Recent Measures Relating to Tax Administration, including Avoidance and Evasion

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1 Recent Measures Relating to Tax Administration, including Avoidance and Evasion Carrie Aiken, Blake, Cassels & Graydon LLP, Calgary Alison Jackson, EY LLP, Calgary Calgary, AB Current Issues Overview Newly announced initiatives 2015 Federal Budget Legislative Proposals CRA Announcements and Administrative Policy 2 Carrie Aiken & Alison Jackson

2 Current Issues Offshore Tax Informant Program (OTIP) Offers informants who are willing to identify themselves a reward of up to 15% of the amount of taxes that are ultimately collected As of May 2014, more than 800 tips, resulting in 80 new files 3 Carrie Aiken & Alison Jackson Current Issues Aggressive Tax Planning Program Included in the Spring Report of the Auditor General Focused on how the CRA manages to ATP program and how Finance responds to requests for legislative amendments to address issues identified by the CRA Confirmed that the ATOP program has the tools to detect, correct and deter non-compliance. Gaps in how the CRA measures performance 4 Carrie Aiken & Alison Jackson

3 Current Issues Underground Economy Advisory Committee Comprises key industry stakeholders from the business community and tax profession Assist government design the CRA s strategy to combat the underground economy Advise on current trends, identify emerging risks, assist in understanding taxpayer compliance behaviour and contribute to the development of innovative compliance tools 5 Carrie Aiken & Alison Jackson Current Issues 2015 Federal Budget Number of tax-friendly measures Limited relief for Canadian source withholding requirements for non-resident employees Extension of accelerated tax depreciation rates for machinery and equipment Phased-in decrease in small business tax rate Increased lifetime capital gains exemption for qualified farm or fishing property to $1M of capital gains 6 Carrie Aiken & Alison Jackson

4 Current Issues 2015 Federal Budget Proposed amendments to s. 241 of the Income Tax Act, s. 295 of Excise Tax Act and s. 211 of the Excise Tax Act, 2001 Will broaden the extent to which taxpayer information obtained under these provisions can be used by CRA officials for debt collection purposes or supplied to other government officials for purposes of administering the statutes identified in the amendments 7 Carrie Aiken & Alison Jackson Current Issues 2015 Federal Budget Proposed amendments to permit the Minister to advance alternative arguments after the relevant reassessment period has expired Cannot increase the total amount of the assessment Corresponding proposals to Excise Tax Act and Excise Tax Act, Carrie Aiken & Alison Jackson

5 Current Issues Federal Budget Enhanced small business tax rate benefit Reduction will be implemented as follows: 10.5% effective January 1, % effective January 1, % effective January 1, % effective January 1, 2019 Adjust gross-up factor and dividend tax credit rate applicable to non-eligible dividends Announced a consultation on active versus investment business 9 Carrie Aiken & Alison Jackson Current Issues Federal Budget Extension to the 2005 temporary measure to provide tax deferral to patronage dividends paid to members by an eligible agricultural cooperative in the form of eligible shares To be eligible, the share must be issued after 2005 and before 2016, but the federal budget proposes to extend this measure to apply in respect of eligible shares issued before Carrie Aiken & Alison Jackson

6 Current Issues Tax Avoidance Deny inter-corporate dividend deduction on dividends received by a taxpayer on a Canadian share in respect of which there is a synthetic equity arrangement Significant amendments to section 55 rules to attack tax avoidance of corporate capital gains 11 Carrie Aiken & Alison Jackson Current Issues Section 55 Amendments Existing s. 55(2) deems an inter-corporate dividend to be proceeds of disposition or a capital gain if one of the purposes of the dividend was to effect a significant reduction in a capital gain on shares (except for the portion of the dividend reasonably attributable to safe-income ) Existing s. 55(2) does not apply to dividends that produce or increase a capital loss on shares 12 Carrie Aiken & Alison Jackson

7 Current Issues Section 55 Amendments Proposed amendment intended to ensure that s. 55(2) applies where one of the purposes of a dividend is to effect a: significant reduction in the fair market value of any share, or significant increase in the total cost of properties of the recipient of the dividend All recharacterized dividends will be deemed to be capital gains (and not proceeds of disposition, as is the case in some circumstances under the existing rule) 13 Carrie Aiken & Alison Jackson Current Issues Section 55 Amendments Amendments provide that s. 55(3)(a) exception to s. 55(2) only applies to deemed dividends under s. 84(3) Exemption no longer applies to dividend actually declared Amendments introduce new rules in s. 55 dealing with stock dividends 14 Carrie Aiken & Alison Jackson

8 Current Issues Administrative Developments Updated and released several folio views, including interest deductibility, payments to employees, what is a partnership Released updated information circular on Advanced Income Tax Rulings and Technical Interpretations (IC 76-6R6) Announced CRA will be extending its pre-ruling consultation program until the end of Carrie Aiken & Alison Jackson Current Issues Administrative Developments Reversed position that a USA is not relevant in analyzing the hypothetical person test under paragraph (b) of the definition of CCPC ( C6) Reversed position that $1 allocated to a restrictive covenant to make contract legally binding would make the exemptions in 56.4(6) and (7) inapplicable ( C6) 16 Carrie Aiken & Alison Jackson

9 Current Issues Administrative Developments Confirmed and summarized existing policy on requests for change to fiscal period ( E5) Changes should only be approved if motivated solely by sound business reasons, which include Aligning fiscal periods with parent or associated company Aligning fiscal periods with business cycle Changing fiscal period the day before a taxdeferred transfer of property 17 Carrie Aiken & Alison Jackson Current Issues Administrative Developments Amended policy on issuing certificates of residency for partnerships Confirmed that each partner (or a representative on behalf of all partners) can request a certificate of residency for the partners and the CRA will certify that the partnership is a Canadian partnership as of a particular time 18 Carrie Aiken & Alison Jackson

10 Current Issues Administrative Developments Contrary to current administrative practice, the spouse of a deceased individual will not be able to claim a gift made by the individual s will for deaths occurring after 2015 ( E5) Released general considerations applicable to crowdfunding in Canada Depending on the facts, monies received under a crowdfunding arrangement could be a loan, capital contribution, gift, income or combination May be taxable if crowdfunding is to develop a new product and the taxpayer carries on a business 19 Carrie Aiken & Alison Jackson Current Issues Conclusion Renewed focus on tax avoidance and evasion Stakeholders remain committee to identifying and addressing perceived abuses in the Canadian tax system Taxpayers and advisors need to stay apprised of changes to long-standing administrative positions and new or proposed legislation 20 Carrie Aiken & Alison Jackson

11 RECENT COURT DECISIONS Heather DiGregorio, Burnet, Duckworth & Palmer LLP Dan Jankovic, Blake, Cassels & Graydon LLP) Calgary, AB Outline Recent Court Decisions McGillivray Restaurant Ltd. v. The Queen 2014 TCC 357 (under appeal) The TDL Group Co. v. The Queen 2015 TCC 60 (under appeal) Kruger Wayagamack Inc. v. The Queen 2015 TCC 90 (under appeal) George Weston Limited v. The Queen 2015 TCC 42 2 Heather DiGregorio & Dan Jankovic

12 Recent Court Decisions De Facto Control McGillivray Restaurant Ltd. v. The Queen 3 Heather DiGregorio & Dan Jankovic Recent Court Decisions Ownership Structure GRR 100% Gordon Howard 100% Morcourt Ruth Howard 24% 76% McGillivray Restaurant Real Estate Portage Avenue Garry Street McGillivray Blvd. (formerly Pembina Highway) 4 Heather DiGregorio & Dan Jankovic

13 Recent Court Decisions Facts 3 Keg restaurants in Winnipeg One was owned by McGillivray Restaurant Ltd. Small business deduction would be shared between the 3 companies if McGillivray was associated with the other two. 5 Heather DiGregorio & Dan Jankovic Recent Court Decisions Ownership Structure Pre-2005 Gordon Howard 100% GRR Mr. Howard worked for Keg starting in 1976 worked his way up from waiter After 20 years, GRR acquired franchises for 3 Keg restaurants Leased premises Portage Avenue Garry Street Pembina Highway 6 Heather DiGregorio & Dan Jankovic

14 Recent Court Decisions Set up Of McGillivray Restaurant Decision was made to replace Pembina location with a new restaurant on McGillivray Blvd. Advisors recommended: The real estate be owned in Morcourt The restaurant itself be owned in a new corp with his Mrs. Howard as majority owner 7 Heather DiGregorio & Dan Jankovic Recent Court Decisions The Two Companies Because Mrs. Howard owned 76% of the shares, the company was "fully independent" of the other corporations But once it was set up, he wouldn't need wife's approval to make any decisions on behalf of the company Mrs. Howard was not involved in the planning, or set-up of the company She contributed $76 for her 76% interest Franchisor was told that Mr. Howard would be running the business Employees were told that Mr. Howard was still the boss The running and operation of all 3 restaurants remained the same after the new McGillivray location was opened. 8 Heather DiGregorio & Dan Jankovic

15 Recent Court Decisions Interdependence of Companies All administration, accounting and head office functions provided by GRR Books and records Bookkeeping Bank accounts for all three companies were consolidated in one McGillivray Restaurant loaned significant amounts to GRR with no interest, security or repayment terms McGillivray Restaurant guaranteed GRR's bank debt and provided a GSA over its assets 9 Heather DiGregorio & Dan Jankovic Recent Court Decisions Mrs. Howard's Roles Mrs. Howard did not ever review the financial statements. Mrs. Howard's roles: Offering her opinion from time to time Particularly from a woman's point of view Responsible for plants on the patios Typically spent a few hours every week evaluating staff, food, décor, atmosphere, and evaluating competitor restaurants 10 Heather DiGregorio & Dan Jankovic

16 Recent Court Decisions Mr. Howard's Roles Mr. Howard's roles: Sole director and President and Secretary Operations Director and General Manager Execute contracts, conduct banking, borrow money, provide guarantees and appoint agents 11 Heather DiGregorio & Dan Jankovic Recent Court Decisions The Law Examines the two lines of de facto case law that have developed Ability to effect a significant change to the board of directors or influence the shareholders who would otherwise have the ability to elect the directors (Narrow) Who is actually in control of day-to-day operations of the company (Broad) 12 Heather DiGregorio & Dan Jankovic

17 Recent Court Decisions Other Cases Cases considered: Silicon Graphics Lenester Sales Transport Couture Plomberie Langlois Mimetix Pharmaceuticals 13 Heather DiGregorio & Dan Jankovic Recent Court Decisions Conclusion on Law Test is effective control over the affairs and fortunes of the corporation Broader manners of influence apply 14 Heather DiGregorio & Dan Jankovic

18 Recent Court Decisions Application to the Facts Mr. Howard had control over all aspects of the company's operations Mr. Howard had considerable influence over Mrs. Howard's decisions in respect of the company Mrs. Howard was severely limited in being able to run the company as a success if she removed Mr. Howard 15 Heather DiGregorio & Dan Jankovic Recent Court Decisions Conclusion Mr. Howard had de facto control over McGillivray Restaurant McGillivray Restaurant was associated with GRR 16 Heather DiGregorio & Dan Jankovic

19 Recent Court Decisions Interest Deductibility The TDL Group Co. v. The Queen 17 Heather DiGregorio & Dan Jankovic Recent Court Decisions Transactions March (2002) 1. Wendy's lends $234M to Delcan 2. Delcan lends to TDL 3. TDL subscribes for additional common shares of Tim s US 4. Tim s US immediately lends to Wendy's without interest (originally intended to be interest bearing) June to November (2002) 1. Tim s US incorporates Buzz Co. 2. Tim s US assigns note (owing by Wendy s) to Buzz Co. as subscription for shares 3. Buzz Co. issues demand for payment on the note to Wendy s 4. Wendy's repays interest-free note (in full) to Buzz Co. by issuing a new interest bearing note (for the same amount, at 4.75%) Interest bearing (7%) Interest bearing (7.125%) Wendy's 1 2 Delcan TDL 3 Tim s US Buzz Co. Borrower Lender 4 U.S. Canada U.S. 18 Heather DiGregorio & Dan Jankovic

20 Recent Court Decisions Issue Whether TDL s deduction of interest on the funds borrowed from Delcan (in order to acquire additional shares of Tim s US) satisfied the purpose test in subpara. 20(1)(c)(i) i.e., whether the borrowed funds were used by TDL for the purpose of earning income (from the additional common shares of Tim s US) the parties did not dispute the eligible direct use of the borrowed funds CRA denied interest deduction for the period during which the loan from Tim s US to Wendy s was non-interest-bearing but allowed the deduction after Wendy s repaid the noninterest bearing note by issuing an interest-bearing one 19 Heather DiGregorio & Dan Jankovic Recent Court Decisions 4 Elements in subparagraph 20(1)(c)(i) 1. Amount must be paid in the year or be payable in the year in which it is sought to be deducted; 2. Amount must be paid pursuant to a legal obligation to pay interest on borrowed money; 3. Borrowed money must be used for the purpose of earning non-exempt income from a business or property; 4. Amount must be reasonable (as assessed by the reference to the first three requirements). 20 Heather DiGregorio & Dan Jankovic

21 Recent Court Decisions Crown Wins TCC relied, in part, on SCC s guidance in Ludco courts should objectively determine the nature of the purpose, guided by both subjective and objective manifestations of purpose In the result, the requisite test to determine the purpose for interest deductibility under s. 20(1)(c)(i) is whether, considering all the circumstances, the taxpayer had a reasonable expectation of income at the time the investment was made [i.e., at the time TDL acquired the shares in Tim s US.] 21 Heather DiGregorio & Dan Jankovic Recent Court Decisions All the circumstances Very broad meaning of the phrase In determining existence of an income-earning purpose for acquiring Tim s US shares, TCC not precluded from examining: series of transactions related to the direct investment the indirect and ultimate use of the funds by Tim s US and other members of the group; and any other relevant factor 22 Heather DiGregorio & Dan Jankovic

22 All the Circumstances Recent Court Decisions When TDL subscribed for additional common shares of Tim s US: 1. Tim s US had been a wholly-owned subsidiary of TDL for 4 years 2. Tim s US had sustained substantial operating losses in those 4 years (although there was a reversing/positive trend) 3. Tim s US was not in a financial position to pay any immediate or short term dividends 4. Group policy of no returns on investments (i.e., dividends) until all capital expenditures were funded year business plan called for substantial capital investments to increase the number of stores in the US but did not plan for or include any dividends 6. There was no history of past dividends Above factors were relevant in determining existence of income-earning purpose especially since evidence was that the loan was intended to be and was outstanding for approximately 7 months in Heather DiGregorio & Dan Jankovic Recent Court Decisions All the Circumstances Dividends were paid in 2007 to 2012, ranging from $100,000 per year from $1M for each of 2010 and 2011 $500,000 in 2012 Court rejects above dividends as proof of income earning purpose In 2006, the Tim Hortons group was spun out of the Wendy s group No evidence was lead to suggest these dividends were in the cards at the time of subscribing for the additional shares of Tim s US in 2002 Projected dividends were not included in the 10 year business plan, the planning memo, or in the corporate resolutions of each of TDL, Tim s US and Buzz Co. 24 Heather DiGregorio & Dan Jankovic

23 Recent Court Decisions TCC Concludes: No Income Earning Purpose TDL did not have a reasonable expectation to earn income from the acquisition of the additional shares of Tim s US at the time of the such acquisition income as either immediate or future dividend income or even increased capital gains 25 Heather DiGregorio & Dan Jankovic Recent Court Decisions TCC: Lack of Credible Evidence TCC was not convinced by submitted evidence that the funds invested in Tim s US were used (or were intended to be used) for any purpose other than to loan monies to Wendy s on an interest free basis The fact the funds used to buy the new shares [of Tim s US] were immediately loaned to Wendy s without interest for about 7 months after which funds were paid back in full suggests no obvious expectation that those funds created or were expected to create any income for Tim s US so as to increase its ability to pay dividends or increase the value of its shares for the future income benefit of [TDL]. If interest had been charged, we would not be here today. 26 Heather DiGregorio & Dan Jankovic

24 Recent Court Decisions TCC Examined Corporate Resolutions TDL s Director s Resolution indicated that TDL funds used to acquire Tim s US shares were expected to be used to repay debt by Tim s US and for future capital expenditures argument that the purpose of such funds was to create wealth through the accumulation of capital for TDL s subsidiary despite the resolution, no repayment of debt was made and no direct capital expenditures were made as all the funds were lent to Wendy s 27 Heather DiGregorio & Dan Jankovic Recent Court Decisions TCC Examined Corporate Resolutions Tim s US Director s Resolution referred to Tim s US indebtedness to Wendy s of $50,000 and authorized Tim s US (upon receipt of TDL s capital contribution of $234M) to: repay accounts payable to Wendy s; and lend any remaining amounts to Wendy s (with or without interest) although the capital contribution far exceeded the amount of the stated indebtedness, no debt was paid to Wendy s Tim s US Director s Resolution does not refer to any capital expenditures mentioned in the TDL s Director s Resolution 28 Heather DiGregorio & Dan Jankovic

