Income Tax Technical News
No. 25
October 30, 2002
Canada Customs and Revenue Agency Agence des douanes et du revenu du Canada
w w w. c r a . g c . c a
In This Issue E-Commerce R e a s o n a b l e E x p e c t a t i o n o f P r o f it Health and Welfare Trusts Refreshing losses Replacement Property Rules and Business Expansion Foreign Exchange Losses Dividend Reinvestment Plans Silicon Graphics Ltd. v. The Queen Partnership The INCOME TAX TECHNICAL NEWS is produced by the Policy and L e g i s l a t i o n B r a n c h . I t i s p r o v id e d f o r i n f o r m a t i on p u r p o s e s o n l y a n d d o e s n o t r e p l a c e t he l a w. I f yo u h a v e a n y c o m m e n t s o r
1
s u g g e s t i o n s a b o u t t h e m a t t e r s d i s c u s se d i n t h i s p u b l i c a t i o n , p l e a s e send them to: Manager, Technical Publications and Projects Section Income Tax Rulings Directorate Policy and Legislation Branch C a n a d a C u s t o m s a n d Re v e n u e A g e n c y O t t a wa O N K 1 A 0 L 5 T h i s i s s u e c o n t a i n s i s s u e s o f c ur r e nt i n t e r e s t t ha t we r e d i s c u s s e d a t a p a n e l a t t h e a n n u a l c o n f e r e n c e o f t h e C a n ad i a n T a x F o u n d a t i o n on September 30, 2002, in Toronto by Roy Shultis, Deputy Assistant Commissioner, Income Tax Ruling Directorate, Policy and Legislation B r a n c h , M i k e H i l t z , D i r ec t o r , R e o rg a n i z a t i o n s a n d R e s o u r c e s D i v i s i o n , Income Tax Rulings Directorate, Policy and Legislation Branch and Marc Vanasse, Director, Business and Partnerships Division, Income Tax Rulings Directorate, Policy and Legislation Branch, Canada C u s t o m s a n d R e v e n u e A g e n c y.
2
E-Commerce
In 1998, the Minister of National Revenue, in response to a report " E L E C T R O N I C C O M M E R C E A N D C A N A D A ' S T A X A D M I N I S T R A T I O " pr e p a r e d b y t h e M i n i s t e r ' s A d v i s or y C o m m i t t e e o n E l e c t r o n i c C o m m e r c e , e s t a b l i s h e d a f r a m e wo r k f o r t h e s t u d y o f e l e c t r o n i c c o m m e r c e . T h e C C R A ' s s t u d y d e a l t wi t h t h e e f f e c t o f E - C o m m e r c e o n a l l a s p e c t s of Canada's tax administration: goods and services tax, customs d u t i e s a n d t a r i f f s a n d i nc o m e t a x . T h e i n c o m e t a x m a t t e r s in c l u d e d c o m p l i a n c e a n d c o l l e c t i o n c o n c e r n s a s we l l a s i n t e r p r e t i v e i s s u e s . T h e l at t e r i s s u e s r e l a t e d t o n o n - r e s id e n t s c a r r yi n g o n b u s i n e s s i n C a n a d a , r e s i d e n t s c a r r yi n g o n b u s i n e s s a b r o a d , t r a n s f e r p r i c i n g a n d t h e c h a r a c t e r i z a t i o n o f el e c t r o n i c t r an s a c t i o n s f o r wi t h h o l d i n g t a x a n d t r e a t y p u r p o s e s . T h e i n c o m e t a x i n t er p r e t i v e s t ud y b e n e f i t e d f r o m t h e advice of a group of eminent Canadian income tax specialists and t o o k i n t o a c c o u n t t h e c on t i n u in g wo r k o f t h e O r g a n i z a t i o n f o r E c o n o m i c C o - o p e r a t i o n a n d D e v e l o p m e n t ( O E C D) wi t h r e s p e c t t o electronic commerce and permanent establishments, attribution of i n c o m e t o p e r m a n e n t e s t a b l i s h m e n t s a n d c h a r a c t e r i z a t i o n o f p a ym e n t s made in an E-Commerce context.
3
T h e s t u d y c o n s i d e r e d t h e c i r c u m s t an c e s u n d e r wh i c h a n o n - r e s i d e n t wh o t r a n s a c t s wi t h C a n a d i a n s t h r o u g h a W e b s i t e m a y b e c o n s i d e r e d t o b e c a r r yi n g o n b u s i n e s s i n C a n a d a . T h e f a c t o r s r e l a t i n g t o t h i s d e t e r m i n a t i o n wi l l b e r e l e v a n t n o t o n l y t o n o n - r e s i d e n t s c a r r y i n g o n b u s i n e s s i n C a n a d a b u t a l s o t o f o r e ig n a f f i l i a t e s o f C a n a d i a n r e s i d e n t s a n d r e s i d e n t s o f C a n a d a c a r r yi n g o n b u s i n e s s i n o t h e r c o u n t r i e s . I t wa s c o n c l u d e d t h a t , in s o m e c i r c u m s t a n c e s , a W e b s i t e lo c a t e d o n a server situated in Canada can constitute a permanent establishment o f a n o n - r e s i d e n t . T h i s c o n c l u s i o n i s c o n s i s t e n t wi t h t h e r e c e n t amendments to Article 5 of the OECD Model Convention. T h e at t r i b u t io n o f i n c o m e o r l o s s t o a p e r m a n e n t e s t a b l i s h m e n t i n a n E-Commerce context raises difficult issues. There is no consensus among the member countries of the OECD concerning the application o f A r t i c l e 7 t o t r a d i t i o n a l f o r m s o f c o m m e r c e . T he c u r r e n t CC R A i n t e r p r e t a t i o n o f A r t i c l e 7 o f t h e M o d e l C o n v e n t i o n d o e s n o t a l wa y s p r o d u c e a r e s u l t t h a t i s c o n s i s t e n t wi t h t h e a r m ' s l e n g t h p r i n c i p l e a s d e v e l o p e d i n t h e T r a n s f e r P r i c i n g G u i d e l i n e s . T h e wo r k i n g h yp o t h e s i s developed by the OECD to apply the Transfer Pricing Guidelines by analogy to permanent establishments is under discussion at the O E C D . G i v e n t h i s u n c e r t a i n t y o n t h i s d i f f i c u l t i s s u e , t h e C C R A wi l l
4
c o n t i n u e i t s c u r r e n t i n t e r p r e t a t i o n o f A r t i c l e 7 a nd wi l l a p p l y i t s i n t e r p r e t a t i o n i n t h e E - Co m m e r c e e n v i r o n m e n t . T h e c h a r a c t e r i z a t i o n o f E - C o m m e r c e p a ym e n t s i s d i f f i c u l t b e c a u s e t h e d i s t i n c t io n b e t we e n t h e d i f f e r e n t " t h i n g s " t h a t m a y b e p u r c h a s e d wi l l b e e l u s i v e i n m a n y s i t u a t i o n s . T h e g e n e r a l p r i n c i p l e s o f characterization set out in the REPORT TO WORKING PARTY NO. 1 o f t h e O E CD C o m m i t t ee o n F i s c a l A f f a i r s a r e in s t r u c t i v e an d wi l l b e o f b e n e f i t t o t h e C C RA i n t h e d e t e r m i n a t i o n o f t h e c h a r a c t e r o f p a ym e n t s . T h e m o s t i m p o r t a n t a s p e c t o f th e E - C o m m e r c e s t u d y c o n c e r n s t h e p u r c h a s e o r l i c e n s i n g o f d i g i t a l p r o d u c t s . T h e CC R A i s o f t he o p i n i o n that the existing Canadian jurisprudence can be applied to the purchase or licensing of digital products. In the case of the purchase o f a d i g i t a l p r o d u c t , t h e C C R A c o n s id e r s t h a t t h e c u s t o m e r m a k e s t h e p a ym e n t t o a c q u i r e t h e o wn e r s h i p o f d a t a t r a n s m i t t e d i n t h e f o r m o f a d i g i t a l s i g n a l . A n y u s e o f c o p yr i g h t i n v o l v e d i n d o wn l o a d i n g t h e p r o d u c t i s no t a n i m p o r t a n t p a r t o f th e t o t a l c o n s i d e r a t i o n p a i d b y t h e p u r c h a s e r . F o r t h i s r e a s o n , t h e p a ym e n t f o r t h e p r o d u c t wo u l d n o t b e c o n s i d e r e d a r o ya l t y a s d e f i n e d i n A r t i c l e 1 2 o f C a n a d a ' s t r e a t i e s t h a t follow the OECD Model Convention.
5
S i m i l a r l y, a p a ym e n t f o r t h e u s e o f , o r r i g h t t o u s e , a d i g i t a l p r o p e r t y wo u l d n o t b e f o r t h e u s e o f c o p yr i g h t a n d wo u l d n o t b e a r o ya l t y f o r t h e p u r p o s e s o f A r t i c l e 1 2 . U n t i l r e c e n t l y, t h e C C R A c o n s i d e r e d a p a ym e n t f o r t h e u s e of , o r r i g h t t o u s e , c u s t o m c o m p u t e r s o f t wa r e t o b e a p a y m e n t f o r a s e c r e t f o r m u la a n d wi t h i n t h e d e f i n i t io n o f r o ya l t y i n A r t i c l e 1 2 . C an a d a h a d a n o b s e r v a t i o n o n t h i s p o i n t i n r e s p e c t o f A r t i c l e 1 2 o f t h e O E C D M o d e l C o n v e n t i o n . T h e D ep a r t m e n t o f F i n a n c e wi t h d r e w t h e o b s e r v a t i o n o n M a r c h 2 8 , 2 0 0 2 . A s a r e s u l t , s u c h a p a y m e n t wo u l d n o w b e c o n s i d e r e d t o b e wi t h i n A r t i c l e 7 of Canada's treaties that follow the OECD Model Convention. I t i s i m p o r t an t t o a p p r e c i a t e t h a t t hi s c o n c l u s i o n wo u l d n o t a p p l y t o t h o s e o f C an a d a ' s t r e a t i e s t h a t i n c l ud e i n A r t i c l e 1 2 a r e f e r en c e t o a p a ym e n t f o r t h e u s e of o r r i g h t t o u s e i n t a n g i b l e p r o p e r t y. I n s u c h c a s e s , t h e pa ym e n t f o r t h e u s e o f o r r i g h t t o u s e a d i g i t a l p r o p e r t y wo u l d b e a p a ym e n t f o r t h e u s e o f in t a n g i b l e p r o p e r t y a n d t h e r e f o r e a r o ya l t y. I n s u m m a r y, t h e C C R A s h o u l d , i n g en e r a l , b e a b l e t o a p p l y t h e s a m e p r i n c i p l e s o f t a x a t i o n t o E - C o m m e r c e t r a n s a c t i on s t h a t it h as a p p l i e d t o c o n v e n t i o n a l c o m m e r c e . T h e C CR A ' s v i e w o f t h e l a w i s g e n e r a l l y c o n s i s t e n t wi t h t h e v i e w o f t h e O E CD a s e x p r e s s e d i n t h e a m e n d e d
6
C o m m e n t a r y t o t h e O E CD M o d e l C o n v e n t i o n a n d t h e R E P O R T T O W O R K I N G P A R T Y N O . 1 r ef e r r e d t o a bo v e . F i n a l l y, t h e C C R A we l c o m e s a n y q u e r i e s yo u m a y h a v e wi t h r e s p e c t t o a n y i n t e r p r e t i v e a s p e c t o f E -C o m m e r c e . T h e C C R A i s p r e p a r e d t o d e a l wi t h t h e m a s i n t e r pr e t a t i o n s o r r u l i n g s , i n t h e c a s e o f pr o p o s e d t r a n s a c t i o n s . I n s h o r t o r d e r , t h e C CR A wi l l i n c l u d e t h e r e s u l t s o f i t s study in an Interpretation Bulletin.
Reasonable Expectation of Profit
T h i s ye a r t h e S u p r e m e C o u r t o f C an a d a r e n d e r e d i t s d e c i s i o n i n t wo c a s e s t h a t c o n c e r n e d t h e a p p l i c a t i o n o f t h e r e a s o n a b l e e xp e c t a t i o n o f profit (REOP) test, BRIAN J. STEWART V. THE QUEEN(1) and THE QUEEN V. JACK WALLS AND ROBERT BUVYER(2).
