Subsection 248(28) - Limitation respecting inclusions, deductions and tax credits

A Canadian resident (and US citizen) had an agreement with the Canadian Competent Authority under Art. XXIX(5) of the Canada-US Treaty, by virtue of which he included his share of the S Corporation’s income as FAPI, claimed a s. 126 credit for the US taxes on that income, and added such FAPI to the ACB of his shares. However, before he received any dividend, he revoked the S Corp’s status as a fiscally transparent entity for US purposes, so that the Agreement thereupon terminated.

The S Corp then paid a dividend to him of income that previously had been included in his income as FAPI (and now was included in his income under s. 90(1).)

The Directorate indicated that where the S Corp was a CFA of the individual, he could take a s. 91(5) deduction of the dividend paid after the Agreement invalidation, with a corresponding reduction to the ACB of his shares.

However, where the S Corp was not a FA at the time of the dividend, no s. 91(5) deduction would be available (but with no corresponding ACB reduction) because in such absence of FA status, Reg. 5900(3) would not deem the dividend to come out of taxable surplus.

The Directorate noted that it could be argued that s. 248(28) would apply to exclude the dividend from his income given that “both the dividend and FAPI arise from the same source, namely the shares of S Corporation.” However, the Directorate preferred the double inclusion alternative:

[T]he better view … is that the dividend income and FAPI inclusion are not the same amount …

[T]he dividend income is a cash distribution on the shares of S Corporation while the FAPI is a notional allocation of the income of S Corporation deemed to be FAPI on its shares of S Corporation … [so that] the dividend income and FAPI are separate amounts of a different nature … [which] would preclude the application of subsection 248(28).

CRA found that, given that s. 80 applied in year of forgiveness of unpaid interest under a CCAA Plan, and in light of the rule of statutory construction according prevalence to the more specific provision and the rule against double-taxation in s. 248(28), ss. 143.4(2) and (4) would not also apply to produce an income inclusion from such forgiven interest.

After finding that psychotherapy expenses potentially could be deducted in computing income of a professional practice, CRA stated:

The fact that psychotherapy fees could give rise to a credit under the Act does not preclude their deduction in the computation of income from your business. However…[under] subsection 248(28)… it would not be possible to deduct psychotherapy expenses under section 9 and claim a medical expense credit for the same amount under section 118.2. Finally, any personal portion of the psychotherapy expenses that will not be deducted in computing income from a business can give rise to a medical expense tax credit provided that all of the requirements under section 118.2 are met.

CRA indicated respecting any potential double taxation arising from the applicability of both s. 84(2) and (3) to a surplus stripping transaction that, in practice, CRA would avoid double taxation through applying s. 248(28)(a). See summary under s. 84(2).

As a result of a wind-up of a 2nd tier FA following a s. 90(6) loan to Canco, there technically would be a double income inclusion to Canco under ss. 90(6) and (12). By virtue of s. 248(28)(a), only one of the two amounts would be included in Canco's income. See detailed summary of Scenario 6 under s. 90(9).

Publico determined to grant stock options to its directors and consultants, as a result of which a private corporation ("Corporation"), that had provided consulting services, was entitled to receive a grant of options. However, such options instead were granted directly to Ms. Y, the sole shareholder of Corporation, who subsequently exercised and sold the acquired Publico shares, reporting a capital gain.

After finding that s. 56(4) or 56(2) applied to Corporation, as it could be regarded as assenting to the direct transfer to its shareholder, CRA noted that such income inclusion to Corporation did not detract from there also being a taxable benefit to Mrs. Y under s. 15 (or 6(1)(a), if it was received by virtue of employment - with a potential deduction to Corporation.) As to whether s. 248(28) applied to include only one benefit, being to Ms. X, CRA stated:

We are of the view that nothing precludes the simultaneous application, on the one hand, of subsection 56(4) or 56(2) at the corporate level, and, on the other hand, of subsection 15(1) or paragraph 6(1)(a) to Ms. X. No reference is made to subsection 15(1) or paragraph 6(1)(a) which precludes its application where subsection 56(4) or 56(2) also applies. Subsection 248(28) would not apply in the circumstances since this statutory provision only provides for the double counting of an amount in respect of the same taxpayer.

CRA will construe paragraph 55(2)(c) so that the amount deemed not to be a dividend is not taxed as a capital gain twice. Paragraph 55(2)(c) will be applied in the year of the increase of the stated capital of the shares; when the shares are sold, the capital gain will be reduced by the amount already included in income pursuant to paragraph 55(2)(c).

Respecting the payment of a preferred share stock dividend that is followed by a sale of the preferred shares, CRA quoted with approval its earlier statement in 9830665 that:

If the disposition of the preferred shares occurs in a taxation year subsequent to the year of the payment of the stock dividend and the sale of the common shares, the taxpayer must apply paragraph 55(2)(b) in respect of the stock dividend and not include a taxable capital gain on the sale of the preferred shares in the subsequent taxation year.

CRA indicated that, although s. 75(2) technically could apply to a real estate unit trust established on commercial terms, it very well might not apply s. 75(2) in such circumstances. However, if s. 75(2) applied to attribute trust income directly to the unitholders, distributions by the trust to the unitholders would not have the character of income distributions, so that such distributions could reduce the ACB of trust units. CRA then stated:

[A]dministrative relief is provided in paragraph 10 of Interpretation Bulletin IT-369R so that income subject to the application of subsection 75(2) is not otherwise included in the income of a beneficiary or trust, as the case may be.

