Following the presentation at the 2017 STEP Canada National Conference, we are pleased to provide you with a summary of the questions discussed at the Canada Revenue Agency ("CRA") Roundtable. Each question is followed by Gowling WLG's summary of the oral responses provided by the CRA. Although we believe our notes accurately summarize the CRA responses, we cannot guarantee that they do. Readers are advised to use the notes that follow with discretion and to refer to and rely on CRA’s official written responses when they become available.
1. Paragraph (b) of the Definition of "Specified Corporate Income"
The inclusion of paragraph (b) in the definition of specified corporate income ("an amount that the Minister determines to be reasonable in the circumstances") in subsection 125(7) creates significant uncertainty in the application of the small business deduction rules. This kind of administrative discretion by the Minister over the determination of an amount, outside of the realm of valuation and arm's length price, appears to be without precedent in the context of the Income Tax Act. Can the CRA advise on how the Minister intends to exercise its administrative discretion in relation to this proposed provision, and in what circumstances would it do so?
The Department of Finance Explanatory Notes indicate that the Minister could determine a lower amount than the paragraph (a) amount as the amount that is reasonable. What is reasonable in the circumstances is a question of fact. CRA will only be able to provide specific examples once it has had the opportunity to consider specific circumstances.
2. GAAR and Capital Distribution to Canco Beneficiary
At the 2016 CTF Annual Tax Conference Roundtable, the CRA indicated that it was considering whether the general anti-avoidance rule ("GAAR") in subsection 245(2) should apply to a situation involving a distribution from a discretionary family trust to a Canco the shares of which are held by a newly established discretionary family trust, thereby avoiding the 21-year deemed disposition that would have otherwise applied if the property had not been distributed by the first trust. Has the CRA made a determination in respect of this matter, and, if so, what are the factors relevant to this determination?
At the 2016 CTF annual tax conference, the CRA provided its opinion on the operation of GAAR in this scenario. The transactions described result in an old trust transferring property to a new trust indirectly (by way of a corporation), thereby avoiding the application of subsection 104(5.8) and deferring capital gains beyond the 21-year anniversary for another 21 years or more. It is the CRA's view that this type of planning circumvents subsection 104(5.8), frustrating the object, spirit and purpose of this subsection, paragraph 104(4)(b) and the Act as a whole. If a distribution is made from a Canadian-resident discretionary family trust to a corporation owned by another Canadian-resident discretionary family trust to defer tax on capital gains (perhaps indefinitely), the CRA will apply GAAR unless there is substantial evidence that GAAR should not apply. This is based on the policy not to allow capital gains to be deferred beyond the lifetimes of the initial beneficiaries.
3. Dual-resident estate and Article IV(4)
Under U.S. law, when a U.S. citizen dies, their estate may be considered a U.S. estate under U.S. domestic law. However, such an estate may also be considered a Canadian resident estate pursuant to where the central management and control of the estate resides. Under paragraph 4 of Article W of the Canada-US Tax Convention (the "Convention"), the Competent Authorities shall by mutual agreement endeavour to settle the question of residency.
- Has the CRA ever used Article IV(4) in order to settle this question?
- Can the CRA tell us what factors are considered by the competent authority when settling the issue?
- Where a U.S. trust is deemed to be a resident of Canada under the provisions of subsection 94(3) of the Act, is it possible to rely on Article IV(4) of the Convention?
- Can the CRA provide an example of a "mode of application"?
The CRA has received few requests to resolve a residency determination as between the CRA and the IRS under paragraph 4 of Article IV of the Canada-US Treaty.
The CRA will apply the criteria outlined in Income Tax Folio S6-F1-C1, Residence of a Trust or Estate. In general, the residency of a trust is a question of fact, determined based on the central management and control test. Where a trust is considered a resident of Canada under Canadian law and of the US under US law, the CRA will look at factors connecting the trust to one place or the other (e.g., residence of the settlor, residence of the beneficiaries, type and location of trust property, and reason for the trust being established in particular jurisdiction). Note that this is a non-exclusive list.
