Tag Archives: Canada Revenue Agency

Proposed Changes to ITC Rules for Holding Corporations

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On July 27, 2018, the Department of Finance announced draft legislation to amend the GST/HST holding corporation rules in section 186 of the Excise Tax Act (Canada) (“the ETA”), effective on and after July 27, 2018. This article summarizes the background, the  proposed rules, and related considerations for corporate groups that rely on the rules in section 186 to claim input tax credits (“ITCs”).

Background

For the most part, the proposed changes focus on subsection 186(1) of the ETA, which generally allows a holding corporation to claim ITCs in respect of GST/HST expenses where the holding corporation and another corporation are “related” as defined in subsection 126(1) of the ETA (“the Related Test”), and the GST/HST expenses can reasonably be regarded as having been acquired for consumption or use in relation to shares or debt of the related corporation (“Purpose Test”). All or substantially all of the property of the related corporation must also be for consumption, supply or use exclusively in the course of its commercial activities (“Property Test”). While both the holding corporation and the related corporation must be corporations, only the holding corporation is required to be resident in Canada and registered for GST/HST.

Over the years, the Canada Revenue Agency (“the CRA”) interpreted the Purpose Test in a manner that significantly limited the scope of subsection 186(1). For example, the CRA’s view as expressed in GST/HST New Memorandum 8.6, “Input Tax Credits for Holding Corporations and Corporate Takeovers”, November 2011, example #3, was that if a parent corporation raises capital by issuing its own shares in order finance the purchase of additional shares in a related corporation, related expenses would be “for consumption or use in relation to HoldCo issuing shares of its capital stock (the first order of supply) and not for consumption or shares in relation to the shares of [the related corporation]” as required to claim ITCs under subsection 186(1).

Practitioners and taxpayers generally took a broader view of subsection 186(1) based on the jurisprudence, including the Tax Court of Canada’s informal decision in Stantec Inc. V.R., [2008] G.S.T.C. 137 (TCC). In the absence of a binding decision from the courts on the scope of this provision (the Tax Court of Canada’s Act provides that an informal procedure judgement is not to be treated as precedent in any other case), the scope of subsection 186(1) remained the subject of dispute.

Proposed Rules

While the proposed changes address some of these issues, they go beyond clarifying the scope of the Purpose Test, and essentially replace it with a detailed set of rules. If the proposed legislation is enacted in its current form, ITC eligibility will no longer turn on whether the inputs “can reasonably be regarded” as being in relation to the shares or debt of a related corporation, but on whether the detailed and specific requirements of paragraph 186(1)(a), 186(1)(b) and 186(1)(c) are met.

Operating Corporation Test

In each case, in order for GST/HST expenses incurred by a holding corporation to be recovered under subsection 186(1), the “operating corporation” test must be met. These requirements are also found in the current version of subsection 186(1), but are being moved into a new provision under the proposed rules.

Pursuant to new subsection 186(0.1) of the ETA, a particular corporation (“Subsidiary”) qualifies as an “operating corporation of another corporation” if the following conditions are met:
1. The Subsidiary is “related” as defined in subsection 126(2) of the ETA to another corporation (“ the Parent”), and 2. All or substantially all of the property of the Subsidiary is property that was last manufactured, produced, acquired or imported by the Subsidiary for consumption, use or supply by the Subsidiary exclusively in the course of its commercial activities.

The test for when two corporations are “related” for these purposes is defined in subsection 126(2) and looks to whether the corporations are related pursuant to subsections 251(2) to (6) of the Income Tax Act (Canada). As discussed further before, the Department of Finance has requested comments on whether this test should be changed to a “closely related” test instead.

For purposes of determining whether an input is for consumption, use or supply exclusively in the course of commercial activities, the CRA’s view, as summarized in New Memorandum 8.6, supra, is that “‘exclusively’ generally means 90% or more for non-financial institutions and 100% for financial institutions.”

Purpose Test

Under the proposed rules, the underlying expenses must also fall under one of new paragraphs 186(1)(a), 186(1)(b) or 186(1)(c) in order to qualify for ITCs. In brief, these provisions would allow ITCs to be claimed for expenses incurred in respect of a Subsidiary that meets the above Operating Corporation Test (“Qualifying Subsidiary”) in the following circumstances:

a) Proposed paragraph 186(1)(a) generally provides for ITCs on expenses incurred by the Parent to dispose of, obtain or hold, shares or indebtedness of a Qualifying Subsidiary, or on expenses incurred by a Qualifying Subsidiary to issue, redeem, convert or otherwise modify same.

