Tax and Estate Planning

The Changeover from Canadian Generally Accepted Accounting Principles ("GAAP") to International Financial Reporting Standards ("IFRS") and/or Private Enterprise GAAP and its Impact on Taxable Income

Kim G C Moody — Wed, 18 Aug 2010 15:29:01 -0700

As you know, Canadian GAAP is being replaced as the required accounting standard for financial reporting in Canada. Effective January 1, 2011 IFRS will now be the new accounting standard for public enterprises. The Canadian Institute of Chartered Accountants (“CICA”) has created a useful guide for users of financial reports in order to assist in interpreting the consequences as a result of the IRFS convergence.

Private enterprises will have the ability to use so-called private enterprise GAAP rather than IFRS as their new accounting standard. For further information on this please see a good report published by the Accounting Standards Board of Canada.

Regular readers of our blog know that Moodys LLP Tax Advisors does not engage in any accounting services whatsoever. Notwithstanding, many of our clients have questioned us as to what the conversion to IFRS or private enterprise GAAP will mean as it relates to their tax affairs. Specifically, will the calculation of taxable income for enterprises that use IFRS or the new private enterprise GAAP be negatively impacted? Overly simplified, it is our firm’s view that the conversion to IFRS or private enterprise GAAP should generally not have any negative impact on the computation of taxable income as compared to prior years. This is because the Income Tax Act (the “Act”) does not mandate that GAAP accounting profits be used in the first instance to compute taxable income (or, simply, to calculate profit for tax purposes). GAAP is not the law. In addition, the Supreme Court of Canada, in the leading case of Canderel, has made it clear that a taxpayer’s goal, in seeking to ascertain profit (for tax purposes) is to obtain an accurate picture of the taxpayer’s profit for purposes of section 3 of the Act for the given year. The Supreme Court stated in Canderel that a taxpayer is free to adopt any method to compute profit which is not inconsistent with:

a) the provisions of the Act;
b) established case law principles; and
c) well accepted business principles.

Practically speaking, IFRS and private enterprise GAAP (and current GAAP) may be a good starting point to compute an accurate picture of profit. However, other methods are certainly available and may not be inconsistent with computations of profit used for tax purposes prior to the mandatory adoption of IFRS or private enterprise GAAP.1 What will be necessary, however, is to understand the detailed differences in computing accounting profits under current GAAP vs. IFRS and/or private enterprise GAAP. Such differences may be a required adjustment in order to get back to the method of computing tax tax profits as was used in prior years.

To illustrate, let us assume that a corporate taxpayer currently uses Canadian GAAP as its starting point to compute profit for tax purposes. While the Act will require many adjustments to the profit calculation (given that the Act contains very specific rules for how certain matters must be treated), IFRS and/or private enterprise GAAP may change the computation of accounting profits for 2011 forward. As an example, what may have been previously expensed in the accounting financial statements of a taxpayer may now be capitalized (and therefore not expensed) pursuant to IFRS and/or private enterprise GAAP. To the extent that the now capitalized item for accounting purposes would be more appropriate as a deduction (and was previously deducted in prior years when computing tax profits) such an adjustment will need to be made to the tax profit calculation which is consistent with the principles of Canderel. Accordingly, tax practitioners will need to be very aware of the detailed differences between current GAAP and IFRS and/or private enterprise GAAP starting in 2011.

The CRA has published a number of publications which appear on their website. Specifically, they have commented on the impact of IFRS on taxable income. In addition, they have published a technical news document - Income Tax Technical News #42 dated May 31, 2010 – which provides useful information on this subject.

The tax professionals at Moodys LLP would be pleased to comment on your own specific issues regarding this topic. Please feel free to contact any one of our tax professionals.

1 To be clear, it is only mandatory for public enterprises to use IFRS as their accounting standard. For private enterprises, if there is no need to use GAAP when preparing financial statements (for example, the users of the financial statements have determined that there is no need to use GAAP) then private enterprise GAAP need not be used.

Government Releases Revised Income Tax Technical Proposals

Kim G C Moody — Mon, 19 Jul 2010 16:02:56 -0700

On July 16, 2010, the Department of Finance released a significant package of income tax technical amendments and explanatory notes. As I am writing this blog, I have a binder of material in front of me that contains all of the material released by the Department of Finance and it is approximately 2 ½ inches thick. Oh joy! Great summer time reading!!

In all seriousness, though, this material is very welcome news given that it contains significant provisions some of which have been outstanding for approximately 8 years. Let’s hope this package gets passed into law soon.

One of the significant amendments included in the income tax technical package are the restrictive covenant proposals. Such provisions are horrifically complex. Our firm wrote a paper on the restrictive covenant draft proposals in 2008. For those interested in an exercise in complexity, feel free to read the paper. Such provisions are wide sweeping and will change how most purchase and sale agreements are handled from a taxation perspective. For further information, take a look at our blog of April 10, 2008.

For the technically inclined, the July 16, 2010 release had the following changes to proposed section 56.4 (the section of the Act that is proposed to deal with the taxation of restrictive covenant amounts):

1. The definition of “eligible corporation” in subsection 56.4(1) (this definition is relevant for the purpose of determining whether the rules in subsections 56.4(5) and (7) apply to provide an exception - for goodwill amounts- from the rule in section 68 that may deem a person who grants a restrictive covenant to receive an amount for the restrictive covenant irrespective of the legal agreement) has been changed to eliminate the previous rule which required that individuals with whom the taxpayer does not deal at arm’s length not hold in aggregate, directly and indirectly, more than 10% of the issued and outstanding share capital of the subject corporation. No such 10% rule now exists in the revised definition.

2. The definition of “restrictive covenant” under subsection 56.4(1) has been amended and tightened to try and provide more clarity than the previous draft definition.

3. There is a new definition of “eligible person” in subsection 56.4(1) which is relevant for the purpose of applying new subsection 56.4(8.1) which will be discussed briefly below. In general, an eligible person in respect of a grantor (the “vendor”) of a restrictive covenant at any time means an individual who is related to the vendor and who is attained the age of 18 years at that time or before.

4. Proposed subsection 56.4(8) (a provision that provides a set of conditions that, if met will cause section 68 to not apply to deem consideration to have been received or receivable by the person granting a restrictive covenant) has been amended in two places. The first is in paragraph (d) which clarifies that to the extent that any amounts have been received, essentially as goodwill, then subsection 56.4(8) cannot apply with respect to such goodwill amounts. The second is that there is now a new paragraph (h) which requires that there be no proceeds received or receivable by the vendor for granting a restrictive covenant in order for subsection 56.4(8) to apply. There are corresponding “coming-into-force” provisions with respect to these new additions as well.

5. As mentioned above, there is a new proposed subsection 56.4(8.1). To the extent that the conditions in the new subsection 56.4(8.1) apply, then section 68 will not apply to deem consideration to be received or receivable by the individual for granting restrictive covenants. Overly simplified, to the extent that the conditions apply, a restrictive covenant granted by an individual who is resident in Canada (at the time of grant) to an “eligible person” (with all the other conditions not documented here being met) then the restrictive covenant rules will not apply. This new provision will be helpful to the extent that a father, for example, sells shares of “Opco” with a restrictive covenant grant to his son and/or daughter. The previous version of the rules made it clear that the restrictive covenant proposals would apply in such an example thus causing problems in succession planning.

6. There are technical amendments, beyond the scope of this blog, in proposed subsection 56.4(9), 212(13)(g) and corresponding “coming-into–force” provisions.

