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August 2016 Executive TaxBriefs

A. Tax Legislation

1. BC Hammers Foreign Buyers with Additional 15% Property Transfer Tax

On July 25th, 2016 the BC Legislature introduced Bill 28 – 2016 Miscellaneous Statues (Housing Priority Initiatives) Amendment Act, 2016 which included provisions to add an additional 15% to the province’s Property Transfer Tax for foreign buyers who apply to register a transfer of property located in the Greater Vancouver Regional District at the Land Title Office on or after August 2, 2016.  This property transfer tax is in addition to the general property transfer tax. This bill also provides the legislative authority to implement a vacancy tax on vacant homes although details of this tax have not yet been announced.

It must be noted that BC has thumbed its nose at the rule of law by introducing the tax effective immediately with no grandfathering provisions. For those buyers with binding sales agreements that will not close until after August 2nd, they will be hit with an additional 15% tax if they honour their contractual obligations. One finds it hard to understand how this new legislation offers a deterrence to foreign buyers already locked into deals.  While one can understand the policy objectives given Vancouver’s world leading real estate price increases – Prime Global Cities Index released by Knight Frank on August 5th noted that Vancouver’s surge in house prices of 36% over the past year was by far the highest in the world which averaged 4.4%.  The second highest was Singapore at 22.5% with Toronto at fourth in the world at 12.6%.  That puts Vancouver price increases at the top in the world for the fifth consecutive quarter. 

With Vancouver real estate being treated by the wealthy, foreign and domestic, as a hot tech stock or gold in a market of plunging currencies, something had to be done.  As it turns out Vancouver is in the perfect storm with an enormous amount of real estate owned by boomers – much of it held free and clear – whose own children are now looking to enter the real estate market.  What happens when someone sells out their west side home purchased for well under $1.0 million some 20 years ago for a price of, say $5.0 million?  They lend each of their adult kids a down payment and now we have 3 families, all local, in the hunt for a new home.

So while the new legislation has been welcomed by the local population, the taxation of uncompleted sales is nothing but a money grab by the Province.  At the end of the day the Province needs to step up and help the city of Vancouver and all municipalities in the Greater Vancouver Regional District to process the development applications which are trapped in “city hall bureaucratic gridlock”.  It is understood there are upwards of 70,000 housing units being proposed for development.  If those applications could be expedited it would make a big difference to the housing supply side.  And at some point Vancouver is going to have to do what almost every major world city has done – allow multiple units to be built where single family homes reign supreme.  One can only imagine what a policy of allowing “semis” on every city lot would do for supply in Vancouver.  Torontonians have lived with semis since the 1920s.  Vancouver, time to move into the 20th Century – never mind the 21st.   And we all need to learn how to do with less space!

The additional 15% property transfer tax follows other property transfer tax measures that British Columbia recently enacted in response to concerns over housing price increases. These measures were announced in British Columbia's 2016 effective February 17, 2016, and provided that newly constructed homes with a value of up to $750,000 are generally exempt from property transfer tax where purchased for use as a principal residence with a partial exemption provided for homes valued between $750,000 and $800,000, as long as the buyer is a Canadian citizen or permanent resident.

In addition, British Columbia increased the property transfer tax rate on any type of taxable transactions to 3% on the portion of a property's value in excess of $2 million for transfers registered on or after February 17, 2016.

Also note:

1. The PTT applies to foreign entities, including:

  • Foreign national (i.e., an individual who is not a Canadian citizen or permanent resident, including a stateless person)
  • Foreign corporation (i.e., either not incorporated in Canada or incorporated in Canada, but controlled in whole or in part by a foreign national or other foreign corporation, unless the shares of the corporation are listed on a Canadian stock exchange)
  • Taxable trustee (i.e., a trustee of a trust that is a foreign national or foreign corporation, or a trust beneficiary that is a foreign national or foreign corporation).

2. The additional tax applies on the foreign entity's proportionate share of any applicable residential property transfer, even when the transaction may be exempt from the property transfer tax. This includes transactions such as:

  • A transfer between related individuals
  • A transfer resulting from an amalgamation
  • A transfer to a surviving joint tenant
  • A transfer where the transferee is or becomes a trustee in relation to the property, even if the trust does not change.

3. The additional tax does not apply to non-residential property, or to trusts that are mutual fund trusts, real estate investment trusts or specified investment flow-through trusts.

4. Registering a transfer - Foreign entities or their legal representative must file an Additional Property Transfer Tax Return (FIN 532) and pay any additional tax (with the general property transfer tax) at the time the property transfer is registered with the Land Title Office.

5. The amendments include anti-avoidance rules to prevent transactions designed to avoid the tax.

6. Where there are multiple transferees, if one transferee does not pay the required additional tax, the other transferees are liable for the unpaid tax. Transferees that fail to pay the additional tax as required may be subject to a penalty equal to the unpaid tax plus interest and a fine of $200,000 for corporations or $100,000 for individuals and/or up to two years in prison.

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2. Accounting Firm 2016 Budget Commentaries

For information on 2016 Federal, Provincial and Territorial budgets please see the following sites:

PricewaterhouseCoopers 
Deloitte 
BDO

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3. Law Firm 2016 Federal Budget Commentaries

4. Status of Tax Treaty Negotiations

For the Status of International Tax Treaty Negotiations on the Department of Finance website, scroll down past the yearly Notices to see the: In Force; Signed but Not Yet In Force and Under negotiation/re-negotiation details. Also included in this section of the Department of Finance website is an update on TIEA's. New from June is:

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5. Department of Finance - Summary of Outstanding Draft Legislation 2016

The Department of Finance Website lists pending, draft tax legislation.  This is where you can find links to the various Notices of Ways and Means Motions and draft technical legislative proposals which have not yet become law, as well as the Department of Finance's explanatory notes for the proposed tax changes.  If you're looking for the status of proposed tax legislation as it progresses though Parliament until it is Proclaimed into Force, please follow this link to the "Federal Statutory Updates".  For additional details on tax legislation contact the Finance official responsible for the particular piece of legislation.  Typically each piece of Draft Legislation provides the name of the responsible official and their contact information. New this month:

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B. CRA's Interpretations

7. MNR Presents Study on Tax Gap Estimation

On June 30, 2016 the Minister announced that CRA has taken the first step to follow through on its commitment to estimate Canada’s tax gap with the presentation of a study on tax gap estimation. This will help the government examine the difference between taxes that would be paid if all obligations were fully respected in all cases and the taxes that are actually paid and collected. The government argues that understanding this will help the Government of Canada crack down on tax evasion and tax avoidance.

This commitment is part of a series of measures announced by the Minister on April 11, 2016, to more effectively combat tax evasion and tax avoidance.

