19 September 2020 IFA Roundtable - Official Response

Q.1 - Relevant currency for purposes of filing form T2057 when parties have different tax reporting currencies

Where a taxpayer transfers property to another corporation on a tax-deferred basis pursuant to section 85, form T2057 must be jointly filed by the transferor and the transferee.

The transfer will have implications for both parties’ Canadian tax results (CTR), as that term is defined in subsection 261(1), though the impact on the transferee’s CTR will be prospective only.

Where the two parties have different tax reporting currencies, within the meaning of subsection 261(1), can the CRA confirm that the amounts to be reported on form T2057 should be denominated in the transferor’s elected functional currency?

Official Response

Where section 85 of the Act applies in respect of a property transferred by a transferor that has a tax reporting currency (as defined in subsection 261(1) of the Act) different from that of the transferee, the CRA requires that two separate form T2057 be filed.

The amounts reported must be denominated in the transferor’s tax reporting currency on the first form T2057 and in the transferee’s tax reporting currency on the second form T2057. The potential application of subsection 261(18) of the Act could be considered based on the facts and circumstances of the asset transfers.

Subsection 261(18) of the Act employs a principal purpose test that will be met if “one of the main purposes of the transfer or of any portion of a series of transactions or events that includes the transfer is to change, or to enable the changing of, the currency in which the Canadian tax results in respect of the property, or property substituted for it, for a taxation year would otherwise be determined”. The subsection then further provides that, even if the principal purpose test is met, it will only apply if the Minister so directs.

One of the objectives of subsection 261(18) of the Act is to protect the integrity of the restriction provided in subsection 261(3) of the Act that permits a corporation to make only one functional currency election (e.g. once a corporation elects to report in USD, it cannot then subsequently elect to report in Euro or revert to CAD reporting and then elect USD again). The first scenario of example 3 in paragraph 1.69 of the Folio S5-F4-C1 – Income Tax Reporting Currency (Feb. 27, 2019) provides an example of a situation where subsection 261(18) of the Act might be applicable. Example 3 of the Folio can be found online at Folio S5-F4-C1.

Q.2 - Withholding tax on mismatched swap payments

A Canadian resident taxpayer (Canco) enters into a Swap Agreement (Swap Agreement) with a non-arm’s length non-resident company (NRco). Payments under the Swap Agreement are made by Canco to NRco annually, while NRco makes its payments to Canco quarterly.

The position expressed in Question 60 at the 1984 CTF Roundtable suggests that, in cases where swap payments are not made contemporaneously, as in the example above, withholding tax may apply to a portion of the outbound payments that represents an interest element.

Does this continue to be CRA’s position?

Official Response

As expressed in many documents, the CRA considers that all amounts payable or receivable under the terms of a swap agreement are on account of income and are deductible or included under section 9 of the Act. This is based on CRA’s longstanding view that payments under a swap agreement do not have any specific character for legal purposes; that is, at law, swap payments are not interest, dividends, rent, royalties, payments for any services or proceeds of disposition, nor do they represent a substitute for a legal obligation to pay such amounts.

In order for withholding tax to apply to the interest component of a swap payment, the legal character of the amount paid by Canco to NRco must be recharacterized as interest for tax purposes. Whether the legal character of an amount paid or received by a taxpayer can be recharacterized for tax purposes was addressed by the Supreme Court of Canada in Shell Canada Ltd v the Queen, [1999] 3 S.C.R. 622 (SCC). In that case, the Court observed that absent a specific provision of the Act to the contrary, or a finding of a sham, the taxpayer’s legal relationships must be respected in tax cases. Applying this principle, it is our view that, generally, withholding tax would not apply in the example described above, absent a finding of a sham or the application of a specific provision of the Act such as section 245 or section 247.

