Tax Blog

UK Court rescinds non-contractual voluntary distribution from trust

In Kennedy & Ors v. Kennedy & Ors, [2014] EWHC 4129 (Ch), a voluntary distribution (appointment) of shares was mistakenly made from a trust to a beneficiary, generating a large tax liability in the UK.  The UK’s High Court of Justice Chancery Division said the principles set out in Pitt v Holt, [2013] 2 AC 108 were satisfied in this case. The beneficiary mistakenly believed the particular clause in the document, which distributed the entire remainder of the trust fund including the shares, gave effect to his earlier instructions under which the particular shares were not to be distributed to him.  The trustees mistakenly believed the clause was in accordance with the beneficiary’s instructions (paragraph 37).  These mistakes were causative and very serious (paragraph 38), did not involve artificial tax avoidance (paragraph 39), and were such that it would be unjust to leave them uncorrected (paragraph 36).  As to the remedy, the mistake made the non-contractual voluntary disposition voidable in equity not void at law (paragraph 41).  The equitable remedy of rectification was not available on the evidence, as this would mean rewriting the clause to exclude from the distribution the particular shares only (paragraph 43).  The equitable remedy of rescission applied because the clause was self-contained and severable and could be rescinded in its entirety (paragraph 46).

CRA would deny request for change to fiscal period of partnership

In 2014-0529311E5, the CRA considered a hypothetical case where a partner was selling its partnership interest and wished to cause a fiscal year end for the partnership before the sale (under s. 249.1(7)).  This change would allow the departing partner access to the partnership’s losses realized before the sale.  Without this change, the partnership’s losses could be reduced by the partnership’s profits realized after the sale and before the end of the partnership’s fiscal period.  The rule in s. 96(1.01) would be of no assistance to the departing partner, as the losses might be eliminated by the end of the partnership’s fiscal period.  The CRA said it would deny the request to change the partnership’s fiscal period on these facts because a change in fiscal year is allowed only where the change is prompted solely by sound business reasons.  Personal convenience of a taxpayer or some tax benefit is not considered a sound business reason (in this context).  Furthermore, in this case the proposed change would result in misaligning the fiscal periods of the multi-tier partnership contrary to the underlying rationale of s. 249.1(1)(c).

CRA rules non-resident not taxable on indirect sale of Canadian real estate

In 2014-0527221R3, the CRA considered whether a company resident in Israel would be taxable in Canada on the sale of a Canadian corporation (Holdco) that owned shares of another Canadian corporation (Opco) whose value was derived from underlying Canadian real estate.  The CRA ruled that the sale was not taxable.  Although the shares of Holdco were taxable Canadian property under the Income Tax Act (Canada), the sale was exempt from tax in Canada by reason of Article XIII of the Canada-Israel tax treaty.  Specifically, the directly held property of Holdco (being the shares of Opco) could not be said to consist principally of real estate situated in Canada.

CRA rules tracking shares acceptable for DSU plan

Paragraph 6801(d) of the Regulations (Reg. 6801(d)) prescribes an exception to the salary deferral arrangement rules for a deferred share unit (DSU) plan that provides for the following: (i) the employee (or his estate) may receive an amount after the employee’s death or retirement (the Event) and no later than the end of the first calendar year commencing after the Event, and (ii) the amount depends on the fair market value (FMV) of shares of the corporate employer (or a related corporation) within the period that commences one year before the Event and ends at the time the amount is received. However, the DSU plan is disqualified under the postamble in Reg. 6801(d) where the employee (or non-arm’s length person) is entitled to obtain a benefit granted for the purpose of reducing the impact of any reduction in the FMV of the shares. In 2012-0457101R3 (recently released), the CRA Rulings Directorate considered whether amendments could be made to an existing DSU plan to add a new class of DSUs based on shares that tracked underlying limited partnership interests in a particular partnership (Tracking Shares), without disqualifying the DSU plan under Reg. 6801(d). The CRA ruled that the amendment could be made. In particular, the postamble in Reg. 6801(d) continued to be met because no action could be taken to reduce the impact of any downward fluctuation in the FMV of the Tracking Shares.

