Tax and Estate Planning Blog : Moodys LLP and SNC Law

Posted by Roberto Domagas CA and Robert Worthington LL.B.

Copthorne Holdings Ltd. v. Canada, 2011 SCC 63 (CanLII) is a recent decision from the Supreme Court of Canada regarding the general anti-avoidance rule (“GAAR”)[1] and provides the much-anticipated interpretation and confirmation of these rules. While the “main event” was whether the transactions undertaken by the taxpayer resulted in abusive tax avoidance to which the GAAR applies, this blog focuses on the Court’s analysis of the meaning of “series of transactions”. The “series of transactions” concept was critical to the outcome of this appeal. The Court provided guidance on how past, present and future transactions are “contemplated”, thereby confirming the framework by which a “series of transactions” would be identified for the application of the GAAR.    

The case facts are exceedingly complex, but for purposes of this blog can be briefly summarized as follows: A Canadian corporation (“Holdco”) sold shares of its subsidiary (“Subco”) to its non-resident parent, thereby creating a sister company relationship between Holdco and Subco. This transaction created the opportunity for a horizontal amalgamation to occur between Holdco and Subco (“Amalco”), versus what would otherwise have been accomplished by way of a vertical amalgamation. What appears to have offended the Minister is that the taxpayer ultimately ended up with the same “structure”, i.e. non-resident parent owning an amalgamated corporation, however the horizontal amalgamation allowed the taxpayer to preserve $67 million of paid-up capital (“PUC”) of the issued shares of Subco, compared to a vertical amalgamation where the PUC would have otherwise disappeared.[2] The significance of preserving (or, in the Crown's view, “duplicating”) the $67 million of PUC is that it was later returned to the parent on a tax-free basis on a share redemption, thereby escaping the application of Canadian withholding tax. The Supreme Court of Canada affirmed the lower Courts' decision, applying the GAAR to deny the tax benefits resulting from the series of transactions, which was found to include the sale of Subco, amalgamation of Holdco and Subco, and share repurchase by Amalco.     

The definition of “series of transactions”[3] includes transactions “completed in contemplation of the series”. The contentious question answered by the Court is whether an offending transaction has to be contemplated prospectively, i.e. the offending transaction is known at the time of a particular transaction, or is it possible to contemplate the offending transaction retrospectively, i.e. whether it is sufficient to connect an offending transaction to a transaction that occurred in the past. In Copthorne, did the taxpayer have to know at the time of the share sale that they were going to undergo a future share repurchase, or is it sufficient to create “a series of transactions” where the offending transaction was executed because the prior sale was contemplated?   

In its analysis, the Court noted in the CRA’s 1988 Roundtable it was said that a “series of transactions” is to be applied prospectively, not retrospectively. The Court also cited academic commentary[4] suggesting the “series of transactions” test should be applied prospectively, and even agreed that the more common sense use of the term “contemplation” is prospective.

Nevertheless, in upholding both lower Courts’ analyses, the Court decided that contemplation of a series may include retrospective contemplation. The main rationale seemed to be a reference to the Court's earlier GAAR decision in Canada Trustco, in which the Court commented that the definition of “series of transactions” in subsection 248(10) included both prospective and retrospective contemplation. The Court was loathe to reverse its relatively recent decision in Canada Trustco. Interestingly, however, nothing in the Canada Trustco case turned on whether a series of transactions could include retrospective contemplation. Further, in its analysis, the Supreme Court stated that the text and context of subsection 248(10) leave open when the contemplation of the series must take place, i.e. the provision allows for either prospective or retrospective connection of a related transaction to a common law series.  

Before the Court’s decision in Copthorne, some commentators expressed that if a retrospective contemplation is permitted, it is all too easy to find that when a later transaction is completed, earlier transactions were known and taken into account.[5]  Indeed, hindsight is 20/20. Irrespective of whether the result in Copthorne is equitable, it seems unfair to taxpayers to allow the Crown to argue with 20/20 hindsight that an earlier transaction was contemplated when the later transaction was completed, and therefore the later transaction was an avoidance transaction as being part of the same series.

The only common law saving “test” from a transaction being considered part of a “series of transactions” is that the transaction requires more than a “mere possibility” or connection with “an extreme degree of remoteness” with the other transactions. However as the Court demonstrated, these hurdles were easily met by the Minister in this case notwithstanding that two years had passed between transactions, and that the rationale for the sale transaction was because proposed changes to the foreign accrual property income rules were imminent. The Court clarified that a “strong nexus” is not required to connect transactions into a series as proposed by the Tax Court, and by the result of this case, establishing a nexus was not onerous.  

The potential ramifications of this “reverse contemplation” principle extend well beyond the GAAR, because several other provisions of the Act contain a series of transactions test. One common example is in subsection 55(2).  We sometimes recommend clients complete a “butterfly” reorganization to “purify” a corporation by transferring assets from an operating corporation (an “Opco”) to another corporation on a tax-deferred basis. The reasons for completing a butterfly/purification reorganization may include putting shareholders in a position to claim the $750,000 capital gains deduction in the event Opco shares are sold in the future. However, a butterfly reorganization is only tax-deferred if it is not part of a series of transactions that includes a sale of shares. As such, if clients are contemplating a specific sale, we would typically advise that a butterfly should not be completed because the sale could be part of the same series of transactions as the butterfly, and consequently, the anti-avoidance rule in subsection 55(2) would apply to trigger a taxable capital gain.

If a specific sale is not contemplated, or if the owners were not marketing Opco (and assuming a number of other conditions are satisfied) a butterfly reorganization may be completed - or so we had thought, prior to Copthorne. The problem is that now the CRA could arguably apply the “retrospective contemplation” analysis and take the position that the subsequent sale was completed in contemplation of the earlier butterfly transaction! 

This result would be unfortunate, and we believe would not be consistent with the tax policy in the Act. We hope the CRA may administratively clarify that it would not apply the series of transactions test retrospectively other than in the GAAR context. In any event, taxpayers should be cautious when undertaking transactions that involve provisions of the Act that contain the “series” test, particularly where anti-avoidance rules are concerned.

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On December 15^th and 16^th I attended the International Taxation conference sponsored by the IRS and held in Washington DC.  There were more than 700 people in attendance and the lunchtime speaker on the first day was Douglas Shulman, the Commissioner of the IRS. At the end of his prepared remarks he answered only three questions posed by the audience. The first question he answered was mine, which was the following:

“On December 2 the US Ambassador to Canada announced that, before the end of the year, the IRS would issue guidance on tax compliance and penalty relief for Canadian residents [Click here for my prior blog on that topic] and then on December 7 the IRS Issued Fact Sheet 2011-13, which doesn’t really address the relief the Ambassador alluded to, though it does provide some guidance. [Click here for my prior blog on the IRS announcement]. Is the Fact Sheet the guidance the Ambassador was alluding to, or should we expect further guidance from the IRS?

Mr. Shulman said that the Fact Sheet was the guidance the Ambassador was alluding to. Further, he said “there is a lot of misinformation out there, and we wanted to clarify [the current state of the law].”

Both my question and Mr. Shulman’s response were quoted in Tax Notes Today on December 16, 2011, which you can read by clicking here.