1 2 0 0 2 D T C 6 9 6 9 ; [ 2 0 0 2 ] 3 CT C 4 2 1 2 2 0 0 2 D T C 6 9 6 0 ; [ 2 0 0 2 ] 3 CT C 4 3 9
7
I n t h e St e wa r t c a s e : · T h e t a x p a y e r a c q u i r e d f o u r c o n d o m i n i u m u n i t s a s p a r t of a s yn d i c a t e d r e a l e s t a t e d e v e l o p m e n t f o r $ 1 , 0 0 0 c a s h e a c h . T h e b a l a n c e o f t h e p u r c h a s e p r i c e wa s f i n a n c e d . · P r o j e c t i o n s f o r r e n t a l i nc o m e a n d e x p e n s e s c o n t e m p l a t e d a n e g a t i v e c a s h f l o w. I t t ur n e d o u t t h a t a c t u a l r e n t a l l o s s e s we r e greater than projected. · F o r t h e t a x a t i o n ye a r s 1 9 9 0 t o 1 9 9 2 , t h e t a x p a y e r c l a i m e d r e n t a l losses on the properties. · T h e s e l o s s es we r e d i s a l l o we d o n t h e b a s i s t h a t t h e t a x p a ye r h a d n o R E O P a n d t h e r e f o r e , n o s o u r c e o f i nc o m e f o r t h e p u r p o s e o f s e c t i o n 9 of the INCOME TAX ACT (the "Act"). · B o t h t h e T ax C o u r t o f Ca n a d a a n d t h e F e d e r a l C o u r t o f A pp e a l upheld the reassessments. In the Walls case: · T h e t a x p a y e r s we r e l i m i t e d p a r t n e r s i n a p a r t n e r s h i p t h a t p u r c h a s e d a m i n i - wa r e h o u s e f o r $ 2 , 2 0 0 , 0 0 0 , p a y a b l e i n t h e f o r m o f $1 i n c a s h
8
a n d t h e b a l a n c e i n t h e f or m o f a n a g r e e m e n t f o r s a l e wi t h i n t e r e s t payable at 24% per annum. · In addition to the interest on the debt obligation, the partnership also paid the vendor management fees and 50% of the net operating profit of the venture under a management and services agreement. · T h e t a x p a ye r s d e d u c t e d t h e i r p r o p o r t i o n a t e s h a r e o f t h e p a r t ne r s h i p losses incurred in 1984 and 1985. · T h e s e l o s s es we r e d i s a l l o we d o n t h e b a s i s t h a t t h e t a x p a ye r h a d no REOP and therefore, no source of income for the purpose of section 9 of the Act. · I t wa s a l s o a r g u e d t h a t t h e l o s s e s s h o u l d b e d e c r e a s e d b y:
· r e d u c i n g t h e p u r c h a s e p r i c e o f t h e m i n i - wa r e h o u s e t o r e f l e c t a
fair market value of $1,180,000; and
· reducing the interest expense by decreasing the debt in excess
o f t h e f a i r m a r k e t v a l u e a n d l o we r i n g t h e i n t e r e s t r at e t o 1 6 % . · T h e t a x p a ye r s f i l e d n o t i c e s o f o b j e c t io n , b u t t h e M i n i s t e r c o n f i r m e d the reassessments.
9
· The Federal Court, Trial Division, dismissed the appeals and upheld t h e M i n i s t e r 's p o s i t i o n wi t h r e s p e c t t o R E O P . · T h e F e d e r a l C o u r t o f A pp e a l s e t a s i d e t h e j u d g m e n t , h o l d i n g t h a t the trial judge erred in applying REOP since the taxpayers did not h a v e a p e r s o n a l m o t i v a t i o n . I t r e m i t t e d t h e m a t t e r t o t h e t r i al j u d g e f o r a d e t e r m i n a t i o n o f t he o u t s t a n d i n g i s s u e s o f wh e t h e r t h e t r a n s a c t i o n wa s a r m ' s l e n g t h a n d a t f a i r m a r k e t v a l u e . · T h e i s s u e o f wh e t h e r t h e s t o r a g e p a r k o p e r a t i o n c o n s t i t u t e d a s o u r c e o f i nc o m e f o r t h e p u r p o s e o f s e c t i o n 9 o f t h e A c t wa s appealed to the Supreme Court. I n b o t h c a s es , t h e C o u r t r u l e d i n f a v o r o f t h e t a x p a ye r s . I n i t s d e c i s i o n i n S T E W A R T ( t h e a n a l ys i s f r o m wh i c h a l s o f o r m ed t h e b a s i s f o r t h e d e c i s i o n i n W A L L S ) , t h e C o u r t s t a t e d t h e R E O P t e s t i s n o t s up p o r t a b l e b y l a w a s a b a s i s t o d e t e r m i n e i f a t a xp a ye r ' s a c t i v i t i e s c o ns t i t u t e a s o u r c e o f i nc o m e u n d e r t h e A c t .
10
Question 1 B e f o r e g e t t in g i n t o t h e im p a c t o f t h e d e c i s i o n s , c o u l d yo u b r i e f l y e x p l a i n t h e b a s i s f o r t h e C C R A ' s p r e v i o u s p o s i t i o n t h a t a b us i n e s s o r p r o p e r t y t h a t h a d n o R E O P wa s n o t a s o u r c e o f in c o m e u n d e r t h e A c t ? Response 1 T h e C C R A ' s p r e v i o u s p o s i t i o n was b a s e d m a i n l y u p o n t h e S u p r e m e C o u r t d e c i s i o n i n W i l l i a m M o l d o wa n ( 3 ) . W h i l e t h e M o l d o wa n c a s e i n v o l v e d t h e d e t e r m i n a t i o n o f wh e t h e r a t a x p a y e r ' s c h i e f s o ur c e o f i n c o m e wa s f a r m i n g , t h e c o u r t n o t e d t h a t i n o r d er t o h a v e a s o u r c e o f i n c o m e u n d e r t h e A c t , t h e t a x p a ye r m u s t h a v e a p r o f i t o r a R E O P . F u r t h e r , i n d e t e r m i n i n g i f a t a x p a y e r h a s a R E O P , t h e f o l l o wi n g criteria should be considered:
· t h e p r o f i t a nd l o s s e x p e r i e n c e i n p a s t ye a r s ; · the taxpayer's training;
3 7 7 DT C 52 1 3 ; [ 1 9 7 7 ] C T C 3 1 0
11
· the taxpayer's intended course of action; and · t h e c a p a b i l i t y o f t h e v e n t u r e , a s c a p i t a l i z e d , t o s ho w a p r o f i t a f t e r
c h a r g i n g c a p i t a l c o s t a l lo wa n c e . Question 2 W h a t i m p a c t wi l l t h e C o u r t ' s d e c i s i o n h a v e o n t h e C C R A ' s u s e o f t h e R E O P t es t ? Response 2 T h e C o u r t ha s s t a t e d t h a t t h e R E O P t e s t s h o u l d n o t b e a c c e p t e d a s a b a s i s t o de t e r m i n e i f a t a x p a y e r ' s a c t i v i t i e s c o n s t i t u t e a s o u r c e o f i n c o m e u n d e r t h e A c t . T h e c o u r t s h a v e s u g g e s t e d a t wo - s t a g e approach:
· T h e f i r s t s t ag e i s t o d e t er m i n e wh e t h e r a t a x p a ye r ' s a c t i v i t y i s
u n d e r t a k e n i n p u r s u i t o f p r o f i t t h a t r es u l t s i n a s ou r c e o f i n c om e u n d e r t h e A c t , o r i s a pe r s o n a l e n de a v o u r . T h i s f i r s t s t a g e i s o n l y r e l e v a n t wh e r e t h e r e i s s o m e p e r s o n a l o r h o b b y e l e m e n t t o t h e a c t i v i t y. T h e v e n t u r e wi l l b e c o n s i d e r e d a s o u r c e o f i n c o m e o n l y if it is undertaken in a sufficiently commercial manner.
12
· I n t h e s e c o nd s t a g e , p u r s u i t o f p r of i t h a s b e e n e s t a b l i s h e d a n d t h e
t a x p a y e r ' s a c t i v i t y i s c l e a r l y c om m e r c i a l i n n a t u r e . I t t h e n b e c o m e s a m a t t e r o f d e t e r m i n i n g wh e t h e r t h e s o u r c e o f t he i n c o m e i s f r o m business or property for purposes of the Act. Question 3 D o e s t h i s m e a n t h a t t h e R E O P t e s t is n o l o n g e r a p p l i c a b l e i n determining if a taxpayer has a source of income under the Act? Response 3 · T h e R E O P t e s t , a s i t p r e v i o u s l y a p p l i e d , wi l l n o l o n g e r b e u s e d t o d e t e r m i n e i f t h e r e i s a s o u r c e o f in c o m e u n d e r t h e A c t . · T h e C C R A wi l l , h o we v e r , q u e s t i o n wh e t h e r a t a x p a y e r i s o p e r a t i n g i n a s u f f i c i en t l y c o m m e r c i a l m a n n e r wh e n t h e a c t i v i t y h a s s o m e personal or hobby element. · A t t h i s p o i n t , a t a x p a ye r ' s v e n t u r e wi l l b e r e v i e we d a n d c r i t e r i a , i n c l u d i n g t h o s e s e t d o wn i n M O L D O W A N , wi l l b e c o n s i d e r e d i n determining if the taxpayer intends to carry on an activity for p r o f i t a n d t he o v e r a l l e v i d e n c e s u p p o r t s t h a t i n t e n t i o n .
13
Question 4 A s s u m i n g a t a x p a ye r ' s a c t i v i t y i s c o m m e r c i a l l y v i a b l e , b u t t he r e i s a p e r s o n a l e l e m e n t , h o w wi l l t h e C C R A a c c o u n t f o r t h e e x p e n s e s r e l a t e d t o t he p e r s o n a l e l e m e n t ? Response 4 · I t i s t h e C CR A ' s v i e w t h a t a c a l c u l a t i o n wi l l h a v e t o b e m a d e u s i n g s o m e r e a s o n a b l e b a s i s , t o d e t e r m ine t h e a m o u n t o f t h e b u s in e s s e x p e n s e s t h a t m a y b e d e d u c t e d i n c a l c u l a t i n g t h e i n c o m e f r om t h e c o m m e r c i a l a c t i v i t y. · T h u s , wh e r e t h e r e i s b o t h a p e r s o n a l a n d b u s i n e s s e l e m e n t t o t h e e x p e n s e s i n c u r r e d a n d t h e y a r e n o t o t h e r wi s e r e s t r i c t e d u n de r t h e A c t , s o m e r e a s o n a b l e b a s i s o f p r o ra t i o n wi l l h a v e t o b e u s ed t o d e t e r m i n e t h e p o r t i o n t h a t r e l a t e s t o t h e b u s i n e s s a c t i v it y. Question 5 C o u l d y o u c o m m e n t o n t h e p a r t o f t he C o u r t ' s d e c i s i o n i n wh i c h i t wa s stated that the realization of an eventual capital gain may be taken
14
i n t o a c c o u n t i n d e t e r m i n i n g wh e t h e r a t a x p a ye r ' s a c t i v i t y i s commercial in nature? Response 5 · T h e C o u r t ha s s t a t e d t h a t t h e m ot i v a t i o n o f c a p i t a l g a i n s a c c o r d s wi t h t h e o r d i n a r y b u s i n e s s p e r s o n ' s u n d e r s t a n d i n g o f " p u r s u i t o f profit." · T h u s , t h e C C R A a c c e p t s t h a t th e r e m a y b e s i t u a t i o n s wh e r e t h e r e a l i z a t i o n o f a n e v e n t u a l c a p i t a l g a i n wi l l b e a f a c t o r i n a s s e s s i n g t h e c o m m e r c i a l i t y o f t h e t a x p a ye r ' s o v e r a l l c o u r s e o f c o n d u c t . · H o we v e r , i t i s e m p h a s i z e d t h a t t h e m e r e a c q u i s i t i o n o f a p r o p e r t y i n a n t i c i p a t i o n o f a c a p i t a l g a i n d o e s n o t p r o v i d e a s o u r c e o f i nc o m e . Question 6 D o yo u h a v e a n y c o n c e r n s t h a t t h e s e c o m m e n t s s e e m t o i m p l y t h a t a capital gain may be considered to be part of a source of income that i s f r o m a b u s i n e s s o r p r o p e r t y?
