Tax and Estate Planning Blog : Moodys LLP and SNC Law

This is not a new topic. However, it is one that we deal with time and time again....especially in recent years.

Tax policy and the implementation of tax legislation in Canada is under the purview of The Department of Finance. Much of Canada's new tax legislation arises from the annual Federal Budget. However, there are also technical amendments released in draft form (often for public comment) throughout the year. Such draft or proposed legislation may be further amended to correct for errors, provide clarification and address public submissions before it is finally released into a Bill. The Bill is then put before Canada's House of Commons and the Senate for debate and eventually receives Royal Assent and becomes law (unless for some reason the Bill fails to pass). The proposed legislation will often contain detailed “coming into force” provisions that establish the date from which a specific proposed provision will have legal application. Often, but not always, the application of the proposed legislation will be effective from a date earlier (i.e. retroactive effect) than the date that the provision is actually passed into law. The process to convert draft legislation to law can often take a long time.

The Department of Finance may also release “comfort letters” in response to parties' concerns with the technical accuracy of certain existing provisions of the Income Tax Act (the “Act”). Such comfort letters often state that The Department of Finance is prepared to correct the perceived problem and further undertake to recommend to the Minister of Finance to release proposals that will achieve such objective. However, the comfort letters are appropriately hedged and state that there is no guarantee that such proposed amendments will become law.

In recent years, there has been a tremendous amount of draft legislation and comfort letters that have been released and have not yet been proclaimed as law. The Office of the Auditor General of Canada pointed out this problem in its 2009 Fall Report.

Two obvious examples of proposed legislation not yet being passed into law come to mind. The first is the non-resident trust and foreign investment entity proposals. These proposals were first introduced in the 1999 Federal Budget and the resulting draft legislation has been revised at least six times over the last 13 years and still remains “proposed” (i.e. not law). The most recent revision resulted in the virtual scrapping of the foreign investment entity proposals but retained the non-resident trust proposals. If passed, much of the effect of these proposals will have retroactive effect to 2007 (with the date of the proposed application being changed many times over the years). The second are the restrictive covenant proposals that were first announced by the Department of Finance on October 7, 2003. Such proposals are extremely complex and we have written extensively on this subject. The restrictive covenant proposals have been amended many times with the most recent being July 2010. Such proposals also have not been passed into law but if passed will generally have retroactive effect to October 7, 2003 (with some exceptions to this general date).

Canada's tax system provides, under section 152, that an individual's tax return for a particular taxation year is generally "statute-barred" from a reassessment on the 3rd anniversary date of the date that the particular taxation year was assessed. For example, if Mr. Apple's 2006 personal tax return was filed in April 2007 and was assessed by the Canada Revenue Agency ("CRA") say May 15, 2007, then Mr. Apple's 2006 tax return would be prevented from any amendment (either by the CRA or by Mr. Apple) on May 15, 2010.

There are some exceptions to the general rule. For example, if Mr. Apple or the person filing the return made any misrepresentation on the 2006 tax return that was attributable to neglect, carelessness, willful default or committed a fraud then the CRA may reassess beyond the May 15, 2010 date (see subsection 152(4) of the Act). Also, there are some circumstances where Mr. Apple may want to file a waiver, also provided for under subsection 152(4), to the CRA that keeps all or parts of the 2006 return open for reassessment. Mr. Apple may also be able to rely on the “taxpayer relief provisions” of subsection 152(4.2) to extend the statute-barred date if he makes an application no later than the day that is 10 calendar years after the end of the particular taxation year in question if he was entitled to a refund or a reduction of taxes payable for that particular year. Corporations or inter vivos trusts are not entitled to benefit from the “taxpayer relief provisions” unlike Mr. Apple as earlier described. Corporations, other than Canadian-controlled private corporations, have similar rules regarding statute-barred dates but generally the date is four years from the date of notice of assessment.

Accordingly, what is a taxpayer to do when they are dealing with a tax matter that might be the subject of proposed legislation? For example, if a taxpayer granted a restrictive covenant in 2011, should he file his tax return on the basis of existing law or under the basis of the proposed legislation (which will generally be very complicated to deal with and may not have favorable tax results in comparison to existing law)? Good question and quite a quandary. When analyzing the issue, one should consider statute barred issues as discussed above and also whether the proposed legislation contains specific provisions that might override the normal rules of subsection 152(4) if a person wanted to ignore the proposed legislation and file on the basis of existing law.

The CRA has a long standing policy that encourages taxpayers to file their tax returns on the basis of proposed legislation. In CRA Income Tax Technical News No. 44, the CRA had the following to say on the topic:

It is the CRA’s longstanding practice to ask taxpayers to file on the basis of proposed legislation. This practice eases both the compliance burden on taxpayers and the administrative burden on the CRA. However, where proposed legislation results in an increase in benefits (for example, Canada child tax benefit) to the taxpayer, or if a significant rebate or refund is at stake, the CRA’s past practice has generally been to wait until the measure has been enacted.

A comfort letter is not considered proposed legislation and usually only reflects the Department of Finance’s views on a particular issue affecting a specific taxpayer. Given that our tax system is on the basis of self?assessment, taxpayers may decide to file on the basis of a comfort letter. Generally, the CRA will not reassess taxpayers who filed on the basis of a comfort letter, provided that they did so in conformity with the comfort letter.

Generally speaking, the CRA will not reassess if the initial assessment was correct in law. As a result, a taxpayer’s request to amend their tax records to reflect proposed legislation will be denied. It is recommended that taxpayers file a waiver in respect of the normal reassessment period to protect their interests.

In the event that the government announces that it will not proceed with a particular amendment, any taxpayers who have filed on the basis of the proposed amendment are expected to take immediate steps to put their affairs in order and, if applicable, pay any taxes owing. Where taxpayers acted reasonably in the circumstances, took immediate steps to put their affairs in order, and paid any taxes owing, the CRA will waive penalties and/or interest as appropriate.

In my opinion, the CRA's guidance usually, but not always, makes sense. From a practical perspective it is also sound. However, everyone's facts are different and, of course, one would need to carefully consider what is appropriate in their circumstances. People should heed professional tax advice on this difficult area of tax law.
 

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Firstly, this is my list not yours. It is very subjective and is a reflection of my many years of experience of being a tax specialist and building a “tax only” advisory practice. Most of the practitioners that are clients and friends of our firm know their tax limitations. However, there are other practitioners whose work we often trip across that do not know their limitations. The simple fact is that tax is tough. I would venture to say that it is one of the most challenging professions in existence.  Unfortunately, there is no tax specialist designation in Canada to help the public identify professionals who have credible knowledge and experience in tax. I’m hopeful that will change soon. 

With the above in mind, here are the top five mistakes we often see.

1.        Taxable Benefit Issues Not Considered
The Canadian Income Tax Act (the ”Act”) is littered with benefit provisions. For example, section 6 of the Act deals with employment benefits. The section is purposefully drafted broadly to capture many types of benefits into the employee's taxable income. Section 15 is another example and applies to many types of benefits received by a shareholder of a corporation. Again, section 15 is purposefully drafted very broadly but also has specific provisions so as to capture certain types of benefits into the shareholder's taxable income. We find in many cases that an inexperienced practitioner may not have considered taxable benefit exposure when reporting on a taxpayer's situation.

For example, consider the situation of Mr. Apple who is the shareholder of a Canadian - controlled private corporation, "Opco". Mr. Apple's acquaintances, and perhaps his advisor, have told him that he should purchase his personal use vacation property through Opco since he “will save a lot of tax”. Wrong. While the specific facts would need to be reviewed in order to give proper advice, it is highly likely that Opco has conferred a taxable benefit on Mr. Apple by virtue of section 15 of the Act as a result of the purchase and personal use of the vacation property. In some cases, such a taxable benefit can lead to ultimate double taxation. I've written and lectured about this many times. Accordingly, be very aware of situations that can cause taxable benefits to arise.

2.        Taxation of Prepaid Amounts

One of the fundamental accounting principles that is taught to accounting students early on in their studies is the ”matching principle”. Overly simplified, it stands for the proposition that expenditures must be matched to the derivation of the related income. For example, if Opco pays $10,000 on January 1, 2012 for an insurance policy that will expire on December 31, 2013, the matching principle will generally cause accountants to not expense the full $10,000 in Opco's 2012 fiscal year (assuming a calendar year end for Opco) but will instead amortize the cost over the period of benefit being 24 months. Accordingly, the prepaid portion of the insurance contact will be capitalized and reflected as an asset on the balance sheet of Opco. 

The same logic applies for amounts received by Opco. For example, let's assume that Opco provides consulting services and charges one of its customers a lump sum amount of $24,000 on January 1, 2012 for services that it will provide over the next 24 months. Let's further assume that Opco has received the $24,000 on January 1, 2012. Using the matching principle, most accountants would record the $24,000 as a deferred liability on the balance sheet of Opco as of January 1, 2012 and amortize such amount to revenue over the next 24 months.
 

For Canadian tax purposes, the receipt of the $24,000 on January 1, 2012 is likely immediately taxable under paragraph 12(1)(a) of the Act irrespective of the fact that it may not have yet been earned for accounting purposes. There are certain reserves under section 20 of the Act that may be available to defer such unearned amounts until the time that it is earned but the facts and circumstances would need to be reviewed as the eligibility for the section 20 reserves are very specific and narrow.

Bottom line.....review amounts received in advance and be aware that more than likely section 12 of the Act will apply to capture such amounts into taxable income irrespective of the accounting treatment.

3.     Salaries Paid to Family Members

Canada's system of personal taxation is one which taxes income at progressive tax rates. Canada's system is also one where each taxpayer must report and pay tax on their own income separately. Unlike the US, there is no ability to jointly file returns and combine income in certain cases. Accordingly, Canada's system will often cause taxpayers and their advisors to look for clever ways to income split amongst family members so as to use multiple progressive tax rates and reduce the overall family tax burden.

One strategy that is used by certain practitioners when advising their entrepreneurial clients is to pay salaries to family members so the business can claim a deduction against its business income and the recipient family member can use their lower progressive tax rates. In some cases, we see significant salaries being paid to very young children. Simple.....but does it work? This particular strategy is one of the many tax myths that exist in practice. We often hear from people that they've heard that salaries of say $7,000 to $10,000 to kids are acceptable since the Canada Revenue Agency (“CRA”) has said so. Or that their buddy has been using such a strategy for years and the CRA has never challenged it so it must be fine.

The fact is salaries paid from a business to family members must be reasonable in the circumstances in order to be deductible and to comply with section 67 of the Act. Any non-reasonable amount will not be deductible to the business but is still taxable in the recipient's hands (which results in double taxation). The facts and circumstances will dictate what is reasonable but let's be serious. As a real example, I have 4 kids ranging from the age of 6 to 15. I love them to death but would it be reasonable to pay my 12 year old $10,000 from my business for ”administrative duties” or “licking stamps” (common examples that we often hear)? Not a chance. Or at the very minimum, highly debatable and not likely.

Further, the salaries must have been incurred to earn income from the business in order to comply with section 18 of the Act. Was the payment of the $10,000 to my 12 year old incurred to earn income from my business? Debatable but not likely. Accordingly, be wary of the many tax myths in this area and be mindful of the sections 67 and 18 risks.

4.      Corporate Surplus Stripping

The use of a corporation to carry on a business is a traditional and often sound strategy. As most readers know, a corporation is a separate legal person. While the corporate vehicle can offer many tax advantages, it also has its downsides or challenges for the private business. One of the most challenging issues is how does a shareholder remove after tax corporate surplus (or what accountants often refer to as retained earnings) in a tax efficient manner? The most traditional way is by way of taxable dividends which are the subject to personal taxation in the individual shareholder's hands.

However, some practitioners want to be clever and find ways to remove corporate surplus to the individual shareholders in a more tax efficient manner. One strategy that we often see involves the use of the $750,000 capital gains deduction (”CGD”) applicable to qualified small business corporation shares. Let's consider the case of Mr. Apple again who owns shares of Opco. Let's assume that the shares of Opco have a fair market value of $500,000 and that all the detailed conditions which need to apply for Mr. Apple to use his available CGD apply. Mr. Apple wants to access Opco's surplus tax free. Accordingly, Mr. Apple's advisor develops the following plan:

a.           Mr. Apple sells his shares of Opco to a new holding company (“Holdco”) that his wife wholly owns for $500,000. 

b.          As payment for the shares, Holdco will issue a promissory note to Mr. Apple in the amount of $500,000.

c.          Given the above sale, Mr. Apple will realize a capital gain of $500,000 (assuming that his adjusted cost base of his Opco shares was nominal) but he  will offset such gains with his available CGD.

d.          Opco then pays dividends over time (whenever it has surplus cash) to Holdco. Since the shares of Opco are wholly owned by Holdco, Holdco will be “connected” with Opco and will generally receive such dividends on a tax free basis.

e.          Holdco will then use the cash to repay the promissory note to Mr. Apple thus resulting in him receiving such cash tax free.

Sounds pretty good right? Well, if it were only that easy. Unfortunately, the above plan simply doesn't work. Section 84.1 of the Act will cause Mr. Apple's capital gain described in step c above to be recharacterized as a taxable dividend. This will result in Mr. Apple not being able to claim the CGD and cause him to pay tax at personal dividend rates. Not good. Section 84.1 is one of the most common reasons why advisors are sued in tax matters.

Similar to section 84.1, there are other anti-surplus stripping rules within the Act. Practitioners need to be aware of such anti-avoidance rules and ensure that their plans are not caught by them.

5.      US Tax Issues Not Considered

The US is one of the only countries in the world that imposes taxation on a citizenship basis. Simply put, if you are a US citizen (or if you are substantially present in the US or are a green card holder) then the US will tax you on your worldwide income (unless you renounce your citizenship which is a separate topic that can come with significant tax complications). Identifying who is a US citizen is not always an easy exercise and is very much a matter that is reserved for US immigration lawyers.

We have written often on US tax matters but for brevity, US citizens resident in Canada often have significant reporting requirements, may have unanticipated US tax liabilities and have exposure to the US transfer tax regime (including the US estate tax depending on the size of the US citizen's estate upon death). 

Know your client. Are you sure they are not US persons? Are you doubly sure? Have you or your client sought US legal advice to confirm? Be careful.

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Posted by Roberto Domagas CA and Robert Worthington LL.B.

Copthorne Holdings Ltd. v. Canada, 2011 SCC 63 (CanLII) is a recent decision from the Supreme Court of Canada regarding the general anti-avoidance rule (“GAAR”)[1] and provides the much-anticipated interpretation and confirmation of these rules. While the “main event” was whether the transactions undertaken by the taxpayer resulted in abusive tax avoidance to which the GAAR applies, this blog focuses on the Court’s analysis of the meaning of “series of transactions”. The “series of transactions” concept was critical to the outcome of this appeal. The Court provided guidance on how past, present and future transactions are “contemplated”, thereby confirming the framework by which a “series of transactions” would be identified for the application of the GAAR.    

The case facts are exceedingly complex, but for purposes of this blog can be briefly summarized as follows: A Canadian corporation (“Holdco”) sold shares of its subsidiary (“Subco”) to its non-resident parent, thereby creating a sister company relationship between Holdco and Subco. This transaction created the opportunity for a horizontal amalgamation to occur between Holdco and Subco (“Amalco”), versus what would otherwise have been accomplished by way of a vertical amalgamation. What appears to have offended the Minister is that the taxpayer ultimately ended up with the same “structure”, i.e. non-resident parent owning an amalgamated corporation, however the horizontal amalgamation allowed the taxpayer to preserve $67 million of paid-up capital (“PUC”) of the issued shares of Subco, compared to a vertical amalgamation where the PUC would have otherwise disappeared.[2] The significance of preserving (or, in the Crown's view, “duplicating”) the $67 million of PUC is that it was later returned to the parent on a tax-free basis on a share redemption, thereby escaping the application of Canadian withholding tax. The Supreme Court of Canada affirmed the lower Courts' decision, applying the GAAR to deny the tax benefits resulting from the series of transactions, which was found to include the sale of Subco, amalgamation of Holdco and Subco, and share repurchase by Amalco.     

The definition of “series of transactions”[3] includes transactions “completed in contemplation of the series”. The contentious question answered by the Court is whether an offending transaction has to be contemplated prospectively, i.e. the offending transaction is known at the time of a particular transaction, or is it possible to contemplate the offending transaction retrospectively, i.e. whether it is sufficient to connect an offending transaction to a transaction that occurred in the past. In Copthorne, did the taxpayer have to know at the time of the share sale that they were going to undergo a future share repurchase, or is it sufficient to create “a series of transactions” where the offending transaction was executed because the prior sale was contemplated?   

In its analysis, the Court noted in the CRA’s 1988 Roundtable it was said that a “series of transactions” is to be applied prospectively, not retrospectively. The Court also cited academic commentary[4] suggesting the “series of transactions” test should be applied prospectively, and even agreed that the more common sense use of the term “contemplation” is prospective.

Nevertheless, in upholding both lower Courts’ analyses, the Court decided that contemplation of a series may include retrospective contemplation. The main rationale seemed to be a reference to the Court's earlier GAAR decision in Canada Trustco, in which the Court commented that the definition of “series of transactions” in subsection 248(10) included both prospective and retrospective contemplation. The Court was loathe to reverse its relatively recent decision in Canada Trustco. Interestingly, however, nothing in the Canada Trustco case turned on whether a series of transactions could include retrospective contemplation. Further, in its analysis, the Supreme Court stated that the text and context of subsection 248(10) leave open when the contemplation of the series must take place, i.e. the provision allows for either prospective or retrospective connection of a related transaction to a common law series.  