Although complex, taxpayers and their advisors will need to pay particular attention to the restrictive covenant proposals when acquiring or disposing of businesses.

Snowbirds Beware!

Kristina Ash — Wed, 30 Jun 2010 10:09:34 -0700

By Paul R. Lebreux LLB, LLM, TEP, Ryan T. Carey CPA (US), LL.M. (US Tax) and Kristina Ash JD LLM (US Tax)

For Canadian residents spending time in the United States (“US”), it is important to ensure that the heat you receive next time you venture south is only felt from the sun, and not the Internal Revenue Service (“IRS”).

Each year thousands of Canadians make the trek to warmer climates in an attempt to avoid Canada’s long, cold winter months. More often than not, these winter retreats take Canadians to the US. Whether your passion is Florida, Arizona or some other favourite southern state, such a retreat may not only put you closer to the sun, but closer to the IRS.

Depending upon the duration of your stay in the US, you may be classified as a US resident for income tax purposes and be required to complete certain tax filings. Most Canadians who spend significant time in the US are required to file a US tax return or other filing in order to avoid paying US taxes on worldwide income.

Determination of US Tax Residency

If you visit the US on a regular basis, there are three categories into which you may fall:

1. Present in the US for 183 days or more in the current tax year. Pursuant to the provisions of the Internal Revenue Code (“IRC” or the “Code”), if you are present in the US for 183 days or more in the current tax year, you will automatically be classified as a US resident and may be required to file a US tax return (Form 1040) in order to report your worldwide income in the US. You may be able to claim a treaty tie breaker under the Canada-US income tax treaty in order to file a non-resident return (Form 1040NR).

2. Present in the US for greater than 31 days, but less than 183 days during the current year and you meet the Substantial Presence Test. If this is the category into which you fall, you will be considered a resident alien and be required to file a Form 1040 in order to report your worldwide income in the US, unless you use the treaty-tie breaker rule or you can demonstrate a closer connection to Canada than to the US (see discussion below under the heading “Substantial Presence Test”).

3. Present in the US for less than 31 days during the current year or do not meet the Substantial Presence Test as set out in category two above. If this is your situation, you will be categorized as a non-resident alien and not be required to file a US tax return unless you have certain US source income for which adequate withholdings have not been made or you are engaged in a US trade or business (including employment within the US).

Substantial Presence Test

In order to determine who is a US resident, the US utilizes a formula which considers the days that an individual is present in the US over a three year period. This formula is commonly known as the Substantial Presence Test. The test calculates the number of days actually spent in the US during the current year, plus the number of days spent in the US in the immediately preceding year multiplied by 1/3, plus the number of days spent in the US in the second preceding year multiplied by 1/6. If the calculation totals 183 days or more, the individual meets the substantial presence test and will be classified as a resident alien. It is important to note that for the purposes of this test, the days present in the US need not be consecutive. You will be considered to have been present in the US on any day that you were physically in the US, whether you are present for the entire day or only part of the day.

The following example demonstrates the effect of the above formula. Mr. and Mrs. Sunshine are residents of Canada and have a winter home in Florida. For the past several years Mr. and Mrs. Sunshine have spent a portion of the winter months in Florida and also some time in the US during other parts of the year.

In 2008, Mr. and Mrs. Sunshine spent 3 months (91 days) in Florida during the winter and an additional 3 weeks (21 days) in the summer. In 2009, Mr. and Mrs. Sunshine spent 4 months (122 days) in Florida during the winter and a further 2 weeks (14 days) in May. In 2010, Mr. and Mrs. Sunshine spent 6 weeks (42 days) traveling in the US and another 11 weeks (77 days) at their home in Florida.

Based on the above, the “substantial presence” test would be applied as follows:

Years                  # of days in US                    Multiplier                    Formula Days
2008                              112                                   1/6                               18.66
2009                              136                                   1/3                                45.33
2010                              119                                     1                                119.00
                                                                                                                   183.00

Mr. and Mrs. Sunshine will therefore be deemed to have been in the US for 183 days during the current year and will meet the Substantial Presence Test. Although this will effectively result in their being classified as resident aliens, they may be able to use an exception to avoid being liable for US income taxes on their worldwide income.

In order to avoid the requirement to file a US 1040 tax return, Mr. and Mrs. Sunshine will each be required to complete and file a “Closer Connection Exception Statement For Aliens” (Form 8840). They must provide evidence to the IRS that they have a closer connection to Canada than to the US in order to escape US taxation. In the event that Form 8840 is not filed on time (June 15, 2011 for the 2010 tax year), Mr. and Mrs. Sunshine would be estopped from claiming a closer connection to Canada, which could result in US taxation of their worldwide income.

You will be considered to have a closer connection to Canada if you can demonstrate that your economic and social ties to Canada are more significant than are your economic and social ties to the US. The following are some of the indicia that the IRS considers in determining the “closer connection”:

1. location of permanent home(s);

2. location of personal belongings (ie. cars, furnishings);

3. location of banking relationships and investments;

4. location of drivers licenses;

5. countries from which you derive the majority of your income; and

6. business and personal ties.

If you have applied for or been granted a “green card” you will not be permitted to claim a closer connection to Canada.

If you are successful in establishing a closer connection to Canada by timely filing a Form 8840, you avoid the necessity of filing a US resident tax return and possibly incurring double taxation.

Residence under the Canada-United States Income Tax Convention

Generally, if an individual fails to file a Form 8840 on time, the individual will be considered a US resident for tax purposes and be required to pay US income tax on his or her worldwide income. Nonetheless, it may still be possible for the individual to have his or her residency status determined under Article IV of the Canada – United States Tax Convention (the “Treaty”).

The main purpose of the Treaty is to reduce the potential of an individual being taxed twice on the same income. The treaty attempts to resolve the issue where an individual is deemed to be a resident in both the US and Canada. You may be classified as a non-resident alien under Article IV for the purposes of calculating your US income tax liability if the following conditions are met:

1. you are deemed to be a resident of both the US and Canada pursuant to each country’s respective tax laws; and

2. your permanent home is in Canada and your personal and economic ties are closer to Canada than to the US.

Although relying on the Treaty may permit you to escape US taxation as a resident on worldwide income, you will still be required to file a US Form 1040NR with a “Treaty-Based Return Position Disclosure under Section 6114 or 7701(b)” (Form 8833). These filings are far more complicated (and thus more expensive to have prepared) and intrusive than a Closer Connection Exception Statement, so most clients prefer to file a Closer Connection Exception Statement if at all possible.

Conclusion

If you are among the thousands of Canadians returning to Canada after a long cold winter, you may want to consider your potential US tax liability and filing requirements before it is too late. If you are a Canadian who spends significant time in the US, it is imperative that you obtain professional advice to determine the extent of your tax filing and tax payment obligations. We expect that the IRS’s increased scrutiny of taxpayers with foreign connections, combined with increasing use of technology, will cause the IRS to pay closer attention to those that are not filing required US forms and returns.

The foregoing information is provided for general informational purposes only and readers are encouraged to consult with their professional advisors as to their specific circumstances.

U.S. Tax (IRS Circular 230): Nothing in this communication (including in any attachment) is U.S. tax or other legal advice that is intended or written to be used, and it cannot be used, by any person to
(i) avoid penalties under U.S. federal, state or local tax law, or
(ii) promote, market or recommend to any person any transaction or matter addressed herein.