After he answered my question he introduced me to Rosemary Sereti, who is Director of International Individual Compliance for the IRS. Ms. Sereti is the chief architect and is in charge of the Offshore Voluntary Disclosure Initiative (OVDI). I spoke with Ms. Sereti at length at the conclusion of the lunch. Ms. Sereti was very generous with her time and provided the following insight:

• She confirmed Mr. Shulman’s comment that the Fact Sheet was the guidance the Ambassador had alluded to.
• Penalty abatement for Canadian residents participating in the OVDI is available only if the taxpayer “opts out” of the program and successfully argues that he had “reasonable cause” for failing to file the returns.
• The IRS is aware of the problems caused by including registered retirement savings plans (RRSPs) in the OVDI penalty computation.
• The IRS is on the lookout for taxpayers who attempt to bring their unfiled returns current by using “quiet disclosure” and those who attempt to resolve their filing obligations in this way will face harsh penalties.

What we can conclude from my interaction with Mr. Shulman and Ms. Sereti is the following:

• First, it is unlikely that there will be a made-in-Canada-solution for those Canadian residents who are not current on their US filing obligations.
• Second, there is the possibility of penalty abatement for participants in the OVDI provided the participant “opts out” of the program and can prove they had reasonable cause for failing to file returns.
• Third, since the IRS is aware of the problems caused by including RRSPs in the OVDI penalty computation and has not issued guidance on the matter it is reasonable to conclude that, for now, the treatment of these accounts is an open issue.
• Fourth, those who attempt to bring their filing obligations current by using “quiet disclosure” may find themselves in much more trouble than if they had used “voluntary disclosure.

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Posted by Faizal Valli CA & Brian Dennehy CPA, JD, LL.M (US TAX)

Now that the OVDI Program is over and the IRS has released its Fact Sheet on US citizens or dual citizens residing outside of the US, this is a good time to reflect on some common circumstances when US citizens resident in Canada may have additional US tax to pay.

One of the common rebuttals that we hear from US citizens residing in Canada who are not compliant with their US tax affairs is “we haven’t filed our US tax returns because the Canadian tax liability is higher than the US tax liability and therefore there is no need to file”. In many cases, it may be true that the Canadian tax liability is higher than the US tax liability but one may never know until a thorough review of all of the facts and income sources has been completed. In addition, such individuals may also need to file other US reporting forms (even when there is no income tax payable) like Form 5471, FBAR, Form 3520/3520A, 8891, etc., but such filing requirements are beyond the scope of this blog. Some common circumstances where US tax may be payable are as follows:

1.   Deferral of Income Accruing in an RRSP

The RRSP rules in Canada are conceptually straight forward...a Canadian resident individual obtains a deduction when computing taxable income for contributions to a RRSP (subject to certain limits) and any earnings accumulated inside the RRSP are automatically tax deferred. Canada does not require a taxpayer to file additional forms or schedules to obtain a deferral of income accruing in an RRSP. 

However, a US citizen must properly and timely file a Form 8891 to obtain such a deferral from his/her US taxable income.  Otherwise, RRSP income is included in the US citizen’s taxable income for the current year. In addition, a Form 8833 must be filed to claim the benefits of the Canada-US Tax Treaty to deduct the current year RRSP contribution from the calculation of US taxable income.    If a return was not filed or if it was filed late, the taxpayer must follow certain procedures to defer the income generated by the account. Simply filing the forms is not sufficient. If these procedures are not followed the taxpayer will likely owe US tax. 

2.  Capital Dividends Received By a US Citizen

Capital dividends, overly simplified, are tax free dividends paid from Canadian private corporations to the extent that the corporation has a “capital dividend account”. Very generally, the capital dividend account of a Canadian private corporation is a surplus account that accumulates tax free amounts (such as the tax free portion of a realized capital gain or life insurance proceeds) that can ultimately be paid out to the shareholders of the corporation tax free. 

The US does not recognize the concept of a “capital dividend.” Corporate distributions to its shareholders are subject to ordering rules which prescribe the characterization of such income. A “dividend” is generally defined to mean any distribution of property made by a corporation to its shareholders out of its earnings and profits.^[1] If a corporation does not have earnings and profits, a corporate distribution to its shareholders is treated as (1) a return of capital and (2) capital gain to the extent the distribution exceeds earnings and profits and the shareholder’s basis. Accordingly, capital dividends are usually fully taxable as dividends for US purposes.

3.   Canadian “Estate Freeze” Transactions

A common strategy used by shareholders of Canadian private corporations is to “freeze” their interest in the corporation and transfer the future growth to some other party. To accomplish an estate freeze one must usually exchange their existing shares for new shares on a tax-deferred basis in Canada. 

An in depth discussion of the complexities of an estate freeze that involves a US person is well beyond the scope of this blog. Simply stated, an estate freeze may result in both US gift and income tax consequences from the transfer and issuance of shares. Additional complexities and potentially harsh tax results may flow by the use of a Canadian trust in the freeze. 

4.   Stock Options

Canada generally has a preferential system to deal with the taxation of stock option benefits. In many cases, the resulting benefit is only half taxable pursuant to section 7 and paragraph 110(1)(d) of the Income Tax Act. In some cases, there may be (or may have been) opportunities available to defer recognition of the resulting stock option benefit to the year of disposition of the stock. 

For US citizens, stock options may trigger taxable compensation as well as a gain on the sale of the acquired shares. Depending on whether the options are publicly traded and other factors, the US will determine compensation as arising on either the date of grant, vest, or exercise. Subsequent tax will arise on the date of sale. Both the timing and characterization of income may result in a disparity in the foreign tax credits available to offset the US income inclusion.

5.   Use of the $750,000 Capital Gains Deduction

Astute readers of our blogs will know that Canadian residents who hold shares of a qualified small business corporation may be able to benefit (to the extent that very detailed tests are met) from the $750,000 capital gains deduction upon the disposition of such shares. 

Generally, gain from the sale of stock is treated as capital gain in the US. The US does not recognize the capital gains deduction claimed by a Canadian resident US citizen. Accordingly, any such gain would be fully taxable in the US in the year of sale. The capital gains deduction claim and reduced tax in Canada may result in insufficient Canadian tax available to offset US tax payable. 

6.   Flow-through Share Deductions

A common tax deduction for high income earning Canadian residents is flow-through share deductions. Overly simplified, a flow-through share deduction is available as a result of an investment in an oil and gas corporation (or partnership) which will renounce their ability to claim deductions on Canadian Exploration Expenses or Canadian Development Expenses in favour of the investor. This can often times reduce Canadian income tax (subject to possible alternative minimum tax). 

From a US tax perspective, deductions and credits available to a corporation cannot be shifted to its shareholders. These deductions/credits comprise a portion of the tax attributes of the corporation. If flow-through share deductions are used by a US citizen to offset his/her Canadian taxable income, he/she may lack sufficient Canadian tax payable to offset US tax payable. 

7.   Principal Residence Exemption

As many people know, Canadian residents are generally exempt from capital gains taxation on realized gains from their “principal residence”. The discussion of a principal residence is beyond the scope of this blog but generally includes a property where a person ordinarily and habitually lives. 

The US allows an individual to exclude up to US$250,000 from the sale or exchange of his/her principal residence from gross income.^[2] To qualify for the exemption, the property for which such exclusion is being claimed must have been used by the person 2 of the previous 5 years. In order to calculate the gain, a US citizen must convert the purchase and sale price into US dollars using the exchange rate in effect on the respective dates. With the rise in the value of the loonie against the US dollar, a US citizen selling his home in Canada may experience an unexpectedly large US taxable gain. 