The release offers these additional observations:

  • 24 other OECD countries that estimate at least one aspect of their respective tax gaps.
  • also published was a document prepared by the Department of Finance Canada, which presents an estimate of the goods and services tax/harmonized sales tax (GST/HST) gap from 2000 to 2014.
  • CRA will also be consulting with stakeholder organizations, including the Canadian Tax Foundation, over the next year to ensure experts, academics, and other interested parties are contributing to Canada’s investigation of tax gap estimation
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8. Service-Related Complaint Form

One can only hope that CRA receives a deluge of its recently released Service-Related Complaint Form RC 193.  Maybe then they will put more effort into hiring and training staff that have a reasonable knowledge of the Income Tax Act.  I think most senior practitioners will tell you that it has become harder and harder to find officers with a solid understanding at the Appeals level of CRA and it is equally bad at the Audit level.

The result is that files take longer to get resolved and end up costing taxpayers more money than ever to have professionals handle their tax appeals.  It would be more than a little interesting to find out the value of taxes initially assessed that are subsequently eliminated before the reassessments make their way to the Tax Court.  Of course, there are a lot of lawyers and accountants who are only too happy to assist their clients in defending these reassessment proposals. However, one has to wonder at what cost.

Admittedly, taxpayers do make a lot a big “mistakes” in filing their tax returns, so it isn’t all one sided.  But given our system assumes you are guilty until proven innocent, one would hope the government would do a better job at training their staff.  So here’s hoping that taxpayers complain away – preferably when they have a real cause for concern.

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9. Request for Capital Dividend Account Balance Verification

If you are a private corporation, T2 schedule 89 is available to summarize the components making up your CDA balance as at a specified date. Taxpayers can use this schedule to request a CDA balance verification, or attach it to Form T2054, Election for a Capital Dividend Under Subsection 83(2), if you are paying out a capital dividend from your CDA. To proceed, mail or fax one completed copy of this schedule, separate from any other return, to your tax services office. However, CRA advises that taxpayers can only request a CDA balance verification once every three years unless filed with Form T2054 “Election for a Capital Dividend Under Subsection 83(2)”.  However, note that an election under subsection 83(2) cannot exceed the balance of the capital dividend account (CDA). If the election amount exceeds the account balance, the corporation may be required to pay Part III tax on the excessive dividends.  So basically, taxpayers will want to use their right to secure confirmation of their CDA balance only when they intend to make a CDA distribution.  Get it wrong and you are looking are big penalties.

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10. CRA Guides and Releases

11. GST/HST/PST

Executive TaxBriefs is dedicated to providing the most current monthly updates on income tax matters affecting Owner-managers.  However, in this news item we also provide links to resources related to important GST/HST/PST resources.

CRA pages on GST/HST:

New GST/HST Forms, Guides or Releases this month:

Provincial PST:

BC PST - General 
BC PST - Verify a PST No. 
BC PST - LegislationRegulations, and Exemptions 
BC PST - Publications and Bulletins

SK PST - General 
SK PST - Legislation 
SK PST - Bulletins

MB PST - General 
MB PST - Legislation 
MB PST - Bulletins

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12. CRA Prescribed Interest Rates and Bank of Canada Exchange Rates

Except for the interest rate for corporate taxpayers’ pertinent loans or indebtedness, prescribed interest rates have not changed since the last quarter.  Interest rates for the third calendar quarter of 2016 are as follows:

  • Overdue taxes 5%
  • Overpaid taxes/non-corporate 3%
  • Benefits and overpaid corporate taxes 1%
  • Change: The interest rate for corporate taxpayers’ pertinent loans or indebtedness will be 4.50%.

Follow this link for prior period prescribed interest rates.

For exchange rates see:

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13. Technical Interpretations, Folios, Interpretation Bulletins and Audit Manual Note

TECHNICAL INTERPRETATIONS: ("TIs") are not published on CRA’s website although inquiries regarding such items may be made directly to the Rulings Directorate by e-mail to itrulingsdirectorate@cra-arc-gc.ca.  

Currently, a website called Tax Interpretations is providing free access to these copyrighted protected materials.  To locate a specific technical interpretation go to http://taxinterpretations.com/ and enter the number of the TI in their search box.

FOLIOS: The Canada Revenue Agency (CRA) issues income tax folios to provide technical interpretations and positions regarding certain provisions of our income tax law. Due to their technical nature, folios are used primarily by tax specialists and other individuals who have an interest in tax matters. While the comments in a particular paragraph in a folio may relate to provisions of the law in force at the time they were made, such comments are not a substitute for a review of the law as enacted from time to time. Folio readers are cautioned to consider such commentary in light of the relevant provisions of the law in force for the particular tax year being considered.  For more information see the Income Tax Folios Index.

INTERPRETATION BULLETINS: Current Listing by IT No.ITB and IT Technical News Index - By Section, by Topic, and more.

AUDIT MANUAL:  CRA's internal audit policies and procedures are now available for review by outsiders in their Audit Manual large parts of which have been disclosed to the public and are available on our website as released January 2012.

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14. NAL Transfer of ECP Pre-2017 and AL Sale Post

TI2016-0641851E5 - 2016/06/07 - Business and Employment Division of the Rulings Directorate

The "eligible capital property" regime will be replaced on January 1, 2017 with rules for a new "capital cost allowance class" (Class 14.1). According to CRA, the following will be the opening balance in Class 14.1 on January 1, 2017:

"Generally speaking, proposed paragraph 13(37)(a) provides that the total capital cost of Class 14.1 at the beginning of January 1, 2017 is 4/3 of the amount that would be the CEC pool balance at the beginning of January 1, 2017; plus 4/3 of the amount of deductions taken that have not been recaptured; less 4/3 of any negative CEC pool balance at the beginning of January 1, 2017."

In this Technical Interpretation, the taxpayer seeks comments from CRA on how the grind to CEC from eligible capital property acquired from a non-arm's length person is accounted for under the new CCA rules. The CEC balance is reduced by variable A.1:

"is the amount required, because of paragraph (1)(b) or 38(a), to be included in the income of a person or partnership (in this definition referred to as the “transferor”) not dealing at arm’s length with the taxpayer in respect of the disposition after December 20, 2002 of a property that was an eligible capital property acquired by the taxpayer directly or indirectly, in any manner whatever, from the transferor and not disposed of by the taxpayer before that time,"

Where the property is ultimately disposed of, the grind will no longer apply, allowing the taxpayer to recognize the higher CEC on the sale.

Under the new CCA proposed legislation, the taxpayer is unable to determine how the CEC balance will be restored on a subsequent sale. CRA has acknowledged the problem and referred the matter to the Department of Finance.