CRA National Project Regarding Domestic Trusts

Kim G C Moody — Mon, 21 Jun 2010 13:45:00 -0700

The past six weeks have been very busy with attending and speaking at various conferences. At three of the conferences (Institute of Chartered Accountants of Alberta Tax Roundtable, Canadian Tax Foundation Prairie Provinces Conference and the STEP National Conference) the CRA was in attendance answering various questions posed by practitioners. The topic of domestic trusts was high on the agenda for questions posed by practitioners.

In the midst of attending the above-noted three conferences, the CRA made it known that a national project on the review of domestic trusts commenced in 2005 and ended in the 2007 and 2008 fiscal year. The CRA noted, from its review, the following recurring issues involving domestic trusts:

1. Domestic trusts had inappropriately deducted trustee/investment fees in the computation of its taxable income;

2. Certain of the domestic trusts had entered into transactions whereby the character of its income had been changed so as to avoid the incidence of “kiddie tax”. Often times this would involve an otherwise dividend being characterized as a capital gain, since capital gains are not subject to the “kiddie tax” (the “kiddie tax” is an informal phrase to describe certain income that is ultimately taxed at the highest tax rate to the extent that it is allocated from a trust, in this example, to a minor beneficiary);

3. Certain of the trusts had entered into transactions whereby the capital gains deduction applicable for qualified small business corporation shares or a qualified farm property had been multiplied amongst various beneficiaries;

4. The trust did not have any evidence of paying income or making the income payable to the beneficiaries. To the extent that such income is not paid or made payable to the beneficiary then the trust would not be able to deduct such income in the computation of its income; and

5. Certain of the attribution rules (such as sections 74.1, 74.2 and subsection 75(2)) applied to the trusts.

The CRA made it known that they would be taking a national approach to their review of trusts once again and, in particular, looking for the above noted issues. Accordingly, practitioners and clients should be aware and be prepared. Trust records should be immaculate and attention paid to detail when entering into tax planning involving domestic trusts.

This subject will get more attention in the coming months and years and, accordingly, Moodys is exploring the possibility of having a special seminar to discuss the pending audits of domestic trusts in the fall. Stay tuned…..

GAAR: KEEPING US OFF-BALANCE?

Sean Dooley — Fri, 28 May 2010 13:37:30 -0700

In an episode of Corner Gas, the main character, Brent, (who is single, has no children and is 40 years old) finds himself overwhelmed by a hot-wheels-tossing 6 year old boy and besieged under a kitchen table while babysitting for a friend. Brent enlists the help of his mother, Emma, who quickly gains control of the situation and explains her two-pronged philosophy for disciplining kids:

“Use their whole name. They hardly ever hear all three of their names so it kind of puts them off balance [mentally]. Second, give them an open ended threat, nothing specific, that way their fertile little imaginations fill in the gap with the worst thing they can think of. A child’s imagination is their strength and their weakness.”

To watch this portion of the episode“Oh Baby,” start at 3:38 of the linked video.

Emma’s philosophy made me think of the general anti-avoidance rule (the “GAAR”). Until the introduction of the GAAR in 1988, one of the greater certainties in tax, while not absolute, was the Duke of Westminster principle that taxpayers may order their affairs so as to minimize the amount of tax payable. The GAAR introduced significant uncertainty and great apprehension as to whether taxpayers could seek to minimize tax. Initially, the GAAR was feared as a “big stick” to reign-in taxpayers and tax planners alike. As the GAAR cases worked their way through the courts, the apprehension may have diminished, but uncertainty remained.

The decision from the Supreme Court of Canada (“Supreme Court”) in Canada Trustco Mortgage Co. v. The Queen 2005 SCC 54 provided a welcome framework in applying the GAAR and restored a measure of certainty. Particular comfort was gleaned from the following words of the Supreme Court:

“The GAAR was enacted as a provision of last resort in order to address abusive tax avoidance, it was not intended to introduce uncertainty in tax planning.”

With the Supreme Court’s split decision in Earl Lipson v. The Queen 2009 SCC 1, many commentators have expressed concern that Lipson introduced new and improved uncertainty. (We discussed the facts of Lipson in our January 9, 2009 blog.) Consider the view of one dissenting judge:

“The approbation by the Court of the Minister's resort to vague generalities or "overriding policy" would only increase the element of uncertainty in tax planning that Canada Trustco sought to avoid.”

There are fears that the “big stick” is back and even whispers of a smell test.

Lehigh

On May 17, 2010, the “certainty” of the GAAR took another twist when the Federal Court of Appeal (“Federal Court”) allowed the taxpayer’s appeal in Lehigh Cement Limited v. The Queen, 2010 FCA 124, reversing the decision of the Tax Court of Canada (the “Tax Court”). The Tax Court had applied the GAAR to a series of transactions that resulted in the avoidance of withholding tax under subparagraph 212(1)(b)(vii) of the Income Tax Act (the “Act”), which, in general terms, exempted interest from withholding tax when paid to an arm’s length party on debt that under no circumstances was 25% of the principal required to be repaid within 5 years of the date of issue of the debt ( the “5/25 Exemption”). Canada has since eliminated withholding tax on all arm’s length interest (other than participating interest payments).

Misuse or Doubt?

The Crown’s primary argument in applying the GAAR in Lehigh was that a non-resident person is not entitled to benefit from the 5/25 Exemption where the right to receive interest is split from the right to receive the principal amount because the transaction did not result in Lehigh “accessing funds in an international capital market.” This phrase is an excerpt from a 1975 Department of Finance budget paper that first proposed the 5/25 Exemption.

The Federal Court rejected the Crown’s invitation to conclude that entitlement to the exemption is “subject to a condition necessarily implied by the existence of a fiscal policy, evidenced only by a sentence in a 1975 budget paper that is said to explain why the exemption was enacted.” The Federal Court emphasized:

“Most importantly, if there is any doubt as to whether the transaction in issue results in a misuse […], Lehigh is entitled to the benefit of that doubt.”

Although the reversal of Lehigh itself by the Federal Court may be viewed as contributing to the uncertainty surrounding the GAAR, the message may be broader than that. Arguably, Lehigh restores a measure of certainty to the principle that when there is any doubt as to whether there is a misuse or abuse of the provisions of the Act when a taxpayer is arranging his or her affairs to minimize tax, the taxpayer should be entitled to the benefit of the doubt. It also inspires confidence that, as questioned by the Supreme Court in Canada Trustco, the Federal Court is unwilling to formulate taxation policies that are not grounded in the provisions of the Act and certainly will not apply ungrounded policies to override the specific provisions of the Act. So it would seem that certainty can be found in doubt.

Update on Recent Department of Finance Activity

Kim G C Moody — Tue, 18 May 2010 15:38:59 -0700

Wow, time flies when you’re having fun……!

May and June are conference months with our firm recently speaking at the STEP Pacific Rim Conference and the Canadian Association of Gift Planners Conference in Edmonton. Our firm will also soon be speaking at the Canadian Tax Foundation Prairie Provinces Conference and the STEP National Conference. Certainly no shortage of activity.

Similarly, the Department of Finance has been busy in the last couple months. Here are some updates:

1. Non-Resident Trust (“NRT”) and Foreign Investment Entity (“FIE”) Proposals

As mentioned in our budget blog of March 5, 2010, it was noted that the Federal Government was reviewing the NRT and FIE proposals. The Government has now established a consultative group to assist it in introducing new draft legislation in this area. Certain organizations have been asked to participate in the consultations with the Department of Finance and therefore we expect activity in this area soon.