8.   Charitable Donations

Canada has a preferential tax system for donations of “listed securities” directly to charity. To the extent that certain conditions are met, the capital gains inclusion rate on a direct donation of listed securities to charity will be zero thereby avoiding any capital gains tax that would otherwise apply. In addition, when calculating allowable charitable donations as a tax credit, Canada limits the amount of charitable donations (that are subject to the credit) in the taxation year to 75% of the taxpayer’s net income plus 25% of taxable capital gains realized on the disposition of property donated to charity and other amounts beyond the scope of this blog. Also, Canada and it provinces provide a generous tax credit equal to the highest marginal tax rate for donations over $200, which can further reduce Canadian tax paid for large donation amounts claimed.

The calculation of the tax benefit for charitable donations generally yields more favourable results in Canada than the US.  In general, the deduction for charitable donations is limited to 20%, 30%, or 50% of a taxpayer’s gross income depending on the property contributed and the classification of the charity.[3] A US tax filer must report charitable donations as an itemized deduction[4] on Schedule A of the Form 1040.  Itemized deductions are restricted in two important ways (1) they are subject to a reduction for high income earning taxpayers and (2) if claimed, must be used in lieu of the standard deduction to which the taxpayer is otherwise entitled.  In 2011, the standard deduction available to a US taxpayer is $5,700.  In other words, a taxpayer only realizes benefits from itemized deductions to the extent he/she can claim an amount in excess of $5,700.  Thus in certain circumstances, a US taxpayer may receive little or no tax benefit for charitable contributions.    

9.   Pension Income Splitting

In 2007, the Canadian Government introduced pension income splitting legislation which enables optional pension income splitting with a spouse. In some cases, this can result in significant tax savings amongst spouses. 

However, pension income earned by a US citizen is attributable and taxable to the person who earned it for US purposes. Although US citizens filing a joint return may realize a similar result, splitting pension income is simply not allowed in the US. As a result, the entire amount of pension income will be recognized by the recipient with only a portion of the tax that would otherwise have been creditable to offset the US taxable income to the extent that Canadian pension splitting is utilized. 

10.  Allowable Business Investment Losses (ABILs)

ABILs are a special type of capital loss that, if certain conditions are met, will result in the allowable loss (which is one half of the realized loss) to be utilized to reduce all other sources of Canadian taxable income. This can be beneficial given that capital losses are only deductible against capital gains. 

Unfortunately, ABILs do not have similar treatment in the US. In general, a loss from the sale of stock is treated as a capital loss. A US citizen may utilize up to $1,500 a year in capital losses to offset other types of income. However, any remaining capital loss can only be used to offset capital gains or be carried forward to another tax year. 

11.  Medical Expenses

Canada has a comprehensive medical expense tax credit regime whereby only certain medical expenses are creditable. 

When calculating US taxable income, medical expenses are deductible as an itemized deduction (as described above in discussing the deduction available for charitable donations). However, the ability to use such expenses to offset US taxable income is even more limited. Medical expenses are only available as an itemized deduction to the extent they exceed 7.5% of an individual’s adjusted gross income. Again, many US citizens may receive little or no tax benefit from incurring medical expenses. 

12.  Canadian Lottery/Gambling Winnings

In Canada, lottery/gambling winnings are generally tax free. 

In the hands of a US citizen, lottery winnings are fully taxable as ordinary income. A taxpayer’s winnings can be offset by substantiated lottery losses. However, the taxpayer must claim these losses as an itemized deduction subject to the overall limit on itemized deductions and the loss of the standard deduction. 

While the above list is not exhaustive, it should give you a flavour that the two taxation systems - Canada’s and the US’ - are not entirely consistent. Although the Canada-US Income Tax Treaty does a very good job of trying to eliminate double taxation, the treaty does not resolve the two countries’ differing tax treatment on certain sources of income and availability of deductions/credits thereby causing different taxes payable. US citizens resident in Canada need to exercise great caution in assuming that their ultimate US income tax liability may not be nil notwithstanding the fact that their Canadian tax affairs are up-to-date. Seek professional help!

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Late on December 7, 2011 the IRS issued Fact Sheet 2011-13 (“Information for U.S. Citizens or Dual Citizens Residing Outside the U.S.”), which provides important guidance on two matters for taxpayers residing outside of the U.S.: first it gives insight into the type of facts that would support a “reasonable cause” argument for the abatement of penalties. Second, it clarifies the procedure to bring current unfiled returns, thereby confirming the IRS’s disdain for “quiet disclosures.” The guidance provided by the Fact Sheet makes clear the importance of engaging a professional who is experienced in these matters.

Facts likely to support a “reasonable cause” argument for the abatement of penalties

 Many of the penalties faced by individuals who haven’t filed their U.S. returns may be reduced to zero provided the taxpayer can prove reasonable cause for not filing. Reasonable cause is a legal doctrine, the application of which is determined by all of the facts and circumstances surrounding the taxpayer’s failure to file. Particular facts that support its application are found in case law, administrative interpretations, the statutes, and the treasury regulations.[1]

The taxpayer was unaware of his U.S. filing obligations

Depending on the particular facts, one of the theories that may support a finding of reasonable cause is that the taxpayer was unaware of his filing obligations. The Fact Sheet lists several facts that the IRS will, apparently, weigh more heavily than others in determining whether being unaware is sufficient to support the “reasonable cause” argument, including:

• The taxpayer’s education;
• Whether the taxpayer has previously been subject to the tax for which the return has not been filed;
• Whether the taxpayer has been penalized before;
• Whether there were recent changes in the tax forms or law the taxpayer could not reasonably be expected to know; and
• The level of complexity of a tax or compliance issue.

The Fact Sheet then gives several examples, the facts of which support a finding of reasonable cause, the most telling of which is Example 4. Under Example 4 the IRS concludes that reasonable cause is shown based on the following facts:

·         The taxpayer complied with tax filing and payment obligations in his country of residence;

·         He was previously unaware of his U.S. filing obligations;

·         After discovering his U.S. filing obligations he filed his previously unfiled returns;

·         He attached a statement to his returns setting forth his reasonable cause argument;

·         He had a legitimate reason for maintaining non-U.S. accounts;

·         There was no indication that he had taken efforts to intentionally conceal the reporting of income or assets; and

·         There was no additional U.S. tax due.

In making the reasonable cause argument, it is critically important to analyze the facts, support the facts with affidavits or other evidence, and to make sure that the facts are supported by existing law. A U.S. lawyer who is experienced with the foregoing is an essential component to prevailing on reasonable cause argument.

Procedure to bring current unfiled returns: DO NOT ATTEMPT “QUIET DISCLOSURE”

The Fact Sheet states that if a taxpayer has not filed returns or foreign bank account reports (FBARs) he should immediately file the delinquent returns (6 years for the FBAR) and attach a statement with the filings that sets forth the reasonable cause argument. This guidance makes clear the IRS’s distain for “quiet disclosures.”

In the past many taxpayers have attempted to bring current their unfiled returns by simply filing the returns without notifying the IRS, this is what is referred to as a “quiet disclosure.” The IRS has publicly stated that it will not tolerate quiet disclosures and that those who attempt to bring their filing obligations current via quiet disclosure risk criminal prosecution. For example, in FAQ 15 of the Offshore Voluntary Disclosure Initiative (OVDI) [2] the IRS stated:

Those taxpayers making “quiet” disclosures should be aware of the risk of being examined and potentially criminally prosecuted for all applicable years.

