Tax Blog

CRA interprets upstream loan rules to avoid double tax

In 2013-0499121E5, the CRA considered a simple case where an upstream loan was made to a Canadian parent (Canco) by a second tier foreign affiliate (FA 2), and was effectively sheltered by Canco’s exempt surplus in respect of FA 2.  FA 2 later liquidated into the first tier foreign affiliate (FA 1).  The CRA said that it would apply the helpful rule in s. 248(28)(a) to remedy the technical double tax problem that arises on these facts.  Double tax arises because: (a) the loan assigned to FA 1 on the liquidation of FA 2 would become a second upstream loan to Canco from FA 1, and (b) the first loan from FA 2 would not have been repaid by Canco on the liquidation of FA 2.

CRA says threshold for business is extremely low

In 2014-0536581I7, the CRA was asked why the so-called fresh start rule for foreign affiliates (s. 95(2)(k) & (k.1)) applies only to income from a foreign affiliate’s business and not to the affiliate’s income from property.  In response, the CRA said that “the threshold amount of activity that is required to cause any corporation (including a FA) to be considered to be carrying on business is extremely low”.  This general principle (among others) will be discussed at the upcoming annual conference of the Canadian Tax Foundation in Vancouver on December 1, 2014.

How to Calculate the Distance when Claiming Moving Expenses

The recent decision of Hauser v. R. 2014 TCC 328 is an illustration of the principles to be applied when determining whether moving expenses are deductible.  The taxpayer moved in order to have a shorter commute to her new job.  The only issue was whether her new home is at least 40 kilometers closer to her new work location such that the move would be an “eligible relocation” as defined in subsection 248(1) of the Income Tax Act.

The Minister argued that the distance should be measured by a major urban road.  If that is the appropriate method of measurement, the new home is only 25 kilometers closer to the new work location.

The taxpayer argued that the preferred route of travel is a freeway around the city to bypass detours and delays caused by the construction on the urban road.  Using the freeway distances, the new home is 45 kilometer closer to the new work location.

Referring to Giannakopoulos v. MNR, 95 DTC 5477 (FCA), the Court said the relevant principle to be applied is that the distance must be determined by the shortest route that one might travel to work, as long as it is a normal route used by the traveling public.

The urban route is a shorter route than the freeway, but was it a normal route used by the traveling public while it was under construction?  The Court said it is appropriate to determine the distance using a route under construction as long as the construction does not last an inordinate amount of time.  The construction project started to cause delays in 2010 and was expected to be completed by November 2012.  The taxpayer moved around August 2012.  Although some evidence showed that the construction lasted longer than expected, the Court found the duration of the construction was not so long as to disqualify the urban road from being the basis of the calculation.  Accordingly, the Court dismissed the appeal.

Time Running Out for “Immigrant Trust” Structures

On February 11, 2014, the federal government announced that it intended to repeal the so-called “immigrant trust” exception found in section 94 of the Income Tax Act (Canada) (the “ITA”). Due to the limited transitional rules provided (and no grandfathering), taxpayers generally have (at most) until the end of this year to remedy immigrant trust structures before they become subject to Canadian tax.

By way of background, a non-resident trust is deemed to be resident in Canada under ITA 94 if there is a “resident beneficiary” under, or a “resident contributor” to, the trust. A long-standing exception to that rule applies to trusts the only contributors to which are individuals who have not been resident in Canada for more than 60 months – commonly referred to as “immigrant trusts”.

Under the draft legislation implementing the government’s announcement, immigrant trusts will generally be deemed resident in Canada from January 1, 2014 onwards (and subject to Canadian tax on income it earns thereafter) unless they meet two stringent criteria: (1) the trust would have been deemed resident in Canada from January 1, 2014 to February 10, 2014 if it were not for the “immigrant trust” exemption; and (2) no “contribution” (which can capture a wide array of transactions) is made to the trust after February 10, 2014 and before 2015. If those requirements are met, an immigrant trust will only generally be deemed resident in Canada beginning January 1, 2015 (provided the 60-month period has not already expired by that date).

Onerous income tax consequences may arise if an immigrant trust continues in existence beyond 2014 (even if the trust can avail itself of the delayed effective date). With the proper tax advice, it may be appropriate to take steps to wind-up or repatriate an immigrant trust structure. Unfortunately, the time for doing so is quickly running out.