Organizations like the Society of Trust and Estate Practitioners (“STEP”) have provided their response to the proposals, so it will be interesting to follow this space.

2. Information Reporting of Tax Avoidance Transactions

As mentioned in our budget blog of March 5, 2010, the Federal Government is proposing new reporting rules which will require certain tax avoidance transactions to be positively disclosed on an ongoing basis. On May 7, 2010 the Department of Finance released a description of the proposals and asked for public comments on the proposals by July 7, 2010.

These proposals have the possibility to significantly impact certain tax advisors and their clients. Stay tuned!

3. Draft Regulations in Respect of the Place Supply Rules for Harmonized Sales Tax (“HST”).

As mentioned in our December 16, 2009 blog, the “place of supply” rules with respect to the new HST regime for British Columbia and Ontario – to be effective July 1, 2010 – has created a lot of controversy. The Government released its draft regulations to these place of supply rules on April 30, 2010.

4. Responses to the Department of Finance Proposals for Employee Life and Health Trusts (“ELHT”).

As mentioned in our March 1, 2010 blog, the Department of Finance released draft proposals on ELHTs on February 26, 2010. If implemented, such proposals will have a dramatic impact on the way certain private and public corporations have planned for their employee benefit programs. Certainly it is understandable, to some extent, why the Department of Finance would want to legislate these proposals. Notwithstanding, some of the proposals appear to be far reaching and likely could be improved upon. To that end, STEP provided its comments to the Department of Finance on April 30, 2010.

Stay tuned on all the above……it is sure to be interesting!

New US Hire Act Will Find You!

Kristina Ash — Fri, 26 Mar 2010 12:44:47 -0700

Uncle Sam Wants YOU to file US tax returns…and he has recruited foreign banks into his army to report you! Now you will get caught if you don’t file returns and report foreign income.

Until last week, United States persons who had never earned income in the United States and had never opened a bank account in the US were generally not on the IRS’s radar screen. With the legislation signed into law on March 18, 2010 foreign financial institutions must determine if any of their account holders are US persons, and if so, the financial institutions must report information to the IRS about those accounts. This blog answers the most popular questions that we have received in regards to this new legislation.

My mother/father was born in the US, but I was born in Canada and have never lived or worked in the US and I do not have a US passport or Social Security number. I have never filed a United States tax return. Am I a US citizen and am I required to file US tax returns?

The rules surrounding citizenship are complex and depend upon when you were born. However, if one of your parents is a US citizen and spent sufficient time living in the US, you may be a US citizen. If both of your parents are US citizens, you are probably a US citizen regardless of whether you or they ever lived in the US. We can help you make a preliminary determination on citizenship, then refer you to qualified immigration counsel who can give you a final legal conclusion on whether you are a US citizen.

If you meet very low income thresholds, you are likely required to file US returns and comply with US tax laws. The good news is that in most cases, the taxes that you paid to Canada will result in foreign tax credits that will cover the taxes that you owe in the United States. We recommend filing tax returns for the current year, and possibly filing for the past several years, in order to avoid finding yourself on the wrong side of the table with the US Internal Revenue Service! The Moodys LLP Tax Advisors team is experienced in handling these types of returns and working with the IRS.

What information is my bank in Canada required report to the IRS?

First, your bank will need to determine whether you are a United States person. If you are a US person, your bank must report your name, address, taxpayer identification number, account number, account balance or value, and the gross receipts and gross withdrawals from the account.

I am a US person who is a minority shareholder in a private corporation. Will this affect me or the private corporation?

Probably. If you own more than 10 percent of the stock in a corporation, more than 10 percent of the profits interests or capital interests in a partnership or beneficially own more than 10 percent of a trust, your bank must report the above information to the IRS. If you own a sufficient interest in the entity or if there are other US persons who own part of the entity, there could be significant tax consequences. Your company might be a Controlled Foreign Corporation (“CFC”) or a Passive Foreign Investment Company (“PFIC”). Ownership of CFCs and PFICs can have disastrous tax consequences if your tax situation is not proactively managed. Talk to an advisor experienced in cross-border tax planning to determine if you have any tax liability. Moodys LLP Tax Advisors are experienced in rendering this type of advice.

I am a shareholder in a corporation, but I am not a US citizen. Could this legislation affect me?

That depends. Do you have any shareholders that are US persons? If so, you may be subject to additional reporting requirements and US tax liabilities, even if you don’t conduct any business in the United States. Discuss your situation with a tax advisor experienced in cross-border planning to determine if you have US tax reporting requirements or exposure. Moodys LLP Tax Advisors are experienced in rendering this type of advice.

I am a shareholder in a corporation that occasionally does business in the United States or that has investments in the US. Will this legislation affect me?

Yes. Even if you don’t have a single US shareholder and you do not have a permanent establishment in the US, if you earn any income in the US, that income may be subject to a 30 percent withholding tax unless you provide the payor with a certificate that states that no US person owns more than 10 percent of the company.

I know that I’m supposed to file a US return, but I’ve never been caught. Why should I start filing now?

This legislation imposes a reporting requirement on foreign (including Canadian) financial institutions. Once these institutions report information about your account to the IRS, the IRS is more likely to find you. If you fail to disclose your assets and the aggregate value of all of those assets is greater than $50,000, the IRS could impose a penalty of $10,000. If you receive a notice and do not provide the information after 90 days, the IRS could impose a $10,000 penalty each month up to $50,000. Moreover, if you fail to disclose the information and the IRS determines that there was an underpayment, an additional 40 percent tax will be assessed on the amount of the underpayment. The statute of limitations with respect to a tax return do not begin running until a return is filed! This means the IRS may pursue you for an unlimited period of time if you do not file a required US tax return for a particular year (or years).

The penalties imposed by this new legislation are in many instances imposed in addition to other penalties which exist under other tax law and bank secrecy law provisions. Failing to file required returns, particularly those related to foreign assets or entities, can result in draconian penalties and criminal prosecution. Moodys LLP Tax Advisors has an experienced team of US tax experts who can assist you with catching up past filings and finding solutions to your tax problems.

What is the Benefit of a Tax Specialist?

Kim G C Moody — Wed, 24 Mar 2010 15:18:50 -0700

Please be warned that this blog may sound like marketing and it is different from our normal blogs. The reason for this is that we were recently asked by a prospect and a client the question:

"What is the benefit of a tax specialist?"

We thought it would be beneficial to answer this great question for our audience. Of course, this question was raised in relation to why the prospect should hire our firm and why the client should continue to work with us. They were both specifically wondering why they should work with us if their existing accounting firm (both large accounting firms) could do the work.

The short answer is that they should utilize our services because we believe that we are one of the more knowledgeable and proactive resources for tax and estate planning advice.

As we say in our mission statement, “we are passionate about tax optimization”.

All of our professionals aggressively stay up-to-date on new case law, legislation and administrative positions. We hold weekly meetings for continuing education and to discuss new developments in tax and estate planning.

Our team of tax lawyers and tax accountants work together in our multi-disciplinary practice which allows us to better identify issues, research, create and implement optimal strategic plans for clients all within one firm. We are the only firm that we are aware of that is structured in this way. In addition, we are one of the few firms in Canada that has in-house US tax practitioners that can offer cross-border solutions.

