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Income tax questions for Revenue Canada: December 10, 1996.

December 10, 1996

On December 10, 1996, Tax Executives Institute held its annual liaison meeting with Revenue Canada--Customs, Excise and Taxation on income tax matters. (TEI held a separate meeting on issues relating to the Goods and Services Tax and other commodity tax issues.) The Institute's agenda for the income tax meeting is reprinted below. The agenda was prepared under the aegis of TEI's Canadian Income Tax Committee, whose chair is Alan Wheable of Canada Trust. J.A. (Drew) Glennie of Shell Canada Limited, the Institute's Vice President-Region I, coordinated plans for the liaison meeting

Tax Executives Institute, Inc. welcomes the opportunity to present the following comments and questions on pending income tax issues, which will be discussed with representatives of Revenue Canada--Customs, Excise and Taxation during TEI's December 10, 1996, liaison meeting. If you have any questions in advance of that meeting, please do not hesitate to call either J.A. (Drew) Glennie, TEI's Vice President for Canadian Affairs, at (403) 691-4900 or Alan Wheable, chair of the Institute's Canadian Income Tax Committee, at (519) 663-1623.

Background

Tax Executives Institute is an international organization of approximately 5,000 professionals who are responsible -- in an executive, administrative, or managerial capacity -- for the tax affairs of the corporations and other businesses by which they are employed. TEI's members represent more than 2,700 of the leading corporations in Canada and the United States.

Canadians make up approximately 10 percent of TEI's membership, with our Canadian members belonging to chapters based in Calgary, Montreal, Toronto, and Vancouver, which together make up one of our nine geographic regions. In addition, a substantial number of our U.S. members work for companies with significant Canadian operations. In sum, TEI's membership includes representatives from most major industries, including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial; telecommunications; and natural resources (including timber and integrated oil companies). The comments set forth in this submission reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.

Canada Revenue Commission

We shall be pleased to hear a brief update and progress report on the activities of the Canada Revenue Commission.

Audit Protocol

Commencing with the 1996 liaison meeting and throughout the ensuing year, there have been a number of discussions between representatives of Revenue Canada and business taxpayers concerning the Department's audit protocol initiative. As a part of the consultation process, the Institute submitted formal written comments on the Draft Audit Protocol Reference Manual (hereinafter "the protocol") on September 27, 1996. In order to advance the consultation process and elaborate on the issues raised in our written submission, we invite Revenue Canada's comments concerning the following:

1. The protocol sets forth a framework for managing the audit process on a prospective basis. The speed with which taxpayers and Tax Services Office Auditors alike embrace the cooperative approach envisioned in the protocol, however, may depend upon the resolution of significant, pending audit issues in open taxation years. Has Revenue Canada developed any measures to expedite the resolution of pending audit issues and cases before, or in connection with, the implementation of the audit protocol? For example, the backlog of taxpayer Scientific Research and Experimental Development (SR&ED) claims is significant in scope and magnitude. Is expedited review of these claims envisioned? Are there additional "back-year" issues that may impede the transition to an audit framework governed by the protocol?

2. One underlying purpose of the protocol is to engender greater openness and trust between Revenue Canada and taxpayers. That trust may be undermined where significant decisions affecting the disposition of the taxpayer's case are made without direct input from and representations by the taxpayer. To allay taxpayer concerns, we recommend that instructions be given to Tax Services Offices that the taxpayer be apprised of all issues affecting it that are under study by Revenue Canada. In other words, where the facts, circumstances, or legal interpretations affecting a taxpayer's issues are under study by the Head Office or other branches within Revenue Canada, we recommend that steps be undertaken to assure that (i) the taxpayer is apprised that personnel outside of the Tax Services Office are involved in the taxpayer's case and (ii) the taxpayer's position on the issues is fairly presented to the Revenue Canada decisionmaker by, for example, inviting the taxpayer to make the presentation. We invite the Department's comments.

