News of Note
Marzen Artistic Aluminum – Tax Court of Canada shifts 100% of the income of a U.S. marketing operation from Barbados to Canada
Email this ContentThe taxpayer, a Canadian window manufacturer which sold its windows in B.C. and the U.S., generated essentially all its profits in its Barbadian subsidiary (SII), which essentially had no assets or employees other than its (very part-time) Barbadian managing director: the taxpayer sold windows for the U.S. market to its U.S. subsidiary ("SWI") at their retail price; SII charged "marketing fees" to the taxpayer which were sufficient to reduce the taxpayer’s income to nil; SII paid fees to SWI for the SWI employees ("seconded" to SII) who did the marketing work at SWI’s payroll cost plus 10%; and SII paid dividends (out of exempt earnings generated from the substantial mark-up of its fees over those of SWI) to the taxpayer which essentially were equal to 100% of the profit of the consolidated group.
Sheridan J applied s. 247(2)(c) to reduce the marketing fees to the sum of: the fees paid by SII to SWI; and those paid to its managing director (which she treated as the comparable uncontrolled price for SII’s services to the taxpayer). One effect of this adjustment was that 100% of the profits of SWI, which it might have earned had it been charged for windows at the wholesale rather than retail price, were shifted from Barbados to Canada, i.e., it was not just profits which normatively should have been earned in Canada which were shifted back to Canada.
This point was not argued directly, but it came up indirectly respecting the approach of the taxpayer’s transfer pricing expert, who considered that the marketing fees paid by the taxpayer were appropriate if they were treated as paid to SII/SWI as an "amalgam." Sheridan J found this to be contrary to the separate entity approach mandated in the 1995 OECD Guidelines (which she referred to rather than the subsequent 2010 Guidelines).
Neal Armstrong. Summaries of Marzen Artistic Aluminum v. The Queen, 2014 DTC 1145 [at 3433], 2014 TCC 194 under s. 247(2) and s. 247(4).
Income Tax Severed Letters 18 June 2014
This morning's release of 22 severed letters from the Income Tax Rulings Directorate is now available for your viewing.
CRA considers that a single condo unit can be a hotel for GST/HST purposes
A residential complex for GST/HST purposes does not include a hotel or inn. CRA considers that where there is a building with multiple condo units (in this case, a condominium resort), each unit is tested to see if it is a hotel or inn on its own rather than by reference to the character of the building as a whole. In P-099, CRA indicates that a hotel or inn generally provides temporary accommodation to the public, with ancillary services where appropriate.
Neal Armstrong. Summaries of 22 July 2013 Interpretation 145125 under ETA – S. 123(1) – Residential complex and General Concepts – Ownership.
Joint Committee makes submissions on acting–in-concert and partnership control concepts in draft Folio
In response to the release in draft form of Folio S1-F5-C1 entitled "Related persons and dealing at arm’s length," the Joint Committee has made detailed submissions that a statement - that highly interdependent dealings presumptively establish a non-arm’s length relationship - does not accord with the jurisprudence, and also has suggested an acknowledgment that generally it is the GP of a limited partnership who controls corporate investments of the partnership.
Starlight No. 3 Fund will avoid FAPI treatment of gains on sale in three years’ time of U.S. apartment buildings by U.S. private REIT subsidiary
The public offering for the Starlight U.S. Multi-Family (No. 3) Core Fund (an Ontario LP) is similar to those for the No. 1 and No. 2 funds. It will invest in U.S. apartment buildings through LLC subsidiaries of a private U.S. REIT. An Ontario subsidiary LP (which will be a corporation for Code purposes) and a Delaware LP will be sandwiched between the public LP and the U.S. private REIT. This will help insulate the public Ontario partnership from the U.S. public partnership rules and may simplify U.S. FIRPTA withholding requirements - while at the same time the structure will still be treated as transparent (under Art. IV.6) for the purposes of U.S. withholding on dividends and interest paid by the U.S. private REIT.
It is intending avoid FAPI treatment on the net rental income and gains on dispositions of the apartment buildings (expected to occur in three years’ time) by relying on the over-five employee safe harbor for leasing businesses and the mother ship tests. 3.5% of the anticipated annual returns of 12% per annum over the three year (partly extendible) term of the Fund are anticipated to come from gains from the sale of the buildings. If the returns from the U.S. business came mostly from (income account) gains from the buildings, the FAPI exclusion would be quite problematic but, as noted, this is not projected to be the case. From a U.S. REIT rule perspective, there is a safe harbour for properties that are held for at least two years if no more than seven properties are sold in a year.
Neal Armstrong and Abe Leitner. Summary of preliminary prospectus for Starlight U.S. Multi-Family Core (No. 3) Fund under Offerings – REIT and LP Offerings - Foreign Asset Income Finds and LPs.
CRA rules on use of s. 88(1)(d) bump to eliminate sandwich structure following a spin-off by public company Target and cash acquisition of Target shares by the Canadian buyco of U.S. public company
A s. 88(1)(d) bump letter deals with a Canadian target with indirect non-resident subsidiaries which, under a plan of arrangement, spins off a Spinco to its shareholders under s. 86, with its remaining shares then acquired by a Canadian subsidiary (BidAmalco) of a U.S. public company (Buyer) in order that there can be a winding-up of Target into BidAmalco, a bump of the shares of the non-resident subsidiaries and their distribution out of BidAmalco so as to eliminate the sandwich structure. As it was an all cash deal, there was no need to wrestle with the new rules which accommodate share consideration paid by Buyco provided that not more than 10% of the value of the Buyer shares is attributable to Target’s property – and, in any event, the transactions may have been implemented before the effective date of those new rules. The ruling letter was issued after the bump designation had already been made by BidAmalco.
