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2023 Quebec budget: tax holiday for investments in critical and strategic minerals
On March 21, 2023, Quebec’s Minister of Finance tabled his budget for the 2023-2024 fiscal year. One of the budget’s key measures is the introduction of a new tax holiday in connection with major investment projects. At first glance, the new measure does not appear to be specifically aimed at the mining industry, but some mining companies involved in the extraction of critical and strategic minerals and planning substantial investments in the near future could greatly benefit from it. Under the new tax exemption, a corporation or partnership that carries out an investment project of more than $100 million in Quebec will be eligible, under certain conditions, for an income tax holiday and a holiday from the employer contribution to the Health Services Fund. As far as income tax is concerned, this new 10-year tax holiday consists of a deduction in the calculation of the company’s taxable income. The deduction is calculated by applying a rate of 15%, 20% or 25% to the cumulative total of eligible project expenditures. Since this tax measure is intended to promote investment outside major urban centres, the rate will vary according to the project’s location, ranging from 15% for projects in areas with high economic vitality, to 20% for projects in areas with intermediate economic vitality and up to 25% for those in areas with low economic vitality. The higher rates of 20% and 25% are more likely to apply to mining projects, which are generally located in remote areas with lower economic vitality. The critical and strategic minerals identified in the context of this measure are the following: antimony, bismuth, cadmium, caesium, copper, tin, gallium, indium, tellurium, zinc, cobalt, rare-earth elements, platinum-group elements, graphite (natural), lithium, magnesium, nickel, niobium, scandium, tantalum, titanium and vanadium. Let’s briefly consider the example of a mining company carrying out a major investment project for lithium mining in the Nord-du-Québec administrative region, designated by the Quebec government as a territory with intermediate economic vitality. During the investment phase, while the mine is being developed and built, the company incurs $200 million worth of eligible expenditures, which are capital expenditures for new mining equipment and heavy machinery for lithium extraction and processing. Evidently, the company will probably sustain a loss during the investment phase, and, because it has no taxable income, it will not be able to immediately benefit from the tax holiday. However, should the company have taxable income of $50 million in year 5, after four years of investment and mine development, it will be able to deduct $40 million of this taxable income under the new tax holiday, reducing its taxable income to $10 million for that year. This $40 million deduction is based on the application of the 20% rate for territories with intermediate economic vitality to the $200 million of eligible expenditures for the mining project. Another point relevant to the mining industry is that the income tax holiday will apply only to tax payable under the provisions of the Taxation Act. In other words, this tax holiday will not reduce the amounts payable under the Mining Tax Act. With respect to the Health Services Fund, companies will generally be eligible for an employer contribution holiday on wages paid to employees for pay periods falling within the exemption period for major investment projects. In order to benefit from this new tax holiday, companies will have to obtain an initial certificate, as well as annual attestations issued by the Quebec Minister of Finance. Our team of professionals specializing in mining and tax law is available to answer all your questions regarding this new measure and to assist you in your mining investment projects in Quebec.
COVID-19: Anticipating Capital Gains, Wealth, Gift and Inheritance Taxes
The deficits being generated by the emergency measures that the federal and provincial governments have implemented since March 2020 are a reminder of the magnitude of our governments’ pre-crisis deficits. This situation will inevitably lead to a greater tax burden for businesses and individuals at some point. Despite the unprecedented nature of these circumstances and the difficult financial situations that organizations find themselves in, steps can be taken now to mitigate repercussions. For several years, there has been increasing speculation about the capital gains inclusion rate being increased. Rumours also abound about the potential creation of an inheritance tax, which would undoubtedly be accompanied by a gift tax and a wealth tax. In this context, it is becoming ever more plausible that the federal government will finally increase the capital gains inclusion rate and tax the value of inheritances and gifts as early as the next budget, which has been postponed because of the ongoing crisis. An annual wealth tax on high net worth individuals could likewise be in the pipeline. As is now customary, the measures would apply as of midnight the night before the budget is tabled, closing the door to most tax planning strategies to reduce the impact of such measures. In the face of this situation, several steps can be taken as of now as, for instance: Crystallization of unrealized capital gains using a business corporation, partnership or trust; Gifts of money or property to family members or trusts; Termination of Canadian tax residency in favour of a lower-tax jurisdiction. The majority of tax planning strategies aiming to reduce or postpone the impact of such measures can be reversed should the anticipated measures not be adopted. In the event that governments do not increase the tax burden straightaway or opt for other, difficult-to-predict measures, well-planned transactions, such as realizing an accumulated gain on certain assets, making a direct gift, or making a gift through a trust, will ensure that additional taxes need not be paid. If you would like more information, our taxation team is available to help you.