3. Building a cooperative audit relationship between Revenue Canada and large-file taxpayers will depend in part on the continuity of personnel assigned to the case by the taxpayer and Revenue Canada alike. Consequently, we recommend that Revenue Canada emphasize in its directions to the field offices the importance of assigning staff for a minimum of one complete audit cycle. In addition, we recommend that part of the audit team carryover from one cycle to the next thereby providing continuity. We invite the Department's comments.

4. The Real-Time Audit section of the draft Reference Manual includes statements to the effect that (i) "when a settlement is reached on any agreed issue, the corporation signs a waiver of objection..." and (ii) "each issue filed in accordance with an agreed position...will not be subject to further audit...." Notwithstanding the assurance that the issue will not be subject to further audit, Revenue Canada clearly retains the power to reassess in respect of the issue while the taxpayer is equally clearly precluded by its waiver from changing its position. We believe that the position espoused in the draft significantly diminishes the principal benefit of a real time audit -- certainty of tax liability at the time of filing a return. In addition, the lack of symmetry between taxpayer's and Revenue Canada's ability to reopen issues erodes taxpayer confidence that a protocol represents a consensual arrangement. Specifically, we believe the lack of mutual undertakings in respect of future reassessments is an impediment to the execution of protocol agreements and invite Revenue Canada's comments on whether it will reconsider the matter.

5. In the interest of promoting more efficient audits and the execution of protocols with taxpayers, has Revenue Canada considered encouraging its Tax Service Offices to agree not to pursue reassessments that fall below a de minimis threshold? The magnitude of a de minimis threshold might vary depending on such factors as the size, complexity, and risk profile of the taxpayer entering into the protocol.

Advance Pricing Agreements

Advance Pricing Agreements (APA) represent a substantial innovation in tax administration to minimize disputes about transfer pricing. Consequently, TEI has supported the APA initiative in both Canada and the United States. We are concerned, however, that the time required to complete an APA is so daunting that taxpayers may be discouraged from initiating the process or become frustrated and withdraw from it. We invite Revenue Canada's comments on whether it is satisfied with the time required to complete individual APAs or whether process improvements have been identified to expedite achieving agreements. Are there common errors that taxpayers should avoid in order to expedite processing of their APA requests?

Transfer Pricing

In determining the proper charge for cross-border services rendered by a parent (or other controlled affiliate) to other members of a multinational group of companies, a taxpayer must weigh a number of factors including the value-added by the service, whether the service provider is engaged in providing similar services to third parties in connection with its principal business activities, and whether the costs involved in providing the services are "shared" costs of the corporate group. In addition, where the same service is provided to affiliates conducting business in various countries, the taxpayer must consider whether the charge for the services is determined in a sufficiently uniform fashion to satisfy the multiple competent authorities that may ultimately review the service charges.

In the case of services rendered by a related foreign parent company to a Canadian subsidiary, will Revenue Canada permit the Canadian service recipient a deduction for the amount of a reasonable mark-up over the parent's actual cost of providing the intercompany service charges? In answering the posed question, assume that the parent company (service provider) is not rendering comparable services to third parties, it applies a uniform mark-up on costs for services rendered to all group members, and that the service is not a principal business activity of the provider.

In a case where the service provider is a Canadian-based parent company, will Revenue Canada require the Canadian company to add a reasonable mark-up over the cost of providing services to related foreign subsidiaries in order to establish that the charge is a proper arm's-length charge?

Auditor General's Report

The Auditor General issued a report recently concerning the advance ruling process. TEI is concerned that the report may diminish the ability of taxpayers to seek advance guidance and attain certainty in respect of the tax effects of their transactions. Does Revenue Canada foresee the report affecting the ruling process in any fashion?

