Category Archives: Recent case

Purchase Price Allocation

Section 68 of the Income Tax Act (Canada) (the “ITA”) allows the Canada Revenue Agency (the “CRA”) to determine the reasonable consideration for the disposition of a particular property. In TransAlta Corporation v. The Queen (2012 FCA 20), the Federal Court of Appeal (the “FCA”) helpfully clarified two important allocation principles for the purposes of section 68 of the ITA.

In 2002, TransAlta sold its regulated electricity transmission business to an arm’s length purchaser for the negotiated price of 1.31 times the net regulated book value of TransAlta’s tangible assets. The parties allocated the bulk of the 31% premium to goodwill. This allocation was a standard allocation of purchase price premium for regulated industries and was supported by valuation theory, audited financial statements and long-standing industry practice. The Minister reassessed TransAlta, pursuant to section 68 of the ITA to reallocate the premium to tangible assets on the basis that the practice by regulated industries of allocating purchase price premium to goodwill was unreasonable as it allowed the vendors to avoid recapture of capital cost allowance on its tangible assets.

In determining whether an allocation of purchase price to a particular property is reasonable under section 68 of the ITA, the FCA provided the following guides: (1) an allocation of purchase price agreed to by arm’s length parties is an important (but not determinative) factor to consider and will be given considerable weight where the parties have strong divergent interests concerning that allocation and less weight where one of the parties is indifferent to that allocation or where both parties’ interests are aligned with respect to that allocation; and (2) the reasonableness test under section 68 of the ITA is not what the CRA believes is reasonable but rather “whether a reasonable business person, with business considerations in mind, would have made the allocation”.

In this case, the FCA concluded that the parties’ agreed allocation of the premium to goodwill was reasonable “precisely because of its compliance with industry and regulatory norms and its consistency with standard valuation theory for regulated businesses and standard accounting principles applied in such industries.” The taxpayer’s appeal was allowed

10-year limitation period

The Federal Court of Appeal recently released its decision in Bozzer v. The Queen, 2011 FCA 186. Since the introduction in 2004 of a 10-year limitation period for interest and penalty relief under subsection 220(3.1) of the Income Tax Act, the CRA has administered the provision as if the 10-year period for applying for relief expires on December 31st of the 10th year following the taxation year assessed (i.e., December 31, 2010 for taxation year 2000).

In a resounding victory for taxpayers, Justice Stratas rejected the Minister’s policy. In line with practitioners, who have argued that interest accrues continuously and that the CRA’s administrative practice has no “fairness” rationale, Justice Stratas accepted Mr. Bozzer’s position that the 10-year limitation period is the 10 years that end with the taxpayer’s application for relief, regardless of the taxation year of the principal tax debt.

However, CRA has not changed its administrative practice. The CRA has not yet expressed any official response to the decision and it remains to be seen if the Minister will appeal to the Supreme Court of Canada or ask the Department of Finance to legislate over the decision.

Farm Losses Revisited by SCC

On Friday March 23, 2012, The Queen v. John R. Craig was heard by the Supreme Court of Canada (SCC). This was the first opportunity for the SCC to revisit the issue of restricted farm losses since its decision in Moldowan v. The Queen, [1978] 1 SCR 480. In Moldowan, the SCC concluded that farm losses could only be deducted against other sources of income, without restriction, if farming or a combination of farming and some other source of income was a taxpayer’s chief source of income. This vague direction resulted in over 30 years of inconsistent decisions from the courts below.

Trust Residence

On April 12, 2012, the Supreme Court of Canada (SCC) released its decision in Fundy Settlement v. Canada (2012 SCC 14). This case was the SCC’s first opportunity to consider the appropriate test for determining the residence of a trust for tax purposes.

Prior to this case, it was widely believed that the residence of a trust was determined by reference to the residence of its trustee. This conventional wisdom had been challenged by the Minister of National Revenue in its assessment of the Fundy Settlement.

The lower courts agreed with the Minister that the appropriate test was not the residence of the trustee, but the corporate “central management and control” test (CMC test). In a terse 19 paragraph decision, the SCC agreed with the courts below.

The case was about a trust that had a Barbados-resident trust company as its trustee and Canadian-resident individuals as the beneficiaries. When the trust disposed of shares of an Ontario corporation, it remitted withholding tax to the Minister of National Revenue on account of the capital gain realized by the trust. The trust then sought to obtain a refund of the Canadian withholding tax on the grounds that the trust was resident in Barbados and, thus, exempt from Canadian capital gains tax under the Canada-Barbados Tax Treaty.

