Notifiable transactions designated by the Minister of National Revenue

Introduction

Some taxpayers are engaging in financial arrangements that seek to reduce tax by generating artificial losses with the use of complex financial instruments or derivatives. 

Tax measures announced in Budget 2017 addressed some of these financial arrangements through specific anti-avoidance rules that targeted certain straddle transactions (basic straddle transactions). Basic straddle transactions involve two or more financial instrument positions entered into concurrently by a taxpayer, that are expected to generate substantially equal and offsetting gains and losses. Shortly before taxation year-end, the taxpayer disposes of the position with the accrued loss (the “loss leg”) and realizes the loss. Shortly after the beginning of the following taxation year, the taxpayer disposes of the offsetting position with the accrued gain (the “gain leg”) and realizes the gain. The taxpayer claims a deduction in respect of the realized loss against other income in the initial taxation year and defers the recognition of the offsetting gain until the following taxation year. The taxpayer claims the benefit of the deferral although economically the two positions are offsetting with nominal risk. Moreover, the taxpayer often attempts to indefinitely defer the recognition of the gain on the gain leg by entering into successive straddle transactions. 

The specific anti-avoidance rules announced in Budget 2017 to address straddle transactions are generally designed to suspend the recognition of straddle losses until such time as the offsetting gain is realized. Nevertheless, the CRA has detected several variant transactions that have emerged using partnerships to attempt to avoid the application of the specific anti-avoidance rules, resulting in tax consequences that are inconsistent with the purpose of the straddle transaction rules.

Designated transactions

The following series of transactions is hereby designated by the Minister of National Revenue for the purposes of section 237.4 of the Income Tax Act, effective November 1, 2023.

1. A taxpayer enters into an agreement to acquire a partnership interest from an existing partner. 
2. The partnership trades foreign exchange forward purchase and sale agreements on margin through a foreign exchange trading account. The foreign exchange forward agreements are essentially straddle transactions where it is reasonable to conclude that each agreement is held in connection with the other and where, in the aggregate, the individual agreements (legs) will generate substantially equal and offsetting gains and losses.  
3. Shortly before the taxpayer’s acquisition of the interest in the partnership, the partnership disposes of the gain leg(s) of the foreign exchange forward agreement(s).  
4. The income from the gain leg(s) is then reflected in the income of the partnership and is allocated to the original partner immediately prior to the acquisition of the interest in the partnership by the taxpayer.
5. Following the acquisition of the partnership interest by the taxpayer, the loss leg(s) are realized and a business loss is allocated to the taxpayer. 

Introduction

Subsection 104(4) of the Income Tax Act sets out what is generally referred to as the “21-year deemed realization rule” for a trust. The purpose of subsection 104(4) is to prevent the use of trusts to defer indefinitely the recognition for tax purposes of gains accruing on certain capital property. When subsection 104(4) applies, it generally treats capital property of a trust (other than certain trusts for the benefit of the settlor, for a spouse or common-law partner of the settlor, or for their joint benefit) as having been disposed of and reacquired by the trust every 21 years at the property's fair market value.

In some situations, a transfer of the trust property to the capital beneficiaries on a tax deferred basis pursuant to subsection 107(2), prior to the 21-year deemed realization date, could be used to defer the tax consequences. Corresponding rules to subsection 104(4) for depreciable property are contained in subsection 104(5). A deferral of the 21-year deemed realization rule is generally not possible when the property is transferred from a trust (the “transferor trust”) to another trust (the “receiving trust”) since subsection 104(5.8) would apply to deem the 21-year anniversary of the receiving trust to occur no later than it would for the transferor trust.

In addition, distributions of a trust’s property (other than property described in any of subparagraphs 128.1(4)(b)(i) to (iii)) to non-resident beneficiaries will be subject to the application of subsections 107(5) and (2.1). In these circumstances, a rollover under subsection 107(2) is not available and the distributed property will be deemed to be disposed at fair market value. 