25 Recent Court Decisions Open Questions Does income from property include capital gains? TCC held that TDL had to demonstrate that its new investment in Tim s US was expected to create or increase the chances for dividends or at least an increase in the value of its Tim s U.S. shares Appears TCC would permit interest deduction even where non-dividend paying shares are purchased Subsection 9(3) provides that, in this Act, income from a property does not include any capital gain from the disposition of that property TCC s reliance on Ludco Although in Ludco the borrowed money was used by the taxpayers to invest in shares expecting to earn dividends and future capital gains, SCC focused on the dividend potential of the shares FCA will hopefully provide insights on this point 29 Heather DiGregorio & Dan Jankovic Open Questions Recent Court Decisions When is the purpose test to be applied? at the time the investment is made? ongoing (year by year) test? CRA allowed interest deduction after Wendy s repaid its interest-free note to Buzz Co. by issuing a new interest bearing note is this consistent with TCC s decision? When determining the income-earning purpose in this case, how do we reconcile the examination of series of transactions and the rejection of the dividends paid from ? 30 Heather DiGregorio & Dan Jankovic

26 Recent Court Decisions Take-aways Subpara. 20(1)(c)(i) requires identification of: 1. the use of the borrowed funds, and 2. the purpose of the borrowed funds The use part of the test: ascertain the eligible direct use of the borrowed funds ongoing test for interest deductibility The purpose part of the test: consider all the circumstances in ascertaining whether the taxpayer has a reasonable expectation of income at the time the investment is made v. ongoing test? 31 Heather DiGregorio & Dan Jankovic Recent Court Decisions Take-aways If interest had been charged, we would not be here today. Evidence matters (especially where courts have to objectively determine the nature of the purpose) Courts can examine corporate resolutions and other documentary evidence what is stated in them should reflect what happens 32 Heather DiGregorio & Dan Jankovic

27 Recent Court Decisions Control Kruger Wayagamack Inc. v. The Queen 33 Heather DiGregorio & Dan Jankovic Recent Court Decisions Ownership Structure Kruger Inc. Government of Quebec Canada Ltd. SGX Rexfor 51% 49% Kruger Wayagamack (Millco) 34 Heather DiGregorio & Dan Jankovic

28 Recent Court Decisions Facts Kruger and the Quebec government purchased an old pulp and paper mill that needed modernization Incurred significant SR&ED expenditures Applied for refundable ITCs The refundable ITCs were not available if Millco was associated with Kruger Inc. 35 Heather DiGregorio & Dan Jankovic Recent Court Decisions Issues Kruger Inc. Government of Quebec Canada Ltd. SGX Rexfor 51% 49% Kruger Wayagamack Q1: Is Kruger Inc. associated with Millco? Q2: Does Kruger Inc. own > 50% of the value of Millco? 36 Heather DiGregorio & Dan Jankovic

29 Recent Court Decisions Issues 1. Whether Kruger Inc. had de jure or de facto control over Millco? 2. Whether Kruger Inc. was deemed to be associated with Millco by virtue of owning share with a value > 50% of the fair market value of the company? 37 Heather DiGregorio & Dan Jankovic Recent Court Decisions De Jure versus De Facto Control de jure and de facto control are both asking the same question: Who has effective control of the corporation Difference between the two tests: de jure control is limited in an examination of constating documents and shareholder register de facto control can look at all relevant factors "Effective control" means the ability to make strategic decisions routine operational control is not enough. 38 Heather DiGregorio & Dan Jankovic

30 Recent Court Decisions How much Control is Effective Control? A dominant influence in the management or direction of the company and the orientation of its future? Must that dominance go beyond operational control of day to day operations and include the ability to make strategic decisions Does one have a dominant influence if one cannot make a significant course change? 39 Heather DiGregorio & Dan Jankovic Recent Court Decisions The USA Key decisions must be decided unanimously Specificity of the mission is significant Kruger could not make strategic decisions that will change the course of Millco 40 Heather DiGregorio & Dan Jankovic

31 Recent Court Decisions What did Kruger have control over? All decisions in relation to management or production operations and management of the modernization project Policies in relation to operations and implementation of the mission Setting parameters for negotiating labour agreements These powers are "operational control". 41 Heather DiGregorio & Dan Jankovic Recent Court Decisions Impact of the USA on De Jure Control Crown Position: The provisions that require unanimity are standard protections for minority shareholders Tax Court: The provisions go beyond minority shareholder protection they also seek to ensure fulfillment of the company's mission This is why Kruger Inc. does not have the power to change the overall course of the company and cannot make strategic decisions. NO DE JURE CONTROL 42 Heather DiGregorio & Dan Jankovic

32 Recent Court Decisions De Facto Control Expand the considerations to all relevant factors 2 groups of factors Three important contracts Kruger's industry knowledge Kruger's Industry Knowledge Kruger is a significant industry player with substantial expertise in the pulp and paper industry 43 Heather DiGregorio & Dan Jankovic Recent Court Decisions The 3 Contracts Management Services Agreement Kruger provided the general manager who was a Kruger employee Kruger also to provide employees on an as-needed basis No profit element simple reimbursement of costs Kruger to ensure that Millco pays the same raw materials costs that Kruger normally pays Marketing Agreement Kruger agrees to sell Millco's products with a fixed percentage commission Kraft Pulp Selling Agreement Kruger agrees to purchase wood pulp from Millco with prices based on thirdparty sales The agreements could only be changed by unanimous shareholder agreement. 44 Heather DiGregorio & Dan Jankovic

33 Recent Court Decisions De Facto Control Crown Argument: These factors indicate Kruger's de facto control over Millco Tax Court: The contracts contain protective elements from Kruger taking advantage of Millco, and they can only be changed with unanimous agreement Kruger has in-depth industry knowledge, but SGF is a knowledgeable investor, and is owned by the Government of Quebec which plays an important role in the pulp and paper industry. Kruger does not have control over strategic decisions. NO DE FACTO CONTROL 45 Heather DiGregorio & Dan Jankovic Recent Court Decisions General Comments on De Facto Control Courts are clearly struggling with determining what "effective" control is in the de facto context. Duha Printers is still the guiding light. Reconciliation lies in the examination of strategic influence which can often be tied to operational control. Contrast Mrs. Howard to SGF Quebec Operational control was not in either hands Mrs. Howard did not have or exercise strategic control SGF Quebec did not relinquish its ability to influence strategic control 46 Heather DiGregorio & Dan Jankovic

34 Recent Court Decisions Issue # 2 Valuation of Shares Deeming provision in s. 256(1.2)(c) One corporation controls another if its owns shares whose value is > 50% of the fair market value of all issued and outstanding shares Further deeming provision in s. 256(1)(g) In determining the fair market value of a share all issued and outstanding shares are deemed to be non-voting Tax Court: For valuation purposes control is ignored 47 Heather DiGregorio & Dan Jankovic Recent Court Decisions Valuation of Shares for s. 256(1.2)(c) Tax Court: First look to dividend and liquidation rights Second, consider other factors but only factors unrelated to voting rights and therefore unrelated to control It is a simple exercise of calculating the financial return per share Also ignores control bestowed by the USA 48 Heather DiGregorio & Dan Jankovic

35 Recent Court Decisions Conclusion 256(1.2)(c) applies to deem Kruger to have control of Millco 49 Heather DiGregorio & Dan Jankovic Recent Court Decisions Taxation of Derivatives George Weston Limited v. The Queen 50 Heather DiGregorio & Dan Jankovic

36 Recent Court Decisions Transactions 1. Prior to 2001, GWL carried on a bakery business through WFI US and its subsidiaries 2. In 2001, the GWL group acquired Bestfoods Baking and its subsidiaries Acquisition was financed entirely by debt, through loans from Canadian banks to GWL (CAD$2.1B and US$400M) GWL s debt to equity ratio rose well beyond its internal corporate policy of 1:1 or lower GWL invested the borrowed funds in its subsidiaries, which then acquired Bestfoods for US$1.765B This acquisition increased the GWL group s net investments in USD Operations from approximately US$800M to over US$2B CDN$ was at a historical low against US$ in To hedge US$ exposure, GWL entered into a number of swaps for terms of mostly years 4. Notional value of the swaps approximated total net investment in USD Operations 5. Swaps were terminated in 2003, with counterparties making a net payment to GWL GWL WFI Can WFI US Debt Swaps USD Operations Bakery Business Banks Counterparties Canada U.S. Bestfoods Business 51 Heather DiGregorio & Dan Jankovic Recent Court Decisions Exposure to Exchange Rate Fluctuations GWL prepared consolidated financial statements in CDN$ in accordance with GAAP combined the assets and liabilities of its controlled subsidiaries, including the USD Operations When the value of GWL s net investments in the USD Operations was translated into CDN$, the exchange rate affected the equity section of GWL s consolidated balance sheet when CDN$ appreciated relative to US$, GWL s consolidated equity decreased when CDN$ depreciated relative to US$, GWL s consolidated equity increased Because CDN$ was at historical lows in 2001, GWL was concerned that CDN$ would appreciate substantially relative to US$ effect of eroding GWL s consolidated equity and worsening its debt to equity ratio, thereby affecting its credit rating and cost of capital 52 Heather DiGregorio & Dan Jankovic

37 Currency Swaps Recent Court Decisions GWL entered into currency swaps to mitigate exposure to exchange rate fluctuations changes in the value of the swaps due to such fluctuations varied inversely with and offset changes in the CDN$ translated value of the net investments in USD Operations due to the same fluctuations if CDN$ appreciated, the increase in the value of the swaps would offset the decrease in GWL s consolidated equity if CDN$ depreciated, the decrease in the value of the swaps would offset the increase in GWL s consolidated equity Were entered into by GWL (and not its subsidiaries) because the counterparties wanted to deal with GWL GWL had a higher credit rating than the subsidiaries, which reduced the cost of swaps 53 Heather DiGregorio & Dan Jankovic Recent Court Decisions Termination of the Swaps By 2003, GWL determined that its currency risk was waning CDN$ had appreciated to a multi-year high against US$ GWL had refinanced or repaid its initial Bestfoods acquisition financing expected to cause its debt to equity ratio to fall GWL needed funds to repurchase certain of its shares GWL and its counterparties agreed to terminate the swaps Because CDN$ had appreciated between 2001 and 2003, the counterparties made net principal repayments (of CDN$ 317M) to GWL 54 Heather DiGregorio & Dan Jankovic

38 Recent Court Decisions CRA Document No I7 The closing out of a derivative will be treated as being on capital account only if the derivative: (a) is a hedge; and (b) linked to an underlying transaction that is the purchase or sale of a capital asset or the repayment of a debt denominated in a foreign currency (or possibly a projected disposition of an asset) if the derivative is linked to an asset or liability that the taxpayer has no intention of disposing of, the derivative will not be sufficiently linked to a capital transaction, and any gains or losses arising from it will be considered to be on account of income The underlying transaction must be entered into by the taxpayer (legal entity) that enters into the derivative 55 Heather DiGregorio & Dan Jankovic Recent Court Decisions Minister s Arguments Amounts reported for GAAP purposes associated with fluctuations in currencies are notional do not give rise to income for tax purposes are not reported in the unconsolidated legal entity statements of GWL The swaps were not linked to any underlying capital transaction of GWL The gain from the termination of the swaps resulted from speculation in the derivatives market or was part of GWL s ordinary business decision to realize a profit termination resulted in a profit of C$317M even though the Bestfoods assets contributing to the US$ exposure were not sold early termination of swaps indicated GWL s supposed original intention had changed by Heather DiGregorio & Dan Jankovic

39 Recent Court Decisions Taxpayer Wins The swaps were a hedge The item at risk to which the swaps were related was Bestfoods and the USD Operations these investments were capital in nature Gains realized on the swaps were on capital account Decision not being appealed 57 Heather DiGregorio & Dan Jankovic Recent Court Decisions Meaning of a Hedge No statutory definition of hedge except in the context of weak currency debts in subsection 20.3(1), which provides indirect guidance it would be unwise for the law to eschew the valuable guidance offered by well-established business principles where statutory definitions are absent or incomplete TCC generally describes hedging as the off-setting of financial risk here the exposure to exchange rate fluctuations that arose from the Bestfoods acquisition 58 Heather DiGregorio & Dan Jankovic

40 Recent Court Decisions The Swaps were a Hedge Bestfoods acquisition represented: a 26% increase in GWL s total assets a doubling of its total indebtedness more than a 200% increase in USD investments The fact that the swaps were not contemporaneous with the Bestfoods acquisition is not fatal, as they occurred over a period that was fairly close to the acquisition 59 Heather DiGregorio & Dan Jankovic Recent Court Decisions The Swaps were a Hedge Swaps were entered into to hedge a real currency risk and to protect consolidated group s equity and not to speculate or make a profit in the financial market TCC takes into account the requirement for GWL to report consolidated financial statements in CDN$ and the influence of the currency translation account on GWL s consolidated equity currency exposure could impact GWL s equity value and could result in a loss of borrowing capacity GWL s risk exposure was commented in Standard & Poor s credit agency report GWL was not permitted by either corporate policy or credit facilities to speculate in currencies early termination of the swaps was consistent with GWL s intentions because at the time of termination the currency risk was reduced 60 Heather DiGregorio & Dan Jankovic

41 Recent Court Decisions Characterization of the Hedging Gain SCC in Shell did not find a link to an underlying transaction to be necessary to characterize a hedge as being on capital account What is important is to identify the risk to which the derivative transaction is related and to determine whether the related item at risk (be it a debt obligation or foreign investments) is capital or income in nature [I]f it is found that the derivative was used to hedge a capital investment, any gain derived from the derivative will be on capital account. 61 Heather DiGregorio & Dan Jankovic Recent Court Decisions Characterization of the Hedging Gain From a commercial perspective, GWL would not have entered into the swaps but for the Bestfoods transaction the item at risk to which the swaps were related was Bestfoods and the USD Operations GWL s indirect investment in USD Operations, like its direct investment in its subsidiaries, was capital in nature Gains realized on the swaps were properly characterized as being on capital account 62 Heather DiGregorio & Dan Jankovic

42 Recent Court Decisions Take-aways TCC rejects that there must be an underlying transaction or proposed disposition TCC rejects that entity must directly own the hedged item No updated policy from CRA even though the case has not been appealed Review your recent transactions involving hedges and reconsider reported treatment of gains or losses following TCC s decision 63 Heather DiGregorio & Dan Jankovic Recent Court Decisions Questions? Thank You 64 Heather DiGregorio & Dan Jankovic

43 Typical Issues When a U.S. Person Is Part of the Mix Alexander Marino, JD/LLM (US Tax), Moodys Gartner Tax Law LLP, Calgary Casey Sloan, CA, KPMG LLP, Calgary Calgary, AB Why Are These Issues Important? Calgary, AB

44 Typical Issues When a U.S. Person is Part of the Mix U.S. Tax Overview: IRC vs. ITA Internal Revenue Code & regulations: 72,356 pages Canada Income Tax Act & regulations: 4,047 pages 3 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Worldwide Taxation U.S. citizens and residents are taxed on their worldwide income, regardless of where it is earned. U.S. reporting obligations. It is not the taxes, it is the penalties for failure to file or late filing. Very few Canadians actually owe U.S. tax. Typically a $10,000 (U.S.D) minimum penalty for failure to file certain information returns (e.g., FBAR, Form 8938, etc.). U.S. citizens and domiciled residents are also subject to the U.S. estate tax at death, regardless of their place of death. $5.34 million (U.S.D) exclusion for Alexander Marino & Casey Sloan

45 Typical Issues When a U.S. Person is Part of the Mix Enforcing U.S. Worldwide Taxation: Foreign Account Tax Compliance Act ( FATCA ) Went into effect July 1, Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Stressful times. 6 Alexander Marino & Casey Sloan

46 Typical Issues When a U.S. Person is Part of the Mix Boris Johnson, the Mayor of London, England Born June 19, 1964, New York City. U.S.A. Emigrated from U.S. to England at age 5. Sold London house in 2009 for $1.85m U.S. dollars. U.S. tax bill in six figures. Asked whether he will pay the bill he responded: No is the answer. It s absolutely outrageous. Why should I? January, 2015 paid the tax bill. February, 2015 announced his intention to renounce U.S. citizenship. 7 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Identifying U.S. Persons 8 Alexander Marino & Casey Sloan

47 Typical Issues When a U.S. Person is Part of the Mix Identification of U.S. Persons 9 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Identification of U.S. Persons 1. Born in the U.S. = U.S. Citizen 2. Born in Canada to two U.S. Citizens = U.S. Citizen 3. Born in Canada to one U.S. Citizen = U.S. Citizen if: Born on or after November 14, 1986: - U.S. Parent resided in U.S. for five years, - Two of which were after that U.S. parent s 14th birthday Born before November 14, 1986: - U.S. Parent resided in U.S. for ten years, - Five of which were after that U.S. parent s 14th birthday 10 Alexander Marino & Casey Sloan

48 Typical Issues When a U.S. Person is Part of the Mix Citizenship for Tax and Immigration 11 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Have I Already Lost My U.S. Citizenship? Expatriating Acts must occur concurrently with intent to renounce citizenship: Obtaining naturalization in a foreign state Taking an oath to a foreign state Serving in the armed forces of a foreign state that is engaged in hostilities with the U.S. Accepting employment with a foreign government Formally renouncing citizenship before a diplomatic or consular office Conviction of treason 12 Alexander Marino & Casey Sloan