Before the Court’s decision in Copthorne, some commentators expressed that if a retrospective contemplation is permitted, it is all too easy to find that when a later transaction is completed, earlier transactions were known and taken into account.[5]  Indeed, hindsight is 20/20. Irrespective of whether the result in Copthorne is equitable, it seems unfair to taxpayers to allow the Crown to argue with 20/20 hindsight that an earlier transaction was contemplated when the later transaction was completed, and therefore the later transaction was an avoidance transaction as being part of the same series.

The only common law saving “test” from a transaction being considered part of a “series of transactions” is that the transaction requires more than a “mere possibility” or connection with “an extreme degree of remoteness” with the other transactions. However as the Court demonstrated, these hurdles were easily met by the Minister in this case notwithstanding that two years had passed between transactions, and that the rationale for the sale transaction was because proposed changes to the foreign accrual property income rules were imminent. The Court clarified that a “strong nexus” is not required to connect transactions into a series as proposed by the Tax Court, and by the result of this case, establishing a nexus was not onerous.  

The potential ramifications of this “reverse contemplation” principle extend well beyond the GAAR, because several other provisions of the Act contain a series of transactions test. One common example is in subsection 55(2).  We sometimes recommend clients complete a “butterfly” reorganization to “purify” a corporation by transferring assets from an operating corporation (an “Opco”) to another corporation on a tax-deferred basis. The reasons for completing a butterfly/purification reorganization may include putting shareholders in a position to claim the $750,000 capital gains deduction in the event Opco shares are sold in the future. However, a butterfly reorganization is only tax-deferred if it is not part of a series of transactions that includes a sale of shares. As such, if clients are contemplating a specific sale, we would typically advise that a butterfly should not be completed because the sale could be part of the same series of transactions as the butterfly, and consequently, the anti-avoidance rule in subsection 55(2) would apply to trigger a taxable capital gain.

If a specific sale is not contemplated, or if the owners were not marketing Opco (and assuming a number of other conditions are satisfied) a butterfly reorganization may be completed - or so we had thought, prior to Copthorne. The problem is that now the CRA could arguably apply the “retrospective contemplation” analysis and take the position that the subsequent sale was completed in contemplation of the earlier butterfly transaction! 

This result would be unfortunate, and we believe would not be consistent with the tax policy in the Act. We hope the CRA may administratively clarify that it would not apply the series of transactions test retrospectively other than in the GAAR context. In any event, taxpayers should be cautious when undertaking transactions that involve provisions of the Act that contain the “series” test, particularly where anti-avoidance rules are concerned.

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In the tax profession, there are a number of issues that bug me. For example, the absence of a tax specialist designation in Canada to help the public distinguish between non-tax specialists and tax specialists bugs me. I first wrote about this issue in our July 11, 2011 blog. The fact is that I've held this view for well over a decade.....it's important to ensure that the public is better served.

Another issue bugs me. Why is it that many professions are regulated, like cosmetology, but tax return preparation is not? Notwithstanding that Moodys' professional services do not really include Canadian tax compliance (we prefer to work with the client's existing tax preparers), the tax preparation industry is a large one and is unregulated. Anyone who wants to prepare tax returns for a fee in Canada is free to do so. Over the years, I've seen some very poorly prepared tax returns that were ticking time bombs for the client / taxpayer. In other cases, the professional preparer simply made errors. In many cases, I believe, the tax laws have simply become too complex for the average tax preparer to understand unless they are a tax specialist. Thank goodness for good tax software. Unfortunately, though, tax software is not fool-proof and requires the astuteness of the operator to ensure that there are no errors.

One would argue, however, that a shrewd consumer will always be able to determine a tax preparer's qualifications to handle their needs, and therefore, regulation is not needed. I don't buy that logic. In many cases, I've seen sophisticated people simply select the cheapest service provider thinking that the tax preparer is on equal footing with other more qualified but more expensive providers.

I can only guess, since I don't have the statistics at my fingertips, that untrained tax preparers cost the Canadian government tremendous amounts of inefficiencies. This is in addition to the cost to the consumer in the form of missed tax deduction and credits, not to mention the cost of errors and the time and money subsequently expended to resolve, including the potential assessment of penalties and arrears interest by the Canada Revenue Agency (“CRA”). Further, I believe that the non-regulation of the tax preparation industry in Canada makes it easier for inappropriate aggressive tax avoidance to occur (like certain charitable tax shelters). 

In the US, the government obviously believes that regulation of the tax preparation industry is important. Today, a paid preparer of US tax returns must register for a "PTIN.” Similar registration requirements exist in Australia. The UK also appears interested in exploring an enrollment or certification system for tax preparers.

At the 2010 STEP National Conference, The Department of Finance was asked whether or not a US style tax preparer registration system was looming for Canada. The answer provided made it seem like the Government of Canada was not interested. However, at a recent tax conference that I was a speaker at, I participated in a Roundtable Q&A session with the CRA. One of the questions dealt with "tax intermediaries." Based upon the answer provided, it is obvious that the CRA is watching the US, Australia and UK experience closely and might be interested in a similar registration system for Canada.

Stay tuned.....I don't think we've seen the end of this story. Hopefully we see a positive result soon.

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On October 31, 2011 (on the fifth anniversary of the income trust amendments) the Department of Finance released a package of income tax and sales and excise tax technical amendments. While most practitioners, including our firm, are still working through the package there are two proposed amendments that are worthy of an early comment.

1.                  Subsection 15(2)

It is proposed that subsection 15(2) be amended to clarify that a partnership can be connected with the shareholder of a particular corporation if that partnership does not deal at arm’s length with, or is affiliated with, the shareholder. The proposed amendment applies in respect of loans made and indebtedness arising after October 31, 2011. This amendment is important and noteworthy given the fact that it was questionable from a read of the existing law as to whether or not partnerships could be connected with the shareholder of a particular corporation. Accordingly, taxpayers and their advisors will need to take a fresh look, in light of this proposed amendment, as to whether or not partnerships will be connected with a corporation thereby causing subsection 15(2) to apply to such loans or indebtedness. To the extent that subsection 15(2) will apply, such loaned amounts may be included in the connected shareholder’s income. 

2.                  Personal Services Business Corporations

The Department of Finance is proposing a significant change for a personal services business carried on by a corporation. Prior to the announcement of these technical amendments, it may have been advantageous for a person, who would otherwise be considered to be an employee, to incorporate their employment services. Such a corporation is commonly known as a Personal Services Business corporation.   Prior to the introduction of the eligible dividend regime, it was not advantageous to have a Personal Services Business corporation since such a corporation would automatically be taxed at the highest corporate tax rate and all expenses (with certain limited exceptions such as salaries to the shareholder) would not be deductible. With the introduction of the eligible divided regime in 2006 and declining corporate tax rates, having a personal services business corporation’s income being taxed at the highest corporate rate and later distributing such surplus as an eligible dividend could provide, in some cases, a significant tax deferral.

The proposed amendment introduced in yesterday’s technical amendments will eliminate any such deferral opportunities by causing any income earned by a corporation from a personal services business to be taxed at a combined Federal-Alberta rate of 38% (as compared to the normal highest corporate rate for 2011 of 26.5%; 25% for 2012). The proposed amendment applies to taxation years that begin after October 31, 2011. Such an amendment should discourage any taxpayer from entering into a personal services business corporation relationship. 

Follow us on Twitter @Moodystax for further updates on these technical amendments.

New GAAR Decision

On October 28, 2011 the Tax Court of Canada released a decision – Global Equity Fund Ltd. v. Her Majesty the Queen. This decision is the latest decision in which the General Anti-Avoidance Rule (“GAAR”) was at issue. The firm that defended the taxpayer has written a good summary blog on the decision and you will find it here. Readers are encouraged to read this interesting decision. Moodys LLP were the tax advisors for the taxpayer in the structuring of the transactions at issue. The taxpayer’s victory was the only “win” of the three similar cases decided by the Tax Court in 2011.

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Have you or your clients ever sold an intangible property like a client list? A recent Tax Court of Canada case, George Smith v. Her Majesty the Queen, highlights the tax implications that can arise on the sale of such a property.

In this case, the property was an insurance brokerage client list. Overly simplified, the facts were as follows:

1.  Mr. Smith practiced as a licensed insurance broker in Quebec for a number of years.

2.  Mr. Smith and another insurance brokerage company (“BFL”) entered into an agreement of referral in November, 1995 whereby BFL provided Mr. Smith with the use of BFL’s office facilities and services in consideration of splitting the commission/fee income earned and paid on any premiums paid the insurer’s policyholder during the term of the agreement.

3.  The agreement of referral also provided BFL with the option to purchase Mr. Smith’s client list.

4.  Mr. Smith and BFL entered into a sale agreement effective January 1, 2002 whereby Mr. Smith agreed to sell his client list to BFL.

5.  On January 1, 2002 Mr. Smith’s client list generated annual base commission revenue of $156,000. Accordingly, BFL and Mr. Smith agreed on a purchase price of 2.25 times the annual commissions which equated to a purchase price of $351,000.

6. Subject to certain adjustments, the purchase price was payable as follows:

a.   January 1, 2002 - $142,000 (40.7%)
b.  January 1, 2003 - $69,500 (19.77%)
c.    January 1, 2004 - $69,500 (19.77%)
d.    January 1, 2005 - $69,500 (19.76%)

7.  It was understood that the purchase price was based on represented annual revenue of $156,000 and that the subsequent payments in 2003, 2004 and 2005 would be calculated by applying the percentage of the scheduled payments (as referred to above), to the actual year’s revenue from the appellant’s clientele received in the subject year multiplied by the acquisition factor of 2.25.

8. The balance of payment due to be paid was also subject to an agreed to interest rate payment. 

9. Given the above, the actual payments received were as follows:

10.  Mr. Smith appears to have included the received amounts in his income yearly pursuant to subsection 14(1) of the Income Tax Act (the “Act”), including the interest amounts received as will be further explained below.

Dispositions of property are usually subject to the “capital gains” rules under subdivision (c) of Part I of Division B of the Act. The result of applying the capital gains rules is that any profit from the disposition of a property is treated as a capital gain with only 50% of such amount being included in taxable income. A further advantage to the capital gains rules is that if all of the proceeds have not yet been received in the year of disposition, then deferral opportunities may exist to tax a portion of the resulting capital gains at the earlier of when the proceeds are received or over a five year period from the disposition date.

However, the capital gains rules do not apply to certain types of property. One of these exceptions is for “eligible capital property”. Eligible capital property receipts, which will generally include client list disposition receipts, are taxed under subsection 14(1) of the Act which falls in subdivision (b) of Part I of Division B of the Act. The good news about being taxed under subsection 14(1) is that any net receipts are also subject to a taxable inclusion rate of 50% (like capital gains). However, a negative aspect of being taxed under this provision is that no tax deferral opportunities are possible (unlike those that might exist for capital gains as described above) for proceeds that are not yet due.

Accordingly, given the 50% taxable treatment laid out in subsection 14(1), Mr. Smith took the position that the subsequent payments he received in 2003 – 2005 were taxed pursuant to such beneficial treatment.

The Canada Revenue Agency (“CRA”) disputed Mr. Smith’s treatment of the received amounts subsequent to the date of disposition of his client list as being subject to subsection 14(1) of the Act. Instead, the CRA reassessed Mr. Smith to include the received amounts (exclusive of the interest payments) in 2003, 2004 and 2005 to be captured under paragraph 12(1)(g) of the Act which includes the following amounts in a taxpayer’s income:

12(1)(g) payments based on production or use -- any amount received by the taxpayer in the year that was dependent on the use of or production from property whether or not that amount was an instalment of the sale price of the property, except that an instalment of the sale price of agricultural land is not included by virtue of this paragraph;

As you can see, paragraph 12(1)(g) is a very broad provision. The downside to being taxed under paragraph 12(1)(g) is that such amounts are fully taxable as opposed to being only 50% taxable to the extent that such amounts were caught under subsection 14(1). 
 

In addition, the interest amounts received by Mr. Smith were reassessed by the CRA to be fully taxed under paragraph 12(1)(c) of the Act as interest income as opposed to being only 50% taxed under subsection 14(1).

Ultimately, the Tax Court of Canada found in favour of the CRA whereby such amounts received by Mr. Smith in 2003, 2004 and 2005 were taxed either as interest income (as appropriate) and amounts taxable under paragraph 12(1)(g) since the “Purchase Price” and the adjustments to the Purchase Price were all computed and determined by the annual commissions received from the appellant’s client list and nothing else. Accordingly, Mr. Smith had an additional 50% income inclusion that he appears to not otherwise have included in his income for his 2003 – 2005 taxation years. 

This case is an important lesson for taxpayers to ensure that dispositions of property and the resulting tax consequences are carefully thought through. Given the broad language of paragraph 12(1)(g), taxpayers and their advisors need to be careful of this trap.

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Do you own US securities (or other foreign stocks) in your personal portfolio? Does your corporation own US securities (or other foreign stocks)? If so, then pay careful attention to the information below.

1.   Filing of Prescribed Form T1135

If you own US securities (or other foreign securities) in your investment portfolio you may be required, pursuant to section 233.3 of the Income Tax Act (the “Act”), to file prescribed Form T1135 with the Canada Revenue Agency (“CRA”) on a timely basis. This requirement catches a lot of people by surprise given the somewhat mundaneness of investing in US stock. However, subsection 233.3(3) of the Act reads as follows:

Returns respecting foreign property -- A reporting entity for a taxation year or fiscal period shall file with the Minister for the year or period a return in prescribed form on or before the day that is

(a) where the entity is a partnership, the day on or before which a return is required by section 229 of the Income Tax Regulations to be filed in respect of the fiscal period of the partnership or would be required to be so filed if that section applied to the partnership; and
(b) where the entity is not a partnership, the entity's filing-due date for the year.

As you can see, it is a “reporting entity” that is required to file such a form. A reporting entity is defined in subsection 233.3(1) of the Act as follows:

"reporting entity" for a taxation year or fiscal period means a specified Canadian entity for the year or period where, at any time (other than a time when the entity is non-resident) in the year or period, the total of all amounts each of which is the cost amount to the entity of a specified foreign property of the entity exceeds $100,000.

A “specified Canadian entity” includes an individual resident in Canada and also a Canadian corporation. In addition, the definition of “specified foreign property” includes a share of the capital stock of a non-resident corporation (which would include a US publicly traded stock).

Accordingly, to the extent that an individual (who owns such stock outside of their registered portfolio) or a corporation owns any foreign stock (including US stock) with a cost in excess of $100,000 at any time in the year then prescribed Form T1135 will need to be timely filed.

There appears to be a myth in the market place that there is an exemption for ownership of US stocks from the filing requirements for a T1135. However, no such exemption exists.

To the extent that prescribed Form T1135 is not timely filed, a person can be subject to a number of penalties. The least onerous penalty is a $25 per day penalty to a maximum of $2,500 for failure to file pursuant to subsection 162(7) of the Act. If the person knowingly or under circumstances amounting to gross negligence fails to file Form T1135, then an additional penalty becomes applicable under subsection 162(10) which will be $500 (or in some cases $1,000) per month that the T1135 is late filed to a maximum of 24 months.

In addition, a person can also be subject to an additional penalty under subsection 162(10.1) if the months that the T1135 is late filed exceeds 24 equal to five percent of the greatest of all amounts each of which is the total of the cost amounts to the person of the specified foreign property.

While these reporting rules have been in existence within the Act since the late 1990's, the CRA was usually very lenient and did not usually charge such penalties if prescribed Form T1135 was late filed. However, such administrative leniency ended without notice in the mid-2000's and there have been a number of reported cases where taxpayers have challenged the CRA's application of such penalties. One interesting case is currently before the Federal Court of Appeal. Click here for a copy of the lower court's ruling.

Accordingly, taxpayers and their advisors need to be very aware of the possible need to file prescribed Form T1135 when investing in foreign stocks, including US stocks.  

2.  Possible Exposure to US Estate Tax

An additional implication, for individuals, of investing in US stocks in your portfolio is that you could be subject to US estate tax even though you are not a US citizen. This is true because US estate tax is applicable to anyone in the world to the extent that they own US-situs property. US-situs property includes shares of US corporations. As an example, consider the following example facts:

1. Mr. Apple’s worldwide net worth is $10 million USD.
2. Mr. Apple is a Canadian resident and Canadian citizen, and is not a US citizen.
3. Mr. Apple’s investment portfolio includes $1 million USD of publicly traded stocks.
4. Mr. Apple dies.
5. The US estate tax rate for 2011 and 2012 is 35 percent with a $5 million USD exemption for US citizens. However, non-US citizens are only entitled to a pro-rated amount of the $5 million exemption which is calculated as the percentage of their US-situs assets ("A") to their worldwide assets ("B") multiplied by the $5M exemption ("C"). In other words, a non-US citizen is generally entitled to an exemption of US estate tax calculated as (A/B) x C.