The Fact Sheet makes clear that unfiled returns must be brought current and the IRS must be informed of the taxpayer’s actions, including his reasonable cause argument. By following these rules, the taxpayer will maximize the possibility of proving reasonable cause and thereby reducing his penalties to zero.

Other penalties may apply.

The Fact Sheet addresses only the penalties that apply for failure to file FBARs and U.S. income tax returns. However, section 3 makes clear that other failure-to-file penalties may apply for other forms that have not been filed. These other forms include:

·         Forms 3520 and 3520A, which are required for certain interests in non-U.S. trusts or estates and gifts or inheritances from non-U.S. persons;

·         Forms 5471 and 8865, which are required for certain interests in non-U.S. corporations and partnerships;

·         Forms 926 and 8865, which are required for certain transfers to non-U.S. corporations and partnerships; and

·         Form 8938, which is a new form that is required to be filed beginning in 2012. The form must be filed by certain individuals who own non-U.S. accounts (much like the FBAR). There is a $10,000 penalty for failure to file this form.

The publication of the Fact Sheet is great news for individuals living outside the U.S. who are not current on their U.S. tax filing obligations because it gives some degree of certainty as to the facts that will support a reasonable cause argument for the abatement of penalties, and it also gives guidance as to the procedure to bring delinquent filings current.

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In the tax profession, there are a number of issues that bug me. For example, the absence of a tax specialist designation in Canada to help the public distinguish between non-tax specialists and tax specialists bugs me. I first wrote about this issue in our July 11, 2011 blog. The fact is that I've held this view for well over a decade.....it's important to ensure that the public is better served.

Another issue bugs me. Why is it that many professions are regulated, like cosmetology, but tax return preparation is not? Notwithstanding that Moodys' professional services do not really include Canadian tax compliance (we prefer to work with the client's existing tax preparers), the tax preparation industry is a large one and is unregulated. Anyone who wants to prepare tax returns for a fee in Canada is free to do so. Over the years, I've seen some very poorly prepared tax returns that were ticking time bombs for the client / taxpayer. In other cases, the professional preparer simply made errors. In many cases, I believe, the tax laws have simply become too complex for the average tax preparer to understand unless they are a tax specialist. Thank goodness for good tax software. Unfortunately, though, tax software is not fool-proof and requires the astuteness of the operator to ensure that there are no errors.

One would argue, however, that a shrewd consumer will always be able to determine a tax preparer's qualifications to handle their needs, and therefore, regulation is not needed. I don't buy that logic. In many cases, I've seen sophisticated people simply select the cheapest service provider thinking that the tax preparer is on equal footing with other more qualified but more expensive providers.

I can only guess, since I don't have the statistics at my fingertips, that untrained tax preparers cost the Canadian government tremendous amounts of inefficiencies. This is in addition to the cost to the consumer in the form of missed tax deduction and credits, not to mention the cost of errors and the time and money subsequently expended to resolve, including the potential assessment of penalties and arrears interest by the Canada Revenue Agency (“CRA”). Further, I believe that the non-regulation of the tax preparation industry in Canada makes it easier for inappropriate aggressive tax avoidance to occur (like certain charitable tax shelters). 

In the US, the government obviously believes that regulation of the tax preparation industry is important. Today, a paid preparer of US tax returns must register for a "PTIN.” Similar registration requirements exist in Australia. The UK also appears interested in exploring an enrollment or certification system for tax preparers.

At the 2010 STEP National Conference, The Department of Finance was asked whether or not a US style tax preparer registration system was looming for Canada. The answer provided made it seem like the Government of Canada was not interested. However, at a recent tax conference that I was a speaker at, I participated in a Roundtable Q&A session with the CRA. One of the questions dealt with "tax intermediaries." Based upon the answer provided, it is obvious that the CRA is watching the US, Australia and UK experience closely and might be interested in a similar registration system for Canada.

Stay tuned.....I don't think we've seen the end of this story. Hopefully we see a positive result soon.

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As many regular readers of our blog or our Twitter feeds (@RoyBerg1, @Moodystax) already know, applications for the 2011 US OVDI ended on September 9, 2011. However, there has been no shortage of activity regarding non-compliant US citizens. Yesterday, our firm received some news from a highly-placed source regarding some further activity. Apparently, a very influential US body has drafted a letter that should be made public later this week. The letter advocates lenient tax treatment for US Citizens residing in Canada who are not current with their filing obligations.

Here is what we believe to be the case:

1.      The letter is addressed to President Obama, Secretary of State Clinton and Ambassador Jacobson.

·         Notably absent on the distribution list are Secretary of Treasury Geithner and IRS Commissioner Shulman.

·         We believe the omission of Geithner and Schulman indicate that the issue is being framed as a diplomatic matter and not as a tax matter.

2.      The letter purports to advocate the following relief for US Citizens residing in Canada for X years provided they are compliant with Canadian tax filing and reporting obligations:

·         Full abatement of the penalty regime under the IRS Amnesty Program;

·         Penalty relief for those who missed participation in the Amnesty Program; and

·         Ability to renounce US Citizenship without the imposition of the Exit Tax.

What we do not know is the effect, if any, the letter will have.

If the letter does manage to effectuate change to the current protocol then that would be great news. The work that practitioners have undertaken so far for their non-compliant US clients may place them in an expedient position to be compliant with their tax affairs. However, it is puzzling to think how the lobbied for changes could be implemented without causing significant other fallout. For example, if the letter effectuates change, would non-compliant US citizens be rewarded for waiting out the previous voluntary disclosure programs? Tricky issues.

We continue to monitor this space closely and will communicate any changes as they become available.

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On October 31, 2011 (on the fifth anniversary of the income trust amendments) the Department of Finance released a package of income tax and sales and excise tax technical amendments. While most practitioners, including our firm, are still working through the package there are two proposed amendments that are worthy of an early comment.

1.                  Subsection 15(2)

It is proposed that subsection 15(2) be amended to clarify that a partnership can be connected with the shareholder of a particular corporation if that partnership does not deal at arm’s length with, or is affiliated with, the shareholder. The proposed amendment applies in respect of loans made and indebtedness arising after October 31, 2011. This amendment is important and noteworthy given the fact that it was questionable from a read of the existing law as to whether or not partnerships could be connected with the shareholder of a particular corporation. Accordingly, taxpayers and their advisors will need to take a fresh look, in light of this proposed amendment, as to whether or not partnerships will be connected with a corporation thereby causing subsection 15(2) to apply to such loans or indebtedness. To the extent that subsection 15(2) will apply, such loaned amounts may be included in the connected shareholder’s income. 

2.                  Personal Services Business Corporations

The Department of Finance is proposing a significant change for a personal services business carried on by a corporation. Prior to the announcement of these technical amendments, it may have been advantageous for a person, who would otherwise be considered to be an employee, to incorporate their employment services. Such a corporation is commonly known as a Personal Services Business corporation.   Prior to the introduction of the eligible dividend regime, it was not advantageous to have a Personal Services Business corporation since such a corporation would automatically be taxed at the highest corporate tax rate and all expenses (with certain limited exceptions such as salaries to the shareholder) would not be deductible. With the introduction of the eligible divided regime in 2006 and declining corporate tax rates, having a personal services business corporation’s income being taxed at the highest corporate rate and later distributing such surplus as an eligible dividend could provide, in some cases, a significant tax deferral.