Tax Aspects of Insolvency and Bankruptcy
The current crisis caused by the COVID-19 pandemic has already caused, and will continue to cause, significant liquidity problems for some businesses. Companies whose financial difficulties threaten their very existence will have to restructure in order to avoid bankruptcy, either by availing themselves of the protection of the Companies' Creditors Arrangement Act1 (the "CCAA") or by using the proposal mechanism of the Bankruptcy and Insolvency Act2 (the "BIA"). Tax considerations related to an arrangement or a proposal accepted by creditors Making use of the provisions of the CCAA or the BIA entails tax considerations for the debtor corporation that directors and owner-operators need to consider. Some of these tax considerations are discussed below. In the context of the restructuring of a debtor company, creditors may accept a partial settlement of their claim or a conversion of their claim into shares in the debtor company. If a corporation is not bankrupt within the meaning of the Bankruptcy and Insolvency Act, the settlement of a debt for an amount less than its principal will have tax consequences for the debtor corporation. For example, certain tax attributes of the debtor corporation such as the balance of loss carryforwards, the undepreciated portion of the capital cost of depreciable property or the adjusted cost base of capital assets will be reduced by the amount of the reduction in the receivable, if any. In certain cases, if the tax attributes of the debtor corporation are insufficient to absorb the amount of debt forgiven, inclusion in the calculation of its taxable income may occur, creating a tax liability. Several strategies can be adopted to limit undesirable consequences in the context of a restructuring under the Companies' Creditors Arrangement Act. As mentioned, it may be possible, among other things, to convert the debt into shares of the debtor company without causing adverse consequences, if the fair market value of the shares issued upon conversion of the debt is equal to the principal of the debt. In some cases, a debt held by a shareholder of the debtor company could be written off without consideration and without the need to issue shares. Finally, it may be possible, in certain situations, to avoid inclusion in the income of the debtor corporation through the use of certain reserve mechanisms or through tax deductions. Insolvency is a delicate situation for any business. Proper tax planning will allow the debtor company to maximize the effectiveness of the restructuring process offered by the CCAA. Our taxation team can help you set up effective planning in this context. R.S.C. 1985, c. C-36 and amendments R.S.C. 1985, c. B-3 and amendments
Sale of a Business: New Tax Planning Option
The sale of a business is often the most significant business transaction in an entrepreneur’s life. In addition, the net proceeds from such a sale often represent an entrepreneur’s only retirement fund. Therefore, it is crucial to maximize such proceeds by reducing or deferring the taxes resulting from the transaction as much as possible. The Canada Revenue Agency (“CRA”) recently reversed an administrative position that it had expressed in 2002 with respect to beneficial tax planning as part of the sale of a business. This change in its rather technical administrative position opens the door to very effective tax planning that offers real tax deferral opportunities to business owners wishing to sell their business. Consider the following example: Sale of 100% of shares to a third party without prior planning Ms. Tremblay wishes to sell 100% of the shares of her company (“Opco”) to a third party for their fair market value (“FMV”) of $10 million. These shares have an adjusted cost base of $1.00. Ms. Tremblay’s direct sale of 100% of Opco shares to a third party would result in a capital gain of approximately $10 million and total income taxes of approximately $2.7 million, assuming that her capital gain is not eligible for the capital gains exemption. In this scenario, Ms. Tremblay would be left with a sum of approximately $7.3 million after taxes. Sale of shares with the newly approved prior tax planning In the second scenario, prior to the sale to the third party, Ms. Tremblay would create a management company (“Gesco”) and transfer 50% of Opco shares to it on a rollover basis, with no immediate tax consequences. Gesco would then internally exchange Opco shares in order to realize a $5 million capital gain within Gesco, resulting in income taxes of approximately $1.26 million for Gesco, a portion of which would later be refunded through the use of a non-eligible refundable dividend tax on hand account. Subsequently, Ms. Tremblay would sell her remaining 50% of Opco shares to Gesco in two transactions of 25% each, both payable by a promissory note equal to the FMV of the shares—in our example, $2.5 million per transaction. Ms. Tremblay would then be deemed to have received two dividends of $2.5 million each. The first would be designated as a capital dividend by Gesco and would therefore be tax-free for Ms. Tremblay. The second would be designated as an ordinary (non-eligible) dividend, resulting in total income taxes of approximately $1.18 million for Ms. Tremblay. The designation of the second dividend as an ordinary dividend would result in a refundable dividend tax on hand for Gesco of approximately $766,000. Gesco, owning 100% of Opco shares having an adjusted cost base equal to their FMV, would sell them to a third party for a sum of $10 million, generating no additional capital gain within Gesco. By using the tax mechanisms of a capital dividend account and a non-eligible refundable dividend tax on hand account, the sale of Opco shares would result in total income taxes of approximately $1.67 million, split between Ms. Tremblay and Gesco. Ms. Tremblay would then be left with proceeds of $3.82 million after taxes, while Gesco would be left with $4.51 million after taxes. Given that Ms.Tremblay would keep funds within Gesco, she would be able to defer the time at which she would be taxed on them, that is, when Gesco would pay her a dividend. In the meantime, she could make investments through Gesco. This type of planning would result in a tax deferral of almost 38% of the income taxes that, without prior planning, would have been payable on the sale of the shares. Our taxation team will be happy to answer all your questions and advise you on the most appropriate tax planning for your business. The information and comments contained herein do not constitute legal advice. They are intended solely to enable readers, who assume full responsibility, to use them for their own purposes.
Resumption of Mergers and Acquisitions: What May Change After the Crisis
The COVID-19 crisis has significantly slowed economic activity in all respects. The area of corporate mergers and acquisitions is no exception, and the level of activity, which was high before the crisis, has dropped significantly because of it. It is difficult to predict when and at what pace such activity will resume, but we expect that, like many other sectors of the economy, this market will be different from what it was before the crisis. Among other things, we expect that the uncertainty regarding economic recovery will see vendors and purchasers increasingly rely on earnout clauses to reach agreements on the value of a business. Opportunities to obtain financing for the acquisition of a competitor or a complementary business are also likely to be limited, which will change how such transactions are financed. The new behaviours made necessary by the post-crisis economic environment will certainly have considerable fiscal impacts. The tax rules applicable to earnout clauses can be complex, and parties to such transactions should learn about them before signing a letter of intent for a potential transaction. Those wishing to sell could get an unpleasant surprise in terms of the net result of the sale of their business if they aren’t properly advised from the outset. In some cases, the sale of a business that would normally be expected to generate a capital gain with only 50% of such gain being included as taxable income could instead be 100% taxable as business income. Earnout clauses offer very interesting tax planning possibilities in some cases, such as the maximization of capital dividend accounts that corporations can use to pay tax-free dividends to their shareholders. The same care should be applied by those wishing to acquire or sell a business with regard to the different methods of financing transactions that are likely to become popular after the crisis, such as partial financing by the vendor. Poor tax planning in this regard could result in liquidity problems for vendors if payment of the balance of the sale price is spread out over too long a period. Purchasers will also want to maximize the tax benefits of this type of financing. The main way to do so involves banking on interest costs resulting from the financing of the purchase price, but to reap such benefits and others, the commercial agreements relating to the purchase must be carefully structured. Tax complexities are numerous in M&A transactions, and those mentioned above are just two examples. The tax incidence of such transactions should be analysed as soon as they are contemplated. Parties to M&A transactions often wait too long before analyzing tax aspects. They thus greatly limit their opportunities to benefit from optimal tax planning. For more information, our taxation team is available to help you.