Given that Mr. Apple owns US-situs property, this legal representatives administering his estate must consider the need to file a US estate tax return and to pay any US estate tax. As a very rough calculation, Mr. Apple’s US estate tax exposure would be as follows:

1. US-situs property - $1 million USD
2. Mr. Apple's worldwide net worth - $10 million USD
3. Mr. Apple's US estate tax exemption entitlement – $1 million USD/$10 million USD x $5 million USD = $500,000 USD
4. Therefore, Mr Apple’s estate tax would be computed as follows:

While the Canada-US Tax Treaty may provide some relief from possible double taxation, the treaty will often not provide full relief. Accordingly, Mr. Apple’s legal representatives will need to look for ways, if possible, to reduce the overall Canadian tax and US estate tax exposure.

Conclusion

Be aware of Canadian foreign reporting requirements and US estate tax exposure when investing in US stocks.
 

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With much fanfare, the “kiddie tax” was introduced into Canadian tax law effective January 1, 2000.  My, how time flies. It does not seem like it was 11.5 years ago that such a tax was introduced to prevent income splitting mischief.

The “kiddie tax” applies on certain types of income (“split income”) received by a child (under the age of 18 throughout the year – the “minor”) who has a parent that is resident in Canada at any time during the year. If applicable, the minor child will end up paying income tax at the highest personal tax rate that would otherwise be payable on the type of income received.   In addition, the parents generally have joint and several liability for the tax.

The most common type of income to which the “kiddie tax” applies is dividend income from a private corporation. It used to be routine planning to have a trust with a minor child as a beneficiary (or have the minor child own the shares directly in the private corporation to the extent that a lawyer would give a legal opinion that the minor child could hold such property) and ultimately pay dividends to the minor child. Prior to the introduction of the “kiddie tax,” such a simple plan was an effective income splitting tool since a child could use up their personal tax credits and in many cases pay no personal income tax up to certain levels of income. 

Another common plan prior to year 2000 was to have a partnership whereby the child (or a trust of which the child was a beneficiary) would be a partner and have the partnership receive income from a related entity. For example, the partnership could provide management or administrative type services to a corporation owned by “Mom” or “Dad” or both. Such income received by the partnership could then be easily allocated to the partners (of which a minor child would be a direct or indirect beneficiary of such partnership income) thus again providing for simple yet effective income splitting.

Both the dividend sprinkling plan and the partnership type plan described above are subject to the “kiddie tax” to the extent that the income is received by a minor child thus eliminating any income splitting advantage associated with such plans. 

One of the most common types of taxable income that is not split income and therefore not subject to the “kiddie tax” is capital gains. Accordingly, many plans involving related private corporations were put in place so as to recognize capital gains. The plan generally involved having certain shares of a private corporation being sold to a related company with the resulting capital gain being taxable in the minor child’s hands. Prior to the 2011 Federal Budget, such a plan was often used to the extent that the practitioner and their client believed that the general anti-avoidance rule (“GAAR”) would not apply. The Canada Revenue Agency, however, was not amused and would often times apply the GAAR to such a plan (with many cases still in the system). The 2011 Federal Budget has introduced a legislative fix to such a plan whereby after March 22, 2011 such capital gains will now be subject to the “kiddie tax.” However, other capital gains realized by a minor (for example, from a publically traded portfolio of assets or shares of a private corporation disposed of to an arm’s length person) will continue to not be subject to the “kiddie tax.” As such, capital gains realized and taxable in the hands of a minor either directly or indirectly is still a common and effective income splitting tool. 

Further, partnerships or trusts that provide services to arm’s length parties are also not subject to the “kiddie tax.”  For example, let us assume that Mom, Dad and a trust for their minor children are partners in a partnership. The partnership carries on the business of selling sandwiches to the public. To the extent that the partnership realizes profits, a reasonable allocation of partnership income can be made to the minor child (either directly or indirectly) without the incidence of the “kiddie tax.” (Section 103 must always be considered when dealing with partnership income allocations since unreasonable allocations might be reallocated by the CRA to a more reasonable allocation after all the factors are considered).

While the “kiddie tax” certainly provides a wrench for simple income splitting plans using minor children, effective planning can still be done today.   However, professional advice should always be sought before implementing any income splitting plan. The professionals at Moodys LLP Tax Advisors would be pleased to assist you in developing an effective plan.

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In my many years of practice, it never fails to amaze me how many people rely on non-qualified persons for advice in one of the most complex topics there is – tax planning or, as Moodys LLP likes to call it, “tax optimization”. There is no shortage of “experts” who seem to think that they understand tax. In this day and age of instant information vis-à-vis the internet, such “experts” continue to flourish and continue to dispense tax advice to their colleagues and buddies. Unfortunately, many of those people end up in our offices seeking advice when things go wrong. In many cases, such advice has led to “planning” which is a ticking time bomb waiting for nasty results should their affairs ever be reviewed. 

One of the most common ticking time bombs that we run across is personal use property owned by a corporation. Routinely, we find cottage properties owned by corporations.  In some extreme cases, we discover situations where the shareholder’s or shareholders’ principal residence is owned by a corporation. Such “planning” is usually disastrous. Why is that? Well, there are a number of reasons. The biggest reason is that personal use property owned by a corporation will result in taxable benefits being applicable to the individual shareholder(s). The relevant provision under the Income Tax Act that requires a taxable benefit is subsection 15(1) which reads as follows:

15(1) Benefit conferred on shareholder -- Where at any time in a taxation year a benefit is conferred on a shareholder, or on a person in contemplation of the person becoming a shareholder, by a corporation otherwise than by

(a) the reduction of the paid-up capital, the redemption, cancellation or acquisition by the corporation of shares of its capital stock or on the winding-up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which section 88 applies,

 (b) the payment of a dividend or a stock dividend,

 (c) conferring, on all owners of common shares of the capital stock of the corporation at that time, a right in respect of each common share, that is identical to every other right conferred at that time in respect of each other such share, to acquire additional shares of the capital stock of the corporation, and, for the purpose of this paragraph,

(i) where

(A) the voting rights attached to a particular class of common shares of the capital stock of a corporation differ from the voting rights attached to another class of common shares of the capital stock of the corporation, and

(B) there are no other differences between the terms and conditions of the classes of shares that could cause the fair market value of a share of the particular class to differ materially from the fair market value of a share of the other class,

the shares of the particular class shall be deemed to be property that is identical to the shares of the other class, and

 (ii) rights are not considered identical if the cost of acquiring the rights differs, or

 (d) an action described in paragraph 84(1)(c.1), (c.2) or (c.3),

the amount or value thereof shall, except to the extent that it is deemed by section 84 to be a dividend, be included in computing the income of the shareholder for the year. [emphasis added]

As you can see, subsection 15(1) is an extremely broad provision which can capture many fact patterns. The difficulty with the provision is that it does not set out detailed rules on how to quantify the taxable benefit. In the case of a cottage property, for example, many people feel that a comparable hotel rate is the appropriate taxable benefit that they need to capture into their personal taxable income or to pay to the corporation for the use of that cottage property. For example, if Mr and Mrs Apple each owned 50 percent of the shares of “OpCo” and OpCo owned a cottage property in Phoenix, Arizona, would the taxable benefit be say, $200 a night (a comparable hotel rate) multiplied by the number of days that they use the property (say five days per year) which equals $1,000? In short, the answer is no. Instead, the Tax Court of Canada has found in cases such as Youngman [1990] 2 CTC 10 (FCA), Donovan [1996] 1 CTC 264 (FCA), and Fingold[1997] 3 CTC 441 (FCA) that the taxable benefits applicable to the ownership of a cottage property by a corporation is not the hotel rate.  Instead, the taxable benefit is generally computed by reference to the cost of the property multiplied by an applicable rate of return. For example, if OpCo had paid $500,000 for the acquisition of the Phoenix, Arizona property and OpCo would normally receive a 15 percent rate of return on its invested capital then likely 15 percent of $500,000 (or $75,000) would be the appropriate amount to include in Mr and Mrs Apple’s personal taxable income annually. 

If you are not already awake or did not know about the risks of personal use assets owned by a corporation, then you should be aware that there is further damage. Firstly, there is no underlying “step-up” in the cost base of the personal use corporately owned assets for the taxable benefit received each year by Mr and Mrs Apple. This can lead to outright double taxation as a result of the corporation owning the personal use property. Secondly, when the property is sold, OpCo will realize a capital gain (assuming the property has increased in value) which may not be sheltered by any principal residence exemption (if the property could otherwise be treated as a principal residence by the individual shareholders). Finally, to the extent that the funds need to be extracted from the corporation, such extraction will normally be considered a taxable dividend (unless other tax free accounts are available such as a shareholder loan account or a capital dividend account). (I have purposely not discussed any GST or HST matters but such issues would also need to be reviewed).

At this point, it may be prudent to let the reader know that the Canada Revenue Agency used to have an administrative position which enabled a corporation (often referred to as “sole purpose/single purpose” corporations) to acquire US personal property without subsection 15(1) applying. However, this administrative position ended for acquisitions of US property after 2004 with some limited grandfathering. Accordingly, people need to be very aware of the dangers of acquiring US personal use property through a corporation. However, such a caution extends to all types of personal use property. For example, we have often seen timeshare properties, personal furniture, recreational vehicles, etc., owned by corporations. It appears that people think that significant tax savings can be achieved by owning such properties through a corporation. Unfortunately, nothing could be further from the truth. 

So what do you do if you have personal use property owned by a corporation and you are one of the shareholders? Unfortunately, there are not many solutions to this difficult issue. Instead, you should be looking to extract the personal use property from the corporation using available tax free accounts. However, if tax free accounts are not available then simply paying the personal income tax on an extraction may be far cheaper in the short and long term to avoid nasty surprises.  

For those of you who would like to see a video on this topic in Moodys’ YouTube channel, click here.

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Before we proceed the reader needs to know that the views expressed below are mine only and do not necessarily represent the views of all the accounting professionals in our firm.

For those of you who have not heard, the Canadian Institute of Chartered Accountants (“CA”) and the Society of Management Accountants of Canada (“CMA”) are currently exploring the environment to see whether merger talks should be held, with the ultimate goal being one designation for the merged body (currently proposed to be “Chartered Professional Accountant” or “CPA”). Seven years ago, the same two bodies brought a proposed merger deal to the table of members, but the proposal was withdrawn before it was brought to a vote by members. This time, however, there is no current proposal agreement but rather the two bodies are simply putting their toe in the water to see whether the current landscape is ripe for a merger. To this end, both professions are engaging their members in a series of dialogues and discussions - both online and in person - to see if there is interest in moving forward with such merger talks. 

I have been closely monitoring the online and in-person discussions. For the people that are not interested in the merger, the reasons given tend to be something like this:

1.   “My designation is better than yours and a merged CPA designation will water down the ultimate accounting profession.”

2.   “I worked very hard to attain my designation and enabling a lesser designation to merge with my higher quality designation is offensive.”

3.   “CA’s and CMA’s do different things and the marketplace recognizes such differences. Why, then, the need for a merged designation when the marketplace clearly differentiates and demands such designations?”

4.   “CPA? That will make us look like American CPA’s!”

As I stated, I have listened very closely to both sides of the debate and, try as I may, the persons who are negative to exploring a possible merger always seem to fall in one of the above categories.

However, good leadership often means taking on controversy for the betterment of all. Instead of resting on ones’ laurels and saying “I’m better than you,” self improvement often requires a good long hard look in the mirror. In this case, the leaders of the CA’s and CMA’s deserve high praise for taking a good long hard look in the mirror to see whether change is necessary for the better good. Perhaps it might not be. But more importantly, perhaps it WILL be. Seven years ago, the world was a different place. The internet and emerging technologies have made the world a much smaller place with people and professions becoming irrelevant very quickly.

While I certainly understand the frustration and defensiveness of a practitioner who worked very hard in their studies to attain a professional status, one would hope that such a practitioner can put their personal interests aside and study both sides of the debate to see whether a merged body would help out the profession as a whole as opposed to them personally. One might ask why should a person pursue such an exercise to set aside their personal interests in order to study the common good? The answer to that is simple … while their personal interests at the moment may be well taken care of given their existing professional status, the profession cannot exist with members who think only of their personal interests as opposed to the common good. It should be common sense that if the profession is improved both in the short term and the long term, the personal interests of the average member will also improve. In my humble opinion, it is simply selfish to only worry about one’s personal interests as opposed to the greater interests of the profession as a whole. 

What are some of the arguments for a merged CA-CMA body? Consider the following:

1.   A combined CA-CMA body will be a very large group and, in fact, one of the largest accounting bodies in the world.
 

2.   The merged body will have the opportunity to take a serious look at new education requirements for new entrants into the CPA profession. Assuming that the entrance levels are as high or higher than the highest current standard for either the CA or CMA then presumably such arguments for a weaker long term designation will disappear.
 

3.   The merged body may have a greater voice at the relevant tables (such as accounting standards, tax legislators and administrators), in order to influence change. Let’s be serious. Canada is a small player in the world scene, but with a merged body we may be able to influence greater change.
 

4.   Efficiencies will likely improve. Currently, each province in Canada has its own provincial office in order to administer the accounting profession. Is this really necessary? Under current law it likely is, but perhaps with a merged body and government involvement efficiencies may ultimately arise.

5.   Let’s be honest. Does the average consumer of accounting services know the difference between the designations? Truthfully! I would respectfully suggest that the answer is no. While there are always exceptions to this rule, on the whole I would suggest that no one really knows the detailed differences between a CA and a CMA unless research is done in order to investigate such. This leads to significant brand confusion amongst consumers of accounting professionals’ services. Any elimination of brand confusion should be welcome both for the short and the long term. 

In addition, to the extent that merger discussions are ultimately entered into, I am hopeful that the merged body takes a sober second look at the need for specializations within the profession. Currently, both CA’s and CMA’s are guilty of publicly stating to the world that they can do many things (such as audit, tax, general accounting, information technology and business valuation). The truth is, the average member cannot do all those services and any statement to the contrary is simply false. While the CA’s have recognized the need to specialize in certain areas such as business valuation (which has a recognized sub-designation of CA.CBV), information technology (with a recognized sub-designation of CA.IT) and others, the obvious missing sub-designations are audit and tax. To suggest that the average CA or CMA knows audit and/or tax at a level appropriate to practice professionally is again incorrect. Quite simply, both audit and tax are specialties on their own that require rigorous training and experience. Any dabbling by a practitioner in these areas is a recipe for disaster. Wouldn’t it be better, to serve the public, to allow users of professional services to know which sub-specialty the particular CPA possesses? Of course it is. Unfortunately the introduction of sub-designations for tax and audit has been very controversial. Witness, for example, a proposal to introduce CA.Tax as a sub-designation earlier in the 2000’s. At the last moment, the CA.Tax proposal was dismissed for reasons that were never publicly made available but, reading between the lines, it is pretty obvious that a certain influential sector of the CA membership would not support it.   It is my hope, for the betterment of the profession as a whole and in the interests of serving the public better, that the tax sub-specialty idea be revisited with the idea of being re-introduced.

While we are on the topic of a “wish list”, wouldn’t it also be a great idea if the merged body had some ability to influence the government regulators who have the power to introduce legislation that would restrict the use of the label “accountant”? Currently, anyone can call themselves an accountant whether or not they are professionally designated. However, other professions are not similar. For example, in both medicine and law people cannot call themselves “doctors” or “lawyers” unless it is true. If they do so without the proper authorization, enforcement action can be taken.

Many more arguments exist on both sides of the merger equation. However, this brief overview is not intended to be an exhaustive treatise on the case for or against a merger. Instead, this overview is intended to provoke thought and, hopefully, some controversy on the discussion that the leaders of the CA’s and CMA’s have raised with members. 

From the tone of this blog, it should be no secret on which side of the fence I am excited about. Having said that, the current discussions are simply that … discussions only. As the old saying goes, “the devil is in the details” and I look forward to reviewing details of a proposed merger and making my mind up about such a proposal at that time. However, perhaps the leaders and the profession will decide that further discussions on this matter should not be done. From my point of view, that would be a huge disappointment. Any time that one has to make progress, it is my opinion, that one should grasp that opportunity and run with it. 

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Posted by Marissa L Halil LLB, BCL and Nicolas Baass LLB, LLM (Tax)

S & D International Group Inc. v. Canada[1] is another recent case on rectification which represents a significant win for taxpayers.[2] In S&D International Group Inc., the Court broadly interpreted its equitable jurisdiction to allow taxpayers to correct transactions producing unintended tax consequences and granted a rectification order despite scant evidence of intent to avoid tax, and despite the fact that the taxpayers were under no misapprehension about the basic nature of the transaction (share repurchase).

S&D International Group Inc. (“S&D” or the “Corporation”) was in the business of developing and marketing real estate in Alberta.  It was owned by three businessmen and their wives. The wives held 75% of S&D’s common shares.[3] The businessmen owned the remaining 25% shares through other corporations. When S&D came under investigation by the Alberta Securities Commission (in relation to the sale of interests in land to various investors), the businessmen decided to distance their wives from the Corporation. The wives’ accordingly sold their common shares back to the Corporation in consideration for land. S&D did not report the disposition of the land on the basis that the adjusted cost base (ACB) of the land was equal to its fair market value (FMV).  Moreover, S&D erroneously transferred 100% of the lands to the wives when it should have only transferred 75%. The CRA reassessed S&D for capital gains, alleging that the FMV of the transferred lands far exceeded the ACB. Moreover the wives were reassessed for a deemed dividend on a repurchase of their shares. A subsequent Cancellation Agreement, drafted without tax advice, which purportedly cancelled the share repurchase and land transfer by S&D, did not have the desired effect of correcting the unintended tax consequences.

