Income Tax Technical News No. 44 13 April 2011 [archived]

If a typical loss-consolidation transaction results in an incidental shifting of income or losses between provinces, simply because the profitco and the lossco happen to have different provincial allocations, there should not be a concern from the perspective of agreeing provinces. If, on the other hand, the transactions are designed to deliberately shift income or loss between provinces, provincial concerns will have to be considered.

In finding that the appreciated amount of an exchangeable debenture when paid on maturity could not be recognized under s. 20(1)(e), CRA stated:

It follows that the appreciation of the principal amount of a debenture over its face value is a payment on account of capital, the deduction of which is prohibited by paragraph 18(1)(b). Paragraph 20(1)(e) does not apply to such appreciation, because this would be an amount paid on account of the principal amount of the debenture, and therefore an excluded amount for the purposes of paragraph 20(1)(e).

Before the decision in Imperial Oil Ltd. and Inco Ltd....CRA's position with respect to exchangeable debentures issued with or without an original discount was that a deduction was generally available under paragraph 20(1)(f) with respect to the original discount as well as the appreciation of the principal amount of the debenture over its face value, provided that such appreciation was inherent to the terms and conditions of the debenture. ...

In light of...Tembec...our above-mentioned position is not supportable at law. Hence, this case limits the deduction of financing costs provided for by paragraph 20(1)(f) to the original discount, granted when an obligation is issued.

CRA stated:

[W]hen a holder of an exchangeable debenture exercises the right to exchange the debenture for the target shares, the holder would dispose of the debenture for proceeds equal to the FMV of the consideration received—that is, the FMV of the target shares. The adjusted cost base (ACB) of the target shares to the holder would equal the FMV of the debenture given up to acquire them which (ignoring interest rate fluctuations) would ordinarily equal the FMV of the target shares.

Is it CRA's position that "where property is transferred to a corporation by a shareholder for no consideration, the corporation will not have any cost base in the property"? CRA responded:

In the absence of a specific provision in the Act to the contrary...a corporation that receives property from its shareholder for no consideration has a cost basis for that property equal to its FMV.

After commenting on a transaction in which a ULC held by a US C corporation (USco) increases its paid-up capital (giving rise to a deemed dividend) and then distributes that PUC to USco, CRA then was asked to consider a Luxembourg s.à r.l. (which is resident in Luxembourg but disregarded for U.S. purposes) inserted between USco and ULC. Would the 5 percent withholding tax rate under the Canada-Luxembourg treaty generally apply to dividends paid by ULC to Luxco? CRA stated:

The 5 percent withholding rate will normally apply if Luxco is the beneficial owner of the dividends. Our recent views on the meaning of "beneficial owner" in the light of Canada v. Prévost Car Inc. are set out in document no. 2009‑0321451C6