Part XIII Non-Resident Tax Issues

A. Statute of Limitations

Should a payer fail to withhold Part XIII tax for amounts paid to a non-resident recipient, there is seemingly no statute of limitations for assessing the Part XIII tax against the payer for its secondary liability. That is to say, if the payer fails to withhold the tax and file the proper forms, there appears to be no provision that triggers an assessment that starts the statute of limitation. In such cases, does Revenue Canada adhere to an administrative policy against issuing assessments following a certain period of time?

B. Leases

In a technical interpretation dated March 28, 1991, Revenue Canada recommended that, when certain lease transactions are treated as financed purchases for the purposes of paragraph 18(1)(b) and subsection 16(1) of the Income Tax Act (hereinafter, "the Act"), the same assessing policy should be applied for all purposes of the Act, including Part XIII. Please provide an update on the status of the Department's recommendation. Has the recommendation been approved? If so, what is its effective date?

C. Discrepancy Notices

Some members report that their responses to Non-Resident Tax (and other similar) Discrepancy Notices have not forestalled the issuance of Notices of Assessments even though the response was submitted within the 30 days stated on the Discrepancy Notice. Moreover, collection actions have apparently commenced on such assessments immediately. Please comment on the controls the Department has established to ensure that responses to Discrepancy Notices are reviewed and evaluated before Notices of Assessment are issued. Does the Department routinely contact the taxpayer submitting a response on the Discrepancy Notice prior to issuing a Notice of Assessment?

Harmonization and Provincial Allocation Issues

A. Provincial Allocation Formula -- Simplification Proposal

The formula for allocating income and capital tax for taxpayers conducting business through more than one permanent establishment is uniform among the provinces and territories. (The formula will also be used for allocation of Harmonized Sales Tax (HST).) The allocation computation, however, is audited separately by each jurisdiction. In some cases, adjustments proposed by certain jurisdictions (i.e., Ontario, Quebec, and Alberta) are accepted automatically by some, but not necessarily all, other jurisdictions. This process of individual audits and separate determinations by the provinces of a uniform rule for allocation of income and capital frequently results in delays in the issuance of reassessments to taxpayers by the provinces. More important, the separate audits can result in double taxation where other provinces fail to make (or accept) corresponding adjustments for any reason (e.g., the year of adjustment is statute-barred in other provinces by the time an audit and appeal in another is concluded). Finally, legal challenges to the separate provincial adjustments to the allocation computation must be pursued in provincial rather than federal courts.

We believe that the process for audits, appeals, and legal challenges to the proper allocation of taxes among the provinces should be modified because the allocation is pursuant to an ostensibly uniform formula agreed upon by all the provinces. Specifically, we recommend that Revenue Canada assume the responsibility for interpreting the application of the allocation formula and verifying taxpayers' allocation computations on audit. In addition, Federal Courts should be given jurisdiction to resolve taxpayer challenges to a reallocation. We believe that our proposal should be advanced as part of the simplification and rationalization agenda of the Canada Revenue Commission. If our proposal is adopted, the process for resolving disputes about the proper allocation of provincial taxes will be substantially simplified, thereby mitigating double taxation and permitting scarce taxpayer and provincial government resources to be more efficiently redeployed. We invite the Department's comments on this and other approaches to simplification or harmonization of provincial allocation.

B. Administrative Issues

1. Allocation Committee. We understand that, sometime late in 1995, Revenue Canada became a participating member on a provincial allocation committee together with representatives from Ontario, Quebec, and Alberta. We invite the Department's comments on the committee's objectives as well as guidance about the manner in which taxpayers may bring issues to the committee's attention. For example, has the committee considered addressing the issue whether audit changes affecting the taxpayer's allocation computations should be eliminated unless the recomputed allocation is accepted by all jurisdictions?

2. Central Paymaster Rules. In its 1993 Budget, Ontario announced Central Paymaster Rules that are to be employed for provincial allocation purposes. Draft regulations to implement the legislation have also been developed. Will Revenue Canada amend its allocation regulations in order to incorporate and parallel the Ontario changes? If Revenue Canada's regulations are not to be amended, how will taxpayers be assured that the allocation rules will be implemented and administered uniformly by the different taxing jurisdictions?

