News of Note
Debt conversions and assumptions can operate asymmetrically as between debtor and creditor
Email this ContentThe conversion (after addition of a conversion right) of an appreciated USD debt into prefs appears to operate in an asymmetrical manner, so that the creditor enjoys rollover treatment under s. 51, whereas the debtor realizes an FX loss under s. 39(2). Similarly, a conversion into shares on a s. 51 rollover basis nonetheless would give rise to a repayment for s. 15(2.6) purposes.
Two rulings suggest that an internal assumption (e.g., by a sub of its parent’s FX debt but without the parent being released) would give rise to a s. 39(2) gain or loss to the parent even though there would be no disposition to the creditor.
The s. 51.1 rollover requires that the principal amounts of the exchanged obligations be the same. In two rulings given after the enactment of s. 261(2)(b), CRA indicated that s. 51.1 applied to the conversion of US-dollar-denominated non-interest-bearing notes into US-dollar-denominated interest-bearing notes with the same principal amount in US dollars (but not the Canadian-dollar equivalent).
When an FX-denominated debt is repaid by issuing a replacement debt denominated in the same currency, there is an argument that no s. 39(2) gain or loss is realized. It also is unclear whether a deemed dividend arises on redemption of preferred shares having a USD-denominated stated capital.
Although CRA has considered that substitutions for s. 93(2.1) purposes are not limited to share-for-share transactions, “there seems to be a reasonable interpretation that a taxable disposition of the shares for cash (or a promissory note) should break the chain of substitutions, such that dividends paid on the original shares should no longer be relevant.”
Neal Armstrong. Summaries of Didier Fréchette and Ryan Rabinovitch, "Current Issues Involving Foreign Exchange" 2015 CTF Annual Conference paper under s. 51(1), s. 39(2), s. 51.1, s. 80(2)(k), s. 84(3), s. 84(4), s. 93(2.01), s. 93(2.1) and s. 112(3).
The expansion under s. 55(2.1)(b) of the scope of s. 55(2) has resulted in potential anomalies
Prior to the introduction of the new s. 55(2.1)(b), a Holdco could create a Subco with common shares having a fair market value equal to their adjusted cost base (by having Opco pay a stock dividend of pref shares with full paid-up capital and transferring those prefs to Subco for high basis shares of Subco) – and then have Subco declare a dividend to it of the Opco prefs, which reduces the FMV of Subco’s shares below their ACB but was not caught by the old s. 55(2) because the purpose of the dividend could not be to reduce a capital gain on the Subco shares. This increased basis in Holdco’s investment could reduce the capital gain realized by it on a subsequent arm’s length sale. New S. 55(2.1)(b)(ii)(B) would likely catch this basis creation as its purpose likely was to increase the total cost amount of Holdco’s property.
A somewhat odd result of the new s. 55(2.1)(b) is that where the FMV of the shares of Opco have temporarily declined below their ACB, the safe-income exception will not apply to a cash dividend paid by Opco, so that it is necessary to address the FMV-reduction purpose test in s. 55(2.1)(b)(ii)(A).
The legislative definition of "sate-income determination time" (which references the beginning of a series of transactions) was designed for a share sale transaction. and has not been amended to align better with the new rules. For example, if a corporation establishes a policy to distribute each year's earnings, it would be unreasonable if the dividend paid to distribute the first year's earnings triggered a safe-income determination time, thereby preventing the subsequent years' earnings from being added to safe income.
Neal Armstrong. Summaries of Rick McLean, "Subsection 55(2): What Is the New Reality?" 2015 CTF Annual Conference paper under s. 55(2.1)(b), s. 55(1) – safe income determination time, s. 55(2.3).
CRA indicates that processing meat can form part of a farming business
Although it stated that the question of whether a processing operation was part of a farming business was a question of fact, CRA indicated that a livestock farmer’s operation of turning his animals into ground or cut meat would be part of his farming business (so that the inventory of such processed meat was eligible for exclusion from his income under the s. 28 cash method of accounting) provided that the processing operation was “incidental to the farming activity” and the income therefrom “not materially significant in relation to the income from farming.” It was assisted in this regard by Tinhorn Creek, where the Tax Court “concluded that winemaking was linked to viticulture and was an integral part of the taxpayer's farming business.”
Neal Armstrong. Summary of 22 September 2016 External T.I. 2015-0594721E5 Tr under s. 28(1)(b).
Starflex – Quebec Court of Appeal indicates that gifts to charities likely cannot be deducted as business expenses
Art. XXI, para. 7 of the Canada-U.S. Convention provides (subject to conditions) that a gift by a Canadian with U.S.-source income to a qualifying U.S. charity is to be treated the same as one to a registered Canadian charity. The Cour du Québec found that a Quebec provision, which exempted income for Quebec purposes if it also was exempted under one of Canada's treaties, did not require Quebec to provide donation deductions for gifts to U.S. charities.
