Top 10 Unusual Income Tax Act and Treaty Provisions

Top 10 Unusual Income Tax Act and Treaty Provisions - Number 1

• Subsection 8(4) reads8(4) An amount expended in respect of a meal consumed by a taxpayer who is an officer oremployee shall not be included in computing the amount of a deduction under paragraph8(1)(f) or 8(1)(h) unless the meal was consumed during a period while the taxpayer wasrequired by the taxpayer’s duties to be away, for a period of not less than twelve hours, fromthe municipality where the employer’s establishment to which the taxpayer ordinarilyreported for work was located and away from the metropolitan area, if there is one, where itwas located.

• Subsection 8(4) and section 67.1 both apply to limit meal expense deductions. CRA says itcannot administratively ignore this rule but has referred it to Finance: CRA Views 2018-0768791C6.

• Therefore, meal expenses should be reimbursed by the employer and not instead deducted bythe employee. Result = 25% deduction if a salesperson takes out a client for a meal.

Paragraph 60(o) – Deduction For Legal Fees – Number 2

60(o) - amounts paid by the taxpayer in the year in respect of fees or expenses incurred in preparing,instituting or prosecuting an objection to, or an appeal in relation to,(i) an assessment of tax, interest or penalties under this Act or an Act of a province that imposes a tax

similar to the tax imposed under this Act,(ii) a decision of the Canada Employment InsuranceCommission under the Employment Insurance Act or to an appeal of such a decision to the SocialSecurity Tribunal,

(ii) a decision of the Canada Employment Insurance Commission under the Employment InsuranceAct or to an appeal of such a decision to the Social Security Tribunal,

(iii) an assessment of any income tax deductible by the taxpayer under section 126 or any interest orpenalty with respect thereto, or(iv) an assessment or a decision made under the Canada PensionPlan or a provincial pension plan as defined in section 3 of that Act;

(iv) an assessment or a decision made under the Canada Pension Plan or a provincial pension planas defined in section 3 of that Act;

Paragraph 60(o) – Deduction For Legal Fees – Cont’d – Number 2

• Amounts must be paid “by the taxpayer” but there is nothing in the provision thatstates that the amounts must be paid “for the taxpayer” or “an assessment of thetaxpayer”.

• Such amounts paid do not enable a deduction for tax evasion charges.• See Flood 2006 TCC 186 for a good example of how paragraph 60(o) applies.

Flood was an interesting set of facts that involved a reassessment of hisMother’s estate that he was administering. Mr. Flood’s $9,000 of expenses wasallowed as a deduction under paragraph 60(o).

Are Siblings Related? Not Always!! Subparagraph 55(5)(e)(i) – Number 3

• By virtue of paragraphs 251(1)(a) and 251(6)(a), brothers and sisters are related forpurposes of the entire Income Tax Act.

• However, subparagraph 55(5)(e)(i) states:in determining whether 2 or more persons are related to each other, in determining whether aperson is at any time a specified shareholder of a corporation and in determining whether control ofa corporation has been acquired by a person or group of persons,(i) a person shall be deemed to be dealing with another person at arm's length and not to berelated to the other person if the person is the brother or sister of the other person,

• Above applies for purposes of section 55.• Yikes!!! This means that you need to be very careful that subsection 55(2) does not

apply when dealing with corporate reorganizations involving brothers and sisters!

Article XXIX: 5 of Canada / U.S. TreatyS-Corporations Held by Canadian Resident – Number 4• XXIX: 5. Where a person who is a resident of Canada and a shareholder of a United States S

corporation requests the competent authority of Canada to do so, the competent authority mayagree, subject to terms and conditions satisfactory to such competent authority, to apply thefollowing rules for the purposes of taxation in Canada with respect to the period during which theagreement is effective:a) the corporation shall be deemed to be a controlled foreign affiliate of the person;

b) all the income of the corporation shall be deemed to be foreign accrual property income;

c) for the purposes of subsection 20(11) of the Income Tax Act, the amount of the corporation's income that isincluded in the person's income shall be deemed not to be income from a property; and

d) each dividend paid to the person on a share of the capital stock of the corporation shall be excluded fromthe person's income and shall be deducted in computing the adjusted cost base to the person of the share.

• Can be very useful when you have Canadian resident shareholders of U.S. S-corps to avoiddouble taxation risks. However, should carefully walk through the above provision to determineimpacts.

• See 2017 STEP National Conference CRA Roundtable question #9 for the procedure that needs tobe followed in order make the application.

Section 143.4 - Contingent Amounts – Number 5

• In Canada v. McLarty, 2008 SCC 26, the Supreme Court of Canada allowed a contingent payment forcapital property to be immediately included in the purchaser’s “cumulative Canadian explorationexpense" (“CCEE”) balance. This decision led to planning opportunities to immediately include and takecapital cost allowance on certain contingent payment obligations.