In many traditional accounting firms, the tax department is often reactive in their approach to client needs. Certainly the existence of the tax department to support the audit and assurance practice is sufficient in many cases and there are many great accounting firms out there. However, given the current business and regulatory environment, we believe that the traditional model makes it more challenging to deliver leading edge services in both accounting and tax, especially if tax is a supporting service and not a leading service. Graphically depicted, we believe that a traditional accounting firm with a tax department is structured like this:

We believe our unique multi-disciplinary and cross-border practice is a proactive approach to tax advisory services that can offer our clients the following benefits:

Specialist level knowledge on a very complex subject matter;
Arrange solicitor client privilege if desired or deemed necessary;
Capability to both develop and implement bespoke tax plans in-house;
Ability to assist accounting firms and law firms with tax matters for their clients; and
Fewer conflicts of interest due to the fact we do not offer audit or accounting services and are focused solely on tax advisory.

Our model enables us to work with our law firm partner to deliver tax advisory services in the model depicted below. We believe that this model is logical, efficient and provides greater value when delivering tax advisory services.

Our research has shown that our tax advisory model is common in Europe, but not in North America due to a variety of reasons including industry regulations. We believe that ultimately our role is to provide specialized, proactive advice that complements your existing advisor, not to compete with them.

Will your professional advisory fees be less as a result of our involvement? In many cases the answer will be “no”. However, if your goal is to reduce your total costs and obtain greater overall value, we believe our firm’s value proposition makes the answer to the question “yes, your overall costs will be less”.

When we explained our tax advisory model to the prospect and the client, they both understood and trusted us to deliver on our value proposition. We believe that our model is the wave of the future and more “stand alone” professional service firms will be created to fill client needs and complement existing advisors.

US Foreign Bank Account Reporting Rules - Update

Kristina Ash — Thu, 11 Mar 2010 09:43:18 -0700

This blog was authored by Kristina Ash JD (US), LL.M. (US Tax)

The US Government has required its citizens to report on their foreign bank accounts since 1970; however, its controversial revisions of October 2008 continue to cause tax practitioners, citizens and persons doing business in the US headaches. We expect the US Government to aggressively enforce these reporting requirements since they assist the US Government in identifying abusive offshore accounts such as the UBS accounts (discussed in our blogs on September 8, 2009 and February 10, 2010).

The foreign bank account reporting requirements are promulgated under the Bank Secrecy Act,1 not the Internal Revenue Code (“IRC”). If a US person has a financial interest in or signature authority over financial accounts in a foreign country where the aggregate value exceeds $10,000, that US person is required to file a Report of Foreign Bank and Financial Accounts (“FBAR,” Form TD F 90-22.1) on or before June 30 of the succeeding year. The potential penalty for an inadvertent failure to file is $10,000; a wilful failure could cost as much as $100,000. In the 2000 version of the FBAR form, the term “United States person” was defined in manner similar to that in the IRC:

United States Person. The term "United States person" means (1) a citizen or resident of the United States, (2) a domestic partnership, (3) a domestic corporation, or (4) a domestic estate or trust.2

In October of 2008, the IRS released a revised FBAR form and accompanying instructions. In the 2008 version, the definition of US persons was expanded to include foreign persons who were doing business in the US. For example, under that definition, a Canadian salesperson from Calgary who goes to Texas once a month to, say, sell oil pumps, would probably be required to report each of his/her personal Canadian bank accounts to the US government. This revised definition caused panic for some Canadians.

On June 5, 2009, the IRS admitted that it “received a number of questions and comments from the public concerning the new filing requirement.”3 It temporarily suspended reporting requirements for those persons who were not US citizens, residents, or domestic entities for the FBARs due on June 30, 2009, and directed the public to rely on the prior (2000) FBAR definition of a US person. Now, the Canadian salesperson in the previous example had a reprieve from the FBAR reporting, but only for the 2008 reporting year.

On February 28, 2010, the IRS published two documents that attempted to further clarify the confusion over its 2008 FBAR form. First, in IRS Announcement 2010-16 (Feb. 28, 2010), it continued its suspension of a filing requirement for non-US citizens, residents or entities, and expanded the suspension to FBARs which would otherwise have been required to be filed for the 2009 and earlier years. Second, the IRS published IRS Notice 2010-23(Feb. 28, 2010) that changed its rules for some filers with signatory authority and some people with foreign hedge funds or private equity funds. The Notice temporarily suspended reporting requirements for persons who have signature authority over, but no financial interest in, foreign accounts until June 30, 2011. Note that the temporary suspension for the signature authority only covers those persons who do not have any other interest in foreign accounts. The Notice also provided relief for persons with an interest in or signature authority over foreign hedge funds or private equity funds. Relief was not extended to persons with interests in foreign mutual funds.

The end result of this additional IRS guidance issued in 2010 is that foreign persons who are not US citizens residents or domestic entities are generally not required to file an FBAR form. This is generally great news for Canadians! Additionally, US persons with interests in foreign hedge funds or foreign private equity funds are not required to report such interests to the US Government. US persons who hold separate interests, joint interests or signature authority over foreign financial accounts (so long as that is not their only foreign account) are still required to deliver Form TD F 90-22.1 to the US Treasury by June 30, 2010. To determine whether you have a reporting requirement under FBAR, feel free to contact our US tax group.

1 31 USC §§5311–5331.
2 IRS Announcement 2010-16 (Feb. 28, 2010) (quoting the July 2000 version of the FBAR instructions).
3 IRS Announcement 2009-51 (June 5, 2009).

2010 Federal Budget

Kim G C Moody — Fri, 05 Mar 2010 12:11:42 -0700

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.

New Tax Legislation - Employee Life and Health Trusts and Olympics

Kim G C Moody — Mon, 01 Mar 2010 15:11:25 -0700

First off, what an Olympics! As a proud Canadian, yesterday will certainly go down in the memory banks as one of the most significant days in Canadian sports history. Vancouver did an amazing job hosting the Olympics and did Canada proud. Of course, many of us were interested in the Canadian men's hockey team result and watching the game was a "pins and needles" exercise but when Sidney Crosby scored the overtime goal what a rush of excitement! Oh Canada!!

Two weeks ago, I was fortunate to attend the Olympics and watch three hockey games. What a fascinating experience to walk the streets of Vancouver and soak in the atmosphere and watch excellent hockey. Like my recent trip to Vancouver to watch AC/DC, one could not help but think about tax.

With the many countries in attendance, I sat in the audience and thought about all the different international tax jurisdictions that were at play. How were the Olympic athletes being taxed? Was Canada going to tax such international athlete's income? (The answer to the latter question is "generally no" given that various technical amendments were added to the Income Tax Act - see, for example subsection 115(2.3) that exempts the international athlete's income earned during the Olympics).

Notwithstanding, the Vancouver Olympics was certainly an eye opener and a very good lesson that the world is small, constantly changing and the tax implications of earning income around the world are extremely complex!

In Canada, income tax law is also changing quickly. This week will be significant in that the Federal Budget will be released on March 4. In addition, on Friday, February 26, 2010, the Department of Finance released new tax proposals to accommodate Employee Life and Health Trusts ("ELHTs").

The proposals (which, if passed, will apply for 2010 forward) create a new type of taxable inter-vivos trust that will enable funds to be accumulated within the ELHT by employer contributions for the benefit of employees' health benefits.

To re-emphasize, the new trust would be a taxable trust which would need to meet very specific requirements with respect to the types of beneficiaries (generally employees, but "key employees" like shareholders need to be carefully considered).

Generally, subject to specific rules, the contributions by an employer to an ELHT will be deductible to the employer. Again, very generally, the new proposals enable that any distributions of income to the employee beneficiaries of the ELHT will also be deductible to the trust including amounts that, prior to these previous proposals, would not have been deductible to the trust (such as reimbursements to employees) under existing law.