b) Proposed paragraph 186(1)(b) generally provides for ITCs in relation to expenses incurred by the Parent to raise capital to the extent the proceeds are transferred for shares or debt to a Qualifying Subsidiary for use exclusively in the course of its commercial activities. The amount claimed under this provision would need to be pro-rated as appropriate if only a portion of the proceeds raised are transferred to a Qualifying Subsidiary or the Qualifying Subsidiary does not use the proceeds exclusively in the course of its commercial activities.

c) Proposed paragraph 186(1)(c) generally provides for ITCs in relation to expenses incurred by the Parent for the purpose of carrying on its activities if all or substantially all (generally understood to mean at least 90%) of Parent’s property is shares, or indebtedness of, Qualifying Subsidiaries unless (i) the expenses were incurred for activities that primarily relate to investments in entities other than Qualifying Subsidiaries, or (ii) the expenses relate to the making of an exempt supply by Parent, other than the financial services that are listed in clauses 185(1)(c)(ii) (A) to (E). The enumerated financial services generally include dealings in shares or debt of a Qualifying Subsidiary or Parent, guarantees in respect of same, the payment or receipt of related dividends or similar amounts, as well as underwriting of shares or indebtedness of a Qualifying Subsidiary.

Thoughts/Takeaways

Section 186 is an important provision, as businesses commonly operate through multiple legal entities, and Canada’s GST/HST regime does not have tax grouping or VAT grouping unlike other jurisdictions. In the absence of section 186 (and other relieving provisions), businesses that operates through multiple legal entities (and incur expenses in respect of non-GST/HST registered subsidiaries that engage in commercial activities outside Canada, for example) would routinely incur unrecoverable GST/HST.

The draft amendments are helpful in resolving long-standing disputes on certain types of costs, including expenses incurred by the Parent to raise its own capital to in turn invest in shares or debt of its subsidiary. At the same time, the proposed rules include new Purpose Test requirements, which raise new questions. For example, while proposed paragraph 186(1)(b) allows ITCs in relation to expenses incurred by the Parent to raise capital, this is only to the extent that the proceeds are transferred for shares or debt to a Qualifying Subsidiary for use exclusively in the course of its commercial activities. It is not clear in what timeframe this transfer of proceeds must occur, and what will be sufficient to meet the requirement that the proceeds be for use by the Subsidiary exclusively in the course of commercial activities.

Other Potential Changes to Section 186

Concurrent with the release of the proposed rules, the Department of Finance announced that it is considering whether the long-standing “related” test currently included in proposed subsection 186(0.1) of the ETA should be replaced with a “closely related” test, consistent with other GST/HST rules that require two corporations to be “closely related” to be treated as one person. This change would require 90% common ownership instead of 50% common ownership under the current rules and would significantly reduce the scope of subsection 186(1).

Also, the rules in section 186 currently only apply where both the parent and related person are corporations. The Department of Finance is considering whether these rules should be expanded to partnerships and trusts.

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Canada Without Poverty v. Attorney General of Canada

jonathan-denney-103328-unsplashOn July 16, 2018, the Ontario Superior Court of Justice delivered a major victory to Canadian charities that devote all or a portion of their resources to non-partisan political activities.

In Canada Without Poverty v. Attorney General of Canada, the Court held that non-partisan political activities constitute charitable activities for the purposes of the Income Tax Act (Canada) (the Act), provided that they are carried out in furtherance of an organization’s charitable purposes. Accordingly, a registered charity may devote significantly more than 10% of its resources to such activities, contrary to long-standing Canada Revenue Agency (CRA) policy.

This decision is of particular interest to registered charities that have been the object of increased audit activity from the CRA for having engaged in political activities. Depending on the specific circumstances at issue, the decision may forge a path to a successful outcome for those involved in administrative audits with the CRA or legal proceedings before the courts.

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Canada Life: The Denial of Rescission is a Troubling Decision for Taxpayers and Professional Advisors

pexels-photo-936722On June 21, 2018, the Ontario Court of Appeal handed down a decision in the case of Canada Life Insurance Company of Canada v. the Attorney General of Canada and Her Majesty the Queen in the Right of Ontario. This is a very troubling decision for taxpayers and their professional advisors. The facts are briefly as follows. The Canada Life Insurance Company of Canada (“CLICC”) and certain of its affiliates carried out a series of transactions and events in December 2007. The purpose of the transactions was to realize a tax loss to offset unrealized foreign exchange gains accrued in the same taxation year. The Canada Revenue Agency (the “CRA”) disallowed the claimed loss in the reassessment of CLICC’s taxes for 2007. Asserting that it had proceeded on the basis of erroneous advice from its tax advisor, CLICC applied to the courts for an order setting aside the transactions and replacing them with other steps retroactive to the date of the original transaction.