CRA restricts new PLOI regime to “new” loans after March 28, 2012

In 2013-0506551E5, the CRA confirmed its view that a loan made after March 28, 2012 cannot benefit from the new regime for a “pertinent loan or indebtedness” (PLOI, s. 15(2.11)) if such loan were part of a “series of loans and repayments” which began before that time.

  1. Instead, the (original) loan made before March 29, 2012 would be caught by the deemed dividend rule in s. 15(2).  The exception in s. 15(2.6) would not save this original loan from s. 15(2), because repayment of the loan would be part of the series of loans and repayments.  Accordingly, any election later filed under s. 15(2.11) in these circumstances would be considered invalid.
  2.  The CRA’s position applies only were there has been “a series of loans and repayments”.  This latter concept is not satisfied where there is: (i) a bona fide loan for a genuine business purpose, (ii) a repayment of that loan from an independent source, and (iii) an unrelated subsequent loan for a wholly different purpose: see Meeuse v. The Queen, 94 D.T.C. 1397 (TCC), at paragraph 16.

CRA confirms views on LTD payments to US resident

In 2014-0531441E5, the CRA confirmed that payments to a US resident under an unfunded long-term disability (LTD) plan by a Canadian employer would be considered salary.  As such, the payment would be subject to employment-related withholdings in Canada (under s. 153).  These payments would also be considered pension income as defined in paragraph 3 of Article XVIII of the Canada-US tax treaty (Treaty).  Accordingly, the US resident could file a tax return in Canada and request a refund of the amount withheld in Canada, to the extent such amount exceeded the maximum 15% rate specified in Article XVIII of the Treaty.

First Reading of BC’s Proposed Liquefied Natural Gas Income Tax Act

On October 21, 2014, Minister of Finance, Michael De Jong, tabled the proposed Liquefied Natural Gas Income Tax Act (the “LNG Act”) for first reading in the BC legislature.  The LNG Act imposes taxation on net income derived from natural gas liquefaction activity in respect of liquefied natural gas (“LNG”) facilities in BC.  The new regime will apply to taxation years beginning on or after January 1, 2017.

The text of the proposed LNG Act can be found here. An overview of the LNG Act’s application, published by the Province of BC, can be found here.  Some of the key features of the LNG Act are as follows:

  • Taxation under the LNG Act is separate from income tax levied under the Income Tax Act (Canada) and the provincial BC Income Tax Act. For some taxpayers all three taxation regimes will be applicable, but it is also possible for a taxpayer to be subject only to the LNG Act, and not the federal/provincial regimes.
  • Taxation under the LNG Act is determined on a per-LNG facility basis. That is, a taxpayer may file a single return under which multiple income streams are consolidated at a single LNG facility. However, where a taxpayer generates income at more than one LNG facility, the taxpayer must file a separate return in respect of the income from each such LNG facility. The LNG Act contains detailed provisions on what constitutes liquefaction activities and LNG facilities.
  • A taxpayer under the LNG Act is any person (corporation, individual or trust) that engages in or has income derived from liquefaction activities at an LNG facility in BC, whether or not the person is liable for any tax under the LNG Act. Such a taxpayer need not be resident in Canada nor is a permanent establishment in BC required. Partnerships are taxed at the partner level.
  • The taxation base under the LNG Act is divided into two general schemes: taxation on net income and taxation on net operating income. A 3.5% rate of taxation is imposed on net income (this rate will be increased to 5% on net income for taxation years beginning on or after January 1, 2037). A 1.5% rate of taxation is imposed on net operating income.
  • Net operating income (taxed at 1.5%) is based on a taxpayer’s profit or loss from business or property derived from liquefaction activities at, or in respect of, an LNG facility in BC. The computation of net operating income is similar to the computation of a taxpayer’s income under the Income Tax Act (Canada), adjusted for various inclusions and exclusions specific to the LNG context. Of particular relevance is the investment allowance deduction in respect of a taxpayer’s ‘adjusted capital investment account’ for an LNG facility.
  • Net income (taxed at 3.5%, and rising to 5% in 2037) is a taxpayer’s net operating income plus any proceeds of the disposition of capital investment property that results in recapture, less certain deductions in respect of net operating losses and capital investment account balances (where applicable).
  • The LNG Act contains a transfer pricing regime that is modeled on the transfer pricing regime under the Income Tax Act (Canada). A summary of the LNG transfer pricing regime, published by BC, can be found here. While both regimes rely on a similar application of the ‘arm’s length principle’, there are some key difference which should be observed. Most notably, under the federal regime, the transfer pricing rules apply to non-arm’s length transactions between taxpayers and non-resident taxpayers, while under the LNG Act, the transfer pricing rules apply to all non-arm’s length transactions (subject only to specific exclusions).