The proposed amendment introduced in yesterday’s technical amendments will eliminate any such deferral opportunities by causing any income earned by a corporation from a personal services business to be taxed at a combined Federal-Alberta rate of 38% (as compared to the normal highest corporate rate for 2011 of 26.5%; 25% for 2012). The proposed amendment applies to taxation years that begin after October 31, 2011. Such an amendment should discourage any taxpayer from entering into a personal services business corporation relationship. 

Follow us on Twitter @Moodystax for further updates on these technical amendments.

New GAAR Decision

On October 28, 2011 the Tax Court of Canada released a decision – Global Equity Fund Ltd. v. Her Majesty the Queen. This decision is the latest decision in which the General Anti-Avoidance Rule (“GAAR”) was at issue. The firm that defended the taxpayer has written a good summary blog on the decision and you will find it here. Readers are encouraged to read this interesting decision. Moodys LLP were the tax advisors for the taxpayer in the structuring of the transactions at issue. The taxpayer’s victory was the only “win” of the three similar cases decided by the Tax Court in 2011.

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Have you or your clients ever sold an intangible property like a client list? A recent Tax Court of Canada case, George Smith v. Her Majesty the Queen, highlights the tax implications that can arise on the sale of such a property.

In this case, the property was an insurance brokerage client list. Overly simplified, the facts were as follows:

1.  Mr. Smith practiced as a licensed insurance broker in Quebec for a number of years.

2.  Mr. Smith and another insurance brokerage company (“BFL”) entered into an agreement of referral in November, 1995 whereby BFL provided Mr. Smith with the use of BFL’s office facilities and services in consideration of splitting the commission/fee income earned and paid on any premiums paid the insurer’s policyholder during the term of the agreement.

3.  The agreement of referral also provided BFL with the option to purchase Mr. Smith’s client list.

4.  Mr. Smith and BFL entered into a sale agreement effective January 1, 2002 whereby Mr. Smith agreed to sell his client list to BFL.

5.  On January 1, 2002 Mr. Smith’s client list generated annual base commission revenue of $156,000. Accordingly, BFL and Mr. Smith agreed on a purchase price of 2.25 times the annual commissions which equated to a purchase price of $351,000.

6. Subject to certain adjustments, the purchase price was payable as follows:

a.   January 1, 2002 - $142,000 (40.7%)
b.  January 1, 2003 - $69,500 (19.77%)
c.    January 1, 2004 - $69,500 (19.77%)
d.    January 1, 2005 - $69,500 (19.76%)

7.  It was understood that the purchase price was based on represented annual revenue of $156,000 and that the subsequent payments in 2003, 2004 and 2005 would be calculated by applying the percentage of the scheduled payments (as referred to above), to the actual year’s revenue from the appellant’s clientele received in the subject year multiplied by the acquisition factor of 2.25.

8. The balance of payment due to be paid was also subject to an agreed to interest rate payment. 

9. Given the above, the actual payments received were as follows:

10.  Mr. Smith appears to have included the received amounts in his income yearly pursuant to subsection 14(1) of the Income Tax Act (the “Act”), including the interest amounts received as will be further explained below.

Dispositions of property are usually subject to the “capital gains” rules under subdivision (c) of Part I of Division B of the Act. The result of applying the capital gains rules is that any profit from the disposition of a property is treated as a capital gain with only 50% of such amount being included in taxable income. A further advantage to the capital gains rules is that if all of the proceeds have not yet been received in the year of disposition, then deferral opportunities may exist to tax a portion of the resulting capital gains at the earlier of when the proceeds are received or over a five year period from the disposition date.

However, the capital gains rules do not apply to certain types of property. One of these exceptions is for “eligible capital property”. Eligible capital property receipts, which will generally include client list disposition receipts, are taxed under subsection 14(1) of the Act which falls in subdivision (b) of Part I of Division B of the Act. The good news about being taxed under subsection 14(1) is that any net receipts are also subject to a taxable inclusion rate of 50% (like capital gains). However, a negative aspect of being taxed under this provision is that no tax deferral opportunities are possible (unlike those that might exist for capital gains as described above) for proceeds that are not yet due.

Accordingly, given the 50% taxable treatment laid out in subsection 14(1), Mr. Smith took the position that the subsequent payments he received in 2003 – 2005 were taxed pursuant to such beneficial treatment.

The Canada Revenue Agency (“CRA”) disputed Mr. Smith’s treatment of the received amounts subsequent to the date of disposition of his client list as being subject to subsection 14(1) of the Act. Instead, the CRA reassessed Mr. Smith to include the received amounts (exclusive of the interest payments) in 2003, 2004 and 2005 to be captured under paragraph 12(1)(g) of the Act which includes the following amounts in a taxpayer’s income:

12(1)(g) payments based on production or use -- any amount received by the taxpayer in the year that was dependent on the use of or production from property whether or not that amount was an instalment of the sale price of the property, except that an instalment of the sale price of agricultural land is not included by virtue of this paragraph;

As you can see, paragraph 12(1)(g) is a very broad provision. The downside to being taxed under paragraph 12(1)(g) is that such amounts are fully taxable as opposed to being only 50% taxable to the extent that such amounts were caught under subsection 14(1). 
 

In addition, the interest amounts received by Mr. Smith were reassessed by the CRA to be fully taxed under paragraph 12(1)(c) of the Act as interest income as opposed to being only 50% taxed under subsection 14(1).

Ultimately, the Tax Court of Canada found in favour of the CRA whereby such amounts received by Mr. Smith in 2003, 2004 and 2005 were taxed either as interest income (as appropriate) and amounts taxable under paragraph 12(1)(g) since the “Purchase Price” and the adjustments to the Purchase Price were all computed and determined by the annual commissions received from the appellant’s client list and nothing else. Accordingly, Mr. Smith had an additional 50% income inclusion that he appears to not otherwise have included in his income for his 2003 – 2005 taxation years. 

This case is an important lesson for taxpayers to ensure that dispositions of property and the resulting tax consequences are carefully thought through. Given the broad language of paragraph 12(1)(g), taxpayers and their advisors need to be careful of this trap.

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Do you own US securities (or other foreign stocks) in your personal portfolio? Does your corporation own US securities (or other foreign stocks)? If so, then pay careful attention to the information below.

1.   Filing of Prescribed Form T1135

If you own US securities (or other foreign securities) in your investment portfolio you may be required, pursuant to section 233.3 of the Income Tax Act (the “Act”), to file prescribed Form T1135 with the Canada Revenue Agency (“CRA”) on a timely basis. This requirement catches a lot of people by surprise given the somewhat mundaneness of investing in US stock. However, subsection 233.3(3) of the Act reads as follows:

Returns respecting foreign property -- A reporting entity for a taxation year or fiscal period shall file with the Minister for the year or period a return in prescribed form on or before the day that is

(a) where the entity is a partnership, the day on or before which a return is required by section 229 of the Income Tax Regulations to be filed in respect of the fiscal period of the partnership or would be required to be so filed if that section applied to the partnership; and
(b) where the entity is not a partnership, the entity's filing-due date for the year.

As you can see, it is a “reporting entity” that is required to file such a form. A reporting entity is defined in subsection 233.3(1) of the Act as follows:

"reporting entity" for a taxation year or fiscal period means a specified Canadian entity for the year or period where, at any time (other than a time when the entity is non-resident) in the year or period, the total of all amounts each of which is the cost amount to the entity of a specified foreign property of the entity exceeds $100,000.