Tax Court Allows Credit for Portion of Inflated Donation Receipts

In David v. Canada (2014 TCC 117), the Tax Court of Canada allowed six appeals concerning the disallowance of charitable donation tax credits on inflated donation receipts.

In each of these appeals, the taxpayers (or their spouses) received inflated donation receipts after donating only 10% of the face value of the receipt. The taxpayers claimed charitable donation tax credits based on their donation receipts and the Minister disallowed the entirety of the credits. The taxpayers appealed to the Tax Court of Canada.

Like its position in other similar cases, the Crown took the position in David that the tax credits were properly disallowed on the basis that the expectation of receiving an inflated tax credit was a benefit that negated any gift otherwise made. The main issue on appeal was therefore “whether an expectation of an inflated tax credit based on an inflated donation receipt is a benefit that negates the gift”.

Relying on the Doubinin case (2005 FCA 298) – a case which the Court acknowledged had very different facts from those in David – the Court held that “the issuance of an inflated tax receipt should not usually be considered a benefit that negates a gift”. The Court further found that while the Doubinin case seems to leave open the possibility that extraordinary circumstances could be taken into account in the analysis, there were no such circumstances to take into account in David.

This is a notable case in that the taxpayers were successful in obtaining a charitable donation tax credit for the 10% of the donation receipt that they had in fact donated. In a number of other recent decisions (e.g., Dhillon, 2014 TCC 25; Johnson, 2014 TCC 84), the taxpayers were not so successful and their credits were disallowed.

CRA applies the GAAR to deny ruling on rollover to a corporate partnership

In 2014-0547321C6, the CRA considered a ruling request which involved a tax-deferred transfer (rollover) of depreciable property to a captive Canadian partnership under s. 97(2), followed immediately thereafter by the contribution of cash to the partnership by a non-resident (as a new partner).  The cash contributed by the non-resident was used to pay out a note that was issued on the rollover.  The CRA confirmed that the GAAR Committee denied the requested ruling on the ground that the transactions resulted in a misuse or abuse of the Act having regard to the rules in s. 100(1), 100(1.4), and 100(1.5).  In particular, had the transactions instead involved a rollover to the captive Canadian partnership followed by a direct sale of a partnership interest to the non-resident, a portion of the deferred recapture (on the rollover) would have been fully taxed under s. 100(1) (on the subsequent sale).  Accordingly, in the CRA’s view the transactions as structured resulted in abusive tax avoidance under s. 245.  The CRA did not expressly comment on whether the result could be different if the partnership held only capital non-depreciable property.

CRA discloses rulings on active trade or business test in LOB Article

Paragraph 3 of Article XXIX-A of the Canada-US tax treaty (Treaty) can extend treaty benefits to a US resident that is not otherwise a qualifying person under the Treaty with respect to certain income derived from Canada. Such income must be derived in connection with, or be incidental to, the active conduct of a trade or business (other than certain investment businesses) carried on in the US by the US resident, or a person related to the US resident, and the US trade or business must be “substantial” in relation to the activity carried on in Canada giving rise to the income. In 2014-0549621C6, the CRA disclosed four cases where the CRA ruled that the US business was substantial in relation to the Canadian activities. In one of these cases, the ratio of US assets and revenues to the Canadian assets and revenues was 0.5 to 1, and the ratio of US employees to the Canadian employees was 0.1 to 1.

Tax Court finds forgiven debt was not disposed of to the debtor company

In Gaumond v. The Queen, 2014 TCC 339, a shareholder forgave his loan to a company as part of the company’s proposal in bankruptcy, which proposal allowed the company to emerge from bankruptcy and continue its R&D activities.  The shareholder claimed a business investment loss (BIL) on the forgiven loan under s. 39(1)(c).  The Tax Court of Canada (TCC) disallowed the BIL on the ground that the loan was not disposed of to anyone when forgiven, let alone to an arm’s length person as required by s. 39(1)(c)(ii).  The TCC also noted the absence of a comparable provision to s. 84(9), which provides (for greater certainty) that where a shareholder has disposed of a share of a corporation as a result of the redemption, acquisition or cancellation of the share by the corporation, the shareholder is deemed to have disposed of the share to the corporation.