While the new proposals for ELHTs appear to be positive, our firm will continue to study the new material but I query whether or not such proposals are intended to replace "health and welfare trusts" (that are not defined in the Income Tax Act but the CRA's administrative comments on health and welfare trusts are laid out in Interpretation Bulletin IT-85R2). Will IT-85R2 eventually be withdrawn by the CRA?

As stated, this is an interesting new set of proposals which we will continue to keep you up-to-date on. Stay tuned.

Bill 53 Proclaimed!

Jeff Hlynski — Fri, 19 Feb 2010 09:51:03 -0700

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.

2010 Alberta Budget, Supreme Court to Hear New GAAR Decision and Other Tidbits

Kim G C Moody — Wed, 10 Feb 2010 15:45:07 -0700

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!!

Interest Deductibility under the Canadian Income Tax Act: Meaning of "payable in respect of the year"

Marissa Halil — Tue, 02 Feb 2010 09:13:01 -0700

In the recent decision of Collins v. The Queen, 2010 FCA 12, the Federal Court of Appeal clarifies the meaning of "an amount payable in respect of the year" - one of the requirements for interest deductibility under paragraph 20(1)(c) of the Income Tax Act (the "Act").

Specifically, in order for interest to be deductible under paragraph 20(1)(c) of the Act, there must be:

(i) an amount paid or payable in respect of the year

(ii) pursuant to a legal obligation to pay interest

(iii) on borrowed money used for the purpose of earning income from a business or property

According to the Federal Court of Appeal, "payable in respect of the year" does NOT mean "due in the year", or "required to be paid in the year".

Interest is considered "payable in respect of the year" where it is properly accrued in the year, even though the full amount of interest was not required to be paid in the year of accrual, but rather, was required to be paid in a subsequent year.

Collins v. The Queen, reversing an earlier decision by the Tax Court of Canada, represents a good win for the taxpayer.

Things are a' Happening!

Kim G C Moody — Thu, 14 Jan 2010 17:04:20 -0700

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.

The Queen v. Remai - A New Take on "Arm's Length"

Marissa Halil — Wed, 23 Dec 2009 11:54:59 -0700

The Federal Court of Appeal has recently confirmed that a taxpayer and a company controlled by the taxpayer’s nephew are considered to “act at arm’s length” in a transaction where the nephew’s company purchases promissory notes from a charity controlled by the taxpayer only to help the taxpayer solve a tax problem.

The Queen v. Remai 2009 FCA 340 involved a charitable donation plan in which the taxpayer, Frank Remai, endorsed $15M worth of notes payable to him from FRM, his wholly-owned company, to the Frank and Ellen Remai Foundation, a charitable Foundation which Frank controlled. Unbeknownst to the taxpayer, such plans had already been shut down in 1997 with the enactment of paragraphs 118.1(13)(a) and 118.1(18)(a) of the Income Tax Act (the “Act”).

These paragraphs made gifts of “non qualifying securities” ineligible for the charitable tax credit. Once the taxpayer realized he could not claim the credit, he attempted to rectify the problem by falling under the relieving provision of paragraph 118.1(13)(c) of the Act. (Under paragraph 118.1(13)(c), a non-qualifying security ceases to be “non-qualifying” if the charity sells the gifted security to a third person with whom the donor deals at arm’s length.)

Accordingly, the Foundation sold the notes for their face amount to Sweet, a company that was controlled by Frank’s nephew. Frank then claimed the charitable donation credit on the assumption that the notes were no longer “non-qualifying” within the meaning of 118.1(13)(c).

The Minister disallowed the charitable donation credit, and the taxpayer’s estate appealed to the Tax Court of Canada, where it was held that the taxpayer properly claimed the charitable donation credit. The Minister then appealed to the Federal Court of Appeal, which examined whether the Tax Court of Canada had properly concluded that the parties were dealing at arm’s length and that the general anti-avoidance rule (“GAAR”) did not apply.

In this case, Frank and Sweet were not related. Thus, paragraph 251(1)(a) — the rule which deems related persons not to be dealing at arm’s length — did not apply. Moreover, as no personal trust was involved, paragraph 251(1)(b) did not apply. The question was how to apply paragraph 251(1)(c), which provides as follows:

(c) where paragraph (b) doesn’t apply, it is a question of fact whether persons not related to each other are at a particular time dealing with each other at arm’s length.

The trial judge interpreted paragraph 251(1)(c) as being applicable when only paragraph 251(1)(b) was not. In other words, he assumed that paragraph (c) could not apply if both paragraphs (a) and (b) were not applicable. The Federal Court of Appeal rejected his interpretation of 251(1)(c). If paragraph (c) doesn’t apply when paragraphs (a) and (b) don’t apply, when would paragraph (c) ever apply? Parliament cannot be presumed to intend provisions to have no practical application.

On the contrary, a study of the legislative history of the provision revealed that paragraph (c) was intended to apply in cases not covered by paragraphs (a) and (b). Remai is an interesting example of how the text of a provision plays a lesser role when there is an error or ambiguity in legislative drafting. Indeed, as the Court put it: “the less than perfect drafting of the provision does not warrant an interpretation that makes a nonsense of the subsection and takes no account of its history, purpose, or structure.”

Although the trial judge had decided that paragraph 251(1)(c) was inapplicable, he nonetheless went on to analyze whether Frank and Sweet, though unrelated, were dealing at non arm’s length. In doing so, he considered the test developed under Peter Cundill & Associates Ltd. v. The Queen [1991] 2 CTC 221 for determining whether unrelated parties are acting at arm’s length, namely, whether: (i) there was a common mind directing the bargaining for both parties; (ii) the parties were acting in concert without separate interests; and (iii) one party exercised defacto control over the other.

The trial judge applied the Cundill factors in quite a taxpayer friendly manner, holding that there was no “common mind” directing the bargaining for both parties in this case because Sweet was not directly or indirectly controlled by Frank, and it freely entered into the transaction after considering its own interests. In this regard, the Federal Court of Appeal held the trial judge committed no “palpable and overriding error”, even though the Federal Court of Appeal noted that Frank entirely drove the proposal, the purpose of which was to benefit him and his Foundation, and that there was no bargaining over the terms of the exchange. (The Federal Court of Appeal noted that the standard of “palpable and overriding error” does not warrant interference by an appellate court merely because the appellate court would have reached a different conclusion if it had been the trier of fact.)

In analyzing factor (ii), both the trial judge and the Federal Court agreed that the parties had “separate interests,” given that Frank’s nephew only entered into the transaction after first ensuring that Frank’s company could honor the notes. The conclusion under factor (ii) is frankly a little surprising. Sweet seemed to have nothing to gain in the transaction, and largely entered into it as a favor to Frank. Yet, both levels of court agreed that the fact that Sweet first ensured that it wouldn’t lose the $15M required to help out the taxpayer reflected a “separate interest”.

With respect to factor (iii), the Federal Court of Appeal agreed with the trial judge that while Frank no doubt “exercised a degree of influence” over his nephew given their family relationship and their business connections, this did not amount to defacto control over Sweet. Indeed, Frank and Sweet’s business dealings had been mutually beneficial and Sweet was not entirely dependent on Frank for its business.