The Minister challenged this position, asserting that the trust was resident in Canada because the role of the trustee was limited and the Canadian-resident beneficiaries were actually managing the trust.

The SCC concluded that, as with corporations, the residence of a trust should be determined by the principle that a trust resides where its real business is carried on, that is, where the central management and control of the trust actually takes place. In reaching its decision, the SCC concluded that corporations and trusts are similar because the function of both is the management of property, and that the application of the CMC test to trusts would promote consistency, predictability and fairness.

The SCC did not reject the possibility that the residence of a trust could coincide with the residence of its trustee, but only when the trustee carries out the function of centrally managing and controlling the trust in the trustee’s place of residence. In the case of the Fundy Settlement, it was found that the Canadian-resident beneficiaries were managing the trust with the result that the trust was resident in Canada.


Attribution Case

On July 13th, 2012, the Federal Court of Appeal dismissed the Crown’s appeal in The Queen v Peter Sommerer (2012 FCA 207)

In 1996, Peter Sommerer’s father, Herbert Sommerer, created an Austrian private foundation of which Peter, his wife and children were beneficiaries. Peter then entered into an agreement with the foundation to sell it certain shares at fair market value. The foundation used part of its endowment money to pay Peter for the shares. The foundation later sold the shares and realized a capital gain.

The main issue in the case was whether subsection 75(2) of the Income Tax Act (Canada) should be interpreted to apply in the context of the fair market value sale of shares, such that the capital gain realized by the foundation could be attributed back to Peter.

The Crown argued that the capital gains realized by the foundation should be attributed to Peter because it was possible that the shares or property substituted for the shares (including the proceeds of their sale) might be distributed to him as a beneficiary. In other words, the Crown argued that subsection 75(2), which generally applies in respect of the settlement of a trust where the settlor is also a beneficiary, should also apply in respect of property that has been purchased by a trust from a beneficiary at fair market value.

The Tax Court of Canada found in favour of the taxpayer on the basis that subsection 75(2) could not apply to a beneficiary in respect of property sold to a trust at fair market value. The Court’s main conclusion was that “once properly unraveled and viewed grammatically and logically, the only interpretation is that only a settlor, or a subsequent contributor who could be seen as a settlor, can be the ‘the person’ for purposes of subsection 75(2) of the Act.”

A unanimous Federal Court of Appeal upheld the Tax Court’s decision. Since Peter was neither the settlor not a subsequent contributor (because the property was sold at fair market value), the Court held that subsection 75(2) did not apply to attribute the capital gains realized by the foundation to him.

T1135 Foreign Property and Income Reporting Requirements

T1135 Foreign Property and Income Reporting Requirements

In Douglas v. HMQ, 2012 TCC 73, a recent decision by the Tax Court of Canada (TCC) under the informal procedure, the TCC surprisingly accepted the taxpayer’s argument that the penalty imposed under subsection 167(2) of the Income Tax Act (Canada) should be waived for the late-filing of a T1135 form.

In this case, the taxpayer knowingly filed his T1 income tax return along with his T1135 nine months late. He assumed that his failure to file on time would not attract a penalty as he did not owe any taxes for the year. However, the Minister imposed the maximum penalty of $2,500 for the late-filed T1135.

The TCC noted that although a judge-made due diligence defense should be used sparingly, the facts in this case justify such application to waive the T1135 penalty. The Court found that the taxpayer acted reasonably in believing that there would be no penalty since no taxes were owing. Notwithstanding that subsection 167(2) imposes a strict penalty, the TCC held that it would be unfair to penalize the taxpayer in these circumstances.

This decision suggests that a taxpayer may have recourse through the TCC for late-filed T1135 penalties when the taxpayer has exercised “all reasonable measures” to comply with the Income Tax Act.

Recent case

Are Management fees deductible?

Tax planning to use tax losses in a corporate group structure may be allowed by the Canada Revenue Agency , using management fees as a tool for that planning may not be. As the recent case, Les Entreprises Rejean Goyette Inc. v. Her Majesty the Queen (2009 CCI 351), in which the Tax Court of Canada (TCC) denied the taxpayer’s deduction of inter-corporate management fees because there was no formal management agreement and, therefore, no legal obligation to pay them.