C. Provincial Allocations -- Netting of Interest Charges

Where the taxpayer's provincial allocation is revised on audit, and assuming that the proper correlative adjustments are made in all other jurisdictions, the taxpayer will owe additional tax in some jurisdictions and be entitled to refunds in others. In addition, the taxpayer will be assessed interest on tax underpayments and be entitled to receive interest on overpayments. In total, the amount of tax and interest will likely entirely offset. The interest on the refund amounts, however, is taxable whereas interest charges on income taxes is not deductible. As an administrative concession, will Revenue Canada permit taxpayers to net the interest payable and refundable from all jurisdictions and only treat the net amount as either taxable (in the case of net refund interest) or nondeductible (in the case of net arrears interest)?

Audits of SR&ED Claims

The manner in which Revenue Canada's auditors are applying the "13 September 1994" cut-off and the 18-month period for claims of qualified SR&ED expenditures continues to puzzle TEI members. When the 1994 (and 1995) budget legislation limiting the period for claiming SR&ED expenditures was introduced, Revenue Canada officials assured taxpayers that auditors would be flexible and fair when reviewing affirmative claims for qualified expenditures omitted from previously filed tax returns. The experience of our members, however, suggests that SR&ED claims are being examined with an unusual degree of stringency, and that only adjustments decreasing the amount of qualified expenditures have been made.

For example, assume a taxpayer incurred qualified expenditures for scientists' salaries for clearly qualified projects for which claims were properly and timely filed. Assume further that expenditures for scientist A's salary were associated with, and reported in connection with, a timely claim for project 1, scientist B's salary was reported in connection with a timely claim for project 2, and salary expense for scientist C, who worked on both projects, was inadvertently omitted from the calculation of the claim for both projects 1 and 2. Finally, assume that A actually worked on project 2, while B actually worked on project 1. Would the taxpayer be permitted to correct its SR&ED claim for project 1 and 2 in order to claim the proper amount of salary expenditure for scientist A, B, or C on audit? Reports suggest that salary expenditures for all three scientists will be disallowed by auditors because taxpayers are not being permitted to correct errors in, and omissions from, their claims.

Where it is clear that expenditures (i) qualify for the SR&ED credit and (ii) relate to a previously identified project for which a timely filed claim was made -- but for which the amounts were erroneously omitted (or misreported) on the taxpayer's claim -- there is seemingly no good policy reason for denying the taxpayer's corrected claim. Hence, please comment on the instructions that have been issued to auditors in respect of audits of SR&ED claims. Are auditors precluded from accepting affirmative claims or adjustments to claims beyond the 18-month claim period, even to correct clerical errors related to misreporting of clearly qualified expenditures related to a claim for a previously -- and properly -- identified SR&ED project? We believe Revenue Canada can -- and should -- be more balanced in its approach to audits of SR&ED claims without opening the door to abuses. A one-way, "trap door" approach to audits of SR&ED expenditures will not enhance the perception of fair and equitable treatment of taxpayers.

Subsectionl5(2) -- Loan to Shareholders

The decision in The Queen v. Selden, 93 DTC 5362 (FCA), interpreting subsection 15(2) surprised many and resulted in proposed legislation to revise section 15. Taxpayers have expressed concerns to the Department of Finance about the scope of relief set forth in proposed subsection 15(2.3). In particular, the relief provision may not be adequate because of the addition of the phrase "bona fide arrangements were made for repayment of the debt or loan within a reasonable time" to that section. Financial institutions make substantial loans, including credit cards, personal lines of credit, business lines of credit, and other forms of revolving credit, that do not require the borrower to repay the entire amount by a fixed date. In addition, a number of individuals, either themselves or through a connected person (such as a parent or a child), have made investments in companies related to financial institutions. As a result, these individuals may inadvertently and inappropriately be subject to tax under subsection 15(2) unless the relief exception of proposed subsection 15(2.3) applies.

