Pending income tax issues: December 7, 2004.
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 7, 2004, liaison meeting. If you have any questions about the agenda in advance of the meeting, please do not hesitate to call David M. Penney, TEI's Vice President for Canadian Affairs, at 905.644.3122 or David V. Daubaras, Chair of the Institute's Canadian Income Tax Committee, at 905.858.5309.
1. Tax Rulings
In a recent tax ruling (2004-0062961R3 (May 5, 2004)), CRA stated that it is "currently undertaking a review of the overall advance income tax rulings process." Commentators have suggested that the review was triggered by recent settlements reached by the CRA with certain film tax shelters that had obtained advance tax rulings. (1)
A. Would CRA clarify whether its ongoing review has prompted interim changes in the advance rulings process? Taxpayers perceive that it is more difficult lately to obtain rulings. Moreover, the time required to obtain a ruling is seemingly longer than in the past.
B. In a number of recent rulings, CRA has declined to limit its consideration of a case to the specific rulings requested by the taxpayer and has delved into matters beyond those specifically identified by the taxpayer. In contrast, in some cases where the taxpayer has requested multiple rulings, CRA has encouraged the taxpayer to confine the requested rulings to a limited number of specific items. Please clarify the circumstances and conditions under which Rulings will (i) confine its review to the rulings requested by the taxpayer, (ii) limit the number, scope, and type of rulings requested by the taxpayer, or (iii) initiate a review of other matters outside the scope of the taxpayer's requested rulings.
C. In light of the review and its potential effect on the rulings process, would CRA please explain why the issues that arose in respect of tax shelter rulings (if, indeed, that is what prompted the review) should affect the rulings process more generally? The vast majority of advance rulings involve ordinary commercial transactions, such as butterfly reorganizations, and it would be regrettable if the focus on tax shelters were to inhibit taxpayers' general ability to obtain rulings for ordinary commercial transactions.
In CRA's response 2.3 to the questions posed in the 2003 TEI liaison meeting agenda, CRA advised that "[t]he CCRA continues to explore obtaining legal authority to permit the resolution of files on the basis of 'risks of litigation'." Would CRA please update TEI on the results of this review? Is the Appeals Division working on any other initiatives that will facilitate resolution of complex, Large File cases?
3. Transfer Pricing Review Committee
At the 2004 Canadian Tax Foundation Conference, CRA representatives said that the Transfer Pricing Review Committee has decided to employ its authority to recharacterize certain types of transactions under subsection 247(2) of the Income Tax Act. Would CRA please describe the facts and circumstances and types of cases that might be candidates for such treatment?
4. GAAR Committee
a. Given the scope and number of personnel changes within CRA and the Department of Finance during the past year, would CRA please update us on the current composition of the GAAR committee?
b. In CRA's response 2.3 to the questions posed in the 2003 TEI liaison meeting agenda, CRA stated that "[t]he CCRA will undertake discussions with the current membership of the GAAR Committee regarding the possibility of allowing taxpayers (or their representatives) to make verbal representations directly to the GAAR Committee." Would CRA please update TEI on the results of its discussions on this important issue?
5. Application of Proposed Section 3.1
TEI has submitted comments to the Department of Finance in respect of draft section 3.1 of the Act relating to the deductibility of interest and other expenses. In those comments we expressed concerns about its potential interpretation and application by CRA. The Department of Finance has repeatedly said that draft section 3.1 is not intended to make substantive policy changes to the current legislation. Moreover, Finance has expressed the view that draft section 3.1 should not result in any significant changes in CRA's administrative practices. Before this legislation becomes part of the Act, would CRA comment on whether, and to what extent, changes to its current administrative practices may result upon the proposal's enactment? We are especially interested in knowing whether CRA believes that changes to Interpretation Bulletin IT-533, Interest Deductibility and Related Issues, would result.
TEI believes that its consultations with CRA on IT-533 were very productive and resulted in more administrable rules and guidelines that benefited taxpayers and CRA alike. Hence, we would be pleased to participate in consultations--either before or after the draft provision's enactment--on whether CRA's assessing practices would be modified as a consequence of enactment of draft section 3.1.
6. Override of Form T2 Information by Desk Assessors
Some members report that CRA desk assessors have used information from the General Index of Financial Information (GIFI) schedule or other sources of information to override the information reported on the Form T2 corporate income tax return. Generally, when differences arise between the GIFI and T2 numbers they are attributable to mapping errors embedded in the GIFI numbers; more often than not, the tax return reflects the correct amounts for tax purposes.
