Corporation E.

These decisions were more authoritative and helpful than decisions dealing specifically with personal aircraft use (paras. 66-67). However (at para. 77):

[T]he aircraft operating costs and the CCA denied to Corporation E can be used to establish the value of the benefit conferred on Mr. A and Mr. B., to the extent that it can be demonstrated that this value approximates the FMV of the benefit received.

Respecting IT-160R3, the Directorate noted that as the personal usage percentage was under 33%, para. 5 thereof did not apply but that, in light of the level of operating expenses, referencing the price of first class tickets for comparable trips would result in too low an estimate of the taxable benefits – so that the guidelines in IT-160R3, paras. 3-5 should not be followed. Instead, the more general guideline in para. 1 “to determine the value of the benefit based on what is reasonable” should be followed, so that “the value of the benefit for the personal use of the Aircraft should be determined based on the FMV of the benefit received.”(para. 91). "[T]he FMV corresponds to the amount the shareholder would have paid under similar circumstances to receive the same benefit from a corporation of which he was not a shareholder.”(para. 99).

A taxable Canadian corporation (Holdco) which is wholly-owned by a trust of which Mr. A is the sole trustee and is a discretionary beneficiary, makes an interest-free loan to another taxable Canadian corporation (Investco) of which Mr. A is the sole shareholder. In finding that this did not give rise to a taxable benefit, CRA indicated that:

• "for the purposes of 15(1) we have generally not considered that a benefit is conferred on a shareholder by reason of the making of a loan to that shareholder…[except] where, for example, there is no reasonable expectation of repayment of the loan amount"
• furthermore, applying s. 15(1) also is problematic as the "loan has been made to Investco, which is not, itself, a shareholder of Holdco"
• "since the amount advanced by Holdco to Investco was a "loan", there is no "payment" that would be considered to have been made that would allow the provisions of s. 56(2) to apply to include the loan amount in the income of Mr. A"
• unlike Massicotte, the case "does not involve a holder of shares of a parent corporation obtaining a benefit from a subsidiary corporation"
• s. 246(1) "does not permit characterizing a loan to a corporation as, instead, one made to the individual who controls that corporation in order to then calculate a benefit under paragraph 80.4(2"
• As there have been no relevant changes since Cooper, s. 105(1) "would not be considered favourably as a ground for including a foregone interest benefit in the income of Mr. A"

A Canadian-resident individual owns all the shares of an Alberta unlimited liability company which, in turn, owns a majority of the membership units of a US LLC. As a result of both corporations being fiscally transparent entities under US tax law, the individual is required under US tax law to pay tax on his proportionate share of the income of the LLC.

The determination of the management of the LLC to pay the US tax liability of the individual would result in an income inclusion to the individual under s. 246(1) given that a payment of that amount by the Alberta ULC would have resulted in an income inclusion under s. 15(1).

In a situation where a second-tier subsidiary provides a benefit to the shareholder of a first-tier corporation, s. 246(1) can be applied on its own to assess the taxpayer for that benefit. (If the first-tier corporation had provided the benefit directly, the benefit would have been taxable under s. 15(1).)

Question 2 at the May 4, 2010 CALU Roundtable concerned the situation where (A) Holdco holds an insurance policy on the life of its shareholder, pays the premium and designates its subsidiary as the beneficiary, or (B) the same situation except that the subsidiary is designated as irrevocable beneficiary and reimburses Holdco for the premiums, or (C) there are two sisters (Corporations 1 and Corporation 2) wholly-owned by Mr. A, with Corporation 1 holding an insurance policy on Mr. A's life and paying the premiums, while Corporation 2 is designated as beneficiary and reimburses Corporation 1 for the premiums paid.

CRA confirmed that s. 15(1) would not apply in Situations A and C, but that s. 246(1) could apply in Situation A, i.e., where Holdco designates its subsidiary as beneficiary. Why should the subsidiary be taxable on the amount of the premium, since Holdco could just as readily pay an amount equal to the premium, in the form of a loan or capital injection? CRA responded:

The application of section 9, paragraph 12(1)(x), subsections 15(1), 245(2) and 246(1) is a question of fact and each situation must be examined individually. … [T]he CRA will examine any situation that involves a corporate group and where the life insurance proceeds included in a corporation's capital dividend account is not reduced by the adjusted cost base of the policy. This can occur where a corporate group holds the policy and another corporation in the group is beneficiary.

S. 246(1) could apply where a corporation (Parentco) holds a life insurance policy for which it pays the premiums and designates its subsidiary (Subco) as the beneficiary. It would be necessary to determine, with all the relevant documentation, whether the reimbursement of premiums should be included in the income of the corporate life insurance policyholder (Parentco) under s. 9 or 12(1)(x) where its subsidiary (Subco) was named as the irrevocable beneficiary of the life insurance policy and reimbursed Parentco for the premiums paid by Parentco.

Mr. X, who is the sole shareholder of Holdco, which in turn is the sole shareholder of Opco receives, along with four Opco employees receive reimbursements from Holdco and Opco for personal expenses. Should s. 246(1) be used as the sole basis for assessment? The Directorate responded:

[S]ubsection 246(1) is generally a provision of subsidiary application since it must be shown that the value of the benefit is not otherwise included (for example, by virtue of paragraph 6(1)(a) or subsection 15(1)) in computing the taxpayer's income … . On the other hand … Massicotte … held that the Minister of National Revenue may assess a taxpayer solely on the basis of section 246 despite the fact that paragraph 6(1)(a) could have been argued … .