Q.3 - Draft IC71-17R6, Paragraph 43

We understand that Information Circular IC71- 17R5 Guidance on Competent Authority Assistance Under Canada’s Tax Conventions is currently being revised. In paragraph 43 of this revised draft information circular, it is stated that paragraph 247(2)(b) is one of the “anti-avoidance provisions of the Act”. Could the CRA elaborate further on its views with respect to this position?

In addition, in the case where paragraph 247(2)(b) is applied to (re)assess, does the CRA intend to restrict a taxpayer’s right to access the Mutual Agreement Procedure (MAP) provision of the pertinent international tax treaty? If so, would the CRA be willing to provide further details regarding this position?

Official Response

The revisions to IC71-17 have not yet been finalized so no definitive comments can be provided at this time. We can confirm that paragraph 43 of the draft revised IC circulated for consultation is intended to reflect the same position as currently exists in paragraph 27 of IC71-17R5 and reflects existing Competent Authority practice. The draft revision only proposes to expand on the existing position by adding examples of particular anti-avoidance provisions of the Income Tax Act (Act).

The CRA considers that paragraph 247(2)(b) of the Act is part of Canada’s anti-avoidance provisions. As with other cases involving the application of Canadian anti-avoidance provisions, the Canadian Competent Authority will not deny requests under the MAP provisions of an international tax treaty where the (re)assessment relies on paragraph 247(2)(b) of the Act and will accept them using the same criteria as any other MAP request. For those cases where the (re)assessment relies on an anti-avoidance provision of the Act as the primary assessing position, such as section 245 or paragraph 247(2)(b) of the Act, the Canadian Competent Authority will limit itself to forwarding the case to the other competent authority for relief from potential double taxation. Similar to GAAR cases that are reviewed by the GAAR Committee, (re)assessments that rely on paragraph 247(2)(b) of the Act are also subject to a rigorous review process by the Transfer Pricing Review Committee before being made.

Q.4 - Update on COVID-19 Measures - Impact of COVID-19 on CRA Procedures

As CRA and taxpayer offices commence re-opening in a number of provinces, would the CRA be able to provide an update on the following matters?

1. What is the current CRA work situation in connection with the conduct of international audits and requests for foreign based information?
2. How has the CRA been managing both the Advance Pricing Arrangement (APA) and Mutual Agreement Procedure (MAP) requests in the current environment and what is the plan going forward?
3. Has the Transfer Pricing Review Committee (TPRC) been meeting regularly during the COVID- 19 pandemic and what is the plan going forward?
4. As there have been significant domestic and international travel restrictions imposed because of the COVID- 19 pandemic, how has the CRA been managing APA and MAP matters with treaty partners?
5. Where Article 9 of a Treaty provides for an express and specific calendar year limitation for assessing or reassessing tax on certain transfer pricing adjustments (Treaty Based Limitation Periods), how is the CRA addressing issues surrounding impending Treaty-Based Limitation Periods? Have extensions been discussed with treaty partners?

Official Response

a

The CRA has resumed a full range of audit work and continues to adapt its practices to reflect the health and economic impacts of COVID-19.

The International and Large Business programs were identified as critical services on the CRA’s Business Continuity Plan in early June, at which time we began bringing these programs online to resume somewhat regular compliance activities.

On September 17, 2020 the CRA launched its National Business Resumption Plan – September 17, 2020 to detail the stages of the resumption of various program and corporate activities and operations that had not resumed during the CRA’s critical services phase under the Business Continuity Plan.

Priority continues to be given to actions that are beneficial to the taxpayer or where taxpayers have indicated there is an urgency to advancing their audit. In prioritizing the resumption, focus is placed on higher dollar audits first, audits close to completion, and those with a strategic importance to the Government of Canada, provinces and territories, or our tax treaty partners.

b.

APA and MAP requests are continuing to be received and being worked on.

APA pre-file meetings are now occurring virtually through teleconference, with the possibility of videoconferencing in the future.

Time limits for mandatory arbitration have not changed as communications and negotiations with foreign tax administrations continue to occur through the same virtual means.

c.

