Pending income tax issues: December 6, 2005.
Tax Executives Institute welcomes the opportunity to present the following comments and questions on income tax issues, which will be discussed with representatives of the Canada Revenue Agency (hereinafter "CRA" or "the Agency") during TEI's December 6, 2005, liaison meeting. If you have any questions about the agenda in advance of the meeting, please do not hesitate to call Monika M. Siegmund, TEI's Vice President for Canadian Affairs, at 403.691.3210 or David V. Daubaras, Chair of the Institute's Canadian Income Tax Committee, at 905.858.5309.
1. Canada-United States Tax Convention
The June 3, 2005, Memorandum of Understanding (MOU) between the Competent Authorities of Canada and the United States in respect of Article XXVI of the Canada-U.S. Income Tax Convention (relating to the Mutual Agreement Procedure (MAP)) is a significant and salutary step toward improving the performance and efficiency of the mutual agreement procedure. TEI commends CRA for working with the Internal Revenue Service to develop the MOU.
A. In Part I. A. of the MOU, the Competent Authorities commit to the principles of consistency and reciprocity in the resolution of submitted cases. In the past, some taxpayers have viewed Canada as being preoccupied with the process while the U.S. Competent Authority has generally focused on the tax result. How will the approaches of the two Competent Authorities resolve themselves in the approach set forth in the MOU? Consistency and reciprocity in the administration of submitted cases are laudable goals if the decisions are based on, and can be tested against, objective standards such as the OECD's published transfer-pricing guidelines. Otherwise, the decisions may result in an informal body of rules to which taxpayers will not have access. Will MAP decisions, particularly those that serve as precedent, be based on legal authorities and publications available to taxpayers as well as the Competent Authorities?
B. Part I. B. of the MOU describes a procedure for an "Agreement on the Facts" of a MAP case. Specifically, the MOU states that, if the Competent Authorities are unable to agree on the underlying facts and circumstances after six months of negotiations, the Competent Authorities will refer the case to a joint panel composed of tax administration officials chosen by the Assistant Commissioner of Appeals for the CRA and the Chief of Appeals for the IRS. Would CRA please elaborate on the role that it envisions for its Appeals officers in the new process? In addition, will taxpayers be informed of factual differences perceived by the Competent Authorities and be invited to make representations regarding the facts before a decision is made?
C. The goals expressed in the MOU are commendable, but significant work remains before the respective tax administrations and taxpayers will reap the full benefit of streamlined administration of MAP cases. Specifically, in Part III of the MOU "the Competent Authorities have identified a number of issues that have resulted, or could result, in a failure to resolve double taxation or taxation contrary to the Convention." Has each of the issues been assigned to a working group for follow-up and resolution? When does CRA anticipate releasing guidelines for settling these issues? A related question is whether CRA considers cases under the general anti-avoidance rules (GAAR) to be eligible for resolution by the Competent Authorities. If such cases are eligible for resolution under MAP, are there special procedural or substantive considerations?
2. Decisions on General Anti-Avoidance Rules
Will CRA be re-evaluating its GAAR assessing practices or its GAAR case review procedures in light of the decisions in Canada Trustco Mortgage Co. v. Canada (2005 S.C.C. 54), and Mathew v. Canada (2005 S.C.C. 55) (sometimes referred to as Kaulius, et al. v. The Queen)?
3. Aggressive Tax Planning
We understand that CRA has identified a number of transactions or structures that it may categorize as "aggressive" tax planning. Would CRA please discuss the scope and nature of the transactions or structures that have been identified in connection with the Department's research into "aggressive" tax planning and provide an update on the current status of the study and initiative? Will there be a public announcement about or guidance arising from the initiative?
4. Treaty-Based Waivers
Information Circular 75-6R2, Required Withholding from Amounts Paid to Non-Residents Providing Services in Canada (February 23, 2005), discusses the process for obtaining treaty-based waivers of withholding for related non-resident service providers. Appendix A, paragraph 8 (pages 19-20), states that CRA will consider issuing treaty-based waivers for related parties so long as there is no perceived element of tax avoidance. Would CRA please advise whether treaty-based waivers for related parties are currently being provided and under what circumstances the waivers are being approved or denied?
5. Appeals--Mediation of Large Files
Question 2 of the 2004 CRA-TEI liaison meeting agenda inquired about Appeals Division initiatives to facilitate the resolution of complex large files. CRA responded that Appeals is promoting the use of mediation as a means of resolving large files. The International Tax Office recently issued a press release stating that Appeals is also considering mediation in Competent Authority cases (e.g., between Canada and the United States). Would CRA provide an update on Appeals' involvement in mediating Competent Authority cases as well as on its broader efforts to employ mediation to resolve large file cases?