49 Typical Issues When a U.S. Person is Part of the Mix Have I Already Lost My U.S. Citizenship? Effective Date FOR TAX PURPOSES Expatriation is effective on the earliest of the following dates IRC 877A(g)(4): The date the individual renounces before a diplomatic or consular office; The date the individual delivers to the U.S. State Department a signed statement of renunciation or confirming an expatriating act; The date the U.S. State Department issues a certificate of loss of nationality; or If a naturalized citizen, the date a U.S. court cancels certificate of naturalization. 13 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix U.S. Tax Compliance Issues 14 Alexander Marino & Casey Sloan

50 Typical Issues When a U.S. Person is Part of the Mix U.S. Income Tax Overview Common Reporting Obligations 1. Individual Income Tax Return Form Treaty Based Return Position Form Specified Foreign Financial Assets >$200K USD (>$400K USD if joint) last day of year; or >$400K USD ($600K USD if joint) at any time during year Form Transfer of Property to Trust (including TFSA, RESP, RDSP) Form Distribution from Trust (including TFSA, RESP, RDSP) Form Distribution from Non-U.S. Estate >$100K (USD) Form trustee of Non-U.S. Trust Form 3520-A 8. Own Canadian Mutual Funds Form Sale of Non-U.S. Partnership Form Partner in Non-U.S. Partnership Form Shareholder, Officer, Director of Non-U.S. Corporation Form Transfer Property to Non-U.S. Corporation Form Signatory Authority over or Ownership Interests in Non-U.S. Accounts FBAR (FinCEN 114) 15 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Typical Canadian tax planning that does not work well for U.S. persons Contributions to RRSPs, RESPs, and TFSAs Comments RRSP contributions are only deductible if the contribution is to a group plan. Treaty Article XVIII(13). RESP and RDSP Contributions are contributions to foreign trusts, subject to reporting on Form 3520-A and 3520 currently taxable in. the U.S. TFSA Contributions are contributions to foreign trusts and subject to reporting on Forms 3520-A and 3520 currently taxable in the U.S.. 16 Alexander Marino & Casey Sloan

51 Typical Issues When a U.S. Person is Part of the Mix Typical Canadian tax planning that does not work well for U.S. persons Capital Dividends and Estate Freezes Comments Capital Dividends Canadian Estate Freeze U.S. tax law does not recognize the concept of capital dividends, and as a result, capital dividends are treated as any other dividend. Distinction is even more pronounced due to the potential 3.8% tax on net investment income which is not eligible for a foreign tax credit. This common Canadian estate planning transaction may result in both U.S. gift and income tax consequences. U.S. planning and tax compliance relating to and resulting from a Canadian estate freeze can be extremely complicated. 17 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Typical Canadian tax planning that does not work well for U.S. persons Stock Options and $800,000 Capital Gains Deduction Comments Stock Options The issuance and exercise of stock options may trigger ordinary income and capital recognition that does not match with such events under Canadian income principles. As a result, there could be a timing disparity that limits the individual s ability to claim the foreign tax credit. $800,000 Capital Gain Deduction The U.S. does not recognize this capital gain deduction. 18 Alexander Marino & Casey Sloan

52 Typical Issues When a U.S. Person is Part of the Mix Typical Canadian tax planning that does not work well for U.S. persons Flow-through Share Deduction and Principal Residence Exemption Comments Flow-through Share Deduction From a U.S. tax perspective, corporate deductions and credits cannot be shifted to shareholders. As a result, such deductions can result in U.S. income tax liability due to insufficient foreign tax credits. Principal Residence Exemption The U.S. allows and individual to exclude up to $250,000 from gain on the sale of a principle residence. Any gain above this amount is taxable. The U.S. also has rules regarding minimum length of ownership. 19 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Typical Canadian tax planning that does not work well for U.S. persons Charitable Donations and Income Splitting Comments Charitable Donations U.S. tax law limits the ability of an individual to deduct charitable donations to a percentage of the individual s taxable income. Pension Income Splitting Pension income is attributable to the individual who earned the income. May result in insufficient foreign tax credit to cover U.S. tax liability. 20 Alexander Marino & Casey Sloan

53 Typical Issues When a U.S. Person is Part of the Mix Typical Canadian tax planning that does not work well for U.S. persons Medical Expenses/PFICs Comments Medical Expenses PFIC Medical expenses are deducted as an itemized deduction (as with charitable donations), however, the ability to use these expenses to offset income is more limited. Generally, they are available as a deduction only to the extent they exceed 10.0% of the individual s adjusted gross income. In general, the U.S. treats Canadian mutual funds, exchange traded funds, and real estate investment trusts as PFICs. PFIC reporting is complicated and can result in a mismatch of the timing, character, and amount of income reported on the Canadian and U.S. tax returns. An interest charge on PFIC income may be levied in certain circumstances. 21 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Typical Canadian tax planning that does not work well for U.S. persons Loan at Prescribed Rate Comments Demand Loan from U.S. Person to Trust U.S. Lender will be deemed grantor of trust. IRC 671. Demand Loan from U.S. Spouse to non-u.s. Spouse Gift to spouse if rate is below market, income inclusion to lending spouse equal to gifted amount. Demand Loan from non-u.s. Spouse to U.S. Spouse Face value of loan is U.S. situs asset and subject to U.S. estate tax. IRC 2104(c)(1). 22 Alexander Marino & Casey Sloan

54 Typical Issues When a U.S. Person is Part of the Mix U.S. Estate and Gift Tax 23 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix U.S. Estate and Gift Tax Overview Non U.S. citizens and individuals who are not domiciled in the U.S. for estate tax principles, are subject to U.S. estate tax on their U.S. situs property, notably: U.S. real property, personal property located in the U.S. (cars, art, jewelry, etc.), and U.S. stocks. Prorated credit available based on amount of U.S. assets vs. total worldwide assets under the Treaty. U.S. citizens and individuals who are domiciled in the U.S. under estate tax principles, are subject to tax on their worldwide estate and are afforded the full unified estate/gift lifetime credit - currently, enough to exempt assets of $5.43 million USD per person from estate and gift tax. Federal rate currently 40% (many states have their own, additional, estate taxes). Not the same definition of residency as income tax 183-day rule. 24 Alexander Marino & Casey Sloan

55 Typical Issues When a U.S. Person is Part of the Mix U.S. Estate and Gift Tax Overview Annual exclusion for gifts for the calendar year is currently $14,000 per recipient U.S. individuals have a heightened annual exclusion currently in the amount of $147,000 for gifts to a nonresident spouse. Nonresidents only subject to U.S. gift tax on U.S. situs property Definition of U.S. situs property is different for gift tax purposes. Excludes U.S. stocks, for example. The Treaty does not provide protection regarding U.S. gift tax 25 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Solutions for Common Situations U.S. citizen couples living in Canada 26 Alexander Marino & Casey Sloan

56 Typical Issues When a U.S. Person is Part of the Mix Solutions for Common Situations Mixed marriage (couple lives in Canada, one spouse U.S. citizen) 27 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Solutions for Common Situations Mixed marriage (couple lives in Canada, one spouse U.S. citizen cont d) 28 Alexander Marino & Casey Sloan

57 Typical Issues When a U.S. Person is Part of the Mix Renouncing U.S. Citizenship Tax Issues (U.S. Exit Tax) 29 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Tax Issues: Avoiding the U.S. Exit Tax under IRC 877A Who does 877A apply to? 1. U.S. citizens who renounce their citizenship; and 2. Long-term U.S. residents who terminate their U.S. residency (Individuals who give up their U.S. Green Cards). a. Long-term U.S. resident is an individual who was a lawful permanent resident (green card holder) at any time in any of the 8 taxable years during the 15-year period preceding termination. b. Even a portion of a year is considered to be a taxable year for the 8 year period. 30 Alexander Marino & Casey Sloan

58 Typical Issues When a U.S. Person is Part of the Mix Tax Issues: Avoiding the U.S. Exit Tax under IRC 877A Cont d 1. The U.S. Exit Tax applies when a renouncing individual violates any one of the below three triggers: a. the individual has a net worth of $2 million (USD) or more at the time of renunciation ( Too Rich trigger); b. the individual had an average annual net income tax liability of more than $157,000 (USD) in the five years ending before the date of expatriation ( Paid Too Much Tax trigger); or c. the individual failed to certify on Form 8854 that he or she had complied with all U.S. Federal tax obligations for the five years preceding the date of expatriation ( Five Years of U.S. Tax Returns trigger). 31 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Tax Issues: Avoiding the U.S. Exit Tax under IRC 877A Cont'd Two exceptions to the application of the U.S. Exit Tax Too Rich and Paid Too Much Tax triggers: 1. Dual at Birth exception applies if the individual: a. became a dual citizen at birth and continued to be a citizen and tax resident of the other country (Canada) at the time of renunciation of citizenship; and b. was a resident of the United States for no more than ten of the fifteen tax years ending with the tax year during which the renunciation of citizenship occurred. 2. Eighteen to Eighteen and a Half exception applies if the individual: a. renounces his or her U.S. Citizenship before the age of 18 and a half; and b. was a resident of the United States for no more than ten years before the age of 18 and a half. 32 Alexander Marino & Casey Sloan

59 Typical Issues When a U.S. Person is Part of the Mix Renouncing U.S. Citizen - Immigration Issues (Non Tax Issues) 33 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Why The Drastic Increase In The Number Of People Renouncing U.S. Citizenship? FATCA 1600 Number of Published Expatriates Per Quarter Q Q /19/09 UBS agrees to release names of 4,450 American clients su.s.pected of evading taxes 3/18/10 FATCA enacted /23/09 IRS announces Offshore Voluntary Disclosure Program Alexander Marino & Casey Sloan

60 Typical Issues When a U.S. Person is Part of the Mix Immigration Issues: 1996 Reed Amendment Exit Interview With Consulate If it is determined that the U.S. citizen renounced for the primary purpose of avoiding U.S. tax, that person will be denied re-entry into the U.S. (8 U.S.C. 1182(a)(10)(E)(2011)). Any alien who is a former citizen of the U.S. who officially renounces U.S. citizenship and who is determined by the Attorney General to have renounced U.S. citizenship for the purpose of avoiding taxation by the U.S. is inadmissible. Same inadmissible list includes: Aliens who are determined to be current or former traffickers of controlled substances. Aliens who have or are engaged in terrorist activities. Participants in Nazi persecution, genocide, or the commission of any act of torture or extrajudicial killing. International child abductors. Current or past involvement in sex trafficking. And the real threat to the American way of life FORMER CITIZENS WHO RENOUNCE CITIZENSHIP TO AVOID TAXATION! $450 (USD) $2,350 (USD) 35 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix Immigration Issues 2013 Proposed Reed Schumer Amendments Senators Schumer (D-NY) and Reed (D-RI) American citizenship is a privilege. But it seems that a privileged few are trying to game the system by accumulating wealth and benefiting from the greatness of the United States and then renouncing their citizenship to avoid paying their fair share of taxes. They are welcome to leave our country, but they should not be welcomed to return without playing by the rules and paying what they owe. 36 Alexander Marino & Casey Sloan

61 Typical Issues When a U.S. Person is Part of the Mix 2013 Proposed Reed-Schumer Amendments Why Now Might Be the Best Time to Get Out. On June 12, 2013, U.S. Senators Jack Reed (D-RI) and Chuck Schumer (D-NY) attempted to add yet another hurdle for those individuals looking to renounce their U.S. citizenship in filing an amendment to the immigration reform bill. The amendment attempted to expand the scope of renouncers that can be found inadmissible to the U.S. after renouncing their U.S. citizenship. The amendment attempted to accomplish: - Automatically excluding any Covered Expatriate that triggers the expatriate exit tax under 877A; - Creating a mechanism to allow a Covered Expatriate (individual caught under 877A) to petition the U.S. Department of Homeland Security for a determination that tax avoidance was not one of the principal purposes of expatriation; and - The Department of Homeland Security may make that determination if the Covered Expatriate can establish through clear and convincing evidence that tax avoidance was not one the principle purposes for the expatriation. 37 Alexander Marino & Casey Sloan Typical Issues When a U.S. Person is Part of the Mix 2013 Proposed Reed-Schumer Amendments Great News The Reed Schumer Amendment died before the immigration bill could be voted on. Bad News Senator Reed slipped the exact same amendment into a Homeland Security Bill on June 24, June 12, 2013 June 24, Alexander Marino & Casey Sloan

62 So Your Client's Employees Are Going to the US? What You Should Know David Turchen, Partner, CPA, CA, CPA (WA) MNP LLP, Abbotsford Monika Szabo, Partner, US Immigration Practice Leader, KPMG Law LLP, Toronto Calgary, AB So Your Client's Employees Are Going to the US? What You Should Know Course Overview Often, a tax practitioner realizes that his or her client has potential cross-border tax issues when the client mentions that its employees have recently been spending time in the US. This session will help Canadian tax practitioners deal with a range of "what happens now?" questions, so they can help their clients to seek timely US tax advice or compliance services. Provide a discussion of how the US visa categories and the corresponding tax obligations work together. 2 Monika Szabo & David Turchen

63 So Your Client's Employees Are Going to the US? What You Should Know SELECTING APPROPRIATE WORK CLASSIFICATIONS If an individual is not a business visitor because his/her activities are considered to be work, the following are some of the more common work status options available: TN - A citizen of Canada or Mexico who seeks temporary entry as a business person to engage in business activities at a professional level may be admitted to the US in accordance with NAFTA. L-1A, L-1B - allows for the transfer of senior managers or executives from a foreign related entity (affiliate, subsidiary or parent) to the U.S. entity provided they will be undertaking work in a senior managerial or executive capacity in the U.S. or possess "specialized knowledge" necessary to carry out the employment function in the U.S. 3 Monika Szabo & David Turchen So Your Client's Employees Are Going to the US? What You Should Know SELECTING APPROPRIATE WORK CLASSIFICATIONS If an individual is not a business visitor because his/her activities are considered to be work, the following are some of the more common work status options available: E1 Treaty Trader, E-2 Treaty Investor These visas are for citizens of countries with which the United States maintains treaties and are coming to the US to engage in substantial trade, including trade in services or technology, in qualifying activities, principally between the United States and the treaty country; or develop and direct the operations of an enterprise in which you have invested a substantial amount of capital. 4 Monika Szabo & David Turchen

64 So Your Client's Employees Are Going to the US? What You Should Know Various factors to consider when initiating an immigration process for hire or transfer Does the employee have more than one nationality? Length of time employed at your company What is their educational background? Do they have professional licenses for their profession? Work location, using third party site for work location? Job description Will the proposed salary be sufficient? 5 Monika Szabo & David Turchen So Your Client's Employees Are Going to the US? What You Should Know Various factors to consider when initiating an immigration process for hire or transfer Does the Company have a US entity? What is the Corporate Structure; affiliate, subsidiary? Number of Employees, volume of travelers? Industry, dependent on type of work permits available; Short and Long term goals for the transfer. 6 Monika Szabo & David Turchen

65 So Your Client's Employees Are Going to the US? What You Should Know Various tax factors to consider when initiating an immigration process for hire or transfer Individual income tax obligations Host country tax implications Reporting and withholding responsibility at entity level Social security tax obligations Visa type and assignment length have an impact Equalization and tax gross-ups considerations 7 Monika Szabo & David Turchen So Your Client's Employees Are Going to the US? What You Should Know Business Visit versus Work Business Visitors typically Remain on home country (Canada) payroll and will not receive salary/payment from US entity Have no intention to transfer to the US Enter for short term in order to attend meetings, discussions and conferences; to negotiate and sign contracts, or to meet with potential clients Do not conduct work, paid or unpaid, on behalf of the home country employer or the US employer in the US Do not engage in any transfer of skills or knowledge; do not advise or execute on project deliverables 8 Monika Szabo & David Turchen

66 So Your Client's Employees Are Going to the US? What You Should Know Samples of Business and Work Activities Samples of Business Activities Attending short business or board meetings, conferences, seminars, conventions or trade shows Attending internal meetings (i.e.: planning process, strategizing, receiving company knowledge to bring back to their home country) Samples of Work Activities Managing people, projects or other functions Any hands on activities that involve duties for which a Canadian would ordinarily be paid Attending other external activities/business development meetings (i.e.: negotiating contracts pre signing, gathering potential project requirement information) Attending project meetings on a project for which a professional s U.S. employer has already been retained and is being paid Providing intra company training to internal colleagues and/or receiving intra company training Plant tours Management consulting Almost any activity involving trades, mechanics, technicians ore related occupations 9 Monika Szabo & David Turchen So Your Client's Employees Are Going to the US? What You Should Know Canadian Corporation US Tax Implications U.S. Federal Income Tax Consequences U.S. federal corporate income tax is due on profits related to a permanent establishment ( PE ) A PE determination is much broader than just assessing employee activities and should be considered before sending employees to the United States to work Failure to make a proper PE determination, and timely file, can cause significant penalties 10 Monika Szabo & David Turchen

