Tax Blog

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.

CRA confirms that a two-partnership structure would not constitute a tiered partnership

In 2014-0528001E5, the CRA was asked to consider a situation where an existing partnership (Partnership A), having an off-calendar fiscal year end, formed a second partnership (Partnership B) indirectly through a subsidiary of Partnership A (A Co).  The other partners of Partnership B dealt at arm’s length with the members of Partnership A.  The CRA confirmed that s. 249.1(1)(c) would not apply to force Partnership A to have a fiscal year end of December 31.  Partnership A’s indirect investment in Partnership B – through A Co – would not in and of itself engage s. 249.1(1)(c), because that provision contemplates a membership interest in one partnership that is held, directly or indirectly through one or more partnerships, by another partnership.  Here the interposition of A Co would break the required link between Partnership A and Partnership B.

CRA says non-interest-bearing loan may engage s. 69

In 2014-0532651E5, the CRA said that a non-interest-bearing loan from one Canadian corporation to another (the latter, a charitable foundation) may engage s. 69(1)(a) if the loan were not repayable on demand.  In these circumstances, the CRA is of the view that the cost of the loan may be less than the principal amount – engaging other rules such as the interest accrual rules in s. 12(9) and Regulation 7000.  However, I find it difficult to see how s. 69(1)(a) could apply in these circumstances.  Even if the two corporations are not dealing at arm’s length, it would seem difficult to conclude that the corporation which makes the loan actually acquires the loan “from” the other corporation (as required by the text of s. 69(1)(a)).

Finance releases revised back-to-back financing rules

Canada has long had an inbound financing rule designed to ensure that Canada’s thin capitalization rules could not be circumvented through a back-to-back loan – phrased in terms of one non-resident member of a group lending funds to another person (an intermediary) on condition that the intermediary in turn lend funds to a Canadian member of the group. In the February 11, 2014 federal budget, the government announced expanded rules designed to capture certain variations of back-to-back loans and their economic equivalents, not only for thin capitalization purposes but also for withholding tax purposes. These rules were further revised when released as draft legislation in August 2014. My Quick Report contains is a very high-level description of these rules, as applied to a foreign-controlled corporate group.

CRA confirms assignment of debt does not constitute repayment

In 2013-0482991E5, the CRA was asked to consider a situation where a Canadian subsidiary (Canco) of a foreign parent (Parent) had lent funds to a foreign company in the group (Debtco). Canco owed Parent a like amount. Rather than Debtco repaying Canco and Canco repaying Parent, Canco simply assigned to Parent the debt owed by Debtco. The CRA confirmed its view that this assignment would not constitute “repayment” of the debt by Debtco for purposes of s. 15(2.6). Accordingly, if the debt remained owing by Debtco for more than one year after the end of the taxation year of Canco in which the loan was made, the loan would be deemed to be a dividend paid by Canco under s. 15(2) and s. 214(3)(a) – triggering Canadian withholding tax (see page 4). Furthermore, if the loan owed by Debtco were instead “novated” to avoid this withholding tax, the CRA would consider applying the general anti-avoidance rule in s. 245 (see page 5).

McKesson: Appellate Advocacy and the Recusal of a Trial Judge

The rules which govern the adversarial trial and appellate process, as distinct from the inquisitorial process, have evolved to help ensure that the issues, as defined by the parties, are decided on the evidence as led by the parties and the applicable law. Counsel are advocates on behalf of the parties and the judge is an impartial adjudicator who hears the evidence, listens to submissions, decides the facts on the basis of the evidence, applies the law to the facts and renders a decision. The appeal process is to ensure that error on the part of the judge may be identified and, where necessary, remedied.

Within this, the conduct of counsel is to be governed by applicable professional rules of conduct including civility and the process, as between counsel and as between counsel and the judge is not to be personal and is not to be personalized. That said, advocacy may be forceful, trials may be fiercely contested, opposing counsel may disagree with one another and counsel and judges may also at times find themselves in disagreement.

And while disagreement will generally be couched in appropriate legal language, such as that a trial judge has erred in his or her interpretation or application of law or has misapprehended the evidence, the legal language and the formal trial or appellate process may not eliminate the fact that counsel who have been ruled against, or a judge whose judgment has been appealed, will feel a personal sting. The robes of counsel and of the judiciary will not always protect against this.

The recent decision of McKesson Canada Corporation v. The Queen, 2014 TCC 266 provides a rare example of where it appears that litigation became, or was perceived as becoming personal as between counsel and the trial judge. In McKesson, the trial ended and appellant’s counsel filed an appeal. However, the trial judge was still seized with the issue of costs and a second incidental issue. On the basis of the notice of appeal and factum that was filed by counsel for the appellant, the trial judge recused himself on his own motion from hearing and deciding the remaining issues.

To begin, it is uncommon that a trial judge would refer to a notice of appeal or factums which have been filed against his or her judgment, but in McKesson the judge wrote:

It is not my habit to review the factums filed in the Federal Court of Appeal in respect of my decisions. In this case, the Appellant’s Factum was drawn to my attention or sent to me by several prominent Canadian tax lawyers as well as by a colleague on the Court.

With the factums having been brought to his attention, the trial judge wrote that he “became aware that the Appellant and Appellant’s counsel… had made certain public written statements about me in its factum in the Federal Court of Appeal…which, upon reflection, appear to me to clearly include:

  1. allegations that I was untruthful and deceitful in my Reasons;
  2. clear untruths about me, what I said and heard in the course of the trial, as well as the existence of evidentiary foundations supporting what I wrote in my Reasons; and
  3. allegations of impartiality on my part.”