When GIFI was introduced, taxpayers understood that the information supplied on the forms would not affect taxpayer returns or audits. Would CRA consider revising its operating procedures in respect of Large File taxpayers and require desk assessors to forward to the Large File Case Manager any information that the desk assessor believes warrants review and potential action? Adopting TEI's recommendation would save substantial time and effort for both taxpayers and CRA alike by precluding unwarranted and unnecessary reassessments and notices of objection. We invite CRA's comments on the proposal.
7. Notice of Objection--Large Corporations
Subsection 165(1.11) of the Act sets forth rules governing notices of objection filed by large corporations. Under subsection 169(2.1), a large corporation is precluded from pursuing, in a subsequent appeal to the Tax Court of Canada, any issue in respect of which the taxpayer did not fully comply with the procedural requirements of subsection 165(1.11). Recently, in Potash Corp. of Saskatchewan, (2) the Federal Court of Appeal reviewed the Tax Court's decision to grant the taxpayer's motion for leave to amend its notice of objection and appeal. In upholding the Crown's appeal, reversing the Tax Court's decision to grant the taxpayer's motion, and refusing the taxpayer's request to amend its notice of objection and appeal, the Federal Court observed that the result was harsh but intended by Parliament.
Often, especially in tax disputes involving large corporations where the issues, facts, and amounts are substantial and complex, taxpayers attempt to obtain disclosure of the factual and legal basis of an assessment prior to filing their notice of objection. Regardless of whether the requested disclosure from CRA is sought pursuant to formal requests under the Access to Information legislation or pursuant to CRA's guidelines in the Administrative Appeals Renewal Initiative--Toward an Improved Dispute Resolution Process, the requested information is frequently not made available on a timely basis. Disclosure of the facts and legal reasoning supporting CRA's assessment is critical to a taxpayer's informed review and analysis of the assessment and preparation of the notice of objection. Without complete and timely disclosure of the basis of an assessment well in advance of the due date for a notice of objection, large corporate taxpayers are arguably denied due process.
We urge CRA to implement a process whereby requests for information concerning the factual and legal basis supporting CRA's assessments of large corporations would be routinely provided to the taxpayer a minimum of 30 days prior to the due date of a large corporation's notice of objection. We also request that an administrative policy be published stating that, when requested information is not disclosed to a large corporation within 60 days of the date of the notice of assessment and prior to the beginning of TEI's recommended 30-day minimum period for taxpayer review of the disclosures, large corporation requests for extensions of time under section 166.1 will be automatically granted. Alternatively, if disclosure is not timely within TEI's recommended minimum review period, then CRA should issue an identical new assessment 20 days prior to the end of the objection period for the original assessment, thereby extending the taxpayer's objection period. We invite discussion of TEI's comments and recommendations.
8. Provision of Contemporaneous Documentation Pursuant to Paragraph 247(4)(c)
Subsection 247(4) of the Act provides that, for purposes of the penalty provisions of subsection 247(3), a taxpayer is deemed not to have made reasonable efforts to determine and use arm's-length transfer prices unless the taxpayer makes or obtains records or documents that provide a complete and accurate description of all the matters referred to in subparagraphs 247(4)(a)(i) through (vi). In addition, under paragraph 247(4)(c) the taxpayer must provide the requested records or documents within three months of a written request from the Minister.
The precise scope, nature, and composition of the records and documents satisfying the documentation requirements of subsection 247(4) in any particular situation is clearly a matter susceptible to reasonable differences of opinion. Nonetheless, the service of a written request on a taxpayer pursuant to paragraph 247(4)(c) initiates a fixed, three-month time period during which the taxpayer must comply or be exposed to the penalties of subsection 247(3) without the benefit of subparagraphs 247(3)(a)(ii) and (iii). TEI submits that, regardless of how diligently or completely a taxpayer complies with a paragraph 247(4)(c) documentation request, it will nearly always be possible for CRA to conceive of additional records or documents that it believes should have been provided and to then request those additional records or documents shortly before or even after the expiration of the three-month paragraph 247(4)(c) period. Even where the additional information is provided in a reasonably timely fashion (in respect of the date CRA makes its request for the additional information), the additional documents and records will likely still be supplied after the expiration of the three-month period of paragraph 247(4)(c). In at least one case, CRA has said that a taxpayer will be denied the protections afforded by subparagraphs 247(3)(a)(ii) and (iii) because additional information, which was requested by the CRA after the expiration of the three-month period of paragraph 247(4)(c), was not provided by the taxpayer until after the expiration of the three-month period even though it was supplied within three weeks of CRA's request.
