Under Section 237.4 of the Income Tax Act, the Minister of National Revenue has the authority to designate, with the concurrence of the Minister of Finance, transactions and series of transactions as requiring disclosure by taxpayers, advisers, promoters, and certain other persons.
The transactions and series of transactions set out in these documents are designated for the purposes of that section.
Where a transaction, or a series of transactions, is the same as or substantially similar to a transaction, or a series of transactions, so designated by the Minister of National Revenue, the transaction, or any transaction in the series, is required to be disclosed to the Canada Revenue Agency in prescribed form and manner.
These transactions are referred to as “notifiable transactions”.
For these purposes, any transaction or series of transactions that is expected to obtain the same or similar types of tax consequences and that is either factually similar or based on the same or a similar tax strategy is considered to be substantially similar.
This is to be interpreted broadly in favour of disclosure.
1. Manipulating CCPC status to avoid anti-deferral rules applicable to investment income
The Income Tax Act contains anti-deferral rules the purpose of which is to ensure that individual taxpayers cannot gain a tax advantage by earning investment income through a corporation they control. More specifically:
- portfolio dividends earned by all private corporations are subject to a special refundable tax under Part IV of the Income Tax Act; and
- “other investment income” (e.g., capital gains, interest, rent and royalties) earned by Canadian-controlled private corporations (CCPCs) is generally subject to a special refundable tax mechanism under Part I of the Income Tax Act, which includes a special tax of 10 2/3 per cent under section 123.3, and is also denied the 13 per cent general rate reduction provided for under section 123.4.
The special refundable taxes under Parts I and IV are meant to ensure that immediate taxation of income earned in these corporations is roughly equal to the tax that would be paid if the income were earned directly by the individual.
The special taxes are fully or partially refundable to the corporations to the extent that they distribute their investment income in the form of taxable dividends.
Some taxpayers are engaging in transactions or arrangements regarding private corporations they control, directly or indirectly.
These transactions seek to avoid CCPC status of such corporations – in circumstances where such corporations are or continue to be controlled (directly or indirectly) by Canadian residents (other than a public corporation) – in order to achieve a tax deferral advantage in respect of other investment income.
The transactions generally involve avoiding “Canadian corporation” or “Canadian-controlled” status, either of which could make it such that the corporation would not be a CCPC. The tax consequences sought in these transactions and circumstances are inconsistent with the purpose of the anti-deferral rules.
Designated transactions
The following transactions and series of transactions are hereby designated by the Minister of National Revenue for the purposes of section 237.4 of the Income Tax Act.
Avoiding “Canadian corporation” status
Foreign continuance: A taxpayer’s corporation that holds investment assets, or assets that subsequently become investment assets, and that is initially incorporated in Canada is later continued under the laws of a foreign jurisdiction.
As a result, it ceases to be a CCPC by virtue of it no longer being a “Canadian corporation”.
However, by ensuring that the central management and control of the corporation are exercised in Canada and that subsection 250(5) does not apply, the corporation remains resident in Canada and, as a result, it is not considered to have emigrated and it is not subject to the foreign accrual property income regime.
Avoiding “Canadian-controlled” status
“Skinny” voting shares: On or after incorporation, a corporation that holds or is capitalized with investment assets, or assets that subsequently become investment assets, issues a majority of special voting shares, redeemable for a nominal amount (also known as “skinny” voting shares), to a non-resident person in order to cause the corporation to not be “Canadian-controlled” and, as such, to not be a CCPC.
The non-resident person who owns the voting shares is often (but not necessarily) an entity owned and controlled by Canadian residents.
Alternatively, the skinny voting shares could be issued to a public corporation instead of a non-resident person.
Option to acquire control: A corporation that holds investment assets, or assets that subsequently become investment assets issues an option to a non-resident person for the acquisition of a majority of the voting shares of a corporation in order to cause the corporation to not be “Canadian-controlled” and, as such, to not be a CCPC.