Taxpayers have requested that the Department of Finance delete the quoted phrase. The Department of Finance has demurred making the requested change because Finance believes that Revenue Canada interprets the minimum payment amount required on credit cards and other revolving lines of credit as sufficient to meet the statute's test for "repayment" and, more generally, that subsection 15(2) does not apply in the "shareholder loan" circumstances described above. Please confirm whether the Department of Finance is correct in its understanding of Revenue Canada's interpretation of both the existing and proposed sections.

Mortgage Interest Subsidy

In last year's liaison meeting agenda, we posed the following:

Many financial institutions in Canada offer their corporate customers a lending program that permit the customers, in turn, to offer their employees a subsidized mortgage interest program. The customers' programs may be open to some or all employees. Under the program, the financial institution provides mortgage financing to qualified employees with the employer making payments to the financial institution to subsidize some or all of the interest due on the employee's mortgage.

Paragraph 4 of IT-421R2 (Benefits to Individuals, Corporations and Shareholders from Loans or Debts) states that, depending on the facts, a loan to an employee by a person other than his employer may be subject to the provisions of section 80.4. Based upon this paragraph (and, very likely, upon advanced tax rulings or written opinions from Revenue Canada), financial institutions and employers have, pursuant to the rules contained in section 80.4, subsections 6(9) and 248(1), paragraph 110(1)(j), and applicable regulations of the ITA, determined the amount of taxable benefit to include in the employees' income.

In five cases at the Tax Court of Canada,(1) Revenue Canada asserted that subsidized interest provided under an employer's mortgage interest subsidy program similar to that described above conferred a taxable benefit to the employee under paragraph 6(1)(a). Although the government's position was upheld in the Krull decision, the taxpayer appealed. In the four cases it lost, the government appealed, asserting that the mortgage subsidy was taxable under either paragraph 6!1)(a) or section 80.4. The Federal Court of Appeals consolidated the cases and decided in each case that no taxable benefit was conferred on the employee under either paragraph 6(1)(a) or section 80.4.

In light of these rulings rejecting the government's assertion, will Revenue Canada clarify how employers should report the mortgage interest subsidy for the 1995 taxation year?

To which we received the following response:

The Department is reviewing its position in light of the Federal Court of Appeal's decision in the cases of Hoefele, Zaugg, Mikkelson, Krall, and Krull and has until December 10, 1995 to file its application to seek leave to appeal to the Supreme Court of Canada.

Accordingly, for the purpose of T4 reporting for 1995, the Department's position continues to be that such interest subsidies are taxable either as the payment of a personal living expense or as a loan received by virtue of employment. Where an employer provides a mortgage interest subsidy to an employee, the benefit should be determined under subsection 80.4(1) of the Act if the mortgage can be considered to have been received by virtue of employment. If there was no employer participation in obtaining the mortgage, the full amount of the subsidy should be included in income as a taxable benefit under paragraph 6(1)(a) of the Act.

The Department accepts however, that mortgage interest differential payments of the type at issue in the Splane decision (90 DTC 6442, affirmed by the Federal Court of Appeal, 92 DTC 6021) are not taxable when paid in the circumstances set out in that case which also involved an employer-requested relocation.

The Department subsequently sought leave to appeal the Hoefele, et al., decisions to the Supreme Court. In light of the Supreme Court's denial of leave to appeal, will Revenue Canada advise how employers should report mortgage interest subsidies?

Change of Control -- Loss Company

Assume that A contributes property with a fair value at the time of contribution significantly in excess of its adjusted cost base to B Company, a loss corporation, in exchange for shares in B company pursuant to section 85. Prior to three years elapsing, C acquires control of B Company in an independent, unrelated transaction and B Company elects under paragraph 111(4)(e) to revalue all of its properties (including the property originally contributed by A) to fair value. Assume further that any gain arising to B Company on the deemed disposition of the contributed asset would be offset by B's loss. In such a case, although B Company continues to own the property, will the paragraph 111(4)(e) election be considered a disposition for purposes of applying subsection 69(11) to A?