Changes to the Taxation of Switch Funds
Effective January 1, 2017, new rules will govern the taxation of mutual fund corporations structured as “switch funds”. Investors switching between funds will no longer be able to do so without incurring taxable capital gains. This article summarizes the impact of such changes. Description of “switch funds” under the current regime In Canada, most mutual funds are structured as trusts and some are structured as corporations (referred to as “corporate class funds”). The mutual fund trust is comprised of a single fund in which investors receive units of the trust, while the corporate class fund can hold several funds. Each fund is structured as a different class of shares, giving investors access to different investment portfolios of the corporation. Under the corporate class structure, investors have the advantage of being able to switch between funds without incurring capital gains or losses. This is because the current rules deem switches between funds not to be a disposition of shares of the corporation, resulting in a tax deferral which is not available to investors of mutual fund trusts. Capital gains tax will be paid later upon the future disposition of the corporation’s shares. Impact of the 2016 Legislative Proposals Effective January 1st 2017, taxpayers switching between funds will be considered to have disposed of their original shares at fair market value and will therefore immediately be taxed on capital gains. However, the 2016 Legislative Proposals provide for the following two exemptions, allowing tax deferral in these specific cases: If the exchange or disposition occurs in the course of a transaction covered by section 86 of the Income Tax Act (“ITA”) or an amalgamation under section 87 ITA, a shareholder will be entitled to a tax deferral provided that: i) all shares of the particular class are exchanged, ii) the original and new shares derive their value in the same proportion from the same property, and iii) the exchange was strictly done for bona fide reasons and not to obtain a tax deferral; or If shares of a class of the mutual fund corporation are exchanged for shares of the same class, provided that: i) the original and new shares derive their value in the same proportion from the same property, and ii) that class is recognized under securities legislation as a single investment fund. The above-mentioned changes will be implemented as of January 1, 2017. Therefore, investors wishing to switch shares within a mutual fund corporation have until December 31, 2016 to benefit from the current tax deferral rules.
Use of “private” mutual fund trusts for employee’ investments through an RRSP
An increasing number of employers are looking at the possibility of creating investment vehicles to allow their employees to make investments in the employer corporation or a portfolio managed by the employer that will qualify for inclusion in, inter alia, registered retirement savings plans (RRSP), registered retirement income funds (RRIF), registered education savings plans (RESP) and tax-free savings accounts (TFSA) (collectively referred to hereinafter as the “Registered Plans”). The following discusses the possible use of an entity that qualifies as a “mutual fund trust” (“MFT”) under the Income Tax Act (Canada) (“ITA”) for that purpose. There are multiple tax benefits that can be derived from MFT status, but the main advantage is that units of an MFT qualify for inclusion in, inter alia, the Registered Plans. This is why this structure is often used by managers of hedge funds or pooled funds that are raising capital from individuals. These conditions are summarized below. 1. Conditions for Mutual Fund Trust qualification a) The trust must be resident in Canada As a general rule, as long as the trustee(s) are resident in Canada and carry out their duties in Canada this should not be an issue. b) The trust must be a unit trust A trust can qualify as a unit trust in one of two alternate ways. First, not more than 10% of the trust’s property may be in bonds, securities or shares of one corporation and at least 80% of the trust’s property has to be in various securities, real property or royalties (closed-end unit trust). Second, interests of each beneficiary must be described by reference to units and the issued units of the trust must have conditions requiring the trust to redeem the units at the demand of the holder at prices determined and payable in accordance with the conditions. The fair market value of such units must not be less than 95% of the fair market value of all of the issued units of the trust (open-end unit trust). c) The trust’s only undertaking is the investing of its funds in property The rules for an MFT and for a unit trust restrict the trust to permitted activities. As a general rule, the trust must restrict its undertaking to investing of funds in property. The trust cannot carry on a business. A trust may own real property and is permitted to acquire, hold, maintain, improve, lease or manage real property as long as the real property is “capital property” of the MFT. d) The trust must comply with prescribed conditions relating to the number of its unitholders, dispersal of ownership of units and public trading Generally, the units must be qualified for distribution to the public or there must have been a lawful distribution of the units to the public in a province. There should be no fewer than 150 beneficiaries of the trust, each of whom hold not less than one block of units and units having an aggregate fair market value of not less than $500. A block of units normally means 100 units if a unit has a market value of less than $25, 25 if the value is between $25 and $100 and 10 units where a unit is $100 or more. e) It must be reasonable to conclude that the trust was not established primarily for the benefit of non-resident persons An additional qualification for MFT status is that it must not be reasonable having regard to all the circumstances that the trust is considered to be established primarily for the benefit of non-resident persons. It is generally accepted that the “primarily” requirement means more than 50% and the trust deed should contain provisions which allow the expulsion of non-residents if the threshold would otherwise be breached. 