A “specified Canadian entity” includes an individual resident in Canada and also a Canadian corporation. In addition, the definition of “specified foreign property” includes a share of the capital stock of a non-resident corporation (which would include a US publicly traded stock).

Accordingly, to the extent that an individual (who owns such stock outside of their registered portfolio) or a corporation owns any foreign stock (including US stock) with a cost in excess of $100,000 at any time in the year then prescribed Form T1135 will need to be timely filed.

There appears to be a myth in the market place that there is an exemption for ownership of US stocks from the filing requirements for a T1135. However, no such exemption exists.

To the extent that prescribed Form T1135 is not timely filed, a person can be subject to a number of penalties. The least onerous penalty is a $25 per day penalty to a maximum of $2,500 for failure to file pursuant to subsection 162(7) of the Act. If the person knowingly or under circumstances amounting to gross negligence fails to file Form T1135, then an additional penalty becomes applicable under subsection 162(10) which will be $500 (or in some cases $1,000) per month that the T1135 is late filed to a maximum of 24 months.

In addition, a person can also be subject to an additional penalty under subsection 162(10.1) if the months that the T1135 is late filed exceeds 24 equal to five percent of the greatest of all amounts each of which is the total of the cost amounts to the person of the specified foreign property.

While these reporting rules have been in existence within the Act since the late 1990's, the CRA was usually very lenient and did not usually charge such penalties if prescribed Form T1135 was late filed. However, such administrative leniency ended without notice in the mid-2000's and there have been a number of reported cases where taxpayers have challenged the CRA's application of such penalties. One interesting case is currently before the Federal Court of Appeal. Click here for a copy of the lower court's ruling.

Accordingly, taxpayers and their advisors need to be very aware of the possible need to file prescribed Form T1135 when investing in foreign stocks, including US stocks.  

2.  Possible Exposure to US Estate Tax

An additional implication, for individuals, of investing in US stocks in your portfolio is that you could be subject to US estate tax even though you are not a US citizen. This is true because US estate tax is applicable to anyone in the world to the extent that they own US-situs property. US-situs property includes shares of US corporations. As an example, consider the following example facts:

1. Mr. Apple’s worldwide net worth is $10 million USD.
2. Mr. Apple is a Canadian resident and Canadian citizen, and is not a US citizen.
3. Mr. Apple’s investment portfolio includes $1 million USD of publicly traded stocks.
4. Mr. Apple dies.
5. The US estate tax rate for 2011 and 2012 is 35 percent with a $5 million USD exemption for US citizens. However, non-US citizens are only entitled to a pro-rated amount of the $5 million exemption which is calculated as the percentage of their US-situs assets ("A") to their worldwide assets ("B") multiplied by the $5M exemption ("C"). In other words, a non-US citizen is generally entitled to an exemption of US estate tax calculated as (A/B) x C.

Given that Mr. Apple owns US-situs property, this legal representatives administering his estate must consider the need to file a US estate tax return and to pay any US estate tax. As a very rough calculation, Mr. Apple’s US estate tax exposure would be as follows:

1. US-situs property - $1 million USD
2. Mr. Apple's worldwide net worth - $10 million USD
3. Mr. Apple's US estate tax exemption entitlement – $1 million USD/$10 million USD x $5 million USD = $500,000 USD
4. Therefore, Mr Apple’s estate tax would be computed as follows:

While the Canada-US Tax Treaty may provide some relief from possible double taxation, the treaty will often not provide full relief. Accordingly, Mr. Apple’s legal representatives will need to look for ways, if possible, to reduce the overall Canadian tax and US estate tax exposure.

Conclusion

Be aware of Canadian foreign reporting requirements and US estate tax exposure when investing in US stocks.
 

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By now many US Citizens (and holders of US green cards) living in Canada are aware that they must file US income tax returns and other forms because of their citizenship status; and that the failure to comply can have ruinous financial consequences. What many don’t know, however, is that the same individuals must also file another annual form or risk losing the tax-free growth in their registered retirement savings accounts (RRSPs).

Article XVIII(7) of the United States - Canada Income Tax Convention  (the “Treaty”) provides that an individual may defer taxation on income accumulated in RRSPs, RRIFs, registered pension plans, and deferred profit sharing plans, however, the individual must make an affirmative annual election in order to avail himself of the tax-free accumulation. The election must be made on the US form 8891 and included annually with a timely filed US income tax return. If the individual has not timely filed US returns, or if he has missed a few years, he cannot remedy this problem by simply filing the delinquent returns. A lot of Canadian residents are in this position.

Fortunately there is a solution to the problem of unfiled forms 8891 which allow the individual to retroactively elect tax-free deferral in his RRSP or other retirement account. Unfortunately, the procedure to remedy the problem is complex and granted at the discretion of the IRS, so the results are not a certainty.

Treasury Regulation 301.9100-1(c) gives the Commissioner of the IRS the discretion to grant a taxpayer a reasonable extension of time to make a regulatory election (such as the election to defer income tax on the form 8891) in certain circumstances. Treasury Regulation 301.9100-3 a) provides that the Commissioner may grant such extension provided: a) the taxpayer acted reasonably and in good faith, and b) granting the extension will not prejudice the interests of the US Government.

The process for requesting the extension under the Treasury Regulations is complex and requires the collection of facts, substantiating those facts (with affidavits and by other means), and making legal and factual arguments to support the request. Even if the taxpayer follows all of the formalities to request an extension, the request may be denied. If the request is denied, the taxpayer will have to pursue the matter in accordance with the administrative procedures established by the IRS.

On August 12, 2011 the IRS granted a taxpayer such an extension to elect tax-deferred treatment of his RRSP.   Under the facts of that ruling, in year one the taxpayer hired a Certified Public Accountant (the US equivalent of a Canadian Chartered Accountant) to prepare his US income tax return. The CPA failed to file form 8891 with the return and the omission was not detected until year two when the taxpayer hired another professional. Finally, and perhaps most importantly, at the time the taxpayer made his request for an extension the IRS had not contacted the taxpayer regarding the omitted election. The taxpayer was able to substantiate the foregoing and was granted the requested extension.

However, even considering the work involved and the uncertainty in the outcome we are advising our clients (and representing them in the process) to immediately seek an extension of the election, even if they have not filed returns for several years. If taxpayers choose to ignore the problem, it will not go away on its own and they will likely wake up one day with a substantial US income tax bill that may not be so easy to resolve.

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With much fanfare, the “kiddie tax” was introduced into Canadian tax law effective January 1, 2000.  My, how time flies. It does not seem like it was 11.5 years ago that such a tax was introduced to prevent income splitting mischief.

The “kiddie tax” applies on certain types of income (“split income”) received by a child (under the age of 18 throughout the year – the “minor”) who has a parent that is resident in Canada at any time during the year. If applicable, the minor child will end up paying income tax at the highest personal tax rate that would otherwise be payable on the type of income received.   In addition, the parents generally have joint and several liability for the tax.

The most common type of income to which the “kiddie tax” applies is dividend income from a private corporation. It used to be routine planning to have a trust with a minor child as a beneficiary (or have the minor child own the shares directly in the private corporation to the extent that a lawyer would give a legal opinion that the minor child could hold such property) and ultimately pay dividends to the minor child. Prior to the introduction of the “kiddie tax,” such a simple plan was an effective income splitting tool since a child could use up their personal tax credits and in many cases pay no personal income tax up to certain levels of income. 