As the primary remedy, the taxpayers argued that the unintended tax consequences constituted a fundamental mistake, and thus sought to have the Court declare the share repurchase and property transfer to be void ab initio, i.e. the rescission of the transactions.  Alternatively, the taxpayers sought rectification of the transactions, whereby S&D would pay for the wives’ shares with cash or reduced land consideration.[4]

The Crown appeared to make persuasive arguments in this case. It argued that neither rescission nor rectification were available as there had been no fundamental mistake. There was no mistake about who was transferring the lands, who it was being transferred to, or why it was being transferred. The reason for the transfer was to avoid liability with the Alberta Securities Commission and that purpose was accomplished. The Crown stated there was no evidence that the parties intended to effect the transactions on a no-tax basis. It also cautioned that rectification should not to be used as means for retroactive tax planning.

The Court found that the taxpayers were mistaken as to the value of the land being transferred to the wives, mistaken in transferring more than 75% of the lands to the wives, and also mistaken as to the effect of the Cancellation Agreement. The issue was whether such mistakes entitled the taxpayers to the remedies they sought.

The Court started its analysis by observing that remedies for mistake have developed and are continuing to expand. The Courts’ jurisdiction to grant equitable relief, it stated, is always discretionary and “hesitated to place same strictures around equitable remedy for as there are for common law mistake.” Importantly, the Court went on to state that the leading authority on rectification, Juliar, should not be interpreted as requiring that the parties demonstrate that the mistake was “a primary and continuing objective of the applicants from the inception of the transaction.” There were no impediments to granting equitable relief in this case, because the taxpayers’ mistake was honest, the transactions were not entered into for any improper purpose, no advantage had been gained by the taxpayers in relation to the transactions, no alternative legal remedy was available to them, and no fault could be attributed to them. The fact that the applicants were not mistaken about the nature of the transaction (i.e. to repurchase the wives’ shares) and the fact that, “as in Juliar”, there was “little evidence” of intention to proceed on a no-tax basis, did not prevent the Court from granting equitable relief. The mistake as to the value of the lands was fundamental and the transactions would not have proceeded in the fashion that they did but for the mistake.

The Court stated that the appropriate remedy in this case was to reduce the amount of land transferred to the wives. The judge writes “a fair interpretation of the Agreement is that it only intended to transfer $5,594,336.25 worth of lands to the wives.” The Cancellation Agreement was declared void ab initio.

Although discussed in the case, the Court's reducing the amount of land transferred to the wives only reduces the amount of corporate tax, rather than eliminating it completely.  Furthermore, there remains the issue of the deemed dividends on the repurchase of the wives’ shares.  Indeed, there seems to be some unexplained disconnect between the repurchase of 75% of the common shares (i.e. the wives’ shares) for the intended consideration of $5.6M, which is arguably less than 75% of the aggregate FMV of the corporation’s shares on the date of repurchase (assuming the CRA’s valuation of the land was correct).  Nonetheless, the case still represents a significant win for taxpayers.

[1] 2011 ABQB 230

[2] Rectification is a court-ordered remedy allowing applicants to correct a written instrument which does not accord with the true intention of the parties. In tax, rectification orders allow taxpayers to correct transactions producing unintended tax results.

[3] There was some contradiction in the case about who held the 75% S&D shares, the wives, or their holding corporation.

[4] If the FMV of the land far exceeded its ACB, it is not clear in the case how reducing the amount of land transferred would entirely eliminate the capital gains tax incurred by the Corporation on the land transfer. Moreover, it is not clear how a cash payment would eliminate the wives’ deemed dividend.

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 Wow! That’s quite a title! Who would think that passion, YouTube and one of the more important provisions in the Income Tax Act (the “Act”) dealing with trust attribution would appear in the same blog? Well, today they do!

Let’s start with passion…those of you who know me personally know that I am rather passionate about a few topics. One of them being income tax and the pursuit of solutions to complex income tax problems and the development of proactive plans.   Well, it seems that a rather famous comedian, David Mitchell, has picked up on our tag line “Passionate About Tax Optimization” and created a short skit on this and other things passionate. This YouTube clip has been floating around the internet for roughly two years now and every time I look at it I chuckle. In my opinion, the old adage remains that if you can’t laugh at yourself there is not much you can laugh at and therefore I thought I would share this rather humorous skit with you in case you haven’t already seen it - David Mitchell gets Passionate about the Subject of Passion.

That’s a nice segway into announcing that Moodys LLP Tax Advisors has started its own YouTube channel to develop short pieces on tax topics. We are still experimenting with YouTube and other social media tools, but we believe that short YouTube clips on important tax topics may be valuable. Take a look at our YouTube channel here, Moodys YouTube, and look regularly for updates.

Now to an important income tax topic that is starting to get a lot of traction. The issue concerns indirect transfers of property and appears to have been rekindled by the St. Michael Trust Corp. (known better as Garron Family Trust) case – that we blogged about on November 18, 2010. In that decision, the Federal Court of Appeal had the following to say:

[75]           There are undoubtedly many ways in which a transfer of property may occur directly or indirectly in any manner whatever, and there is very little guiding jurisprudence. However, it is now well established that if the existing common shares of a corporation worth, say, $100, are exchanged for preference shares with a value that is fixed at some lesser amount, say, $80, and new common shares are issued to a new shareholder for nominal consideration, the holders of the preference shares have indirectly transferred property worth $20 to the new subscriber (see Canada v. Kieboom (C.A.), [1992] 3 F.C. 488, at paragraph 21).

[76]           Kieboom recognizes that the entire value of any corporation is represented by its shares, which are property. The allocation of the value of a corporation between shares of different classes is determined by their terms and conditions. Therefore it is possible to change the value of a class of shares, and to shift value from one class of shares to another, by changing their terms and conditions. The hypothetical reorganization described above results in an indirect transfer of property worth $20 from the holders of the fixed value preference shares to the new subscriber.

Kieboom was a case that involved a situation where “Dad’s” shares of a corporation were diluted in value because certain other family members were able to subscribe for shares of the subject corporation for a nominal value. The Federal Court of Appeal found that Dad had transferred property (indirectly) to the family members equal to the diluted value.

The above two paragraphs are rather controversial amongst the tax community and much has been written about the Kieboom case. It is my opinion that if one accepts the above two paragraphs and accepts the reasoning in Kieboom then many “garden variety” estate freezes that occur where there is an under-valuation of the preferred shares could result in an indirect transfer of property to the new common shareholder. 

For example, let’s assume that “Mom” owns 100% of the shares of OpCo. OpCo has a purported fair market value (“FMV”) of $1M. One of the numerous methods to effect an estate freeze in favor of Mom’s family would be to have Mom transfer her OpCo shares on a tax deferred basis to a holding company- “HoldCo” - whereby Mom would receive $1M of redeemable, retractable preferred shares of HoldCo with an aggregate redemption value of $1M.  A new discretionary family trust could be properly settled such that Mom, Dad and family members are beneficiaries of the trust.    Given that the FMV of HoldCo at that point would be nominal (since presumably the only asset of HoldCo would be the shares of OpCo with a $1M value), the newly settled family trust could subscribe, using its own funds, for new common shares of HoldCo for a nominal amount thereby enabling any future increase in the value of its HoldCo shares to accrue in favor of the family beneficiaries. Normally, such an estate freeze transaction would be accompanied by price adjustment mechanisms which would become applicable if the $1M value was found to be the incorrect value. The price adjustment mechanism would cause the redemption value of the preferred shares to automatically be increased or decreased (as appropriate in the circumstances) thereby still resulting in a tax deferred estate freeze.

Such an above plan is rather standard estate planning and has been for years. Tax practitioners and advisors go to great lengths to ensure that a devastating trust attribution rule – subsection 75(2) – does not apply when using a trust in such a plan. Subsection 75(2) reads as follows:

(2) Trusts [revocable, etc.] -- Where, by a trust created in any manner whatever since 1934, property is held on condition

     (a) that it or propertysubstituted therefor may

 (i) revert to the person from whom the property or property for which it was substituted was directly or indirectly received (in this subsection referred to as "the person"), or

 (ii) pass to persons to be determined by the person at a time subsequent to the creation of the trust, or

 (b) that, during the existence of the person, the property shall not be disposed of except with the person's consent or in accordance with the person's direction,

any income or loss from the property or from propertysubstituted for the property, and any taxable capital gain or allowable capital loss from the disposition of the property or of propertysubstituted for the property, shall, during the existence of the person while the person is resident in Canada, be deemed to be income or a loss, as the case may be, or a taxable capital gain or allowable capital loss, as the case may be, of the person.

 To the extent that subsection 75(2) applies in respect of the trust property, all income, losses, capital gains, and capital losses attributes back to the person who transferred the property to the trust. In addition, if subsection 75(2) was applicable, any transfer of capital property from the trust to a capital beneficiary, in satisfaction or partial satisfaction of one’s capital interest in the trust, would occur at FMV which would often be tax deferred otherwise. Accordingly, the application of subsection 75(2) is usually devastating for an estate freeze plan including a trust.   

Given the comments of the Federal Court of Appeal in Kieboom and recently in St. Michael Trust/Garron Family Trust, if the FMV of the OpCo shares referred to in the example above is actually $3M as opposed to $1M, could it be viewed that Mom transferred $2M of property to the newly settled family trust, thereby evoking the provisions of subsection 75(2)?   If one holds the view that there has been an indirect transfer of property to the trust then the answer would be “yes”.    Given such, tax advisors and their clients will need to be well aware of this fast moving area of tax law and be very careful to ensure that there has been no indirect transfers of property to a trust which might cause subsection 75(2) to apply (especially if the price adjustment mechanisms in the agreements are not effective).

It appears that the CRA is already starting to pick up on this view after the St. Michael Trust/Garron Family Trust decision. A Technical Interpretation released on April 13, 2011 into the tax databases (Technical Interpretation 2010-0366301I7) describes a fact pattern that is very similar to the example described above. The CRA uses the reasoning in the St. Michael Trust/Garron Family Trust and Kieboom cases to assert that there is an indirect transfer of property to a trust.    In other words, the CRA is of the view that the freezor transferred property indirectly to a trust that had subscribed for new common shares of a corporation that was the subject of the estate freeze. To be clear, the CRA has stated for years that it would apply the reasoning in Kieboom in a fact pattern similar to that as described in the example herein (see for example Technical Interpretation 982385 dated October 13, 1999). However, the CRA has also said that it would not apply the reasoning in Kieboom in the course of an estate freeze where the trust pays full FMV for the equity shares that are issued in the course of an estate freeze (see Technical Interpretation 9225295 dated December 9, 1992).

I could get into a lot more detail on this issue and debate its merits but I will have to leave this to another time where I can spill more ink on this subject (and my assistant’s ears are feeling better so that she can transcribe more of my dictation). Stay tuned…this subject will certainly be the subject of discussion in the tax community for months and years to come.

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Section 231.2 - Requirement to Provide Documents or Information to the CRA - is Unconstitutional and Without Effect – In Quebec at Least: Chambre des notaries du Quebec c. Canada

Most tax practitioners are familiar with CRA’s attempts to obtain their clients information by way of sections 231.2 of the Income Tax Act (the “Act”). This provision allows the CRA to require that any person provide any information or any documents for the purpose of administering or enforcing the Act. What practitioners may not be familiar with is a recent Quebec Superior Court decision which declares this provision (and connected provisions) unconstitutional and without effect by virtue of sections 52 of the Canadian Charter of Rights and Freedoms! This decision is Chambre des Notaires du Quebec c. Canada [2010] R.J.Q. 2069. So, why have you not heard of this decision? Most likely because it has only been released in French – the English translation is no doubt pending.

Notaries in Quebec are required to go through law school like lawyers. They also have the same obligations to maintain solicitor-client privilege as lawyers. As such, consider notaries and lawyers to be the same for the purposes of this decision – lawyers, please do not take offense. In this decision, a number of notaries were required, pursuant to section 231.2, to provide information and documents regarding their clients. In addition to the request for documents or information, the CRA would usually remind the notaries of the possibility of a fine and imprisonment if the request was not complied with.[1] Needless to say, the notaries were placed in a somewhat uncomfortable position of either complying with the order and compromising the solicitor-client relationship or ignoring the order and exposing themselves to potential fines and imprisonment! Following further CRA requests under section 231.2 to the notaries, the Chambre des notaries du Quebec decided to obtain a declaratory judgment declaring that section 231.2 was an unconstitutional violation of the solicitor-client relationship. The Quebec Superior Court agreed!

Following an extensive review of Supreme Court’s jurisprudence on solicitor-client privilege, the Court summarizes solicitor-client principals as follows:

1.       With respect to the privilege, there is no reason to make a distinction between a criminal law matter and a civil law matter;

2.       A soon as there is a legitimate professional relationship between a lawyer and a client, all actions, documents and all information are, prima facie, covered by the solicitor-client privilege;

3.       The party challenging the existence of the privilege has the burden of proving that the privilege does not exist;

4.       The exceptions to solicitor-client privilege should be extremely rare and should be used only as a last measure, once all other possibilities have been exhausted;

5.       Legislation (such as the Act) must make sure that they scrupulously respect the existence of the privilege to prevent untimely divulgation of protected information; and

6.       Any legislation that is susceptible to impair the privilege should be interpreted restrictively and cannot require the divulgation of protected documents.

The Court notes the Supreme Court’s statement in Lavallee v. R [2002] 3 S.C.R. 209 that the legislator should strive to take all necessary steps to assure that solicitor-client privilege is respected to the fullest extent. The Court also notes the Supreme Court’s statement that any legislative regime which does not directly allow a client, who is the holder of the privilege, to know that his privilege is threatened and therefore protect his rights under the privilege, is constitutionally unreasonable.

Based on the foregoing, the Court identifies three fatal lacunas in section 231.2 and 231.7. Firstly, these sections are not drafted in such a way that the client, holder of the privilege, can learn of the threat to his rights and thus protect it. Indeed, requests under section 231.2 were sent directly to the notaries without warning to the client. Secondly, the Court found the five day delay under section 231.7 to be unreasonably short. Finally, the Act did not impose as a condition that it is demonstrated that the violation of the solicitor-client privilege was a last resort solution. As such, the Court found that section 231.2 was not a minimal infringement of the solicitor-client privilege and declared it to be unconstitutional and without effect.

The Attorney General of Canada had requested a stay of the decision for a period of one year, so as to allow for potential legislative changes. The Chambre des Notaires du Quebec did not object to this stay. However, the Court refused this request on the basis that the rights under the solicitor-client privilege trumped administrative considerations! Strangely enough, the Court also declared section 231.2 and 231.7 to be unconstitutional and without effect – but only with respect to Quebec lawyers and notaries!!   Quite odd considering the Act is a Federal statute. Furthermore, it is odd that Quebec residents should arguably be afforded better constitutional protection than residents elsewhere in Canada. Do not all Canadian residents benefit from the same principals of fundamental justice? 

In any event, this decision is very important for any tax lawyers facing a CRA request under section 231.2, especially in light of CRA’s recent aggressive attempts to obtain privileged information. Unsurprisingly, this decision is under appeal to the Quebec Court of Appeal. It also has Supreme Court written all over it.

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On March 22, 2011, Finance Minister Jim Flaherty, introduced the 2011 Federal Budget. The Budget contains a few “goodies” but will be remembered more for the anti-avoidance provisions that it contains. The more interesting and relevant (for our clients and friends) income tax measures that were introduced in the Budget were as follows:

No Tax Rate Changes

The Budget does not propose any tax rate changes for individuals or corporations.

New “Kiddie Tax” for Capital Gains

The Federal Budget proposes to introduce a new “Kiddie Tax” for capital gains realized by, or included in the income of, a minor from a disposition of shares of a corporation to a person who does not deal at arm’s length with a minor, if taxable dividends on such shares would have been subject to the “Kiddie Tax”.   Capital gains that are subject to this measure will be treated as non-eligible dividends and, therefore, will not benefit from capital gains inclusion rates and will not qualify for the lifetime capital gains deduction.

This proposal appears to target certain transactions which would attempt to create capital gains by entering into a series of complex transactions with private corporation shares and having such capital gains taxed in a minor’s hands. The first version of the “Kiddie Tax” rules, first introduced in year 2000, were not applicable to capital gains realized by a minor individual. The CRA had been attacking such strategies and transactions using the general anti-avoidance rule (“GAAR”) but now will have the legislative authority to deny the usefulness of such a strategy. 

This new measure will apply to capital gains realized on or after March 22, 2011. 

Elimination of the Deferral of Corporate Tax by the Use of Partnerships

For those classic rock lovers (or perhaps better described as 1980s music lovers), you might recall a classic line in a Prince song “…we’re gonna to party like it’s 1999…” Well, tax advisors and their clients will have to substitute the words “party” for “cry” and “1999” for “1995”. This is because these new proposals, described below, smell an awful lot like the rules introduced in 1995 (under sections 34.1 and 34.2) which eliminated deferrals for individual proprietors/partners and professional corporations.