Finally, the Federal Court of Appeal held that the trial judge committed no palpable and overriding error in concluding that there had been no abuse under the GAAR. Relying on writings by tax authors, the Federal Court of Appeal held that the purpose of paragraph 118.1(13)(c) and subsection 118.1(18) was to disqualify certain gifts from a charitable tax credit because of the practical difficulty of assessing their fair market value. In this case, the sale price paid by Sweet provided a reliable basis for assessing the fair market value of the notes, and thus, the purpose of the relevant provisions was not frustrated.

The Crown argued that the purpose of the relevant provisions was rather to prevent donors from claiming a charitable credit for the value of a gift when they retained control of the funds from which the gift would be satisfied. While the 1997 Budget appeared to support the position of the Crown, (the budget stated that the new measures would deal with loan-backs which had been used to enable taxpayers to claim tax credits for charitable gifts without having to forego use of the funds), the Federal Court of Appeal rejected the Crown’s position.

The Court was not persuaded that preventing taxpayers from claiming a charitable tax credit where the taxpayer doesn’t forego the use of gifted funds was the purpose of the relied on provisions. In any event, the Court noted that Frank no longer retained control of the gifted funds once the promissory notes were sold to Sweet.

Although surprising in some respects, Remai is a welcome development for taxpayers.

Department of Finance Responds to GST and Financial Services Court Decision

Jeff Hlynski — Wed, 16 Dec 2009 14:02:37 -0700

On December 14, 2009 the Minister of Finance issued a News Release and Backgrounder setting out the Government of Canada’s response to an April 2009 court decision on the application of GST to certain investment management fees.

As you may recall (from our blog of July 6, 2009), the Federal Court of Appeal had ruled in favour of the taxpayer, Canadian Medical Protective Association (“CMPA”), in their bid to have their investment management fees charged to their discretionary investment account considered as a “financial service” and thereby exempt from GST under Schedule V of the Excise Tax Act (the “ETA”).

The Government’s response to that decision was the December 14, 2009 press release; in their words, an effort to “reaffirm the policy intent and provide certainty respecting the GST”. The proposals state that they will “clarify” that “financial services”, as defined for purposes of the ETA, do not include investment management services, in spite of the Appeal Court’s ruling. In addition, they have identified a number of credit management and credit facilitatory services which are also confirmed to not be financial services.

Additional details are available at: http://www.fin.gc.ca/n08/09-115-eng.asp.

It is important to note that these proposals apply not only to services rendered from December 14, 2009 forward, but also to previous transactions where the service provider had originally charged GST. Our understanding of this wording is that if the supplier had originally charged GST and the recipient had applied for a rebate (based on the CMPA case) the rebate will be denied. Also the Canada Revenue Agency has up to the later of one year after these proposals become law and the normal reassessment period under section 298 of the ETA to reassess. An exception exists for any case where a final determination has already been made by the courts.

Draft legislation was not included with the proposals, so complete details are not available. However, such legislation will be introduced at “an early opportunity”.

The CMPA case was of particular interest to the mutual fund industry as they faced the prospect of Ontario’s new 13% HST (beginning July 1, 2010). It would appear, at this time, that the Ontario Government is not prepared to extend an exemption to the mutual fund industry from the extension of the HST to the management fees they incur. The reason this is a concern to our readers across Canada is because the place of supply rules will likely apply to have that 13% tax apply to all mutual funds that are managed in Ontario (which is the vast majority – at least for now!).

We await the release of detailed legislation and will also monitor the HST situation, but for those hoping for a break on the application of the HST to mutual fund investment costs, these legislative proposals clearly indicate the Government is moving in the opposite direction

Resolving Unintended Tax Consequences - Rectification, Rescission and Mistake

Nicolas Baass — Mon, 07 Dec 2009 15:21:05 -0700

Income tax is complicated. As such, mistakes in transactions are liable to occur from time to time, especially when professional advisors do not consult tax specialists prior to undertaking transactions.

The Court of Queen's Bench of Alberta ("QBA") has added another arrow to taxpayers' quivers when mistakes lead to unintended tax consequences. In Stone's Jewellery Ltd. v. Arora 2009 ABQB 656, a well thought out and structured judgment by Madam Justice Strekaf, the taxpayer sought an order to rectify or rescind two transactions involving the transfer of land that resulted in the unanticipated assessment of more than $6 million in taxes. The Canada Revenue Agency ("CRA") opposed the taxpayer's action.

The facts in this case are as follows: Ashok Arora and Saroj Arora (the "Aroras") - were directors and shareholders of Stone's Jewellery Ltd. ("Stone's"). In 1996 Stone's entered into a real estate purchase agreement and a caveat against the land was filed on Stone's behalf. The purchase transaction did not close until 2004, (the "2004 transfer") by which time the land's value had substantially increased. At the time of closing and, based on advice from their lawyer and accountant, the Aroras registered the land in their personal names instead of Stone's. This was done in an attempt to shield Stone's assets from any potential creditors that might arise on the development of the land.

In 2006, the land had further increased in value and was then transferred (the "2006 transfer") to an Alberta numbered corporation ("Alberta Ltd."), a corporation wholly-owned by the Aroras. The transfer was to occur on a tax deferred basis pursuant to section 85 of the Income Tax Act (the "Act").

The CRA reassessed Stone's for the 2004 transfer as a disposition of the land to the Aroras. Indeed, the CRA was of the view that Stone's had initially acquired the land. The Aroras were also reassessed on the basis of a shareholder benefit as a result of the appropriation of the land from Stone's. The CRA further reassessed the Aroras for the 2006 transfer on the basis that the land was inventory and thus not "eligible property" and could therefore not be transferred on a tax deferred basis pursuant to section 85.

The Court seems to have been sympathetic to the fact that the transfers were made between siblings and wholly-owned corporations of the siblings. The Court repeatedly points out that the transfers were between the Aroras and wholly-owned corporations, and thus no income was generated to offset the tax arising from the transactions.

In their application to the QBA, the taxpayers submitted that they were entitled to relief based on the principles of rectification, mistake (both at common law and equity), and failure of a condition precedent. The CRA contested the application on the basis that rescission should not be granted where other legal remedies are available and where a taxpayer seeks to effect retroactive tax planning.

The taxpayers first argued that the transfer of land was conditional on no adverse tax consequences occurring. As such there was failure of a condition precedent and thus no transaction ever took place. The Court swiftly dealt with this issue by stating that lack of tax consequences was not a true condition precedent.

The Court then examined both the doctrine of equitable rectification and common law and equitable mistake. The Court also proceeded with an in-depth examination of the two leading tax cases on the issue of rectification: 771225 Ontario Inc. v. Bramco Holdings Co. Ltd. (1995), 21 O.R. (3d) 739 (C.A.) and Attorney General of Canada v. Juliar (A.G.) (2001), 50 O.R. (3d) 728 (C.A.).

The Court first examines the 2006 transfer. Based on the evidence presented to the Court, Madame Justice Strekaf concludes that the transaction was undertaken on the mistaken belief, by all the parties, that it could be done on a tax deferred basis pursuant to section 85 of the Act.

Justice Strekaf notes that rectification is not the proper form of relief in the case at hand as "[t]he Court does not have the power to direct that the 2006 Transfer proceed on a tax free basis pursuant to section 85 of the Income Tax Act in accordance with the parties' intentions."

The Court concludes that if relief can be obtained it must be obtained either by a declaration that the transaction is void ab initio at common law or rescinded in equity as a result of the mistake made by the parties in respect of the transaction.