67 So Your Client's Employees Are Going to the US? What You Should Know Canadian Corporation US Tax Implications Cont d State & Local Income Tax Consequences Typically Can. Co. will need to file and possibly pay taxes in a state when they have nexus Employees working in the United States typically creates nexus Not all states have a corporate based income tax (may tax other ways) There are even city and other local based taxes that should be considered 11 Monika Szabo & David Turchen So Your Client's Employees Are Going to the US? What You Should Know Employer Federal Withholding Obligations in US U.S. Federal Income Tax Consequences for Services Performed in the United States NRA employees are excepted when The services are de minimus (less than 90 days present and US $ 3,000 from foreign employer) Certain other exceptions The employee is exempt from federal income tax under the Treaty Employee provides Form 8233 to employer US Person Exceptions above don t apply (income can be re-sourced) 12 Monika Szabo & David Turchen

68 So Your Client's Employees Are Going to the US? What You Should Know Employer Federal Withholding Obligations in US Cont d U.S. Federal Income Tax Payroll Compliance Form 941 is used to report activity Remittance of payments are not always quarterly (depends on how much due) There are substantial penalties for failure to timely file, timely pay, timely deposit, and accuracy related Form W-2 Reports the wage related income to the employer There are penalties for failure to timely file 13 Monika Szabo & David Turchen So Your Client's Employees Are Going to the US? What You Should Know Other Employer Federal Withholdings U.S. Federal Insurance Contributions Act ( FICA ) FICA can apply to payments of wages for services performed as an employee in the United States Applies regardless citizenship or residence of either employee or employer Exception for certain NRAs (ie. farmer s and students) Relief under US-Canada totalization agreement can alleviate some issues for Canadian resident employees Utilize Form 941 or 944 can be used to report activity if exclusions are not applicable Significant penalties for failure to timely file, timely pay and timely deposit! 14 Monika Szabo & David Turchen

69 So Your Client's Employees Are Going to the US? What You Should Know Other Employer Federal Withholdings Cont d U.S. Federal Unemployment Tax Act ( FUTA ) Similiar NRA exceptions to FICA Relief available under US-Canada Employment Insurance Agreement Application based on where the majority amount of services are performed Utilize Form 940 to report activity if exclusions are not applicable Significant penalties for failure to timely file, timely pay and timely deposit! Obamacare Potential exposures to Can. Co. if they have a U.S. resident employee 15 Monika Szabo & David Turchen So Your Client's Employees Are Going to the US? What You Should Know U.S. Tax Status of Employee U.S. Federal Income Tax Consequences U.S. Residents (includes certain green card holders) and Citizens ( U.S. Persons ) Report worldwide income for U.S. federal income tax purposes Foreign tax credit mechanism helps mitigate double tax Non-resident Aliens ( NRAs ) Non-business U.S. sourced income is taxed (flat withholding rates) Income effectively connected with a U.S. trade or business (taxed at graduated rates) 16 Monika Szabo & David Turchen

70 So Your Client's Employees Are Going to the US? What You Should Know U.S. Tax Status of Employee Cont d State & Local Income Tax Consequences Residents can be taxed on their worldwide income (if there is a tax based on individuals) Rarely a foreign tax credit mechanism exists Usually don t follow the U.S.-Canada income tax treaty ( the Treaty ) rules Non-residents can be taxed on state & local sourced income 17 Monika Szabo & David Turchen So Your Client's Employees Are Going to the US? What You Should Know Employment Income Earned in U.S. U.S. Federal Tax Consequences U.S. Persons Taxable regardless (ie. they report their worldwide income) May be sourced to Canada if employee a taxable Canadian resident (ie. Canada gets first right to tax) NRAs Not taxable if: Wages don t exceed US$ 10,000; or Individual is present in U.S. for less than 183 days (in aggregate) and remuneration is not paid by a U.S. resident person and not derived from a PE in the U.S. 18 Monika Szabo & David Turchen

71 So Your Client's Employees Are Going to the US? What You Should Know Employment Income Earned in U.S. Cont d State & Local Income Tax Consequences Rules vary by state Canadian Income Tax Consequences Resident report worldwide income (including U.S. based employment income) Able to offset Canadian tax with a foreign tax credit for U.S. taxes 19 Monika Szabo & David Turchen So Your Client's Employees Are Going to the US? What You Should Know Canadian Pension Contribution Issues RPPs Plans are not recognized for U.S. federal income tax purposes creating negative consequences to employer and employee The Treaty can provide relief for certain short-term U.S. based employment transfers Various conditions must be met to qualify RRSPs Plans are not recognized for U.S. federal income tax purposes creating negative consequences to employee Either plans are not typically recognized for U.S. state & local income tax purposes 20 Monika Szabo & David Turchen

72 So Your Client's Employees Are Going to the US? What You Should Know Further Considerations Third-Party Payroll Providers State reportings can make things very complicated! Helps reduce administrative burden of all U.S. withholding and reportings Are you paying for the employee s personal tax filings in the United States? Do they already have filing obligations? Risks and costs for non-compliance can be severe Reporting can get complicated and expensive Creates a taxable benefit to the employee 21 Monika Szabo & David Turchen So Your Client's Employees Are Going to the US? What You Should Know Further Considerations Cont d Equalization Agreements With Employees Eliminates the additional tax burden of being sent abroad Creates complexity for the employer to administer Using a controlled U.S. based entity instead of Can. Co. to perform U.S. based activities Many tax and non-tax reasons to set up Utilize secondments if you need Canadian based employees to assist with core activities Lending arrangement between Can. Co. and US entity Consider shadow payroll 22 Monika Szabo & David Turchen

73 So Your Client's Employees Are Going to the US? What You Should Know Questions 23 Monika Szabo & David Turchen

74 Purchase and Sale of an Owner-Managed Business to Private Equity Aroon Sequeira, CA, CBV Sequeira Partners Inc. Calgary, AB Private Equity - Overview Private Equity as an Asset Class Equity Fixed Income Real Estate Infrastructure Private Equity Opportunity for investment in the private company market Direct invest or invest through managed private equity funds 2 Aroon Sequeira

75 Private Equity - Overview Typical Business Structure Investors ( LP s ) Fund Managers ( GP ) PE Fund Venture Buy-out Mezzanine Special purpose 8,000 + funds globally with over a trillion under management 3 Aroon Sequeira Private Equity - Overview PE fund looks for strong: Management Growth Returns Fund time horizon typically years Typical Platform investment time horizon of 5-7 years Return expectations of 25%+; use of leverage to enhance returns Alignment of interests between PE and Vendor 4 Aroon Sequeira

76 Private Equity - Overview What s in it for the GP? This is what they do! Management fee + lift beyond threshold return (eg. 2/20 model) What s in it for the LP? Portfolio diversity and superior returns What s in it for the Business Owner? Major liquidity event with opportunity to stay in the game Value added partner 5 Aroon Sequeira Private Equity - Overview Entry Acquire a platform company Investment thesis Strong management team Usually significant debt and material rollover of vendor equity Add on to an existing platform Attributes of both a sale to PE and sale to strategic Usually some rollover of vendor equity 6 Aroon Sequeira

77 Private Equity - Overview Example Sally is 53 years old and started Widget Manufacturing Inc. ( Widgetco ) 25 years ago TTM sales of $75 mm and TTM EBITDA of $15 mm The company holds a # of key patents 75% of revenue in Western Canada & Northwest US The business has immense global potential but Sally is not sure it makes sense to expand 7 Aroon Sequeira Private Equity - Overview The Deal Sale to US Capital Partners Share purchase for total Enterprise Value of $90 mm Sally retains 25% Equity interest U.S. Capital Partners leverages at 3x EBITDA Sally remains as CEO and retains a seat on the board Sally enters into a 5-year non-compete Incentive plan for key managers to align interests (bonuses + earned equity of up to 5%) All of Sally s personal guarantees removed Long term lease on real estate owned by Sally Shareholders agreement executed concurrent to SPA 8 Aroon Sequeira

78 Private Equity - Overview The Entry Math 9 Aroon Sequeira Private Equity - Overview The Build 30% compounded growth organic + 3 acquisitions Much of the growth from international expansion Two key outside directors added to the Board Sally and one of the PE Managing Directors had issues from time to time but nothing insurmountable New CFO put in place, COO added to the org chart Succession planning initiatives undertaken to allow Sally to decrease role 10 Aroon Sequeira

79 Private Equity - Overview The Exit Alternatives for exit IPO Sale to Strategic Sale to another PE Recaps sometimes used for partial liquidity Borrow and withdraw Sale/Lease back of real estate 11 Aroon Sequeira Private Equity - Overview The Exit 4 years later Industry is doing well, Widgetco now has $42 mm of EBITDA and U.S. Capital decides to go to market Globalco, a large competitor, acquires 100% of the shares for $294 mm of Enterprise Value U.S. Capital Partners exits completely Sally, now 57, enters into a 2-year management contract and signs a 5-year non-compete Key managers that earned equity sign a 2-year management contract and 2-year non-compete 12 Aroon Sequeira

80 Private Equity - Overview The Exit Math 13 Aroon Sequeira Private Equity - Overview Conclusion Private equity increasing in prominence as an asset class Wide array of fund sizes, investment philosophy, degrees of specialization etc. Increasingly appears on private company transactions Very viable option for the private business owner that wants liquidity but not ready to exit completely 14 Aroon Sequeira

81 Purchase and Sale of an Owner Managed Business to a Private Equity Fund Michael Munoz Deloitte LLP Calgary, AB Transaction Considerations Canadian Venture Capital and Private Equity Association 2014 Statistics Canadian Funds: 33 Canadian PE Funds Raised $12B in 2014 Declining in Q (under $1B) 2 Michael Munoz

82 Transaction Considerations Canadian Venture Capital and Private Equity Association 2014 Statistics Canadian Investments: 296 Deals in the Canadian marketplace $41.2B of PE investment in Canadian businesses Similar number of deals through Q (76) Size is down through Q1 ($5.4B) 3 Michael Munoz Transaction Considerations Canadian Venture Capital and Private Equity Association 2014 Statistics Mid and Small Markets: Less than $100M 76% of reported deals Less than $10M 36% of reported deals 4 Michael Munoz

83 Transaction Considerations Agenda 1. What can be gained from a sale to private equity 2. Private equity sensitivities 3. Tax issues and considerations assets vs. shares forms of consideration Canadian controlled private corporation (CCPC) status 5 Michael Munoz Transaction Considerations 1. What can be gained from a Sale to Private Equity 1. Liquidity and Continued Investment 2. Succession Planning or Shareholder Reorganization 3. Growth Capital or Balance Sheet Support 6 Michael Munoz

84 Transaction Considerations 2. Private Equity Sensitivities 1. Management Retention 2. Future Exit 3. Flow Through Structures 7 Michael Munoz Transaction Considerations 2. Private Equity Sensitivities 1. Management Retention Keep or Replace In the owner-manager context, usually keep Flexible capital structure can accommodate vendor objectives and align interests 8 Michael Munoz

85 Transaction Considerations 2. Private Equity Sensitivities 2. Future Exit Growth within hold period Incentive based consideration Corporate structure 9 Michael Munoz Transaction Considerations 2. Private Equity Sensitivities 3. Flow Through Structures Tax efficient or tax exempt investors Limit operational taxes Leveraged corporation Partnerships Cash distributions sufficient to pay tax Increased ROI for tax exempt investors Allows for each investor (or class of investor) to govern their own tax results 10 Michael Munoz

86 Transaction Considerations 2. Private Equity Sensitivities 3. Flow Through Structures 11 Michael Munoz Transaction Considerations 3. Tax Issues and Considerations 1. Assets vs. Shares Buy Assets Stepped up tax cost No liabilities assumed Sell Shares Tax rates capital gains, sales taxes Exemptions 12 Michael Munoz

87 Transaction Considerations 3. Tax Issues and Considerations 1. Assets vs. Shares Negotiating the structure COST BENEFIT Increased price Increased return to investors Tax rate difference Tax Accounts Exemptions Indirect Taxes Tax Shield Liabilities Post-Close Reorganizations PE Fund Benefits 13 Michael Munoz Transaction Considerations Tax Issues and Considerations Assets vs. Shares Dispositions of Goodwill Currently results in a fully distributed tax rate that is close to the capital gains rate 2014 Federal Budget - Consultation on eligible capital property regime Proposal to create a new CCA class, which would increase the fully distributed tax rate on disposition 14 Michael Munoz

88 Transaction Considerations Tax Issues and Considerations Assets vs. Shares Benefits to the fund of an asset purchase Purchase of assets by partnership to establish a flow through structure Partial rollover (hybrid transaction) Income is allocated so less need for tax shield Tax distributions increase when more income is realized - cash flow management 15 Michael Munoz Transaction Considerations Tax Issues and Considerations 2. Forms of Consideration Deferred compensation Debt ( vendor take back ) Financing option Deferred over 5 years (or less) Potential for early exit 16 Michael Munoz

89 Transaction Considerations Tax Issues and Considerations 2. Forms of Consideration Deferred compensation Earn out A form of consideration to solve valuation disputes Paragraph 12(1)(g) CRA administrative position (IT-426R) Reverse earn out 17 Michael Munoz Transaction Considerations Tax Issues and Considerations 2. Forms of Consideration Partnership interests Flexibility Preferred interests Carried interests Allocations Character of income Reasonability S Michael Munoz

90 Transaction Considerations Tax Issues and Considerations 3. CCPC Status Why does it matter to a private equity fund? Tax rates and rules Refundable Tax & Small Business Deduction Stock options (s. 7(1.1)) Deferral of recognition Capital gain rate (if 2 year hold period) 19 Michael Munoz Transaction Considerations Tax Issues and Considerations 3. CCPC Status How is it determined? CCPC Definition in s.125(7), Paragraph (a) Factually controlled by a group of NR CCPC Definition in s.125(7), Paragraph (b) Fictitious person test Aggregate all shares held by NR and Public companies and treat as a single shareholder 20 Michael Munoz

91 Transaction Considerations Tax Issues and Considerations 3. CCPC Status Application CCPC Definition in s.125(7), Paragraph (a) Group of persons - Silicon Graphics De facto control Factual determination 21 Michael Munoz Transaction Considerations Tax Issues and Considerations 3. CCPC Status Application CCPC Definition in s.125(7), paragraph (b) Ownership Control 22 Michael Munoz

92 Transaction Considerations Tax Issues and Considerations 3. CCPC Status Summary Control test, not ownership test Canadian fund manager creates a strong fact toward a portfolio company satisfying the definition of a CCPC 23 Michael Munoz Transaction Considerations Conclusion Private equity is active in small and mid market M&A Flexible transaction partner for a tailored solution Private equity sensitivities will influence a transaction Tax and commercial issues and opportunities exist in all transaction structures (a natural by-product of their flexibility) 24 Michael Munoz

93 Succession Planning in a Family Enterprise Susan Naylen Sorrell, Prairie Mountain Partners Brian Kearl, Gowlings Calgary, AB Family Enterprise The Intersection of Family and Business Calgary, AB

94 Family Enterprise Succession Family Businesses Outperform 12.00% 10.00% 8.00% 6.00% [VALUE] % Price Performance: Canadian Companies (CAGR %) [VALUE] % [VALUE] % [VALUE] % 4.00% 2.00% 0.00% 15 Years 20 Years Family Non Family Source: Spizzirri & Fullbrook, Susan Naylen & Brian Kearl Family Enterprise Succession Family Business have Short Lifespans Survive to 2 nd Generation: 30% Survive, 30% Survive to 3 rd Generation: 15% Survive, 15% Survive the 3 rd Generation: 5% Survive, 5% 70% Fail 85% Fail 95% Fail Survive Fail Survive Fail Survive Fail 4 Source: Bigliardi 2009 Source: Bigliardi 2009 Source: IFC Susan Naylen & Brian Kearl

95 Family Enterprise Succession Family Roles are Defined First I ll love you forever, I ll like you for always, as long as I m living my baby you ll be. Robert Munsch 5 Susan Naylen & Brian Kearl A Conceptual Framework The Three Circle Model: Defining Roles Calgary, AB

96 Family Enterprise Succession Three Circle Framework Business Ownership Family Adapted from R. Tagiuri and John A. Davis (1982) Bivalent Attributes of the Family Firm, as printed in Understanding Family Business Susan Naylen & Brian Kearl Family Enterprise Succession Three Circle Framework Ownership Business Family Governed by Family Council Defined by Family Charter Focus: Family education, Family issues, Estate planning Family speaks as one voice to business 8 Susan Naylen & Brian Kearl

97 Family Enterprise Succession Three Circle Framework Ownership Governed by Board of Business Directors & Management Focus: Business matters, Daily operations, Employee selection (incl. family members) Goal may be socioeconomic wealth Family 9 Susan Naylen & Brian Kearl Family Enterprise Succession Three Circle Framework Ownership Business Family Governed by Board of Directors Defined by Shareholder Agreement Owners have a say strategic plan, compensation, divestitures and dividend policies 10 Susan Naylen & Brian Kearl

98 Family Enterprise Succession Obligation to the Corporation The duty of a director is to act honestly and in good faith, with a view to the best interests of the corporation Family run enterprises are not immune from litigation 11 Susan Naylen & Brian Kearl Intergenerational Transfers Risks in Transition Calgary, AB