Presently, the income tax rules enable two or more corporations to enter into a partnership relationship and have a significant deferral of corporate income tax to the extent that a business is carried on through the partnership. Corporate partners are only required to include its proportionate share of partnership income in its taxable income for completed fiscal periods of the underlying partnership. For example, assume that two corporations have December 31, 2010 as its most recent normal taxation year end. Let us further assume that the two corporations are partners in a partnership relationship and the underlying partnership has a January 1 taxation year end. The two corporations would report in their December 31, 2010 tax return their share of partnership earnings for the completed taxation year of the partnership that ended during its December 31, 2010 year end. This, in our example, would be the completed partnership taxation year of January 1, 2010 thereby, in substance, enabling a deferral of income tax for one year of the partnership profits.

The Budget papers state “the deferral of tax, whether intentional or not, when income is earned through a partnership, is inequitable. It also creates an incentive to use business structures that have little purpose other than tax deferral which is not economically productive”.

Accordingly, the 2011 Federal Budget “proposes to limit the deferral of tax by a corporation that has a significant interest in a partnership having a fiscal period different from the corporation’s taxation year. In computing the corporation’s income for a taxation year, in respect of a fiscal period of the partnership that begins in the taxation year and ends in a subsequent year, the corporation will be required to accrue income from the partnership for the portion of the partnership’s fiscal period that falls within the corporations’ taxation year (“Stub Period”)”.

This new measure will apply to a corporate partner (other than a professional corporation) for a taxation year if:

• the corporate partner is a member of a partnership at the end of the taxation year;
• the partnership’s last fiscal period that began in the taxation year ends in a subsequent taxation year of the corporate partner; and
• the corporate partner, together with affiliated and related parties, was entitled to more than 10 percent of the partnership’s income (or assets in the case of wind-up) at the end of the last fiscal period of the partnership that ended in the taxation year.

As mentioned, the government introduced similar rules for individuals in 1995. It appears these new proposals piggyback on much of the 1995 legislation in the way that it will require corporate partners to accrue their Stub Period income.  

In general, the corporate partner will be required to calculate their income as follows:

1. Add the corporate partner’s share of the income or loss of the partnership from the fiscal period that ends in the year;
2. Add the accrued income, if any for the Stub Period (“Adjusted Stub Period Accrual”); and
3. Subtract the Adjusted Stub Period Accrual, if any, for the corporate partner’s previous taxation year.

To calculate the Stub Period Accrual, one can choose to use the “Formulaic Approach” (which, in general terms extrapolates the Stub Period income using the current year partnership income inclusion) or the “Designation Approach” which enables corporate partners to designate a Stub Period Accrual that is lower than the calculated amount under the Formulaic Approach. However, if the Designated Amount turns out to be less than the actual pro-rata income then the corporate partner will be subject to an additional income inclusion in the following year. The additional income inclusion will be equal to the amount of the shortfall multiplied by the average prescribed rate for underpayment of tax for the period. In addition, if the shortfall is larger than 25% of the lesser of the pro-rated actual amount and the amount determined under the Formulaic Approach, there will be an income inclusion equal to 50% of the amount in excess of the 25% threshold.

These new proposals also contain measures which will enable partnerships to change their fiscal periods to align with the taxation year of one or more corporate partners. A one-time election, which the Budget papers call a “Single-tier Alignment Election”, will be provided that will enable a partnership to change its fiscal period on the following conditions:

• The last day of the new fiscal period must be after March 22, 2011 and no later than the latest day that is the last day of the first taxation year that ends after March 22, 2011 of a corporate partner that has been a member of the partnership continuously since before March 22, 2011;
• The election must be in writing and filed with the Minister of National Revenue on behalf of the partnership on or before the earliest of all filing-due dates for the return of income of any corporate partner for the taxation year in which the new fiscal period ends;
• At least one of the corporate partners would, in the absence of the election, have an Adjusted Stub Period Accrual greater than nil in its first taxation year ending after March 22, 2011; and
•  All members of the partnership are corporations other than professional corporations.

The Budget documents also acknowledge that these measures could result in significant taxable income for a corporate partner’s first taxation year that ends after March 22, 2011. Accordingly, the Budget proposes transitional relief to recognize the incremental amount gradually over the five taxation years that follow that first taxation year.

The amount upon which a transitional reserve may be claimed is referred to as “Qualifying Transitional Income” (QTI). This reserve will be computed on a partnership-by-partnership basis if a corporate partner is a member of two of more partnerships. A corporate partner will generally be eligible for transitional relief in respect of its QTI from a partnership in accordance with the following schedule.

Corporate partner’s first taxation year1] that ends after Budget Day and in the calendar year

Like other reserves, the amount of a QTI reserve deducted in a taxation year will be included in income in the following taxation year.

The QTI of a corporate partner in respect of a partnership will be the sum of its Adjusted Stub Period Accrual and its Alignment Income in respect of that partnership. If the sum is negative, the QTI is zero.

To try to put this in a bit of plain English, let’s look at the following example:

2011 Budget – Elimination of Partnership Income Deferral

Assumptions:

1. Corporation C has a December 30 fiscal year end and is a member of Partnership P.
2. Partnership P has a December 31 fiscal year end.
3. Under current rules, Corporation C would include in its December 30, 2011 taxation year the income from Partnership P’s December 31, 2010 fiscal period.
4. Assume Partnership P had income of $100,000 in 2010 and has the same amount of income in each of 2011 to 2016

Corporation C’s calculation of Income from Partnership P using the “Formulaic Approach”

There are other specific proposals, beyond the scope of this summary, that restrict the ability to claim a reserve and other proposals for multi-tiered partnerships.

These proposals will result in significant work for corporate partners to comply with. Start planning now.

Employee Profit Sharing Plan Trusts (“EPSP”)

EPSPs are often used for income splitting and for CPP and EI avoidance. Our firm has written on this many times and commented on this type of “Planning” and the risks therein. Obviously, the government is also concerned.  The Budget documents announce they will review the existing rules for EPSPs to determine whether technical improvements are required in order to prevent inappropriate income splitting with family members or avoid CPP or EI payments. However, the government will undertake consultations to seek the view of stakeholders before any amendments are enacted.

Children’s Arts Tax Credit

The Federal Budget proposes to introduce a Children’s Arts Tax Credit which will enable parents to claim a 15% non-refundable tax credit based on an amount of up to $500 in eligible expenses per child under the age of 16, paid in the year.

An eligible expense will be a fee paid in the taxation year to a qualifying entity to the extent that the fee is for the registration or membership of a child in an eligible program of artistic, cultural, recreational or developmental activities. It appears that this tax credit will very much be based on the parameters of the children’s fitness tax credit which was introduced in the 2007 Federal Budget. 

Hmmm…I wonder if the cost of my kid’s new tattoo will qualify for this new credit? Just kidding…

Family Caregiver Tax Credit

The Federal Budget proposes to introduce a Family Caregiver Tax Credit of 15% on an amount of $2,000 and will apply beginning in 2012. Caregivers of dependants with a mental or physical infirmity, including spouses, common-law partners and minor children will appear to benefit by claiming an enhanced amount for an infirm dependent under one of the existing dependency-related credits.

Donation of Flow-through Shares

Existing law enables an individual to acquire a flow-through share and donate such share to a charity with very little after-tax cost. The reason for this is that the individual acquirer of the flow-through share is often entitled to claim the renounced expenditures flowed through to the investor and also benefits from a zero capital gains inclusion rate (to the extent that the share is a listed security) if it is directly donated to a charity. In addition, the donor receives a charitable receipt/donation for the fair market value of the donated share. (Recall that the adjusted cost base of a flow-through share is nil and therefore any donation or sale of the flow-through share would normally result in a capital gain but for the tax rule that deems the capital gain to zero if the “listed security” is directly donated to charity).

The Federal Budget recognizes the significant tax benefits to individual donors to the extent that flow-through shares are donated to charity and appears to want to reduce the amount of the tax benefit on such a plan. Proposed rules will now not enable a zero capital gains inclusion rate for the capital gain up to the original cost of the flow-through share and will therefore result in a capital gain to the original cost.

RRSP Amendments

The Budget proposes to introduce rules that would significantly change the types of investments that RRSPs may hold without penalty. In addition, the Budget proposes to introduce anti-avoidance rules that would significantly restrict “RRSP strips”. These proposals are well beyond the scope of this summary but our firm would be pleased to discuss this with you in more detail.

Charitable Sector Amendments

There are numerous proposed amendments in the Budget that will tighten the receipting, regulatory and governance matters for charities that are beyond the scope of this summary.

Previously Announced Measures

The Budget confirmed their commitment to move forward with previously announced income tax proposals (such as the non-resident trust rules, the restrictive covenant rules and the March 16, 2011 proposals).

Other Miscellaneous Tax Measures

Other smaller proposed tax measures include correcting inefficiencies with the existing child tax credit, expanding medical expense tax credits for other dependants, proposed amendments to the tuition tax credit to recognize fees paid to take an examination that is required to obtain a professional status and further proposed amendments to the tuition tax credit to loosen the eligibility for the tuition tax credit for studies outside of Canada. In addition there are proposed amendments for RESPs to enable transfers between RESPs for siblings without tax penalties and without triggering the repayment of certain grants, certain amendments to the RDSP rules and proposed changes to the individual pension plan (IPP) rules.

Of course, given the existing uncertain political environment, it is questionable whether the March 22, 2011 Federal Budget will ever get voted on. Will we instead see a new budget introduced by a new government? Time will tell. In the meantime, the professionals at Moodys LLP Tax Advisors would be pleased to discuss the Federal Budget measures with you.

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 On March 16, 2011, the Department of Finance released draft income tax legislation for comment. The Department of Finance is looking for comments from the public by April 15, 2011. 

One of the proposals introduces new section 143.4 of the Act. This new section is in direct response to a Federal Court of Appeal decision – Collins v. The Queen, 2010 FCA 12 that we blogged about on our February 2, 2010 blog.  The Federal Court of Appeal, reversing an earlier decision by the Tax Court of Canada, enabled two taxpayers to deduct accrued but unpaid interest expense even though they had an existing right to satisfy their interest obligations by electing to pay a substantially lower amount of interest.   Our firm’s view was that the decision of the Federal Court of Appeal was the correct decision. However, the government obviously has a different point of view. In its explanatory notes to the release of the draft legislation, the Department of Finance stated the following:

“In response, and in general terms, the Government proposes to clarify through amendments to the ITA that the amount of a taxpayer’s unpaid expenditure otherwise deductible for income tax purposes does not include an amount in respect of which the taxpayer, or a person that does not deal at arm’s length with the taxpayer, has a right to reduce or eliminate.  For greater certainty, this treatment will also apply where the right is contingent upon the happening of another event, or in any other way, if it is reasonable to conclude having regard to all the circumstances that the right will become exercisable.  In the Collins case, this would mean that the interest payable under the original obligation in excess of the lower amount that the taxpayer could elect to pay would not be deductible for income tax purposes unless and until it was actually paid.

This proposal is to apply in computing income for taxation years that end on or after Announcement Date”

 Proposed section 143.4 consists of seven new proposed subsections. In general, as the above quote indicates, a taxpayer will be restricted by the amount that they are able to deduct for an expenditure (or capitalize to an asset) for amounts that the taxpayer has a “right to reduce.” To the extent that the taxpayer ultimately pays the “right to reduce” amount, the taxpayer will be able to deduct the payment at that time. The new proposals also contain provisions that would require an income inclusion to the extent that a “right to reduce” an expenditure (that was previously deducted for in a previous taxation year) now exists and the new proposals would have applied to reduce the expenditure to the extent that the law had been in place. 

These income tax proposals are controversial. From many practitioners point of view, the decision in Collins was the correct one. However, as earlier stated, the government obviously has a different point of view and wishes to “protect Canada’s tax base.” 

To the extent that these provisions are passed into law, the new proposals are intended to apply in respect of taxation years ending on or after March 16, 2011. Accordingly, friends and clients of our firm will need to ensure that, when calculating taxable income and/or computing appropriate amounts that are capitalized, they will need to review for “rights to reduce” amounts in order to carefully apply new proposed section 143.4.

For example, some of the various expenditures or arrangements that will need to be carefully looked at will be:

1.    Lease Agreements – do the agreements contain contractual provisions that offer the lessor certain options to reduce the cost?

2.    Debt Arrangements – similar to Collins, are there contractual arrangements that enable the debt holder to reduce their future carrying costs?

3.    Earn-outs – many business acquisitions are arranged in such a way that future profits (or other amounts thereof) are paid to the vendor into the future. Will these new proposals affect such arrangements? Perhaps. A close review of the business deal and the new proposals will need to be carried out,

The tax professionals at Moodys would be pleased to discuss these proposals with you.

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In 2008, the Organisation for Economic Cooperation and Development (“OECD”) released a discussion paper regarding their project on high-net-worth individuals. The discussion paper was intended for public comment. Tax advisors who read the discussion paper and who work with private clients were certainly concerned about some of the comments made.  In September 2009, the OECD released a publication entitled “Engaging with High-Net-Worth Individuals on Tax Compliance”. The publication explored “….the significant challenges to tax administration [when dealing with high-net-worth individuals] due to the complexity of their affairs, their revenue contribution, the opportunity for aggressive tax planning and the impact of their compliance behavior on the integrity of the tax system”. Given the OECD’s activity in recent years regarding high-net-worth individuals, tax advisors (like our firm) were not surprised to see certain countries start to engage more with that group. 

For example, in October, 2009, the US tax administrators – the IRS - announced the formation of a high-net-worth audit group named the Global High Wealth Industry group which is housed in the IRS large and mid-sized business operating division. From many accounts, the audits by the Global High Wealth Industry group have been particularly harsh. 

In Canada, the CRA has been announcing at various tax conferences throughout the last year that their audit practices would change to focus on high-net-worth individuals. A recent article in last weekend’s National Post confirmed that such audits have commenced.  The article refers to a questionnaire that the CRA has provided to high-net-worth individuals to complete. Our firm has a copy of the 18 page questionnaire and has reviewed it. Many of the questions are simply requesting facts but one could certainly view the questions to be rather invasive. 

High-net-worth families and individuals are certainly going to be targeted into the future by tax administrators around the world. For Canadians, the message is to get ready and be prepared.   Our firm can certainly assist in such preparation.

Lastly, the IRS announced yesterday a new special voluntary disclosure initiative for US taxpayers who have unreported income from offshore assets. This is the second attempt by the US to encourage voluntary disclosures for unreported income from offshore assets (see our blogs of September 8, 2009 and August 25, 2009). However, a quick read of the current second initiative seems to us to be particularly harsh. The program will be available for US persons to voluntarily disclose their unreported income through August 31, 2011.  Participants in the new program face a 25% penalty (which may be reduced in some circumstances to either 12.5% or 5%) of the amount in the foreign bank accounts in the year with the highest aggregate account balance covering the 2003 – 2010 time period. Participants will also have to pay back taxes and interest for up to 8 years as well as accuracy related and/or delinquency penalties. US persons affected by this proposal will have to ensure that they seek proper US legal advice. 

No shortage of activity….stay tuned!

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'We are excited to announce that Moodys LLP Tax Advisors has developed an innovative way to keep you up-to-date with the most recent tax developments. Yesterday, we unveiled our iPhone/iPad application for you to download for free on the Apple App Store.

Moodys Mobile is your connection to the Canadian and cross-border tax world. We keep aggressively current in the dynamic field of tax and estate planning and now you can benefit from our efforts. Our multi-disciplinary team, consisting of both lawyers and accountants, filters through many tax proposals, legislative amendments, court decisions and administrative announcements to provide relevant highlights in the tax world.

Moodys Mobile will give you relevant tax information through our blog and Twitter feeds. You will also find instant access to corporate, small business, eligible and non-eligible dividend and other personal income tax rates for all provinces, at your fingertips.  Moodys Mobile is a practitioner's must-have app to guide you through the incredibly dynamic world of tax and estate planning.[1]

As we excitedly begin our journey into the mobile community, we encourage your feedback regarding our professional services, blog services, web, and mobile presence. All comments or inquiries may be posted through our website or Moodys Mobile. Our professionals strive to provide the community with relevant information on a timely basis. We look forward to continuing to provide value in the years to come.

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The news yesterday that Steve Jobs was taking a medical leave from Apple and the coincidental news received by our firm that a good friend and colleague was diagnosed with cancer lead me to think that, of course, life is very fragile and certainly a gift. It also reminded me that succession planning is very critical when dealing with the affairs of a private client. 

If you are the advisor for a private client, do you know what would happen in the event of an untimely death of your client? Disability of your client? Do you know your client’s intentions on an ultimate succession? Do your clients wish to sell (to the extent that they can) their business interests? If you are the private client, have you thought about these issues? 

Succession planning is loaded with tax issues that our firm regularly advises on. A partial list (and certainly not an exhaustive one), would be as follows:

1.      Do you know what the tax results would be on an untimely death of one of the family members that holds direct or indirect equity interests in the private client?  

2.      Are wills in place with appropriate provisions so as to provide maximum desired tax deferral? 

3.      Has a calculation of the estimated income tax payable been completed and updated so as to put all parties on notice as to what the estimated cash outlay will be on an untimely death?

4.      Are sinking funds in place?

5.      Is proper life insurance in force?

6.      Are shareholder agreements, partnership agreements, or trusts deeds in place and appropriately drafted so as to provide logical succession to the desired parties? 

7.      If the documents referred to above are in place, are the parties confident of the tax results deriving therefrom? Is there maximum flexibility in the terms of the documents so as to facilitate for possible changes in income tax law into the future?

