Author: Alan Schwartz

Analysis, Canada

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

On 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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Analysis, Canada

New Proposals on the Taxation of Private Corporations can result in Double Taxation

ottawa-815375_1920Much has been written regarding the proposals released by the Department of Finance on July 18, 2017 to limit income splitting and holding passive investments inside a private corporation.[1]  A third measure, namely, placing limits on the conversion of income to capital gains is aimed at preventing an individual selling shares of a corporation to a non-arm’s length person followed by a sale by the non-arm’s length person to a connected corporation.  The foregoing transaction would result in the individual realizing a capital gain based on the fair market value of the transferred share followed by the tax-free extraction of corporate surplus of the transferred corporation.  This is considered an inappropriate conversion of what would otherwise be a payment of dividend income into a capital gain.  The difference in tax rates is about 14%.

The problem is in the application.  Discussions with officials from the Department of Finance indicate that these proposals will prevent some normal post death tax planning aimed at preventing double taxation of the same economic gain (the “pipeline plan”).

The pipeline plan is illustrated in the following example:  Taxpayer A incorporates a company and invests $100 for shares of the company.  The company starts a business or buys investments for $100.  Ten years later the shares of the company are worth $5 million.  Taxpayer A dies, a capital gain of $4,999,900 is realized.  However, the cost of the assets or investments in the company remains at $100.  Thus, if the assets or the investments are sold for $5 million, there is a gain of the same $4,999,900, i.e., the same gain is taxed twice, once in the hands of the deceased taxpayer and once in the hands of the company.  To prevent this economic double taxation, the shares of the company are sold by the estate of Taxpayer A to a new corporation for the same $5 million which then is amalgamated with the company.  The tax result is that the cost base of the assets in the amalgamated company and paid-up capital of the shares of the amalgamated company is increased to $5 million.  This prevents double taxation of the same gain.

Yet, the Department of Finance officials have indicated that the pipeline plan is not available because the transfer of the shares from the deceased Taxpayer A to his estate is a non-arm’s length transfer that is caught by the new proposal.  It is a stretch to think of death as a “specific type of avoidance transaction”.

There is a procedure available to deal with the double taxation issue but there is a stringent time requirement which often causes such a procedure to not be available.[2]

The Minister of Finance should heed the words of Shakespeare “Striving to do better, oft we mar what’s well”.  At a bare minimum, the Minister should announce that these rules will not affect pipeline transactions.

 

[1]       See also our commentary on the proposal, “Targeting Private Corporation Tax Planning: the Canadian Federal Government’s Proposal“.

[2]       Namely, making an election pursuant to subsection 164(6).

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Analysis, Canada

Tax Residency of Trusts in Canada: Application of the Central Management and Control Test Post-Garron

Canadian and provincial income taxes are assessed on worldwide income on the basis of a taxpayer’s residence. Subsection 104(2) of the Income Tax Act (the “Tax Act”) provides that a trust is deemed to be an “individual” for purposes of the Tax Act. Consequently, trusts that are resident in Canada or deemed to be resident in Canada will be taxed on their worldwide income as opposed to only their Canadian source income. Despite the tax implications accompanying a taxpayer’s residency status, the Tax Act provides little in the way of guidance for determining the residency of a trust. As a result, Canadian courts have been tasked with making this determination.

Central Management and Control

In 2009, Garron Family Trust (Trustee of) v. R.[1] changed the long-standing approach to determining the residency of trusts in Canada.[2] The test set out in Garron provides that the residency of a trust is where the central management and control of the trust actually takes place.[3] The court clarified that the assessment into who has central management and control is a question of fact to be examined on a case by case basis. In concluding that the central management and control of the Summersby and Fundy trusts (the “S&F Trusts”) resided with the beneficiaries, the court considered several factors, including:

  • Whether the evidence or lack of evidence demonstrated an active or passive role taken by the trustee in its management of the trust;
  • The true controlling minds behind investment decisions and management of the S&F Trusts’ assets;
  • The use of a protector mechanism to exert control over the trustee;
  • The beneficiaries’ demonstrated interest in the trustee’s management of the S&F Trusts;
  • The trustee’s expertise in managing trusts; and
  • The trustee’s knowledge of the transactions it had been asked to approve.

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