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15. Taxability of Employer-Provided Tuition Assistance

TI2015-0623221E5 - 2016/04/26 - Business and Employment Division of the Rulings Directorate

It's generally understood that any benefit received in the context of one's employment will be taxable. Acccording to paragraph 11 of the decision of the Federal Court of Appeal in McGoldrick v. Canada (2004 FCA 189):

“As a general rule, any material acquisition in respect of employment which confers an economic benefit on a taxpayer and does not constitute an exemption falls within paragraph 6(1)(a)... Where something is provided to an employee primarily for the benefit of the employer, it will not be a taxable benefit if any personal enjoyment is merely incidental to the business purpose”

In this Technical Interpretation, the taxpayer is seeking comments from CRA on whether tuition assistance provided by an employer to the family member of an employee is considered income to the employee. The tuition assistance is provided through a scholarship plan in the collective agreement negotiated between the employer and the employee union. In response, CRA references s.6(1)(a)(vi) of the Tax Act, which is an exception to an income inclusion under s.6(1)(a). The subparagraph states:

"that is received or enjoyed by an individual other than the taxpayer under a program provided by the taxpayer’s employer that is designed to assist individuals to further their education, if the taxpayer deals with the employer at arm’s length and it is reasonable to conclude that the benefit is not a substitute for salary, wages or other remuneration of the taxpayer;"

The key here is that the employee and the employer are dealing at arm's length and that the tuition assistance is not a substitute for salary or wages of the employee. CRA lists the following factors in determining whether assistance is a substitute for salary and wages:

  • the employee does not receive lower salary, wages, or other remuneration than other employees (i.e., employees with similar credentials, similar job functions, experience, seniority, etc.) whose family members do not receive (or are not eligible to receive) tuition assistance;
  • the employee does not forego salary, wages, or other remuneration to which he or she is entitled (currently or in a future year), to fund or partially fund the tuition assistance;
  • there is no evidence which links the tuition assistance to a specific reduction in the employee's salary, wages, or other remuneration.

This is a nice exception to the general employee income inclusion rule under s.6(1)(a).

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16. Application of Non-Capital Losses by Newly Amalgamated Corporation

TI2016-0651951E5 (F) - 2016/6/20 - Reorganizations Division of the Rulings Directorate

Amalgamating companies within the corporate group is a strategy often used to utilize losses. Amalgamating companies need to be of the same jurisdiction, and it is always important to ask the question whether amalgamating makes sense from a non-tax prospective.

When amalgamating companies, losses of the predecessor corporations can be carried forward and applied against income of the amalgamated company. Losses of the amalgamated company cannot be carried back unless the predecessors had a parent/subsidiary relationship, and only against the income of the parent. According to 1.47 of Folio S4-F7-C1:

Subject to the restrictions in ss.111(3) to 111(5.4) and paragraph 149(10)(c), ss.87(2.1) permits the new corporation to deduct any net capital losses, non-capital losses, restricted farm losses, farm losses or limited partnership losses of the predecessor corporations in the same manner and to the same extent that such losses would have been deductible by the predecessor corporations had there not been an amalgamation. Ss.87(2.1) generally does not allow losses incurred by the new corporation to be carried back and applied against the taxable income of any predecessor corporation, nor does it affect the determination of the fiscal period or income of the new corporation or any predecessor corporation. However, for amalgamations of a corporation (referred to in this paragraph and in paragraph 1.52 – 1.53 as the parent corporation) and one or more of its subsidiary wholly-owned corporations, ss.87(2.11) will allow the new corporation to carry back losses incurred after the amalgamation to the predecessor parent corporation (see paragraph 1.52).

Also see our June TaxBrief Article 25 - Application of Losses on a Wind-up or Amalgamation.

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17. Can a Partner of an LP File a S.39(4) Election

TI2014-0559961E5 (F) - 2016/6/20 - Reorganizations Division of the Rulings Directorate

Whether Canadian securities are held as inventory or capital property is a question of fact. The question turns on the intention of the taxpayer, but because it is difficult for CRA to determine what the true intention of the taxpayer is, CRA often considers the surrounding facts, including history of similar transactions, nature of the property, knowledge of the taxpayer, secondary intention, etc. What is certain, however, is that CRA has a predisposition to treat all gains as income gains and all losses as capital losses, whereas taxpayers have a predisposition to treat all gains as being on account of capital and all losses as being on account of income.

Many taxpayers invest in securities, with some wins and some losses. Trying to ascertain whether trades are on account of income or capital would be difficult. s.39(4) of the Tax Act does provide taxpayers with certainty, if they are willing to make the election. The provision states:

"Except as provided in subsection 39(5), where a Canadian security has been disposed of by a taxpayer in a taxation year and the taxpayer so elects in prescribed form in the taxpayer’s return of income under this Part for that year,

(a) every Canadian security owned by the taxpayer in that year or any subsequent taxation year shall be deemed to have been a capital property owned by the taxpayer in those years; and

(b) every disposition by the taxpayer of any such Canadian security shall be deemed to be a disposition by the taxpayer of a capital property."

In this Technical Interpretation, the taxpayer is seeking comments from CRA on whether a limited partner in a limited partnership can make an election under s.39(4). In response, CRA references s.39(4.1), which deems partners (limited partners too according to CRA) to own and dispose of the Canadian securities owned by the limited partnership. The provision states:

"For the purpose of determining the income of a taxpayer who is a member of a partnership, subsections 39(4) and 39(5) apply as if

(a) every Canadian security owned by the partnership were owned by the taxpayer; and

(b) every Canadian security disposed of by the partnership in a fiscal period of the partnership were disposed of by the taxpayer at the end of that fiscal period."

However, CRA is quick to point out the restrictions on the availability of the s.39(4) election. According to s.39(5):

"An election under subsection 39(4) does not apply to a disposition of a Canadian security by a taxpayer (other than a mutual fund corporation or a mutual fund trust) who at the time of the disposition is

(a) a trader or dealer in securities,

(b) a financial institution (as defined in subsection 142.2(1)),

(c) to (e) [Repealed, 1995, c. 21, s. 49(3)]

(f) a corporation whose principal business is the lending of money or the purchasing of debt obligations or a combination thereof, or

(g) a non-resident,

or any combination thereof."

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18. Tax Treatment of Taxable Dividends Received by Beneficiary of a Trust

TI2016-0647621E5 - 2016/6/3 - Reorganizations Division of the Rulings Directorate

This Technical Interpretation is in French and has been translated.

Income received by a beneficiary of a trust is deemed to be income from property. However, designations can be made for certain types of income of a trust that allows for the income to retain its original character when it is paid out to be beneficiary. S.104(19) of the Tax Act deems a taxable dividend of the trust to be a taxable dividend received by the beneficiary and not received by the trust.

In this Technical Interpretation, the taxpayer is seeking comments on when such income is received by the beneficiary. According to the preamble of s.104(19):

"…deemed to be a taxable dividend on the share received by a taxpayer [the beneficiary], in the taxpayer’s taxation year in which the particular taxation year ends [the trust]…"

CRA states that the beneficiary receives the dividend at the end of the trust's taxation year, and provides the following explanation:

"This position is based on the fact that the trust cannot make the designation before the end of its taxation year and that the requirement that the trust is resident in Canada throughout the year cannot be satisfied until the end of the taxation year of the trust."

When the taxable dividend is received may have an effect on the tax treatment of other items. Specifically, in terms of whether corporations are connected, Paragraph 8 of Interpretation Bulletin IT-269R states:

"For purposes of ¶6, the determination of whether an assessable dividend was received from a “connected” corporation must be made at the time that the dividend was received by the recipient corporation. If the assessable dividend was received from the payer corporation at a time when that corporation was not connected to the recipient corporation (see ¶11), then the dividend is subject to Part IV tax as described in ¶6(a), notwithstanding that the payer corporation may have been connected to, or might subsequently become connected to, the recipient corporation at some other time during the taxation year."