8.      Further to #7 above, are the “good tax pools” being contemplated in the use of any succession plan? For example, is the general rate income pool of a Canadian controlled private corporation (which can provide for eligible dividends being paid from this pool which are taxed at a lower rate to the recipient) or the capital dividend account (which can result in tax free dividends being received by the recipient) properly utilized? Are the pools being fairly allocated?

9.      If the succession plan involves transferring assets to the next family generation, have the income tax consequences of this been thoroughly thought out? Many private clients are surprised to learn that the transfer of assets to the next generation will generally not occur tax-free. Approximately 25 years ago there used to be Canadian income tax provisions that would provide for a tax deferred transfer of certain private corporation shares to the next generation. These provisions no longer exist (with the exception of certain farming or fishing property) and, therefore, the transfer of assets to the next family generation needs to be carefully thought through.

10. Have the GST or HST consequences of a succession plan been considered? We find that this is an often missed component of a succession plan.

11. Have potential double tax consequences upon death been thoroughly considered and an action plan designed? For example, to the extent that there is an untimely death and a resulting income tax consequence to the deceased’s estate, have the income tax consequences to the beneficiaries of the deceased’s estate been considered so as to minimize potential double tax upon the ultimate receipt of the deceased’s former property? This is a tricky area of succession planning and, with careful thought, double tax exposure can often be minimized.

12. Upon an untimely disability, will powers of attorney and other legal documents be in effect so as to enable a continuation of the business affairs of the disabled person? 

13. Is the private client’s corporate structure that is currently in place the best structure so as to enable certain tax preferential deductions (such as the capital gains deductions) to be utilized upon a disposition - forced or otherwise - of the shares of the private corporation?

14. If the client is philanthropic, have the charitable gifts been designed appropriately so as to enable maximum charitable tax credits to be claimed? This is a tricky area of succession planning.

15. If there are US citizens in the family, have the US tax consequences been thought through upon the ultimate succession of assets? On a death, has the US estate tax been considered? The cross-border succession plan is a very complex area of tax law.

As noted above, this list is certainly not exhaustive but hopefully gives you a taste of some of the issues that must be thought through when dealing with succession planning. Please ensure that your - or your client’s - affairs are in order so as to enable a logical and tax efficient succession plan. We would be pleased to assist you with your succession plan.

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We here at Moodys are not immune to the social media phenomenon that has been spreading like wildfire for the past few years. Over the past 18 months or so, Moodys has been working with advisors to try and harness the power that certain social media technology can deliver. It has been an interesting experience to say the least with our eyes being opened greatly. 

The one real eye opener for us has been that social media tools like Facebook, LinkedIn, Twitter, etc.  are not tools that you can fundamentally control.  That is the underlying premise of social media….you cannot control it. You might be able to influence, but you fundamentally cannot control it. A prominent social media expert and co-author of the bestselling book “Groundswell”, Charlene Li, states that social media is often treated as just another marketing channel and she believes that is a mistake. Instead, she believes that social media can be used to forge meaningful relationships with your clients, target prospects and contacts. This is the goal that we here at Moodys are trying to achieve with our use of social media.

Accordingly, all of the team members at Moodys have LinkedIn accounts. For example, my LinkedIn account is Kim Moody – Directory/LinkedIn. I’d encourage you to visit my LinkedIn account and other Moodys’ team member accounts and give us honest feedback about how Moodys can invest in a relationship with you.

Our firm has also been experimenting with Twitter and although our experiment is young, it is interesting to see the power of this social medium.  Feel free to follow us. 

Our experiment with social media here at Moodys will continue to evolve. Charlene Li and our external consultants believe that social media will permeate through everything society does in the next five years. They also believe that the next interesting wave of change will be at the corporate level where it will change the way that all of us conduct business. I believe they are  right…..and we are committed to getting it correct and, more importantly, listening to our clients and contacts to ensure that the shape of Moodys continues to develop in the way that our clients want to see it evolve.

In addition, Moodys is proud to announce the delivery of its first webcast, “The New Restrictive Covenant Income Tax Rules”. This is the first in a series of many to come that will deliver recorded webcasts on proactive tax topics. Be warned that this first webcast is very technical in nature but it is an important topic that practitioners and clients should be aware of. In addition, as previously announced, our firm is also doing live webinar delivery of our seminar series. Once the live webinar has been completed, a recorded version will also be available for purchase. Accordingly, we are pleased to deliver our first recorded webinar on Owner Manager Tax Planning that was presented live on September 14, 2010. Feel free to visit and purchase the seminar material.

Well…that‘s it for now. We will see you in the social media space but hopefully we will see you live or speak to you on the telephone as well. Here’s to providing value!

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Well, today is Moodys LLP's third anniversary! I can't believe how fast time has gone by. Our firm has continued to grow, expand and add value-added services. The most recent service expansion has been US cross-border services. This has been a challenging addition given how complex the US taxation area is but it's also been a lot of fun and exciting given how much these services are needed. We're committed to continuing to grow this area and our existing service offerings......expect future teammate additions soon. Of course, having a great firm is all about having great team members, partners and, of course, clients. Thanks to our clients for your continued support. Thanks to the Moodys teammates......you're all amazing. Thanks to our law firm partner - Shea Nerland Calnan LLP - the support you provide is much appreciated. Finally, thanks to all of our suppliers....we appreciate your support.

UPDATES

 Well, a lot has been happening in the last couple of weeks. Here's a brief update.

 1.       Aggressive Tax Reporting Proposals

 As we've written about in our blogs of September 8, 2010, the Department of Finance has released draft legislation for the aggressive tax proposals. The Department requested comments from interested parties no later than September 27, 2010. Many parties have made submissions. The Society of Trust and Estate Practitioners ("STEP") is one such body that made a submission (their second submission). This space is changing quickly. For example, the United States recently released the final form and requirements for when a corporation will have to disclose its uncertain tax positions ("UTPs") to the Internal Revenue Service. These rules, in my opinion, are much more invasive than the Canadian proposals but given how countries around the world are introducing similar types of provisions, it will be interesting to see if Canada tinkers with the proposals in the future. Stay tuned.

2.       Employee Life and Health Trusts ("ELHTs")

As discussed in our blog of March 1, 2010, the Department of Finance introduced proposals for ELHTs on February 26, 2010 and such proposals were slightly amended by the release of a second round of draft legislation on August 27, 2010. The Department of Finance asked for interested parties to provide comments by September 27, 2010. Well, the Government did not waste any time in trying to get this piece of draft legislation passed. On September 30, 2010, yesterday, the Government introduced the Sustaining Canada's Economic Recovery Act  to the House of Commons. It appears that the Government is committed to getting the ELHT legislation passed quickly. When passed, the ELHT legislation will significantly change the way old "health and welfare trusts" are used. Again, stay tuned.

 3.       Garron Appeal Heard

 As discussed in our blog of September 16, 2009, the Tax Court decision of Garron was a landmark decision involving the residency for tax purposes of a trust. On September 30, 2010 (yes.....yesterday again), the Federal Court of Appeal heard the taxpayer's appeal with the decision reserved. The tax community anxiously awaits the Court's decision.

 4.       Collins and Aikman Appeal Decision

 As discussed in our blog of June 29, 2009, Collins and Aikman was a GAAR decision that was in favor of the taxpayer. The Crown appealed the decision. On September 29, 2010, the Federal Court of Appeal heard the appeal. In a bit of a surprising move, the Federal Court of Appeal released its decision from the bench and dismissed the Crown's appeal (meaning that the taxpayer was successful again). The overall decision was five paragraphs long. While it is a little early to digest what this decision may mean for the ever changing GAAR landscape, it was interesting to see how decisive the appeal was handled by the Federal Court of Appeal.

That's it for now.....thanks again for the last three years and here's to another three decades (or centuries) of multi-disciplinary tax advisory services for the private client. Cheers!      

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On September 17, 2010 the Canada Revenue Agency (the “CRA”) announced changes to its administrative policy on filing requirements for partnership information returns. The administrative changes will apply for partnership fiscal periods ending on or after January 1, 2011, so December 31, 2010 and earlier fiscal periods are not affected.

As a reminder, a partnership is not a taxpayer or a taxable entity, but the partnership’s income is taxable in the hands of the partners themselves. Nevertheless, Income Tax Regulation 229 requires all partnerships to file an annual “information return” in prescribed form (i.e. Form T5013 and its supporting schedules). Only one partner must file a partnership return on behalf of the partnership and the partner(s). Administratively, it has been CRA’s policy that a partnership with fewer than 6 partners did not need to file a partnership return, unless one of the partners was another partnership.

Effective January 1, 2011, the new administrative policy requires a partnership return to be filed annually by a partnership that carries on business in Canada, or a Canadian partnership with Canadian or foreign operations/investments if:

1. at the end of the fiscal period, the partnership has an absolute value of revenues plus expenses of $2 million or more, or has more than $5 million in assets, or
2. at any time during the fiscal period the partnership

-          is a tiered partnership (i.e. has another partnership as a partner, or is a partner in another partnership),

-          has a corporation or trust as a partner,

-          invested in flow-through shares, or

-          is requested to file a return by the Minister.

Regarding the first criterion, the “absolute value of revenues plus expenses” means the sum of total revenues and total expenses from the partnership’s financial statements, not revenues minus expenses, which results in net income. In addition, “assets” means the cost of all tangible and intangible assets, without taking into account any depreciation or amortization.

So, which partnership will not have to file a partnership return? Using the new criteria, it appears that a partnership where all partners are individuals (i.e. none of the partners is a trust, corporation or another partnership) will not have to file, unless its revenues plus expenses are $2 million or more, or its gross assets exceed $5 million. In addition, it appears that a partnership will not be required to file a partnership return where it ceases to meet any of the new criteria above in a fiscal period. However, this circumstance is not specifically mentioned in the CRA announcement, and further clarification is required.

Note that an exempt partnership may still wish to file a partnership return to protect itself from a potentially unlimited reassessment period, since the CRA has three years from the date of assessment of the partnership return to reassess the partnership (assuming no misrepresentation attributable to neglect, carelessness or wilful default has been made).

Finally, the CRA announcement also states that Form T5013 is being updated for the 2011 year, so more reporting changes may be forthcoming.

For more information see www.cra-arc.gc.ca/whtsnw/tms/prtnrshp-eng.html.

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On August 27, 2010, the Department of Finance released the draft legislation for the AT proposals that were first announced in the Federal Budget of March 4, 2010 which our firm commented on in our March 5, 2010 blog. Various organizations such as the Society of Trust and Estate Practitioners (“STEP”) and the Canadian Tax Foundation have also since commented on the AT proposals.

New proposed section 237.3 of the Income Tax Act (“Act”) will deal with the AT proposals. I will try to summarize the material by answering a series of obvious questions below.

Who do the AT proposals apply to?

New section 237.3 provides a series of definitions including “advisor” and “promoter”. The definitions are extremely broad and will generally capture any accountant, lawyer, financial planner, investment advisor, etc. who assists with or promotes a tax plan that provides tax benefits and receives fees (the definition of advisor also includes a person who provides “contractual protection” – another defined phrase that generally captures arrangements that protect the person who is entering into the arrangement). While the draft legislation is much more detailed than described herein, suffice it to say that the AT proposals apply to promoters, advisors and taxpayers who enter into transactions that are “reportable transactions” as described below.

What conditions need to exist for the AT proposals to apply?

For the AT proposals to apply, there must be a “reportable transaction” (a defined phrase in the draft legislation). Very generally, a reportable transaction is an avoidance transaction (defined pursuant to the general anti-avoidance rule (“GAAR”) legislation in section 245 of the Act) where, at any time, any two of the following paragraphs apply:
 

a)            An advisor or promoter has or had an entitlement to a fee that to any extent:

                     i.      is based on the amount of a tax benefit;

                   ii.      is contingent upon the obtaining of a tax benefit; or

                  iii.      is attributable to the number of persons who participate in the transaction or have been provided access to advice or an opinion given by the advisor or promoter regarding the tax consequences from the transaction,

b)            An advisor or promoter in respect of the avoidance transaction has or had confidential protection in respect of the avoidance transaction or series, or

c)             The person, advisor or promoter has or had contractual protection in respect of the avoidance transaction or series.

Again, as stated earlier, the draft legislation is much more detailed than that written above and attention will need to be paid to the details. In addition, there are numerous defined phrases that will need to be considered such as a “fee” (which is very broadly defined and can capture essentially any consideration received by the advisor or promoter) and “confidential protection” which, generally, will capture a confidentially agreement whereby the details of the tax plan are not to be disclosed to anybody. The phrase “contractual protection” is also defined and very generally includes protection for the taxpayer to the extent that the tax plan is attacked by an appropriate authority. 

If there is a reportable transaction, what happens?

New subsection 237.3(2) of the AT proposals require that, to the extent there is a reportable transaction, there must be a prescribed form disclosure in respect of such transaction and such disclosure must be filed with  the CRA by:

a)            Every person for whom a tax benefit results;

b)            Every person who has entered into, for the benefit of the person in (a) above, an avoidance transaction that is a reportable transaction; and

c)             Every advisor or promoter who is entitled to a fee.

When must such information returns be filed with the CRA to the extent that section 237.3 applies?

The draft legislation requires that if any person is required to file an information return in respect of a reportable transaction then it must be filed by June 30 of the calendar year following the calendar year in which the transaction first became a reportable transaction in respect of the person. However, if any person is required to file an information return in respect of a reportable transaction the filing by any such person of the information return with full and accurate disclosure in respect of the transaction is deemed to be made by each person to whom that requirement applies in respect to the transaction.

What happens if the information returns that are required to be filed are not filed?

If the information returns that are otherwise required to be filed are not filed, then the tax benefit that may otherwise be available to the taxpayer is denied. In addition, a person is liable to a penalty which is computed separately.

What are the penalties and who do they apply to?

The penalties apply to every person who fails to file an information return which is otherwise required to be filed. Overly simplified, the penalty amount that applies to the advisor or promoter will generally equal the fees that were received by such people. The taxpayer who entered into the transaction will generally be subject to a penalty equal to the amount of the fee that was paid to the advisor/promoter. In addition, all of the persons who are liable to a penalty in respect of the transactions are jointly and severally liable to pay such penalties (up to the amount of the penalty that they are otherwise liable for).

Are there any exceptions to the penalties?

Yes. Firstly, the draft legislation provides that a person is not liable to a penalty if the person has exercised the degree of care, diligence and skill to prevent the failure to file the prescribed information with the CRA that a reasonably prudent person would have exercised in comparable circumstances.

Secondly, a reportable transaction does not include a transaction or series of transactions that includes the acquisition of a tax shelter for which prescribed information has already been filed with the CRA, or the issuance of a flow-through share for which prescribed information has been filed.

When do these new rules apply?

The new AT proposals apply in respect of avoidance transactions that are entered into after 2010 or that are part of a series of transactions that began before 2011 and is completed after 2010.

It is important to note that if the filing of an information return under section 237.3 would be required before July 1, 2011, the information return is deemed to be filed before that day if it is filed before 2012.

Is Canada cutting new ground here with these new proposals?

No.  Other jurisdictions such as Quebec, the US, the UK and other countries have introduced similar legislation. Reasons that have been set forth by the various other countries and Quebec for introducing such rules are to assist tax administrators with early identification of transactions that may otherwise have not been easy to find for audit purposes. US rules, as an example, appear to be a lot more invasive than the Federal proposals but time will tell whether or not such rules are tinkered with to achieve the fiscal policy result that the Federal Government is intending to achieve.

Can you provide me with an example of how these new rules might apply?

Sure, consider the following:

1.             An accountant, Mr. Apple, has a public practice firm.

2.             Mr. Apple is approached by Mr. Orange to participate in a particular tax strategy that Mr. Orange’s company has developed.

3.             For every client that Mr. Apple refers, he will receive $5,000 for every instance that a client “acquires” the tax strategy.

4.             Mr. Apple must sign a confidentiality agreement with Mr. Orange’s company that he will not disclose the particular tax strategy to anyone other than clients of his that have signed the confidentiality agreement referred to below.

5.             In addition, if any of Mr. Apple’s clients participate in the strategy, they will need to sign a confidentiality agreement with Mr. Orange’s company.

6.             If any of Mr. Apple’s clients participate in the tax strategy, the client would pay Mr. Orange’s company a flat fee of $25,000.

7.             Mr. Orange informs all of his clients that if the tax strategy is ever challenged by the CRA that Mr. Orange’s company would pay for the costs associated with the tax dispute.

8.             Mr. Apple has referred 100 clients to Mr. Orange and received $500,000 as a referral fee from Mr. Orange’s company.

9.             The CRA has audited the 100 clients and denied the tax benefit to the clients via reassessment.

10.         All of the transactions and/or series referred to above ended in 2011.

Analysis

·               Does new section 237.3 apply?

·               If so, what are the reporting obligations?

·               If the reporting obligations are not complied with, what are the consequences?

Does Section 237.3 Apply?

·                Yes, new section 237.3 will apply since the transactions or series were entered into after 2010 or were part of a series of transactions that began before 2011 but are completed after 2010.

·                Mr. Apple is likely an “advisor” since he has provided assistance or advice with respect to…planning…or implementing the transaction to any person. Mr. Orange’s company is also likely an advisor.

·                Mr. Apple and Mr. Orange’s company are also likely “promoters” since they promote or sell the plan/scheme and make representations that a tax benefit could arise from the transaction or series. They also both accepted consideration in respect of the plan.

