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TEI-Canada Customs and Revenue Agency laison meeting agenda: income tax issues.

December 7, 1999

On December 7, 1999, Tax Executives Institute held its annual liaison meeting with Revenue Canada on pending income tax issues. The Institute's agenda for the meeting was prepared under the aegis of TEI's Canadian Income Tax Committee, whose chair is John M. Allinotte of Dofasco, Inc. Marlie R.M. Burtt, the Institute's Vice President-Region I, coordinated preparations 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 the Canada Customs and Revenue Agency (hereinafter "Revenue Canada") during TEI's December 7, 1999, liaison meeting. If you have any questions about the agenda in advance of that meeting, please do not hesitate to call either Marlie R.M. Burtt, TEI's Vice President for Canadian Affairs, at (403) 269-8736 or John M. Allinotte, chair of the Institute's Canadian Income Tax Committee, at (905) 548-7200, ext. 6821.

I. Recent Developments

We invite Revenue Canada to provide an update on recent developments and initiatives to improve the tax audit and administrative processes. We are especially interested in progress reports on pending guidance projects, including information circulars (IC), bulletins, and guidelines. For example, what is the status of the revised guidelines on withholding tax and the Regulation 105 waiver process? As another example, during last year's meeting there was a discussion of the steps that Revenue Canada would be undertaking, including a substantial increase in staffing, to accelerate the resolution of Advance Pricing Agreements (APAs) and Competent Authority issues. Have those steps been implemented and what progress has been made to address the backlog of cases, especially APAs?

II. Canada Customs and Revenue Agency

TEI was pleased to support the legislation that resulted in the establishment of the Canada Customs and Revenue Agency. In addition, we appreciated the opportunity to have a representative on the steering committee and provide input to the Ministry of National Revenue in respect of the organization and operation of the Agency. TEI hopes to build on the fruitful relationship that has developed over many years with Revenue Canada and, indeed, augment the opportunities for constructive dialogue. Hence, TEI invites an update on the status of the reorganization of Revenue Canada as an independent Agency. TEI also requests a discussion of how the reorganization may affect TEI's national and chapter liaisons with the government and we solicit the government's views and feedback on how to improve and expand the consultative process on the widest possible range of substantive and procedural matters.

III. Transfer Pricing Information Circular

We invite a discussion of the scope and degree of administrative tolerance that Revenue Canada will afford to taxpayers in satisfying the plethora of new transfer-pricing documentation requirements set forth in revised Information Circular IC 87-2R. The transfer-pricing legislation itself provides precious little guidance about the documentation that taxpayers are expected to create and maintain in order to establish the arm's-length nature of their prices. Moreover, the final revised IC, which was issued September 27, 1999, contains a number of changes from the draft IC released with the legislation in September 1997. Since the substantive provisions of the legislation came into force in 1998 and penalties were effective for 1999, we believe that, at a minimum, that taxpayers' 1998 and 1999 taxation year returns should benefit broadly from administrative tolerance in respect of satisfying all of the circular's numerous guidelines and requirements. Assuming Revenue Canada agrees, we urge it to issue public guidance on the degree and scope of administrative tolerance.

IV. Tax Avoidance -- Audits

Revenue Canada has significantly increased the resources assigned to tax avoidance audits. Indeed, TEI believes that a subtle shift in audit practice is underway. Increasingly, auditors are advancing strained interpretations of the Act in search of "avoidance" transactions rather than objectively determining whether a transaction is subject to section 245 of the Act. We believe that this may be a result of Revenue Canada's practice of hiring and assigning auditors to search exclusively for tax avoidance transactions. In other words, wherever a tax avoidance auditor is assigned to a case, there is a strong likelihood that such an auditor will find, in his or her view anyway, an avoidance transaction in order to justify the use of Revenue Canada's audit resources.

When the general anti-avoidance rules (GAAR) were introduced, the Government assured taxpayers that they would be employed only as a last resort. Where tax avoidance auditors are assigned to work specific taxpayer cases even before the case manager has determined that a transaction should be scrutinized for the potential application of GAAR, however, the likelihood increases that the scope and magnitude of audit controversies will increase. Compliant taxpayers should not be placed in a position where every transaction is scrutinized for the potential application of GAAR.

TEI invites a discussion of the training Revenue Canada is providing its auditors to identify "offensive" transactions and ensure that only the "right" issues are pursued pursuant to the guidelines provided by the Head Office. In addition, TEI invites a discussion of how Revenue Canada will employ the additional resources that were recently announced as being devoted to tax avoidance transactions.

V. Tax Avoidance -- Referral to Head Office

The GAAR Committee at the Head Office seemingly becomes involved in GAAR issues at two stages. In an informal preliminary stage, Revenue Canada auditors seek an initial review by the Committee to determine the "GAAR-ability" of a particular issue. At that time, some of the underlying facts of a transaction are presented to the Committee by the auditors, but the taxpayer has no input into the process or the presentation of the issue to the Committee. Indeed, many taxpayers are not even aware that an issue has been referred to the GAAR Committee until the second stage. In that second stage, a formal review of the transaction and issues is conducted through substantive written representations to the Committee by the taxpayer and the auditor.