Practitioners should be mindful of this timing issue to avoid an unexpected Part IV assessment against the dividend.

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19. Tainting of a Spousal Trust and Application of Para 8 of IT-305R4

TI2016-0632631C6 - 2016/05/03 - Question 4 - CALU (Conference for Advanced Life Underwriting) Roundtable – May 2016

A rollover of property to a spouse or to a spousal trust is an effective tool to minimize or defer tax. Such rollovers can be done inter vivos or on death. On an inter vivos transfer, tax effectiveness may be reduced until the death of the transferor spouse, due to attribution.

The conditions of a spousal trust created on death can be found in s.70(6)(b) of the Tax Act:

"a trust, created by the taxpayer’s will, that was resident in Canada immediately after the time the property vested indefeasibly in the trust and under which

(i) the taxpayer’s spouse or common-law partner is entitled to receive all of the income of the trust that arises before the spouse’s or common-law partner’s death, and

(ii) no person except the spouse or common-law partner may, before the spouse’s or common-law partner’s death, receive or otherwise obtain the use of any of the income or capital of the trust,"

In this Technical Interpretation, the taxpayer is seeking confirmation from CRA that paragraph 8 of Interpretation Bulletin IT-305R4 is still valid. The paragraph states:

"Once a trust qualifies as a spouse trust under the terms of subsection 70(6), it remains a spouse trust and is subject to the provisions affecting such trusts (for example, paragraph 104(4)(a)) even if its terms are varied by agreement, legal action or breach of trust. However, these events may cause other provisions of the Act to apply, such as paragraph 104(6)(b) and subsections 106(2) and 107(4)."

Hence, according to paragraph 8, it would seem that even if the conditions on the restriction of income and capital are subsequently breached, such a breach would not taint the trust as the time to determine whether the trust is a spousal trust is at the time it was created.

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20. Folio S2-F3-C2: Benefits and Allowances Received from Employment

Folio S2-F3-C2 explains the federal income tax treatment of benefits and allowances received from employment. The Chapter discusses the specific provisions of the Act and the principles developed by the courts that establish which benefits and allowances are included in an employee’s income and the amount to be included.

For a less technical overview of employment benefits and allowances and a comprehensive list of common employment benefits and allowances, CRA recommends that taxpayers look to Guide T4130 – Employers’ Guide Taxable Benefits and Allowances.

Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment, replaces and cancels Interpretation Bulletin IT-470R (Consolidated), Employees’ Fringe Benefits, ¶7 and 8 of IT-131R2, Convention expenses, ¶12 of IT-148R3, Recreational Properties and Club Dues, and Income Tax Technical News No. 40.

CRA notes that in addition to consolidating content from the former publications, general revisions have been made to improve readability. Any substantive technical and interpretive changes to the information from the former publications are described in Chapter History.

Please note the following changes:

¶2.2 - 2.4 are added to discuss the tax treatment of benefits and allowances received by an individual who is both an employee and a shareholder of a corporation. The paragraphs also highlight the importance of establishing whether such benefits and allowances are conferred on an individual in the capacity of an employee or shareholder.

¶2.6 is added to discuss the meaning of the terms salary, wages and other remuneration.

¶2.33 - 2.35 (formerly included in ¶24 of IT-470R) are expanded to provide a general description and overview of the tax treatment of employer contributions to and benefits received from a group sickness or accident insurance plan. ¶2.34 is added to reflect paragraph 6(1)(e.1), which was added by S.C. 2012, c. 31, s. 2(2) and (3). Paragraph 6(1)(e.1) applies to contributions made to a group sickness or accident insurance plan that provides lump sum payments or pays benefits where there has been no loss of employment income. The amendment applies to contributions made on or after March 29, 2012, that are attributable to an employee’s coverage after 2012.

¶2.26 (formerly included in ¶3 and 10 of IT-470R) is updated and example 6 is added to reflect the Federal Court of Appeal’s decision in The Queen v Carroll A. Spence, 2011 FCA 200, 2011 DTC 5111, which concluded that it is the fair market value of a benefit that should be included in an employee’s income. The paragraph also discusses the meaning of the term fair market value.

This Folio covers the following subjects:

  • Employee-shareholder
  • Definitions
  • General overview
  • Employment benefits
  • General
  • Economic advantage
  • Primary beneficiary
  • Value of a benefit
  • Third-party benefits
  • Personal capacity
  • Automobile benefits
  • Group sickness or accident insurance plan
  • Group term life insurance policy
  • Other employment benefits
  • Excluded benefits
  • Health and medical
  • Disability-related
  • Counselling services
  • Education for family members
  • Part-time employment
  • Special work sites and remote work locations
  • Employment allowances
  • Excluded allowances
  • Special, separation, or representational allowances
  • Board and lodging allowances - amateur athletes and members of recreational programs
  • Travel allowances
  • Motor vehicle allowances
  • Administrative policies
  • Reporting and withholding requirements
  • Application
  • Reference
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C. Tax Court Cases

21. Undeclared Dividends Result in Gross Negligence and Penalties - Melman

Melman (2016 TCC 167) is a TCC decision of Bocock J involving the imposition of gross negligence penalties. In 2007, two holding companies owned and controlled by the taxpayer paid him dividends totaling $15. 08 million, yielding $18. 85 million in taxable dividends. Unfortunately, the accountants for Mr. Melman failed to include those dividends in his 2007 tax return and the taxpayer did not read or review the tax return before signing it due to time constraints.  CRA imposed gross negligence penalties against Mr. Melman and, of course, he appealed.

Of interest is the court’s finding that “Mr. Melman was and is one of the most knowledgeable, highly educated and experienced merchant bankers in this country and perhaps beyond. He specializes in balance sheet enhancement and income stream optimization. He is a former executive vice-president of a major Canadian Chartered bank. He sat on boards of directors for companies and organizations whose names appear daily in the business pages of national and international newspapers. Although he indicated he had a lack of knowledge regarding the specifics of the Canadian tax system, his testimony revealed a keen and deep knowledge of equities, debt and related income and profits generated from such property, namely shares and bonds of companies.

The TCC then went on to find that “[f]undamentally and statutorily, gross negligence errors occur within the return of income and their filing. This appeal is no different. Instead of reporting taxable dividends of $18,850,000.00, the sum of just over $2,500.00 was reported. As factually outlined above, the contrasts between reported and unreported income amounts shout from the line items within the 2007 return, whether representing total, net, and/or taxable income. The primary, rudimentary and simplest way for Mr. Melman to have detected the error was to review a draft copy, duplicate copy or execution copy of his tax return before he signed it. This simple and required act he admittedly did not do.”

In the end, the TCC confirmed, “[a]t signing, the critical time relevant to the Court’s assessment, Mr. Melman’s otherwise meticulous, watchful and exacting self lapsed. But for these identifiable and cumulative lapses, the Court believes that the omission of the dividends in the return would likely have been detected by Mr. Melman. The manifest and dramatic impact of the dividend omission on every important summary line item in the 2007 tax return cannot be understated. The Court’s balanced prediction of probable detection marches squarely along with Mr. Melman’s lazer beam and frequently relished detection and communication of other far less and sometimes inconsequential omissions, typos and other stylistic errors committed by his longstanding, trusted accountants, who were, themselves, relatively new arrivals to his personal holding companies for which 2007 T-5s were not prepared.”