2. Mutual Fund Trust as investment vehicle in a private corporation The characteristics of an MFT make it an attractive vehicle to facilitate employee participation in a private corporation or in a portfolio to the extent that the number of employees interested in becoming shareholders of the employer corporation meet the minimum requirement of 150 unitholders. Since the units of an MFT qualify for inclusion in the Registered Plans, the employee may decide to invest in the private employer corporation or the portfolio through the Registered Plan. A direct equity investment in the private employer corporation or in a portfolio may not qualify for inclusion in the Registered Plans since the Income Tax Regulations (Canada) provide for strict conditions for the qualification of such an investment as a “qualified investment”. The interposition of an MFT whose units are “qualified investments” between the Registered Plans and the employer corporation or the portfolio managed by the employer would provide more comfort in that regard. An interesting question is whether each Registered Plan would count as a single unitholder for purposes of the minimum requirement of 150 unitholders described above. Since the ITA treats each Registered Plan as a trust under the ITA (and therefore as a distinct person from the beneficiary or annuitant), an argument could probably be made that each Registered Plan should count as a distinct unitholder for purposes of the 150 unitholders requirement. This position seems to be consistent with statements by the Canada Revenue Agency (“CRA”) to the effect that all qualified investments of a plan trust must be owned by the trustee of the plan trust and not by the annuitant, beneficiary or subscriber under the plan trust. In the case of a share or other security, registration of the security in the name of the trustee of the plan trust is proof of the trustee’s ownership.1 Moreover, the CRA has taken the position in the past that where a group RRSP is established and it “holds” the units of an MFT, the number of beneficiaries of the MFT will at least be equal to the number of annuitants of the group RRSP. Each participant in a group RRSP should therefore count as one unitholder. 3. Prohibited investments rules In structuring the participation of employees in the private employer corporation or the portfolio managed by the employer through an MFT, the rules governing “prohibited investments” under the ITA should be considered. Registered Plans holding prohibited investments are subject to severe penalties under the ITA. Units of an MFT will generally be “prohibited investments” for a Registered Plan to the extent that the unitholder’s interest in an MFT, either alone or together with non-arm’s length persons, is 10% or more. As a result, while each of the Registered Plans of a single unitholder could possibly count as distinct unitholders for purposes of the 150 unitholders requirement discussed above, the “prohibited investments” rules would impose a very strict set of limitations in terms of the threshold of ownership interest in units. 4. Securities Registration Requirements The employer managing the MFT must also ensure that it meets all of the registration requirements imposed by Canadian securities regulatory authorities. If the MFT will be used to invest in the employer corporation, there are likely to be circumstances allowing the employer not to have to register as an investment fund manager or adviser. However, if the employer instead offers a different portfolio for the employees to invest in (for example, a portfolio selected by it in connection with the management of the portfolio of the pension plans that are administered by it), it will likely have to register at least as an adviser and probably also as investment fund manager. Conclusion While the structuring of employees’ equity investments through the use of an MTF could be advantageous, various incidental rules must be considered in order to ensure that the units of such a “private” MFT can qualify for inclusion in a Registered Plan. Income Tax Folio S3-F10-C1, Qualified Investments-RRSPs, RESPs, RRIFs, RDSPs and TFSA.
Loss of the capital gain exemption related to the disposition of qualified small business corporation shares: beware of the options for acquiring shares
A recent decision of the Tax Court of Canada in the case of Line Durocher c. Sa Majesté La Reine1 illustrates the dangers of granting a simple option for acquiring shares in the specific context of the implementation of a shareholder agreement in respect of the Canadian-controlled private corporation status (CCPC) for the purposes of the Income Tax Act (Canada) (ITA) and the possibility of being eligible to the capital gain exemption upon the disposition of “qualified small business corporation shares” (QSBCS). BACKGROUND Aviva Canada Inc. (“Aviva”), a financial institution and a wholly-owned Canadian subsidiary of Aviva International Holdings Limited (“Aviva International”), a corporation which does not reside in Canada, acquired, in the context of a shareholder agreement entered into during fiscal year 2002, an option allowing it to acquire the shares of the financial holding corporation (“Holdco”), which indirectly controlled the Dale Parizeau corporation, which operated an insurance firm. This option, if exercised, gave control of Holdco and, indirectly, of Dale Parizeau. Beginning in 2002, due to the grant of the option for the Holdco shares to Aviva, Holdco’s shares and, accordingly, those of Dale Parizeau, could no longer qualify as QSBCS under the ITA since Aviva was controlled by Aviva International. Accordingly, these shares no longer met the conditions to be considered as QSBCS, with the result that the related capital gain exemption was lost. Holco’s shares were sold to Aviva during fiscal year 2008. The taxpayers unsuccessfully tried to claim the capital gain exemption from the disposition of the Holdco shares. Holdco’s shareholders, 15 in total, were denied the exemption by the Canada Revenue Agency, a decision which was upheld by the Tax Court of Canada. The ITA provides for an exception whereby granting an option or other right to acquire shares has no impact on the CCPC status for the purpose of the capital gain exemption. However, this exemption is only applicable if the rights are granted in the context of a purchase-sale agreement respecting a share of the share capital of a corporation2. The exception does not apply in the context of a shareholder agreement. It is to be noted that pursuant to section 148 of the Act respecting the distribution of financial products and services, not more than 20% of the shares of an insurance firm or the related voting rights may be held directly or indirectly by financial institutions, financial groups or legal persons related thereto. However, this prohibition does not apply to an option for acquiring shares. COMMENTS It is important to mention that the grant to Aviva of the option for acquiring Holdco’s shares in the context of entering into a shareholder agreement has had serious consequences for the 15 Holdco shareholders, that is, the loss of the capital gain exemption for each of them. Everything had been put into place to allow them, through family trusts, to multiply the exemption for the beneficiaries of the trusts. This obviously highlights the importance of retaining the services of tax experts in the context of conducting business transactions and establishing corporate structures, particularly with respect to the impact of entering into a shareholder agreement. It is to be noted that the above decision has been appealed before the Federal Court of Appeal. 2011-1393 (IT) G, dated December 9, 2015. 110.6(14)(b) ITA.