Use of foreign trusts is a concern where it may result in the deferral or avoidance of Canadian tax. Under Canadian law, a trust deemed to be resident in Canada under subsection 94(3) will be considered resident for the purpose of the Treaty. A trust that is considered to have dual residence may apply to the CRA for a determination of residence. The tests of residency under section 94 are not inferior or superior to any other tests of residency. Section 94 anticipates providing full relief for any taxes paid by the trust.
Paragraph 4 of Article IV does not require the competent authorities to come to a conclusion, and in fact the competent authorities may not be able to agree. However, they can still determine the question of residence at least for the purposes of the application of the Treaty.
The Treaty should be applied to a deemed resident trust to avoid any unexpected double tax. The CRA will accept requests from trusts seeking relief from double tax, either unilaterally or in conjunction with the competent authority from the other contracting state.
4. US Grantor Trust
A Canadian resident individual (Mr. C) who is a citizen of the United States (U.S.) settles a revocable living trust for the benefit of himself and his family members. The trust is factually resident in the U.S. (i.e., the trust is resident in the U.S. for U.S. income tax purposes and the central management and control of the trust resides in the U.S.).
The trust property includes certain real estate interests situated in the U.S. and marketable securities from which the trust earns U.S. source property income.
As the trust is a "grantor trust", it is disregarded for U.S. tax purposes. Accordingly, Mr. C reports all income earned by the trust on his U.S. income tax return and pays the related U.S. income tax. However, the trust is a trust for Canadian income tax purposes, and is not an arrangement that is deemed not to be a trust as described in subsection 104(1). Further, as Mr. C is a "resident contributor" to the trust, as defined in subsection 94(1), the trust is deemed to be resident in Canada for certain purposes of the Act by virtue of subsection 94(3). As a result, the trust is subject to Canadian income taxation on its worldwide income.
Since Mr. C pays the U.S. income tax in respect of the trust's U.S. source property income each year, the trust cannot claim a foreign tax credit under section 126 as the trust does not pay the U.S. tax. Similarly, the trust cannot claim a deduction under subsection 20(12) in respect of the tax paid by Mr. C. To deal with the mismatch of foreign income and foreign tax paid, the trustee has suggested two possible alternatives to effectively transfer the foreign source property income to Mr. C. Under the first alternative, the trust can make all of its income payable to Mr. C in the tax year and make a subsection 104(22) designation such that the income retains its character as U.S. source income in Mr. C's hands. Second, instead of having the trustee allocate the trust income to the beneficiaries, Mr. C can elect to have subsection 94(16) apply to himself and the trust. As Mr. C is the sole contributor to the trust, the application of subsection 94(16) will result in the trust's income being attributed to Mr. C.
Could the CRA comment on the availability of the foreign tax credit and the deductions under subsections 20(11) and 20(12) under each of these alternatives?
Assume Mr. C has no other US-source income.
A 104(22) designation would probably be the normal course for a Canadian-resident or deemed-Canadian-resident trust. Note that paragraph 94(3)(a) deems a trust to be resident in Canada only for the purposes listed in subparagraphs (i) to (x). Subsection 108(5) does not impact the territorial source of the income, which is a question of fact. For a US-resident trust, as long as the trust distributes the trust's income, under subsection 104(13) such income will be considered to be income of Mr. C. A subsection 104(22) designation is not needed to obtain the foreign tax credit or the deduction under 20(11). Under subsection 108(5), the income received by a beneficiary from a trust is deemed to be trust income, so a deduction under subsection 20(11) should be available to reduce the amount of tax paid in Canada. Under subsection 20(12), a Canadian-resident beneficiary can deduct US income tax paid in respect of the trust income. Any amount claimed will reduce non-business income tax paid for purposes of the foreign tax credit.
With respect to a subsection 94(16) election, the amount of trust income to be included in Mr. C's income is determined by the formula in paragraph (a). He should report 100% of the income earned by the trust. While this election may seem attractive, as it results in attribution without distribution, note that such election is not revocable. Income to be included in the contributor's income is designated as income from a source in Canada under paragraph (b), subject to paragraph (c). Mr. C cannot claim a deduction under subsection 20(11), but he can claim under subsection 20(12) in respect of US tax paid.
5. Allocation of safe income to discretionary dividends
At the 2016 CTF Annual Conference, the CRA indicated that it was conducting a study of how safe income on hand should be allocated for corporations that have issued shares that are entitled to discretionary dividends, and when a dividend disproportionate to the respective pro rata interest is declared on such shares. Can the CRA provide an update on this study?