Decontamination Costs

We invite Revenue Canada's views concerning the deductibility of land decontamination costs under the following three situations:

1. A company acquires contaminated land that will be used in its business operations. For book purposes, an estimate of the decontamination costs is added to the cost of the land, together with an equivalent reserve on the other side of the balance sheet. In the following taxation year, clean-up costs are incurred and the payment is charged against the reserve. The income statement of the financial statements is not charged for the clean-up costs incurred.

2. Same situation as in 1 except that additional contamination occurs as a result of the taxpayer's ordinary business operations and, hence, additional clean-up costs are incurred during the 15 years following acquisition of the land. The additional costs are treated as expenses and charged against current operations in the income statement.

3. Same as 2 except that the additional clean-up costs are added to the cost of the land for book purposes.

Replacement Property

Proposed amendments to paragraph 13(4. l)(a) of the Act in the June 20, 1996, Notice of Ways and Means Motion will add the condition that in order for a particular depreciable property to qualify as a replacement property it must be "reasonable to conclude that the property was acquired by the taxpayer to replace the former property." Will the Department consider a particular depreciable property qualified replacement property where the original intention for the acquisition was that the property be for expansion purposes but that, as a result of unforeseen circumstances, it is used a replacement property?

Consider the following example. A corporate taxpayer receives approval from its board of directors to expand its packaging operations, which currently consists of one packaging machine, by acquiring a second packaging machine. The new machine is under construction at the taxpayer's business by the equipment supplier when the existing packaging machine is partially destroyed by fire. Title and ownership of the second machine passes to the taxpayer shortly after insurance proceeds for the destroyed first machine are received but subsequent to the end of the taxpayer's taxation year in which the recaptured capital cost allowance on the disposition of the first machine was reported in income. Will the Department confirm that, when the second machine is acquired, it qualifies as a "replacement property" with respect to the first machine even though the second machine was originally ordered and intended for expansion of the business?

Subsection91 (4)

Please confirm that under subsection 91(4) of the Act, where an amount has been included in income in year 1 under subsection 91(1), a deduction may be taken in year 1 in respect of accrued foreign tax related to year 1 that is paid subsequently in year 2.

Large Corporation Tax -- Hedged Debt

Section 3860 of the Canadian Institute of Chartered Accountants (CICA) Handbook summarizes the financial statement presentation and disclosure for financial instruments, including corporate debt denominated in a foreign currency that is hedged or otherwise combined with a foreign currency swap or forward contract. The net result of the guidance in the Handbook (subsection 3860.34, paragraph 3860.41(a), subsection 3860.09, and paragraphs 3860.05(a), (b), and (c)) is that, where there is no legal right of offset, foreign denominated debt must, for fiscal years beginning on or after January 1, 1996, be translated at the foreign exchange rate in effect as at the date of the balance sheet. In addition, the "net principal value" of the currency swap or forward contract must be reflected as an asset or liability (referred to below as a "hedge asset" or "hedge liability") at the presentation date. Prior to 1996, the net principal value of the foreign currency swap or forward contract was netted against (or combined with) the debt.

Example 1 illustrates the financial statement presentation under the new rules.

Under the rules in effect until 1995, the financial statements would have reflected a net debt of $130 M every year. What is Revenue Canada's position on the treatment of the amounts presented as a hedge asset and a hedge liability in the example above for the purpose of computing taxable capital under section 181.2 of the Act?

Large Corporation Tax -- Unrealized Foreign Exchange Gain or Loss

New paragraphs 181.2(3)(b.1) and (k) introduced in the June 20, 1996, Notice of Ways and Means Motion, apply to 1995 and subsequent taxation years. Will Revenue Canada confirm that its assessment policy for years ending prior to 1995 will be to exclude unrealized foreign exchange gains and losses from the calculation of capital?