15
Response 6 · A s n o t e d a b o v e , t h e a c qu i s i t i o n o f a p r o p e r t y i n a n t i c i p a t i o n o f a capital gain does not provide a source of income under the Act. · T h e p r o p o s it i o n t h a t a c a p i t a l g a i n i s n o w i n c l u d e d i n c a l c u l a t i n g i n c o m e t h a t i s f r o m a b u s i n e s s o r p r o p e r t y s o u r c e wo u l d b e c o n t r a r y t o t h e o v e r al l s c h e m e o f t h e A c t . Question 7 I f a t a x p a ye r ' s l o s s i s n o t f r o m a s ou r c e o f i n c om e u n d e r t h e A c t b e c a u s e t h e a c t i v i t y i n q u e s t i o n i s n o t c a r r i e d on i n a s u f f i c ie n t l y c o m m e r c i a l m a n n e r , s a y f o r e x a m p l e i n t h e c a s e o f a r e c r e a t io n a l p r o p e r t y, wi l l t h e e x p e n s e s t h a t g e n e r a t e d t h e l o s s b e d e d u c t i b l e i n c a l c u l a t i n g a c a p i t a l g a i n f r o m t h e di s p o s i t i o n o f a p r o p e r t y ? Response 7 No. · P u r s u a n t t o p a r a g r a p h 4 0 ( 1 ) ( a ) o f t h e A c t , o n l y o u t l a ys a n d expenses incurred for the purpose of disposing of a property wi l l b e d e d u c t i b l e i n t h e c a l c u l a t i o n o f t h e g a i n .
16
· The courts have stated that the phrase "for the purpose of" in subparagraph 40(1)(a)(i) means "for the immediate or initial p u r p o s e o f " a n d n o t t h e e v e n t u a l o r f i n a l g o a l wh i c h t h e t a x p a y e r may have in mind(4). · T h e r e f o r e, i f a t a x p a ye r ' s a c t i v i t y i s n o t o f a c o m m e r c i a l n a t u r e , t h e a n n u a l e xp e n s e s i n c u r r e d i n r e l a t i o n t o t h a t p r o pe r t y m a y n o t b e c a r r i e d f o r wa r d a n d d e d u c t e d i n t h e c a l c u l a t i o n o f a c a p i t a l g a i n o r l o s s wh e n i t i s d i s p o s e d o f . Question 8 If a taxpayer's involvement in a venture is motivated by tax c o n s i d e r a t i o n s , wi l l t h i s b e v i e we d a s a p e r s o n a l e l e m e n t s u c h t h a t i t c o u l d a f f ec t t h e d e t e r m i n a t i o n o f wh e t h e r t h e a c t i v i t y h a s a s u f f i c i e n t d eg r e e o f c o m m e r c i a l i t y t o b e c o n s i d e r e d a s o u r c e o f income under the Act?
4 See the Federal Court of Appeal decision in AVIS IMMOBILIEN G . M . B . H. V . T H E Q U E E N ( 1 9 9 7 D T C 50 0 2 )
17
Response 8 I f a t a x p a ye r i s m ot i v a t ed b y t a x c o n s i d e r a t i o n s wh e n h e o r s h e e n t e r s i n t o a b u s i n e s s o r p r o p e r t y v e n t u r e , t h i s wi l l n o t d e t r a c t f r o m t h e venture's commercial nature or characterization as a source of income under the Act.
Health and Welfare Trusts
Background F o r a n u m be r o f ye a r s , t h e C C R A h a s b e e n a l l o wi n g e m p l o y e r s t o o p e r a t e t h e i r h e a l t h a n d we l f a r e p r o g r a m s t h r o u g h a " t r u s t " arrangement. The CCRA's position on the income tax implications for s u c h a r r a n g e m e n t s , k n own a s h e a l t h a n d we l f a r e t r u s t s , i s s e t o u t i n I n t e r p r e t a t i on B u l l e t i n I T - 8 5 R 2 , d a t e d J u l y 3 1 , 1 9 8 6 , H E A L T H A N D WELFARE TRUSTS FOR EMPLOYEES. T h e t yp e s o f b e n e f i t s a d m i n i s t e r e d b y a n e m p l o y e r t h r o u g h h e a l t h a n d we l f a r e t r u s t a r r a n g e m e n t s a r e r e s t r i c t e d t o :
18
( a ) g r o u p s i c k n e s s o r a c c i de n t i n s u r a n c e p l a n s ( b ) p r i v a t e h e a l t h s e r v i c e s pl a n s ( c ) g r o u p t e r m li f e i n s u r a n c e p o l i c i e s , o r (d) any combination of a) to c). E s s e n t i a l l y, t h e C C R A a l l o ws t h e s e t r u s t s t o b e t r e a t e d a s c o n d u i t s : a n e m p l o y e e d o e s n o t r e c e i v e o r e n jo y a b e n e f i t a t t h e t i m e t h e e m p l o y e r m a k e s a c o n t r i b u t i o n t o a h e a l t h a n d we l f a r e t r u s t . F u r t h e r , a n y i n c o m e t a x a d v a n t a g e t h a t a n em p l o y e e wo u l d o t h e r wi s e g e t i s n o t a f f e c t e d b e c a u s e o f t h e h e a l t h a n d we l f a r e t r u s t . F o r e x a m p l e , p a ym e n t b y t h e t r u s t e e s o f h e a l t h an d we l f a r e t r u s t s o f a l l o r p a r t o f an employer's contribution to a private health services plan, does not g i v e r i s e t o a t a x a b l e e m p l o ym e n t b e n e f i t . T h e l e g i s l a t i v e e x e m p t i o n i n s u b p a r a g r a p h 6 ( 1 ) ( a ) ( i ) f l o ws t h r o u g h t o t h e e m p l o y e e s . E m p l o ye r s c a n d e d u c t c o n t r i b u t i o n s t o h e a l t h a n d we l f a r e t r u s t s i n t h e y e a r t h e l e g a l o b l i g a t i o n t o m a k e th e p a ym e n t t o t h e t r u s t a r is e s , t o the extent they are reasonable and laid out to earn business or property income.
19
T h e b u l l e t i n d e s c r i b e s t h e t a x i m p l i c a t i o n s f o r t h e t r u s t . I n ge n e r a l terms, none of the receipts from an employer are taxable, nor are the p a ym e n t s d e d u c t i b l e i n t h e t r u s t . H owe v e r , t h e t r u s t i s t a x e d a s a n i n t e r v i v o s t r u s t o n a n y i n v e s t m e n t in c o m e g e n e r a t e d b e c a u s e o f i n v e s t m e n t s m a d e i n t h e c o u r s e o f m a n a g i n g t h e e m p l o ye e b e n e f i t programs. The minimum tax rules must be considered as they could also have application. In recent months, there has been a significant issue related to t h e f u n d i n g o f h e a l t h a n d we l f a r e t r u s t s a n d t h e q u a n t u m o f t h e d e d u c t i o n s t h a t a n e m p l o ye r c a n c l a i m wh e n m o n e y i s i n v e s t e d i n the trust to fund the employees' benefits. Question 1 W h a t i s t h e l e g a l b a s i s f o r a h e a l t h a n d we l f a r e t r u s t u n d e r t h e INCOME TAX ACT? Response 1 H e a l t h a n d we l f a r e t r u s t s a r e n o t s pe c i f i c a l l y d e f i n e d o r d e s c r i b e d i n t h e A c t . T h ey b e c a m e r e c o g n i z e d a d m i n i s t r a t i v e l y b y t h e C C R A i n t h e
20
m a n n e r s e t o u t i n I T - 8 5 R 2 , a f t e r e xt e n s i v e c o n s u l t a t i o n s wi t h t h e t a x community and employee benefits consultants in the 70s. Question 2 S i n c e t h e l a s t v e r s i o n o f t h e b u l l e t i n wa s i s s u e d i n 1 9 8 6 , h a v e t h e r e been any significant changes to the CCRA's position on health and we l f a r e t r u s t s ? Response 2 No, there have been no major changes to the CCRA's overall a d m i n i s t r a t i v e p o s i t i o n s s e t o u t i n t h e b u l l e t i n . T h e r e h a v e , h o we v e r , b e e n c h a n g e s t o t h e l a w t h a t m a k e s om e o f t h e e x p l a n a t i o n s o f t h e income tax rules in the bulletin outdated. For example, the bulletin still has the discussion on the former $25,000 exemption for coverage u n d e r a G R O U P T E R M L I F E I N S U R A N C E P O L I C Y . W e wi l l u p d a t e t h e b u l l e t i n t o r e f l e c t c u r r en t l a w. Question 3 H a v e a n y i m p o r t a n t i s s ue s a r i s e n r e c e n t l y t h a t wo u l d b e o f i n t e r e s t t o a d m i n i s t r a t o r s / t r u s t e e s o f h e a l t h a n d we l f a r e t r u s t s ?
21
Response 3 Yes, a significant issue has been considered over the last few months i n c o n n e c t i o n wi t h t h e f u n d i n g o f t h e c o s t o f l o n g - t e r m d i s a b i l i t y benefits under "group sickness and accident plans" that are a d m i n i s t e r e d b y e m p l o y e r s t h r o u g h a h e a l t h a n d we l f a r e t r u s t . Question 4 B e f o r e g e t t in g i n t o t h e is s u e o n f u n d i n g , c o u l d y o u b r i e f l y c o m m e n t o n the CCRA's general position in regard to the funding of a health and we l f a r e t r u s t ? Response 4 Y e s , t h e C CR A ' s g e n e r a l p o s i t i o n o n f u n d i n g i s d e s c r i b e d i n p a r a g r a p h 6 o f I T - 8 5 R 2 , wh i c h s t a t e s t h a t a n e m p l o ye r ' s c o n t r i b u t i o n s m u s t n o t exc e e d t h e a m o u n t r e q u i r e d t o p r o v id e t h e h e a l t h a n d we l f a r e b e n e f i t s , a n d t h a t t h e p a ym e n t s c a n n o t b e m a d e o n a v o l u n t a r y o r g r a t u i t o u s b a s i s . I n t h i s r e g a r d , we wo u l d l i k e t o e m p h a s i z e t h a t t h i s m e a n s t h e " c u r r e n t " c o s t of p a y i n g o u t t h e benefits for a particular year. This is usually based on an actuarial
22
d e t e r m i n a t i o n wh e r e t h e e m p l o ye r h a s e n g a g e d a c a r r i e r t o pr o v i d e t h e h e a l t h a n d we l f a r e b e n e f i t s . Question 5 C o u l d y o u n o w e xp l a i n r e c e n t d e v e l o p m e n t s i n r e g a r d t o t h e c o s t o f f u n d i n g b e n e f i t s i n a h e a l t h a n d we l f a r e t r u s t ? Response 5 T h e m a i n i s s u e h a s b e e n wi t h wh a t we h a v e r e f e r r e d t o a s t h e o v e r - f u n d i n g o f b e n e f i t s t h r o u g h l u m p s u m p a y m e n t s b y e m p l o ye r s t o a h e a l t h a n d we l f a r e t r u s t . B y t h i s , we m e a n t h a t e m p l o ye r s we r e p r o p o s i n g t o f u n d 1 0 0 % o f t h e e s t i m at e d v a l u e o f a l l f ut u r e be n e f i t s p a y a b l e wi t h r e s p e c t t o i n s u r e d c l a i m s u n d e r t he l o n g - t e r m d i s a b i l i t y b e n e f i t s p r o v i d e d u n d e r a h e a l t h a n d we l f a r e t r u s t . T h a t i s , t he e m p l o y e r wo u l d c o n t r i b u t e a l u m p s u m a m o u n t t o a h e a l t h a n d we l f a r e t r u s t t h a t wo u l d f i n a n c e n o t o n l y t h e c u r r e n t b e n e f i t s p a ya b l e u n d e r t h e p l a n , b u t t h e e s t i m a t e d c o s t o f t he b e n e f i t s t ha t wo u l d b e p a y a b l e o v e r a n u m b e r o f ye a r s .