As a result, the TCC concluded that the penalties were warranted because of wilful blindness to the content of actual 2007 tax return which Mr. Melman assented to, participated or acquiesced in with respect to the  omission of dividends in circumstances amounting to gross negligence.

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22. RRSP Beneficiary held Jointly Liable for Estate RRSP Liability - s.160.2 - O'Callaghan

O’Callaghan (2016 TCC 169) is a decision of the TCC which serves as a reminder for estate plannners that you need to be careful with RRSP beneficiary designations and the associated tax liability. When the taxpayer’ s brother died, she received about $275,000 from his two RRSPs under which she was the sole named beneficiary.  As a result of the deemed disposition of the RRSPs upon her brother’ s death, a tax bill of some $100,000 arose in her brother’s estate.

From the amount the taxpayer received from the RRSPs, she forwarded the sum of $135,000 to another sibling who became the brother’s legal representative.  The taxpayer argued that amount was to be used to pay the related tax liability inherited by the estate. The deceased brother’s tax liability relating to the deemed disposition of RRSPs was only partially paid leading CRA to assess the taxpayer under s. 160. 2 of Tax Act for the principal amount of brother’s outstanding tax debt being approximately $58,000.

Because the taxpayer was the sole beneficiary of her brother’s RRSPs and she received funds directly from the trustee of RRSPs without any deduction at source, the taxpayer became jointly and severally liable with the brother’s estate to pay the brother’s tax arising in his year of death.  CRA assessed the taxpayer on the basis that s.160.2(1) of Tax Act was applicable in the circumstances and all of its conditions were met for the assessment on a joint and several liability basis.

The taxpayer argued that the deceased’s estate has the primary liability for any taxes owed in respect of the RRSPs and that s.160.2 of the Tax Act only applies if the deceased’s estate does not have sufficient assets to pay the liability arising out of the RRSPs. As the deceased’s estate had sufficient assets to pay the tax owing on the RRSPs, the taxpayer argued that CRA was not entitled to assess the appellant for the tax owing.

S. 160.2(1) of Tax Act did not impose any obligation on CRA to attempt to collect the unpaid estate taxes from the estate or its representative before issuing the s.160.2(1) assessment.  In addition, the TCC held that the cheque remitted to her brother in his personal capacity, approximately eight months before he was appointed as legal representative of estate, could not be considered in any way as payment of tax as the Tax Act specifically required that payments of any tax amounts owing be paid directly to Receiver General.

Accordingly, the appeal was dismissed.  It never fails to amaze this writer what family will do to one another over money.  We don’t know all the facts in this case but one can well imagine.  Perhaps estate planners should insist on a list of wishes or instructions for all beneficiaries of an estate when preparing a Will.  This set of instructions would explain how the assets and liabilities of the deceased are to be handled. Of course the presumption is that people will seek professional advice, but that is not always the case – at least until things go wrong, when it is often too late!

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23. Another Complex Tax Avoidance Plan Bites the Dust - Golini - TCC

Golini (2016 TCC 174) is a decision of Miller, J. of the TCC that represents the latest in a long series of cases involving complicated tax driven scams that have been shut down by the courts.  The decision could well have been based on that well known leagal maxim: “if it seems too good to be true …”.  This plan was called by CRA’s counsel as the “smoke and mirrors” plan while the taxpayer’s advisors called it the “RCA Optimizer Plan”.  What is interesting is that the court neither relied primarily on a finding that the transactions were a sham nor did it rely on GAAR.  Instead the court looked to ss. 15(1) and 246(1) to conclude the taxpayer received a taxable benefit within the meaning of s.15(1) in the amount of $5.4 million.  Failing that the court also concludes that some of the transactions are sham transactions and failing that concludes that the transactions are GAARable as they defeat the legislative intent and underlying policy of s.84(1) of the Tax Act.

The actual transactions are very complex - as demonstrated by the 14 charts attached to the judgement as schedule A.  One will realize from the following description that these arrangements were very much tax driven:

  • Taxpayer and his successful business undertook complicated planning arrangement for taxpayer’s retirement in consultation with Empire advisors
  • Scheme involved exchange of shares between taxpayer’ s two holding companies H Co. and O Inc., $6 million bridge loan from bank, purchases of annuity and of insurance policy, offshore transactions moving funds into Canadian company to make loan of $6 million to taxpayer, guaranteed by H Co., for purchase of O Inc. shares with dividend
  • CRA assessed taxpayer, denying claimed interest expense of approximately $400,000 and including in income taxable dividend in amount of $7.5 million
  • Documents clearly reflected taxpayer’s obligation to pay $40,000 per year in guarantee fee to H Co. and $80,000 in interest to Canadian company until earlier of death or 15 years, in return for receiving loan for $6 million
  • Immediate access to $6 million tax free, with only obligation of guarantee fee of $40,000 for 15 years was benefit arising from his taxpayer’ s position as shareholder and conferred by H Co.
  • Regardless of whether there was absolute assignment or assignment arising only on default, transactions were structured so that there would be no sensible reason for taxpayer to repay loan
  • H Co. was using its assets to pay taxpayer’s debt, regardless of whether documents would allow him to behave irrationally and forego that benefit
  • Given that guarantee was pre-ordained to come into play, $40,000 annual guarantee fee was inadequate
  • Transactions increased taxpayer’s net worth
  • H Co. agreed to use insurance proceeds from policy it owned to pay off its shareholder’s debt
  • Based on expert valuation evidence, H Co. conferred benefit of $5.4 million on taxpayer as its shareholder, clearly falling within purview of s. 15(1) of Tax Act.
  • Taxpayer was still allowed to claim $120,000 per year, whether identified as guarantee fee, interest, or simply fees to get benefit
  • On yearly basis, taxpayer would deduct interest payable on Canadian company’s loan while bringing in as taxable benefit interest portion ultimately absorbed by O Inc.
  • Apart from $80,000 cash payment, inclusion and deduction would offset one another, regardless of whether rate was 5.5 per cent or 8 per cent
  • Taxpayer was entitled to annual deduction of cash portion of $80,000
  • Effect of findings by TCC would increase taxpayer’s tax liability beyond amount assessed by CRA with result that appeal dismissed.
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D. Practitioners' Forum

24. Your Family Vacation Home: Succession Planning Considerations

The following Article is by Catherine Kim of Boughton Law Corporation.

The value of real estate in British Columbia and the Golden Horseshoe in Ontario has risen dramatically over the past decades and long-time owners of recreational properties have seen substantial growth in the value of their family “cottages’, many of which are full on secondary residences.  Where owners have held such properties for many years, the capital gains on the growth in value triggered upon death or a change of ownership can be significant.  For sentimental reasons, many wish to ensure that a cottage stays within the family upon their death. To avoid the unintended financial and personal consequences tied to the passing recreational property to the next generation, many families are implementing strategies to proactively address capital gains taxes as well as ownership and control of the recreational property. 