Proposed changes to tax rules on stock options
The election of a majority Liberal government last October 19 signaled that there would be numerous changes to Canadian tax policy, particularly for individuals. One of these changes which has made waves in the business community is the reform of the tax regime applicable to stock options. Under section 7 of the Income Tax Act (Canada) in its current form, the benefit realized by an employee on exercising stock options is treated as employment income. However, in most cases, the employee can claim a deduction equal to 50% of this benefit, meaning, from an economic standpoint, that the employee benefits from similar treatment to capital gains on this taxable benefit. As a general rule, the taxable benefit on stock options is taxed at the same time as the option is exercised, i.e. when the shares are acquired. However, the taxation is delayed until the shares are disposed of, where the corporation that issued the options was a “Canadian-controlled private corporation” at the time the stock-option plan took effect. The stock-option deduction granted to employees, which cost the federal government $750 million in 2014 according to the projections of the Department of Finance, was targeted by the Liberal Party because it considers that the deduction disproportionately favours high-income taxpayers. Moreover, the announced changes in this regard are aimed at increasing the federal government’s revenues in order to finance a reduction in the tax burden of the middle class. In their electoral platform, the Liberals stated that they intended to increase the tax on benefits from stock options issued to employees by setting a cap on the applicable deduction. However, in the same breath, they acknowledged that stock options are a useful compensation tool for start-up businesses. Therefore, employees that receive stock-option benefits of $100,000 or less per year will not be affected by the new cap. On the other hand, the Liberal program makes no distinction between options issued by public corporations and those issued by Canadian-controlled private corporations. Also, no details were provided on when this reform would come into force nor on the transitional measures that would apply to options that have already been issued. This uncertainty prompted some people to advise stock-option holders to exercise them as soon as possible to avoid the new unfavourable rules that could apply as soon as they are announced. The new federal Minister of Finance, the Honourable Bill Morneau, elaborated on the government’s intentions in this regard during a press conference held at the time the Update of Economic and Fiscal Projections was presented on November 20, 2015 The Minister indicated that he would continue his reflection on the tax treatment of stock options in the coming months, but provided an important clarification: any change will only apply to options issued on or after the date the decision is announced. Consequently, any option issued prior to that date will receive the current tax treatment. Mr. Morneau stated during the press conference that he wished to dispel any uncertainty and avert any hasty decision making by certain taxpayers. While these statements should be welcomed, some uncertainty remains on the precise amendments that will be made to the tax treatment of stock options. Given the statement by the Minister of Finance last November 20 that it is not necessary for stock-option holders to rush the exercise of their stock options in order to avoid the application of new less advantageous rules, it would be preferable for taxpayers to make reasoned decisions in this regard based on their tax situation as a whole and other expected legislative changes, such as the addition of a 33% tax bracket on taxable income exceeding $200,000. Bill C-2, which Minister Morneau tabled before the House of Commons on December 9, 2015, does not deal with the reform of the tax regime for stock options. That reform will possibly be announced in the 2016-2017 budget, which will be made public in the early months of 2016. In the meantime, opponents of these amendments will certainly make their voices heard, such as start-up companies, which do not often have the means to offer competitive salaries and that rely on a stock-option plan to attract and retain key employees. In this context, companies that have set up stock-option plans for their employees would be well advised to review them and ensure that their compensation policies remain adequate and competitive in light of the anticipated changes to the tax treatment of such options.
Major changes enable registered charitable organizations to invest in limited partnership units
The federal budget presented on April 21, 2015 (the “Budget”) contains important measures enabling registered charitable organizations and private and public foundations (hereinafter collectively referred to as “Registered Organizations”) to invest their funds in units of a limited partnership. Prior to announcing these measures, the Income Tax Act (Canada) (“ITA”) prohibited such investments by Registered Organizations because, by investing in a limited partnership, they were considered to be operating the limited partnership’s business. The consequence of making such a prohibited investment was that the Registered Organization’s registration could be revoked and, thus, that they could lose their income tax exemption and their ability to issue receipts for donations. According to the measures announced in the Budget, the ITA will be amended to provide that Registered Organizations are not considered to be operating the business of a limited partnership because they have invested in the units of such an entity. These changes will apply to any investment made by a Registered Organization in a limited partnership on or after April 21, 2015. It is important to note that the proposed changes only apply when a Registered Organization becomes a member of a limited partnership if the following conditions are met: The enabling legislation governing the limited partnership provides that the liability of members of the partnership is limited; The member deals at arm’s length with the general partner; and The total fair market value of the interests held by the member and by any persons or partnerships with whom it is not dealing at arm’s length, does not exceed 20% of the fair market value of all the interests held by all of the members of the partnership. --> 1. The enabling legislation governing the limited partnership provides that the liability of members of the partnership is limited; 2. The member deals at arm’s length with the general partner; and 3. The total fair market value of the interests held by the member and by any persons or partnerships with whom it is not dealing at arm’s length, does not exceed 20% of the fair market value of all the interests held by all of the members of the partnership. These changes will give Registered Organizations greater flexibility in the range of investments they can make.
FATCA for investment funds – Be ready for May 1, 2015!