23
Question 6 Could you describe the CCRA's position relating to the so-called o v e r - f u n d i n g o f t h e b e ne f i t s b y t h e p a ym e n t o f a l u m p s u m a m o u n t , including the effect on the deductions that may be claimed by the e m p l o y e r a s we l l a s a n y c o n s e q u e n c e s f o r h e a l t h a n d we l f a r e t r u s t s t h a t o t h e r wi s e m e e t t h e c r i t e r i a o u t l i n e d i n I T - 8 5 R 2 ? Response 6 T h e C C R A ' s p o s i t i o n i s t h a t , i n t h o se s i t u a t i o n s wh e r e a n e m p l o ye r ' s c o n t r i b u t i o n s t o a h e a l t h a n d we l f a r e t r u s t a r e f o r f u t u r e b e n e f i t s , subparagraph 18(9)(a)(iii) of the Act applies to the deductibility of s u c h c o n t r i b u t i o n s b y e m p l o ye r s . T h a t i s , t h e lu m p s u m a m o u n t wi l l be regarded as having been made or incurred as consideration for i n s u r a n c e f o r a p e r i o d a f t e r t h e e n d o f a t a x a t i o n y e a r . W e ha v e a l s o concluded that contributions of lump sum amounts to fund future b e n e f i t s wo u l d n o t , i n an d b y i t s e l f , d i s q u a l i f y a t r u s t a s a he a l t h a n d we l f a r e t r u s t . H o we v e r , t h e c o n t r i b u t i o n s m u s t s t i l l b e b a s e d o n a c t u a r i a l d e t e r m i n a t i o n s o f a m o u n t s n e e d e d t o f u n d t h e f u t ur e h e a l t h a n d we l f a r e o b l i g a t i o n s .
24
Question 7 I n t h e c o u r s e o f c o n s i d e r i n g th e o v e r - f u n d i n g i s s u e , t h e r e h a s b e e n s o m e d i s c u s s i o n o n t h e i m p a c t o f t h e C a n a d i a n P a c i f i c L i m i t ed ( 5 ) d e c i s i o n a n d wh e t h e r i t wo u l d s u p p o r t t h e f u l l d ed u c t i o n i n a t a x a t i o n y e a r , o f t h e l u m p s u m a m o u n t s p a i d t o f u n d f u t ur e b e n e f i t o b l i g a t i o n s i n a h e a l t h a n d we l f a r e t r u s t . T h i s i s b a s e d o n t h e r e a s o n i n g t h a t , s i n c e t h e C o u r t s u p p o r t e d t h e p o s i t i o n t h a t t h e lu m p s u m i n q u e s t i o n i n t h a t d e c i s i o n wa s h e l d t o b e a l eg i t i m a t e b u s i n e s s d e d u c t i o n a n d n o t p r o h i b i t e d b y p a r a g r a p h 1 8 ( 1 ) ( e ) b e c a u s e i t wa s c o n t i n g e n t , t h e full amount should be a legitimate business deduction in a taxation year. C o u l d y o u o u t l i n e t h e C C R A ' s p o s i t i o n o n t h e i m p a c t , i f a n y, o f t h e CP decision on the deduction by employers of lump sum amounts c o n t r i b u t e d t o a h e a l t h a n d we l f a r e t r u s t t o f u n d c u r r e n t a n d f u t u r e obligations?
5 CANADIAN PACIFIC LIMITED V. THE MINISTER OF REVENUE (ONTARIO), ( n o w t h e M i n i s t e r o f F i n a n c e ) , 9 9 D T C 5 2 8 6 ; [ 20 0 0 ] 2 CT C 3 3 1 , (Ontario Court of Appeal).
25
Response 7 The CCRA has accepted the outcome in CANADIAN PACIFIC that t h e a m o u n t s s e t a s i d e f o r t h e f u t u r e p a ym e n t o f b e n e f i t s we r e n o t " c o n t i n g e n t " i n n a t u r e . F o r h e a l t h a n d we l f a r e t r u s t s , t h i s m e a n s t h a t contributions for actuarially required contributions by an employer t o a h e a l t h a n d we l f a r e t r u s t wi l l n o t b e d e n i e d a s a d e d u c t i o n u n d e r p a r a g r a p h 1 8 ( 1 ) ( e ) a s no t e d a b o v e . H o we v e r , a s a l s o n o t e d , s u b p a r a g r a p h 1 8 ( 9 ) ( a ) ( i i i ) a p p l i e s . I n t h i s r e g a r d , a u d i t o f f ic i a l s i n t h e t a x s e r v i c e s o f f i c e ha v e a l r e a d y i s s u e d r e a s s e s s m e n t s ap p l y i n g this rule.
26
Refreshing losses
A n a r t i c l e i n C a n a d i a n T a x H i g h l i g h t s i n A p r i l o f t h i s ye a r ( 6 ) r a i s e d t h e q u e s t i o n o f wh e t h e r t h e o p e n i n g s u m m a r y s t a t e m e n t a t t a c h e d t o a published CCRA advance income tax ruling (doc. no. 2001-0090213) indicates a shift in the CCRA's administrative policy concerning "in-house" loss-consolidation transactions.
6 Dean Gresdal, "Loss Refreshing Abusive?" in CANADIAN TAX HIGHLIGHTS, vol. 10, no 4, April 23, 2002.
27
T h e a r t i c l e s e t o u t t h e c o n c e r n a s f o l l o ws : " T h e r u l i n g i n v o l v e s L o s s c o , wi t h n o n - c a p i t a l l o s s e s , l e n d i n g a t i n t e r e s t t o i t s p r o f i t a b l e s u b ( Pr o f i t c o ) , wh i c h s u b s c r i b e s f o r p r e f e r r e d s h a r e s o f a n ew L o s s c o s u b , wh i c h o n - l e n d s t h e f u n d s b a c k t o L o s s c o i n t e r e s t - f r e e . P r ofi t c o r e d u c e s i t s t a x a b l e i n c o m e v i a t h e i n t e r e s t p a i d t o Lo s s c o , wh i c h u s e s i t s no n - c a p i t a l l o s s e s t o s h e l t e r t h a t i n t e r e s t i n c o m e. T h e C C R A s u m m a r y s t a t e m e n t s a ys that if an affiliated group undergoes a tax-loss consolidation and a group member (Profitco) deducts interest expense and thereby i n c u r s a n o n - c a p i t a l l o s s , t h e n e wl y c r e a t e d l o s s i s a b u s i v e : i t ' e f f e c t i v e l y a l l o w[ s ] t h e a f f i l i a t e d g r o u p t o r e f r es h o n e o f i t s m e m b e r ' s [ s i c ] e x i s t i n g n o n - c a p i t al l o s s e s , wh i c h i s b e yo n d t h e scope of a tax loss consolidation.'" 1) C o u l d t h e C C R A p r o v i d e c l a r i f i c a t i o n a s t o wh e n a l o s s - c o n s o l i d a t i o n t r a n s a c t i o n t h a t ha s t h e e f f e c t o f "refreshing" losses might be considered to be abusive? C a n a l o s s - c o n s o l i d a t i o n t r a n s a c t i on b e i m p l e m e n t e d f o r t he purpose of using non-capital losses of Lossco from a prior taxation year (as opposed to non-capital losses that are
28
2)
anticipated to arise in Lossco in the current or future taxation years)? CCRA Position 1) The summary statements attached to published CCRA rulings and interpretations are merely intended to provide a very brief s yn o p s i s a s a n a i d t o t he r e a d e r i n d e t e r m i n i n g wh e t h e r t h e m a i n d o c u m e n t i s o f r e l e v a n c e o r i n t er e s t . A s t h e a r t i c l e i n d i c a t e s , i t c a n b e m is l e a d i n g t o r e a d t h e s u m m a r y s t a t e m e n t wi t h o u t a c o m p l e t e u n d e r s t a n d i n g o f t h e d oc u m e n t i t s e lf a n d t h e circumstances behind it. Loss-consolidation transactions involving a "Lossco" lending at i n t e r e s t t o a n a f f i l i a t e d "P r o f i t c o " t h a t s u b s c r i b e s f o r p r ef e r r e d s h a r e s o f L o s s c o ( o r a su b s i d i a r y o f L o s s c o ) wi l l n o t n e c e s s a r i l y b e c o n s i d e r e d t o r e s u l t i n a n a b u s e , wi t h i n t h e m e a n i n g o f subsection 245(4), merely because the interest deduction results i n a n o n - c a p i t a l l o s s i n P r o f i t c o . I n pa r t i c u l a r , t he C C R A wo u l d n o t ordinarily consider an abuse to result solely because the nonc a p i t a l l o s s s o c r e a t e d is c a r r i e d b a c k t o a p r e v i o u s t a x a t i o n y e a r o f P r o f it c o in a c c o r d a n c e wi t h s e c t i o n 1 1 1 . F u t h e r m o r e , t he C C R A wo u l d n o t o r d i n a r i l y c o n s i d e r a n a b u s e t o r e s u l t s o l e l y b e c a u s e
29
t h e n o n - c a p i t a l l o s s s o c r e a t e d h a s a c a r r yf o r wa r d p e r i o d t h a t e x t e n d s b e y o n d t h e o r i g i n a l c a r r yf o r wa r d p e r i o d f o r L o s s c o ' s l o s s e s , p r o v i d e d t h a t i t is d e d u c t e d wi t h i n t h e o r i g i n a l c a r r yf o r wa r d p e r i o d . Losses may be considered to be "refreshed" in a l o s s - c o n s o l i d a t i o n t r a n s a c t i o n i n wh i c h L o s s c o t r a n s f e r s d e p r e c i a b l e p r o p e r t y, o n wh i c h t h e r e i s u n r e a l i z e d r e c a p t u r e , t o a f f i l i a t e d P r o f i t c o , t h er e b y a l l o wi n g L o s s c o t o d e d u c t l o s s e s b e f o r e t h e y e x p i r e a n d P r o f i t c o t o ac q u i r e t h e d e p r e c i a b l e s a t a n i n c r e a s e d u n d e p r e c i a t e d c a p i t a l c o s t . H o we v e r , s u c h a t r a n s a c t i o n wo u l d n o t o r d i n a r i l y b e c o n s i d e r e d t o r e s u l t i n a n abuse solely because it avoids the expiry of a non-capital loss, since the loss is deducted against income (the recapture) that a r o s e i n t h e o r i g i n a l l o s s c a r r yf o r wa r d p e r i o d .
30
I t s h o u l d b e n o t e d , o f c ou r s e , t h a t a l o s s - c o n s o l i d a t i o n transaction that seeks to circumvent other loss-limitation rules, s u c h a s t h os e i n s u b s e c t i o n 1 1 1 ( 5 ) , c o u l d b e c o n s i d e r e d t o r e s u l t in a misuse or an abuse(7). 2) Yes.
Replacement Property Rules and Business Expansions
We understand that the CCRA has received a number of inquiries on how the replacement property rules are affected by business e x p a n s i o n s . T h e i n q u i r i e s h a v e a r i s e n b e c a u s e o f t h e s t a t em e n t i n ¶ 1 5 o f I nt e r p r e t a t i o n B u l l e t i n I T - 25 9 R 3 , E X C H A N G E S O F P R O P E R T Y , t h a t t h e r e p l a c e m e n t p r o p e r t y r ul e s a r e n o t i n t e n d e d t o e n c o m p a s s business expansions.
7 S e e t h e De p a r t m e n t o f F i n a n c e T E C H N I C A L N O T E S wi t h r e s p e c t t o t h e i n t r o d u c t i o n o f s u b s e c t i o n 2 4 5 ( 4 ) i n B i l l C - 13 9 , J u n e 3 0 , 1 9 8 8 .