Yes, the TPRC has been meeting regularly throughout the COVID-19 pandemic. There have been no delays in scheduling the monthly meetings nor in the decision making process. The meetings have been held via secured government teleconference phone lines to ensure that all protected information is discussed in a secure environment. The plan is to continue with these virtual meetings until it is determined that TPRC members are able to physically return to the office.

d.

The CRA developed a webpage on Canada.ca to provide guidance on international income tax issues raised by the COVID-19 crisis.

This webpage describes many potential issues, including Income Tax Residency; Carrying on business in Canada/permanent establishment; Cross-border employment income; Waiver Requests – Payments to non-residents for services provided in Canada; Disposition of taxable Canadian property by non-residents of Canada; and Non-Resident Employer Certification and outlines the CRA's approach to address each of them.

The administrative approach taken by the CRA in addressing these issues is intended to assist taxpayers during this time of crisis. It does not represent any interpretive position or intention to establish any broader policy by the CRA.

The CRA is continuing the communications with all treaty partners as necessary. Any sensitive correspondence and submissions to treaty partners are being sent/received through protected secure mailboxes. Regular discussions and negotiations at individual level and team level are taking place virtually through phone calls and teleconferences. The CRA has also introduced the possibility of videoconferencing communications through Cisco WebEx on a limited basis in an effort to move forward the cases. Additionally, functional interviews for APAs are also being conducted virtually along with treaty partners.

e.

There is no flexibility to extend Treaty Based Limitation Periods and, wherever possible, we have been meeting those deadlines and reassessing in time. For domestic situations, in the early days of the COVID-19 pandemic, we processed only high risk reassessments. Reassessments that were close to becoming statute barred were generally in that category, particularly for material issues. Whenever there is no treaty statute barred concern, the domestic limitation periods to issue a reassessment set out in section 152 are still relevant, taking into account any extension that may be applicable as a result of the Order made by the Minister of National Revenue on August 31, 2020 pursuant to subsections 7(1) and (5) of the Time Limits and Other Periods Act (COVID 19). Where more time is required for issues to be considered due to challenges arising from COVID-19, taxpayers are invited to provide waivers as needed.

Q.5 - Transfer Pricing Memorandum TPM-17 and COVID-19

According to CRA’s Transfer Pricing Memorandum on the impact of government assistance on transfer pricing (TPM- 17), the cost base should not be reduced by the amount of government assistance received unless there is reliable evidence that arm’s length parties would have done so given the specific facts and circumstances. It is presumed that the Canadian taxpayer will keep the government assistance, unless it can be proven that arm’s length enterprises would effectively share all or part of that assistance.

What are the CRA’s views on the impact and treatment of the COVID- 19 related government assistance programs in the context of TPM- 17, and whether CRA’s position may in any way be different given the unprecedented business circumstances caused by the pandemic (i.e. what sort of market evidence would CRA expect to see if the taxpayer decides to offset costs against the COVID- 19 government assistance received in determining the final transfer pricing charge)?

Official Response

The purpose of the TPM-17 is “to provide guidance on the impact and treatment of government assistance in the context of a transfer pricing analysis” to ensure that when a cost-based method is being used as a proxy for observing an arm’s length price for goods or services in a related party cross border transaction, any government assistance is properly accounted for in determining the transfer prices. Where government assistance has been received that assists in paying some of the costs of either labor or capital items (depending on the relevant cost base), that assistance will not usually be used to reduce the cost base for the purpose of determining the value provided by the party in the transaction.

The COVID-19 related government assistance is a temporary emergency measure implemented to support Canadians and Canadian businesses facing hardship as a result of the global COVID-19 outbreak. Given the nature of the assistance and circumstances under which it is provided, it is unlikely that market evidence would exist to support that arm’s length enterprises would effectively share all or part of this this type of emergency assistance. Accordingly, COVID-19 related government assistance would be expected to form part of the tax base of the recipients.

The example below illustrates how the Canada emergency wage subsidy (CEWS) should be treated for transfer pricing purposes.