In order to avoid situations where CRA issues follow-up requests for additional records or documents shortly before or after the end of the three-month period for the taxpayer's response, TEI recommends that the CRA establish a formal policy whereby formal requests under paragraph 247(4)(c) will be issued only as a last resort and only after taxpayers have failed to respond within a reasonable time to informal requests for information. We invite CRA's comments and a discussion of the CRA's policies and practices in respect of formal requests under paragraph 247(4)(c).
9. Tax Shelter Numbers
Section 237.1 of the Act requires registration of any transaction that falls within the definition of a "tax shelter." Because of the expansive nature of the definition of a tax shelter and the adverse consequences of failing to register a transaction that CRA might later view as falling within its overbroad scope, taxpayers frequently register ordinary business transactions in order to obtain protection from penalties and interest.
The T5001 registration form requires, among other things, that draft copies of any selling instruments, marketing brochures, prospectuses, and similar materials be filed with CRA as a prerequisite for the issuance of a tax shelter registration number. Where the registration is requested on a protective basis for an ordinary business transaction, however, no such documents are generally available. Members report that they have encountered inconsistent CRA practices and procedures when applying for tax shelter registrations for such transactions. Would CRA publish its procedures and guidelines for addressing protective applications for tax shelter registration? Publishing the guidelines will provide assurance that taxpayer requests will be handled on a routine and timely basis. We invite a discussion of TEI's request.
10. Payments from a Registered Pension Plan (RPP)
In Technical Interpretation 2002-0163535--Payments from RPP, Deferred Profit Sharing Plan or Supplementary Unemployment Benefit Plan (December 9, 2003), CRA advised that:
... regardless of whether a payment from an RPP to a participating employer represents a return of an overpayment by the employer made due to clerical or administrative error, a return of an excess employer contribution to avoid the revocation of the plan registration, a refund of plan administration expenses paid by the employer, or a payment of plan surplus, the amount will constitute a superannuation or pension benefit.
As a result, the payment from the RPP is subject to withholding. The result seems incorrect, especially in respect of a reimbursement of plan administration expenses to the employer sponsoring the plan. Would CRA consider making an exception to the withholding requirement in the case of a reimbursement of plan expenses to the employer? If CRA will not so provide, is the withholding tax treated as an income tax installment for the taxpayer-employer?
11. Partnership Returns
Regulation 229(1) requires every member of a partnership that carries on business in Canada to make an information return in prescribed form and provide "such other information as may be required by the prescribed form." Regulation 229(2) permits (and CRA Guide T4068 confirms that) one partner (the "Designated Partner") may prepare the partnership information return (T5013 Summary) and supporting T5013 information slips on behalf of all the partners. The bulk of the information that must be reported pertains to the partnership itself and can be determined solely by the Designated Partner from the books of the partnership. Box 45 on the T5013 information slip, however, requires disclosure of the "Limited partner's at-risk amount," which for various reasons (e.g., the adjusted cost base of the partnership interest and method of financing the partnership interest) is usually unique to each member of a limited partnership. More important, the Designated Partner will generally not know the "at risk" amount and it is impractical to require the Designated Partner to seek this information from partners who, for various reasons, choose not to disclose it to the Designated Partner. As a result, the Designated Partner may face a penalty under subsection 165(2) for making a false statement for either leaving Box 45 blank, which occurs frequently, or for completing the Box based on incomplete or incorrect information.
Would CRA be prepared to exercise the discretion afforded by subsection 220(2.1) of the Act to waive the requirement that a limited partner's at-risk amounts be included on the T5013 information slip? More broadly, would CRA consider eliminating the current requirement to report a limited partner's at risk amount on the T5013 information slip?
12. Subsection 1104(7)--Guidelines for Determining "One Project"
Under paragraph 1104(7)(a) of the Income Tax Regulations, a "mine" is considered to include (among other things) a well for the extraction of material from a deposit of bituminous sands. The calculation of a taxpayer's Capital Cost Allowance (CCA) claim for Class 41 property is extremely difficult for mines because the CCA claim depends on the calculation of income from each separate mine. To minimize the burden of the calculation of the deduction on a mine-by-mine basis, paragraph 1104(7)(c) provides that "all wells of a taxpayer for the extraction of material from a deposit of bituminous sands or oil shales that the Minister, in consultation with the Minister of Natural Resources, determines constitute one project, are deemed to be one mine of the taxpayer." (Emphasis added.)
The designation is obtained by requesting an advance tax ruling. The difficulty in making the request or obtaining the ruling is that the term "project" is not defined in the Act and there is no guidance available in opinions, public rulings, published guidelines, and, arguably, the jurisprudence to aid taxpayers and CRA in making the determination.