In a particular case … the CRA could extend this position so that no reduction to the ACB of a beneficiary's capital interest would be made by virtue of subparagraph 53(2)(h)(i.1). …

[W]e have doubts as to whether paragraph 248(28)(a) can be invoked to ensure that no negative adjustment can be made to the ACB of the taxpayer's capital interest to prevent double taxation.

On the day before a third party acquired all of the shares of a Canadian-controlled private corporation (CCPC), two directors of its directors exercised their stock options and then, on the acquisition date, the shares so acquired by them were purchased for cancellation by Opco so to reduce the number of issued and outstanding shares to the number agreed with the third party acquirer. In rejecting a suggestion that s. 248(28) should preclude the application of s. 84(3) to the purchase for cancellation of the directors’ shares since a benefit under s. 7(1) would have already been computed, CRA stated:

[I]t is our position that subsection 248(28) does not apply to a deemed dividend on the redemption, acquisition or cancellation by a corporation of shares of its capital stock for which a section 7 benefit is included in an employee's income. …[T]he section 7 benefit and the dividend computed under subsection 84(3) result from two different events, namely, the exercise of a stock option by the employee and the redemption, acquisition or cancellation of the shares by the corporation.

A lease is amended to add an option to purchase and to increase the annual lease payment by an amount that would be in excess of the fair market value rent in the absence of the option. The additional lease payment are treated for purposes of s. 49(5) as payments in respect of the extension of the original option, with the result that, for purposes of s. 49(1), such amount are deemed to be proceeds of disposition in respect of the grant of the option at the time of receipt of each such payment.

Upon the exercise of the option, the vendor by virtue of s. 248(28) will not be required to include in its proceeds of disposition the amounts included as capital gains under s. 49(5) and 49(1) except to the extent that pursuant to s. 49(4) it files amended tax return to exclude such amounts from the computation of its income for those taxation years as proceeds of disposition.

Allocations made to the spouse of a retired partner pursuant to s. 96(1.1) would, depending on the circumstances, also be included in the income of the retired partner under s. 56(2) or (4). S.248(28) would not prevent this result.

Contrary to a previous position, CCRA has concluded that s. 248(28) does not preclude the application of s. 84(3) on the redemption of shares even where that redemption triggers an employment benefit that was deferred by s. 7(1.1): "The benefit under section 7 of the Act and the dividend computed under subsection 84(3) of the Act are determined as a result of different events and there is no amount that has been included in income under section 7 of the Act that is included a second time contrary to paragraph 248(28)(a) ... a taxpayer will generally have a capital loss on the disposition, which will already account for both the inclusion of the section 7 benefit and the subsection 84(3) dividend. This will mean the taxpayer will only be taxed once on the economic gain received as a result of the exercise of the option and the disposition of the shares."

After noting that where an RRSP provides a secured guarantee of a loan to the annuitant, the fair market value of the property given as security will be included pursuant to s. 146(10), CCRA went on to note that where a payment is made from the RRSP because of the exercise of a security interest to repay such secured debts, although there is a benefit as per s. 146(1), it is not to be included in the annuitant's income pursuant to s. 146(8) by virtue of s. 248(28)(a) (so as to avoid double taxation under ss. 146(10) and (8)).

Holding companies made interest-bearing advances to a partnership (the S.E.N.C.) CRA proposed to disallow the interest deduction to the S.E.N.C. and to include the amount of the advances in the income of the holding companies pursuant to s. 15(2) (on the basis that the S.E.N.C. was connected to the shareholders of the holding companies since each partner was considered not to deal at arm's length with the S.E.N.C.). The taxpayer considered that the disallowance of the interest expense to the S.E.N.C. resulted in additional income allocated to the partners and that the latter must also include the same amount in their income for tax purposes pursuant to s. 15(2), contrary to s. 248(28). The Directorate rejected this position, stating:

[A]n amount that is not deductible pursuant to paragraph 20(1)(c) and an amount included in income pursuant to subsection 15(2) do not refer to the same amount. In our view, these two provisions of the Act apply independently of each other.

The following example was provided respecting a preferred share held by a financial institution whose paid-up capital (and apparently, redemption amount) was increased:

The Agency commented that "it would have to be established that the increase in fair market value of the shares was solely the result of the increase in paid-up capital". The Agency also noted that "the use of subsection 248(28) in this situation is cumbersome and may not provide an appropriate result in all circumstances".

A Canadian resident corporation lends money to a foreign affiliate which, in turn, lends money to non-affiliated and non-resident corporations. In these circumstances, s. 248(28) does not affect the application of s. 17, which may cause an income inclusion in respect of the first amount under s. 17(1) and an income inclusion in respect of the second amount under s. 17(2). In these circumstances, "section 17 does not require a particular amount to be included in income more than once. That is, section 17 requires only one income inclusion in respect of any particular amount owing".

"Where an employee has income from employment under paragraph 7(1)(a) related to the disposition, by virtue of subsection 7(1.1), of shares and a deemed dividend under subsection 84(3) of the Act related to the redemption of shares in the same or a different year, we are of the view that subsection 248(28) of the Act will apply so that there will be no income inclusion under subsection 84(3) of the same amount as a deemed dividend resulting on the redemption of the shares."

Under the proposed version of s. 4(4), interest to which s. 18(4) applied in a previous year will not be required to be included in income under s. 9(1) in the year it is forgiven. Where s. 80 applies, the forgiven interest will not be included in income under s. 9(1).

There is no provision in the Act permitting a shareholder/manager to reduce the amount of salary received by him to the extent that such salary is not deductible by virtue of s. 67 to the payor corporation.