This right to acquire control through the majority of the voting shares is often (but not necessarily) held by a non-resident entity that is owned by Canadian residents or accommodating non-resident persons.
Alternatively, the option to acquire control could be issued to a public corporation instead of a non-resident person.
2. Straddle loss creation transactions using a partnership
Some taxpayers are engaging in financial arrangements that seek to reduce tax by generating artificial losses with the use of complex financial instruments or derivatives.
Tax measures announced in Budget 2017 addressed some of these financial arrangements through specific anti-avoidance rules that targeted certain straddle transactions (basic straddle transactions).
Basic straddle transactions involve two or more financial instrument positions entered into concurrently by a taxpayer, that are expected to generate substantially equal and offsetting gains and losses.
Shortly before taxation year-end, the taxpayer disposes of the position with the accrued loss (the “loss leg”) and realizes the loss.
Shortly after the beginning of the following taxation year, the taxpayer disposes of the offsetting position with the accrued gain (the “gain leg”) and realizes the gain.
The taxpayer claims a deduction in respect of the realized loss against other income in the initial taxation year and defers the recognition of the offsetting gain until the following taxation year.
The taxpayer claims the benefit of the deferral although economically the two positions are offsetting with nominal risk.
Moreover, the taxpayer often attempts to indefinitely defer the recognition of the gain on the gain leg by entering into successive straddle transactions.
The specific anti-avoidance rules announced in Budget 2017 to address straddle transactions are generally designed to suspend the recognition of straddle losses until such time as the offsetting gain is realized.
Nevertheless, the CRA has detected several variant transactions that have emerged using partnerships to attempt to avoid the application of the specific anti-avoidance rules, resulting in tax consequences that are inconsistent with the purpose of the straddle transaction rules.
Designated transactions
The following series of transactions is hereby designated by the Minister of National Revenue for the purposes of section 237.4 of the Income Tax Act.
- A taxpayer enters into an agreement to acquire a partnership interest from an existing partner.
- The partnership trades foreign exchange forward purchase and sale agreements on margin through a foreign exchange trading account.
- The foreign exchange forward agreements are essentially straddle transactions where it is reasonable to conclude that each agreement is held in connection with the other and where, in the aggregate, the individual agreements (legs) will generate substantially equal and offsetting gains and losses.
- Shortly before the taxpayer’s acquisition of the interest in the partnership, the partnership disposes of the gain leg(s) of the foreign exchange forward agreement(s).
- The income from the gain leg(s) is then reflected in the income of the partnership and is allocated to the original partner immediately prior to the acquisition of the interest in the partnership by the taxpayer.
- Following the acquisition of the partnership interest by the taxpayer, the loss leg(s) are realized and a business loss is allocated to the taxpayer.
3. Avoidance of deemed disposal of trust property
Subsection 104(4) of the Income Tax Act sets out what is generally referred to as the “21-year deemed realization rule” for a trust. The purpose of subsection 104(4) is to prevent the use of trusts to defer indefinitely the recognition for tax purposes of gains accruing on certain capital property.
When subsection 104(4) applies, it generally treats capital property of a trust (other than certain trusts for the benefit of the settlor, for a spouse or common-law partner of the settlor, or for their joint benefit) as having been disposed of and reacquired by the trust every 21 years at the property’s fair market value.
In some situations, a transfer of the trust property to the capital beneficiaries on a tax deferred basis pursuant to subsection 107(2), prior to the 21-year deemed realization date, could be used to defer the tax consequences. Corresponding rules to subsection 104(4) for depreciable property are contained in subsection 104(5).
A deferral of the 21-year deemed realization rule is generally not possible when the property is transferred from a trust (the “transferor trust”) to another trust (the “receiving trust”) since subsection 104(5.8) would apply to deem the 21-year anniversary of the receiving trust to occur no later than it would for the transferor trust.
In addition, distributions of a trust’s property (other than property described in any of subparagraphs 128.1(4)(b)(i) to (iii)) to non-resident beneficiaries will be subject to the application of subsections 107(5) and (2.1).