Since the legislation affording accelerated CCA claims for in situ oil sands projects has been in the Act for eight years, would CRA commit to publishing guidelines to help taxpayers determine how to comply with this provision? There are large numbers of in situ oil sands projects that are currently in the planning or development stage. Hence, TEI urges the issuance of guidance on this important issue.
13. Transfer of Part VI.1 Tax
Pursuant to subsection 191.3(1), related corporations can transfer among themselves a part VI.1 tax liability of any member of a group. The transfer is deemed to occur in the taxation year of the transferee corporation ending at or before the end of the transferor's year end. Where the transferee's taxation year ends immediately after the transferor's year end (e.g., on January I for a transferee and December 31 for a transferor), the transferee may incur interest charges under subsection 157 (1) for a late payment of tax instalments even though the transferor made instalments on a timely basis.
For example, assume a transferor corporation has a December 31, 2003, year end and transfers some of its Part VI.1 tax to a transferee corporation that has a January 1, 2004, year end. Assume further that the election under subsection 191.3(2) is timely filed on June 30, 2004. On these facts, the transferee would have been required to pay the part VI.1 tax within two months of its January 1, 2003, year end (i.e., March 1, 2003), even though the transferee is even not aware at that date that a transfer agreement will be made in 2004. Moreover, if no dividends had been declared and paid by the March 1, 2003, instalment due date, the liability for Part VI.1 tax may not have even been incurred.
Would CRA issue guidelines to provide relief from interest charges to taxpayers within a related group where a transferor of Part VIA tax makes timely installments, including the Part VI.1 tax, but a difference in year ends makes it impossible for the transferee to pay timely installments for the transferred liability? It seems inequitable that the transferee may be subject to interest charges or penalties where the government has received timely installments from the transferor and has use of the funds. We invite a discussion of TEI's proposal.
14. Pension Plans
Assume the following facts: A Canadian resident individual taxpayer is employed by a Canadian resident corporation that is a wholly owned subsidiary of a U.S. resident corporation. The Canadian resident individual renders employment services in Canada. The Canadian resident individual participates in the U.S. parent corporation's pension plan, which is a qualified plan under section 401 of the Internal Revenue Code (such as a 401(k) plan). The plan is governed by a U.S. resident trust. The pension plan also qualifies as an employee benefit plan under the Income Tax Act (Canada).
A. Will the trust governing the U.S. qualified pension plan constitute an "exempt foreign trust" under draft section 94?
B. If the answer to question A is yes, will the trust governing the pension plan constitute a "foreign investment entity" under draft section 94.1 of the Act and will the taxpayer, thus, have to report income inclusions under draft subsection 94.1(4)?
C. If the answer to question B is yes, but the taxpayer elects under paragraph seven of Article XVIII of the Canada-U.S. Income Tax Convention, will the taxpayer be exempt from income inclusions that would otherwise result under draft subsection 94.1(4)? Will the treaty also exempt the taxpayer from other income inclusions that might otherwise result under other provisions of Part I of the Act, such as subsection 12(4)?
15. Canadian Exploration Expense
Paragraph 66.1(6)(k.2) of the definition of Canadian Exploration Expense (CEE) excludes from CEE--
any portion of any expense that may reasonably be considered to have resulted in revenue earned by a taxpayer if (i) the expense is otherwise described by subparagraph (f)(i), (iii) or (iv) and the revenue is earned before a new mine of the taxpayer in the mineral resource referred to in paragraph (f) comes into production in reasonable commercial quantities, or (ii) the expense is otherwise described by paragraph (g) and the revenue is earned before the new mine referred to in that paragraph comes into production in reasonable commercial quantities,... The explanatory notes for the provision state: New paragraph (k.2) of the definition "Canadian exploration expense" confirms, for greater certainty, that mining exploration expenses and pre-production expenses described in paragraph (f) or (g), other than clause (f)(ii), do not include any portion of the expenses that may reasonably be considered to have resulted in revenue earned by the taxpayer before the mineral resource or mine referred to in those paragraphs come into production in reasonable commercial quantities. This provision confirms that production revenue earned prior to the commencement of production in reasonable commercial quantities is to be netted out in computing Canadian exploration expense.
Would CRA please confirm how it will determine what portion of the expenses incurred pursuant to paragraphs (f) and (g) will be considered to have resulted in revenue earned by a taxpayer pursuant to paragraph (k.2)? Please consider the following:
A. Assume that various costs incurred total $10 million (for stripping, engineering, drilling coreholes, legal costs for regulatory approvals, etc.) and that production revenue prior to the production of reasonable commercial quantities is $1 million. What is the eligible cost to be added to CEE? What are the criteria for determining the costs to add to CEE? TEI believes that the CEE addition would be $9 million and that revenue would not be included in income. Alternatively, $1 million would be included in income but that amount would be offset by a corresponding $1 million cost that would not be included in CEE. Would CRA confirm TEI's understanding of the provisions? If TEI's interpretation is incorrect, would CRA please explain the proper calculation?