Another common plan prior to year 2000 was to have a partnership whereby the child (or a trust of which the child was a beneficiary) would be a partner and have the partnership receive income from a related entity. For example, the partnership could provide management or administrative type services to a corporation owned by “Mom” or “Dad” or both. Such income received by the partnership could then be easily allocated to the partners (of which a minor child would be a direct or indirect beneficiary of such partnership income) thus again providing for simple yet effective income splitting.

Both the dividend sprinkling plan and the partnership type plan described above are subject to the “kiddie tax” to the extent that the income is received by a minor child thus eliminating any income splitting advantage associated with such plans. 

One of the most common types of taxable income that is not split income and therefore not subject to the “kiddie tax” is capital gains. Accordingly, many plans involving related private corporations were put in place so as to recognize capital gains. The plan generally involved having certain shares of a private corporation being sold to a related company with the resulting capital gain being taxable in the minor child’s hands. Prior to the 2011 Federal Budget, such a plan was often used to the extent that the practitioner and their client believed that the general anti-avoidance rule (“GAAR”) would not apply. The Canada Revenue Agency, however, was not amused and would often times apply the GAAR to such a plan (with many cases still in the system). The 2011 Federal Budget has introduced a legislative fix to such a plan whereby after March 22, 2011 such capital gains will now be subject to the “kiddie tax.” However, other capital gains realized by a minor (for example, from a publically traded portfolio of assets or shares of a private corporation disposed of to an arm’s length person) will continue to not be subject to the “kiddie tax.” As such, capital gains realized and taxable in the hands of a minor either directly or indirectly is still a common and effective income splitting tool. 

Further, partnerships or trusts that provide services to arm’s length parties are also not subject to the “kiddie tax.”  For example, let us assume that Mom, Dad and a trust for their minor children are partners in a partnership. The partnership carries on the business of selling sandwiches to the public. To the extent that the partnership realizes profits, a reasonable allocation of partnership income can be made to the minor child (either directly or indirectly) without the incidence of the “kiddie tax.” (Section 103 must always be considered when dealing with partnership income allocations since unreasonable allocations might be reallocated by the CRA to a more reasonable allocation after all the factors are considered).

While the “kiddie tax” certainly provides a wrench for simple income splitting plans using minor children, effective planning can still be done today.   However, professional advice should always be sought before implementing any income splitting plan. The professionals at Moodys LLP Tax Advisors would be pleased to assist you in developing an effective plan.

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In my many years of practice, it never fails to amaze me how many people rely on non-qualified persons for advice in one of the most complex topics there is – tax planning or, as Moodys LLP likes to call it, “tax optimization”. There is no shortage of “experts” who seem to think that they understand tax. In this day and age of instant information vis-à-vis the internet, such “experts” continue to flourish and continue to dispense tax advice to their colleagues and buddies. Unfortunately, many of those people end up in our offices seeking advice when things go wrong. In many cases, such advice has led to “planning” which is a ticking time bomb waiting for nasty results should their affairs ever be reviewed. 

One of the most common ticking time bombs that we run across is personal use property owned by a corporation. Routinely, we find cottage properties owned by corporations.  In some extreme cases, we discover situations where the shareholder’s or shareholders’ principal residence is owned by a corporation. Such “planning” is usually disastrous. Why is that? Well, there are a number of reasons. The biggest reason is that personal use property owned by a corporation will result in taxable benefits being applicable to the individual shareholder(s). The relevant provision under the Income Tax Act that requires a taxable benefit is subsection 15(1) which reads as follows:

15(1) Benefit conferred on shareholder -- Where at any time in a taxation year a benefit is conferred on a shareholder, or on a person in contemplation of the person becoming a shareholder, by a corporation otherwise than by

(a) the reduction of the paid-up capital, the redemption, cancellation or acquisition by the corporation of shares of its capital stock or on the winding-up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which section 88 applies,

 (b) the payment of a dividend or a stock dividend,

 (c) conferring, on all owners of common shares of the capital stock of the corporation at that time, a right in respect of each common share, that is identical to every other right conferred at that time in respect of each other such share, to acquire additional shares of the capital stock of the corporation, and, for the purpose of this paragraph,

(i) where

(A) the voting rights attached to a particular class of common shares of the capital stock of a corporation differ from the voting rights attached to another class of common shares of the capital stock of the corporation, and

(B) there are no other differences between the terms and conditions of the classes of shares that could cause the fair market value of a share of the particular class to differ materially from the fair market value of a share of the other class,

the shares of the particular class shall be deemed to be property that is identical to the shares of the other class, and

 (ii) rights are not considered identical if the cost of acquiring the rights differs, or

 (d) an action described in paragraph 84(1)(c.1), (c.2) or (c.3),

the amount or value thereof shall, except to the extent that it is deemed by section 84 to be a dividend, be included in computing the income of the shareholder for the year. [emphasis added]

As you can see, subsection 15(1) is an extremely broad provision which can capture many fact patterns. The difficulty with the provision is that it does not set out detailed rules on how to quantify the taxable benefit. In the case of a cottage property, for example, many people feel that a comparable hotel rate is the appropriate taxable benefit that they need to capture into their personal taxable income or to pay to the corporation for the use of that cottage property. For example, if Mr and Mrs Apple each owned 50 percent of the shares of “OpCo” and OpCo owned a cottage property in Phoenix, Arizona, would the taxable benefit be say, $200 a night (a comparable hotel rate) multiplied by the number of days that they use the property (say five days per year) which equals $1,000? In short, the answer is no. Instead, the Tax Court of Canada has found in cases such as Youngman [1990] 2 CTC 10 (FCA), Donovan [1996] 1 CTC 264 (FCA), and Fingold[1997] 3 CTC 441 (FCA) that the taxable benefits applicable to the ownership of a cottage property by a corporation is not the hotel rate.  Instead, the taxable benefit is generally computed by reference to the cost of the property multiplied by an applicable rate of return. For example, if OpCo had paid $500,000 for the acquisition of the Phoenix, Arizona property and OpCo would normally receive a 15 percent rate of return on its invested capital then likely 15 percent of $500,000 (or $75,000) would be the appropriate amount to include in Mr and Mrs Apple’s personal taxable income annually. 

If you are not already awake or did not know about the risks of personal use assets owned by a corporation, then you should be aware that there is further damage. Firstly, there is no underlying “step-up” in the cost base of the personal use corporately owned assets for the taxable benefit received each year by Mr and Mrs Apple. This can lead to outright double taxation as a result of the corporation owning the personal use property. Secondly, when the property is sold, OpCo will realize a capital gain (assuming the property has increased in value) which may not be sheltered by any principal residence exemption (if the property could otherwise be treated as a principal residence by the individual shareholders). Finally, to the extent that the funds need to be extracted from the corporation, such extraction will normally be considered a taxable dividend (unless other tax free accounts are available such as a shareholder loan account or a capital dividend account). (I have purposely not discussed any GST or HST matters but such issues would also need to be reviewed).