99 Family Enterprise Succession Stages of Family Run Business Founder(s) Sibling Partnership Transition Risk Cousin Consortium Transition Risk 13 Susan Naylen & Brian Kearl Family Enterprise Succession Stages of Family Run Business Founder(s) Sibling Partnership Most difficult transition Structure Single Leader Partnership Decisions Centralized Collaboration Governance Little to None Rules and Roles Defined 14 Susan Naylen & Brian Kearl

100 Family Enterprise Succession The Dynastic Dream creates Blindness IF THIS TRANSITION IS NOT MANAGED WELL, THE FAMILY HAS A HIGHER RISK OF LOSING ITS WEALTH THROUGH BAD INVESTMENT DECISIONS AND OVERCONSUMPTION John Davis Sibling Partnership Founder(s) Sale of Business 15 Susan Naylen & Brian Kearl Family Enterprise Succession Tax Considerations: Ownership Transition Cash-Out - Current Owners Safe Income Strips Capital Gain Planning Asset Sales 16 Susan Naylen & Brian Kearl

101 Family Enterprise Succession Tax Considerations: Ownership Transition cont Equity Shift From Current Owners to Next Generation Standard Estate Freeze Stock Dividends Disproportionate Dividends Valuation Concerns and Sham 17 Susan Naylen & Brian Kearl Family Business Longevity Genetics are not enough Calgary, AB

102 Family Enterprise Succession Keys to Longevity 2007 MassMutual study concluded that there was a high correlation between family longevity and 1) a written strategic plan 2) an active board of directors 3) regularly scheduled family meetings 19 Susan Naylen & Brian Kearl Family Enterprise Succession Longevity in Three Circle Framework Ownership Board of Directors Strategic Plan Business Family Meetings Family 20 Susan Naylen & Brian Kearl

103 From Founder to Sibling Partnership A Case Study where siblings assume a nonmanagement role Calgary, AB Family Enterprise Succession Three Circle Role Definition Ownership Business Family 22 Susan Naylen & Brian Kearl

104 Family Enterprise Succession Changes to Family Council Education is likely required regarding role and limits of family in business matters Clear communication regarding socioeconomic wealth goals to business and management Family issues are dealt with at family meetings Family must learn to speak to business with a single voice 23 Susan Naylen & Brian Kearl Family Enterprise Succession Changes to Ownership Circle Shareholder agreement may be revised to reflect change in ownership structure Voting rights Sales of shares to non family owners Allowable transfers of shares Owners must understand that all shareholders must be treated equally Minority oppression Limits of shareholder agreements 24 Susan Naylen & Brian Kearl

105 Family Enterprise Succession Changes to Ownership Circle Typically each sibling has a seat at the board Board rarely accomplishes much Siblings at in own best interest instead of interest of corporation Formalization of board and governance structure necessary 25 Susan Naylen & Brian Kearl Family Enterprise Succession Evolution towards Independent Board Founders Children Other Family 26 Susan Naylen & Brian Kearl

106 Family Enterprise Succession Evolution towards Independent Board Founders Advisor Advisory Board Mentor Children Other Family 27 Susan Naylen & Brian Kearl Family Enterprise Succession Evolution towards Independent Board Independent Board Founders Other Family Children 28 Susan Naylen & Brian Kearl

107 Family Enterprise Succession Changes to Business Centralized decision making must move towards collaboration and focus on teamwork Successor must understand family goals Socioeconomic wealth aspirations must be clearly defined 29 Susan Naylen & Brian Kearl Family Enterprise Succession Challenges with Alignment The success of established family run business is attributed to the family s desire to protect the business and its reputation Family managers face significant risk and alignment with non-managing family members an issue Family run firms tend to pay less than the market but job security is higher Significant challenges exist regarding compensation of management as share based compensation usually is not an option 30 Susan Naylen & Brian Kearl

108 Family Enterprise Succession Tax Considerations: Management Compensation Implement Multiple Plans short-term, medium-term & long-term Without Equity Component tax-preferred compensation more difficult Cash bonuses, RRSP matching, phantom stock appreciate rights payments, etc. 31 Susan Naylen & Brian Kearl Family Enterprise Succession Conclusion as long as I m living my baby you ll be Technical solutions will unravel over time if the underlying emotional issues are not addressed Family issues must be acknowledged and dealt with in family meetings Governance helps define roles and helps to ensure fairness 32 Susan Naylen & Brian Kearl

109 Alligators under Rocks A Review of Common Mistakes and Errors Made by Tax Professionals Carolyn Engel, Deloitte Calgary, AB Alligators Under Rocks I m sorry to say so but, sadly it s true that bang-ups and hang-ups can happen to you. - Dr. Suess 2 Carolyn Engel

110 Alligators Under Rocks Agenda The Hit List Commonly misapplied sections of the Income Tax Act Illustrative Examples A Simple Succession Plan A Divorce Really Can Get Worse A Group is Sometimes Family The Anti-Dilution Effect The Surplus Strip Slip-Up Basis Shifting Moving Cash within the Related Group Some of these illustrations will specifically address changes announced to subsection 55(2) in the 2015 Federal Budget Concluding Remarks 3 Carolyn Engel Alligators Under Rocks The Hit List Deemed Dividends on Sale (ITA 84.1) Inter-corporate dividends (ITA 55(2)) Capital Gains Exemptions (ITA 110.6) Part VI.1 tax on Dividends Shareholder Benefits and Loans (ITA 15) Late filing of returns and forms (various) Excess Capital Dividend Elections (ITA 83) Superficial loss and loss deferral rules (ITA 54, 40(3.3) & 40(3.4)) Attribution Rules (ITA ) Forgiveness of Debt (ITA 80) 4 Carolyn Engel

111 Alligators Under Rocks A Simple Succession Plan Dad wants to retire and sell his business to his son. Dad inherited the business from his dad ( Grandfather ) in Grandfather s estate claimed the then $500K capital gains exemption on the shares. Opco. Common shares: (Soft) ACB = $500K PUC = Nominal FMV = $2M 5 Carolyn Engel Alligators Under Rocks A Simple Succession Plan Interest Bearing Loan at FMV Obtained a valuation report and included a PPA clause in purchase and sale agreement. Opco. Dad can claim the capital gains exemption (watch for AMT), resulting in a capital gain of $687K $687K = $2M - $500K - $813.6K Opportunity to claim reserve on the gain in excess of exemption; Interest expense should be deductible if rate is reasonable, fixed and nonparticipatory; ITA 69(1) risk is managed; The Problem: This option becomes inordinately expensive to Son as he is required to pay back Dad using after-tax dollars. 6 Carolyn Engel

112 Alligators Under Rocks A Simple Succession Plan Interest Bearing Loan at FMV HoldCo. and Opco. are amalgamated to match interest expense against operating income. Holdco. Opco. The Problem: Dad receives a deemed dividend per ITA 84.1 on full $2M FMV as nil hard ACB; and Dad can not utilize his capital gains exemption. 7 Carolyn Engel Alligators Under Rocks ITA 84.1: The Traps (paraphrased) Where a taxpayer resident in Canada (other than a corporation) disposes of shares that are capital property of the taxpayer ( subject shares ) to another corporation with which the taxpayer does not deal at arm s length and, immediately after the subject corporation and purchaser corporation are connected: Where shares of the purchaser corporation have been issued as consideration, in computing the PUC of those shares, there shall be deducted.; and A dividend shall be deemed to be paid to the taxpayer by the purchaser corporation at the time of the disposition equal to the FMV of the non-share consideration in excess of the greater of: the PUC and ACB (subject to ITA 84.1(2)(a) & (a.1)) of the subject shares immediately before the disposition. 8 Carolyn Engel

113 Alligators Under Rocks ITA 84.1: The Traps (paraphrased) Pursuant to ITA 84.1(2): a) If the share was originally acquired before 1971, the ACB should be computed without reference to the V-Day FMV adjustment; and a.1) If the share was originally acquired after 1971 (including substituted shares) and from a non arm s length person, the ACB should be reduced by any V-Day FMV adjustment or capital gains exemption claimed by the non-arm s length previous owner(s). This includes a chain of non-arm s length previous owners. ACB is reduced by past Capital Gains Exemptions and V-Day adjustments 9 Carolyn Engel Alligators Under Rocks ITA 84.1: The Traps (paraphrased) 84.1(2) continued: b) The taxpayer is deemed to be non-arm s length with the purchaser corporation if the taxpayer was a member of the same group (< 6) that controlled the subject corporation immediately before the disposition and controlled the purchaser corporation immediately after the disposition; and d) A trust and a beneficiary (or person related to that beneficiary) are deemed to be non-arm s length. An unrelated group of persons may result in a deemed non-arm s length relationship 10 Carolyn Engel

114 Alligators Under Rocks ITA 84.1: The Traps (paraphrased) Pursuant to ITA 84.1(2.01), for purposes of the ACB adjustment in 84.1(2)(a.1): a) Where a share owned by a particular person (or a substituted share) has by one or more transactions or events between persons not dealing at arm s length become vested in another person, the particular person and the other person are deemed at all times not to be dealing at arm s length with each other whether or not the particular person and the other person coexisted. What does this mean? Consider the relationship between deceased taxpayers, their estates, and beneficiaries of the estate.even if not yet born at time of death! Consider former spouses 11 Carolyn Engel Alligators Under Rocks Estate Freeze Alternative Consider implementing an estate freeze: Dad exchanges common shares of Opco for preferred shares under ITA 86 and Son subscribes for new common shares for future growth Dad redeems preferred shares over time Dad still pays tax at marginal rate on deemed dividends; Part VI.1 could apply to Opco where Dad no longer holds a substantial interest. 12 Carolyn Engel

115 Alligators Under Rocks Insert Corporate Holdco Dad s Holdco. Interest Bearing Loan at FMV Son s Holdco. Opco. Dad transfers Opco. shares to Dad s Holdco under ITA 85(1) at an elected amount of $1,313.5K for share consideration to crystallize CGE. Dad s Holdco. sells shares of Opco. to Son s HoldCo. for a loan. Dad s Holdco realizes a capital gain (consider claiming a reserve) on FMV in excess of $1,313,5K Son s Holdco. and Opco. amalgamate to match interest expense with operating income. 13 Carolyn Engel Alligators Under Rocks A Divorce Really can get Worse! Opco. A couple is planning a divorce; Husband owns the company; It is not possible to borrow enough money to pay the wife with after-tax personal funds. The only funding for the divorce is the business borrowing capacity. ACB = Nominal PUC = Nominal FMV = $3.2M 14 Carolyn Engel

116 Alligators Under Rocks A Divorce Really can get Worse! C/S: ACB/PUC: $1 FMV: $1.6M P/S: ACB/PUC : $1 FMV: $1.6M Holdco. Opco. P/S: ACB/PUC : $1 FMV: $1.6M Husband executes a freeze by paying a Hi-Low preferred share stock dividend from Opco.; Husband creates Holdco.; Husband transfers ½ of the preferred shares of Opco. to wife under ITA 73(1); Husband rolls his remaining preferred shares in Opco. to Holdco.; and Preferred shares have a put/call option for the purchase/sale of the preferred shares by Holdco. 15 Carolyn Engel Alligators Under Rocks A Divorce Really can get Worse! Couple divorces; Ex-Wife exercises put/call option requiring Holdco. to purchase all of her preferred shares in exchange for a note. Holdco. redeems ½ the preferred shares to pay out the Ex-Wife. C/S: ACB/PUC = $1 FMV = $1.6M P/S: ACB/PUC = $1 FMV $1.6M HoldCo. Opco. Loan: $1.6M The Problem: The sale likely triggers a dividend under ITA 84.1 to be received by Ex-Wife. Opco. is potentially liable for Part VI.1 tax on the deemed dividend >$500K. 16 Carolyn Engel

117 Alligators Under Rocks A Group is Sometimes Family Ms. A 25% Opco. Ms. B 75% Ms. A & Ms. B are unrelated; Ms. A wants to reduce her investment to an insignificant shareholding. ACB = Nominal PUC = Nominal FMV = $1.6M 17 Carolyn Engel Alligators Under Rocks A Group is Sometimes Family Ms. A 5% $0.4M Cash Holdco. Opco. Ms. B ACB = $0.4M PUC = Nominal FMV = $1.2M 95% Ms. A & Ms. B incorporate Holdco acquiring a 5% and 95% respective interest; Ms. A sells her shares of Opco to Holdco for cash proceeds; Ms. A expects to report a capital gain offset by the CGE; (i.e., no tax due) Ms. B transfers her shares to Holdco under ITA 85(1); The Problem: Ms. A is deemed to have received a dividend pursuant to ITA Carolyn Engel

118 Alligators Under Rocks Group of Persons Counsel argued: this legislation can lead to absurd and repugnant results because it disregards the actual facts concerning lack of control. In her ruling, the Judge stated: It is clear that section 84.1 is an anti-avoidance provision that is designed to prevent the tax free extraction of corporate surplus. It is also clear, though, that the provision could potentially overreach its antiavoidance objective in certain cases. This result was clearly intended by Parliament, in my view. 19 Carolyn Engel Alligators Under Rocks ITA 84.1: Ask yourself Who are the purchaser and seller? What is their current and past relationship? Will the purchaser and subject corporation be connected? Is there any non-share or boot consideration? What is the hard ACB of the subject shares? Could Part VI.1 tax apply in respect of any actual or deemed dividend? Is there valuation risk? 20 Carolyn Engel

119 Alligators Under Rocks The Anti-Dilution Effect RDTOH: $0 Holdco 80% 800 shares ACB/PUC: Nominal Ms. A Ms. B Ms. C Ms. D Opco Employeeco FMV: $10M Safe Income: $6M 33% each 20% 200 shares ACB/PUC: Nominal All shareholders are unrelated; Ms. A wants to take $2M from Opco through Holdco; Holdco requests Opco to repurchase 200 shares. (Shares are first offered to Employeeco.) The re-purchase results in a deemed dividend to Holdco under ITA 84(3). The Problem: Does ITA 55(2) apply? 21 Carolyn Engel Alligators Under Rocks ITA 55(2): (As Currently Enacted) (paraphrased) Where a corporation has received a dividend deductible under ITA 112 as part of a series of transactions one of the purposes of the dividend (or results of the dividend if 84(3) applied), is to effect a significant reduction in the gain that but for the dividend would have been realized upon a FMV disposition that could reasonably be attributable to anything other than safe income, the amount of the dividend: Shall be deemed not to be a dividend received by the corporation; Where a corporation has disposed of the share, shall be deemed to be proceeds of disposition; and Where a corporation has not disposed of the share, shall be deemed to be a gain in the year in which the dividend was received. 22 Carolyn Engel

120 Alligators Under Rocks ITA 55(3)(a) related party exceptions: (paraphrased) Subsection (2) does not apply to any dividend received by a corporation a) If, as part of the series of transactions, there was not at any particular time v. a significant increase in the total of all direct interests in the dividend payor by unrelated persons; or 2015 Budget Proposal: The related party exceptions now only apply in respect of deemed dividends under ITA 84(3). The proposals no longer provide exception in respect of dividends or stock dividends under unless as part of a butterfly/wind up transaction. 23 Carolyn Engel Alligators Under Rocks The Anti-Dilution Effect RDTOH: $0 Ms. A Ms. B Ms. C Ms. D Holdco Employeeco 33% each As a result of the share repurchase, Employeeco increased its direct interest in Opco. Exceptions of ITA 55(3)(a) do not apply 75% 600 shares ACB/PUC: Nominal Opco 25% 200 shares ACB/PUC: Nominal FMV: $8M Safe Income: $4.8M 24 Carolyn Engel

121 Alligators Under Rocks The Surplus Strip Slip-up ITA 85(1) transfer of Opco to Holdco Holdco Opco ITA 84(1) deemed dividend Mr. A owns all of the shares of Opco, which have a nominal ACB, safe income of $1M and FMV of $1.8M. Mr. A incorporates Holdco and rolls shares of Opco to Holdco under ITA 85(1) electing at $800K in exchange for shares of Holdco (no boot). Mr. A recognizes a capital gain of $800K and claims the CGE. Opco increases its PUC by $1M, resulting in a deemed dividend under ITA 84(1) and a corresponding increase in the ACB of the Opco shares to $1.8M under ITA 53(1)(b). 25 Carolyn Engel Alligators Under Rocks The Surplus Strip Slip-up As a result of the previous transactions, Holdco now has an ACB in the Opco shares of $1.8M. Holdco sells shares of Opco to an unrelated third party for $1.8M with nil capital gain. Problem: Holdco Does ITA 55(2) apply? Opco FMV: $1.8M ACB: $1.8M 26 Carolyn Engel