31
R e c e n t l y, yo u h a v e b e e n a s k e d t o c on s i d e r wh e t h e r a f a r m e r c o u l d use the replacement property rules on the voluntary disposition of real p r o p e r t y wh e n t h e e x i s t i n g f a r m l a n d i s r e p l a c e d wi t h a s u b s t a n t i a l l y l a r g e r p i e c e o f l a n d . R ea s o n s f or s el l i n g t h e e x i s t i n g f a r m l an d c o u l d i n c l u d e i t s p r o x i m i t y t o a n u r b a n a r e a wh e r e t h e l a n d i s v e r y v a l u a b l e c o m p a r e d t o a m o r e r e m o t e a r e a . I f e x i s t i n g f a r m l a n d i s r e p l a c e d wi t h a l a r g e r f a r m , t h e q u e s t i o n a r i s e s a s t o wh e t h e r t h e n e w f a r m l a n d c o u l d b e c o n s i d e r e d a r e p l a c e m e n t p r o p e r t y, o r b e r e g a r d e d a s a b u s i n e s s e x p a n s i o n a n d t h e r e f o r e , e xc l u d e d b y v i r t u e o f yo u r p o s i t i o n in the bulletin. Question 1 Could you briefly explain the basis for the concern about the use of the replacement property rules in relation to business expansions? Response 1 I n g e n e r a l t e r m s , t h e r ep l a c e m e n t p r o p e r t y r u l e s i n t h e I N C O M E T A X A C T r e q u i r e t h a t i t b e r ea s o n a b l e t o c o n c l u d e t h a t a n e w p r o p e r t y wi l l b e a c q u i r e d t o r e p l a c e a f o r m e r p r o p e r t y. A s s u c h , t h e r e m us t b e a
32
c o r r e l a t i o n o r c a u s a l r e l a t i o n s h i p b e t we e n t h e a c q u i s i t i o n o f t h e n e w p r o p e r t y a n d t h e d i s p o s i t i o n o f t h e f o r m e r p r o p e r t y. Question 2 I n l i g h t o f t hi s p a r t i c u l a r r e q u i r e m e n t i n t h e A c t , c o u l d yo u e x p a n d on the bulletin position as it relates to business expansions? Response 2 T h e s t a t e m en t i n ¶ 1 5 , t h a t t h e r e p l a c e m e n t p r o p e r t y r u l e s a r e n o t i n t e n d e d t o e n c o m p a s s b u s i n e s s e x p a n s i o n s wa s m a d e i n t he s i t u a t i o n wh e r e i t c o u l d n o t b e r e a d i l y d e t e r m i n e d wh e t h e r o n e p a r t i c u l a r p r o p e r t y i s a c t u a l l y b e in g r e p l a c e d b y a n o t h e r . H e n c e , i t i s i m p o r t a n t t o c o n s i d e r t he e x a m p l e g i v e n . T h e c om m e n t s we r e m a d e i n t h e c o n t e x t o f a t a x p a ye r wh o wa s i n t h e p r o c e s s o f e x p a n d i n g a r e t a i l o p e r a t i o n b y o p e n i n g a n d c l o s i n g a n u m b e r o f l o c a t i o n s . T he n e w p r o p e r t i e s a c q u i r e d d u r i n g t h i s t yp e o f " b u s i n e s s e x p a n s i o n " we r e n o t c o n s i d e r e d r e p l a c e m e n t p r o p e r t i e s b e c a u s e t h e r e wa s n o c o r r e l a t i o n o r c a u s a l r e l a t i o n s h i p b e t we e n t h e i r a c q u i s i t i o n a n d t h e d i s p o s i t i o n o f the existing properties.
33
Question 3 A r e t h e r e a n y o t h e r i m p o r t a n t c o n s i de r a t i o n s wh e n a p a r t i c u l a r property is purchased under a business expansion? Response 3 T r a n s a c t i o n s s u r r o u n d i n g t h e s e c a s e s a r e o f t e n n o t s t r a i g h t f o r wa r d a n d h a v e p e c u l i a r i t i e s t h a t a r e s p e c i f i c t o a t a x p a ye r ' s b u s i n e s s . A d e t e r m i n a t i o n o f wh e t h e r a n e wl y a c q u i r e d p r o p e r t y c a n r e a s o n a b l y be considered a replacement property under these rules can only be m a d e a f t e r c o n s i d e r i n g a l l t h e f a c t s a n d c i r c u m s t a n c e s s u r r ou n d i n g a particular situation. I n c o n c l u s i o n , i t i s d i f f i c u l t t o e n vi s io n a l l s i t u a t i o n s wh e r e p r o p e r t y p u r c h a s e d u n d e r a b u s i n e s s e x p a n s i o n wi l l n o t q u a l i f y a s a r e p l a c e m e n t p r o p e r t y. H o we v e r , t h e e x a m p l e g i v e n i n t h e b u l l e t i n c a n b e a u s e f u l g u i d e . I wo u l d t h e r e f o r e l i k e t o p o i n t o u t t h a t t h e f a c t t h a t a p r o p e r t y i s p u r c h a s e d u n d e r a b u s i n e s s e x p a n s i o n wi l l n o t , i n a n d b y i t s e l f , m ea n t h a t t h e p r o p e r t y c a n n o t b e c o n s i d e r e d a r e p l a c e m e n t p r o p e r t y.
34
Question 4 W i l l I n t e r p r et a t i o n B u l l e t i n I T - 2 5 9 R 3 b e c h a n g e d t o c l a r i f y t h e c o m m e n t s on b u s i n e s s e x p a n s i o n ? Response 4 T h e b u l l e t i n wi l l b e a m e n d e d t o c l a r i f y t h a t t h e e m p h a s i s wi l l b e p l a c e d o n wh e t h e r a c o r r e l a t i o n o r c a u s a l r e l a t i o n s h i p e x i s t s b e t we e n t h e a c q u i s i t i o n o f t h e n ew p r o p e r t y a n d t h e d i s p o s i t i o n o f t h e e x i s t i n g p r o p e r t y wh e n d e t e r m i n i n g i f a p a r t ic u l a r p r o p e r t y i s a r e p l a c e m e n t p r o p e r t y, a n d n o t s i m p l y o n t h e f a c t t h a t t h e n e w p r o p e r t y i s a c q u i r e d because of a business expansion. Question 5 C a n a t a x p a ye r g e t c e r t a i n t y o n t h e t a x i m p l i c a t i o n s wh e n c o n t e m p l a t i n g t h e p u r c h a s e o f a r ep l a c e m e n t p r o p e r t y? Response 5 A s d i s c u s s e d i n I n f o r m at i o n C i r c u l a r 7 0 - 6 R 5 , A D V A N C E I N C O M E T A X R U L I N G S , t he C C R A p r o v i d e s a n a d v a n c e i n c o m e t a x r u l i n g s e r v i c e
35
to promote voluntary compliance, uniformity and self-assessment b y p r o v i d i n g c e r t a i n t y wi t h r e s p e c t t o t h e i n c o m e t a x i m p l i c a t i o n s o f p r o p o s e d t r a n s a c t i o ns . I n f a c t , t he C C R A h a s i s s u e d r u l i n g s i n t h e past involving the application of the replacement property rules to a b u s i n e s s e x p a n s i o n . T h e r e f o r e, pr o v i d e d a l l t h e f a c t s a r e p r e s e n t e d i n t h e r u l i n g r e q u e s t i n a c c o r d a n c e wi t h t h e p r o c e d u r e o u t l i n e d i n t h e c i r c u l a r , t h e C C R A wi l l c o n s i d e r a r e q u e s t f o r a n a d v a n c e i n c o m e t a x ruling on proposed transactions involving the replacement property rules in a business expansion.
Foreign Exchange Losses
T h e f o l l o wi n g i s s u e h a s t o d o wi t h t h e r e c h a r a c t e r i z a t i o n o f a f o r e i g n e x c h a n g e l o s s t o a n a m o u n t d e d u c t ib l e u n d e r P a r a g r a p h 2 0 ( 1 ) ( f ) o f t h e I N C O M E T A X A C T ( t he " A c t " ) . T he c o r p o r a t e t a x p a y e r i n c u r r e d foreign exchange losses on the repayment of long-term debt denominated in US currency because the US dollar appreciated a g a i n s t t h e C a n a d i a n d o l l a r o v e r t h e p e r i o d b e t we e n t h e b o r r o wi n g o f t h e m o n e y a n d t h e r e p a y m e n t o f t h e d e b t . T h e c o r p o r a t e t a x p a ye r i s s u e d U S d o l l a r o b l i g a t i o n s b u t n o t a t a d i s c o u n t . T h e b o r r owe d m o n e y wa s u s e d f o r c a p i t a l p u r p o s e s . T h e t a x p a y e r h a s r e q u e s t e d
36
t h a t t h e f o r ei g n e x c h a n g e l o s s e s s u s t a i n e d o n t h e r e p a ym e n t o f d e b t may be claimed as a deduction from income under paragraph 20(1)(f) of the Act. L e g i sl a t i ve C o n t e x t P a r a g r a p h 1 8 ( 1 ) ( f ) p r o v id e s t h a t " i n c o m p u t i n g t h e i n c o m e o f a t a x p a ye r f r o m a b u s i n e s s o r p r o p e r t y n o d e d u c t i o n s h a l l b e m a d e in respect of an amount paid or payable as or on account of the principal amount of any obligation described in paragraph 20(1)(f) except as expressly permitted by that paragraph". P a r a g r a p h 2 0 ( 1 ) ( f ) r e a d s i n p a r t a s f o l l o ws : " ( f ) a n a m o u n t p a i d i n t h e ye a r i n s a t i s f ac t i o n o f t h e p r i n c i p a l a m o u n t o f a n y b o n d , d e b e n t u r e ... o r s im i l a r o b l i g a t i o n . . . o n wh i c h i n t e r e s t wa s s t i p u l a t e d t o b e p a ya b l e , t o t h e e x t e n t t h a t t h e amount so paid does not exceed, (i) i n a n y c a s e wh e r e t h e o b l i g a t i o n wa s i s s u e d f o r a n a m o u n t n o t l e s s t h an 9 7 % o f i t s p r i nc i p a l a m o u n t , a n d t h e y i e l d f r o m t h e o b l i g a t i o n . . . d o e s no t e xc e e d 4 / 3 o f t h e i n t er e s t
37
s t i p u l a t e d t o b e p a ya b l e o n t h e o b l i g a t i o n , e x p r e s s e d i n t e r m s of an annual rate on (A) the principal amount of the obligation, if no amount is payable on account of the principal amount before the maturity of the obligation, or the amount outstanding from time to time as or on account of the principal amount of the obligation, in any other case,
(B)
t h e a m o u n t b y wh i c h t h e l e s s e r o f t h e p r i n c i p a l a m o u n t o f t h e o b l i g a t i o n a n d a l l a m o u n t s p a i d i n t h e ye a r o r i n a n y preceding year in satisfaction of its principal amount exceeds t h e a m o u n t f o r wh i c h t h e o b l i g a t i o n wa s i s s u e d , a n d ( i i ) i n a n y o t h e r c a s e , 1 / 2 o f t h e l e s s e r of t h e a m o u nt s o p a i d a n d t h e a m o u n t b y wh i c h t h e l e s s e r o f t h e p r i n c i p a l a m o u n t o f t h e o b l i g a t i o n a n d a l l a m o u n t s p a i d i n t h e ye a r o r i n a n y p r e c e d i n g t a x a t i o n y e a r i n s a t i s f a c t i on o f i t s p r i n c i p a l a m o u n t e x c e e d s t h e a m o u n t f o r wh i c h o b l i g a t i o n wa s i s s u e d : " I n s u b s e c t i o n 2 4 8 ( 1 ) o f t h e A c t , " p r in c i p a l a m o u n t " , i n r e l a t i o n t o a n y obligation, means "the amount that under the terms of the obligation
38
o r a n y a g r e e m e n t r e l a t i n g t h e r e t o , is t h e m a x i m u m a m o u n t o r maximum total amount, as the case may be, payable on account of the obligation by the issuer thereof [...]" CCRA Position T h e i s s u e i s wh e t h e r t h e " p r i n c i p a l a m o u n t " o f a d e b t d e n o m i n a t e d in a foreign currency is based on the foreign currency rate on the date o f i s s u e o f t h e o b l i g a t i o n , t h e s p o t r a t e a t t h e t im e t h e d e b t i s p a i d o r t h e a v e r a g e o f f l u c t u at i n g r a t e s f ro m t i m e t o t im e . T h i s i s a l s o r e l e v a n t f o r t h e a p p l i c a t i o n o f t h e 9 7% t e s t a n d t h e yi e l d t e s t i n paragraph 20(1)(f). There is no indication either in paragraph 20(1)(f) o r t h e d e f i n i t i o n o f " p r i n c i p a l a m o u n t " i n s u b s e c t i o n 2 4 8 ( 1 ) w h en t h e "principal amount" is to be determined in respect of a foreign currency o b l i g a t i o n . I f t h e " p r i n c ip a l a m o u n t " i s t o b e d e t e r m i n e d a t t h e t i m e of issue, there is no discount since the amount of foreign currency e x c h a n g e l o s s wo u l d n o t b e a s c e r t a in e d a t t h a t t i m e . S i n c e t h e t e r m " p r i n c i p a l a m o u n t " i n t he A c t d o e s n o t s p e c i f y t h e t i m e a t wh i c h t h e " p r i n c i p a l a m o u n t " h a s t o b e d e t e r m in e d , t h e t im e o f d e t e r m i n a t i o n i s d e p e n d e n t o n t h e c o n t e x t o f t h e wo r di n g o f a p a r t i c u l a r p r o v i s i o n a n d t h e i n t e n t an d p u r p o s e o f t h a t p r o v i s i o n .