Taxpayers frequently find during the course of developing their representations that the facts and analysis submitted to the GAAR committee during the first stage proceedings were either incomplete or described in a misleading or incorrect fashion. Moreover, additional facts or other related transactions that the taxpayer considers highly relevant to an understanding of the transaction are routinely omitted. When either occurs, and the GAAR Committee decides at the first stage to pursue an issue based on the incomplete or incorrect facts, the taxpayer is rarely able to persuade the Committee at the second stage to reverse its decision. Would Revenue Canada be amenable to permitting taxpayers to become involved at the very first referral in order to develop an agreed statement of facts to be presented to the GAAR Committee?

VI. Audits of Scientific Research & Experimental Development (SR&ED)

Audits of scientific research and experimental development (SR&ED) activities, expenditures, and related investment tax credits (ITCs) continue to be extremely time consuming and frustrating for taxpayers. Indeed, such issues are subject to rigorous scrutiny with more of Revenue Canada's resources seemingly devoted to auditing this area than other income tax matters. Moreover, the opportunity and process to resolve disputes about SR&ED claims is constricted, even after referral to Appeals.

TEI believes that the program announced last year whereby Revenue Canada will co-ordinate the resolution of SR&ED claims on a national basis is a step in the right direction. We request a status report on the progress to date in restructuring the administration of the SR&ED program. In addition, TEI would be pleased to work with Revenue Canada in restructuring the administration of the SR&ED program.

VII. SR&ED -- Joint Projects with a Foreign Participant

SR&ED projects are often conducted jointly by a Canadian taxpayer and a participant in a foreign jurisdiction. Assuming the Canadian taxpayer carries out qualifying SR&ED activities, incurs the costs related to those activities in Canada, has an unfettered right to any benefit arising from the project, and ultimately does benefit from the results of the joint SR&ED project, will Revenue Canada confirm that the Canadian taxpayer may claim the ITCs related to eligible SR&ED expenditures incurred in Canada even though --

1. The joint project was directed primarily from the foreign jurisdiction; or

2. The majority of the project's expenditures were incurred in the foreign jurisdiction?

VIII. Paragraph 161(7)(b)

Paragraph 161(7)(b) of the Income Tax Act (the Act) governs the computation of interest upon a carryback of non-capital losses. Specifically, interest is calculated from the "balance due day" to the latest of:

1. The first day following the subsequent taxation year;

2. The day the return for the subsequent taxation year is filed;

3. The day on which an amended return for the year is filed; and

4. The day on which a written request is made that results in a reassessment for the year after taking the deduction into account.

These rules can produce inequitable results for corporations. For example, where a carryback is used to offset taxable income arising from a reassessment following an audit, the interest on the reassessment will often be higher as a result of circumstances beyond the control of the taxpayer, including delays in the commencement or conduct of the audit.

Recognizing the potential inequity of these rules, Revenue Canada formerly provided administrative relief to taxpayers under a Verification and Collection Directive. Regrettably, however, the directive was cancelled with effect for carrybacks requested after October 27, 1997. TEI believes that the withdrawal of this Directive was misguided and contrary to the spirit of fairness that led to the introduction of section 161.1 of the Act, relating to the offset of refund and arrears interest.

Questions:

1. Will Revenue Canada explain the tax policy or administrative reasons underlying the decision to withdraw the Directive?

2. Can taxpayers obtain relief similar to that provided under the Directive through, for example, the fairness provisions, the negotiation of an audit protocol, or through discretion afforded to auditors?

TEI believes that the relief provided by the longstanding Directive was effective and workable and its application well understood by taxpayers and the government. Hence, we urge Revenue Canada to reinstate it.

IX. Assessment Practices

We invite Revenue Canada to comment upon whether it endorses the following practices employed by the Audit Division:

1. A taxpayer is reassessed on an issue. The taxpayer objects and the objection is allowed by the local Appeals Office. Notwithstanding the favourable disposition of the issue by a local Appeals Office, the Audit Division reassesses the same issue again in a subsequent year knowing that neither the facts nor the law has changed.

2. The Audit Division refers issues to the Head Office for an opinion in order to prevent the local Appeals Office from varying or vacating Audit's reassessment.

X. Interest Deductibility

The Federal Court of Appeal recently decided Ludco Enterprises Ltd. v. The Queen, 99 DTC 5153 (FCA 1999), and John R. Singleton v. The Queen, 99 DTC 5362 (FCA 1999). Both decisions relate to the interpretation of paragraph 20(1)(c) of the Act, but express divergent opinions on whether the legal form or economic substance of a taxpayer's transactions are controlling for purposes of determining the deductibility of interest.

In Ludco, the corporate taxpayer invested in companies structured to accumulate capital gains in a tax haven. Initially, the corporations the taxpayer invested in adopted a "no dividend" policy; eventually, however, nominal dividends were paid to the taxpayer-investor. The trial judge found that the taxpayer's purpose for the borrowing was to acquire shares in investment companies. The investment companies, moreover, were found to be organized for the purposes of (1) avoiding or postponing the payment of taxes and (2) converting at least half of the taxable income from the "business" activities into capital gains. The Court of Appeal accepted the trial judge's findings of fact, upholding the denial of the taxpayer's interest deduction. Since corporate taxpayers routinely make common share equity investments in ventures (in both arm's length and non-arm's length companies) where no immediate return of income is likely, will Revenue Canada provide its views about whether an interest deduction in such cases is jeopardized under Ludco?