Spinco agreed with Buyer that for the following two years it would not purchase Buyer shares or debt, or any securities that derive their value, directly or indirectly, from such securities. (Such a purchase would be problematic under s. 88(1)(c)(vi)(B)(III)(2) given that initially Target and Spinco2 have the same shareholders in common.)
Neal Armstrong. Summary of 2013 Ruling 2011-0397081R3 under s. 88(1)(c)(vi)(B)(III).
CRA rules on using Treaty step-up to avoid the application of s. 55(2) to a spin-off made to effect an arm’s length sale
The U.S. parent of a Canadian corporation (Amalco) is indirectly selling the "XYZ" business, carried on through subsidiaries of Amalco, to an arm’s length purchaser (Buyer). This will be accomplished through a spin-off transaction in which the shares of Amalco are split on a s. 86 reorg into "Keep" pref and new common shares, the U.S. parent transfers its Keep pref to its newo subsidiary ("Canco") on a Treaty-exempt basis in consideration for common shares of Canco, Amalco sells the "Keep" assets to Canco on a taxable basis for a note, and Amalco redeems the Keep pref by way of set-off against the note it received for the Keep assets (and, contrary to the usual Rulings practice, not first issuing a redemption note). As Amalco now only holds the XYZ business, it can be sold by the U.S. parent on a Treaty-exempt basis to Buyer.
This is the opposite of the purchase butterflies of yesteryear: there is no outside gains tax (under the Treaty); but there is inside gain on the spin-off of the Keep assets. S. 55(2) does not apply to the deemed dividend arising on the redemption of the Keep pref as their basis was stepped up under the Treaty.
Neal Armstrong. Summary of 2012 Ruling 2011-0403291R3 under s. 55(2) and s. 248(1) – disposition.
Howard – High Court of Australia finds that merely assigning a future damages award rather than the law suit entitlement is not effective to shift the resulting income
At the same time as the taxpayer launched an action against some co-venturers, he assigned any resulting award of damages to a corporation of which he was a director. The corporation included the ultimate award in its income. Before considering the effect of this assignment, the High Court found that the award was his income rather than corporate income on general principles, as in the circumstances he would not have breached his fiduciary obligations to the corporation if he had pocketed the damages himself.
As for the assignment, the reasons suggest that the taxpayer would have successfully avoided a personal income inclusion if he had assigned his entitlements under the law suit to the corporation rather than just assigning any future damages award.
The second point is generally consistent with Canadian cases finding that amounts received by a taxpayer subject to a pre-existing obligation to pay them to a third party should be excluded from its income (Premium Iron Ores, Wilson, Leonard Pipeline, Canadian Fruit, Minet, cf. Canpar), and might be viewed as partially codified by s. 56(4).
Were the facts reversed so that Howard as fiduciary had been obligated, but failed, to pay the award over to the corporation, the amount likely would have been income to him under Canadian principles notwithstanding his lack of legal entitlement to it (Angle, Penny).
Neal Armstrong. Summaries of Howard v. Commissioner of Taxation, [2014] HCA 21 under s. 9 – compensation payments and s. 9 – nature of income.
CRA considers that the HST/GST treatment of new residential housing purchased for head leasing is different than if it is purchased for leasing
If a person purchases newly constructed housing for the purpose of leasing or licensing it to an individual as a place of residence, it generally will pay the GST/HST on the purchase price subject to any new housing rebate arrangements, and that will be the end of it. However, as explained in News No. 91, if it instead purchases such housing for the purpose of supplying it under a head lease to another person (the head lessee) who in turn subleases the housing to an individual as a place of residence, it will be required to self-assess itself for GST/HST on the fair market value of the housing at the time possession is given to the head lessee, and it can claim an input tax credit for the GST/HST paid on the housing purchase.
This different treatment of the second (head lease/sublease) scenario is significant if the housing continues to appreciate between its purchase and the time of taking possession.
Neal Armstrong. Summary of Excise and GST/HST News – No. 91 under ETA – s. 191(1).
Galachiuk – Tax Court of Canada finds that the taxpayer can demonstrate due diligence for either of the two years at issue under a s. 163(1) penalty
S. 163(1) imposes a 10% penalty on the amount of underreported income in a return (or 20% taking into account what usually is a matching provincial penalty) if any amount of income was also underreported in one of the three preceding taxation years. Graham J found (in the face of conflicting decisions on the point) that there was a due diligence defence for a s. 163(1) penalty if the taxpayer established due diligence in either of the two years, so that it was not necessary for the taxpayer to establish due diligence for the second year. Accordingly, because it was reasonable for the taxpayer not to notice that he had not received a T3 slip for $683 for 2008, he could avoid the penalty for not reporting a $436,890 withdrawal from his pension plan in 2009 (for which his excuse was lame).
Neal Armstrong. Summary of Galachiuk v. The Queen, 2014 DTC 1153 [at 3494], 2014 TCC 188 under s. 163(1) and General Concepts - Onus.