TFSA Audits Continue

It’s early 2015 and the CRA continues to aggressively audit Tax-Free Savings Accounts (TFSAs), going as far back as 2009 when TFSAs were first introduced. And why not? There is typically no time limit on issuing these types of assessments.

Two main kinds of assessments have come to the fore within the TFSA context. The first is an advantage assessment issued to the holder (the person who contributes the money). The second is for carrying on business within the TFSA (for example, actively trading stocks), issued to the trustee of the TFSA itself.

Advantage assessments are issued under Part XI.01 of the Income Tax Act. In contrast, ordinary income taxes are assessed under Part I. Part XI.01 has its own regime for filing returns, reporting any advantages, and paying tax on those advantages. A person who had no inkling that there was an advantage associated with a TFSA would not even think to file a Part XI.01 return. Without such a return, there is no initial assessment (even a nil assessment). Without an initial assessment, the normal three-year limitation clock does not begin to tick. The CRA can therefore come along at any time thereafter and assess an advantage.

Assessments taxing business income are issued to the trustee of the TFSA itself, as most TFSAs are trusts. Most trusts (including TFSAs) are technically required to file a tax return under Part I of the Income Tax Act each year, but nobody thinks to file a tax return for a TFSA – a tax-free savings account. Furthermore, the trustee – not the contributor – would be responsible for filing the return, not the beneficiary/contributor. Again, without an initial filing to generate at least a “nil” assessment, the limitation period never starts.

In sum, the CRA continues to adopt a leisurely pace in auditing TFSAs. They are, unfortunately, entitled to do since the types of assessments being issued are rarely, if ever, precluded by the limitation periods in the Income Tax Act.

Can CRA Renege on an Assessing Agreement?

Occasionally, the CRA agrees with a taxpayer, in advance, to assess tax in a particular way. Those agreements arise most frequently in the context of advance income tax rulings but, as in Szymczyk v. The Queen, 2014 TCC 380, other instances can arise. Are assessing agreements binding on the CRA?

In 1981, the Department of Finance substantially revamped the Income Tax Act rules determining the amount of employee automobile benefits. General Motors, concerned with the complexity of the new rules and the administrative costs that would be incurred in tracking and computing the auto benefits for its executives and senior managers, approached Revenue Canada (predecessor of the CRA) with a proposal to use a simplified calculation for computing auto benefits. In 1982, Revenue Canada issued a letter agreeing with GM’s proposal, and the simplified formula was used by GM without incident for many years.

In 2010, CRA audited the GM executives and senior managers. CRA determined that the simplified formula contained in the letter agreement was not mandated by the Income Tax Act, and reassessed to include additional standby charges and operating expense benefits in the employees’ incomes. Mr. Szymczyk took issue with the government reneging on its agreement, and appealed.

His first appeal was to the Federal Court of Canada (2013 FC 1219 (CanLII)). There he argued that the CRA was estopped from assessing past years contrary to the agreement. The Federal Court held that it did not have jurisdiction, and that Mr. Szymczyk ought to go to the Tax Court to determine the correctness of the assessment. So he did.

The Tax Court appeal was heard under the informal procedure, reserved for small amounts in issue and theoretically having no precedential value. In the end, the case was decided on a technical pleadings issue (which will be of no use to others who were assessed on the same basis as Mr. Szymczyk). However, the Tax Court did make some useful comments about the scope of an assessing agreement.

On the issue of estoppel, the Court stated (para 38): “Although the Minister cannot be bound if an approval is contrary to law, in my view, an approval should not be set aside by courts too readily on grounds that it is contrary to law. Latitude should be given to the approval unless it is clearly not supportable by the law.” This is a sensible view of the effect of an assessing agreement. If there is some support for the position, it should be upheld.

Despite apparently upholding the validity of the letter agreement, the Tax Court went on to state that the facts and the law had materially changed since 1982 when the letter agreement was issued. These changes were sufficiently material to invalidate further reliance upon the letter agreement. Absent the pleadings point, it appears that the CRA would have otherwise succeeded. This will encourage CRA, where it does not like the result, to strive to find “material” differences between the represented facts and the actual facts. Beware in drafting advance income tax ruling requests.

It remains to be seen whether another case from this group will be pushed forward to be determined on the merits.