39
O t h e r p r o v i s i o n s o f t h e A c t c o n t e m pl a t e f o r e i g n c u r r e n c y s i t u a t i o n s . F o r p u r p o s e s o f s e c t i o n 8 0 o f t h e A c t , p a r a g r a p h 8 0 ( 2 ) ( k ) s t at e s , " wh e r e a n o b l i g a t i o n i s d e n o m i n a t e d i n a c u r r en c y ( o t h e r t h a n C a n a d i a n c u r r e n c y) , t h e f o r g i v e n a m o u n t a t a n y t i m e i n r e s pe c t o f a n o b l i g a t i o n s h a l l b e d e t e r m i n e d wi t h r e f e r e n c e t o t h e r e l a t i v e v a l u e o f t h a t c u r r en c y a n d C a n a d i a n c u r r e n c y a t t h e t i m e t h e o b l i g a t i o n w as i s s u e d " . A s s u c h , f o r e i g n c u r r e n c y f lu c t u a t i o n s a f t e r t h e t i m e a n obligation is issued are ignored for the purposes of section 80 of the A c t . A l s o , p a r a g r a p h 1 5 . 1 ( 7 ) ( b ) r e f er s t o " t h e t ot a l o f a l l a m o u n t s e a c h o f wh i c h i s t h e p r i n c i p a l a m o u n t o u t s t a n d i n g i m m e d i a t e l y a f t e r t h a t time". T h e C C R A h a s s t a t e d i n I n t e r p r e t a t i on B u l l e t i n I T - 3 6 1 R 3 , d e a l i n g wi t h s u b p a r a g r a p h 2 1 2 ( 1 ) ( b ) ( v i i ) , t h a t wh e r e a n o b l i g a t i o n i s i n f or e i g n c u r r e n c y, a n y f l u c t u a t i o n i n t h e C a n a d i a n d o l l a r r e l a t i v e t o t he f o r e i g n c u r r e n c y i s n o t a f a c t o r i n d e t e r m i n i n g wh e t h e r a t a p a r t i c u la r t i m e t h e C a n a d i a n b o r r o we r i s o b l i g e d t o p a y m o r e t h a n 2 5 % o f t h e p r i n c i p a l amount of the loan. I t i s t h e C CR A ' s p o s i t i o n t h a t f o r p ur p o s e s o f p a r a g r a p h 2 0 ( 1 ) ( f ) of t h e A c t , t h e t i m e a t wh i c h t h e " p r i n c i p a l a m o u n t " i s t o b e d e t e r m i n e d s h o u l d b e a t t h e t i m e o f i s s u e a n d t h i s i s t h e r e l e v a n t t i m e at wh i c h
40
t h e d i s c o u n t , i f a n y, s h o u l d a l s o b e a s c e r t a i n e d . T h e " 9 7 % t e s t " a n d the "yield test" should also be applied at the time of issue of the debt. Any loss should be governed by subsection 39(2) of the Act.
Dividend Reinvestment Plans
A " D i v i d e n d R e i n v e s t m e n t P l a n " o r "D R I P " i s a n a r r a n g e m e n t u n d e r wh i c h t h e c o m m o n s h a r e h o l d e r s o f a p u b l i c c o r p o r a t i o n a r e e n t i t l e d t o d i r e c t t h a t c a s h o t h e r wi s e r e c e i v a b l e b y t h e m a s r e g u l a r d i v i d e n d s b e u s e d t o p u r c h a s e a d d i t i o n a l c o m m o n s h a r e s o f t h e c o r p or a t i o n , u s u a l l y a t a d i s c o u n t f r om t h e i r m ar k e t p r i c e . D RI P s s o m et i m e s a l s o h a v e a n " O p t i o n a l P u r c h a s e " c om p o n e n t u n d e r wh i c h p a r t i c i p a n t s u n d e r t h e D R I P a r e e n t it l e d t o p u r c h a s e a l i m i t e d n u m b e r o f c o m m o n s h a r e s , i n ad d i t i o n t o t ho s e p u r c h a s e d wi t h r e i n v e s t e d d i v i d e n d s , usually at market price. Question W h a t i s t h e C C R A ' s p o s i t i o n wi t h r e s p e c t t o wh e t h e r p a r t i c i p a n t s u n d e r s u c h r e i n v e s t m e n t p l a n s ca n b e a s s e s s e d t a x a b l e b e n e f i t s ?
41
Response I n o u r v i e w, a c o r p o r a t i o n t h a t p e r m it s a s h a r e h o l d e r t o u s e d i v i d e n d s t o p u r c h a s e a d d i t i o n a l s h a r e s o f t he c o r p o r a t i o n f o r a n a m ou n t l e s s t h a n t h e i r f ai r m a r k e t v a l u e c o n f e r s a b e n e f i t o n t h e s h a r e h o l d e r i n t h e a m o u n t o f t h e d i s c ou n t a t t h e t im e t h a t t h e s h a r e s a r e p u r c h a s e d . C o n s e q u e n t l y, s u b s e c t i o n 1 5 ( 1 ) i s po t e n t i a l l y a p p l i c a b l e t o r i g h t s under DRIPs. P a r a g r a p h 1 5 ( 1 ) ( c ) p r o v id e s t h a t s u bs e c t i o n 1 5 ( 1 ) d o e s n o t ap p l y wh e r e t h e c o r p o r a t i o n c o n f e r s o n a l l o wn e r s o f c o m m o n s h a r e s i d e n t i c a l r i g h t s t o a c q u i r e a d d i t io n a l s h a r e s o f t he c o r p o r a t i o n . H o we v e r , t h e C C R A u n d e r s t a n d s t h a t t h e p a r a g r a p h 1 5 ( 1 ) ( c ) e x c e p t i o n i s n o t a v a i l a b l e wi t h r e s pe c t t o m o s t DR I P s , s i n c e f o r e i g n s e c u r i t i e s l a ws m a y p r e v e n t t h e c o r po r a t i o n f r o m p e r m i t t i n g n o n - r e s i d e n t s h a r e h o l d e r s t o p a r t i c ip a t e u n d e r t h e p l a n . N e v e r t h e l e s s , i t i s t h e lo n g s t a n d i n g a d m i n i s t r a t iv e p r a c t i c e o f t h e C C R A t h a t a s u b s e c t i o n 1 5 ( 1 ) b e n e f i t wi l l n o t b e a s s e s s e d i n r e s p e c t o f a b e n e f i t a r i s i n g f r o m t h e r e i n v e s t m e n t o f d i v id e n d s i n a d d i t i o n a l s h a r e s u n d e r a D R I P , p ro v i d e d t h a t t h e a m o u n t p a i d f o r t h e ad d i t i o n a l s h a r e s i s n o t l e s s t h a n 9 5 % o f t h e i r f a i r m a r k e t v a l u e . H o we v e r , t h i s
42
a d m i n i s t r a t i v e p r a c t i c e wi l l n o t b e a p p l i e d i n r e s p e c t o f a b e n e f i t arising from the acquisition by a shareholder of additional shares of t h e c o r p o r a t i o n f o r a n a m o u n t t h a t is l e s s t h a n t h e i r f a i r m a r k e t v a l u e pursuant to an Optional Purchase component of a DRIP.
S I L I C O N G R A P H I C S L T D . V . T H E Q UEEN , 2002 DTC 7112; [2002] 3 CTC 527 (FCA)
A l i a s R e s e a r c h I n c . , a p r e d e c e s s or o f t h e t a x p a y e r , c l a i m e d e n h a n c e d SR&ED benefits under subsection 127(10.1) and section 127.1 in i t s 1 9 9 2 a n d 1 9 9 3 t a x a t i o n ye a r s . D u r i n g t h o s e y e a r s , t h e c o m m o n s h a r e s o f A li a s we r e p u b l i c l y t ra d e d o n t h e N A S D A Q e x c h a n g e i n t h e U n i t e d S t a t e s . T h e c o m m o n s h a r e s we r e wi d e l y - h e l d a n d m o r e t h a n 5 0 % o f t h o s e s h a r e s we r e o wn e d b y n o n - r e s i d e n t s . A l i a s ' pr i n c i p a l p l a c e o f b u s i n e s s wa s i n T o r o n t o , a n d a m a j o r i t y o f t h e b o a r d o f d i r e c t o r s a n d t h e e n t i r e m a n a g e m e n t t e a m we r e r e s i d e n t s o f C a n a d a . T h e m a n a g e m e n t t e a m an n u a l l y p r e p a r e d a s l a t e o f p e o p l e t o b e e l e c t e d t o t he b o a r d , wh i c h wa s a l wa y s a c c e p t e d b y t h e s h a r e h o l d e r s . In December 1991, Silicon Graphics Ltd., a U.S. public corporation, agreed to advance up to $5 million to Alias in consideration of a
43
s e c u r i t y i n t e r e s t i n A l i a s ' a s s et s a n d t h e i s s u a n c e o f wa r r a n t s t o a c q u i r e c o m m o n s h a r e s o f A l i a s . T he l o a n wa s o u t s t a n d i n g f o r s e v e n we e k s , d u r i n g wh i c h t i m e S i l i c o n G r a p h i c s L t d . a p p r o v e d d a i l y c a s h f o r e c a s t s a nd d e t e r m i n e d wh i c h c r e d i t o r s o f A l ia s wo u l d b e p a i d . S i l i c o n G r a p h i c s L t d . a l s o m a d e f in a n c i a l c o n t r i b u t i o n s t o A l ia s f o r s o f t wa r e d e v e l o p m e n t a n d m a r k e t i n g . C e r t a i n d i r e c t o r s a n d o f f i c e r s of Al i a s we r e f o r m e r l y a s s o c i a t e d wi t h S i l i c o n G r a p h i c s L t d . a n d A l i a s s o f t wa r e o n l y o p e r a t e d o n h a r d wa r e o f S i l i c o n G r ap h i c s L t d . T h e i s s u e b e f o r e t h e T ax C o u r t o f Ca n a d a wa s wh e t h e r A l i a s wa s " c o n t r o l l e d , d i r e c t l y o r i n d i r e c t l y i n a n y m a n n e r wh a t e v e r , b y o n e o r m o r e n o n - r e s i d e n t p e r s o n s " wi t h i n t h e m e a n i n g o f t h e "Canadian-controlled private corporation" (CCPC) definition in subsection 125(7) and the extended meaning of control in s u b s e c t i o n 2 5 6 ( 5 . 1 ) . T he T a x C o u r t o f C a n a d a c o n c l u d e d t h a t t h e n o n - r e s i d e n t s h a r e h o l d e r s h a d D E J U R E c o n t r o l o f A l i a s be c a u s e t h e y h e l d t h e s i m p l e m a j o r i t y o f v o t in g s h a r e s , n o t wi t h s t a n d i n g t h a t t h e r e wa s n o c o m m o n c o n n e c t i o n b e t we e n t h e m . B e c a u s e o f t h i s f i n d i n g , t h e T a x C o u r t of C a n a d a f o u n d i t wa s u n n e c e s s a r y t o c o n s i d e r wh e t h e r n o n - r e s i d e n t s h a d D E F A C T O c o n t r o l o f A l i a s .
44
S i l i c o n G r a p h i c s L t d . a pp e a l e d t o t h e F e d e r a l C o u r t o f A p p ea l . O n t h e i s s u e o f D E J U R E c o n t r o l , t h e F e de r a l C o u r t o f A p p e a l e q u a t e d t h e p h r a s e " c o n t r o l b y o n e o r m o r e p e r s o n s " i n t h e C C P C d e f i n i t i o n wi t h the phrase "control by a person or group of persons", and, based on p r i o r c a s e l a w, a g r e e d wi t h S i l i c o n G r a p h i c s L t d . t h a t i n o r d e r f o r a g r o u p o f p e r s o n s t o b e in a p o s i t i o n t o e x e r c i s e D E J U R E c o n t r o l , a c o m m o n c o n n e c t i o n m u s t e x i s t b e t we e n t h e s h a r e h o l d e r s . A s t h e r e wa s n o e v i d e n c e o f a c om m o n c o n n e c t i o n , t h e F e d e r a l C o u r t o f A p p e a l o v e r t u r n e d t h e T a x C o u r t o f C a n a d a ' s d e c i s i o n . I n r ea c h i n g i t s c o n c l u s i o n , t h e F e d e r a l C o u r t o f A pp e a l r e f e r r e d t o t h e 1 9 98 legislative amendment to the CCPC definition, adding paragraph (b) of the CCPC definition, prior positions taken by the CCRA on control by g r o u p s a n d t h e p o l i c y u n d e r l yi n g t a x a d v a n t a g e s g i v e n t o CC P C s . W i t h r e s p e c t t o t h e s e c on d i s s u e , t he F e d e r a l C o u r t o f A p p ea l s t a t e d that in order for there to be finding of DE FACTO control, " ... a person o r g r o u p o f p e r s o n s m u s t h a v e a c le a r r i g h t a n d a b i l i t y t o e f f e c t a s i g n i f i c a n t c h a n g e i n t h e b o a r d o f d i r e c t o r s o r t he p o we r s o f t h e b o a r d o f d i r e c t o r s o r t o i n f l u e n c e i n a v e r y d i r e c t wa y t h e s h a r e h o l d e r s wh o wo u l d o t h e r wi s e h a v e t h e a b i l i t y t o e l e c t t h e b o a r d o f d i r e c t o r s . " I n t h e F e d e r a l C o u r t o f A p p e a l ' s v i e w, t h e r e wa s n o e v i d e n c e t o s h o w t h a t
45
S i l i c o n G r a p h i c s L t d . s at i s f i e d t h o s e c r i t e r i a . I n s t e a d , t h e F ed e r a l C o u r t o f A pp e a l f o u n d t h a t D E F A C T O c o n t r o l r em a i n e d i n C a n a d a . Question 1 I n t h e R e v en u e C a n a d a F o r u m at t h e 1 9 9 4 C a n a d i a n T a x F o u n d a t i o n conference, the CCRA expressed the view that since the CCPC definition in subsection 125(7) did not refer to control by a "group o f p e r s o n s " , i t wa s m e a n t t o m e a n o wn e r s h i p o f t h a t n u m b e r o f s h a r e s t h a t wo u l d c o n s t i t u t e c on t r o l ( 8 ) . C o n t r a r y t o t h i s p o s i t i o n , i n S i l i c o n G r a p h i c s L t d . , t h e F e d e r a l C o u r t o f A pp e a l t o o k t h e p o s i t i o n t h a t t h e reference to "one or more" in the CCPC definition essentially meant "group of persons", and therefore, there must be a common c o n n e c t i o n b e t we e n t h e n o n - r e s i d e n t s h a r e h o l d e r s i n o r d e r f o r t h e m to have de jure control.