The Quebec Court of Appeal did not deal with this aspect of the case. The taxpayer had requested, at the trial's opening, to amend its pleadings to claim, in the alternative, that its donations made to U.S. charities were deductible as business (promotional) expenses, relying on Olympia. In confirming the refusal below to allow this amendment, the Court of Appeal essentially found that Olympia was inconsistent with the Symes approach to statutory interpretation, stating:
The specific tax treatment provided in the TA respecting gifts must prevail similarly to the pronouncements of the Supreme Court in Symes… . The Court specified there that child care expenses could not be deducted as business expenses under the applicable tax principles, in the face of a specific and complete regime for child care expenses provided in section 63 of the Income Tax Act. The same reasoning should be favoured in addressing the treatment of gifts.
Neal Armstrong. Summary of Emballages Starflex Inc. v. Agence du revenu du Québec, 2016 QCCA 1856 under s. 18(1)(a) - income producing purpose.
Severed letters from April 2010 onwards are available
We have continued to upload back issues of severed letters and our collection now includes all those issued by the Income Tax Rulings Directorate since April 2010.
CRA considers that an exempt low-rental housing corp can use a CDA
CRA considers that one-half of the capital gains generated by a private corporation that is exempt as a low-rental housing corporation under s. 149(1)(n) are added to its capital dividend account and can be paid out as capital dividends.
However, should it lose its exempt status, it also would lose its CDA under s. 89(1.2) – and the timing of the capital gains arising to it under the s. 149(10) disposition of its property would preclude those gains from being added to the available amount of its CDA.
Neal Armstrong. Summaries of 17 August 2016 Internal T.I. 2016-0639251I7 under s. 89(1) – capital dividend account - (a) and s. 89(1.2).
CRA indicates that significant employer discretion as to stock option vesting will oust an “agreement” to acquire the shares
CRA considers that in order for there to be a s. 7/110(1)(d) agreement to issue shares, there must be “legally binding rights and enforceable obligations” respecting the covered shares. CRA has provided various examples illustrating the implications of this view.
For example, where under a fully discretionary stock bonus plan, the shares are issued when the employer’s discretion is exercised, the plan will not be considered to be a s. 7 plan, so that it generally will be required to qualify as a three-year bonus plan or deferred share unit plan. On the other hand, “if the eventual issuance of the shares is subject to time or other objective vesting conditions,” the share issuance will be governed by s. 7 (because there was an agreement between the time of the grant and the issuance).
A second example is where employees are granted options with FMV exercise prices but which are exercisable only upon the corporation subsequently notifying the employees of its decision on the number of options that each employee may exercise. CRA considers that the employee would not have a legal agreement to acquire the shares before receiving such notification, so that the s. 110(1)(d) deduction would not be available if the shares had appreciated over the exercise price in the interim.
A third example (similar to the second) is where a trust is established by the employer to acquire and hold shares of the employer for employees, but allocations among the employees are entirely at the discretion of the trustees – so that CRA would consider that there is no agreement to acquire the shares until such discretion is exercised.
Neal Armstrong. Summaries of 19 September 2016 Internal T.I. 2016-0641841I7 under s. 7(3)(b), s. 110(1)(d) and s. 7(2).
Income Tax Severed Letters 21 December 2016
This morning's release of seven severed letters from the Income Tax Rulings Directorate is now available for your viewing.
Full text translations of the balance of the APFF Roundtable questions are available
The table below links to full-text translations of the balance of the APFF Roundtable questions and answers (Q.9 to Q.21) and the first three from the APFF Financial Strategies and Instruments Roundtable - as well as of the French internal technical interpretation which was released last Wednesday (reflecting minor CRA corrections to a previous version of the same interpretation).
The translations are paywalled in the usual (3 work-weeks per month) manner.
Great-West Life – Federal Court of Appeal states that the GST “financial services” definition should be applied based only on the “predominant elements” supplied
A third party (Emergis) provided automated claims processing services to Great-West Life, which administered or insured various client drug plans, so that the prescription drug claim of an employee would be processed at the pharmacy counter upon presentation of a magnetic card.
In the Tax Court below, Owen J ultimately found that the charges of Emergis to Great-West for this service were taxable under the Financial Services and Financial Institutions (GST/HST) Regulations, as they were "quintessentially administrative in nature." More interestingly, he also found that in the absence of this Regulation, the service would have been exempt as being for the payment of insurance policy claims – notwithstanding that the Emergis service entailed the provision of taxable supplies described in para. (r.4) of the financial services definition, e.g., collecting, collating or providing information. He stated that "those services do not represent the essential character or substance of the supply, which is paying drug benefits to plan members."
In the Court of Appeal, Woods JA did not comment directly on the (now, apparently ineffectual) para. (r.4) rule, but appeared to essentially agree with this general approach when she stated:
…[I]t is necessary to determine the predominant elements of the supply if it is a single compound supply. It is only the predominant elements that are taken into account in applying the inclusions and exclusions in the “financial service” definition.
Neal Armstrong. Summary of Great-West Life Assurance Co. v The Queen, 2016 FCA 316 under Financial Services and Financial Institutions (GST/HST) Regulations.