122 Alligators Under Rocks The Surplus Strip Slip-up The CRA s view: It is not reasonable to conclude that the gain realized on the rollover of the Opco Shares to Holdco is entirely attributable to something other than safe income, and that in turn, the subsequent dividend is entirely attributable to safe income such that ITA 55(2) would not apply. Rather, the safe income should be apportioned to each part of the gain. For example: $1,000K Dividend * $800K Gain/$1,800K FMV = $445K of safe income attributed to the initial gain recognized $1,000K Dividend * $1,000K Gain/$1,800K FMV = $555K of safe income attributed to remaining gain/dividend Alberta Ltd. significantly challenged this view, but does the proposed legislation invalidate that decision? 27 Carolyn Engel Alligators Under Rocks Proposed ITA 55(2.1): (paraphrased) ITA 55(2) applies to a taxable dividend where as part of a series of transactions: a) The dividend recipient is entitled to a deduction under ITA 112 b) It is the case that: i. One of the purposes of the dividend (or results of the dividend if 84(3) applied), is to effect a significant reduction in the gain that but for the dividend would have been realized upon a FMV disposition; OR ii. One of the purposes of the dividend (other than an ITA 84(3) dividend) is to effect a: Significant reduction in the FMV of any share, or A significant increase in the cost of property; AND c) The amount of the dividend exceeds the safe income that could reasonably be considered to contribute to the gain that could be realized on a FMV disposition immediately before the dividend. 28 Carolyn Engel

123 Alligators Under Rocks The Surplus Strip Slip-up Consider: Is the gain derived from assets with untaxed/unrealized appreciation (i.e. undeveloped land, marketable securities, real estate, etc.), or from goodwill derived from ongoing business activities? Existing legislation: One can argue that the safe income on hand can be reasonably attributed wholly or partially to different sources/portions of the gain. Proposed Legislation: It would be more difficult to argue that the safe income did not reasonably contribute to a gain derived from goodwill. This may bolster the CRA s view that some apportionment of safe income may be appropriate. 29 Carolyn Engel Alligators Under Rocks Cash for additional common shares and ITA 85(1) transfer Basis Shifting Opco Subco Cash dividend Subco Shares FMV ACB Opening $1M $1M Additional CS $1M $1M Cash Dividend ($1M) ITA 85(1) transfer $1M 3 rd Party Sale $2M $2M Transaction Steps: 1) Assume the ACB, FMV and Safe Income of Subco are all $1M; 2) Opco subscribes for additional common shares of Subco for $1M; 3) Subco declares and pays a $1M cash dividend; 4) Opco transfers assets with an appreciated FMV of $1M under ITA 85(1); and 5) Opco sells the common share of Subco to a third party for FMV of $2M and does not realize any gain or loss. 30 Carolyn Engel

124 Alligators Under Rocks Proposed ITA 55(2.5): (paraphrased) For the purposes of clause (2.1)(b)(ii)(A), whether a dividend causes a significant reduction in the FMV of any share is to be determined as if the FMV of the share, immediately before the dividend, was increased by an amount equal to the FMV of the dividend received on the share. What does this mean? 31 Carolyn Engel Alligators Under Rocks How Far do the ITA 55 Proposals Reach? If all dividends arguably reduce the FMV of the underlying shares: should all inter-corporate dividends (other than deemed dividends under ITA 84(3) within a related party context) be deemed to be a gain under ITA 55(2), subject to the availability of safe income? If in a loss or no gain scenario, does the safe income harbor even apply? 32 Carolyn Engel

125 Alligators Under Rocks Moving Cash within the Related Group Holdco Cash Dividend Due to accelerated tax depreciation, Opco is generating positive net income and surplus cash but has not accumulated any safe income; Opco PUC & ACB: Nominal Appreciated FMV Safe Income: Nominal Opco declares and pays a cash dividend to distribute the net profits & excess cash; Should ITA 55(2) apply? Was one of the purposes of the dividend to reduce the FMV of the shares? No applicable exception in ITA 55(3) 33 Carolyn Engel Alligators Under Rocks What Else Could be Caught? Potentially: Income balancing transactions using preferred shares Estate freezes executed via the issuance of stock dividends Various purification techniques used to preserve QSBC status Ordinary course dividends where there is insufficient safe income Possible Solutions: Implement a share reorganization and subsequent redemption under subsection 84(3) in order to access the amended ITA 55(3)(a) related party exceptions. Domestic inter corporate upstream loans may be a solution until any inherent temporary differences resolve themselves and safe income becomes available. 34 Carolyn Engel

126 Alligators Under Rocks Proposed ITA 55(2): (paraphrased) If this subsection applies, the taxable dividend received a) Is deemed not to be a dividend; and b) Is deemed to be a gain of the dividend recipient for the year in which the dividend was received. The dividend is now deemed to be a gain in all cases (i.e., as opposed to additional proceeds of disposition where the share is disposed) 35 Carolyn Engel Alligators Under Rocks The Anti-Dilution Effect: Revisited RDTOH: $0 Holdco 75% 600 shares ACB: $3M PUC: Nominal Ms. A Ms. B Ms. C Ms. D Opco Employeeco FMV: $8M Safe Income: Nominal 33% each 25% 200 shares ACB: Nominal PUC: Nominal Assume the redeemed shares: Have a FMV of $2M Have an ACB $1M Have nominal PUC & SI Current Legislation: Dividend is added to Proceeds of disposition $1M Gain = $2M - $1M Proposed Legislation: Dividend is deemed to be a gain $2M Gain 36 Carolyn Engel

127 Alligators Under Rocks ITA 55(2): Ask yourself Is an ordinary, stock or deemed dividend contemplated? Consider the definition of the amount of a stock dividend Is there any built-in-gain in respect of the shares? Will the dividend significantly reduce the FMV of the enterprise? Would the gain be reasonably attributable to safe income or unrealized/untaxed profits? Conversely, did safe income reasonably contribute to the gain? How has safe income been calculated? Have you considered making successive safe income dividend designations? As part of the series, will there be any change in ownership? Did an unrelated party increase their direct interest in the shares? Consider anti-dilutive effects to other shareholders Consider siblings 37 Carolyn Engel Alligators Under Rocks Stay Tuned on ITA 55(2) 38 Carolyn Engel

128 Alligators Under Rocks Acknowledgements Thank you to Monica Cheng, David Nielsen and John Ormiston of Deloitte for their significant contributions to this presentation and accompanying paper. 39 Carolyn Engel

129 Trust Update 2015 Catherine Brown Faculty of Law, University of Calgary William Fowlis, QC, FCA, TEP Miller Thomson LLP Calgary, AB Overview Background Graduated Rate Estates ( GREs ) Subsection 104(13.3) Subsection 104(13.4) Life Interest Trusts: Issues, Planning & Drafting Practice Points Suggested Legislative Changes and Clarifications 2 Catherine Brown & William Fowlis

130 Background Budget 2013 Flat Top Rate Tax for Testamentary Trusts announced August 29, 2014 Draft Legislation released (30 day consultation) Flat Top Rate Tax for all Trusts except GREs (graduated rate estates) and QDTs (qualified disability trusts) Access to relief provisions for post mortem planning and charitable giving restricted to GREs (NEW) Restrictions to s. 104(13.1) and (13.2) Designations (NEW) Introduction of Life Interest Trust Rules (NEW) Rules for charitable donations on death after 2015 (NEW) October 10, 2014 NWMMs released (re released October 20th) December 16, 2014 Bill C 43 receives Royal Assent April 21, 2015 No amendments to above EFFECTIVE for taxation years ending after 2015 (No grandfathering) 3 Catherine Brown & William Fowlis Graduated Rate Estates (GRE) A GRE is an estate (NOT a trust created under a will) Estate must meet the following conditions: no more than 36 months have passed since death estate is a testamentary trust for tax purposes estate designates itself as the GRE in its first tax return deceased s SIN provided in estate tax return no other estate is designated as the GRE of the deceased No grandfathering Deemed year end at end of GRE status 4 Catherine Brown & William Fowlis

131 Graduated Rate Estates Why is GRE status important? graduated tax rates on income earned and retained in the estate no tax installment obligations off calendar year end permitted GRE status is also required to: access new flexible donation credit rules for donations made in Will or by the estate (for deaths after 2015) benefit from nil capital gains inclusion for donation of shares on death (for deaths after 2015) access s. 164(6) and s. 112(3.2) loss carry back rules 5 Catherine Brown & William Fowlis Cost of Loss of GRE Status Alberta (based on 2015 rates) Saskatchewan Manitoba $12,612 x 3 years $14,249 x 3 years $14,649 x 3 years Loss of other benefits of GRE status may be much more significant 6 Catherine Brown & William Fowlis

132 Subsection 104(13.3) Subsection 104(13.3) makes a designation under 104(13.1) and (13.2) INVALID if, after the application of the designation, the trust has taxable income Designations available to allow the trust to use losses and other tax attributes ISSUE: Does not allow a designation to use tax credits (donation tax credits or ITCs) in trust Applies starting in Catherine Brown & William Fowlis Subsection 104(13.3) (cont d) UNCERTAINTY: Does subsection 104(13.3) allow the use of both loss carry forwards and loss carry backs UNCERTAINTY: Can a late filed designation be made under subsection 104(13.1) and (13.2)? No need to make a subsection 104(13.1) or (13.2) designation where income is not paid or payable to a beneficiary 8 Catherine Brown & William Fowlis

133 Life Interest Trusts Subsection 104(13.4): shift of tax burden Trusts affected Issues Subsection 160(1.4): joint and several liability The Fallout: managing, planning and drafting 9 Catherine Brown & William Fowlis Life Interest Trusts: Shift of Tax Burden New s. 104(13.4): On the death of the life interest beneficiary (or the second death for a joint partner trust): trust has deemed year end at end of day of death, and all income of the trust for shortened year (including any capital gains realized on the 104(4) deemed disposition) is deemed payable in year to deceased life interest beneficiary Result: Capital gains on deemed disposition (and any amounts that are trust income) are included in deceased life interest beneficiary s terminal return and the trust claims a deduction Primary tax burden shifted from Trust to estate of life interest beneficiary (may include Both gains of deceased settlor and gains accrued in the life interest trust) 10 Catherine Brown & William Fowlis

134 Life Interest Trusts: Trusts Affected Life Interest Trusts trusts for which a deemed disposition occurs on the death of the surviving life interest beneficiary: spousal and common law partner trusts joint spousal and common law partner trusts alter ego trusts self benefit trusts (politician s blind trusts) s. 107(4.1) trusts (qualifying dispositions) Applies on deaths after 2015 No grandfathering 11 Catherine Brown & William Fowlis Impact on the Estate All trust income and capital gains in the year of death including income from actual or deemed dispositions and phantom income are included in the terminal return Carry over losses, charitable and medical tax credits and other special tax provisions available in the terminal year apply against the included trust income May impact what the estate beneficiaries would otherwise receive if they were able to preserve tax attributes to, for example, amend prior year returns 12 Catherine Brown & William Fowlis

135 Avoiding Liability? There is NO mechanism to avoid the application of s. 104(13.4) to trust structures currently in place A variation of the trust or a release or surrender of the trust interest by an affected beneficiary will not avoid tax liability on death Liability for a beneficiary could attach years after, for example, removal of the spouse of a spousal trust 13 Catherine Brown & William Fowlis The Bright Side Tax liability is calculated in deceased s terminal return based on deceased s tax attributes carry over losses, charitable and medical tax credits and other special tax provisions that apply on death may offset the included income or capital gains terminal year return is subject to progressive rates access to the capital gains deduction of the settlor of an alter ego or self benefit trust 14 Catherine Brown & William Fowlis

136 Life Interest Trusts: Subsection 160(1.4) S. 160(1.4): Life interest beneficiary and trust are jointly and severally liable for tax due as a result of s. 104(13.4) BUT Explanatory Notes (released Oct 30, 2014) Existing subsection 160(2) of the Act empowers the Minister of National Revenue to assess the liability that arises under subsection 160(1.4) against the trust at any time, and it is intended that the Minister apply subsection 160(2), in respect of an amount owing under subsection 160(1.4), as though the trust were liable in the first instance for that amount. 15 Catherine Brown & William Fowlis Life Interest Trusts: The Fall out Advising clients under the new provisions: Existing structures between now and 2016 in 2016 and beyond New structures planning drafting 16 Catherine Brown & William Fowlis

137 Example 1: Between Now and 2016 Larry s mother Marion is 96. She is the beneficiary of a testamentary spousal trust set up by her deceased husband George that includes a rental property with significant accrued gains and a low UCC. It is a second marriage for Marion and George. Randy is George s son. Randy is the sole capital beneficiary of the spousal trust Larry is the sole capital beneficiary of Marion s estate Larry and Randy are trustees of the spousal trust and Larry is personal representative of Marion s estate The trust income is $80,000 per year. Potential tax liability on the deemed disposition of the rental property on Marion s death exceeds $500, Catherine Brown & William Fowlis Example 1 Spousal trust Larry and Randy are trustees Marion s estate Larry is executor Marion income interest Randy capital interest Larry is the beneficiary 18 Catherine Brown & William Fowlis

138 Potential Options Do nothing An immediate sale of the trust assets A surrender of Marion s income interest to the trust under subsection 106(3) (may require a variation of the trust) An amendment to the trust document to achieve the above and/or or to clarify intention of the settlor that trust pay the tax liability A variation of the trust to clarify intention of the settlor that trust pay the tax liability, add an encroachment clause for the benefit of the affected beneficiary. (Distribute trust assets to cover the tax liability during the beneficiary s lifetime) Wind up the trust If the Parties are still alive and competent enter additional agreement(s) to address the tax liability An agreement among the beneficiaries with the trustees Other? (Advice and Direction) 19 Catherine Brown & William Fowlis Do Nothing If Marion dies in 2015 the tax liability on the deemed disposition of the rental property on her death is payable by the spousal trust Randy is the sole capital beneficiary; his share is reduced If Marion dies in 2016 the tax liability will fall to Marion s estate Larry is the sole beneficiary; his share is reduced 20 Catherine Brown & William Fowlis

139 Sale of Trust Assets Tax liability from an actual disposition is borne by the spousal trust if: property is sold in 2015 property is sold in 2016 but Marion survives until January 1, 2017 As the beneficiary of Marion s estate, Larry s best option is for the spousal trust to sell the rental property As trustee of the spousal trust can Larry make the decision given his conflict of interest? Does Larry need Advice and Direction from the court? 21 Catherine Brown & William Fowlis Marion Surrenders her income interest to the trust: Subsection 106(3) If a trust distributes trust property to a beneficiary in satisfaction of all or any part of the beneficiary's income interest, the trust is deemed to have disposed of the property at its FMV Marion would not be deemed to receive proceeds on the disposition of her income interest Result: Tax liability in the spousal trust May require a variation of the trust 22 Catherine Brown & William Fowlis

140 Marion Surrenders her Income Interest (cont d) Surrender of her interest would not end Marion s tax liability on the under s. 104(3.4) Liability attaches and remains because her life is the life that triggers the deemed disposition Potential Benefits results in an actual disposition in the trust thus transferring the tax liability to the trust provides Marion with compensation for her income interest and proceeds from the trust to pay her later tax liability 23 Catherine Brown & William Fowlis Amendment to the Trust Document Most modern trust deeds contain the power to vary the trust terms Why? The original drafter of the trust cannot know the future and what might be needed to provide for beneficiaries or to deal with changes in laws especially tax laws If the power to amend permits, consider adding an encroachment clause to distribute assets to the life interest beneficiary to pay the tax due or discretion to make payment to the CRA 24 Catherine Brown & William Fowlis

141 Variation of the Trust Variation will depend on the applicable provincial legislation Success is never sure even if all the current beneficiaries agree Court must consent on behalf of contingent beneficiaries Good option to avoid allegations by trust beneficiaries of a breach of fiduciary duty if the trustee compensates the estate for subsection 104(13.4) tax liability 25 Catherine Brown & William Fowlis Wind up the Trust Trusts assets are distributed to the beneficiaries in satisfaction of their interests in the trust This may require an amending power, consent of the beneficiaries or a variation of the trust This may be contrary to George s wishes 26 Catherine Brown & William Fowlis

142 Parties Establishing the Arrangements enter into Additional Agreements If the estate plan is based on the assumption that tax liability on will be paid by the spousal trust, the parties could enter into contractual arrangements to achieve that result Example: the settlor of the spousal trust could contractually bind his or her estate to set aside sufficient funds to pay the tax liability that arises on the death of the spouse beneficiary Because the settlor is dead this is not a possibility 27 Catherine Brown & William Fowlis Agreement between the Beneficiaries with the Trustees To protect the trustees of the spousal trust from liability to a beneficiary, an agreement with the beneficiaries of the spousal trust could confirm the beneficiaries consent to the payment by the spousal trust of the subsection 104(13.4) taxes owed by the estate of the life interest beneficiary 28 Catherine Brown & William Fowlis

143 Seek Advice and Direction of the Court Application made in summary form Protects trustee against future claim of failure to properly discharge their duties and indemnification Court is generally unwilling to: take on the job of exercising the fiduciary discretion of the trustee (possible exception if trustees are dead locked) or decide issues better suited to resolution through conventional litigation 29 Catherine Brown & William Fowlis Example 2 The spousal trust did not dispose of the rental property in Marion at 97 passes away peacefully in her sleep in January of As a result the trust is subject to a deemed disposition of the trust asset and all of the trust income for 2016 up to and including the date of Marion s death is included in Marion s terminal period return. Larry is the personal representative of Marion s estate. He is also one of two trustees of the spousal trust. 30 Catherine Brown & William Fowlis