Capital Gains Taxes

Start by familiarizing yourself with some of the basic rules of capital gains taxes, which include but are not limited to the following:

  • Deemed Disposition on Death:  Upon death, your assets are deemed to have been disposed of at fair market value.  For example, a cottage purchased decades ago for $200,000 could now be worth $1,000,000 leaving you currently sitting on a $800,000 gain, half of which would be subject to capital gains tax based on your tax bracket – typically at a top marginal rate that would result in tax on the entire gain in the range of 25% or in our example $200,000 of taxes.
  • Capital Expenses: Expenses incurred on renovations and improvements on the cottage can be added to what you paid to acquire the property, raising your cost base for tax purposes and reducing any capital gains assuming that the expenses are capital in nature.
  • Spousal Transfer on Death: Upon death, ownership of the cottage property can be transferred to your spouse tax-free and on a “spousal rollover” basis, which defers capital gains taxes until the death of the surviving spouse.
  • Principal Residence Exemption: A principal residence is generally exempt from capital gains taxes and provided that you ordinarily inhabit the cottage at some point each year and earning rental income is not the primary motive for owing the property, the cottage could be designated a principal residence – this designation must be done annually – the principal residence exemption exempts from taxation a portion of an otherwise taxable capital gain on a principal residence determined by a formula the numerator of which  is the number of years you have designated the particular residence as your “PR” plus one (to deal with multiple residences in the year of a move) divided by the number of years one owns the PR.  If you own multiple residences (a family can only designate one PR each year), the key is to compare the capital gains that have accrued on each property.  Before designating the property with the largest accrued gain (the designations are not required to be filed annually – notwithstanding the requirements specified on the prescribed form), keep in mind that any gains that continue to accrue in a property you do not designate as your principal residence will eventually be taxed.

Transfer to the Next Generation

This is the tough part.  Assuming your family can deal with the tax bill, can you find a way for the kids to share the “family cottage”.   The starting point is to have an open conversation with your children to gauge their respective levels of interest in the cottage.  Include in your discussion details of the financial and maintenance responsibilities of the cottage and whether, in light of this, they would want to keep the property.  Where one child expresses a greater interest in the cottage over the others, one option is to leave the cottage to that child while leaving the remainder of your children with sufficient assets to maintain distributions out of your estate on an overall equal basis.  In these circumstances, planning for equal distributions requires a determination of the estimated net value of your estate and assessing what portion of the estate the cottage comprises.  Leaving control equally amongst your children could lead to endless family disputes after mom and dad are gone.  In many cases, it is just best to sell the property when mom and dad are no longer able to use it.  Otherwise the “family cottage” can just lead to a whole series of problems, never mind a tax bill that will have to be paid out of the estate’s available assets.  What is worse, if the “family cottage” happens to be in the US there may be a huge estate duties tax bill associated if no tax planning has been done.  In such circumstances, the best plan may be to sell the property before the death of the survivor of mom and dad.

If you decide to ultimately transfer the cottage to your children, consider the following options:

  • Inter Vivos Trust:  You may set up a trust to hold your cottage property naming yourself and your children as beneficiaries of the trust.  A trust separates the control and management of assets from its ownership and allows you to grant ownership of the cottage to the beneficiaries while retaining your continued use of the property.  Generally, a transfer of property into an inter vivos trust in favour of its beneficiaries gives rise to a deemed disposition of the property at fair market value.  However, in certain scenarios (such the use of an “alter ego” or “joint partner” trust), trusts can be structured to enable a transfer of your property into a trust without triggering capital gains tax.  Alternatively, you may decide to use your principal residence exemption to shelter any gain from the deemed disposition.  By holding a cottage property in a trust, taxes on any capital gains that accrue during the trust’s existence would be deferred until the beneficiaries ultimately sell or transfer title to the cottage.  Having the property held in the trust also removes such property from your estate, the benefits of which include reduced probate fees payable out of the estate and having the property fall outside the scope of wills variation claims involving your estate.  The terms of a trust can provide you as a trustee with both control and flexibility in how the trust operates, a major caveat being the “21-year deemed disposition” rule.  Under this rule, property held in trust is generally deemed to be disposed of at fair market value every 21 years.  Accordingly, any accrued capital gains are taxable every 21 years.  The 21 year deemed disposition rule does not apply  to “alter ego” and “joint partner” trusts but those trusts can only be utilized by settlors who are 65 years of age or older.
  • Testamentary Gift:  Ownership of the cottage can be passed to your children by way of your Will, or a testamentary trust, or a trust created under your Will that comes into effect upon your death.  The deemed disposition of your property at death would trigger tax payable by your estate on any accrued gains on the cottage, unless your property is transferred directly to your spouse or a spousal trust.  If you anticipate a taxable gain, life insurance can be obtained to cover the taxes payable upon the deemed dispositions of property at your death or the principal residence exemption may be available to shelter the gain specific to the cottage.  In forming part of your estate however, the cottage would be subject to probate fees and exposed to any wills variation claims made against your estate.  In considering the use of a testamentary trust, keep in mind that the progressive tax rates previously enjoyed by such trust, as well as estates, only apply for the first 36 months and thereafter testamentary trusts are now taxable at the top marginal rate.
  • Sale of Cottage to Your Children:  Gifting or selling the property to your children during your lifetime, and thereby relinquishing any control in the property, triggers immediate capital gains and taxes such as property transfer tax payable in your name, but any future gains will be taxed in your children’s hands when they eventually sell or transfer title to the cottage.  This option is ideal for properties with a minimal amount of accrued capital gains such as a recently purchased cottage or a cottage that otherwise has limited capital gains perhaps because of the fact that there have been substantial capital improvements over the years.
  • Joint Tenancy with Right of Survivorship:  Adding your children on as joint owners of the property has tax consequences similar to those of a sale  - although because adding a child as a joint tenant on title does perhaps represent the transfer of a full beneficial interest at the time and therefore a reduce taxable gain at the time – this may be a viable option that allows mom and dad to retain some control during their lifetime.  Upon the death of an owner, ownership of the property would pass to the surviving owner(s) without forming part of the deceased’s estate or triggering probate fees.  In such an arrangement, consider having a co-ownership agreement put in place to govern the management and control of the property.  The agreement should include an allocation of financial and maintenance responsibilities, a decision-making process for aspects such as use, renovations and financing, and processes triggered in the event of an owner’s default, incapacity or death.

Having a dialogue with your children and implementing an effective strategy to deal with capital gains taxes and ownership issues is a critical way of sparing your children from future conflicts that may otherwise end up in court and reduce the value of your estate.  If you are not prepared to do that, then serious consideration should be given to a sale of the property when mom and dad are no longer able to use the property.