8 See also Issue No. 3 of the INCOME TAX TECHNICAL NEWS, dated January 30, 1995.
46
D o e s t h e C C R A a c c e p t t h e F e d e r a l C o u r t o f A pp e a l ' s f i n d i n g s , a n d i f s o , wh a t a r e t h e i m p l i c a t i o n s ? Response 1 Y e s . W e a c c e p t t h e f i n d in g s o n t h i s is s u e a n d h a v e n o t s o u g h t l e a v e t o a p p e a l t o t h e S u p r e m e C o u r t o f Ca n a d a . I n t he c o n t e x t o f t h e C C P C definition, the findings are largely of historical interest given that p a r a g r a p h ( b ) o f t h e C C P C d e f i n i t i o n wo u l d a p p l y, f o r ye a r s a f t e r 1 9 9 5 , t o d e n y C C P C s t a t u s i n wi d e l y- h e l d s i t u a t i o n s , s u c h a s t h a t wh i c h e x i s t e d i n S I L I C O N G R A P H I C S L T D . Question 2 W i l l t h e C CR A i n t e r p r e t c o n t r o l b y " o n e o r m o r e p e r s o n s " , as u s e d i n o t h e r s e c t i on s o f t h e A c t , t o m e a n "g r o u p o f p e r s o n s " i n a c c o r d a n c e wi t h S i l i c o n G r a p h i c s L t d . ? F o r i n s t a n c e , t h i s wo r d i n g a p p e a r s i n p a r a g r a p h s 8 3 ( 2 . 2 ) ( c ) an d ( d ) a n d p a r a g r a p h s 8 3 ( 2 . 4 ) ( c ) a nd ( d ) , r e l a t i n g t o c a p i t a l d i v i d e n d s , a n d i n t h e f o l l o wi n g d e f i n i t i o n s : " c a p i t a l dividend account" and "private corporation" in subsection 89(1), "financial institution" in subsection 142.2(1), "restricted financial
47
institution" and "term preferred share" in subsection 248(1) and "eligible corporation" in subsection 5100(1) of the Income Tax Regulations. Response 2 Y e s . T h e r e is n o b a s i s f o r l i m i t i n g t h e f i n d i n g s i n S I L I C O N G R A P H I C S LTD. on this issue to the CCPC definition. Question 3 Have there been any other developments regarding the interpretation of the CCPC definition in subsection 125(7)?
48
Response 3 Y e s . T h e r e is o n e n e w d e v e l o p m e n t r e g a r d i n g t h e a p p l i c a t i o n o f p a r a g r a p h ( b ) o f t h e C C P C d e f i n i t i o n t o m u l t i - t ie r e d c o r p o r a t e s t r u c t u r e s s im i l a r t o t h a t wh i c h e x i s t e d i n P A R T H E N O N I N V E S T M E N T S L T D . V . T H E Q U E E N ( 9 ) . Re c a l l t h a t i n P a r t h e n o n , t h e F e d e r a l C o u r t o f A p p e a l h e l d t h a t c o n t r o l m e a n t u l t i m a t e c o n t r o l , wi t h t h e r e s u l t t h a t C C P C s t a t us wa s n o t d e n i e d t o t h e c o r p o r a t i o n a t t h e b o t t om o f t h e corporate chain by reason of the interposition of a non-resident c o r p o r a t i o n i n t h e m i d d l e o f t h e c o r p o r a t e c h a i n , wh e n u l t i m a t e c o n t r o l l a y wi t h a C a n a d i a n r e s i d e n t a t t h e t o p o f t h e c or p o r a t e c h a i n . F o r t a x a t i o n y e a r s t h a t b e g i n a f t e r N o v em b e r 1 9 9 9 , s u b s e c t i o n s 2 5 6 ( 6 . 1 ) and (6.2) apply to override the position taken by the Federal Court of Appeal in Parthenon.
9 9 7 DT C 53 4 3 ; [ 1 9 9 7 ] 3 CT C 1 5 2 ( F C A ) .
49
T h e P A R T H E N O N c a s e o n l y d e a l t wi t h t h e a p p l i c a t i o n o f wh a t i s n o w p a r a g r a p h ( a ) o f t h e C C P C d e f i n i t i o n . T h e C C RA i s o f t h e v i e w, h o we v e r , t h a t p a r a g r a p h ( b ) o f th e C C P C d e f i n i t i o n wo u l d a p p l y t o d e n y C C P C s t a t u s i n f a c t u a l s i t u a t i o n s s i m i l a r t o t h a t wh i c h e x i s t e d i n P a r t h e n o n f o r ye a r s a f t e r 1 9 9 5 . P a r a g r a p h ( b ) r e q u i r e s s h a r e s , n o t only of the corporation in question, but those of all corporations, o wn e d b y a n o n - r e s i d e n t p e r s o n , a p u b l i c c o r p o r a t i o n ( o t h e r t h a n a p r e s c r i b e d v e n t u r e c a p i t a l c o r p o r a t i o n ) , o r a c or p o r a t i o n d e s c r i b e d i n p a r a g r a p h ( c ) of t h e C C P C d e f i n i t i o n , t o b e at t r i b u t e d t o a h yp o t h e t i c a l p e r s o n . I f t h e h yp o t h e t i c a l p e r s o n wo u l d d i r e c t l y o r i n d i r e c t l y c o n t r o l t h e c o r p o r a t i o n i n q u e s t i o n , t h e l a t t e r wo u l d n o t be a CCPC. F o r i l l u s t r a t iv e p u r p o s e s , c o n s i d e r t he f o l l o wi n g s c e n a r i o : C a n c o 1 i s a Canadian corporation that is controlled by a Canadian resident. C a n c o 1 o wn s m o r e t h a n 5 0 % o f t h e v o t i n g s h a r e s o f P u b c o , a C a n a d i a n p u b l i c c o r p o r a t i o n , wh i c h i n t u r n o wn s m o r e t h a n 5 0 % o f t h e v ot i n g s h a r e s o f Ca n c o 2 , a C a n a d i a n c o r p o r a t i o n . I n d e t e r m i n i n g C a n c o 2 ' s s t a t u s a s a C C P C , i n t he C C R A ' s v i e w, p a r a g r a p h ( b ) wo u l d a p p l y t o a t t r i b u t e t h e s h a r e s o f C a n c o 2 h e l d by Pubco to a hypothetical person. Because this hypothetical person
50
wo u l d t h e n d i r e c t l y c o n t r o l C a n c o 2 , C C P C s t a t us wo u l d b e d e n i e d n o t wi t h s t a n d i n g t h e f a c t t h a t u l t im a t e c o n t r o l o f C a n c o 2 l a y wi t h a C a n a d i a n r e s i d e n t . A s no t e d a b o v e , p a r a g r a p h ( b ) wi l l a l s o a p p l y i f c o n t r o l b y t h e h yp o t h e t i c a l p e r s o n i s i n d i r e c t . T h is wo u l d a r i s e i f , i n s t e a d o f o wn i n g t h e s h a r e s o f C a n c o 2 d i r e c t l y, P u b c o o wn e d 1 0 0 % o f t h e v ot i n g s h a r e s o f Ho l d c o , a C a n a d i a n c o r p o r a t i o n , wh i c h i n t u r n o wn e d m o r e t h a n 5 0 % o f t h e v o t i n g s h a r e s o f Ca n c o 2 . I n t h is c a s e , C a n c o 2 wo u l d n o t b e a C C P C b e c a u s e p a r a g r a p h ( b ) wo u l d a p p l y t o a t t r i b u t e t h e s h a r e s o f Ho l d c o t o t h e h yp o t h e t i c a l p e r s o n , wh o wo u l d then have indirect control of Canco2. Question 4 T h e F e d e r a l C o u r t o f A pp e a l s e t o u t c i r c u m s t a n c e s i n wh i c h a p e r s o n o r g r o u p o f p e r s o n s wo u l d b e c o n s i d e r e d t o h a v e d e f a c t o c o n t r o l . T h e s e c i r c u m s t a n c e s a r e n a r r o we r i n s c o p e t h a n t h o s e s e t o u t b y t h e C C R A i n ¶ 2 1 o f I n t er p r e t a t i o n B u l l e t i n I T - 6 4 R 4 , C o r p o r a t i o n s : Association and Control, dated August 14, 2001. How does this d e c i s i o n a f f e c t t h e s e v ie ws ?
51
Response 4 T he CCRA is not prese n t l y co nsid eri ng an y c han ge to the cri t eria contai ne d in ¶ 21 of Interpretatio n Bull etin IT -64R4 as a res ult of the S I L I C O N G R A P H I C S decisi on. T here are t wo c ases inv olvi ng the app licati on of subsecti o n 256( 5.1) that hav e be en ap pe ale d to the F edera l Co u r t of Appeal: M I M E T I X P H A R M A C E U T I C A L S I N C . V . T H E Q U E E N A N D R O S A R I O P O I R I E R I N C . V . T H E Q U E E N ( 1 0 ) . T he CCRA is of the vie w th a t the T ax Co urt of Cana d a decis io n i n M I M E T I X ( 1 1 ) seems to sugg est that the circu m stances in wh ic h D E F A C T O c o n t r o l m a y arise ma y n ot be as nar ro w as thos e set out in S I L I C O N G R A P H I C S .
1 0 C o u r t f i l e N o . A - 6 3 - 02 a n d C o u r t f i l e N o . A - 37 8 - 0 2 , r e s p e c t i v e l y. 1 1 2 0 0 1 D T C 1 0 2 6 ; [ 2 0 0 2 ] 1 CT C 21 8 8 ( T C C ) .
52
F or instance , it is noted that the T ax Court of Ca nad a in M I M E T I X found that a non-r esid ent shar eho lder had D E F A C T O control of the app ell ant in part bec a use the n on- resid ent sha r eho lder e xe r cised the p o wers of the ap pel lan t 's board of directors, wh ich is n ot a situation cit ed b y the F edera l Co u r t of Appeal in S I L I C O N G R A P H I C S . Given the u nc ertaint y surrou ndi ng the scop e of D E F A C T O control, the C CRA inte nds to wa it for the F ede ral Co urt of Appe al's de cisio ns in M I M E T I X and R O S A R I O P O I R I E R prior to consider ing wh eth er an y cha ng e is necess ar y to our positi on o n D E F A C T O control in Interpretatio n Bu lleti n IT -64R 4.