Large Corporation Tax -- Outstanding Cheques

At the May 1995 TEI Annual Conference in Hull, Revenue Canada commented that outstanding cheques must be included in determining the amount of a corporation's bank overdraft for purposes of computing the tax on large corporations under Part I.3 of the Act. In October 1995, the court in The Grocery People Ltd. v. The Minister of National Revenue (1996 ETC 90) commented, as follows

I'm prepared on the basis that no

liability exists between the bank

and its customer, the taxpayer in

this case, until such time as the

bank accepts the cheque for

payment and allows the account

to go into overdraft -- the mere

presentation of a cheque by the

taxpayer to its creditor does not

create a bank indebtedness and

using the plain meaning of the

words "loans and advances,"

there is no loan or advance

until the bank says there is and the

bank has not done so in this case.

Will the court's comment affect Revenue Canada's position that outstanding cheques be included as a bank overdraft liability for purposes of computing Part I.3 tax?

Overseas Credit

In a technical interpretation dated April 18, 1995 (document number 9500997), Revenue Canada stated that an employer will not be considered to be carrying on business in another country with respect to one of the specified types of activities set forth in clause 122.3(1)(b)(i)(B) of the Act unless the activity is the principal activity of the employer. Please clarify the basis for Revenue Canada's position since the Act does not specify that the required activity be a principal activity.

Permanent Establishment

Consider the following situation. Canadian Company A has permanent establishments in Ontario and Quebec. The Company has a maintenance contract to service Customer 1 at locations in province X and province Y (other than Ontario and Quebec) and Company A maintains between 5 and 10 employees at each customer location. The employees report to work daily at the customer's premises. There is a Company site supervisor at each location who reports to a Company Project Manager in Ontario.

Customer 1 provides the office area, spare parts, supplies, assemblies, test equipment, calibration services, and janitorial services. The test equipment at each Customer location is worth in excess of $100,000. The Customer's equipment being serviced at each location is worth in excess of $1,000,000. Company A's employees do not have the authority to contract on behalf of the Company at these locations. A computer and fax machine, owned by Company, are kept at each Customer location for use by Company's employees. Of the Company's aggregate gross revenues, 2.5 percent and 1.5 percent are derived from the Customer contract for work performed in Provinces X and Y respectively. Does Company A have a permanent establishment in Province X and Province Y if the Company's 5 to 10 employees are on site at each location for 1 month? 6 months? Or more than 12 months?

Employer CPP & UI

Employer provides a short-term disability program for the benefit of its employees. In order to facilitate the expeditious delivery of cheques to the employee, the Employer will occasionally pay the short-term disability benefit directly to the employee and then seek reimbursement from Employer's Insurer. Under such circumstances --

1. Is Employer required to pay the employer portion of Canadian Pension Plan and Unemployment Insurance (CPP & UI) on these benefits?

2. If the Insurer provides the T4 slip for the earnings to the employee, is the Employer required to pay the employer portion of CPP & UI?

Transfer of Pay by Employer to RRSP

Where an employer makes a lump-sum payment, such as a bonus or payment in lieu of notice, please confirm that the employer is not required to withhold income tax on amounts that are transferred directly to a registered retirement savings plan (RRSP).

Offshore Finance Companies

Comments made by representatives of Revenue Canada at the 1995 Canadian Tax Foundation Conference implied that a Canadian corporation that is controlled by non-residents, will be subject to a "GAAR attack" should the corporation establish an offshore finance company. In this respect, we would appreciate your commenting on the following questions:

1. What is the technical support for this position?

2. Are there any circumstances under which a non-resident controlled Canadian corporation will be permitted to establish an offshore finance company?