In Singleton, an individual withdrew $300,000 from his law firm partnership capital account and used the proceeds to fund the purchase of a home registered in his wife's name. On the same day, the taxpayer borrowed substantially the same sum and contributed it to the law firm's capital account. The court ruled that the interest payable on the borrowed money was deductible because the direct or immediate use of the borrowed funds was for the purpose of "earning income." What is Revenue Canada's view of this decision? Can individual taxpayers borrow funds and obtain an interest deduction on the borrowing where the purpose is to invest in a mutual fund with a stated investment policy objective of "capital appreciation"? Alternatively, can companies secure deductions on debt where the purpose of the borrowing is to invest in companies that will require reinvestment of future earnings in the business for a significant, even indefinite, period of time?

XI. Benefit Plans

Over many years, Revenue Canada has developed a number of administrative positions to which company benefit plans are required to adhere that are beyond the requirements explicitly imposed by the statute. As a result of changes in company compensation policies and practices as well as the evolution of non-tax laws affecting pension and welfare benefit plans, many company benefit plans may not fit squarely within Revenue Canada's published administrative positions, even though the plans clearly satisfy the requisite statutory definitions for a plan. For example, Revenue Canada maintains that medical expenses paid by a "private health services plan" must qualify for the medical expense tax credit. That requirement, however, is not explicit in the definition of a private health services plan. As another example, many companies extended plan benefits to the same-sex partners of employees long before the courts agreed that same-sex partners qualify as a spouse for income tax purposes. Another example involves a plan that provides spousal benefits to a non-employee (whether of the same or opposite sex) where the employee and his or her partner have not cohabited for a period of 12 months.

Questions:

1. What administrative remedy (or sanction) will Revenue Canada apply to employer health and dental plans that do not satisfy all of the administrative requirements for a private health services plan? More specifically, what is the tax effect to the employee and the employer of being offside of Revenue Canada's administrative positions? Are the scope and frequency of the violations of the administrative positions relevant in determining the sanctions or remedies applied?

2. What is the legal basis for Revenue Canada's imposing a requirement that a "private health services plan" can only pay expenses that are otherwise eligible for the medical expense tax credit?

3. Has Revenue Canada considered establishing a program to permit long-established private health services plans that are in technical violation of Revenue Canada's administrative requirements to return to full compliance with all of the rules?

XII. Foreign Affiliate Reporting and Form T-106(98)

Depending on their fiscal reporting period, Canadian corporations have been subject to the foreign affiliate reporting requirements for either two or three taxation years. Form T-1134 requires companies to disclose in significant detail the organization, operating activities, and financial results of each of their foreign affiliates on an annual basis. The cost to taxpayers of implementing the information system changes to collect and report the extensive foreign affiliate information was substantial and the annual compliance costs are burdensome. As important, the elaborate disclosures on that form were developed through a comprehensive consultation process in which taxpayers and business taxpayer representatives (including TEI) submitted comments on the draft T-1134 foreign affiliate reporting form. Following those consultations, the draft form was revised to eliminate some unnecessary and extremely burdensome computations, including a requirement to report the Adjusted Cost Base (ACB) of the investment in a foreign affiliate or controlled foreign affiliate.

Notwithstanding the consensus arising from the consultative process that annual reporting of ACB information is of little utility to the government for ongoing foreign affiliates, the requirement to report the information on a current basis has reappeared on Form T-106(98). In addition, Revenue Canada has developed a new audit questionnaire for disclosure of information about the activities and finances of foreign affiliates located in tax-haven jurisdictions.

1. In view of the previous consensus that annual reporting of ACB yields little beneficial information to the government while imposing the burden of a complex and costly annual computation on taxpayers, we invite Revenue Canada to discuss the reasons for reinstituting the reporting requirement on a different form.

2. During TEI's 1998 annual liaison meeting, representatives of the Department of Finance justified the required annual disclosures on Form T1134 by explaining that "Revenue Canada will now be able to obtain this information (1134's) before they begin their audits, making the audit more efficient." In view of the substantial information elicited on Form T-1134 and Revenue Canada's access to that information before commencing its audits (as well as Revenue Canada's ability to verify the taxpayer's disclosures during audit), what is the purpose and utility of requiring taxpayers to complete the separate tax-haven questionnaire during audits?

XIII. Regulation 105(1) Withholding Tax Remittance Schedule

Both "employee source deductions" and the 15-percent withholding tax on payments to non-residents for services performed in Canada (i.e., withholding required pursuant to Regulation 105(1)) must be remitted to Revenue Canada within three business days of the last day of four periods within the calendar month during which the compensation is paid to the employee or service provider. Since employee pay periods are fixed and controlled by the employer and payments are made at regular and predictable times each month, Revenue Canada's so-called Threshold 2 remittance requirements are easily administered for employee source deductions.

In contrast, payments to non-residents for services are frequently made pursuant to invoices rendered by the service provider, and, hence, the timing of the payments is irregular and unpredictable. In addition, the amount of each payment to (and the corresponding withholding from) service providers will vary whereas employee salaries and wages and (the corresponding employee source deductions) tend to be fixed and regular or, at least, predictable. For reasons of administrative efficiency, the withholding tax on payments to non-resident service providers can be more easily accounted for and the proper amount of aggregate withholding tax computed and reconciled with the underlying payments to the service providers, and the tax remitted to Revenue Canada on an aggregate monthly basis. In addition, monthly remittance of Regulation 105(1) withholding taxes will permit companies and Revenue Canada alike to reduce cheque processing costs. Moreover, Revenue Canada will be able to verify more efficiently that the proper amount of tax has been withheld and remitted by focusing on fewer taxpayer reports. We recommend that Revenue Canada consider permitting taxpayers to remit Regulation 105(1) withholding tax on a monthly rather than a weekly or bi-weekly basis. We invite the Department's comments on our recommendation.