Partnership Issues
Background I n b r o a d t e r m s , t h e I N C O M E T A X A C T ( t h e " A c t " ) i s s t r u c t u r ed t o t a x t h e income of individuals, corporations and trusts. The Act provides for definitions for each of these terms. Unlike the above-mentioned terms, a "partnership" is not defined in the Act. Moreover, in general, a partnership is not considered a
53
" p e r s o n " f o r p u r p o s e s o f t h e A c t n o twi t h s t a n d i n g t h e f a c t t h a t c e r t a i n provisions in the Act refer to a "person" to include a partnership. I t i s a q u e s t io n o f f a c t an d l a w a s t o wh e t h e r a p a r t n e r s h i p e x i s t s . T h e C o u r t s ( 1 2 ) ha v e n o w e s t a b l i s h e d t h e f o l l o wi n g g e n e r a l c r i t e r i a ( wh i c h is based on the definition of partnership under the relevant provincial l a w) wh e n d e t e r m i n i n g wh e t h e r a p a r t n e r s h i p e x i s t s : · there must be a business; · this business must be carried on by 2 or more persons; · there must be a view to profit.
12 See the Supreme Court of Canada decisions in CONTINENTAL B A N K L E A S I N G C O R P O R A T I O N V . T H E Q U E E N ( 9 8 DT C 6 5 0 5 ; [ 1 9 9 8 ] 4 C T C 1 1 9 ) , S P I R E F R E E Z E R S L T D V . T H E Q U E E N ( 2 00 1 D T C 5 1 5 8 ; [ 2 0 0 1 ] 2 CT C 4 0 ) a n d B A C K M A N V . T H E Q U E E N ( 20 1 D T C 5 1 4 9 ; [ 2 0 0 1 ] 2 CT C 1 1 ) . M O R E R E C E N T L Y , S T A N L E Y W I T K I N V . T H E Q U E E N ( 2 0 0 2 D T C 7 0 4 4 ; [ 2 0 0 2 ] 3 CT C 1 8 4 ) r e i n f o r ce d t h e c r i t e r i a e s t a b l i s h e d i n the foregoing cases.
54
O n c e i t i s es t a b l i s h e d t h a t a p a r tn e r s h i p d o e s e x i s t , s u b s e c t i o n 9 6 ( 1 ) o f t h e A c t ge n e r a l l y p r o v i d e s t h a t a p a r t n e r s h i p i s a " f l o w- t h r o u g h " e n t i t y, wi t h i n c o m e c o m p u t e d a t t h e p a r t n e r s h i p l e v e l ( a s i f t h e partnership is a separate person) and allocated to the members of the partnership. Each member of a partnership, in turn, reports and p a ys t a x o n t h e i r p r o p o r t i o n a t e s h a r e o f s u c h i n c o m e . T h e s ou r c e s o f i n c o m e r et a i n t h e i r c ha r a c t e r wh e n f l o we d f r o m t h e p a r t ne r s h i p t o t h e m e m be r s o f t h e p a r t n e r s h i p . Question 1 The CCRA's position provides that a partnership is a contractual r e l a t i o n b e t we e n p e r s o n s a n d t h e r e f o r e n o t a le g a l e n t i t y. I n r e c e n t y e a r s , l e g i s l a t i o n h a s b e e n e s t a b l i s h e d i n t h e U S [ s u c h a s t he DELAWARE REVISED UNIFORM PARTNERSHIP ACT (DRUPA)] to allow the creation of "partnerships" that are separate legal entities. This a p p e a r s t o c o n t r a d i c t t he C C R A ' s p o s i t i o n . C a n y o u p r o v i d e a n y c o m m e n t s wi t h r e s p e c t t o t h i s m a t t er ?
55
Response 1 The CCRA announced in the June 14, 2001 INCOME TAX TECHNICAL N E W S ( N o . 20 ) t h a t it i s it s v i e w th a t g e n e r a l l y t h e a t t r i b u t e s o f a n e n t i t y f o r m e d u n d e r t h e D R U P A a n d c a r r yi n g o n b u s i n e s s i n c o m m o n wi t h a v i e w t o a p r o f i t m o r e c l o s e l y r e s e m b l e t h o s e o f a C a na d i a n g e n e r a l p a r t n e r s h i p u n d e r o u r c o m m o n l a w. T h i s a p p r o a c h h a s b e e n f o l l o we d b y t h e C o u r t s , i n p a r t i c u l a r , B A C K M A N , S P I R E F R E E Z E R S , a n d CONTINENTAL BANK. Question 2 U n d e r p r o v i n c i a l p a r t n e r s h i p l a ws , p a r t n e r s h i p s m u s t h a v e a " v i e w t o p r o f i t ". Un d e r D R U P A , l e g a l e n ti t i e s m a y b e c r e a t e d f o r n o n - p r o f i t purposes. Would these DRUPA entities be partnerships for Canadian purposes? Response 2 No. It is the CCRA's view that entities governed by the DRUPA that a r e n o t c r e a t e d t o c a r r y o n b u s i n e s s wi t h a v i e w t o a p r o f i t un d e r c o m m o n l a w p r i n c i p l e s wo u l d n o t r e s e m b l e C a n a d i a n p a r t n e r s h i p s .
56
C o n s e q u e n t l y, s u c h e n t i t i e s wo u l d n o t b e c o n s i d e r e d p a r t n e r s h i p s f o r the purposes of the Act. W e h a v e r e c e i v e d r e q u e s t s wi t h r e s p e c t t o t h e d e t e r m i n a t i o n o f the Canadian tax status of foreign partnerships formed in other j u r i s d i c t i o n s . T h e d e t e r m i n a t i o n o f wh e t h e r a p a r t n e r s h i p e x i s t s f o r C a n a d i a n t a x p u r p o s e s i s a m a t t e r of c o m m o n o r c i v i l l a w a n d c a n only be made in the context of an advance tax ruling request. Question 3 S i m i l a r l y, l e g i s l a t i o n i n t h e U . S . a l l ows f o r t h e c r e a t i o n o f L i m i t e d Liability Companies (LLCs), to operate as separate legal entities a n d a l l o ws b u s i n e s s p r o f i t s ( o r l o s s e s ) t o b e a ll o c a t e d a n d t a x e d in the hands of the members. W h a t i s t h e C C R A p o s i t i o n wi t h r e s p e c t t o t h e s e e n t i t i e s ? Response 3 T h e C C R A h a s r e v i e we d t h e p r o v i s i o n s o f t h e l e g i s l a t i o n wi t h r e s p e c t t o L L C s i n s o m e S t a t e s . B a s e d o n t h e r e v i e w, i t i s g e n e r a l l y t h e
57
C C R A ' s p o s i t i o n t h a t a n L L C i s co n s i d e r e d a c o r p o r a t i o n f o r C a n a d i a n tax purposes. Question 4 O n e o f t h e c r i t e r i a o f a "p a r t n e r s h i p " i s t h a t t h e p a r t i c u l a r b u s i n e s s i s c a r r i e d o n wi t h " a v i e w t o a p r o f i t " . D o e s t h e C C R A c o n s i d e r t h i s t o m e a n a " r e a s o n a b l e e x p e c t a t i o n o f pr o f i t " ( R E O P ) a s e s t a b l i s h e d i n MOLDOWAN? Response 4 N o . T h e " v i ew t o a p r o f i t " t e s t t h a t d e t e r m i n e s i f a p a r t n e r s h i p e x i s t s i s a c o m m on o r c i v i l l aw i s s u e , wh i l e t h e R E O P t e s t i s a d e t e r m i n a t i o n o f wh e t h e r t h e r e i s a b u s i n e s s o r s ou r c e t e s t u n d e r t h e I N C O M E T A X ACT. The Courts have established that in order for a partnership to e x i s t , t h e r e m u s t b e a " r e l a t i o n b e t we e n p e r s o n s c a r r yi n g o n a b u s i n e s s i n c o m m o n wi t h a v i e w t o a p r o f i t " . T he C o u r t s h a v e e s t a b l i s h e d t h a t t h i s t e s t i s d if f e re n t f r o m t h e m o r e d i f f i c u l t R E O P t e s t . W h e t he r t h e r e e x i s t s a " v i e w t o a p r o f i t " r e q u i r e s a n i n q u i r y i n t o the intentions of the parties entering into the alleged partnership.
58
T h i s d e t e r m in a t i o n i s g e n e r a l l y a f i n d i n g o f f a c t a n d l a w f o r e a c h particular case. Question 5 N o w m o v i n g a wa y f r o m t h e i s s u e o f wh e t h e r a p a r t n e r s h i p e x i s t s a n d t o t h e c o m pu t a t i o n o f i nc o m e f o r a p a r t n e r s h i p . I n t e r p r e t a t i on B u l l e t i n I T - 1 3 8 R p r o v i d e d a n e x a m p l e wi t h r e s p e c t t o a p a r t n e r s h i p a g r e e m e n t t h a t p r o v i de s f o r t h e a l l o c a t i o n o f a n a n n u a l s a l a r y p a i d t o o n e p a r t n e r , a f t e r wh i c h t h e p a r t ne r s d i v i d e t h e i n c o m e (or loss) of the partnership. This position appears to contradict recent comments made in a recent CCRA technical interpretation. C a n yo u c l a r i f y t h e C C R A ' s p o s i t i o n wi t h r e s p e c t t o a "s a l a r y " p a i d to an individual partner? Response 5 T h e C C R A i s o f t h e v i ew t h a t s a l a r i e s p a i d t o i n d i v i d u a l p a r t n e r s a r e not deductible in computing the partnership's income for income tax
59
p u r p o s e s . T h i s c o n c e p t i s a n e x te n s i o n o f t h e ge n e r a l c r i t e r i a established under the provincial Partnerships Acts. As an example, s e c t i o n 2 4 , p a r a g r a p h 6 o f t h e P a r t ne r s h i p A c t of O nt a r i o s pe c i f i c a l l y s t a t e s " n o pa r t n e r i s e n t i t l e d t o r e m u n e r a t i o n f o r a c t i n g i n t h e p a r t n e r s h i p b u s i n e s s . " C o n s e q u e n t l y, a n y a m o u n t s p a i d a n d d e d u c t e d a s s u c h i n t h e f i n a n c i a l s t a t e m e n t s o f t h e p a r t ne r s h i p a s s u c h m u s t b e a d d e d b a c k wh e n c o m p u t i n g p a r t n e r s h i p i n c o m e . T h e C C R A wi s h e s t o c la r i f y t h a t I nt e r p r e t a t i o n B u l l e t i n I T - 13 8 R h a s b e e n wi t h d r a wn i n 2 0 0 0 s i n c e m u c h o f t h e i n f o r m a t i o n i t c on t a i n e d wa s o u t o f d a t e . I nf o r m at i o n wi t h r e sp e c t t o t h e c o m p u t a t i o n o f i n c o m e for partnerships can be found in the GUIDE FOR THE PARTNERSHIP INFORMATION RETURN (T4068). Question 6 T h e n e x t q ue s t i o n d e a l s wi t h t h e " p a r t n e r s h i p i n t e r e s t " . A l i m i t e d p a r t n e r s h i p m a y i s s u e d i f f e r e n t u n i t s o f t h e p a r t ne r s h i p . D o e s t h e C C R A a c c e p t t h a t t h e A CB o f t h e d i f f e r e n t p a r t n e r s h i p u n i t s b e c o m p u t e d s e p a r a t e l y, i n t h e s a m e m a n n e r t h a t o n e c o m p u t e s t h e A C B o f s h a r e s t h e y h o l d i n a c o r p o r a t i o n ( p r e f e r r e d , c om m o n ) ?
60
Response 6 N o . I t i s t h e C C R A p o s i t i o n t h a t a t a x p a y e r ' s i n t e r e s t i n a l im i t e d p a r t n e r s h i p i s c o n s i d e r e d o n e c a p i t a l p ro p e r t y. C o n s e q u e n t l y, i n a d i s p o s i t i o n o n e wo u l d c o m p u t e t he A C B o f t he p a r t n e r s h i p i n t e r e s t as the aggregate of the units. In a partial disposition, the ACB of the p a r t i a l i n t e r e s t d i s p o s e d wo u l d b e d e t e r m i n e d p u r s u a n t t o s u b s e c t i o n 43(1) of the Act.
61
Free itnews-25-lp-e.pdf - Canada
| File Size: | 223.4 kB |
| Pages: | 63 |
| Date: | August 24, 2009 |
| File Format: | |
| State: | Canada |
| Category: | Tax Forms |
| Author: | LXC706 |
| Word Count: | 34,658 Words, 83,648 Characters |
| Page Size: | Letter (8 1/2" x 11") |
| URL |
http://www.cra-arc.gc.ca/E/pub/tp/itnews-25/itnews-25-lp-e.pdf |
| Download itnews-25-lp-e.pdf ( 223.4 kB) |
Preview itnews-25-lp-e.pdf
Popular Searches
United States Free Forms
Canada Free Forms
United Kingdom Free Forms
Australia Free Forms