… Thus, while the Minister may invoke subsection 246(1) as the sole ground for assessment, we believe it is preferable that the assessment refer - if the facts of the situation are appropriate - to the provisions of specific application. … [T]herefore … the assessment should rely on paragraph 6(1)(a) and/or subsection 15(1) as the main grounds … .

Mr. A wholly-owned Holdco, which held a minority interest in Opco. The principal residence of Mr. A and Ms. A (spouses), held by Holdco, is transferred to a newly-formed partnership between Holdco, Mr. A and Ms. A holding 98%, 1% and 1% interests, respectively, but with Holdco continuing to be responsible for the mortgage loan. Mr. A who, but for this structure, would reasonably be considered to be an Opco employee, provides services to Opco on behalf of the Partnership. This structure targeted (i) avoiding a taxable benefit to Mr. A from the use of the principal residence, (ii) avoiding source deductions respecting his services to Opco and (iii) generating the small business deduction for Holdco.

Regarding the first benefit, the Directorate stated that it could be argued that a benefit was indirectly conferred on Mr. A pursuant to s. 246(1), as to which it stated:

[CRA] may assess Mr. A solely on the basis of that provision, as determined in Massicotte … . Furthermore, if the residence had been held by Holdco directly, Mr. A would have received a benefit … under subsection 15(1). Thus … although the residence is owned by the Partnership, Holdco, as a partner with a 98% interest in the Partnership, may exercise sufficient influence over the Partnership to be able to confer a benefit indirectly on Mr. A.

After finding that a corporation’s payment of the personal expenses of an unpaid director gave rise to s. 6(1)(a) inclusions to him, the Directorate stated:

[S]ubsection 246(1) is a provision of subsidiary application since it must be shown that the value of the benefit is not otherwise included (e.g., by virtue of subsection 6(1)(a)) in computing the taxpayer's income under Part I … .

A partnership in whose farming business the partners are actively involved owns the residence of one of the partners, who does not pay rent, but pays all the annual expenses of the residence. CRA noted (as per its summary):

Except for paragraph 12(1)(y), there is no statutory provision that would apply to a partner by reason of the partner’s personal use of partnership property.

Mr. A is one of the two trustees for an inter vivos trust for his minor children that provides for the distribution of all income to the beneficiaries, with the trust electing under s. 104(13.1). Mr. A voluntarily pays the income taxes owed by the trust.

Does s. 105(1) (or any other provision) apply to tax the beneficiaries on the income taxes paid by the trustee personally? After indicating that s. 105(1) did not apply, CRA stated:

[I]t should be noted that the amount of tax paid by Mr. A does not represent income on which a taxpayer would have been taxed if he had received it directly. Therefore, the beneficiaries would not be taxed on the amount of tax paid by Mr. A under subsection 246(1).

The four equal common shareholders of Opco were X (a director and vice president), his wife ("Y"), Y's sister and the sister's husband, and X and Y also held preferred shares. After Opco, which had been carrying on a business, fell into financial difficulties, it sold the property of that business to X at an undervalue, without any change to Opco’s share capital. After finding that s. 15(1) might apply to the sale, the Directorate stated:

Subsection 246(1) would apply … to the extent that Opco conferred on X, directly or indirectly and in any manner whatever, a benefit and to the extent that the value of that benefit would be included in computing X's income if it were a payment that Opco had made directly to X. In that regard, it appears that if Opco had made a payment directly to X, that payment would, inter alia, have been required to be included in computing X's income pursuant to …, paragraph 6(1)(a). Thus … the value of the benefit that Opco conferred on X would be included in computing X's income under paragraph 246(1)(a).

A shareholder transferred a universal life insurance policy, that was an exempt policy, on the individual’s life to a wholly-owned corporation for consideration equal to the cash surrender value, which was less than the adjusted cost basis (ACB) of the policy. Following the transfer, the corporation was named as the beneficiary.

After noting that under s. 148(7) the proceeds equaled the cash surrender value, CCRA stated:

The fair market value of a life insurance policy is not necessarily equivalent to its cash surrender value. The age and health of the insured, the value of the accumulation fund, the cash surrender value and the amount of premiums paid at the date of transfer are all factors to be considered when determining the fair market value of a life insurance policy. If, in this case, it appears that the fair market value of the policy is greater than the cash surrender value, there will be a benefit conferred by the shareholder to the corporation since the transfer of the policy will be for consideration equal to the cash surrender value. There is no provision in the Act that taxes such a benefit. This issue is currently under review by the Department of Finance.

"It our general position that the term 'shareholder' as used in subsection 15(1) of the Act would not include a person who indirectly controls a corporation through a holding corporation. Although the provisions of subsection 15(1) of the Act would not normally apply in respect of the value of any benefit conferred by a corporation on an indirect shareholder, the provisions of subsection 246(1) of the Act could apply to include the amount of the benefit in the hands of the indirect shareholder."

Re potential application of s. 246(1) to a holder of common shares where his father exchanges preferred shares of the corporation for preferred shares having a lower redemption amount and for options.