6. Details of Assessments
The Notice of Objection rules of subsection 165(1.11) of the Income Tax Act impose significant procedural requirements on large corporations in order to appeal a reassessment. CRA is aware of the additional burdens imposed on large corporations and generally strives to supply the additional information that large corporations need in order to comply with those rules. To that end, we would appreciate a discussion of the following:
A. Many members report that they routinely receive a copy of the T7WC, Explanation of Changes for Reassessment, from their large file case manager, but the practice is seemingly not universal. We would appreciate CRA's confirming that it is CRA's policy to provide the T7WC as a matter of course during or at the conclusion of an audit.
B. The T7WC is often helpful in determining the substantive issues that must be described in the Notice of Objection. Occasionally, reassessments are made without a description of the technical basis of the reassessment. The omission of a description of the technical basis for the substantive issues, in turn, can severely impede a taxpayer's effort to effectively comply with the requirements of subsection 165(1.11). Hence, TEI believes that CRA should establish a national policy requiring that a description of the technical basis of the substantive issues in the reassessment be included in the T7WC delivered to taxpayers. We invite CRA's reaction.
C. Similarly, a vague or incomplete description of the technical basis of a reassessment will hinder a taxpayer's efforts to prepare a complete and concise notice of objection. Is there a national standard for the preparation, presentation, and summary of proposed audit adjustments?
7. Large Case File Audits
On numerous occasions, TEI and CRA have discussed CRA's policy that an integrated corporate group should have one large file case manager and be managed as an integrated audit. Contrary to that policy, several TEI members report undergoing a number of contemporaneous audits in the same location, on the same information and compliance systems, with the same tax department but with different large file case managers. Would CRA please explain the circumstances under which it deviates from its stated policy of assigning only one large file case manager for the audit of an integrated corporate group?
8. Partnership Income Allocations
We understand that the CRA is challenging a number of partnership income allocation agreements under paragraph 96(1)(f) of the Act even though all the partners to the agreement are at arm's length and are taxable Canadian corporations. TEI does not understand the abuse that is being targeted and submits, moreover, that, if there is an abuse, CRA should address it under section 103 of the Act.
The files being challenged have agreements that reflect a so-called two-step partnership income calculation. The income allocations in such agreements take into account that some partners contribute depreciable capital property to the partnership while others contribute cash. As a result, it makes commercial sense to allocate capital cost allowance (CCA) deductions, as well as the income on the subsequent sale of the property (to the extent the gain accrued prior to the transfer to the partnership), to the partner that contributed the particular property.
A simple example of the operation of a two-step income allocation is, as follows:
Partner A and Partner B are at arm's length, both are taxable Canadian corporations, and each owns a 50-percent interest in the Partnership. Partner A contributes (on a rollover basis) $1,000 of depreciable properties (with a CCA rate of, say, 25-percent declining balance) with a capital cost and undepreciated capital cost of $800. Partner B contributes $1,000 cash. Prior to the allocation of CCA, the income of the Partnership for the year is $150. Hence, the allocation of income, as agreed by the partners under the Partnership Agreement, is, as follows:
Preliminary Partnership Income (Level 1) $150 Partnership Level CCA (25% x $800) (200) Partnership Income (Loss) to be allocated (Level 2) (50) Partner A Level 1 Amount (50% of $150) $75 CCA attributed to Partner A assets (200) Partner A Level 2 Amount (125) Partner B Level 1 Amount (50% of $150) $75 CCA attributed to Partner B assets NIL Partner B Level 2 Amount $75 Partnership Income allocated to Partners (Level 2) ($50)
Taking the example a step further, assume that in the following year the property is disposed of for $1,100. Under most two-step allocation agreements, the first $200 of capital gain will be allocated to Partner A since the asset that A contributed had a $200 built-in gain when it was transferred to the partnership.
We do not believe that partnership agreements among taxable, arm's-length Canadian corporations that employ two-step allocations illustrated above are inherently abusive. Indeed, partners can generally agree to share income from the partnership in any manner they wish as long as it reflects commercial reality. Provided the income allocation agreed to by the partners (who are assumed to be members of the partnership as at the fiscal year end of the Partnership) is in the aggregate equal to the income of the Partnership as calculated under the Act, the allocation should not be subject to challenge under paragraph 96(1)(f) because that provision is not an anti-abuse rule. In TEI's view, partnership allocations should only be subject to challenge under subsection 103(1) (in the case of arm's length partners) or subsection 103(1.1) (in the case of non-arm's length partners). If partner income allocation arrangements can be ignored or set aside under paragraph 96(1)(f), then section 103 is superfluous. As important, the proposed assessing actions by the Agency will likely result in double tax since CRA likely will not make consequential assessments to reduce the other partners' income. We invite the Agency's comments.
9. Ontario Tax Administration
TEI supports the announced initiative of merging the administration of the Federal and Ontario tax systems. Would CRA please update TEI on the status of the initiative, including:
* What is (are) the target date(s) for implementation?