• In 2011, section 143.4 was introduced to curtail the type of planning permitted by McLarty.• Generally, section 143.4 of the ITA requires a taxpayer’s expenditure to be reduced to the extent of any

contingent amount with respect to expenditure.143.4(1):• contingent amount, of a taxpayer at any time (other than a time at which the taxpayer is a bankrupt), includes an

amount to the extent that the taxpayer, or another taxpayer that does not deal at arm’s length with the taxpayer, hasa right to reduce the amount at that time.

• expenditure, of a taxpayer, means an expense, expenditure or outlay made or incurred by the taxpayer, or a cost orcapital cost of property acquired by the taxpayer.

• right to reduce means a right to reduce or eliminate an amount in respect of an expenditure at any time, including,for greater certainty, a right to reduce that is contingent upon the occurrence of an event, or in any other waycontingent, if it is reasonable to conclude, having regard to all the circumstances, that the right will becomeexercisable.

Section 143.4 - Contingent Amounts – Cont’d - Number 5

• If an arm’s length taxpayer has a right to reduce an amount, then paragraph143.4(2)(b) reduces the amount of the expenditure or cost base in the year.

• When contingent amounts are paid, those amounts are added or deducted from costbase in the year of payment.

• Section 143.4 applies broadly and can apply where a contingent amount is receivablebut not yet paid. For example, the entire amount of an earnout may not be included incost base, until it is paid.

Subsection 4(3) – Source Foreign Tax Credits - Number 6

• Certain deductions under section 60 are not allocable to a source for the purpose of the foreign tax credit regime.

• For example, a Canadian resident withdrawing their IRA in the U.S. will typically want to contribute those funds to hisor her RRSP in order to avoid immediately paying Canadian tax on the withdrawal by using paragraph 60(j) of the ITA.

• The RRSP contribution would shelter the Canadian tax, however U.S. tax would remain payable and no foreign taxcredit in Canada would be available because the paragraph 60(j) deduction has reduced that foreign income (entirelyor in part).

• Subsection 4(3) prevents the funds that are subject to a paragraph 60(j) deduction, from reducing that foreign sourceincome. Therefore, the foreign tax paid on withdrawal can be sheltered by any other Canadian source income.

• Early withdrawal penalties for a U.S. IRA are considered creditable for Canadian FTC purposes.

• CRA View 9634955 reaches the same conclusion in respect of the foreign tax credit being available, despite therebeing a deduction for the contribution to the RRSP. The CRA stated that:

The taxes withheld by the administrator of the IRA is considered to be non-business taxes paid to the United States. Consequently,an individual may be entitled to claim a foreign tax credit with respect to U.S. withholding taxes deducted from any lump-sumwithdrawal from an IRA. The foreign tax credit is generally computed as the lesser of the foreign taxes paid and a proportion of theCanadian taxes paid. The proportion is the taxpayer's foreign income divided by the taxpayer's total adjusted income. We note that,in determining the proportion, the foreign income is not reduced by the amount of the deduction under paragraph 60(j) of the Act.

Subsection 39(1.1)(b) and (c) – Foreign Currency Gains/Loses - Number 7

• For individuals (other than a trust), foreign currency dispositions resulting in a capitalgain or loss from subsection 39(1) of the ITA, are reduced by $200 through thecomputation formula in paragraphs 39(1.1)(b) and (c). The $200 amount is not just ade minimus threshold, in the formula; all foreign currency capital gains and losses arereduced by $200.

Subsections 10(1),10(4), 10(5) and How Contingent Fee Arrangements are Treated – Number 810. (1) Valuation of inventory — For the purpose of computing a taxpayer's income for a taxation year from abusiness that is not an adventure or concern in the nature of trade, property described in an inventory shall bevalued at the end of the year at the cost at which the taxpayer acquired the property or its fair market value at theend of the year, whichever is lower, or in a prescribed manner.

10(4) Fair market value — For the purpose of subsection (1), the fair market value of property (other thanproperty that is obsolete, damaged or defective or that is held for sale or lease or for the purpose of beingprocessed, fabricated, manufactured, incorporated into, attached to, or otherwise converted into property for saleor lease) that is(a) work in progress at the end of a taxation year of a business that is a profession means theamount that can reasonably be expected to become receivable in respect thereof after the end of the year; and(b)advertising or packaging material, parts, supplies or other property (other than work in progress of a business thatis a profession) that is included in inventory means the replacement cost of the property.

10(5) [Meaning of] Inventory — Without restricting the generality of this section,(a) property (other than capital property) of a taxpayer that is advertising or packaging material, parts or supplies or work in

progress of a business that is a profession is, for greater certainty, inventory of the taxpayer;

(b) anything used primarily for the purpose of advertising or packaging property that is included in the inventory of a taxpayer shallbe deemed not to be property held for sale or lease or for any of the purposes referred to in subsection (4); and

(c) property of a taxpayer, the cost of which to the taxpayer was deductible by virtue of paragraph 20(1)(mm), is, for greatercertainty, inventory of the taxpayer having a cost to the taxpayer, except for the purposes of that paragraph, of nil.