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25. CRA Establishes Strategy to Investigate Canadian Properties Purchased with Offshore Money

A recent article in Business in Vancouver (BIV) identifies a secret strategy briefing for CRA auditors that has revealed plans to crack down on real estate tax cheats in Vancouver, with 50 auditors being assigned to investigate purchases funded by unreported foreign income.  The presentation notes for the seminar was delivered on June 2, 2016 and leaked to the South China Morning Post (SCMP).  Apparently the presentation acknowledges that there has been only one successful audit of worldwide income conducted in British Columbia in the past year.

The BIV indicates that the briefing says the crackdown will “review the top 500 highest risk files within our region” focusing on four areas:

  1. real estate projects,
  2. unreported worldwide income,
  3. property “flipping,” and
  4. under-reporting of capital gains from home sales and under-reporting of goods and services tax (GST) on sales of new homes.

The audits will focus on “individuals living in high-valued areas in B.C. who are reporting minimal income not supporting their lifestyle,” as well as those who buy “high-end homes with minimal income being reported.”

Property flippers who swiftly resell homes for profit will meanwhile be audited to see if their properties truly qualify for exemption from capital gains tax, granted to people selling their principal residence.

While a CRA spokeswoman said that “the CRA cannot comment or release information related to risk assessment or non-compliance strategies,” she said real estate transactions in Toronto have been the subject of greater scrutiny, for some years.

In addition to the 50 redeployed income auditors, the leaked briefing says CRA is assigning 20 GST auditors and 15 other staff to the real estate project in B.C.

Census data from 2011 has previously shown that 25,000 households in the City of Vancouver spent more on their housing costs than their entire declared income, with these representing 9.5% of all households.

But far from being impoverished, such households were concentrated in some of the city’s most expensive neighbourhoods, where homes sell for multimillion-dollar prices.

Yet the briefing says the crackdown “will not address the major concerns about affordability of real estate.”

The leaked documents show that in addition to the single audit on global income in the last fiscal year, CRA in B.C. conducted 93 successful audits on property flips, 20 on capital gains tax and 225 on under-reported GST. The audits yielded $14.4 million in new tax, of which $10 million was GST. There were $1.3 million in fines.

As of April 29, there were 40 audits of global income under way, 205 related to flipping, 34 related to capital gains and 428 related to GST.

The average Vancouver house price now sits around $1.75 million for the metropolitan region, while the Real Estate Board of Greater Vancouver’s “benchmark” price for all residential properties is $889,100, a 30% increase over the past year. However, incomes remain among the lowest in Canada, making Vancouver one of the world’s most unaffordable cities.

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26. Personal Income Tax Return Review by CRA

In an article published in its Tax Factor newsletter dated July 8, 2016, BDO writes to advise on CRA’s approach to processing more than 25 million personal income tax returns each year. As BDO notes, the vast majority of these returns are assessed without adjustment or review.

However, as BDO explains, in order to maintain the integrity of the tax system a number of returns are reviewed in more detail each year. Often CRA requests additional information to support a claimed tax deduction or tax credit prior to assessing a personal income tax return

How does CRA determine which returns to review?  BDO explains that “[b]ased on the rules of statistical averages, at some point your personal income tax return may be one of those selected by the CRA for review. It is important to note that a pre- or post-assessment review is not an audit, and if your return is selected for review, it is not an indication that the return was prepared incorrectly.”

The four main reasons why CRA may select  a return review include:

  1. random selection;
  2. comparison of information on returns to information received from third-party sources, such as T4 slips from your employer or T5 slips from financial institutions;
  3. certain types of deductions taken or credits claimed; and
  4. an individual’s review history. (In situations where you were selected for review in a previous year, and where an adjustment was made to the claim that was reviewed, you may find that you will again be subject to a CRA review in a subsequent year).

BDO advises that whether a return is electronically filed or paper filed does not affect one’s chances of being subject to a CRA review. However, be sure to keep invoices and receipts for income received and expenses or credits claimed on your return.

In general, the law requires that receipts and other documents supporting a tax return be kept for at least six years after the year in which they were claimed. This means that records for the 2015 calendar year should be kept at least until the end of 2021.

Supporting documentation frequently requested by CRA includes support for claims for:

  • medical expenses,
  • charitable donations,
  • child care expenses,
  • child fitness expenses,
  • foreign tax credits,
  • tuition fees,
  • business investment losses,
  • moving expenses,
  • support payments,
  • proof of payment of foreign taxes when a foreign tax credit is claimed
  • and where employment expenses are claimed be ready to provide –
    • Form T2200, Declaration of Conditions of Employment
    • a letter from his employer stating the amounts that were paid to the taxpayer for travel and motor vehicle expenses
    • a listing of vehicle expenses
    • a listing of meals and entertainment expenses, and receipts for all expenses claimed
    • receipts for all expenses claimed.

Taxpayers should also be cautioned that CRA routinely matches information reported on an assessed tax return to other information that has been provided by other sources. Make sure that all T4s and T5s are included.  Failure to do so could result in penalties even if no additional tax is owing. 

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27. CRA Assesses 1,000 Pharmacists for $58M for Incentives Received from Generic Drug Companies

In a recent article from Fasken Martineau dated July 21, 2016, Jenny P. Mboutsiadis advised that after a four year investigation, CRA has assessed more than 1,000 pharmacists for unreported benefits received from generic drug companies. The benefits included gift cards, travel vouchers, and pre-paid credit cards given to pharmacists by generic drug companies to entice them to substitute their product for brand-name products when filling prescriptions.

CRA auditors identified 15 pharmacies in Newfoundland and Labrador that had failed to report the benefits.  The probe eventually expanded across the country and the CRA went as far as getting a Federal Court order requiring the generic drug companies to disclose information about the incentives they gave to pharmacies. Subsequently, the CRA sent letters to approximately 22,000 pharmacies inviting them to review their tax returns and report any unreported benefits. The CRA gave the pharmacies an opportunity to avoid penalties if they voluntarily corrected their tax returns and paid the corresponding tax and interest due.

The author reports that “CRA says that the total unreported income is more than $58 million. Although no criminal charges were laid, financial penalties for failing to report the benefits as income were levied on those who did not take up the CRA’s offer to voluntarily correct their returns. It is noteworthy that these penalties and the corresponding interest can sometimes surpass the original tax due on the income amounts.”

What is interesting is CRA bulk review approach to going after an industry, or taxpayers with similar business activities, with respect to a particular tax matter. CRA uses these “projects” of a way of efficiently tackling an area where it suspects widespread non-compliance or abuse. Auditors are provided with specialized training to familiarize them with the industry so that they can identify anomalies, and then taxpayers in that industry are audited quickly and methodically.

The bottom line suggested by the author is that if a taxpayer becomes aware of a project in their area of business and finds themselves in a position that may attract CRA attention, they should consider making a filing under CRA’s Voluntary Disclosures Program (VDP). A successful VDP application means that a taxpayer will not be charged penalties or prosecuted with respect to the disclosure, and some interest relief may be granted as well.

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28. Tax Advantages for Canadian Unlimited Liability Companies (ULC)

The following Article is by Catherine Kim of Boughton Law Corporation.