* What are the priority actions with respect to the timing of the implementation?
* What specific provincial functions will be assumed by CRA (installments, return processing, audits, appeals, etc.) and when?
* Will Ontario harmonize its legislation with the Federal Income Tax Act?
* Will Ontario accord jurisdiction over provincial income tax matters to the Tax Court of Canada?
TEI members have already participated in workshops and meetings to discuss some of the implementation issues. Is there anything TEI can do to assist in or expedite the implementation process? Finally, has CRA had discussions for similar initiatives with Alberta or Quebec?
10. Published Administrative Positions
At TEI's May 2005 Annual Canadian Tax Conference, representatives from CRA suggested that the Agency may not adhere to its own published administrative positions where taxpayers "push" the published positions "too far." Such a position is inconsistent with prior CRA practice and jeopardises the certainty of outcome on which a voluntary self-assessment tax system is premised. Please confirm that taxpayers may continue to rely on published administrative positions except in the rarest of cases or where there is a dispute whether a taxpayer's facts fit within the published administrative position.
11. Subsection 95(6) and Tax Avoidance
What is the status of the Draft Technical News on subsection 95(6)?
12. Recharacterization of Transactions under Section 247
Would CRA please advise whether it has recharacterized any transactions under section 247 of the Act and, if so, describe the nature of the transactions that were recharacterized?
13. Rulings Review
In response to Question 1 of the 2004 CRA-TEI liaison meeting agenda, CRA stated that the entire advance rulings function was undergoing a review. As of last year's meeting, no changes to the rulings process had been recommended or made. Would CRA provide an update on the status of its review? Does CRA anticipate making any changes in the rulings process? If so, what changes are expected and when will they be announced and implemented?
14. Vehicle Benefits
There have been a number of recent court cases (e.g., James MacMillan v. The Queen, 2005 T.C.C., Timothy Fox and Brian Richardson v. the Queen, 2003 T.C.C., and Donald Anderson, Robert Auckland, Howard Harder, Wyatt Penner and Keith Scott v. The Queen, 2002 T.C.C.) where it was decided that employees using field vehicles did not have any personal use of the vehicles when driving to (from) home from (to) their place of business. Generally, the employer viewed all use of the vehicle to be necessary in its business and prohibited personal use of the vehicle. Would CRA please comment on its position regarding the use of such vehicles for travel between the employee's home and place of business? Does the Agency's answer change if the vehicles meet the definition of "automobile" for income tax purposes?
15. Mark-to-Market Property
The Accounting Standards Board of the Institute of Chartered Accountants of Canada has issued two new standards: CICA 1530, Comprehensive Income, and CICA 3855, Financial Instruments--Recognition and Measurement. For fiscal years beginning on or after October 1, 2006, adoption of these standards by financial statement issuers will change the financial accounting treatment and reporting of certain financial instruments, including specified debt obligations (SDOs) defined in subsection 142.2(1) of the Act. Specifically, SDOs that satisfy the CICA 3855 definition of "available for sale" will be reported on the balance sheet at their market value, but the income will continue to be recorded in the income statement on an accrual basis. The difference between the market value of the instrument and the accrual value of affected instruments will be reported in "Other Comprehensive Income" (OCI)--a new category of Shareholders Equity.
Currently, SDOs are excluded from mark-to-market treatment for income tax purposes because they are not marked to market for financial statement purposes and thus do not satisfy the definition of "mark-to-market property" in paragraph 142.2(1). Hence, the new financial accounting standards may create ambiguity about the proper income tax treatment of some SDOs. Since the purpose of the mark-to-market tax rules is to report the proper amount of income subject to tax, we believe a reasonable interpretation of paragraph b of the definition of "mark-to-market property" in subsection 142.2(1) is that it requires only instruments that are marked to market for income statement purposes to be marked to market for income tax purposes. Under this interpretation, the new accounting standard would not change the taxation of affected SDOs because the income statement treatment of the instruments has not been changed by the new standards. This interpretation would also be consistent with the current requirement that the reconciliation of accounting and taxable income begin with the income per the financial statements without considering OCI. Does CRA concur with TEI's interpretation?
16. Section 159 Certificates
Would CRA explain its standards, processes, and management benchmarks to measure whether section 159 certificates are being issued on a timely basis, especially for simple companies with few assets or liabilities? In the experience of TEI members, section 159 certificates are rarely issued quickly enough to satisfy the requirements and exigencies of commercial transactions, including a winding up. As a result, taxpayers may not submit requests for section 159 certificates in as many cases as may be appropriate.
Tax Executives Institute appreciates this opportunity to present its comments and questions. We look forward to discussing our views with you during our December 6, 2005, liaison meeting.
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|Date:||Nov 1, 2005|
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