At this point, it may be prudent to let the reader know that the Canada Revenue Agency used to have an administrative position which enabled a corporation (often referred to as “sole purpose/single purpose” corporations) to acquire US personal property without subsection 15(1) applying. However, this administrative position ended for acquisitions of US property after 2004 with some limited grandfathering. Accordingly, people need to be very aware of the dangers of acquiring US personal use property through a corporation. However, such a caution extends to all types of personal use property. For example, we have often seen timeshare properties, personal furniture, recreational vehicles, etc., owned by corporations. It appears that people think that significant tax savings can be achieved by owning such properties through a corporation. Unfortunately, nothing could be further from the truth. 

So what do you do if you have personal use property owned by a corporation and you are one of the shareholders? Unfortunately, there are not many solutions to this difficult issue. Instead, you should be looking to extract the personal use property from the corporation using available tax free accounts. However, if tax free accounts are not available then simply paying the personal income tax on an extraction may be far cheaper in the short and long term to avoid nasty surprises.  

For those of you who would like to see a video on this topic in Moodys’ YouTube channel, click here.

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Before we proceed the reader needs to know that the views expressed below are mine only and do not necessarily represent the views of all the accounting professionals in our firm.

For those of you who have not heard, the Canadian Institute of Chartered Accountants (“CA”) and the Society of Management Accountants of Canada (“CMA”) are currently exploring the environment to see whether merger talks should be held, with the ultimate goal being one designation for the merged body (currently proposed to be “Chartered Professional Accountant” or “CPA”). Seven years ago, the same two bodies brought a proposed merger deal to the table of members, but the proposal was withdrawn before it was brought to a vote by members. This time, however, there is no current proposal agreement but rather the two bodies are simply putting their toe in the water to see whether the current landscape is ripe for a merger. To this end, both professions are engaging their members in a series of dialogues and discussions - both online and in person - to see if there is interest in moving forward with such merger talks. 

I have been closely monitoring the online and in-person discussions. For the people that are not interested in the merger, the reasons given tend to be something like this:

1.   “My designation is better than yours and a merged CPA designation will water down the ultimate accounting profession.”

2.   “I worked very hard to attain my designation and enabling a lesser designation to merge with my higher quality designation is offensive.”

3.   “CA’s and CMA’s do different things and the marketplace recognizes such differences. Why, then, the need for a merged designation when the marketplace clearly differentiates and demands such designations?”

4.   “CPA? That will make us look like American CPA’s!”

As I stated, I have listened very closely to both sides of the debate and, try as I may, the persons who are negative to exploring a possible merger always seem to fall in one of the above categories.

However, good leadership often means taking on controversy for the betterment of all. Instead of resting on ones’ laurels and saying “I’m better than you,” self improvement often requires a good long hard look in the mirror. In this case, the leaders of the CA’s and CMA’s deserve high praise for taking a good long hard look in the mirror to see whether change is necessary for the better good. Perhaps it might not be. But more importantly, perhaps it WILL be. Seven years ago, the world was a different place. The internet and emerging technologies have made the world a much smaller place with people and professions becoming irrelevant very quickly.

While I certainly understand the frustration and defensiveness of a practitioner who worked very hard in their studies to attain a professional status, one would hope that such a practitioner can put their personal interests aside and study both sides of the debate to see whether a merged body would help out the profession as a whole as opposed to them personally. One might ask why should a person pursue such an exercise to set aside their personal interests in order to study the common good? The answer to that is simple … while their personal interests at the moment may be well taken care of given their existing professional status, the profession cannot exist with members who think only of their personal interests as opposed to the common good. It should be common sense that if the profession is improved both in the short term and the long term, the personal interests of the average member will also improve. In my humble opinion, it is simply selfish to only worry about one’s personal interests as opposed to the greater interests of the profession as a whole. 

What are some of the arguments for a merged CA-CMA body? Consider the following:

1.   A combined CA-CMA body will be a very large group and, in fact, one of the largest accounting bodies in the world.
 

2.   The merged body will have the opportunity to take a serious look at new education requirements for new entrants into the CPA profession. Assuming that the entrance levels are as high or higher than the highest current standard for either the CA or CMA then presumably such arguments for a weaker long term designation will disappear.
 

3.   The merged body may have a greater voice at the relevant tables (such as accounting standards, tax legislators and administrators), in order to influence change. Let’s be serious. Canada is a small player in the world scene, but with a merged body we may be able to influence greater change.
 

4.   Efficiencies will likely improve. Currently, each province in Canada has its own provincial office in order to administer the accounting profession. Is this really necessary? Under current law it likely is, but perhaps with a merged body and government involvement efficiencies may ultimately arise.

5.   Let’s be honest. Does the average consumer of accounting services know the difference between the designations? Truthfully! I would respectfully suggest that the answer is no. While there are always exceptions to this rule, on the whole I would suggest that no one really knows the detailed differences between a CA and a CMA unless research is done in order to investigate such. This leads to significant brand confusion amongst consumers of accounting professionals’ services. Any elimination of brand confusion should be welcome both for the short and the long term. 

In addition, to the extent that merger discussions are ultimately entered into, I am hopeful that the merged body takes a sober second look at the need for specializations within the profession. Currently, both CA’s and CMA’s are guilty of publicly stating to the world that they can do many things (such as audit, tax, general accounting, information technology and business valuation). The truth is, the average member cannot do all those services and any statement to the contrary is simply false. While the CA’s have recognized the need to specialize in certain areas such as business valuation (which has a recognized sub-designation of CA.CBV), information technology (with a recognized sub-designation of CA.IT) and others, the obvious missing sub-designations are audit and tax. To suggest that the average CA or CMA knows audit and/or tax at a level appropriate to practice professionally is again incorrect. Quite simply, both audit and tax are specialties on their own that require rigorous training and experience. Any dabbling by a practitioner in these areas is a recipe for disaster. Wouldn’t it be better, to serve the public, to allow users of professional services to know which sub-specialty the particular CPA possesses? Of course it is. Unfortunately the introduction of sub-designations for tax and audit has been very controversial. Witness, for example, a proposal to introduce CA.Tax as a sub-designation earlier in the 2000’s. At the last moment, the CA.Tax proposal was dismissed for reasons that were never publicly made available but, reading between the lines, it is pretty obvious that a certain influential sector of the CA membership would not support it.   It is my hope, for the betterment of the profession as a whole and in the interests of serving the public better, that the tax sub-specialty idea be revisited with the idea of being re-introduced.

While we are on the topic of a “wish list”, wouldn’t it also be a great idea if the merged body had some ability to influence the government regulators who have the power to introduce legislation that would restrict the use of the label “accountant”? Currently, anyone can call themselves an accountant whether or not they are professionally designated. However, other professions are not similar. For example, in both medicine and law people cannot call themselves “doctors” or “lawyers” unless it is true. If they do so without the proper authorization, enforcement action can be taken.

Many more arguments exist on both sides of the merger equation. However, this brief overview is not intended to be an exhaustive treatise on the case for or against a merger. Instead, this overview is intended to provoke thought and, hopefully, some controversy on the discussion that the leaders of the CA’s and CMA’s have raised with members. 

From the tone of this blog, it should be no secret on which side of the fence I am excited about. Having said that, the current discussions are simply that … discussions only. As the old saying goes, “the devil is in the details” and I look forward to reviewing details of a proposed merger and making my mind up about such a proposal at that time. However, perhaps the leaders and the profession will decide that further discussions on this matter should not be done. From my point of view, that would be a huge disappointment. Any time that one has to make progress, it is my opinion, that one should grasp that opportunity and run with it. 

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