The Court summarizes the doctrine of common law mistake as follows:

At common law, a distinction was drawn between a mistake that constituted an error which went to the identity of the contract and caused the contracting party to obtain something other than what they had intended and a lesser error where the contracting party obtained what they had intended but it turned out to be less valuable. Only the former was considered to be a fundamental mistake which went to the root of the contract, or the intention to contract, so as to render the contract void ab initio. Any lesser mistake that went only to the motivation to contract or to questions of quality would only give rise to damages.

The Court concludes that the ineligibility of the land for the section 85 rollover constitutes a "fundamental mistake that went to the root of the contract." As such the 2006 transfer was void ab initio at common law.

The Court continues its analysis by stating that even if it had not found the contract void at common law, it would have exercised its equitable discretion to rescind the transfer agreement because:

(a) the mistake was to the effect of the transaction itself and not merely as to its consequence or the advantage to be gained by entering into the transaction;

(b) there is no alternate adequate legal remedy available. On this point it is interesting to note that the CRA's contention that the taxpayers could appeal the assessment was rejected by the Court because "if the taxes claimed by CRA are properly owing unless the transaction is rescinded, how can appealing the assessment ever provide an adequate legal remedy to address the problems created by the transaction?";

(c) rescission of the transfer does not result in retroactive tax planning. In this respect the Court distinguishes the case of Bramco in which the Ontario Court of Appeal declined to provide equitable relief on the basis that "...courts do not look with favour upon attempts to rewrite history in order to obtain more favourable tax treatment". The Court points to the Juliar decision as evidence that given the proper circumstances courts may exercise their equitable discretion to offer relief in tax cases; and

(d) granting equitable relief did not prejudice third parties in this case.

The Court also examined the 2004 transfer in light of the same criteria. The Court also found that the 2004 transfer was void ab initio at common law, but that it would have applied its equitable discretion to rescind the transfer had common law not applied.

As a result of the above, both the 2004 and 2006 transfers were declared void ab initio by the Court, with the result that the land remained registered in the name of Stone's. Presumably, as the Court found the transaction to never have occurred, there was no transaction on which the taxpayers could be taxed.

This decision is good news for taxpayers who are caught in the unenviable situation of having to remedy unforeseen tax consequences. While the Juliar decision allowed a taxpayer to rectify a transaction, the doctrine of mistake, as explained in this case, provides more flexibility in restoring the parties to the situation that existed pre-transaction. Indeed, in this case rectification could not have saved the taxpayer from more than $6 million of tax liability.

To Bonus, Or Not To Bonus, That Is Still The Question

Faizal Valli — Mon, 30 Nov 2009 11:30:00 -0700

For many years, accountants for Canadian-controlled private corporations ("CCPCs") have followed the old adage of advising their clients to "bonus down" to the Small Business Limit (the amount of active business income earned in Canada that is subject to the lowest corporate tax rate), as it generally provided the owner-manager/shareholder with higher after-tax cash than the alternative of paying tax in the corporation, and then ultimately paying dividends to the owner-manager/shareholder.

This is because corporate income subject to the general tax rate was poorly integrated when such income was eventually paid as a dividend to the owner-manager/shareholder.

Table 1 roughly displays the lack of integration for a corporation earning $1,000,000 of taxable income in the late 1990's.

Table 1 - Approximate 1990's Example

With the introduction of the eligible dividend regime effective January 1, 2006, tax integration for high rate corporate income has greatly improved. Table 2 provides an illustration of tax integration for an Alberta based CCPC with $1,000,000 of taxable income.

The first option in each year displayed is to pay a bonus of $500,000 down to the Small Business Limit (which is now $500,000 effective January 1, 2009) and extract the remaining surplus out as a non-eligible dividend.

The second option in each year displayed is not to pay a bonus, but rather subject the corporate income to the lower rate of tax on the first $500,000 of corporate profits and the high rate of corporate tax on the next $500,000. The after-tax corporate surplus would then be extracted using a combination of non-eligible dividends and eligible dividends.

As illustrated, the total after tax cash is only $3,600 to $4,100 higher between 2009 and 2012 for the Bonus option versus the No Bonus option. Accordingly, one could say that for Alberta based CCPCs, the tax system is now essentially integrated. (Note that the general corporate tax rate for Alberta corporations is declining for every year from 2009 to settle at 25% in 2012. Similarly, the personal tax rate for Alberta resident individuals on eligible dividends is increasing every year from 2010 to settle at 19.29% in 2012).

Click here for Table 2.

What if the owner-manager/shareholder has no immediate need for funds? Some practitioners have suggested to us that bonusing down to the Small Business Limit still provides higher after-tax cash than retaining such cash in the corporation. We decided to test this strategy in the following example illustrated in Table 3. Again, suppose a CCPC has $1,000,000 of taxable income, and the owner-manager/shareholder has no immediate need for funds. In this case, the two options are as follows:

1. Pay a bonus of $500,000 down to the Small Business Limit and retain the remaining after-tax corporate income within the corporation. In this case, the owner-manager/shareholder will have some after-tax cash in their hands personally.

2. The second option is to retain the income in the corporation, i.e. not to pay a bonus or a dividend.

In order to compare apples to apples, let's further assume that the corporate retained earnings in both options above are paid out in 2012 by way of a dividend (2012 was purposely selected as the year to withdraw the corporate surplus since this will be the year, as mentioned above, that the eligible dividend rate is settling at its highest rate of 19.29% - an increase of approximately 5% from the 2009 rate of 14.55%).

Click here for Table 3.

As Table 3 illustrates, the cumulative after-tax cash is approximately $50,000 higher in the bonus option, or about 2%. In addition, under option 2, the lower eligible dividend rates from 2009 to 2011 are foregone in favor of retaining funds within the corporation.

However, under option 1, the bonus payment in 2009 to 2012 results in a "prepayment" of tax. In other words, under option 1, the owner-manager/shareholder is prepaying taxes of about $50,000 to $70,000 in each of 2009 to 2012, in order to save $50,000 in taxes in 2012 when the accumulated surplus is paid out.

To elaborate, the first $500,000 of taxable income is subject to the small business tax rate under both option 1 and 2. If the next $500,000 is paid out as a bonus in 2009, it would be subject to a 39% personal tax rate in Alberta. However, if this $500,000 is retained (and therefore taxed) in the corporation, it would be subject to a 29% general corporate tax rate in 2009. Therefore, there is a $50,000 "prepayment" of tax in the bonus option, or 10% of $500,000.

To put it another way, if the $500,000 is retained in the corporation, there is a tax deferral of 10% until such funds are eventually paid to the owner-manager/shareholder (by way of a dividend). This tax deferral increases steadily to 14% by 2012 when the general corporate tax rate declines to 25%. This deferral of tax is significant and our analysis, of course, ignores the time value of money and the rate of return that could be earned on the deferred tax.

The decision to bonus or not will ultimately depend on whether the owner-manager/shareholder needs funds personally. If the answer is "no" then there is a very compelling argument to not bonus. Of course, not bonusing will come with some cons (such as increased corporate income tax installments and increased cash in the company) but such cons can be easily dealt with by way of good cash management and additional planning. CCPCs that also rely on refundable SR&ED tax credits should be careful about paying high rate corporate tax since this may reduce their refundable tax credits. In addition, Alternative Minimum Tax ("AMT") should always be considered when paying out dividends. With regards to both Option 1 and 2 in Table 3, there is no AMT payable in 2012 when the accumulated earnings are paid out.

Bill 53 Receives Royal Assent! - Lunch Seminars on New Tax Planning Opportunities

Roberto Domagas — Thu, 26 Nov 2009 17:17:47 -0700

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.