When incorporating a Canadian subsidiary, a US business can opt for its subsidiary to be a corporation whose shareholders have limited liability or for it to be an unlimited liability company (“ULC”).  Shareholders of a ULC face different levels of liability for the corporation’s debts and liabilities depending on the province the company incorporates under.  Alberta, British Columbia and Nova Scotia allow for the creation of ULCs under each of their corporate statutes. 

Despite the shareholder’s exposure to liability, ULCs are commonly used by US investors to carry on business in Canada primarily to allow the US parent company to look through the ULC so as to permit the US shareholder to get full credit of Canadian taxes paid by their Canadian ULC subsidiary against the taxes payable in the US by that parent on the Canadian income.  It should be noted that ULCs are treated as a taxable Canadian corporation for Canadian tax purposes.  For US tax purposes, where a ULC has one shareholder it is treated as a flow-through or disregarded entity and where the ULC has more than one shareholder, it is considered a partnership.  As such, ULCs are a “hybrid” entity being considered a taxpayer in one jurisdiction and “fiscally transparent” in another.  “Fiscally transparent” is used in the sense that the entity itself does not incur tax obligations in regards to its income, rather it is its owners that incur the tax obligations. 

Income Tax Advantages

In contrast to Canada, the US does not provide full integration between corporate and personal taxation that results from corporate structures.  As such an important advantage is that ULCs avoid double taxation in the US.  Where a US corporation is the sole shareholder of a Canadian ULC, the ULC will be disregarded as an entity separate from its shareholder unless it elects otherwise and this enables the income of the ULC to be consolidated with that of its US parent.  The consolidation of income generally allows the US parent to claim foreign tax credits in the US to offset Canadian tax paid by the ULC.  Overall, this structure may enable a US parent with a ULC subsidiary to pay a lesser total amount of taxes than if the US parent used an ordinary corporation as a subsidiary.

With the above mentioned consolidation of income, ULCs also enable losses to flow through to its shareholder to offset the income of any US shareholder and also permit investment in passive Canadian investments without attracting US anti-avoidance rules applicable to foreign holding companies.  With a ULC, a US shareholder can elect to treat the ULC as a corporation for US income tax purposes such that income of the ULC will not be taxed in the US until it is repatriated.  Canadian tax rates are generally lower than US tax rates and the ability to make this election provides US shareholders with flexibility in deferring US income tax on the ULC’s income.

Withholding Tax and Article IV(7)(b) Anti-Avoidance Rule

As a starting point, recall that dividends paid by a Canadian corporation to a non-resident are subject to 25% Part XIII withholding tax under the Income Tax Act (Canada).  However, the rate of withholding tax may be reduced under Canada’s bilateral tax treaties.  ULCs may also enjoy favourable tax treatment on their retained earnings.  Where a US parent corporation is the sole shareholder of a Canadian ULC and the US parent satisfies the limitation on benefits provision of the Canada-US Tax Convention (the “Convention”), retained earnings of the ULC can be repatriated to the US parent with only 5% Part XIII withholding tax applying to the distribution.  The 5% withholding tax may also be offset by a foreign tax credit.  However, in order to qualify for the 5% withholding tax in light of the anti-avoidance rule in Article IV(7)(b) under the Convention, the repatriation of retained earnings to the US parent must be completed though a two-step distribution, which is outlined below.

Article IV(7)(b) is an anti-avoidance rule applicable to “hybrid” entities which, as discussed above, includes ULCs.  The rule was added to the Convention to counter the abuse of the distinct treatment of hybrids in different countries for the purposes of reducing tax.  Essentially, Article IV(7)(b) prevents treaty benefits from applying if:

  1. the “Source State” (i.e., the country from which amounts are paid, such as Canada) views the payee as receiving the amount from a payer resident in the Source State;
  2. the payer is treated as fiscally transparent under the law of the “Residence State” (i.e., the country in which the payee is resident, such as the US); and
  3. because of the payer being treated as fiscally transparent under the law of the Residence State, the treatment of the amount received by the payee is not the same as its treatment would be if the payer were not treated as fiscally transparent under the law of the Residence State.

The application of the above to a Canadian ULC with a US Parent, is as follows:

  1. Canada views the US parent as receiving the dividend from a corporation resident in Canada;
  2. the ULC is treated as fiscally transparent in the US; and
  3. since the ULC is treated as fiscally transparent, the dividend is disregarded for US tax purposes whereas it would not be disregarded if the ULC were not treated as fiscally transparent.

Based on the foregoing, the anti-avoidance rule in Article IV(7)(b) catches dividends paid by a Canadian ULC to its US parent thereby preventing a reduction of the 25% Part XIII withholding tax. 

The Two-Step Distribution

Article IV(7)(b) is widely considered to be broader than necessary in that it inadvertently captures transactions that are not abusive tax avoidance.  A ULC distributing retained earnings to its US parent is generally understood as an example of how the anti-avoidance rule adversely impacts a transaction that is not abusive.  CRA appears to share this view as it has allowed a method, known as a “two-step distribution”, to get around Article IV(7)(b) and to permit a ULC’s retained earnings to be repatriated with only 5% withholding tax applying to the distribution.  As noted above, the two-step distribution can be used provided that a US parent corporation is the sole shareholder of a Canadian ULC and that it satisfies the limitation on benefits provision of the Convention. 

The two-step distribution is outlined as follows:

  1. Increase in PUC:  ULC increases the paid-up capital (“PUC”) on a class of its shares by capitalizing retained earnings.1  For Canadian tax purposes, the increase in PUC on a class of shares by capitalizing retained earnings triggers a “deemed dividend” on those shares and the amount of the deemed dividend is equal to the increase in PUC.  The amount of the deemed dividend is also subject to Part XIII withholding tax but the withholding tax is reduced to 5% pursuant to the Convention.  Article IV(7)(b)’s anti-avoidance rule does not apply to deny treaty benefits because the deemed dividend would be disregarded for US tax purposes regardless of whether the ULC is fiscally transparent or not.  Therefore, the third requirement of Article IV(7)(b) is not met, and the rule does not apply.
  2. Reduction of PUC:  ULC reduces its newly created capital and distributes that amount to its US parent.2  A reduction of capital on a class of shares does not give rise to Canadian taxation provided the reduction does not exceed the amount of PUC on that class of shares.  Accordingly, the ULC can return capital to its US parent without triggering further tax as long as the returned amount is not in excess of the amount of retained earnings capitalized in step 1 above.  Generally, this return of capital does not trigger US taxation.

ULCs can be useful vehicles for implementing investment or expansion by US investors and businesses into Canada.  However, assessing whether a ULC is appropriate requires a careful consideration of the circumstances relating to the US investor and business, as well as the goals of the investor.

For a quick overview of a BC ULC see the linked summary.

Footnotes:  Due to formatting restrictions, footnotes in this article are listed below.

  1. Under corporate law, the PUC of a class of shares generally equals the capital of that class of shares.  Accordingly and under corporate law, the capitalization of retained earnings increases PUC by the amount capitalized.  For ULCs incorporated in BC, retained earnings can be capitalized by a directors’ resolution or an ordinary resolution of the shareholders.
  2. For a BC ULC, a reduction of capital is completed by a shareholder’s special resolution.
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