This is under review by the CRA, and CRA is not willing to provide comments until such review is complete.
6. Application of GAAR to share redemption transactions relying on paragraph 55(3)(a)
In CRA document #2015-061068106, the CRA indicated that it would seek to apply GAAR to a transaction that relies on paragraph 55(3)(a) to artificially create or unduly preserve ACB. The CRA listed the below as an example of such transaction:
"A note or other property (other than assets owned by the dividend payer at the beginning of the series that includes the redemption) received by a dividend recipient as consideration for a redemption of shares in a reorganization that is exempt under paragraph 55(3)(a) is used by a person to generate ACB that is significantly greater than the ACB of the shares that were redeemed."
We see the CRA applying this principle in CRA document #2015-0604521E5, which describes a reorganization where a promissory note was issued to Holdco on a share redemption and the promissory note was subsequently transferred to Newco as a capital contribution. The deemed dividend arising on the share redemption would not be subject to subsection 55(2) if paragraph 55(3)(a) applied. Since the amount of the promissory note was higher than the ACB of the redeemed shares and the amount of the promissory note increased Holdco's ACB of the shares of Newco, the CRA viewed these transactions to have artificially increased the ACB in the hands of Holdco and indicated that it would seek to apply the GAAR for Holdco's reliance on paragraph 55(3)(a).
Can the CRA confirm that a subsequent transaction to 'use' the note or other property (including cash) received as consideration for a share redemption, such as the transfer of the note to Newco in CRA document #2015-0604521E5, is a necessary trigger for a GAAR determination with respect to paragraph 55(3)(a)? In other words, could the receipt of a note or other property with ACB higher than the ACB of the redeemed shares in itself cause the GAAR to apply?
One of the roles of subsection 55(2.1) is to investigate whether one of the purposes of the dividend is to significantly increase the cost amount of property held by the dividend recipient. Where subsection 55(3)(a) is deliberately triggered, GAAR may apply.
7. Subsection 55(2) and pipeline planning
An individual dies and leaves in his or her estate a holding company (H1) with an investment portfolio. A capital gain is recognized by the deceased. The estate then structures a pipeline type transaction where the shares of H1 are transferred to H2 and the estate receives a note. Later, the shares of H1 held by H2 are redeemed or purchased for cancellation. Now that subsection 55(2) applies when there is a purpose of reducing fair market value or increasing cost amount, does this mean that the provisions could apply to deem a capital gain to result? Would the estate have a carryover of the safe income of the deceased or would the starting safe income to the estate be nil?
It is assumed that the ACB of the shares of H1 to the estate is equal to the FMV at the time of the transfer to H2 and at the time of the redemption.
If the shares are redeemed for FMV, then paragraph 55(2.1)(a) does not apply since the redemption would not result in the reduction of any gain. The purpose test in paragraph 55(2.1)(b) does not apply to a dividend deemed to have been paid under subsection 84(3). Therefore, subsection 55(2) does not apply.
This scenario is different from a situation that abuses paragraph 55(3)(a) or (b), and the CRA would not seek to apply GAAR.
There is no carryover of safe income from an individual to his or her estate, since the safe income is already included in the ACB of the shares to the estate.
8. Articles IV and XXVI: Single-member disregarded U.S. LLC
Consider a single-member disregarded U S limited liability company ("SMLLC") whose member is a resident of Canada. If the mind and management of the SMLLC resides in Canada, Canadian domestic income tax law would treat the SMLLC as a corporation resident in Canada. Since the SMLLC is not liable for U.S. income tax, the SMLLC is not a resident of the U.S. for purposes of applying the Canada-US Tax Convention (the "Convention"). As such, paragraph 3 of Article IV of the Convention cannot be relied on to tie-break the SMLLC to the U.S. Accordingly, the SMLLC would be required to file a T2 corporate income tax return and report its worldwide income, including any U.S. source income. This is the case, even though any such U.S. source income would also be subject to U.S. income tax in the hands of the member of the SMLLC. Moreover, the SMLLC would not be entitled to claim any foreign tax credit for the U.S. income tax paid by its member. Assume that, for the purposes of the question, the U.S. source income is taxable in the U.S. on the basis that it is business income earned through a permanent establishment in the U.S.