·                The transactions entered into by the clients of Mr. Apple are likely reportable transaction(s) since:

a)      The transactions are likely avoidance transactions and an advisor or promoter (Mr.  Apple and Mr. Orange) have had an entitlement to a fee that is attributable to the number of persons who participate in the transaction(s) (clause 237.3(1)(a)(iii)(A) of the definition of “reportable transaction”).

b)      Mr. Apple and Mr. Orange’s company had “confidential protection” in respect of the  transactions (paragraph 237.3(1)(b) of the definition of “reportable transaction”).

c)       Mr. Apple’s clients had “contractual protection” in respect of the transactions  (subparagraph 237.3(1)(c)(i) of the definition of “reportable transaction”).
 

·               Since two of the three paragraphs are met (in this case all three paragraphs are met), the transactions are “reportable transactions”.

Reporting Obligations

·                Mr. Apple’s clients must file prescribed information (paragraph 237.3(2)(a)).

·                Mr. Apple and Mr. Orange’s company must file prescribed information (paragraph 237.3(2)(c)).

·                Mr. Apple’s clients and Mr. Apple and Mr. Orange’s company will satisfy reporting obligations if full and accurate disclosure is made by any person (not for the entire 100 clients though…each client must be considered separately) – (subsection 237.3(4)).

·                The information return must be filed by June 30 of the calendar year following the calendar year in which the transaction first became a reportable transaction (subsection 237.3(5)).

·                If information returns are not filed, subsection 245(2) will be deemed to apply to the reportable transactions resulting in denial of tax benefits for Mr. Apple’s clients (paragraph 237.3(6)(a)).

·                 A person is liable to a penalty (paragraph 237.3(6)(b)).

·                 Penalties under subsection 237.3(8) must be calculated.

·                 Mr. Apple’s penalty - $5,000 x 100 = $500,000 (limited to $500,000 because of subsection 237.3(10)).

·                 Mr. Orange’s company penalty – $25,000 x 100 = $2,500,000 (paragraph 237.3(8)(a) and limited to this amount because of subsection 237.3(10)).

·                 Each of Mr. Apple’s clients - $30,000 (the sum of the advisor and promoter fees).

·                 Joint and several liability – subsection 237.3(9).

·                 Note that each taxpayer client has joint and several liability that is not limited and  therefore each client’s possible penalty exposure is $60,000.

Can you comment on some of the implications of these rules?

Sure. The AT proposals will have wide sweeping changes to the practice of tax. Taxpayers and their advisors need to be well aware of these proposals and the potential penalties that they could become liable for if they do not pay careful attention to these new reporting rules. Here are some quick things to think about:

1.             Are the new rules going to harm solicitor-client privilege in some cases? 
 

The answer to this question is very debatable. Some people that we have discussed this matter with believe strongly that the AT proposals strike at the very heart of the solicitor-client relationship. However, other practitioners point to certain Supreme Court of Canada case law which clearly states that you cannot legislate over solicitor-client privilege. Stay tuned….this matter will likely be hotly debated into the future.
 

2.             What exactly does the phrase “…avoidance transactions that are entered into after 2010 or that are part of a series of transactions that began before 2011 and is completed after 2010…” mean? 
 

For example, what if some proprietary transactions/strategies were entered into by a taxpayer in 2005 to increase the cost base of capital property (and such transactions are likely avoidance transactions) but the capital property is disposed of by the taxpayer in 2012? Will the tax advisor be required to file an information return in respect of transactions that were entered into in 2005?  Good question…not sure what the answer is but certainly taxpayers and their advisors should consider this and come to an appropriate conclusion.
 

3.             Overall, taxpayers and their advisors, especially accountants, lawyers, financial planners, etc. will need to carefully consider the promotion of a tax plan or strategy given the broadness of this draft legislation.

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This blog is co-authored with Faizal Valli and Paul R. LeBreux (of Global Tax Law Corporation, Counsel to Moodys LLP)

On March 4, 2010, Federal Finance Minister Jim Flaherty released the 2010 Federal Budget (the "Budget"). The Budget contained a significant amount of tax material in comparison to recent budgets. Find below the relevant tax measures that are worthy of discussion.

PERSONAL TAX MEASURES

A. Stock Options

i. Elimination of Employer Deductions in Certain Cases

The use of stock options in employee remuneration has been common over the recent years. In some situations, the realization of a stock option benefit by an employee can result in tax preferential treatment given that the employee may be eligible for a 50% stock option deduction against the resulting stock option benefit. In some cases, the employee may actually dispose of the "rights" under the stock option agreement in exchange for cash paid by the employer. The result of such a disposition of rights for a cash settlement by the employer is that the employee may realize a preferential tax benefit (i.e. a stock option benefit less a 50% deduction) and the employer may deduct such payment in the computation of its income.

The Budget proposes to prevent both the stock option deduction for the employee and the expense deduction by the employer from being claimed from the same employment benefit. Accordingly, the stock option deduction will generally be available to the employees who dispose of stock option rights only in situations where the employer makes an election to forgo the deduction for the cash payment. These measures apply to dispositions of stock options after 4:00 p.m. EST March 4, 2010.

ii. Elimination of the Stock Option Deferral

In the early 2000s, the Federal Government introduced complex rules to enable employees of publicly traded companies to make an election to defer the recognition of their stock options benefits. The election was generally available for benefits in respect of up to $100,000 of employee qualifying stock options vesting in a particular year. The rules were tremendously complex but generally very useful in many cases.

The Budget proposes to repeal the tax deferral election legislation with respect to employee stock options exercised after 4 p.m. on March 4, 2010. Existing deferrals appear to be not affected by the Budget proposals. Also, deferrals for stock options exercised by employees of Canadian controlled private corporations are unaffected.

iii. Significant Relief for Under-Water Stock Options

The 2010 Budget introduced a relieving measure for "under-water" stock option shares. The proposed relief may apply to individuals who have disposed of stock option shares and previously deferred the stock option deduction over the last 10 years, by way of the "Fairness Provisions" in the Income Tax Act ("the Act").

Generally, this election may be beneficial if the tax otherwise payable on the stock option benefit is greater than the proceeds received on the sale of "under-water" shares.

a. Background and Example

Many individuals previously exercised their stock options when share prices were high. However, as a result of subsequent economic factors, the fair market value of such shares may be significantly lower than when the stock options were exercised. Such shares are commonly referred to as under-water stock option shares. In some cases, if the stock option benefit was deferred, individuals are faced with a future tax liability on the stock option benefit that is greater than the fair market value ("FMV") of their shares.

In order to understand the proposed relief provided in the 2010 Budget, consider the following example. Suppose Bill (an Alberta resident taxpayer) exercised a stock option in 2006 to purchase shares of Bill's employer, Pubco, a Canadian public corporation. Bill paid an aggregate exercise price of $20,000 for Pubco shares, which had an aggregate FMV at that time of $100,000. As a result, Bill realized a stock option benefit of $80,000 on the exercise.

Under current legislation, Bill could likely elect to defer the recognition of such stock option benefit until the year in which he disposed of his Pubco shares (pursuant to current subsection 7(8) of the Act, up to an annual limit of $100,000 of "strike price" on such stock options vesting in a particular year). In our example, Bill chose to make an election to defer the $80,000 stock option benefit.

Suppose further that in 2010, Bill's Pubco shares had a FMV of only $10,000, and were expected to decrease further in the future. Accordingly, Bill decided to sell his Pubco shares in 2010 for proceeds of $10,000. Under current legislation, the following would result:

1. Bill would realize the stock option benefit of $80,000 (that was previously deferred), and would receive a 1/2 deduction under paragraph 110(1)(d) of the Act, resulting in taxable income of $40,000, and taxes payable of $15,600.

2. Bill would realize a capital loss of $90,000 (Bill's ACB being $100,000 of FMV at time of exercise, less proceeds of $10,000).

As you can see, Bill would receive proceeds of $10,000 on the sale of shares, but would be faced with a $15,600 tax liability. In addition, Bill would have a capital loss of $90,000 which may be carried back three years or carried forward indefinitely against capital gains realized. To be further clear, the $90,000 capital loss would not be deductible against the $80,000 employment benefit.

b. Proposed Relief

To mend the above situation, the 2010 Budget has proposed that in the year in which a taxpayer is required to include the stock option benefit (as a result of disposing their under-water shares), such taxpayer may elect to pay a "special tax" equal to the taxpayer's proceeds of disposition from the sale of such under-water shares. Where such an election is made, the Budget proposes that:

1. The taxpayer will be able to fully offset the stock option benefit, and

2. The taxpayer must include a capital gain equal to the lesser of:

a. the stock option benefit, and

b. the capital loss realized on the disposition of the under-water shares.

In the example above, the proposed relief would apply as follows: Bill could elect to pay a special tax equal to the proceeds of disposition on his Pubco shares, or $10,000. If Bill made such election, the following would apply:

1. Bill would be able to claim a deduction to fully offset his stock option benefit of $80,000, and

2. Bill would have to report a capital gain equal to the lesser of:

a. Bill's stock option benefit of $80,000, and

b. the capital loss of $90,000.

Therefore, Bill would have to report a capital gain of $80,000. This would reduce his capital loss to $10,000 from $90,000.

c. A Twist

The economic impact would be slightly different if Bill realized capital gains in 2010 of $20,000 in the rest of his investment portfolio. Based on the above example, if Bill elected to pay the special tax of $10,000, the following would apply:

1. Bill could still claim a deduction to fully offset his $80,000 stock option benefit,

2. Bill would have to report a capital gain of $80,000 based on the above example.

As a result, Bill's total 2010 capital gain would be $100,000, and his capital loss on the under-water shares would be $90,000, resulting in a capital gain of $10,000 (or taxable capital gain of $5,000).

d. Application of Proposed Relief

As mentioned earlier, the proposed relief may apply to individuals who disposed of their under-water shares (and had previously deferred their stock option benefit) in the last 10 years, based on the "Fairness Provisions" in subsection 152(4.2) of the Act. This might provide HUGE relief to taxpayers who were affected by the inability to offset the capital loss against the stock option benefit within the last 10 years if they had previously deferred the stock option benefit. Individuals who have not yet disposed of their under-water shares and wish to have the proposed relief apply must do so before 2015.

e. Summary

As alluded to above, the special election will only be economically beneficial if the tax liability on the stock option benefit is greater than the proceeds received on the under-water shares.

iv. Changes to Withholding Remittance Requirements

Current law provides rules that require employers to remit source withholdings to the Government in respect of employment benefits. The Budget intends to clarify the existing law to ensure that an amount in respect of tax on the value of the stock option benefit is required to be remitted to the Government by the employer. As stated in the Budget, this proposal is intended to prevent situations in which an employee is unable to meet their tax obligation as a result of a decrease in the value of their shares.

B. US Social Security Benefits

US social security benefits received by Canadian residents are currently taxed at an 85% inclusion rate. However, prior to 1996, the Canada-US tax treaty only required a 50% income inclusion as opposed to 85%. The Budget proposes to reinstate the 50% income inclusion for Canadian residents who have been in receipt of US social security benefits since before January 1, 1996 and for their spouses and common-law partners who are eligible to receive survivor benefits. This measure will apply to US social security benefits received on or after January 1, 2010.

C. Roll-over of RRSP Proceeds to a Registered Reitrement Disability Plan ("RDSP")

RDSPs were introduced in the 2007 Federal Budget to assist parents and caregivers for the long term financial security of a child with a severe disability. The Budget proposes to extend the existing RRSP roll-over rules (which apply upon the death of a person where such RRSP proceeds are transferrable to a surviving spouse, financially dependant child and/or a mentally infirm child) to RDSPs. The roll-over rules to RDSPs will apply for deaths that occur on or after March 4, 2010 but will be subject to the beneficiaries' existing RDSP room. However, there are certain transitional rules that were announced in the Budget where the death of an RRSP annuitant occurs after 2007 and before 2011.

D. Medical Expense Tax Credit

The Budget proposes to disallow as a medical expense tax credit any expenses that were incurred for purely cosmetic procedures aimed at enhancing ones appearance (such a lipo-suction, hair replacement procedures, Botox injections, and teeth whitening). Cosmetic procedures that are required for medical or reconstruction purposes such as surgery to correct a deformity arising from, or directly related to a congenital abnormality, a personal injury resulting from an accident or trauma, or a disfiguring disease will continue to qualify for medical tax expense credits. Such measure will apply for expenses incurred after March 4, 2010.

BUSINESS INCOME TAX MEASURES

A. Loss Trading

Recent media articles have highlighted the Department of Finance's interest in publicly traded income trusts or publicly traded partnerships ("SIFTs") that use certain tax strategies to acquire "Losscos" as a result of the looming requirement for SIFTs to convert to a corporation. The Budget intends to amend the acquisition of control rules in the Act to ensure that such rules will impose restrictions on the use of losses of "Losscos" in situations where units of a SIFT are exchanged for shares of a corporation. Proposed legislative amendments were not included with the Budget documents and therefore the "devil is in the details" but, in reviewing the Budget Documents, it would appear that most "Lossco" type deals involving SIFTs are essentially dead.

B. Section 116 Amendments

Section 116 of the Act requires purchasers of "Taxable Canadian Property" ("TCP") acquired from non-residents of Canada to withhold a portion of the purchase price and remit it to the Government unless the non-resident obtains a "clearance certificate" from the Canada Revenue Agency ("CRA"). However, in order to obtain a clearance certificate the non-resident vendor must remit an amount or post security, or satisfy the CRA that no tax will be owing. The Budget is proposing new rules to amend the definition of TCP so as to exclude certain shares of private corporations and other interests that do not derive their value principally from real property situated in Canada, Canadian resource property, or timber resource property. This measure will eliminate section 116 compliance obligations for these types of properties. The measure is HUGE and somewhat surprising. If a non-resident disposes of, say, shares of a Canadian private corporation (whose value is not principally derived from real property in Canada, Canadian resource property or timber resource property) then such non-resident will not be subject to the section 116 requirements to apply for a clearance certificate (or remit funds, post security etc...) or file a Canadian income tax return.

This is certainly welcome news for the investment community which may be encouraged to invest in Canada as a result of the reduced administrative burden. On the other hand, one could query the tax policy behind this measure since the CRA will now have no advance notice of dispositions where it could disagree with the non-resident's assertion that the property was not TCP. Interesting.

C. NRT and FIE Proposals (this section written by Paul R. LeBreux of Global Tax Law Corporation, a well-recognized international tax expert)

It is hard to believe that it has been 11 years since the proposed changes to overhaul the taxation of non-resident trusts (NRTs) and foreign investment entities (FIEs) were first introduced in the 1999 Federal Budget. Since the first draft of the legislation was released June 22, 2000, the implementation date of the legislation and its retroactive effective date have been delayed and amended numerous times. The last 11 years have seen new drafts of the proposals released, each time with substantial amendments, no less than six times. Most recently, proposals for amendments were tabled during the second session of the 39th Parliament, however these proposals were not enacted before Parliament was dissolved in September 2008. Budget 2009 stated that the Government would review the outstanding proposals before proceeding with measures in this area and today, the Budget reintroduces this controversial initiative, with some not so minor amendments designed to "simplify" these complex provisions.

Some of the more interesting revised proposals which will address certain concerns and challenges and also provide a degree of simplification are:

• Entities exempt from tax under section 149 of the Act (for example, pension funds and registered charities) will be granted an exemption from resident-contributor and resident-beneficiary status.
• Investments in bona fide commercial trusts will not be caught by the new NRT rules.
• A commercial trust will not be caught by the deemed residence rules if it satisfies certain criteria, including that the trust not be a discretionary or personal trust and that each beneficiary be entitled to both the income and capital of the trust.
• Loans by a Canadian financial institution to a non-resident trust will not cause the financial institution to be a resident contributor to the trust provided the loan is made in the ordinary course of business.
• Resident contributors to a trust that is deemed resident under these rules will no longer be jointly and severally liable for the trust's income tax obligations, but would only be liable for their proportionate share of the trust's income.

However, the Budget will also propose substantial modifications that effectively introduce a whole new level of complexity to the NRT legislation. The Budget proposes to modify the taxation of a deemed Canadian resident trust by dividing the trust's property into "resident" and "non-resident" portions. The resident portion will consist of property acquired by the trust through contributions from residents and certain former residents (and property substituted for such property). The non-resident portion will consist of all other property contributed to the trust. It is proposed that income earned on the non-resident portion will be excluded from Canadian taxation as long as it is not from sources in Canada on which non-residents would normally be required to pay tax.

New ordering rules would be introduced for distributions to trust beneficiaries. For example, distributions to Canadian resident beneficiaries will be deemed to be made first out of the resident portion of the trust's income, while distributions to non-resident beneficiaries will be deemed made first out of the non-resident portion of the trust. Distributions to non-resident beneficiaries out of the non-resident portion of the trust will not be subject to Canadian withholding tax, whereas a distribution to a non-resident beneficiary out of the resident portion of the trust will be subject to withholding tax.

It is further proposed that, when income of the trust is not distributed to beneficiaries, the amount of the accumulated income will automatically be deemed to be a contribution by the trust's connected contributors and will form part of the resident portion for the next taxation year, unless the said accumulated income is kept separate and apart from all the property forming the resident portion.

Some other interesting proposals regarding NRTs:

• The reassessment period for income in respect of trusts subject to these rules will be extended by three years.
• The Tax Conventions Interpretation Act will be amended to clarify that a trust that is deemed to be resident in Canada under these rules is a resident of Canada and subject to Canadian tax for treaty purposes.
• The measures regarding non-resident trusts will apply retroactively to the 2007 and later taxation years, except for the attribution of trust income to resident contributors, which applies only to taxation years ending after March 4, 2010.