144 Example 2: The Dawn of 2016 Tax liability for trust income in the year of the life interest beneficiary s death clearly falls on Marion s estate under subsection 104(13.4) Tax and non tax questions: Should the trustee of the spousal trust write a check to cover the estate s new and unexpected tax liability or wait for the CRA to take action? Will the Trustee be in breach of his/her fiduciary duty to the trust beneficiaries if an attempt is not made to collect tax paid by the trust under subsection 160(1.4) from the estate or the estate beneficiaries? 31 Catherine Brown & William Fowlis Estate The personal representative will be concerned about fiduciary obligations to the estate beneficiaries and about potential personal liability on the distribution of estate assets Will the estate lose its status as a testamentary trust and therefore as a graduated rate estate if the trust pays the tax? Will the payment of tax by the trust on behalf of the estate be viewed as a subsection 105(1) benefit and taxable to the estate? Should somebody should pay the tax in timely fashion to avoid interest and potential penalties? 32 Catherine Brown & William Fowlis

145 Possible Loss of GRE Status Issue: Will the estate lose its status as a testamentary trust and therefore as a GRE if the trust pays the estate s tax Voluntarily? In payment of its s. 160(1.4) liability? Payment of the Taxes By Who? GRE or Spousal Trust To Who? CRA or GRE When? Possible Fixes 33 Catherine Brown & William Fowlis Non Tax Issues Beneficiaries What recourse do the beneficiaries of the trust have if the trustees choose to pay the tax balance owed by the estate without being assessed under subsection 160(1.4)? 34 Catherine Brown & William Fowlis

146 Non Tax Issues Creditors Assuming the trustee is sympathetic to the estate and exercises discretion to pay the tax resulting from subsection 104(13.4) on behalf of the estate, what recourse if any do creditors of the estate or trust have if the trustees choose to pay the tax balance before being assessed? Can the estate creditors challenge the payment if the payment is made directly to the CRA on behalf of the estate? 35 Catherine Brown & William Fowlis What is the prudent approach for the trustee? The trustee should not pay the estate s subsection 104(13.4) tax until issued with a subsection 160(1.4) assessment Assuming the trustee has the power to pay the tax and exercises the discretion to do so, he or she should seek releases from the trust beneficiaries Note: A distribution by the trust to the estate may not prevent joint and several liability of the trust for the amount if the estate has other creditors who seek to claim the amount 36 Catherine Brown & William Fowlis

147 What Steps? What steps, if any, should the personal representative of the deceased beneficiary s estate take? Personal representative is liable to the extent of distribution of estate assets prior to issuance of a clearance certificate Do not distribute estate assets until a clearance certificate is issued for the estate, or it is clear there are sufficient assets to pay both the deceased s and the estate s tax liability To the extent that tax owing by the estate is a result of subsection 104(13.4), presumably the trust would be pursued under subsection 160(1.4) before the personal representative under subsection 159(3) 37 Catherine Brown & William Fowlis Example 3: Post Mortem Planning Larry s mother Marion is 96 and lives in Calgary. She is the beneficiary of a testamentary spousal trust established by her deceased husband George that owns fixed value preferred shares in Holdco having a value of $5,000,000, a NIL adjusted cost base and a NIL paid up capital. It was a second marriage for Marion s deceased husband George. Larry and George s son Randy, are the trustees of the spousal trust. Larry is the personal representative of Marion s estate. Randy owns the common shares in Holdco. 38 Catherine Brown & William Fowlis

148 Example 3 Marion Randy ST Preferred Shares FMV $5M ACB/PUC $0 Holdco 39 Catherine Brown & William Fowlis Life Interest Trusts Subsection 104(13.4) and Loss Carry back Planning: On Marion s death, deemed disposition of Holdco shares $5M capital gain deemed payable to Marion and is reported in Marion s terminal return Holdco shares redeemed by Holdco from Spousal Trust within three taxation years Shares redeemed for $5M $5M taxable dividend to the Spousal Trust Capital loss of $5M realized in spousal trust 40 Catherine Brown & William Fowlis

149 Life Interest Trusts Subsection 104(13.4) and Loss Carry back Planning (cont d): While spousal trust can elect to carry back capital loss to tax year of the trust in which Marion died, all capital gains were previously deemed payable to Marion when the T3 Return was initially filed Can spousal trust make a late designation under 104(13.2) to have capital gain payable to Marion taxed in the spousal trust? Under legislation unclear; but CRA has provided administrative concession that late filed 104(13.2) permitted to provide for loss carry back If cannot implement planning, risk of double tax because spousal trust not typically designed to carry on to utilize losses 41 Catherine Brown & William Fowlis Life Interest Trusts Problems and Technical Issues: Timing issue the tax becomes owing on the date that Marion s terminal return is due; presumably 160(1.4) and 160(2) can only be applied once the terminal return is filed and assessed Interest will always apply to tax liability because the Trust should pay only after receiving a 160(2) demand to pay Increased compliance where loss carry back: File T3 trust tax return excluding deemed income File terminal T1 return reporting deemed income File amended T3 trust return including s. 104(13.2) designation, offsetting gain with loss carry back File amended T1 return removing gain due to loss carry back Refund and refund interest issues 42 Catherine Brown & William Fowlis

150 Life Interest Trusts Use of other tax attributes (loss carry backs) or tax credits in Estate will offset tax on deemed income under subsection 104(13.4) Detrimental to estate beneficiaries Reduces tax liability for which Trust is potentially liable 43 Catherine Brown & William Fowlis 2016 and Beyond 2016 and Beyond: Drafting under the New Regime Make the life interest spouse a (discretionary) capital beneficiary of the spousal trust with payment to estate on spouse s death Trust terms may require trustee to pay the subsection 104(13.4) tax or provide trustee with power to pay 44 Catherine Brown & William Fowlis

151 Practice Points and Planning Thoughts Payment of the Estate s taxes resulting from s. 104(13.4) Income Inclusion By Who? To Who? When? Arrangements between the Life Interest Trust and the Estate Arrangements between the Life Interest Trust and its Beneficiaries Arrangements between the Estate and its Beneficiaries 45 Catherine Brown & William Fowlis Practice Points and Planning Thoughts (cont d) Dealing with Conflicts of Interest Considerations when the structure may not be easily changed 46 Catherine Brown & William Fowlis

152 Practice Points and Planning Thoughts (cont d) Drafting in light of the New Rules Wills Trusts What about existing documents/arrangements that could be changed? Ensuring clients understand the impact of these rules on their planning Build sufficient flexibility into documents Consider impact of tax planning on the client s objectives 47 Catherine Brown & William Fowlis Practice Points and Planning Thoughts (cont d) Does an Alter Ego Trust or Joint Partner Trust provided advantages over a Will Sale of Trust Assets 48 Catherine Brown & William Fowlis

153 Suggested Legislative Changes and Clarifications Graduated Rate Estate Only one Estate Need for designation? Address tainting of testamentary Trust status S. 104(13.3), (13.1), (13.2) Use of Loss Carry Back Use of available tax credits Permitting late designations under s. 104(13.1) and (13.2) Technical Issues 49 Catherine Brown & William Fowlis Suggested Legislative Changes and Clarifications (cont d) S. 104(13.4) Eliminate Replace with rules that preserve tax base but avoids tax liability / asset ownership mismatch Grandfathering 50 Catherine Brown & William Fowlis

154 Changes in Wills and Gifting on Death Richard E. Eisenbraun, Borden Ladner Gervais LLP Calgary, AB Changes in Wills and Gifting on Death Presentation Overview Graduated Rate Estates Gifting at Death Before the 2014 Budget 2014 Budget Key Changes 2015 Budget Key Changes 2 Richard E. Eisenbraun

155 Changes in Wills and Gifting on Death Graduated Rate Estates Major Changes to the Testamentary Trust Rules New Concept of a Graduated Rate Estate (GRE) Most Tax Advantages Now Flow From GRE Status New Rules Apply Starting in 2016 No Grandfathering 3 Richard E. Eisenbraun Changes in Wills and Gifting on Death Graduated Rate Estates To be a GRE, the trust must satisfy the following conditions: The estate must be a testamentary trust. This means that all contributions must be as a consequence of the taxpayer s death. The individual s SIN must be provided with the estate s tax return. 4 Richard E. Eisenbraun

156 Changes in Wills and Gifting on Death Graduated Rate Estates The estate must designate itself as the individual s GRE. No other trust can designate itself as the individual s GRE. GRE status only lasts for 36-months. 5 Richard E. Eisenbraun Changes in Wills and Gifting on Death Benefits of GRE Status Access to Graduated Tax Rates Capital Loss Carry-Back Flexible Charitable Donation Tax Credit Rules Basic Alternative Minimum Tax Exemption Part XII.2 Tax Exemption 6 Richard E. Eisenbraun

157 Changes in Wills and Gifting on Death Benefits of GRE Status No Instalment Payments Ability to Flow-Out Certain Benefits More Favorable Loss Restriction Rules Administrative Benefits 7 Richard E. Eisenbraun Changes in Wills and Gifting on Death Complications with GRE Rules GRE Planning is Now Critical Without GRE Status, the Ability to Match Taxable Income with Deductions / Tax Credits Can Be Lost 36-Month Rule Life Interest Trusts Multiple Wills 8 Richard E. Eisenbraun

158 Changes in Wills and Gifting on Death Basic Donation Tax Credit Rules Tax Incentive to Make Donations to Qualified Donees. Apply to Current Year or Next Five Taxation Years. During Lifetime Tax Credits can be used up to 75% of Income. Upon Death Tax Credits can be used in Terminal Return and Preceding Year up to 100% of Income. Estate Use of Tax Credits is restricted to 75% of Income. 9 Richard E. Eisenbraun Changes in Wills and Gifting on Death New Flexible Charitable Donation Rules Gifts on Death are Deemed Made by Taxpayer s Estate and by No Other Person Includes gifts made by Will, by the Estate and of proceeds of a Life Insurance Policy, RRSP, RRIF or TFSA. Gift is Deemed to be made when Property is Transferred to Donee Previously, gifts by Will were deemed to occur immediately before death. 10 Richard E. Eisenbraun

159 Changes in Wills and Gifting on Death New Flexible Charitable Donation Rules If the Estate is a GRE, the GRE can apply tax credits to: Last Two Taxation Years of the Deceased Individual. GRE s Taxes for Current Year and Next Five Years. Preceding Year of the Estate. No more ability to allocate to spouse s return after death. 11 Richard E. Eisenbraun Changes in Wills and Gifting on Death New Flexibility in Drafting Wills My Trustees are directed to make charitable donations of property acquired by my estate on and as a consequence of death, or property substituted therefor, to such qualified donees under the Income Tax Act (Canada) as may be selected by my Trustees in an amount sufficient to entirely offset the Canadian income tax liability incurred by myself in my terminal year and the one preceding taxation year (collectively, Tax Liabilities ). My Trustees shall have full discretion to select qualified donees, which may include but are not limited to [list of favourite charities and other qualified donees], as well as the amounts donated to each qualified donee. The total cumulative donations made pursuant to this bequest shall be as close as practically possible to the amount required to fully offset the Tax Liabilities. 12 Richard E. Eisenbraun

160 Changes in Wills and Gifting on Death Life Insurance, RRSPs, RRIFs and TFSAs Subsection 118.1(5.2) facilitates gifts in respect of life insurance, RRSPs, RRIFs and TFSAs. Gift is deemed to be made by the GRE. Flexible charitable donation tax credits apply. 13 Richard E. Eisenbraun Changes in Wills and Gifting on Death Valuation and Timing Issues Previously, a gift by Will was valued at the time of death. Under the new rules, a gift will be valued at the time that the gifted property is transferred to the qualified donee. New rules are more intuitive for recipients of gifts. Need to adjust planning for possible changes in value. Consider selling assets for cash and donating cash. 14 Richard E. Eisenbraun

161 Changes in Wills and Gifting on Death Tax-Advantaged Gifts Favorable tax treatment Capital gain is nil. Charitable donation tax credits available. Incentive to gift property with high unrealized gains. GRE has the ability to utilize flexible charitable donation tax credit rules. 15 Richard E. Eisenbraun Changes in Wills and Gifting on Death Tax-Advantaged Gifts Share, debt or right listed on a designated stock exchange Share of a mutual fund corporation Unit of a mutual fund trust Interest in a segregated fund Certain government or government guaranteed debt Ecological gifts Certified cultural property 2015 Budget Proposes to extend rules to private corporation shares and real estate 16 Richard E. Eisenbraun

162 Changes in Wills and Gifting on Death Non-Qualifying Securities Punitive Rules apply to gifts made of a share, debt or other interest in an entity controlled by the donor or a person who does not deal at arm s length with the donor (a NQS ). Charitable donation tax credits are denied until the securities cease to be NQS (a Triggering Event ). If no Triggering Event within 5 years, credits are denied. Essentially reduced to 36-months because of GRE rules. 17 Richard E. Eisenbraun Changes in Wills and Gifting on Death Non-Qualified Investment Imputed interest or dividends apply where a private foundation owns a share or debt issued by a person: who is a member, shareholder, trustee, settlor, officer, official or director of the foundation; who has, or is a member of a group of persons who do not deal at arms length, who have contributed more than 50% of the capital of the foundation; or who does not deal at arm s length with any person described above. 18 Richard E. Eisenbraun

163 Changes in Wills and Gifting on Death Excess Business Holdings Regime Applicable to Private Foundations. Less than 2% - No reporting or divestment obligations. 2% to 20% - Must report holdings of private foundation and all non-arm s length persons. Greater than 20% - Must report and must divest some shares of the entity over time. Extended divestment period of five years for gifts by way of bequest. 19 Richard E. Eisenbraun Changes in Wills and Gifting on Death 104(13.1) and (13.2) Designations Designations allow income or capital gains to be taxed in the Trust in cases where the relevant property has been distributed to a beneficiary in the year. Designations will no longer be allowed where the Trust s taxable income is greater than nil. In other words, the designations can now be used only to offset losses (but not charitable donation tax credits). 20 Richard E. Eisenbraun

164 Changes in Wills and Gifting on Death Life Interest Trusts Spousal trusts, Alter-Ego Trusts and Joint Spousal or Common Law Partner Trusts. On Death of Life Interest Beneficiary, there is now a Taxation Year End and Deemed Disposition by the Trust. However, all of the Trust s Income and Capital Gains are Deemed to be Taxable in the hands of the Deceased Life Interest Beneficiary. New Rule Makes Trust and Beneficiary s Estate Jointly and Severally Liable for the Tax Liability. 21 Richard E. Eisenbraun Changes in Wills and Gifting on Death Life Interest Trusts New rules may be problematic if gifts are made upon the death of the life interest beneficiary. Income from deemed disposition is taxable in deceased life interest beneficiary s return. BUT: Tax credits fall within the life interest trust s return and may be stranded. Possible Solutions? 22 Richard E. Eisenbraun

165 Changes in Wills and Gifting on Death Charitable Remainder Trusts Irrevocable trust under which income accrues to life tenants and capital accrues to qualified donees. Qualified donee has a vested interest in the capital. CRA policy was that a gift was made of the interest in the trust at the time of death. Does the CRA policy continue apply under the new rules? 23 Richard E. Eisenbraun Changes in Wills and Gifting on Death Questions? 24 Richard E. Eisenbraun

166 Tax Planning During an Economic Slowdown Andrew Bateman, Felesky Flynn LLP Anthony Strawson, Felesky Flynn LLP Calgary, AB Introduction Tax Planning During an Economic Slowdown A slowing economy may give rise to a changing set of business circumstances, which may involve: Economic losses Shortage of cash and/or credit Debt refinancing Loss of business contracts Loss of employees Increased focus on efficiency and cost control 2 Andrew Bateman & Anthony Strawson

167 Tax Planning During an Economic Slowdown Introduction A slowing economy also may give rise to a different set of tax considerations, which possibly include: Increased focus on tax efficiency overall (e.g., cost control) Realizing, utilizing and preserving losses Obtaining advice on refinancings and restructurings Greater focus on deferring taxes and recovering taxes paid Seeking future tax benefits based on low current asset valuations Adjusting strategies in tax disputes 3 Andrew Bateman & Anthony Strawson Agenda Tax Planning During an Economic Slowdown Loss utilization Impaired debt planning Depressed values Other opportunities Selected pitfalls 4 Andrew Bateman & Anthony Strawson

168 Tax Planning During an Economic Slowdown Conventional Related Group Planning Amalgamations Post amalgamation losses available going-forward and to carry back to parent on a vertical short-form Pre-amalgamation losses available going-forward Wind-Ups Post wind-up losses available going-forward and to carry back to parent Pre wind-up losses of subsidiary available to parent for tax years commencing after commencement of wind-up 5 Andrew Bateman & Anthony Strawson Tax Planning During an Economic Slowdown Conventional Related Group Planning Tax deferred transfers of property with inherent gains or that is generating profits to loss corporations Form partnership to combine profit and loss businesses Management Fees Although these are often inappropriately used and insufficiently documented Debt/Preferred Share Structures Profitco borrows to invest in shares of related corporation, often using a daylight loan Numerous rulings 6 Andrew Bateman & Anthony Strawson