Pursuant to paragraph 1 of Article XXVI of the Convention, a person may approach the competent authority of the Contracting State of which the person is a resident, if the person considers that the actions of one or both of the Contracting States result in taxation not in accordance with the provisions of the Convention. Although the member of the SMLLC and the SMLLC are distinct taxpayers in the eyes of Canadian income tax law, they are one and the same from the perspective of U.S. income tax law. It could be viewed that, from the U.S. perspective, the member is double-taxed on the same U.S. source income: the member's U.S. source income is taxed once under U.S. income tax law, and the same income is taxed again under Canadian income tax law also in the hands of the member (since the SMLLC is disregarded from the U.S. perspective).
Does the Convention provide relief from double taxation in the circumstances described? Would the answer be the same for U.S. LLPs or LLLPs?
The CRA agrees that paragraph 3 of Article IV of the Treaty does not apply in the circumstances described, and SMLLC is therefore subject to tax on its worldwide income in Canada as a resident thereof. In determining any foreign tax credit, it was confirmed that (pursuant to the Treaty) any tax payable is subject to the Income Tax Act (Canada).
US tax paid by the member would not be creditable against Canadian tax assessed against the US LLC.
There is a CRA internal working group studying Delaware and Florida LLPs and LLLPs. They note that double taxation could be avoided entirely if the LLC elects to be taxed for US purposes as a C Corp, in which case it would be liable for US income tax and ultimately deemed to be resident only in the US. Or the LLC can elect to be taxed as an S Corp, in which case it would be treated as a flow-through entity for US purposes. Note that there are numerous conditions that must be met to be eligible to be treated as an S Corp, including that there are no non-resident shareholders.
9. Paragraph 5 of Article XXIX — procedures for Qualified Subchapter S Corporation Subsidiary
Under paragraph 5 of Article XXIX of the Canada-US Tax Convention (the "Convention"), the Competent Authority of Canada may agree to allow a Canadian-resident shareholder of a United States S Corporation to apply the following rules for Canadian tax purposes with respect to the period during which the agreement is effective:
- the corporation shall be deemed to be a controlled foreign affiliate of the person;
- all the income of the corporation shall be deemed to be foreign accrual property income;
- for the purposes of subsection 20(11) of the Income Tax Act, the amount of the corporation's income that is included in the person's income shall be deemed not to be income from a property; and
- each dividend paid to the person on a share of the capital stock of the corporation shall be excluded from the person's income and shall be deducted in computing the adjusted cost base to the person of the share.
The cumulative effect of these rules synchronizes the recognition of income in Canada with that of the US and allows the shareholder to claim a foreign tax credit in respect of the amount of US tax paid on his or her share of the S Corporation's income. However, paragraph 5 of Article XXIX of the Convention does not apply automatically. It only applies to a shareholder of an S Corporation who requests and enters into an S Corporation Agreement with the Canadian Competent Authority. Additionally, if the shareholder has an interest in more than one S Corporation, a separate S Corporation Agreement is required for each corporation. This was recently confirmed by the CRA at the 2015 STEP CRA Roundtable.
Can the CRA comment on the situation of an S Corporation that holds the shares of a qualified subchapter S Corporation subsidiary ("QSSS"). A QSSS is a wholly-owned subsidiary of an S Corporation for which a separate U.S. tax election is made to treat it as a pass-through entity. In such situation, is the Canadian-resident shareholder of the S Corporation required to enter into two separate S Corporation Agreements: one with respect to the parent S Corporation and the other with respect to the QSSS? Or would the S Corporation Agreement for the parent S Corporation automatically cover the QSSS?
There was a question at the 2015 STEP Conference in respect of an S Corp agreement, and there is some additional background in that question. It is the CRA's understanding that when an S Corp elects to treat a subsidiary as a QSSS, the subsidiary is no longer treated as a separate corporation under US law. If the shareholder of an S Corp has entered into an S Corp agreement with the CRA, the income received is deemed to be FAPI. In that case, there is no need to enter into a separate S Corp agreement between the CRA and the subsidiary.