It is on this basis that the trial judge decided, on his own motion to consider whether to recuse himself.

In his reasons, the trial judge observed that “[c]ounsel on each side in the appellate court is free to make whatever arguments they wish, including claiming or denying support in the record, the use of emphasis and spin, or even trying to argue a case it thinks it can win instead of the case it has. That is all of counsel’s choosing…” That said, the trial judge did not leave it for the appellate court to decide whether the appellant’s “emphasis and spin” had merit such that the appeal must be allowed. And, for purposes of the recusal motion, the trial judge considered and addressed several of the grounds of appeal advanced by the appellant and it is in this portion of the reasons that the apparent division between the appellant and appellant’s counsel, and the trial judge becomes unfortunate.

To illustrate, under the heading “Where it Appears That the Appellant States in its Factum Untruthful Things About the Trial Judge”, the trial judge referred to the appellant’s factum in which it was pleaded that “the Trial Judge discarded the case pleaded and argued by the parties and decided the appeal on grounds that were not raised in the pleadings or argued at trial, but made their first appearance in the Trial Judge’s Reasons well after the trial was over.”

The trial judge addressed this as follows:

 It appears very clear to me that, while the Appellant may have every right to seek to challenge the evidentiary foundation of my conclusions and findings, they have simply told clear untruths about me and what I did or did not say when they state that McKesson’s tax motivation was not ever put to them during the trial and that they were therefore deprived of any opportunity to address it. (Emphasis added)

The trial judge used similarly strong language as he addressed other arguments advanced by the appellant. For example, in response to whether the trial judge addressed a particular issue in the course of the trial, the trial judge wrote: “One can read what they will into the Appellant’s decision not to argue the point or conduct redirect examination, but it appears to me to be patently untrue that I did not raise it with the Appellant early, at times when they could respond with additional evidence, with a summary of the evidence to change my impression, or with whatever legal argument they chose.” (Emphasis added)

Further, and similarly: “For the Appellant to state in their Factum that I am the one who raised these issues, without them ever being raised at the trial, and that I raised them independently for the first time in my Reasons, appears to me to be the Appellant again telling clear untruths about me.” (Emphasis added)

In a separate section, the trial judge concluded that the appellant’s factum was “deliberately misleading” and “inherently and demonstrably untrue”. “I believe the Appellant was telling untruths about me that go beyond the appellate advocacy craft of colour, spin and innuendo.”

The trial judge concluded that on the basis of the “public allegations” raised by the appellant, “I am unable to decide the remaining matters impartially.”

In his concluding remarks, the trial judge addressed the personal attack which he perceived had taken place against him:

Canadians should rightly expect their trial judges to have broad shoulders and thick skins when a losing party appeals their decision, but I do not believe Canadians think that should extend to accusations of dishonesty by the judge, nor to untruths about the judge. Trial judges should not have to defend their honour and integrity from such inappropriate attacks. English is a very rich language; the Appellant and its counsel could have forcefully advanced their chosen grounds for appeal without the use of unqualified extreme statements which attack the personal or professional integrity of the trial judge.

Within the law governing the circumstances under which a judge must recuse him or herself, there is a presumption that members of the judiciary are impartial and it is a presumption that is not easily set aside. The test as characterized by one court is to ask: “What would an informed, reasonable and right-minded person, viewing the matter realistically and practically, and having thought the matter through, conclude?”

The McKesson case will almost certainly prompt discussion and debate within the legal community and it might be that the community will one day have the benefit of the wisdom and guidance that might flow from the decision of an appellate court. Until then, informed, reasonable and right-minded people will likely view it as altogether unfortunate that the appellate advocacy of senior and respected counsel has caused a senior and respected trial judge to find that he has been accused of dishonesty, and in so finding, to also conclude that statements which are untrue have been made against him. For the parties to the litigation who hope to have the legal issues addressed and resolved, for the legal community which is generally close knit and collegial, and for the public who is looking in, this is unfortunate indeed.

CRA issues another favorable ULC ruling under the Canada-US treaty

When the Canada-US tax treaty was amended by the Fifth Protocol (effective 2010), new Article IV(7)(b) was added to eliminate treaty benefits for certain hybrid entity arrangements which generated deductions in Canada but no corresponding income pick-up in the US.  The actual wording of the new rule inappropriately extended to simple Canadian unlimited liability company (ULC) structures, which did not achieve this mischief.  For example, Article IV(7)(b) applied to deny the treaty withholding tax rate on interest and dividends paid by a Canadian ULC to its a US parent company, notwithstanding that the ULC was disregarded for US tax purposes and therefore all of the ULC’s income was (immediately) taxed in the US.  The Canada Revenue Agency (CRA) has since issued favorable rulings which allow such US parent companies to restructure and thereby avoid the technical application of Article IV(7)(b).  Ruling 2013-0491331R3 (recently released) is the latest of such rulings:

  1. The US parent formed a limited partnership with one of its shareholders, and thereafter transferred to the partnership its interest-bearing noted owed by the ULC.
  2. This simple step meant that the actual wording of Article IV(7)(b) would not be engaged, and interest paid by the ULC to the partnership would be exempt from withholding tax under Article XI(1) of the treaty.
  3. The CRA further confirmed that Canada’s general anti-avoidance rule would not apply because all of the ULC’s income would continue to be subject to tax in the US.  In other words, no abuse arose because the restructured arrangement did not result in the mischief to which Article IV(7)(b) was directed.