XIV. Detailed Support for Adjustments in Reassessments

Taxpayers frequently receive reassessments that do not provide sufficient information from which they can determine the legal basis for Revenue Canada's adjustments. When preparing a Notice of Objection, large taxpayers are required to disclose the legal reasons for their objection. This is a daunting, perhaps impossible, task where the taxpayer is not informed of the basis for the underlying adjustment. We invite Revenue Canada to comment on its policy and practices with respect to providing detailed support for its adjustments. What recourse does a taxpayer, especially a large-file taxpayer, have when it receives an assessment without an explanation of the underlying basis for the adjustment?

XV. Submissions to Ottawa by Tax Services Offices

During the course of their audits, companies frequently learn that submissions have been made by the tax auditors to Revenue Canada Headquarters in Ottawa for advice on the treatment of particular issues. In some cases, taxpayers are afforded the opportunity to review the submission by the Tax Services Office (TSO) and make an independent submission representing the taxpayer's view of the facts and law. The practice of affording taxpayers the opportunity of either reviewing the submission or making an independent representation to Ottawa, however, is inconsistent among TSOs across Canada.

In TEI's view, Revenue Canada is better served by knowing the views of both the auditor and the taxpayer. Indeed, one vital reason for permitting the taxpayer to participate in the submission is to ensure that the facts are fully presented and agreed upon. If the facts are not fully presented, there is no assurance that the Head Office is considering and resolving the correct issues, let alone correctly resolving the issues that are presented. Hence, the government may be wasting its scarce audit resources resolving irrelevant issues or resolving them based on incomplete or even inaccurate facts.

TEI recommends that Revenue Canada publish guidance establishing uniform, equitable procedures to govern the taxpayer's participation in submissions made by TSOs. Specifically, we recommend that the procedure provide that:

1. The TSO and the taxpayer shall make a joint representation of facts, or, where full agreement on the facts cannot be reached, separate representations by each party of the disputed facts.

2. The TSO and the taxpayer present the issues in a joint conference with Headquarters.

3. The TSO and the taxpayer present their own positions with respect to the issues.

XVI. Rights to Object and Appeal Following the Liquidation and Dissolution of a Corporation

Subsection 220(6) was added to the Act in 1996 in order to override section 67 of the Financial Administration Act (FAA) and any other provision of a law of Canada or a province that precludes the assignment of a Crown debt. This provision addresses a practical problem where a corporation being dissolved has an amount receivable from the government.

Where a corporation has been dissolved, however, uncertainty remains about the legal recourse available to shareholders relating to the open taxation years of the dissolved corporation. For example, subsection 67(b) of the FAA states that "no transaction purporting to be an assignment of a Crown debt is effective so as to confer on any person any rights or remedies in respect of that debt." Since audits of corporations are frequently concluded long after a corporation is liquidated or dissolved, it is essential that the corporation's shareholders have the right to file a Notice of Objection and Appeal to an assessment made by the Minister following the liquidation or dissolution of a corporation. In view of Revenue Canada's position that a corporation must be dissolved within one year of its liquidation (except under very limited circumstances), clarification of this right is crucial.

1. What is Revenue Canada's position in respect of the shareholder's rights to file a Notice of Objection and Appeal of an assessment issued to a corporation in the situation described above? In addition, please address the same question under the following alternative circumstances:

a. Where the corporation has been liquidated (i.e., the assets have been transferred to the shareholder following a resolution to liquidate the corporation) but the corporation has not yet been dissolved.

b. Situations where the corporation has been dissolved.

c. Will the answer to part "a" or "b" change depending on the statute under which the liquidated corporation is originally incorporated?

d. Will the answer to part "a" or "b" change if the Notice of Objection and Appeal is filed before the corporation is liquidated or dissolved but the issue is resolved subsequent to the liquidation or dissolution?

2. Paragraph 42 of Information Circular IC 81-11R3 (March 26, 1993) addresses transfers of overpayments and states that "requests for a transfer of a refund to a third party are prohibited by section 67 of the FAA. The Department will therefore deny such requests." In view of the introduction of subsection 220(6) in 1996, has Revenue Canada modified the position stated in the Information Circular?

XVII. Advance Rulings For "In-House" Loss-Transfer Arrangements

Without formal announcement, Revenue Canada has seemingly discontinued, or at least modified, its practice of issuing advance rulings on intra-group or "in-house" loss-transfer arrangements. It is unclear whether this change in procedure is a result of the decision in C.R.B. Logging Co. Limited v. The Queen, Tax Court of Canada No. 96-95(IT)G (February 19, 1999), and hence limited to the facts and circumstances in that case, or whether it reflects a broad change in administrative practice or procedure with far-reaching tax policy implications. TEI recommends that Revenue Canada clarify its position in respect of "in-house" loss-transfer arrangements as soon as possible. Specifically, will Revenue Canada continue to issue rulings on in-house loss-transfer arrangements? If Revenue Canada will generally issue such rulings, are there specific arrangements or fact patterns, such as that presented in C.R.B. Logging, on which Revenue Canada will decline to rule?