10. Application of 104(6), (13) and (24)
Where a trust pays an expense for the benefit of a beneficiary, is the beneficiary required to direct and concur with the payment of the disbursement on the beneficiary's behalf in order for the payment to be deductible to the trust pursuant to subsections 104(6) and (24), and included in the beneficiary's income pursuant to subsection 104(13)? For example, a father who is the trustee of a discretionary family trust takes his children (who are beneficiaries of the trust) out for dinner. The father itemizes his children's expenses, reimburses himself out of the trust funds for the meal expense incurred on behalf of the trust beneficiaries, and issues T3 slips to each child.
According to the CRA's comments in ITTN 11, Payments Made by a Trust for the Benefit of a Minor Beneficiary, (September 30, 1997), this arrangement is acceptable for expenses paid on behalf of minor children. However, we are aware of similar situations which the CRA has recently audited and proposed to reassess because a beneficiary did not direct and concur with such payments incurred on their behalf. Can the CRA advise as to whether there has been a change in policy from ITTN 11?
All previously archived ITTN documents, including ITTN-11, were cancelled and removed from the CRA website in 2012; CRA directs taxpayers to refer to Income Tax Folios instead. ITTN-11 outlines 3 requirements for such payments to be deducted from a trust's income and included in a beneficiary's income:
- The trustee must exercise discretion to make an amount payable.
- The trustee must provide notification of such exercise to the parent and receive a consent and direction to pay from the parent.
- It must be reasonable to consider that the payment was made for the child's benefit.
A determination as to whether these requirements are met can only be made on a review of all relevant facts, including the terms of the trust. Where a trustee seeks to deduct income from the trust and include it in the income of a beneficiary, the onus of proof that the income was paid or payable to the beneficiary in the year lies with the taxpayer. See the court's comments in the Degrace Family Trust case at paragraph 5 where it is noted that the expenditure must clearly have been made by the trustee for the unequivocal benefit of the beneficiary.
In the case of a payment from a trust to a parent to reimburse household expenses, the onus of proof cannot be met by simply totalling expenditures and dividing by the number of family members.
ITTN-11 was published a long time ago. The CRA intends to review the commentary to determine its continued validity and may provide a further comment if appropriate.
11. Spousal rollover and substituted property
As a consequence of the death of a taxpayer, and where certain conditions are met, subsection 70(6) allows property held by the deceased immediately before the death, to be transferred to a trust described in paragraph 70(6)(b) on a tax-deferred "rollover" basis. This provision requires, inter alia, that the property has vested indefeasibly with the spousal trust within 36 months of the taxpayer's death.
Suppose the will of a deceased taxpayer provides that certain assets are to be transferred to a spousal or common law partner trust. Before doing so, and while property of the estate is being administered, certain property might change or be substituted by the Estate. For example, shares might be converted from one class to another. If so, is the spousal rollover still available? If not, does the gain recognized on the tax return of the deceased have to be amended?
The CRA previously commented on this scenario at a recent APFF Conference. The spousal rollover applies on property-by-property basis, and requires that the transferred property be property held by the deceased prior to death. Substituted property would not qualify for the rollover, since this concept is not referred to in subsection 70(6).
It is a question of fact whether a particular property has been transferred to a spousal trust and whether the spousal trust's interest in the property has vested indefeasibly.
In this case, the question is whether the transfer to and indefeasible vesting in the spousal trust occurred prior to the reorganization. Further information would be required to make a determination. If not, the shares would not be eligible for the subsection 70(6) rollover, and subsection 70(5) would apply, meaning there would be a deemed disposition.
12. Subsection 75(2) and T3 reporting requirements
As most trust and tax practitioners know, subsection 75(2) of the Income Tax Act will attribute trust income, losses, capital gains and capital losses to the contributor / settlor if certain conditions are met. The 2016 T3 Guide (T4013) states the following:
“Certain related amounts, including taxable capital gains and allowable capital losses from that property or the substituted property, are considered to belong to the contributor during the contributor's life or existence while a resident of Canada. The trust must still report the amount on the trust's T3 return and issue a T3 slip reporting the amount as that of the contributor of the property.”