The LNG Act is not yet passed into law; however, persons active in the LNG sector should familiarize themselves with its potential application. The LNG Act should be carefully considered prior to carrying out investment or activity in BC’s LNG sector to ensure that such efforts are carried out in a tax-efficient manner.

The above points do not represent an exhaustive summary of the proposed LNG Act. Over the coming months, the new legislation will likely be the subject of increased commentary as it progresses through the BC legislature.

TCC finds principal purpose of business was to derive rental income

In 0742443 B.C. Ltd. v. The Queen, 2014 TCC 301, the company provided storage units along with other services.  The company argued that its net revenue from all activities constituted active business income for purposes of the small business tax regime in s. 125.  The Tax Court disagreed.  Here are some brief observations.

  1. There was no question company carried on a business.  The company was not merely a passive person simply drawing income from property.  Rather, the company was engaged in at least some activity connected with earning rental revenue.  Accordingly, the company was earning income from business, not income from property – as a general principle.
  2. However, carrying on a business (alone) is not sufficient to gain access to the preferential tax rate in s. 125 (paragraph 14).  Excluded from this preferential rate is a business the principal purpose of which is to derive income from property (paragraph 14).  This statutory test looks to the nature of the revenues earned in the business (paragraph 15).
  3. On the facts, the principal purpose of the company’s business was to derive rental revenues from its storage units.  In some cases, there may come a tipping point where the provision of services overcomes the provision of property (paragraph 29).  This tipping point was not reached on the facts here.

CRA reverses two prior positions in foreign affiliate context

The CRA recently reversed two prior positions in the foreign affiliate context: one on the redemption of preferred shares in a controlled foreign affiliate, the other on the recharacterization rule in s. 95(2)(a)(ii)(D).

  1. In 2014-0528361E5, the CRA reversed its prior statement in 2012-0439741I7. The CRA (now) agrees that a premium realized by a Canadian parent company (Canco) on the redemption of mandatory redeemable preference shares held in its controlled foreign affiliate results in proceeds of disposition, and not a dividend. Canco may change this result by filing an election under s. 93(1), so as to convert a capital gain into a deemed dividend. Such election can be useful where the deemed dividend would be considered paid from underlying exempt surplus, which is essentially tax free to Canco (s. 113(1)(a)).
  2. In 2014-0519801I7, the CRA reversed – without explanation – its prior position in 2013-0496841I7. In the latter document, the CRA concluded that s. 95(2)(a)(ii)(D) did not apply to a complex restructuring so as to convert interest income into active business income (in respect of a purchase note). Although not clear from 2014-0519801I7, the CRA may have reversed this prior position based on the words “directly or indirectly” in s. 95(2)(a)(ii).

Federal Charities that Haven’t “Continued” under New Legislation Risk Triggering Tax Liabilities

October 17, 2014, three years from the date the Canada Not-for-profit Corporations Act (CNCA) generally came into force, is the deadline under the CNCA for federal charities and non-profits incorporated under the old Canada Corporations Act to formally “continue” under the CNCA.  The requirements for the transition are described here.  Corporations Canada intends to start the dissolution process immediately for charities and non-profits that have not continued by the deadline.

For an active charity, dissolution could involve disastrous GST/HST implications in addition to potentially crippling income tax implications.  The charity would cease to exist as a legal person, which would generally lead to the revocation of its status as a registered charity.   Consequently, supplies by the charity that were previously GST/HST exempt because of that status could become taxable.

Steps should be taken immediately by any federal charity that has not yet continued under the CNCA.

This blog was co-written by Noah Sarna and Rosemary Anderson.