Subsections 10(1),10(4), 10(5) and How Contingent Fee Arrangements are Treated – Cont’d – Number 8• 2017 Federal Budget – changes to WIP; essentially took away section 34

reserve.• Introduced subsection 10(14.1) transition rule – 5 years.• So how is contingent fee arrangements to be determined?• Recall that WIP is any amount that is “expected to become receivable”?

Subsections 10(1),10(4), 10(5) and How Contingent Fee Arrangements Are Treated – Cont’d – Number 8• CRA’s Comments on Contingent Fee Arrangement https://www.canada.ca/en/revenue-

agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/budget-2017-building-a-strong-middle-class/billed-basis-accounting.html

• How will the proposed change impact designated professionals that provide services on acontingency fee basis?

• Under the terms of a contingency fee arrangement, all or a portion of a designated professional’sfees may only become known and billable at some time after the taxation year in which theprofessional provided services under the arrangement (e.g., where, under the terms of a writtencontingency fee agreement between a personal injury lawyer and a client, legal fees are onlybillable by the lawyer on a periodic basis as amounts are received by the client under a negotiatedsettlement or a court judgment). Until such time, there is often no liability on the professional’s clientto pay any fee; consequently, no amount is receivable by the professional until the right to collectthe amount is established. Under these circumstances, for purposes of determining the value of theprofessional’s work in progress at the end of the year, no amount would normally be recognized. Asa result, the proposed change to eliminate the ability of designated professionals to elect to usebilled-basis accounting is not expected to have any impact on these types of contingency feearrangements where the terms and conditions of such arrangements are bona fide.

Subsections 10(1),10(4), 10(5) and How Contingent Fee Arrangements Are Treated – Cont’d – Number 8• Huh?• How does that interpretation make sense?• Have posed this question at the upcoming 2019 STEP National Conference at

the CRA Roundtable.

Subsection 45(3) - Principal Residence and Change in Use - Number 9

• Subsection 45(1) generally deems a disposition of capital property where there hasbeen a change in use.

• A capital gain triggered by a change in use pursuant to subsection 45(1) can bedeferred by subsection 45(3), where the property becomes a principal residence andno capital cost allowance has been taken. The election is made on disposition of theprincipal residence.

• Through a subsection 45(3) election, a principal residence designation can also bemade for an additional four years while the property was rented, because ofparagraph (d) of the definition of “principal residence” in section 54.

Definition of “Common-Law Partner” – Subsection 248(1) – Number 10

“Common-law partner", with respect to a taxpayer at any time, means a person whocohabits at that time in a conjugal relationship with the taxpayer;a) Has so cohabited throughout the 12-month period that ends at that time; andb) Would be the parent of a child of whom the taxpayer is a parent, if this Act were read

without reference to paragraphs 252(1)(c) and (e) and subparagraph 252(2)(a)(iii),and,for the purpose of this definition, where at any time the taxpayer and the person cohabitin a conjugal relationship, they are, at any particular time after that time, deemed to becohabiting in a conjugal relationship unless they were living separate and apart at theparticular time for a period of at least 90 days that includes the particular time becauseof a breakdown of their conjugal relationship.

Definition of “Common-Law Partner” – Subsection 248(1) - Number 10

• What does “conjugal relationship” mean? Does that mean that the couple has to havesexual relations?‒ No.

• The leading definition of "cohabit in a conjugal relationship" was provided by theSupreme Court of Canada in M v. H, [1999] 2 S.C.R. 3 at p. 50: Molodowich v. Penttinen[1980 CanLII 1537] (Ont. Dist. Ct.), sets out the generally accepted characteristics of aconjugal relationship. They include shared shelter, sexual and personal behaviour,services, social activities, economic support and children, as well as the societalperception of the couple. However, it was recognized that these elements may bepresent in varying degrees and not all are necessary for the relationship to be found tobe conjugal....

• So be careful about assuming that a person is in a conjugal relationship. It’s much more‒ or less– than just sexual relationships.

• See Pierre v. Agence du Revenue Quebec 2019 QCCQ 2137 “….after a certain numberof years of existence as a couple, the absence of such relations [sexual] does notprevent the court from characterizing their relationship as martial or conjugal.”

Honourable Mentions

• Many provisions in section 81 (that provides for non-taxable treatment of veryspecific amounts);

• Section 56.4 – the restrictive covenant provisions that have been around formany years now but are unfortunately routinely ignored by general practitioners.Ignore at your peril; and

• Subsection 104(18) – age 40 trusts.