The Foreign Account Tax Compliance Act, or FATCA, has been an integral part of Canada’s tax system for over a year. Originally legislated under U.S. law, FATCA allowed the Internal Revenue Service (“IRS”) to obtain information from financial institutions about the financial accounts of U.S. citizens and residents. This U.S. regime was introduced into Canada through the Intergovernmental Agreement for the Enhanced Exchange of Tax Information under the Canada-U.S. Tax Convention (“IGA”) and then through the enactment of Part XVIII of the Income Tax Act. Under Canada’s FATCA regime, Canadian financial institutions, including several investment funds, are required to file their first report on their U.S. reportable accounts by May 1, 2015. STATUS Under the FATCA, only Canadian financial institutions can have obligations to register and report the U.S. reportable accounts they maintain. Investment funds are generally considered a Canadian financial institution. An investment fund, its general partner, fund manager and holding companies are usually required to report under the FATCA rules. A fund’s limited partners may also have their own FATCA obligations. Most Canadian investment funds have addressed the issue of their FATCA status and obtained a global intermediary identification number (or “GIIN”) from the IRS. However, there is still some uncertainty which can cause market players to put off analyzing their obligations or registering. There are several reasons for this, including the fact that the rules are relatively new, the lack of formal administrative positions regarding their application, qualification and exception issues, etc. For an investment fund, these issues require an in-depth analysis of all entities forming part of its structure in order to come to an adequate determination. It should be noted that an investment fund that determines that it does not qualify as a financial institution for the purpose of FATCA could be considered a passive non-financial foreign entity and be required to report such information at the request of a financial institution and disclose more information about its beneficiaries in order to determine their status. DUE DILIGENCE A reporting Canadian financial institution is required to determine whether the financial accounts it maintains for its clients contain U.S. indicia (residence and citizenship of account holder, place of birth, mailing address, telephone number, etc.). This verification includes a review of available information about the account by the financial institution and a mechanism for requesting information. Such a request may be in the form of an IRS Form W-8, an official IRS document, or an equivalent document prepared by the financial institution, to be filled out by the account holder. A financial institution is required to collect this information for existing accounts and any new account it opens for a client. The financial institution’s verification obligations may be more or less strict depending on the account, the date it was opened and its value. REPORTING Canadian financial institutions are required to file an electronic report on their U.S. reportable accounts with the Canada Revenue Agency (“CRA”). The first such report covers financial accounts held by financial institutions as of December 31, 2014 and must be filed by May 1, 2015. Financial institutions must also complete, by June 30, 2015, a review of their high-value financial accounts, i.e. those worth one million dollars ($1M) or more, held as of June 30, 2014. After that, financial institutions will be required to file annual reports. EVOLUTION The FATCA rules are the precursor of a broad, evolving trend toward the exchange of information about taxpayers’ assets among the tax authorities of different countries. The United Kingdom has set up a similar although less wide-sweeping regime than the U.S. China is also looking at the possibility of setting up its own regime but has not released any details so far. The Organisation for Economic Co-operation and Development (“OECD”) has also set up a common standard for the automatic exchange of information regarding financial accounts, which Canada has committed to implement by 2018. This standard is expected to be similar to FATCA but involve all countries that have signed agreements involving the automatic exchange of information. In future we will certainly see greater transparency and increased reporting requirements regarding information about financial accounts to be provided to the tax authorities. Since investment funds are directly affected by these rules, they should make sure they have the tools they need to meet these requirements.
Rules on mark-to-market properties — A pitfall to avoid
The Income Tax Act (Canada) contains specific rules which apply to certain properties held by financial institutions known as the mark-to-market properties rules (hereinafter “MTMP”). These complex rules are often poorly understood and can result in unexpected tax consequences in various situations and, in particular, in the context of project financing involving the issuance of units in a limited partnership. Generally when the MTMP rules apply, a financial institution must declare as income any increase in value not realized at the end of the taxation year on the MTMP held by such financial institution, whether or not such property was the subject of an actual disposition. The expression “financial institution” is specifically defined for purposes of the MTMP rules and includes not only banks but insurance companies and entities controlled by insurance companies, as well as partnerships in which more than 50% of the fair market value of its interests are held by one or more financial institutions. In such a case, the partnership would automatically become subject to the MTMP rules to the extent that it holds MTMP. Such a partnership must therefore declare an income for the taxation year in question in respect of any increase in the value of the MTMP held by it, and allocate such income to all its unitholders, regardless of whether or not they are financial institutions. Corporate shares will be considered to be MTMP where a financial institution holds less than 10% of the fair market value of the corporation’s shares or of the voting rights attached to such shares. In addition, the definition of MTMP includes various other types of property the fair market value of which is attributable to MTMP. For example, mutual fund units, units in a limited partnership, insurance policies or other derivative financial instruments may be regarded as MTMP to the extent that the value of such investments is primarily attributable (more than 50%) to MTMP. However, it should be noted that the ownership of shares of an “eligible small business corporation” (defined for purposes of the MTMP rules as being a corporation whose assets have a carrying value which does not exceed $50,000,000 and which employs 500 persons or less) will not be considered to be MTMP. The MTMP rules apply to financial institutions such as banks and insurance companies or any entity controlled by such financial institutions. However, as noted above, because of the broad definition of “financial institution” in the context of the application of the MTMP rules, other entities may also inadvertently be considered to be financial institutions if the percentage of their unit or share ownership is held by one or more financial institutions. In this regard and specifically in the context of the formation of a limited partnership which may eventually make investments which could be considered MTMP, it is important to provide for a clause limiting the ownership of units by financial institutions so as to ensure that the limited partnership will not be considered to be a financial institution under the MTMP rules. In the event that such a restriction is not desirable, the limited partnership agreement and the limited parntership’s investment policies should provide that the investments to be made by the limited partnership must not consist of MTMP. Thus, even if the limited partnership itself were considered to be a financial institution, the MTMP rules would have no impact since no investment made by the limited partnership would meet the definition of MTMP. In conclusion, the MTMP rules must be taken into consideration in any major structured investment project, particularly in connection with a limited partnership in which financial institutions are likely to acquire a substantial interest.