The problem arose because the tax loss was to be triggered by the winding up of a limited partnership. The mistake was that the general partner of the limited partnership, CLICC GP, was also wound up at the same time that the partnership was wound up. This resulted in the limited partner, CLICC, carrying on the business of the limited partnership alone within three months of the dissolution of the partnership.

CLICC originally applied for an order rectifying the transaction so as to move the winding-up of the general partnership from December 31, 2007 to April 30, 2008. The taxpayer was successful in its application before the application judge. However, the Attorney General appealed the decision. While the appeal was pending, the Supreme Court of Canada, in the case of the Fairmont Hotels,[1] overruled previous decisions which permitted rectification. The change in law restricted the scope of the equitable remedy of rectification to the correction of written agreements. Continue Reading »

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MLI Implementation in Canada

new-york-690868_1920On May 28, 2018, nearly a year after Canada became a signatory to the OECD’s Multilateral Instrument (“MLI”), a notice of ways & means motion has been tabled by the Minister of Finance (Canada) in the House of Commons signalling the Canadian government’s intention to introduce legislation to ratify the MLI.  On June 20, 2018, Bill C-82, which will enact the MLI, received first reading in the House of Commons. The MLI has been signed by 78 countries including Canada.

When the MLI is ratified by Canada and the other signatories, existing bilateral tax treaties may be modified to apply certain agreed to minimum standards  on treaty abuse and improving dispute resolution that were endorsed by participating countries under the OECD /G20 Base Erosion and Profit Shifting (BEPS) Project.

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Search warrant’s validity does not need to be confirmed for CRA to examine items seized as part of criminal investigation

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Originally published on Fasken’s White Collar Post blog, under the title “CRA Can Examine Items Seized During Criminal Investigation Before Validity of Search Warrant Confirmed“.

By Jenny P. Mboutsiadis and Anastasia Reklitis

The Canada Revenue Agency (“CRA”) can examine and make copies of items seized by the Royal Canadian Mounted Police (“RCMP”) pursuant to search warrants issued during a criminal investigation without having to wait for a determination of whether the warrants were valid.  This was confirmed by the British Columbia Supreme Court in Canada Revenue Agency v. Royal Canadian Mounted Police, 2016 BCSC 2275.  The CRA has not appealed the decision.

In this case, the CRA applied to the court under subsection 490(15) of the Criminal Code, RSC, 1985, c. C-46, for access to items obtained by search warrants.  The search warrants had been issued based on the belief that those named in the warrants (“Named Persons”) had committed criminal offences, such as laundering proceeds of crime, possession of property obtained by crime, and importing and trafficking in a controlled substance.  The items seized included large amounts of cash, numerous documents and computers, and other electronic devices and media containing business, accounting, and tax records.

The CRA argued that it was permitted access because it is a person “who has an interest in what is detained”, thereby satisfying the applicable Criminal Code provision.  The Named Persons opposed the CRA’s application on numerous grounds.  The RCMP took no position.

The Named Persons’ first argument was that a determination that the seizure is lawful is a pre-condition to the CRA’s entitlement to access any materials.  The Named Persons had already commenced the process in the Provincial Court that could possibly lead to the quashing of some or all of the search warrants and argued that, therefore, the CRA’s application should be adjourned until the validity of the warrants is determined from that process.  The court rejected this argument and explained that the warrants were presumptively valid and the Named Persons have the burden to establish otherwise.  A mere challenge with vague possibilities was not enough to satisfy the court that the warrants were invalid.

The Named Persons’ second argument was that the CRA’s application should fail because it did not have an interest in the seized items.  The court found to the contrary:  the CRA did have an interest because the items could be relevant to various tax investigations in which it was involved, which were independent of the RCMP investigations.  In particular, the items were relevant to determining potential tax offences involving some or all of the Named Persons, including tax evasion and the filing of false tax returns.

The Named Persons’ third argument was that any order allowing the CRA access should contain specific restrictions relating to privacy, privileged material, and relevance.  The court refused to place any restrictions as it did not find it appropriate to limit the examination of the evidence.

The CRA’s application was allowed and access to the seized items was granted.  In doing so, the court stated that there is nothing inherently wrong with law enforcement officials cooperating and sharing legally-obtained information.  Preventing the CRA from accessing the RCMP gathered information would delay the CRA’s investigation, thereby prejudicing its effectiveness and the likelihood of charges arising from it.  The court’s view was that it is in the public interest that the RCMP and CRA investigations proceed concurrently as they concern offences arising from the same search warrants.

 

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