A Canadian subsidiary (CanCo) of a multinational group provides services in Canada to a foreign affiliated company (ForCo). CanCo’s business and its employees are affected by the global COVID-19 outbreak and qualify for CEWS, a temporary emergency measure implemented to support Canadians and Canadian businesses facing hardship. The purpose of the CEWS is to encourage Canadian employers who are facing economic hardship to retain employees who are still on the payroll and re-hire workers previously laid off as a result of COVID-19 and thereby help employers to more easily resume normal operations following the crisis. CEWS assists workers to keep their jobs by preventing further job losses so they can continue to pay their bills and provide for their families during the emergency period.

The transfer price between CanCo and ForCo applies a 10% mark-up [1] to CanCo's costs incurred to perform the services. CanCo incurs salary costs of $60 and other costs of $40. CanCo is eligible for the CEWS and receives an emergency wage subsidy of $10.

Appropriate transfer pricing treatment of the CEWS

In this example, the transfer price to ForCo is correctly calculated where the cost base ($100) is not reduced by the CEWS ($10).

Appropriate transfer pricing treatment of the CEWS
Transfer price calculation		CanCo income statement
Salary costs	$60	Revenue (transfer price to ForCo)		$110
Other costs	$40	Salary costs	$60
Tota costs	$100	CEWS	($10)
Add 10% mark-up	$10	Other costs	$40
Transfer price to ForCo	$110	Total costs		$90
		Net income		$20

In this example, the transfer price to ForCo is incorrectly calculated where the cost base ($100) is reduced by the CEWS ($10). The CEWS does not reduce the cost base for the purpose of calculating the transfer price

Inappropriate transfer pricing treatment of the CEWS
Transfer price calculation		CanCo income statement
Salary costs	$60	Revenue (transfer price to ForCo)		$99
Less: (CEWS)	($10)	Salary costs	$60
Other costs	$40	CEWS	($10)
Tota costs	$90	Other costs	$40
Add 10% mark-up	$9	Total costs		$90
Transfer price to ForCo	$99	Net income		$9

Q.6 – Subsection 212.3(9) and the GAAR

At all relevant times, a non-resident corporation (NRco) owns all the common shares of a corporation resident in Canada (Canco), which shares are the only issued and outstanding shares of Canco.

After March 28, 2012, Canco acquires all the shares of the capital stock of a non-resident corporation (FA1) for $100.

This is an investment by Canco described in paragraph 212.3(10)(a), such that the combined application of subsection 212.3(2) and 212.3(7) requires the reduction of the paid-up capital (PUC) on the common shares of Canco by $100.

At a subsequent time, the following series of transactions is implemented:

1. New FA2 is incorporated under the laws of a foreign jurisdiction and Canco subscribes for 100 common shares of New FA2 for a nominal amount. This is an investment by Canco described in paragraph 212.3(10)(a), such that subsection 212.3(7) requires the PUC of the common shares of Canco to be reduced by a nominal amount.
2. New FA2 borrows $100 on a daylight basis (Daylight Loan) from an arm’s length third party.
3. New FA3 is incorporated under the laws of a foreign jurisdiction. Using the proceeds of the Daylight Loan, New FA2 subscribes for 100 common shares of New FA3 for $100, such that New FA3 is at that time a wholly-owned subsidiary of New FA2.
4. FA1 acquires the common shares of New FA3 from New FA2 in consideration for a promissory note in the amount of $100.
5. FA1 makes an in-kind return of capital on its common shares held by Canco by transferring to Canco the common shares of New FA3. This acquisition of the New FA3 shares is an investment by Canco described in paragraph 212.3(10)(a) that is not subject to subsection 212.3(2) in application of subparagraph 212.3(18)(b)(vii).
6. Canco contributes the common shares of New FA3 to New FA2 in consideration for additional common shares of New FA2, such that subsection 85.1(3) applies to this transfer of shares. This is an investment by Canco described in paragraph 212.3(10)(a) that is not subject to subsection 212.3(2) in application of subparagraph 212.3(18)(b)(ii).
7. New FA3 is liquidated into New FA2.
8. New FA2 repays the Daylight Loan using the proceeds received on the liquidation of New FA3.