In these circumstances, a rollover under subsection 107(2) is not available and the distributed property will be deemed to be disposed at fair market value.
Some taxpayers are engaging in transactions that seek to avoid or defer the 21-year deemed realization rule or that seek to avoid the rules in subsections 107(5) and (2.1) even though the property continues to be held, directly or indirectly, by a trust or by a non-resident beneficiary.
Designated Transactions
The following transactions and series of transactions are hereby designated by the Minister of National Revenue for the purposes of section 237.4 of the Income Tax Act.
Indirect transfer of trust property to another trust : A Canadian resident trust (“New Trust”) holds shares of a corporation resident in Canada (“Holdco”) that is or will become a beneficiary of another Canadian resident trust (“Old Trust”) that holds property that is capital property or land included in the inventory of a business of Old Trust.
At any time prior to its 21-year anniversary, Old Trust transfers the property to Holdco on a tax deferred basis pursuant to subsection 107(2).
In the result, the 21-year rule will not apply to Old Trust, and a new 21-year period will start to run with respect to New Trust, providing for a much longer period of deferral.
New Trust’s assets will reflect the property formerly held by Old Trust but may have a higher tax basis than such property.
Indirect transfer of trust property to a non-resident: One or more of the non-resident beneficiaries of a Canadian resident trust hold shares of a corporation resident in Canada (“Holdco”) that is or will become a beneficiary of the trust. At any time prior to its 21-year anniversary, the trust transfers property (other than property described in any of subparagraphs 128.1(4)(b)(i) to (iii)) to Holdco on a tax deferred basis pursuant to subsection 107(2).
In the result, the 21-year rule will not apply to the trust, with the transfer of the trust’s property to Holdco providing for a much longer period of deferral.
The non-resident beneficiaries of the trust hold shares of Holdco that reflect their former indirect interest in the property of the trust, possibly providing an opportunity to have such property transferred by Holdco to the non-resident beneficiaries at some future time without triggering the application of subsections 107(2.1) and 107(5).
Transfer of trust value using a dividend: A Canadian resident trust (“New Trust”) holds shares of a corporation (“Holdco”) that is or will become a beneficiary of another Canadian resident trust (“Old Trust”) that holds property that is shares in a Canadian corporation (“Opco”).
At any time prior to Old Trust’s 21-year anniversary, Opco redeems shares held by Old Trust and issues a promissory note or gives cash as consideration.
In so doing, Opco is deemed pursuant to subsection 84(3) to have paid, and Old Trust is deemed to have received, a dividend equal to the amount by which the amount paid by Opco on the redemption exceeds the PUC in respect of the shares.
The deemed dividend is designated by Old Trust and deemed to be received by Holdco pursuant to subsection 104(19).
The dividend is deductible in the hands of Holdco pursuant to subsection 112(1). The cash or the promissory note is paid or made payable in the year by Old Trust to Holdco as payment for the dividend allocated to it.
In the result, the 21-year rule will not apply to Old Trust, and a new 21-year period will start to run for New Trust, providing for a much longer period of deferral. New Trust’s assets will reflect the value of the property formerly held by Old Trust but will undoubtedly have a significantly higher tax basis than such property.
4. Manipulation of bankrupt status to reduce a forgiven amount in respect of a commercial obligation
Sections 80 to 80.04 of the Income Tax Act set out the rules that apply when a commercial debt obligation is (or is deemed to be) settled or extinguished for less than its principal amount or the amount for which it was issued.
These rules are commonly referred to as the debt forgiveness rules and debt parking rules.
When such an obligation is settled or extinguished, it generally gives rise to a “forgiven amount” as defined in subsection 80(1).
The “forgiven amount” at any time is generally equal to the principal amount of the obligation less the amount, if any, paid at the time in satisfaction of the obligation. In certain circumstances, the forgiven amount may be reduced by other amounts.
A forgiven amount in respect of an obligation issued by a debtor is required to be applied against certain tax attributes of the debtor, including loss carryovers, in a specified order, as provided in subsections 80(3)