Quarterly legal newsletter intended for accounting, management, and finance professionals, Number 23
CONTENTS The 2014 Federal Budget Plan sounds the death knell for two family tax planning measures much appreciated by entrepreneurs and some professionals The Expert and the Court You signed a contract for services... with an employee? How to properly identify the relationship between the parties and what are the consequences of a wrong categorization ? Application of GAAR to a cross-border debt “clean-up” transaction: The Pièces Automobiles Lecavalier Inc. CaseTHE 2014 FEDERAL BUDGET PLAN SOUNDS THE DEATH KNELL FOR TWO FAMILY TAX PLANNING MEASURES MUCH APPRECIATED BY ENTREPRENEURS AND SOME PROFESSIONALSMartin BédardINCOME SPLITTING THROUGH A TRUST OR PARTNERSHIPFirst, the 2014 Federal Budget Plan (the “Budget”) ends the possibilities for splitting the income of trusts and partnerships in respect of business and rental income attributed to a minor child.Such income will henceforth be considered as being part of the split income of the trust or partnership and taxed at the marginal rate.As described in the Budget, the conditions of application of this new measure are as follows: the income is derived from a source that is a business or a rental property; and a person related to the minor is actively engaged on a regular basis in the activities of the trust or partnership to earn income from any business or rental property, or has, in the case of a partnership, an interest in the partnership (whether held directly or through another partnership) The structures affected by these new measures could be used by professionals conducting their activities through a partnership of which their minor children or a trust established for their benefit were members. Such structures allowed for directly or indirectly allocating a portion of the income of the partnership to the minor child and thus benefit from progressive tax rates.As of 2014, the rules governing split income will apply to these structures, which will no longer offer a tax benefit. However, it is still possible to split such income with related persons who have reached the age of majority.POST-MORTEM INCOME SPLITTING: THE TESTAMENTARY TRUSTThe Budget also puts an end to the progressive tax rates applicable to a testamentary trust, a measure which was announced in the 2013 Federal Budget Plan.Up to now, testamentary trusts were allowing their beneficiaries to benefit from several progressive tax rates. Among the tax planning possibilities associated with the availability of such progressive tax rates were the use of numerous testamentary trusts, the postponement of the completion of the administration of an estate for tax purposes or the avoidance of the Old Age Security Recovery Tax.Testamentary trusts will henceforth be uniformly taxed at their marginal tax rates. However, progressive tax rates will remain applicable in the following two cases: (i) for the thirty-six (36) first months of an estate which is a testamentary trust and (ii) in the case of a trust whose beneficiaries are eligible for the federal disability tax credit.The Budget also provides that the tax year-end of testamentary trusts must henceforth be December 31 of each year starting December 31, 2015.These measures will apply to taxation years 2016 and following.THE EXPERT AND THE COURTDominique VallièresIn the context of litigation, lawyers frequently require the testimony of experts, particularly accountants. Well presented, this evidence may have a decisive influence on the outcome of a trial. In the contrary situation, a debate on the quality of the expert or the weight to be given to his or her testimony may occur. This is why we review in this bulletin the role, qualification and credibility of the expert.THE ROLE OF THE EXPERTThe role of the expert is to express an opinion based on his or her scientific, economic or other knowledge, which exceeds that of the judge and without which it is impossible to draw from the facts the correct conclusions. In other words, when the judge is able by himself to understand the facts and draw the correct inferences, an expert is neither necessary nor admissible. For example, the calculation of the gross profits from a contract, which only constitute a mathematical operation, will not require a particular expertise and an accountant called upon to testify on that matter will be at best considered as an ordinary witness. The role of the expert is to enlighten the Court in as objective or impartial a manner as possible.THE QUALIFICATION OF THE EXPERTTo express his or her opinion, the expert must first be recognized as such by the Court. The expert will therefore be first examined respecting his or her training and experience. If the expert qualification is contested, and the Court considers that the expert is insufficiently qualified, it may refuse to hear him or her. The qualifications of the expert must be related to the matters about which he or she testifies.The training of the witness and his or her practical experience, will be considered. Although either may be enough, a really convincing expert will generally have solid training and experience, failing which, even if the Court accepts to hear him or her, less weight may be given to his or her testimony.THE WEIGHT GIVEN TO HIS OR HER OPINIONAs is the case with any other witness, the Court will have to assess the credibility of the expert, particularly in the presence of contradictory opinions. The Court may review the seriousness of the steps taken by the experts. It will give more weight to the opinion of a witness who directly noted the facts and reviewed the data than to the opinion of another witness who only relied on what he or she has been told. A mostly theoretical opinion or an opinion which only describes principles will also be given less weight. It is important for the witness to explain why the particular facts of the case allow for drawing a particular conclusion. Furthermore, in the presence of diverging schools of thought on a particular item, the Court appreciates that the expert considers them and explains why one should be favoured over the other in the situation at hand. Dogmatism, the absence of justification and the out of hand dismissal of a recognized approach will also generally be negatively perceived.This is consistent with the very basis of the role of the expert, which is to impartially and objectively enlighten the Court. The Court will want to ensure that the expert keeps the required distance and independence to issue a credible opinion. If the Court perceives that the expert is taking sides or “pleads the case” of the party who retained his or her services, his or her credibility will suffer. Thus, even though it is admissible, the testimony of the expert and his or her conduct will be more closely scrutinized if it is demonstrated, for instance, that he or she is employed by a party or expressed in the past an opinion on similar issues.Although this situation is rarer, the Court could even refuse to hear the witness if it is convinced that he or she will be unable to be impartial. Such may be the case when the expert personally advocates in favour of the position defended by a party or the fact that he or she was personally involved in similar litigation. The animosity or the closeness which may exist between the expert and a party may also negatively