More fundamentally, Revenue Canada's challenge to the structure employed by the taxpayer in C.R.B. Logging is troubling since loss-transfer arrangements have been routinely employed by companies and benignly accepted by Revenue Canada. If Revenue Canada will not issue advance rulings in cases similar to C.R.B. Logging, what are the unusual facts or the abuse in the C.R.B. Logging case that led Revenue Canada to challenge it? Should other taxpayers that implemented similar arrangements prior to the decision in C.R.B. Logging expect a challenge from Revenue Canada?

XVIII. Transfer Pricing

We invite Revenue Canada to comment on whether the transfer-pricing provisions in section 247 of the Act will apply with respect to a long-term agreement between parties that, at the time of entering into such agreement, are at arm's length, but that subsequently become related.

In order to frame the discussion, assume the following facts. A taxpayer enters into an agreement to supply products to a U.S. customer for a term of 15 years. Such long-term agreements are customary in the industry and prices during the term of the agreement are adjusted by way of an agreed formula that employs posted benchmark market prices. Following, say, six years, the taxpayer -- by way of an arm's-length merger or acquisition -- becomes related to the customer, but the terms of the supply agreement are unchanged and continue in force for the duration of the original agreement. Would the transfer-pricing provisions apply to this arrangement at the time the parties become related (i.e., after year 6)?

The transfer-pricing adjustment provision in subsection 247(2) seemingly applies only where the words of the preamble are satisfied, i.e., where a taxpayer and a non-arm's length non-resident person are participants in a transaction or series of transactions. In view of the foregoing facts, is this test applied on a onetime basis at the time the supply agreement is entered into? Assume that the agreement results in a continuing series of shipments or deliveries under the contract. An argument can be made that a supply agreement such as that contemplated in the assumed facts should be considered as one "transaction" for purposes of subsection 247(2) rather than a series of transactions even though it involves a continuing series of actions (i.e., the continuing supply and payment for product). The continuing actions are a result of a single event (the entering into of the agreement) that governs the parties' relationship automatically throughout the term of the agreement unless modified or terminated. Consequently, assuming the parties are at arm's length when the agreement is entered into and assuming the terms of the agreement are not subsequently modified, a change in the parties' relationship from arm's length to non-arm's length should not bring the parties into the transfer-pricing provisions with respect to the supply agreement. We invite Revenue Canada's views on this interpretation of subsection 247(2).

XIX. Calculation of Exempt Surplus

The incorporation of a new holding company in the United States to hold the shares of an existing U.S. corporation and the formation of a new U.S. consolidated group seemingly produces unintended results in the calculation of exempt surplus where the pre-existing group has loss carryovers. To illustrate the issues for discussion, assume the following facts.

A new U.S. Holding Company (Holdco) forms a consolidated group by the acquisition of 100 percent of the shares of old U.S. Loss Company (Lossco). In this transaction, Holdco becomes "the primary affiliate" for purposes of the exempt surplus regulations. Lossco has U.S. losses carried forward from taxation years prior to the incorporation of Holdco. These losses subsequently offset the taxable income and taxes of the consolidated group.

Regulation 5907(1.1) provides rules for the adjustment of the exempt surplus pools of consolidated groups by equitably shifting surplus to the appropriate members of the group. Under Regulation 5907(1.1)(a)(v), when the losses of Lossco are used to reduce the taxable income of the group (in this case Holdco's income specifically), Holdco's exempt surplus should be increased by the amount of tax that would otherwise be payable. In other words, since Holdco's dividend-paying potential is increased by the amount of taxes avoided by offsetting the losses of Lossco against Holdco income, Holdco's exempt surplus should be increased by the amount of tax savings. Under the regulations, however, the increase in exempt surplus is made at the "end of the year of the loss" and where Lossco's carryforward losses are used to offset Holdco income, Holdco has no taxation year at the "end of the year of the loss."

It is our understanding that Revenue Canada will not permit the exempt surplus of Holdco to be increased in this circumstance. As a result, Lossco's surplus will have been reduced by the operating losses. Moreover, Holdco's surplus will be reduced under Regulation 5907(1.1)(a)(ii) in respect of the taxes otherwise payable with no compensating increase under subparagraph (v). Would Revenue Canada confirm TEI's understanding of Revenue Canada's position? Assuming our understanding is correct, would Revenue Canada consider changing its position in order to mitigate this anomaly?

XX. Withholding Taxes on Director's Fees

TEI understands that Revenue Canada has issued a waiver of withholding under Regulation 105 on fees paid to some U.S. resident individuals who serve as members of a Canadian corporation's board of directors. We believe that Revenue Canada's waiver is based on its interpretation of Article XIV of the Canada-United States Tax Treaty that the individual's services as a member of a board of directors are of an "independent nature" as well as representations that the non-resident individual (1) works no more than 15 days in Canada, (2) maintains no fixed base in Canada, and (3) has no other sources of income from within Canada.

Would Revenue Canada confirm that fees paid for services rendered by members of a board of directors are treated as compensation for services of an independent nature for purposes of the Canada-United States Treaty? Assuming a waiver of withholding is granted in such cases, what additional administrative requirements are imposed on the non-resident? For example, is the non-resident individual required to file a federal tax return reporting the director's fees and then claim the benefit of the treaty exemption to reduce his or her tax liability to nil?