Paragraph 85(1)(e.2) Issues

Consider the following situation. Company A owns 75 percent of the issued and outstanding share capital of Company B and 80 percent of the issued and outstanding share capital of Company C. Company C owns the remaining 25 percent of the share capital of Company B. Company B owns the remaining 20 percent of the issued and outstanding share capital of Company C.

Company A transfers to Company B a capital property in exchange for Company B common shares. The fair market value of the capital property of $1 million significantly exceeds the adjusted cost base of $100. Company A and B intend that the property be transferred at fair value. Hence, a valuation of Company B is undertaken to determine the proper number of shares to issue to A in the exchange. Moreover, the asset transfer agreement between A and B includes a provision requiring an adjustment of the number of shares to be issued to A should the fair value of the contributed property vary significantly (up or down) from the appraised value determined by A and B. Company A and B jointly elect to have the provisions of subsection 85(1) of the Act apply to the transfer. The agreed amount of the joint election is the adjusted cost base of the property at the time of the transfer.

Please comment on the following questions concerning the transaction:

1. Does Revenue Canada consider Company B to be a "wholly-owned corporation" of Company A so that paragraph 85(1)(e.2) will not apply?

2. If Company B is not considered a "wholly-owned corporation" within the meaning of subsection 85(1.3) and Revenue Canada subsequently determines that Company B did not issue enough common shares on the initial transfer of the property, would Revenue Canada consider that a benefit has not been conferred on a related person (as contemplated in paragraph 85(1)(e.2)) solely on the basis of the companies' intentions in undertaking the transaction?

3. If the answer to question 2 is no, could the taxable transaction be remedied by Company B issuing additional common shares to A pursuant to the price adjustment clause in the asset transfer agreement?

Administrative Issues on Amalgamation

Short-form vertical amalgamations are frequently employed by Canadian corporations as a means of eliminating unneeded wholly-owned subsidiary corporations. With the introduction of the Single Business Registration Number, TEI members are being advised that one result of the amalgamation is that the amalgamated corporation must obtain a new Business Number even where it retains the name and structure of the parent corporation. On the other hand, a new Business Number is not required where the subsidiary is wound up into the parent corporation even though the tax effect is the same in nearly all respects.

When the GST registration number was not linked to the corporate tax account number, it was possible to obtain permission to retain the parent corporation's GST number following the amalgamation. Under the new system, however, a new GST number, payroll account number(s), and corporate tax account number are assigned as a result of the requirement of obtaining a new Business Number. In the case of the GST number, many forms (invoices especially) must be replaced, computers reprogrammed, or both every time an amalgamation occurs. Can the Department explain why a new Business Number is required following a short-form vertical amalgamation when all of the account balances and tax attributes of the parent corporation will transfer to the amalgamated corporation?

Conclusion

Tax Executives Institute appreciates this opportunity to present its comments and questions. We look forward to discussing our views with you during our December 10, 1996, liaison meeting.

Example 1

On January 1 1996, Canco issues a US$100 M denominated debt when the exchange rate is US$1 = CAN $1.30. The debt matures on January 1, 1999. On the same date, Canco enters a currency swap transaction ("the hedge") under which it agrees to exchange its US$100 M liability for a CAN$130 M liability to be reexchanged on the maturity date.
1. On December 31, 1996, the exchange rate is US$1 = CAN$1.40.
The financial statement presentation at that date is:

Asset Liability
Hedge asset $10 M Debt $140 M

2. On December 31, 1997, the exchange rate US$1 = CAN$120. The
financial statement presentation at that date is:

Asset Liability
Debt $120 M
edge liability $10 M

3. On December 31, 1998, the exchange rate is US$1 = CAN $1.30.
The financial statement presentation at that date is:

Asset Liability
 Debt $130 M


(1) Hoefele v. The Queen, 94 DTC 1878; Zaugg v. The Queen, 94 DTC 1882, Mikkelson v. The Queen, 95 DTC 5602; Krall v. The Queen, 95 DTC 5602; and Krull v. The Queen, 95 DTC 5602.
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