While the recommended approach to report the amount of the attributed income is certainly a good practical approach, it may not be consistent with the law. Subsection 104(6) will only provide a deduction against trust income for amounts paid or payable to the beneficiaries which requires the issuance of a corresponding T3 slip to the recipient beneficiaries. In many cases, however, the terms of the trust that is affected by subsection 75(2) will not have any amounts paid or payable to the contributor / settlor and ultimately the taxation of the applicable amounts in the contributor / settlor's hands is only because of subsection 75(2) and not subsection 104(6). Accordingly, when preparing the accounting records for the trust, the subsection 75(2) attributed amounts are not recorded as being paid or payable to the contributor / settlor since the facts of the particular case will often not require the actual payment of such amounts to the contributor / settlor. Given such, many practitioners do not agree that a T3 slip should be issued to the settlor and, instead, the attributed amounts should simply be recorded as an elimination of the applicable reported amounts on the T3 return and a subsequent direct reporting by the contributor / settlor. Can the CRA comment on this approach please?
The CRA addressed a similar question at the 2006 STEP Conference. The T3 return is both an income tax and information reporting return, including the requirement to issue income slips to the beneficiaries. These specific regulations are set out in section 204 of the Income Tax Regulations, promulgated under section 221 of the Act. Given the nature of the T3 return, the statutory requirement to file a T3 return exists where the trustee has control of or receives income or gains in the trustee's fiduciary capacity, even if the trust has nil income because subsection 75(2) applies to attribute all the income of the trust to another person.
13. TFSA audit project
Subsection 146.2(6) of the Income Tax Act provides that if a TFSA "carries on one or more businesses" then Part I tax is payable on its business income. We are aware that this has been a focus for CRA audit and reassessment activities targeting taxpayers who actively traded securities in their TFSA. Can the CRA provide an update on the result and its future intention on its activities in respect of this area? Also, does the CRA have any plans to educate the public on what the acceptable limits are on securities trading to prevent a TFSA account from being considered to be carrying on a business?
The CRA is committed to maintain a compliance presence in respect of TFSAs. Millions of additional taxes have been recovered as a result of audits of TFSAs. An Income Tax Folio was released recently which indicates that the determination as to whether a particular taxpayer carries on a particular business is a question of fact. IT-479R sets out factors developed by the courts that are relevant to determining whether a taxpayer carries on a business of securities trading. As there is nothing unique about TFSAs in the context of securities trading, there is no plan to provide any additional guidance specific to TFSAs.
14. Dedicated Telephone Service
The Income Tax Rulings Directorate recently confirmed at the 2017 CPA-BC & CRA Roundtable the CRA's plan to introduce a new dedicated telephone service (DTS) for income tax service providers, which was originally announced in Budget 2016. Under a three-year pilot project beginning in July, 2017, the DTS will initially be offered to certain Chartered Professional Accountants in Ontario and Quebec. The DTS is intended to provide participants in the project with access to experienced CRA staff who can help with more complex technical issues.
Can the CRA provide an update on this pilot project?
The new dedicated line for tax preparers was launched last week and has received a positive response so far. Access will be gradually expanded over the coming weeks. Registration is open to eligible CPAs in Ontario and Quebec. Registrations are ongoing and will continue to be accepted under the pilot project up to 3,000 registrants. If the 3-year pilot is successful, the program may be extended to taxpayers across Canada.
This service is intended to be a technical resource for those preparing tax returns, but not a resolution line to deal with specific taxpayer issues. It is also not intended to be a resource for specialized practitioners with complex tax issues.
15. Registration of Tax Preparers Program
On January 17, 2014, the Minister released a proposal to introduce the Registration of Tax Preparers Program (RTPP) which is a registration system for tax preparers who prepare tax returns for a fee, and requested input from taxpayers, tax preparers and other stakeholders. Can the CRA comment on the input it has received, and the status of this proposal?
The registration of tax preparers program (RTPP) was part of a plan to improve compliance for small businesses. It was designed to address recurring errors in individual and corporate returns, minimize red tape, emphasize a collaborative approach between preparers and the CRA, and improve long-term compliance. The CRA has determined that to be effective, the program would require a significant investment which the CRA is not willing to make, so CRA is considering other options available through existing programs (e.g., dedicated telephone services pilot program).