XXI. Large-Case Audit Procedures

In some large-case files, audits are handled by more than one Tax Services Office (TSO) or by more than one large-case file manager. We invite a discussion of Revenue Canada's policies for administering large-case files where more than one TSO or large-case file manager is involved. Specifically, what practices and procedures are in place to ensure that issues will be resolved and, as important, resolved consistently? Under what conditions will a company be assigned multiple large-case file managers? Where more than one case manager is assigned to a case, is there one person with overall responsibility for making the decisions on the audit with whom the taxpayer can deal directly?

XXII. Section 13(21.2)

Under clause A of subparagraph 13(21.2)(e)(iii) of the Act, a transferor of property is deemed to own the property until immediately before the first time at which a 30-day period begins throughout which neither the transferor nor a person affiliated with the transferor owns the transferred property. [n other words, when property is transferred between related companies, any loss to the transferor arising from the transfer is deferred until the property is subsequently disposed of by the transferee.

Assume corporation A transfers property to corporation B while B is related to or affiliated with A and that, absent affiliation, the transfer would produce a loss to A. At a later date, B's affiliation with A is terminated while B continues to own the property. Please confirm that upon the disaffiliation of the two companies, corporation A may claim the previously denied loss. TEI submits that a transferor of property (A in this case) should be allowed to claim the loss at that time because the change in the legal relationship between A and B is similar to a change of control of A for which clause 13(21.2)(e)(iii)(D) explicitly permits a loss to be recognized. Following any method of disaffiliation between a transferor (A) and a transferee (B), it will be extremely difficult for the transferor to monitor when the transferee actually disposes of the property. Hence, the previously denied loss should be recognized on disaffiliation. Would Revenue Canada confirm this view?

XXIII. Paragraph 15(2.3)

Assume the following facts. A subsidiary of a Canadian parent company acts as the "banker" or centralized financing arm for a large Canadian corporate group that includes multiple Canadian corporate taxpayers. Under the arrangement, the subsidiary accepts and deposits all cash of the corporate group and makes all payments required to be made by any corporation in the corporate group. Temporary cash reserves of the group are invested by the subsidiary in the ordinary course of its business in corporate and government debt instruments.

Would Revenue Canada confirm that subsection 15(2) does not apply to debt instruments held by the subsidiary even though the debt is issued by a non-resident company that is connected with the subsidiary's shareholder? In answering the question, assume the investment is made by the financing subsidiary in the ordinary course of its business. In our view, subsection 15(2.3) prevents the application of subsection 15(2). Would Revenue Canada please confirm that view?

XXIV. Macmillan Bloedel

The management of financial risks arising from transactions, investments, or liabilities denominated in foreign currency is an important and challenging task for international companies. To the extent possible, companies desire certainty of the tax and financial results. As a result we would appreciate Revenue Canada's views in respect of the application of a recent case. Specifically, in The Queen v. MacMillan Bloedel Ltd., Federal Court of Appeal No. A-655-97 (July 13, 1999), the court held that the additional amount paid by a Canadian taxpayer on the redemption of preferred shares issued in U.S. dollars is a capital loss under subsection 39(2). The loss arose because of an increase in the value of the U.S. dollar relative to the Canadian dollar between the dates the shares were issued and the date the shares were redeemed. Does Revenue Canada accept the result and reasoning of this decision? Will Revenue Canada request the Department of Finance to propose amendments to the Act in order to clarify any aspects of such transactions?

XXV. Guarantee Fees

Assume that a Canadian parent corporation and its U.S. subsidiary participate in a shared credit facility that benefits both parties. The agreement calls for a guarantee from the Canadian parent on any loan to the U.S. subsidiary and a guarantee from the U.S. subsidiary on a loan to the Canadian parent. No guaranty fees are charged or paid between the two corporations. Would Revenue Canada confirm whether the Canadian corporation is required to include a deemed guarantee fee in income? If there is a provision that requires the inclusion of a deemed guarantee fee, would Revenue Canada also permit a deemed expense for the guarantee fee presumably paid to the U.S. subsidiary? Assuming there is a deemed payment of a guarantee fee to the U.S. subsidiary, is there a withholding tax issue? Assume the Canadian corporation is required to act on its guarantee. Is the payment a capital loss?

XXVI. Scope of Proposed Subsection 6(23)

There is substantial ambiguity about the scope of proposed subsection 6(23) and the treatment of various types of relocation expenses paid or reimbursed by the employer. Will Revenue Canada issue additional guidance soon detailing the types of relocation expenses that will be considered taxable benefits under this proposed provision? In the same vein, it would be beneficial if Revenue Canada clarified for taxpayers, to the extent possible in the same document, the relationship between amounts subject to an income tax inclusion under this provision and amounts eligible for an employee moving expense deduction under section 62 of the Act.

XXVII. Employer Provision of Duplicate Housing Costs During an Employee Relocation

We request that Revenue Canada consider the following situations involving duplicate housing costs reimbursed by the employer to the employee and comment on the taxability of the payments as well as the availability of a deduction for moving expenses by the employee under section 62. In each case, assume the employee commences employment at a new work location after September 1998.