affect the expert. In this respect, it is important for the expert to be transparent to the party who retains his or her services.CONCLUSIONThe really useful expert is the one whose conduct may be summarized by these three words: competence, thoroughness and objectivity.YOU SIGNED A CONTRACT FOR SERVICES… WITH AN EMPLOYEE? HOW TO PROPERLY IDENTIFY THE RELATIONSHIP BETWEEN THE PARTIES AND WHAT ARE THE CONSEQUENCES OF A WRONG CATEGORIZATION?Valérie Korozs and Martin BédardThe Court of Appeal of Québec recently issued an interesting decision on this subject in the Bermex international inc. v. L’Agence du revenu du Québec case1 (“Bermex”).It must be noted that regardless of the fact that the parties have described their agreement as a contract for services or an agreement with a self-employed person, a court is not in any way bound by such a description.The courts have developed certain criteria for analyzing the legal status of a person in order to determine whether that person is an employee or a self-employed person. Among these criteria, the relationship of subordination, that is, whether a person works under the direction or control of another person, has always been decisive.What about when a person is not, strictly speaking, “under the direction or control of another person”,2 due to the fact that he or she runs the business? This is the question the Court of Appeal had to answer in the Bermex case.The Court adopted a broad interpretation of the concept of the subordination relationship by considering the degree of integration of the worker into the company, a criterion derived from the common law.THE FACTSFollowing a tax audit of four companies, the Agence du revenu du Québec (the “Agency”) concluded that Mr. Darveau, their main director and officer, did not have the status of a self-employed person but rather that of an employee. Accordingly, the Agency was of the view that the management fees paid to Mr. Darveau had to be considered employment income and therefore, had to be included in the companies’ payroll.The four companies targeted challenged the Agency’s assessments before the Court of Québec but to no avail.THE DECISION OF THE COURT OF APPEALJust like the trial judge , the Court of Appeal concluded that the intent of the parties to enter into a service contract was not clear from the evidence in the case.The fact that Mr. Darveau was a shareholder of the appellant corporations allowed him some freedom of action, giving the impression that he acted as a self-employed person. It is not surprising that as an officer, Mr. Darveau managed his own schedule, work and compensation nor is it surprising that he was not under the direct supervision of another authority. This freedom resulted from his status as an officer and not from the contract for services upon which he was relying.The Court of Appeal placed a particular emphasis on the fact that it was the appellant companies who assumed all risk of loss and who profited from the activities: [translation] “Yet, a company does not assume the errors of an external consultant”.3 Mr. Darveau did not bring any [translation] “expertise requiring the intervention of an external person in an area that he knows better than anyone, he simply deals with the day-to-day problems of his companies, as he so acknowledges.”4CONCLUSIONAccording to the line of case law followed by the Court of Appeal in the Bermex case, one shall take criteria such as control, ownership of tools, expectation of profits and risks of loss, as well as integration into the company into consideration for the purpose of determining a person’s status as a self-employed individual or an employee.An erroneous categorization of the nature of the contract may have significant financial impacts on the company and the individual in question, both from a tax and labour law perspective. It is therefore essential to undertake a careful analysis of the true status of the person involved before the beginning of the contractual relationship._________________________________________1 2013 QCCA 1379.2 Article 2085 of the Civil Code of Québec.3 Para 59 of the Court of Appeal’s judgment.4 Para 60 of the Court of Appeal’s judgment.APPLICATION OF GAAR TO A CROSS-BORDER DEBT “CLEAN-UP” TRANSACTION: THE PIÈCES AUTOMOBILES LECAVALIER INC. CASE LAVERY, AN OVERVIEWÉric GélinasThe Tax Court of Canada recently rendered a decision dealing with the general antiavoidance rule (“GAAR”) in the context of the elimination of a cross-border debt between Greenleaf Canada Acquisitions Inc. (“Greenleaf”) and Ford US, its American parent company, prior to the sale of Greenleaf’s shares, who owed the debt, to a third party. In the case under review, Ford US subscribed for additional Greenleaf shares and Greenleaf used the proceeds from the subscription to repay its debt to Ford US.The purpose of the transactions in question was to avoid the application of section 80 of the Income Tax Act (“ITA”) upon the forgiveness of a portion of the debt. Without the debt repayment, the rules pertaining to debt parking contained in paragraphs 80.01(6) to (8) ITA would have resulted in the application of section 80 ITA in such a way as to reduce Greenleaf’s tax attributes and even add to its income the portion of the “forgiven amount” not being sheltered.The Minister of National Revenue (“Minister”) was of the view that GAAR applied to the “clean-up” transaction in such a way that Greenleaf had to realize a capital gain of $15 million on the forgiveness of the debt. Greenleaf’s tax attributes were accordingly reduced and certain adjustments to its taxable income were made pursuant to section 80 ITA.ANALYSIS OF THE COURTFrom the outset, the taxpayer acknowledged that the transactions provided it with a tax benefit, namely, the preservation of Greenleaf’s tax attributes through the avoidance of the provisions of section 80 ITA.As to whether these transactions constituted “avoidance transactions”, the taxpayer attempted, particularly through the testimony of the accounting expert, to prove that they had been carried out only for US tax and accounting purposes, and that they therefore had bona fide non-tax purposes and did not constitute avoidance transactions. The Court did not rely on this testimony because it constituted hearsay. Furthermore, the Court applied the negative inference doctrine since no representative of Ford US had testified and that the testimonies provided were deemed not to be credible.With respect to the issue of abuse, the Court agreed with the Minister’s argument to the effect that the “clean-up” transactions were abusive since they circumvented the purpose and spirit of section 80 ITA: if the debt had not been repaid using the proceeds from the subscription, the rules governing debt parking would have applied and Greenleaf’s tax attributes would have been reduced pursuant to section 80 ITA.CONCLUSIONThis decision is particularly important in a context of debt reorganization within a corporate group. The type of transactions discussed in the decision under review is frequently used. Practitioners will have to pay particular attention to the tax impact of such a transaction. When it is possible to do so, it will obviously be preferable to simply convert a debt into shares of the debtor corporation to the extent that paragraph 80(2)(g) ITA is applicable so that no forgiven amount will result from the conversion.