Does the CRA agree that the in-kind return of capital in step 5 would give rise to a $100 reinstatement of the PUC on the common shares of Canco in application of subsection 212.3(9)? If so, assuming that one or more of the steps that are part of the series of transactions is an avoidance transaction, would the CRA be of the view that they would reasonably be considered to result in a misuse or abuse of the provisions of the Act such that subsection 245(2) would be applicable?

Official Response

The $100 in-kind return of capital described in step v) above is a circumstance described in clause B of element A of the formula in subparagraph 212.3(9)(b)(ii) and as such, would arguably result in a reinstatement of the PUC on the common shares of Canco that was reduced by subsections 212.3(2) and 212.3(7) on the acquisition by Canco of all the shares of the capital stock of FA1.

The CRA is of the view that the series of transactions described above results directly or indirectly in a misuse or abuse of the scheme of section 212.3 in general and paragraph 212.3(9) in particular.

Q.7 (IFA Q. 3 – IFA provided) - Regulation 5901(2)(b) Pre-Acquisition Surplus Election

Provided that the requirements of paragraph 5901(2)(b) of the Income Tax Regulations (Regulations) are met, an election (Regulation 5901(2)(b) election) may be filed by a corporation resident in Canada to “side step” the normal surplus ordering rules and treat a particular dividend paid by a foreign affiliate of that corporation as having been paid out of the pre-acquisition surplus of the affiliate in respect of the corporation. One of the requirements, as provided for in subparagraph 5901(2)(b)(ii) of the Regulations, is that no shareholder of the affiliate is, at the time of the dividend, a partnership a member of which is either “a” corporation that would, in the absence of subparagraph 5901(2)(b)(ii) of the Regulations, be eligible to elect under subparagraph 5901(2)(b)(i) of the Regulations in respect of the particular dividend, or a foreign affiliate of such a corporation.

A foreign affiliate (FA) of a corporation resident in Canada (Canco1) has issued and outstanding Class A common shares and Class B common shares.

Canco1 owns 100% of the Class A shares and a limited partnership (LP) owns 100% of the Class B shares.

One (or more) of the members of LP is a corporation resident in Canada (Canco2) that has a sufficient partnership interest in LP, such that FA is considered to be a foreign affiliate of that corporation as defined under subsection 95(1) of the Income Tax Act (Act) for the purposes described in subsection 93.1(1.1) of the Act. None of the members of LP is Canco1, a foreign affiliate of Canco1, or a corporation resident in Canada that is related to Canco1 (or a foreign affiliate of such a corporation).

FA pays a dividend to Canco1 in respect of the Class A shares of FA (Class A dividend) that, absent paragraph 5901(2)(b) of the Regulations, would be deemed under subsection 5901(1) of the Regulations to have been paid out of the exempt surplus, hybrid surplus or taxable surplus of FA in respect of Canco1 and in respect of Canco2.

Canco1 will not make an election under subsection 90(3) of the Act in respect of the Class A dividend.

Canco1 wishes to elect under subparagraph 5901(2)(b)(i) of the Regulations for the Class A dividend to be treated as having been paid out of FA’s pre- acquisition surplus in respect of Canco1.

Is the CRA of the view that the requirement imposed by subparagraph 5901(2)(b)(ii) of the Regulations that no member of LP be eligible to elect under subparagraph 5901(2)(b)(i) of the Regulations would be met in these circumstances such that Canco1 is eligible to make a valid Regulation 5901(2)(b) election in respect of the Class A dividend?

Would the CRA’s view change if FA only had a single class of issued and outstanding shares and paid a dividend to both Canco1 and LP?