1. As a consequence of a relocation, an employee is required to maintain two residences for a period of time. The employer reimburses the employee for carrying costs on either the new residence or the old residence. These costs exceed $5,000 and they are incurred for a period of time prior to the employee's family joining the employee at the new work location. (A common example of this is where the employee's family remains at the old location in order to permit the children to complete the school year at the old location.)

2. The employee's family moves at the same time as the employee and less than $5,000 of duplicate costs related to the old residence are reimbursed.

3. Is the answer to situation 2 different if the reimbursement is in respect of the costs at the new residence?

4. The employee's family moves at the same time as the employee and duplicate housing costs in respect of the new residence exceeding $5,000 are reimbursed by the employer.

XXVIII. Amended Section 17 -- Interpretative Issues

Section 17 was recently amended and poses a number of difficult interpretative questions and issues. We would appreciate your guidance in respect of the following questions:

1. Assume a Canadian corporation is the sole source of funding for a foreign affiliate. Is the condition in subparagraph 17(2)(b)(i) satisfied? If the answer is yes, is the answer the same where the Canadian corporation is a major or significant source of the foreign affiliate's funding?

2. If the answer to part I is yes, and a Canadian corporation is the sole source of funding for a foreign affiliate that makes loans to non-affiliated third parties at commercial rates within an investment business and the income on such loans is relevant to the calculation of the amount included under subsection 91(1) of the funding corporation:

a. To the extent that the funding of the foreign affiliate making the loans is by way of equity contribution from the Canadian corporation, are the third party loans subject to subsection 17(2)?

b. Would the answer to part "a" be different if the funding is by way of a loan at a rate at least equal to the prescribed rate?

c. If a loan as described above requires an inclusion on a deemed loan under subsection 17(2), is there any way to offset the interest taxed on the real loan?

d. Would the interest from the third parties described in the assumption meet the test in subparagraph 17(1)(b)(iii)?

e. Would the answer to part "d" be different if there were no net inclusion under subsection 91(1) because of varying factors, including the underlying tax or that there is no net profit?

3.

a. Where a foreign affiliate (i) is partly funded by the Canadian parent and partly by third-party loans, (ii) has made a deemed loan under subsection 17(2), and (iii) whose assets consist of low-interest debt obligations, commercial debt obligations, and other assets, then how is the income inclusion calculated? Does the entire amount described in paragraph 17(2)(a) generate a deemed loan under subsection 17(2) if it is reasonable to conclude that any portion of such amount is related to a loan or transfer as described in subparagraph 17(2)(b)(i)? If some amount less than the entire amount described in paragraph 17(2)(a) generates a deemed loan, how is the lesser amount of the deemed loan determined--by a tracing or an apportionment method?

b. What happens if the mix of funding of the foreign affiliate changes over time?

c. What happens if the mix of assets of the foreign affiliate changes over time?

XXIX. Section 16.1 -- Partnerships and Tax-Exempt Entities

Increasingly, active operating businesses are being carried on in Canada through publicly traded limited partnerships. Moreover, tax-exempt entities such as pension and mutual funds frequently invest in such partnerships. In many cases the general partner is unable to determine whether the limited partners are tax exempt because the interests are either unregistered or held at a stock brokerage in "street name." For valid reasons, the businesses in these limited partnerships may lease equipment to others and, hence, the lessees may request that the lessor make a joint election under section 16.1 of the Act.

One requirement for a valid election under section 16.1 is that the lessor be "a person resident in Canada." The preamble to section 16.1 was recently amended to provide that the lessor must be "... a person resident in Canada other than a person whose taxable income is exempt from tax under this Part...." The Explanatory Notes to the legislation imply that the amendment was enacted to counter certain transactions where tax-exempt entities were able to significantly reduce their financing costs but at a considerable cost to the fisc. Specifically, the Department of Finance was concerned with transactions where equipment that would otherwise have been used directly by a tax-exempt entity in the course of providing services is instead leased to a taxable entity that provides the services on behalf of the tax-exempt entity. The lease revenues are then used by the tax-exempt to finance the asset purchase.

1. Assuming all partners in a partnership are taxable entities, can a section 16.1 election be made with a limited partnership as the lessor? In two separate technical interpretations (see 9112095 and 9708635), the Income Tax Rulings & Interpretations Directorate of Revenue Canada opined that a partnership can be a party to a section 16.1 election as either a lessee or a lessor. While there is a strong legal basis for the position that a partnership can be lessee in a section 16.1 election, the case is less clear that a limited partnership can be a lessor. Briefly, under paragraph 96(1)(a) of the Act, where a taxpayer is a member of a partnership, income is computed as though the partnership were a separate person resident in Canada. Since section 16.1 is relevant in computing the partner-shiplessee's income, it follows that the partnership should be considered "a person resident in Canada" for purposes of section 16.1. This rationale seemingly does not track as well for a partnership acting as a lessor under a section 16.1 election. Technical interpretation 9708635, however, properly confirms that a partnership can be a lessor in a section 16.1 election, but the interpretation omits the explanation for its position. Will Revenue Canada please confirm that a valid section 16.1 election can be made with a partnership as the lessor and explain the basis for its position?

2. Assuming the answer to Question 1 is yes, would the recent amendment regarding tax-exempt lessors preclude a publicly-traded limited partnership, which may from time to time have unit holders that are tax-exempt entities, from being a lessor in a section 16.1 election? In responding to the question, assume that the ownership interest of such tax-exempt entities ranges from 20 to 50 percent of the partnership.