The proposals effecting FIEs were minor in comparison to that for NRTs. The Budget amends the FIE rules as follows:

• The prescribed interest rate applicable in computing the income inclusion for an interest in an offshore investment fund property is increased to the three-month average Treasury Bill rate plus two percentage points.
• Existing rules will be broadened to require beneficiaries of certain non-resident trusts to report income on a modified foreign accrual property income basis so that these rules apply to any resident beneficiary who, together with non-arm's-length persons, holds 10 percent or more of the fair market value of any class of interests in a non-resident trust.
• The reassessment period will be extended by three years for interests in offshore investment fund properties, and require more detailed reporting will be required in respect of "specified foreign property".
• The measures regarding FIEs will apply for taxation years that end after March 4, 2010.

OTHER TAX MEASURES

A. Information Reporting of Tax Avoidance Transactions

Similar to our blog on Quebec's take on tax avoidance of October 21, 2009 and also recent US proposals that we blogged about on February 10, 2010, the Budget proposes a requirement to report certain tax avoidance transactions. Legislative proposals were not released but a promise was made to release details on the proposals at an early opportunity. The Government also announced a consultation process with stakeholders will take place with the view to improving the "fairness of the Canadian tax system". The Budget did, however, announce that a "reportable transaction" would be an avoidance transaction, as currently defined in the Act, which is entered into by or for the benefit of the taxpayer that bears at least two of the following three "hallmarks":

1. A promoter or tax advisor in respect of the transaction is entitled to fees that are to any extent attributable to the amount of the tax benefit from the transaction, contingent upon the obtaining of a tax benefit from the transaction, or attributable to the number of taxpayers who participate in the transaction or who have been provided access to advice given by the promoter or advisor regarding the tax consequences from the transaction,
2. A promoter or tax advisor in respect of the transaction requires "confidential protection" about the transaction, or
3. The taxpayer or the person who entered into the transaction for the benefit of the taxpayer obtains "contractual protection" in respect of the transaction (otherwise than as a result of a fee as described in the first hallmark).

A transaction that is a tax shelter or flow-through share arrangement will not be impacted by these proposals.

Upon discovery of a reportable transaction that has not been reported when required, the CRA could deny the tax benefit resulting from the transaction. If the taxpayer still wanted to claim the tax benefit, it would be required to file with the CRA any required information and to pay a penalty (quantum unknown as at this time).

These are certainly interesting times, and these proposals are another example of the ongoing push around the world towards financial transparency. One will have to wait and see what form of penalty will be arising from such proposals and what the ultimate legislation looks like. As we mused about in our February 10, 2010 blog, we are of mixed mind with respect to such proposals. On the one hand, one can certainly see the tax policy benefits from this. However, how far will the Government go in order to seek transparency of tax transactions? Will solicitor-client privilege be of any future benefit in tax transactions? (Certainly today solicitor-client privilege is generally of great value.) Will such proposals ultimately discourage tax professionals entering into the practice of tax? The musings will continue but hopefully such issues will be discussed in the public consultation process to find an appropriate balance.

B. Taxation of Corporate Groups

The Government announced in its Budget documents that it has heard concerns from the business community and from the provinces regarding the utilization of tax losses within corporate groups. The Government announced that it will explore whether new rules for the taxation of corporate groups - such as the introduction of a formal system of loss transfers or consolidated reporting-could improve the functioning of the tax system. This is certainly welcome and may eliminate certain tax risks (such as section 67 reasonableness issues) that currently exist.

C. Previously Announced Tax Measures

The Budget documents announced that the Federal Government intends to proceed with previously announced tax measures such as amending GST legislation on Financial Services and to introduce various tax technical amendments (such as the previously announced restrictive covenant rules).

D. Repeal of Charitable Expenditure Rule

Charities are subject to a charitable expenditure rule which generally requires the charity to spend 80% of the previous year's tax receipted donations plus other amounts relating to enduring property and transfers between charities and 3.5% of all assets not currently used in charitable programs or administration if such assets exceed $25,000 ("capital accumulation rule"). The charitable expenditure rule has been the subject of much debate over the years and the Federal Government acknowledges in its Budget documents that some stakeholders have called for the elimination of the disbursement quota because it imposes an unduly complex and costly administrative burden on charities particularly small and rural charities.

Accordingly, the Budget proposes to repeal the charitable expenditure rule for fiscal years that end on or after March 4, 2010. This, to us, is a bit of a surprise but certainly welcome.

The proposal to reform the disbursement quota comes with two additions. The first is that the current exception from the capital accumulation rule for charities having $25,000 or less in assets is to be increased to $100,000 for charitable organizations. In addition, the Budget proposes to extend existing anti-avoidance rules for charities to situations where it can reasonably be considered that a purpose of a transaction was to delay unduly or avoid the application of the disbursement quota.

SUMMARY

As stated earlier, this is certainly a deep budget as compared to prior years with respect to tax measures. Moodys LLP Tax Advisors will keep you up to-date on the progress of these measures.

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Further to our blog postings of November 26, 2009 and October 27, 2009, this legislation was finally proclaimed on February 4, 2010 and comes into force on March 1, 2010.

These changes allow for the common-law partners/spouses of certain Alberta incorporated professionals (including physicians, dentists, chiropractors, optometrists, lawyers, CA's, CMA's and CGA's) and/or their children and/or a special purpose trust (of which minor children of the professional can be the only beneficiaries) to own non-voting shares of a professional corporation.

As previously mentioned, we believe these changes, while positive, are only one step forward in allowing professionals the same planning opportunities already afforded to other Alberta entrepreneurs and to incorporated professionals in other jurisdictions within Canada.
 

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The tax world moves quickly. This blog entry will highlight a few miscellaneous updates that are of relevance to most of our friends and clients.

2010 Alberta Budget

The 2010 Alberta Budget was released yesterday, February 9, 2010. From a tax perspective, there were no changes. Some tax practitioners had speculated that the Alberta Government might be forced to increase personal tax rates given the budget deficit that it currently faces. However, no tax increases (or decreases) were announced. As discussed in our blog entry of October 21, 2009 regarding Quebec's take on fighting aggressive tax planning, Alberta appears to be concerned about aggressive tax planning as well. In their budget papers, the Alberta Government announced that it is dealing with aggressive tax planning by working with other provincial and federal jurisdictions to identify and pursue tax avoidance schemes. In addition, Alberta announced that it has increased its capacity to identify, audit and litigate these transactions. It will be interesting to see whether or not Alberta eventually follows the lead of Quebec in fighting aggressive tax avoidance.

Tax avoidance is a highly controversial topic. There are many people who believe that tax avoidance is legitimate tax planning. If the tax plan is technically sound, one could argue that the government should not be able to challenge such planning. However, if such tax avoidance violates the clear spirit and policy intent of the provisions of the Income Tax Act then many practitioners believe that fighting tax avoidance is a necessary duty of the government. From my personal perspective, I somewhat stand on the fence on tax avoidance. However, when certain advisors develop tax plans that are "proprietary" or are enveloped in secrecy or confidentiality agreements then this will often offend me since such plans should (client confidentiality issues aside) be able to withstand transparency. There are many people who do not agree with me on this, but I have lived with this belief for many years. Stay tuned ... this issue is far from over.

Supreme Court to Hear Appeal of Copthorne

The Supreme Court of Canada, on January 28, 2010, agreed to hear the appeal of Copthorne Holdings v. The Queen. The case involves the computation and utilization of paid-up capital ("PUC"). The Federal Court of Appeal had utilized the general anti-avoidance rule ("GAAR") to prevent a possible double counting of PUC. This case will be of interest to many people given that the Supreme Court of Canada will again analyze the GAAR. The Supreme Court has not heard many GAAR cases and, therefore, the Court's analysis will be of great interest to tax practitioners.

UBS Tax Affair Update

Further to our January 14, 2010 blog entry, a recent Swiss Court challenge by a UBS account holder has put the UBS settlement with the US Government in doubt. See a news article that discusses the court decision. The Swiss Government appears to be committed to ensuring that the UBS settlement agreement gets approved. Again, stay tuned .... this story has not yet ended.

United States Propose Transparency of Uncertain Tax Positions

On January 26, 2010, the United States Internal Revenue Service ("IRS") announced proposals that would require certain taxpayers to annually disclose uncertain tax positions in the form of a concise description of those positions and the maximum amount of US income tax exposure if the taxpayer's position is not sustained. The IRS wants comments from the public on this proposal by March 29, 2010. Very generally and oversimplified, these proposals are intended to apply to companies who have assets of US$10M or greater.

Frankly, this is an astounding proposal! If enacted, it could potentially provide the IRS with a roadmap of all the potential tax issues in many taxpayers' files! Wow!

Will Canada be far behind the US? Time will tell. While one can understand the desire for transparency, has the US taken this desire too far? The Canada Revenue Agency has gone as far as requesting auditor/accountant working papers. The accounting community was very concerned about such requests and the CICA established a task force. A good summary of this issue was released by the Canadian Tax Foundation in 2005. To my knowledge, no significant progress has been announced since that time. Again, stay tuned ...

Olympics

Next week, various members of our firm are heading off to the Olympics to catch some of the events, including Canada's first hockey game against Norway. We are all very excited about this once in a lifetime opportunity to see Canada's Olympic team on home soil. Go Canada Go!!
 

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Happy belated New Year! I hope that your holiday season (although it may now seem long forgotten) was a refreshing and wonderful time for you and your families.

For me, the holiday season was a great time to reconnect with family (sometimes too much family!), to rejoice about the wonderful world we live in and feel thankful for all the tremendous blessings that have been bestowed upon us. In addition, I often use the time to try to see what future career aspirations my young children have and specifically to see if they're interested in following in Dad's tax footsteps. At times, especially while we're driving and taxiing our kids to skiing or to other sporting events, I'll ask them what they want to do with their lives. I'll throw out questions such as "do you want to be a tax lawyer or a tax accountant?" The common response is "no way Dad!!!"

I guess my kids don't yet see the benefits of sleeping with the Income Tax Act.....

Notwithstanding that my children might think my career is not dynamic, hopefully they will soon learn that the tax advisory profession is a constant and fun challenge to keep current so as to provide such fresh knowledge to our wonderful clients. Some of the more exciting updates are as follows:

US Estate Tax

Unexpectedly, the US Estate Tax does not exist as of January 1, 2010. For many US tax practitioners, the scheduled 2010 elimination of the US Estate Tax was not expected to see the light of day since most thought that the US law-makers would bring in temporary fixes or perhaps a permanent fix to keep the US Estate Tax in existence for 2010. However, that did not happen and, as I write, there is no US Estate Tax for those who die in 2010. Most people believe that US law-makers will make some form of retroactive fix for 2010 so as to bring back the US Estate Tax for 2010 deaths. However, there is no shortage of discussion as to whether such a retroactive fix would be constitutional. See the Tax Prof Blog and the Drudge Retort  for more opinions on this topic.

Bill 53 - Professional Corporation - Still not Proclaimed

As our blog entries of November 26, 2009 and October 27, 2009 discussed, there are new opportunities for introducing family members into the shareholdings of Alberta professional corporations. However, such legislation (although it has received Royal Assent) has not yet been proclaimed into effect. As our blog entries discussed, there are significant problems with this legislation. Our office has been in contact with the Alberta Minister of Finance with respect to such issues and I had hoped to have a meeting with the Minister to further discuss such matters. However, the Minister who I had been chatting with has recently been replaced by a new Minister and therefore our office will try to reach out to the new Minister to discuss our concerns.

2010 Federal Budget

Although Parliament is not in session until early March, the Federal Government has announced that it will release its 2010 budget in early March. There is much speculation as to what the Federal Budget will contain given the grab bag of goodies that the budget contained last year. Will we see an extension of the home renovation tax credit? Will corporate tax rates continue to decline as scheduled? Will personal tax rates continue to be static or, given the need for revenues, will we see some form of tax increase? I guess we will have to wait and see....

UBS Affair

As our blog entries of August 25, 2009 and September 8, 2009 discussed, the US Government continues to pursue people who have evaded taxes using secret bank accounts in offshore jurisdictions. Canada is also making movement on this area. This topic has been getting wide main stream media coverage (see a recent CBS video on this subject). The end of this issue is not near. The US Government continues to prosecute people. Canada will likely do the same. Accordingly, taxpayers who have not properly disclosed foreign bank accounts, or who have not reported the income from these accounts should immediately seek tax and legal advice.

New US Tax Advisory Service

As many readers know, our firm is a Canadian tax advisory boutique where we limit our practice to tax advice to private clients and to their advisors. Earlier this week we were excited to announce the addition of Ryan T. Carey, a US tax lawyer and US CPA. Ryan and his team of US tax advisors would be pleased to discuss US cross-border tax matters and solutions with you.

See our services description for more information on this exciting new addition to Moodys LLP.

Economic Conditions Improving

Overall, our firm is pleased to report that our activity levels are significant which, in my opinion, is great evidence that the local economic conditions are improving. Memories of the recession and the suddenness of it are still fresh and therefore we are not relishing in the up-tick in the economy quite yet. However, we are pleased to see that our clients are experiencing improved conditions. This means that many clients should continue to plan their tax affairs proactively.

So, that's it for now.... As you can see, I'll be chatting with my kids tonight about how exciting the tax advisory profession is! I'm sure they will finally understand what I mean.
 

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Further to our Blog of October 27, 2009, Bill 53 - Professional Corporations Statutes Amendment Act - has received Royal Assent today and is expected to be proclaimed (pursuant to an Order-in-Council) soon.

As previously discussed, these long awaited changes allow for common law partners / spouses and children of a professional and/or a special purpose trust (of which minor children of the professional can be the only beneficiaries) to own non-voting shares of a professional corporation.

The tax advantages can be quite significant.  As an example, a professional corporation can now pay approximately $30,000 in dividends to the common law partner / spouse shareholder with nominal personal tax and little tax risk assuming that the common-law partner / spouse has no other income.  Previously, such income splitting was often restricted to salaries paid to a spouse/common-law partner, which was always subject to a reasonability test.  Note that dividends paid to a minor child will be subject to the so-called "kiddie tax" which essentially renders this type of income splitting ineffective.

However, if the professional has children who are of the age of majority (18), the professional will now have the ability to income split with them as well.  This will allow the professional to pay for expenditures such as university or provide other such assistance in a tax efficient manner.

In addition to the planning noted above, the tax team at Moodys has developed solutions that consider the following in light of the new Acts:

1. Income splitting;
2. Valuation issues;
3. Estate planning;
4. Retention of control; and
5. Asset protection.

Moodys will be holding two complimentary lunch seminars on December 11 and 16 from 12:00 to 1:15 pm where the new Acts and our thoughts on planning will be discussed.

Please contact our office at 403-693-5100 to reserve a spot.

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Good news for Albertan professionals who are regulated by the Health Professions Act (doctors/dentists/chiropractors/optometrists), Legal Profession Act (lawyers), Medical Profession Act and Regulated Accounting Profession Act (accountants).

On October 26, 2009 Bill 53 – Professional Corporations Statutes Amendment Act, 2009 passed first reading in the Alberta Legislative Assembly. This Bill, if enacted, will have some significant repercussions on how professionals set up their business affairs in order to minimize income taxes.

Currently, under Alberta law, only members of the above noted professions are allowed to hold shares in professional corporations. The use of a professional corporation does not shield the professional from personal responsibility, but it does allow for certain interesting tax benefits, such as a deferral of some income tax until amounts are paid out by the professional corporation. The proposed amendments will allow professionals, their spouse, common-law partners, children or a trust (all of the beneficiaries of which are children of the professional) to hold non-voting shares of the professional corporation. As such, holding corporations still cannot be shareholders of professional corporations.

This amendment will provide ample opportunity for income and capital gains splitting with spouses and children. Indeed, barring the application of the attribution rules and the “kiddie tax”, spouses and children of professionals will be able to receive dividends from the professional’s corporation.

One unfortunate limitation on the holdings of non-voting shares by a trust is that such a trust, as referred to above, can only have children of the professional as beneficiaries of the trust. This restriction will likely cause existing “family trusts” that have other family members as beneficiaries to be ineligible to hold non-voting shares of professional corporations.

The second limitation is that the trust will have to transfer its shares to the professional’s children within 90 days after the child or children attain the age of 18. This may have a “cooling” effect on those professionals who want to maintain some control over their children’s ownership of the shares after they reach 18.

This begs the question as to how a discretionary trust for the benefit of the children will achieve this objective as there may be no fixed interest for the child turning 18.

In addition to the above mentioned issues, practitioners will have to pay close attention as to how family members will be inserted as non-voting shareholders of the professional corporation. Some obvious options will be:

1.  Issuing non-voting shares at fair market value; and

2.  Performing an estate freeze on the professional’s existing shareholdings and then issuing new nominally valued non-voting shares to family members.

Whatever the solution a practitioner chooses, issues involving taxable benefits under sections 15 and 246 along with the attribution rules and “kiddie” tax (which will, for example, be applicable for dividends paid to minor children shareholders) must be closely considered.

Despite these limitations, these amendments will provide for interesting future tax planning opportunities for professionals. The amendments come into force on Proclamation.

Great news! Stay tuned….

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