169 Tax Planning During an Economic Slowdown Less Conventional Related Group Loss Planning Example Stow (2010 TCC) Two corporations owned by taxpayer s spouse formed general partnership and incurred large currency trading losses (on an 80/20 basis) Two weeks later (after losses incurred) taxpayer acquired 80% interest in the partnership 80% of partnership loss allocated to taxpayer at end of partnership fiscal period Partnership continued for several years Held: S. 103 did not apply 7 Andrew Bateman & Anthony Strawson Tax Planning During an Economic Slowdown Partnership Example Continued Loss business could be carried on by existing partnership or transferred into a new partnership Prior to fiscal period end, a related person or entity best able to use the losses could acquire substantial partnership interest Loss could offset income from other sources, or be carried back to prior years Deferral advantages may arise after the business becomes profitable again, or structure could be unwound Liability issues may pose practical limitations 8 Andrew Bateman & Anthony Strawson

170 Tax Planning During an Economic Slowdown Third Party Loss Utilization or Monetization Generally, transactions that seek to use an unrelated person s losses are subject to much more restrictive streaming rules or may be viewed as aggressive Same or similar business type transactions generally are the easiest to close and lead to the least uncertainty (and highest price for losses) Nevertheless, other transactions also are undertaken to monetize tax attributes (very fact specific) 9 Andrew Bateman & Anthony Strawson Tax Planning During an Economic Slowdown Impaired Debt Planning Doubtful or bad debts Debt forgiveness rules Allowable business investment losses ( ABILs ) Asset seizure rules 10 Andrew Bateman & Anthony Strawson

171 Doubtful or Bad Debts Tax Planning During an Economic Slowdown Main provisions - paragraphs 20(1)(l) and 20(1)(p) and subsection 50(1) Important considerations: Have all possible doubtful/bad debts been considered (e.g., accrued but unpaid fees)? Does a taxpayer s ordinary business include the lending of money? For bad debts, what measures have been taken? 11 Andrew Bateman & Anthony Strawson Tax Planning During an Economic Slowdown Debt Forgiveness The general requirements for section 80 to apply are: 1) there is a commercial obligation (being a commercial debt obligation or distressed preferred share) 2) issued by a debtor 3) that is settled or extinguished (various deeming rules may apply) 4) there is a forgiven amount (being the lesser of the amount for which obligation was issued and principal amount, minus the amount paid in satisfaction of the obligation, if any) 12 Andrew Bateman & Anthony Strawson

172 Debt Forgiveness Tax Planning During an Economic Slowdown Where the rules apply, a forgiven amount is applied to: (1) mandatorily reduce certain tax attributes, (2) optionally reduce certain tax attributes, and (3) result in an income inclusion at 50% of any remainder Certain deeming rules may also cause debt forgiveness to apply: - amalgamations and wind-ups - debt parking rules - statute barred debt 13 Andrew Bateman & Anthony Strawson Tax Planning During an Economic Slowdown Debt Forgiveness Important planning considerations: insolvency deduction reserve for corporations (5 year) or individuals discretion of Minister to re-designate results transfer of forgiven amount to related persons distressed preferred shares debt parking exceptions income debts, 80% threshold 14 Andrew Bateman & Anthony Strawson

173 Tax Planning During an Economic Slowdown ABILs The general requirements to claim an ABIL: 1) a taxpayer realizes a capital loss 2) resulting from a disposition of property to which subsection 50(1) applied, or to an arm s length person 3) where the property was a share of a small business corporation ( SBC ), or a debt payable by a SBC, but excluding debt payable to a corporation by a non-arm s length person 4) to the extent the capital loss exceeds certain other amounts 15 Andrew Bateman & Anthony Strawson ABILs Tax Planning During an Economic Slowdown Possible issues include: Demonstrating that a purchaser is arm s length Establishing a debt as bad Debt forgiveness (and debt parking) consequences Proving the SBC requirement is satisfied ABIL limitation rules Acquisition of control ABILs not permitted 16 Andrew Bateman & Anthony Strawson

174 Tax Planning During an Economic Slowdown Seizure Rule Where a property is seized, the creditor is deemed to acquire it at a cost equal to the amount of the debt Debtor is deemed to dispose of the property for the same amount The character of the seized property to the creditor is not necessarily dictated by the character of the debt to the creditor or seized property to the debtor Disposition of the seized property may result in a more favourable result to the creditor or the debtor May, for example, replicate ABIL result 17 Andrew Bateman & Anthony Strawson Tax Planning During an Economic Slowdown Seizure Rule Examples B.C. Ltd. (2001 TCC): Taxpayer sold service station; consideration included vendor take back debt Buyer agreed to transfer station back to taxpayer for (among other things) release on debt Deemed cost of station per s exceeded value Taxpayer claimed write down under s. 10(1) Held: On the facts, the station was not inventory or part of an adventure in the nature of trade 18 Andrew Bateman & Anthony Strawson

175 Tax Planning During an Economic Slowdown Seizure Rule Examples Continued Saskatchewan Wheat Pool (2008 TCC): Taxpayer owned 40% of corporation s shares and debt Corporation used debt to acquire land on income account Taxpayer acquired 40% interest in land in satisfaction of debt; deemed cost exceeded value Taxpayer intended to sell as soon as possible and realized an accounting profit Held: Loss on income account; fully deductible 19 Andrew Bateman & Anthony Strawson Tax Planning During an Economic Slowdown Seizure Rule Examples Continued B.C. Ltd. (2014 TCC): Taxpayer loaned money to arm s length corporation Corporation could not repay and taxpayer acquired patents owned by the corporation as a result Deemed cost/ucc of patents exceeded value Approximately two years later patents were transferred to a related corporation and a terminal loss was claimed Held: Patents were acquired for purpose of earning income; terminal loss allowed 20 Andrew Bateman & Anthony Strawson

176 Seizure Rule Take Aways Tax Planning During an Economic Slowdown Particularly useful where doubtful/bad debt rules or ABIL rules are not satisfied Very important to take steps to support the desired character of the property in the hands of the creditor Particularly in non-arm s length situation, consider implications to the debtor 21 Andrew Bateman & Anthony Strawson Tax Planning During an Economic Slowdown Depressed Values Depressed asset values may cause certain transactions to be desirable: Estate freeze, refreeze or thaw Taxable contributions to a family trust Emigration from Canada (becoming non-resident) Transfer of assets to low tax jurisdiction Acquisitions e.g., arm s length, shotgun clauses Inventory writedowns Triggering hedging gains and losses 22 Andrew Bateman & Anthony Strawson

177 Depressed Values Re-freeze Example Tax Planning During an Economic Slowdown BEFORE AFTER Mr. X preferred shares FMV $10 Million ACB $500,000 Mr. X preferred shares FMV $1 Million ACB $500,000 after initial freeze after refreeze during economic slowdown 23 Andrew Bateman & Anthony Strawson Tax Planning During an Economic Slowdown Other Opportunities Year-End Changes Changing corporate year end to accelerate loss carryback Techniques GAARable? Information Circular 88-2, paragraph 21 Blackberry Remission Order Deferral partnerships S. 34.3: May reduce accrual based on actual Collapse or change year if a loss 24 Andrew Bateman & Anthony Strawson

178 Other Opportunities Tax Planning During an Economic Slowdown Long-Term Incentive Plan Refresh Reprice underwater options Convert cash draining plans into stock plans Convert employer deduction plans into non-deductible stock plans with better tax result Including employee buyco structures 25 Andrew Bateman & Anthony Strawson Tax Planning During an Economic Slowdown Pitfalls in Troubled Times Loss issues loss restriction event loss suspension or denial rules consider a loss determination request Cash issues - GST/employee source deductions Tax liability issues sections 159 and 160 Contract termination payments and receipts Damage payments and receipts Large corporation status 26 Andrew Bateman & Anthony Strawson

179 Pitfalls in Troubled Times Director Liability Example Tax Planning During an Economic Slowdown Directors A B C Collected but unremitted GST $1 million 27 Andrew Bateman & Anthony Strawson Recap Loss utilization Impaired debts Depressed values Other opportunities Other pitfalls Tax Planning During an Economic Slowdown 28 Andrew Bateman & Anthony Strawson

180 Tax Planning During an Economic Slowdown Questions? 29 Andrew Bateman & Anthony Strawson

181 When is a Loss a Loss and When Can You Claim a Loss Tim Kirby, Felesky Flynn LLP Rick Barnay, PricewaterhouseCoopers LLP Sean W. Hiebert, PricewaterhouseCoopers LLP Calgary, AB When is a Loss a Loss... Introduction Losses: what s the big deal? Complexity Competing policies High value Changing landscape 2 Rick Barnay, Sean Hiebert & Tim Kirby

182 When is a Loss a Loss... Agenda Overview of the Loss Restriction Event (LRE) Regime vs Old Regime Old Regime LRE Regime Corporations and Trusts Impact of LRE on Non-Capital and Net Capital Losses Suspended Loss Rules Subsection 13(21.2) and certain related provisions Subsection 40(3.3), 40(3.4) and certain related provisions Historical Ruling Review and Practicalities ATR-66 in the LRE Regime Overview of some practical considerations 3 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... Old Regime: The Basics Only applied to corporations Deemed year-end Losses became restricted on an acquisition of control Same or similar business 4 Rick Barnay, Sean Hiebert & Tim Kirby

183 Old Regime: The Basics When is a Loss a Loss... 5 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... Old Regime: Planning Opportunities Structures were developed to: Shift profits or profitable businesses to losscos; or Acquire significant interests in loss trusts 6 Rick Barnay, Sean Hiebert & Tim Kirby

184 When is a Loss a Loss... Old Regime: Planning Opportunities 7 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... Old Regime: Planning Opportunities 8 Rick Barnay, Sean Hiebert & Tim Kirby

185 When is a Loss a Loss... Old Regime: Planning Opportunities 9 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... Old Regime: Planning Opportunities 10 Rick Barnay, Sean Hiebert & Tim Kirby

186 LRE Regime: The Basics Budget 2013 When is a Loss a Loss... Losses became restricted on a loss restriction event Corporations and trusts No longer restricted to acquisitions of control 11 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... LRE Regime: Corporations A corporation will undergo a LRE if: A person or group of persons exceeds 75% threshold; Immediately prior, the person or group was below 75% threshold; Person or group does not control; and Person or group does not control in order to avoid one or more specified provisions 12 Rick Barnay, Sean Hiebert & Tim Kirby

187 When is a Loss a Loss... LRE Regime: Corporations If a corporation undergoes a LRE, then: Deemed acquisition of control; Deemed loss of control; and Deemed lack of related and affiliated status 13 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... LRE Regime: Trusts A trust will undergo a LRE if: A person becomes a majority-interest beneficiary; or A group of persons becomes a majority-interest group of beneficiaries Does a person or group of persons have a beneficial interest in greater than 50% of either the income or capital of the trust? 14 Rick Barnay, Sean Hiebert & Tim Kirby

188 LRE Regime: Trusts When is a Loss a Loss... Various exceptions in subsection 251.2(3) for certain: Affiliated party transactions; Estate transactions; Trust variations, trust conditions and powers and equity transactions; Reorganizations; Grandfathered transactions; and Investment funds 15 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... LRE Regime: Trusts Additional rules: Deemed majority-interest beneficiary; Control; Affiliated = related; Anti-avoidance; Deemed acquisitions of control; and Timing 16 Rick Barnay, Sean Hiebert & Tim Kirby

189 When is a Loss a Loss... LRE Regime: Non-Capital Losses For pre-lre non-capital losses to be carried forward: Loss business must continue for profit or with REOP; Losses may be used against income from: The loss business; or A similar business Same test for post-lre non-capital losses to be carried back to pre-lre taxation years 17 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... LRE Regime: Capital Losses Pre-LRE capital losses cannot be carried forward to post-lre taxation years Post-LRE capital losses cannot be carried back to pre-lre taxation years Realization of accrued capital losses Paragraph 111(4)(e) election 18 Rick Barnay, Sean Hiebert & Tim Kirby

190 Suspended Loss Rules When is a Loss a Loss Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... Suspended Loss Rules Application of 13(21.2), 40(3.3), 40(3.4) and certain related provisions Overview of Legislation Impact of LRE Regime Highlight of CRA View Doc in respect of 13(21.1) and 40(3.3)/40(3.4) 20 Rick Barnay, Sean Hiebert & Tim Kirby

191 13(21.2) Legislation When is a Loss a Loss... In respect of Depreciable Capital Property: Applies to individual as well as corporation, trust and partnership Accrued Terminal Loss on Property Owned or Right to Own Taxpayer or Affiliated Person 30 day period Suspended Terminal Loss = Notional Property Continued CCA Claim on Notional Property 21 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... 40(3.3)/40(3.4) - Legislation In respect of Non- Depreciable Capital Property: Applies to corporation, trust and partnership (not individuals) Accrued Capital Loss Property Property/ Identical Property Acquired ( Substituted Property ) Taxpayer or Affiliated Person 60 day period Suspended Loss Deferred 22 Rick Barnay, Sean Hiebert & Tim Kirby

192 When is a Loss a Loss... 13(21.2) Loss Triggering Events When is the suspended loss available? The earliest of : A. Non-affiliated person owns or right to own transferred property B. Change in Use of transferred property C. Change in Residence or tax Status of transferor D. Transferor subjected to Loss Restriction Event E. If transferor is a corporation taxable wind-up 23 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... 40(3.3)/40(3.4)- Loss Triggering Events When is the suspended loss available? The earliest of: A. Non-affiliated person owns Substituted Property B. Change in Residence or tax Status of transferor C. Transferor subjected to Loss Restriction Event D. Deemed disposition of Substituted Property pursuant to Section 50 E. If transferor is a corporation taxable wind-up 24 Rick Barnay, Sean Hiebert & Tim Kirby

193 When is a Loss a Loss... Other Applicable Legislation Subsections 13(24) and 13(25) Prevent the transfer of certain tax attributes Depreciable property acquired within 12 months prior to an LRE Property was not used in a business prior to commencement of 12 month period by relevant taxpayer One consequence, property is not eligible for addition into UCC until after the LRE 25 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... Other Applicable Legislation Subsection 40(3.6) Applies in respect of share redemptions to an affiliated corporation Applies to corporation, trust, partnership and individual Denied loss is not suspended; rather added to cost of any remaining shares Subsection 112(3) Capital Loss reduced to extent of historical Capital Dividends Loss is permanent and not suspended Deemed $nil loss also $nil for CDA (CRA view: E5) 26 Rick Barnay, Sean Hiebert & Tim Kirby

194 Impact of LRE Regime When is a Loss a Loss... For both 13(21.2) and 40(3.3)/40(3.4) expanded the application of a triggering event for a trust: Old Regime only - AOC rules applied to a corporation LRE Regime - applies to a corporation and trust Added complexity for triggering in LRE Regime: Section256.1: Expansion of de facto control under Old Regime to include de jure control under LRE Regime LRE Regime is more complex for corporations and a new reality and complexity for trusts. 27 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... 13(21.2) CRA View No E5 Overview of Facts: Personal Trust disposed of depreciable property with accrued loss Acquired by Affiliated Person Trust was wound up prior to expiry of 30 day period Conclusion in 2004, 13(21.2) did not apply as 13(21.2)(c) not satisfied Conclusion in Post LRE Regime, no change The impact of LRE Regime: Changed the application of a triggering event Did not impact test applied at the end of 30 day period 28 Rick Barnay, Sean Hiebert & Tim Kirby

195 When is a Loss a Loss... 40(3.3) CRA View No E5 Overview of 3 Scenarios Reaffirmation of 2 historical Administrative positions in the LRE Regime: 2003 Designate the ordering of the sale of a property 2001 Algebraic Formula to permit partial loss 29 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... 40(3.3) CRA View No E Algebraic Formula to permit partial loss DL = (least of S, P, and B) / S L» DL: Denied Loss» S: Number of items disposed of at the time to nonaffiliated» P: Number of items bought in 60 day period» B: Number of items remaining end of period» L: Loss otherwise determined 30 Rick Barnay, Sean Hiebert & Tim Kirby

196 When is a Loss a Loss... 40(3.3) CRA View No E5 Highlight of CRA View - CRA View Doc No E5 Scenario 1: No suspended loss Why? Designating the sale of the substituted property prior to end of period 2003 letter Scenario 2: Initial Loss of $100, Suspended Portion $ Letter Suspended Loss of $83.33 released 2003 Letter 31 Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... 40(3.3) CRA View No E5 Scenario 3: Facts i. February 1: Acquire 100 Publico Shares ii. iii. iv. February 28: Acquire 50 Publico Shares (Substituted Property) March 15: $100 loss on Disposal of 60 Publico Shares to Non- Affiliated March 16: Dispose of 50 Publico shares 25 disposed of to a non-affiliated 25 disposed of to a affiliated 32 Rick Barnay, Sean Hiebert & Tim Kirby

197 When is a Loss a Loss... 40(3.3) CRA View No E5 Scenario 3: Analysis i. Strict Application, a substituted property is owned at the end of the period (March 15) by an affiliated person -> Full Denial of $100 loss on 60 shares ii. iii. Application of 2003 letter Designate Substituted Property shares sold on March 16 (i.e = 50) Application of 2001 letter Only 25 of the 50 Substituted Property Shares were sold, therefore DL = (least of S, P, and B) / S L DL = 25 / 60 x $100 DL = $ Rick Barnay, Sean Hiebert & Tim Kirby When is a Loss a Loss... Ruling Review and Practicalities 34 Rick Barnay, Sean Hiebert & Tim Kirby