Official Response

In the Assumed Facts, whether Canco1 can elect under paragraph 5901(2)(b) of the Regulations in respect of the Class A dividend to deem that dividend to have been paid out of the pre-acquisition surplus of FA in respect of the corporation turns on the interpretation of clause 5901(2)(b)(ii)(A) of the Regulations. In particular, that determination turns on whether Canco2 is a corporation that would, in the absence of subparagraph 5901(2)(b)(ii) of the Regulations, be eligible to make a Regulation 5901(2)(b) election in respect of the Class A dividend.

The interpretation of paragraph 5901(2)(b) of the Regulations needs to be made according to a textual, contextual and purposive analysis to find a meaning that is harmonious with the Act as a whole.

With respect to the Regulation 5901(2)(b) election, the October 24, 2012 Technical Notes issued by the Department of Finance indicate the intention for shareholders to have the ability to access their adjusted cost base (ACB) first:

“This election is meant to allow the shareholders of a foreign affiliate to access their capital first as measured by the adjusted cost base (“ACB”) of the shares rather than a legal notion of paid-up capital.”

If a corporation resident in Canada or its foreign affiliate receives a dividend from a foreign affiliate that is prescribed to be a pre-acquisition surplus dividend in respect of the corporation, the corporation or the recipient affiliate (as the case may be) is required to reduce its ACB of the relevant shares of the foreign affiliate that paid the dividend.

Even though the preamble of paragraph 5901(2)(b) of the Regulations does not specify to whom the “whole dividend” referred to in this paragraph is paid by the foreign affiliate, it is our view that, when paragraph 5901(2)(b) of the Regulations is interpreted based on a contextual and purposive analysis of this provision, the “whole dividend” referred to in the preamble is a reference to a dividend that would cause a consequential ACB adjustment to the shares of the foreign affiliate on which it is paid, if a Regulation 5901(2)(b) election could be made in respect of that dividend.

In the Assumed Facts, if Canco2 was entitled to make a Regulation 5901(2)(b) election in respect of the Class A dividend, there would be no consequential ACB adjustments with respect to Canco2 or LP since neither Canco2 nor LP owns any Class A shares. On that basis, we are of the view that the Class A dividend is not a “whole dividend” as referred to in the preamble of paragraph 5901(2)(b) on which Canco2 would be eligible to make a Regulation 5901(2)(b) election, even in the absence of subparagraph 5901(2)(b)(ii) of the Regulations. As such, with respect to the Class A dividend, the condition of subparagraph 5901(2)(b)(ii) of the Regulations would be met, with the result that Canco1 could make the Regulation 5901(2)(b) election.

Limiting the exclusion in subparagraph 5901(2)(b)(ii) of the Regulations as explained above is, in our view, consistent with the legislative intent of this subparagraph. As indicated in the October 24, 2012 Technical Notes to paragraph 5901(2)(b):

“There are some circumstances in which this new pre-acquisition surplus election is not available. First, because of the special deferred treatment given to pre-acquisition surplus dividends paid on foreign affiliate shares held by a partnership (as per subsections 92(4) to (6) of the Act), this new election is not available where any electing corporation (as described in subparagraph 5901(2)(b)(i)), or a foreign affiliate of such a corporation, is a member of a partnership and that partnership is a shareholder of the dividend-paying foreign affiliate. […]”

We would not reach the same conclusion if the Assumed Facts were changed such that FA only had one class of shares issued and outstanding, and LP owned a portion of those shares and received a portion of the dividend paid by FA. It is our view that in these circumstances Canco2 would, in the absence of subparagraph 5901(2)(b)(ii) of the Regulations, be eligible to make a Regulation 5901(2)(b) election in respect of the dividend. Since Canco2 would be “a corporation” referred to in clause 5901(2)(b)(ii)(A) of the Regulations, it is our view that in these circumstances the condition of clause 5901(2)(b)(ii)(A) would not be met, with the result that neither Canco1 nor Canco2 would be eligible to make a Regulation 5901(2)(b) election.