B. Under the example above, some of the "pre-production expenses" are ordinarily considered to be capital (e.g., corehole drilling costs) and some are ordinarily considered to be operating costs of post-commercial production. Would this change the result in (A) and, if so, how?
C. Under the example, if the pre-commercial revenue in a taxation year is $1 million and substantially all of the costs are added to the CEE pool and claimed in the immediately preceding year (which typically happens where the start-up and commissioning occurs at the beginning of a year), would the cumulative CEE pool be adjusted in the year the revenue is received?
D. If the pre-commercial revenue exceeds the costs otherwise eligible for CEE, how is that revenue treated?
E. If subsection 66(12.1) applies, whereby the cumulative CEE is reduced pursuant to paragraph G of that definition, will CRA clarify that the same amount would not be considered to be "revenue" for purposes of paragraph (k.2) so that the expenses would not be reduced twice or by more than the "revenue" received?
16. Hybrid Partnerships
At the 2004 International Fiscal Association seminar in Montreal, representatives from CRA stated that CRA is reviewing its position regarding the treatment of a Canadian partnership and its U.S. partners when the Canadian partnership is treated as a corporation under the U.S. check-the-box rules. CRA's current position is that for Canadian tax purposes it looks through the partnership to permit treaty benefits to the partners on amounts received by that partnership. At the seminar, CRA stated that it was reviewing its position because it conflicts with Article I, Section 6.2 of the commentary to the OECD model treaty. Has CRA completed its review? Would CRA provide an update on the status of its review, the issues considered, the outcome, and the likely date when the results of its review will be published?
17. Part VI Tax
Assume a taxpayer, a financial institution, is in the process of settling various issues under appeals for a taxation year that is currently statute-barred and for which waivers have been filed for the issues under objection. As a result of the settlement, the taxpayer's Part I tax liability will change. Since the taxpayer is a financial institution, it is also subject to Part VI tax. For purposes of computing the amount of Part VI tax, subsection 190.1(3) permits the taxpayer to reduce its Part VI tax payable by an amount equal to the total of its Part I tax liability for the taxation year. In addition, if a financial institution is unable to reduce its Part VI liability to nil as a result of its Part I tax liability, a $220 million discretionary capital deduction is available under section 190.15. The discretionary deduction must be allocated among the financial institutions within the related group.
A. Since the taxpayer's Part I tax liability will change as a result of audit adjustments under appeal, will the taxpayer be able to request a revision to Schedule 039--Agreement Among Related Financial Institutions--Part VI Tax--in order to reallocate the portion of the $220 million capital deduction that is not required to reduce the taxpayer's Part VI tax liability to nil? Assume the taxpayer does not have a waiver in place for the reallocation of the $220 million capital deduction for the taxation year in question.
B. If the taxpayer is able to file an amended Schedule 039 to reallocate a portion of the $220 million capital deduction to a related financial institution, is administrative relief available that would permit the related financial institution to recover its Part VI tax if the taxation year of the related financial institution is statute barred? If administrative relief is not available, is this an issue that would be addressed by the Fairness Committee?
Example Assessment #1 Taxpayer A Taxpayer B* Part VI tax payable $10,000,000 $8,000,000 Less: Part I tax liability ($ 5,000,000) ($0) Part VI (before capital deduction) $5,000,000 $8,000,000 Capital Deduction ($220 million x 1.25%) $ (2,750,000) $0 Net Part VI tax payable $ 2,250,000 $8,000,000 Assessment #2 Taxpayer A Taxpayer B Part VI tax payable $10,000,000 $8,000,000 Part I tax liability ($11,000,000) ($0) Part VI (before capital deduction) $0 $8,000,000 (Cannot be reduced below zero by Part I tax.) Capital Deduction ($220 million x 1.25%) $0 $ (2,750,000) Net Part VI tax payable $0 $ 5,250,000
* Taxpayer B is statute barred for the taxation year in question.
Tax Executives Institute appreciates this opportunity to present its comments and questions. We look forward to discussing our views with you during our December 7, 2004, liaison meeting.
(1) See Canadian Tax Highlights (June 2004).
(2)  2 C.T.C. 91 (FCA), leave to appeal to Supreme Court of Canada denied.
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|Date:||Nov 1, 2004|
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