3. If a partnership whose tax-exempt partners own in excess of some threshold percentage of the partnership cannot be a lessor in a section 16.1 election, what would Revenue Canada's position be if at the time of making the election the partnership has no tax-exempt partners but at a subsequent time during the lease term a tax-exempt entity acquires an interest in the partnership?

XXX. Effect of the Parthenon Decision on the Definition of Control

In Parthenon Investments, Limited v. the Minister of National Revenue, 97 DTC 5343 (FCA 1997) the court held that control of a subsidiary rests with the ultimate parent company. In order to clarify the application of the court's decision, TEI invites Revenue Canada's views about the following:

ParentCo, a Canadian company, is engaged solely in a manufacturing business. Subsidiary A is 100 percent directly held by ParentCo, is in the business of lending money, and is a restricted financial institution (RFI) within the meaning of paragraph (e) of subsection 248(1). Subsidiary B is 100 percent directly held by Subsidiary A and is engaged solely in the business of manufacturing.

1. Is Subsidiary B, by virtue of Subsidiary A's direct ownership interest, also deemed an RFI pursuant to paragraph (f) of the definition of an RFI in subsection 248(1)?

2. Alternatively, does the Parthenon decision stand for the proposition that Subsidiary B is not an RFI since ParentCo has ultimate control of Subsidiary B, i.e., one looks through intermediate owners to the ultimate parent?

XXXI. Valuation of Employee Achievement Awards and Gifts

Many large employers have established Christmas gift and employee recognition programs as a means of rewarding employees, generally in a symbolic but significant fashion, for long-term service, safety achievements, or other contributions. Indeed, the programs are necessary in order to remain competitive with other Canadian and international companies. Most awards consist of tangible products such as clocks, watches, pens, golf clubs, hats, jackets, and gift certificates. Revenue Canada's longstanding position is that employer gifts and awards constitute a taxable benefit to employees unless (1) the award or gift is valued at $100 or less, and (2) the employer does not claim a deduction for the amount of the gift. In addition, the income exclusion is limited to one gift per year per employee. Notwithstanding price increases owing to inflation, the nominal $100 threshold for imputing a taxable benefit from these items has not been adjusted for many years. Hence, the long-service award of, say, a $110 clock engraved with the company logo and employee's name will cost the employee $55 of income tax and the employer the administrative cost of tracking and reporting the taxable benefit. Hence, the antiquated threshold substantially diminishes the intangible value of heightened employee morale and goodwill that companies seek to promote with employee recognition programs.

In contrast, the United States permits an annual income exclusion for certain qualifying achievement awards (generally for long-term service or safety) valued up to US$1,600. (An annual income exclusion of up to US$400 is permitted for other types of awards.) Not only is the employee exempt from tax on qualifying awards, but a deduction for the same amount is permitted to the employer. TEI recommends that Revenue Canada consider increasing the de minimis threshold for imputing a taxable benefit on employee gifts to an amount that is competitive with the United States. In view of the administrative costs necessary to establish and operate such programs, the $100 threshold is simply too parsimonious. We invite Revenue Canada's response.

XXXII. ITC Recapture

Does Revenue Canada have a position or published guidelines about whether or when "First and Second Term Shared-Use-Equipment" used primarily in the prosecution of SR&ED will be considered to be "converted to commercial use" for purposes of subsection 127(27) and the related ITC recapture provisions?

XXXIII. Format of Tax Returns

In order to reduce paper consumption and waste, most application software programs permit users to print hardcopy of their electronic files on both sides of a sheet of paper. So too, where computer software is used to generate and print tax returns, the software can generally print the tax return on both sides of the paper. Does Revenue Canada currently accept tax returns where the information is printed on both sides of the paper? If not, will the Department consider amending its rules to permit such filings?

XXXIV. Criteria for Permanent Establishment -- Customs v. Income Tax

Many U.S. TEI member companies have Canadian subsidiaries with operating businesses in Canada. In most cases, the Canadian subsidiaries have been active in Canada for years, paid income taxes, and have been subject to audit by the Income Tax Division. Hence, the companies are substantial enough to be deemed to have a permanent establishment (PE) in Canada. Recently, some of these Canadian subsidiaries have been audited by the Customs Division. In their assessment notices, the Customs auditors have asserted a higher valuation for the imported goods based on the end-selling price to customers in Canada. In effect, the Customs auditors ignored the transfer of title to the goods as well as the valuation on the intercompany sale of goods from the U.S. Company to the Canadian subsidiary, asserting that the Canadian companies do not have a PE -- at least not for Customs purposes. Will Revenue Canada please explain the basis of, and the differences in, the criteria for a PE for Customs and Income tax purposes? Please explain how a longstanding, viable Canadian subsidiary that has paid substantial income taxes over the years can be deemed to have a PE for Income Tax purposes but none for Customs purposes. If the parent company made an adjustment to the intercompany billing to the subsidiary, up to the customs' value, would the Canadian subsidiary be entitled to an increased income tax deduction for its cost of goods sold to the Canadian customer? Are there any other substantive or procedural requirements the subsidiary must satisfy to claim the increased deduction?

XXXV. 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 7, 1999, liaison meeting.
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