Some taxpayers are engaging in transactions that seek to avoid or defer the 21-year deemed realization rule or that seek to avoid the rules in subsections 107(5) and (2.1) even though the property continues to be held, directly or indirectly, by a trust or by a non-resident beneficiary. 

Designated Transactions

The following transactions and series of transactions are hereby designated by the Minister of National Revenue for the purposes of section 237.4 of the Income Tax Act, effective November 1, 2023.

Indirect transfer of trust property to another trust

A Canadian resident trust (“New Trust”) holds shares of a corporation resident in Canada (“Holdco”) that is or will become a beneficiary of another Canadian resident trust (“Old Trust”) that holds property that is capital property or land included in the inventory of a business of Old Trust. At any time prior to its 21-year anniversary, Old Trust transfers the property to Holdco on a tax deferred basis pursuant to subsection 107(2).

In the result, the 21-year rule will not apply to Old Trust, and a new 21-year period will start to run with respect to New Trust, providing for a much longer period of deferral. New Trust’s assets will reflect the property formerly held by Old Trust but may have a higher tax basis than such property.

Indirect transfer of trust property to a non-resident

One or more of the non-resident beneficiaries of a Canadian resident trust hold shares of a corporation resident in Canada (“Holdco”) that is or will become a beneficiary of the trust. At any time prior to its 21-year anniversary, the trust transfers property (other than property described in any of subparagraphs 128.1(4)(b)(i) to (iii)) to Holdco on a tax deferred basis pursuant to subsection 107(2). 

In the result, the 21-year rule will not apply to the trust, with the transfer of the trust’s property to Holdco providing for a much longer period of deferral. The non-resident beneficiaries of the trust hold shares of Holdco that reflect their former indirect interest in the property of the trust, possibly providing an opportunity to have such property transferred by Holdco to the non-resident beneficiaries at some future time without triggering the application of subsections 107(2.1) and 107(5).  

Transfer of trust value using a dividend

A Canadian resident trust (“New Trust”) holds shares of a corporation (“Holdco”) that is or will become a beneficiary of another Canadian resident trust (“Old Trust”) that holds property that is shares in a Canadian corporation (“Opco”).  At any time prior to Old Trust’s 21-year anniversary, Opco redeems shares held by Old Trust and issues a promissory note or gives cash as consideration. In so doing, Opco is deemed pursuant to subsection 84(3) to have paid, and Old Trust is deemed to have received, a dividend equal to the amount by which the amount paid by Opco on the redemption exceeds the PUC in respect of the shares. The deemed dividend is designated by Old Trust and deemed to be received by Holdco pursuant to subsection 104(19). The dividend is deductible in the hands of Holdco pursuant to subsection 112(1). The cash or the promissory note is paid or made payable in the year by Old Trust to Holdco as payment for the dividend allocated to it. 

In the result, the 21-year rule will not apply to Old Trust, and a new 21-year period will start to run for New Trust, providing for a much longer period of deferral. New Trust’s assets will reflect the value of the property formerly held by Old Trust but will undoubtedly have a significantly higher tax basis than such property.

Introduction

Sections 80 to 80.04 of the Income Tax Act set out the rules that apply when a commercial debt obligation is (or is deemed to be) settled or extinguished for less than its principal amount or the amount for which it was issued. These rules are commonly referred to as the debt forgiveness rules and debt parking rules. When such an obligation is settled or extinguished, it generally gives rise to a "forgiven amount" as defined in subsection 80(1). The "forgiven amount" at any time is generally equal to the principal amount of the obligation less the amount, if any, paid at the time in satisfaction of the obligation.  In certain circumstances, the forgiven amount may be reduced by other amounts. A forgiven amount in respect of an obligation issued by a debtor is required to be applied against certain tax attributes of the debtor, including loss carryovers, in a specified order, as provided in subsections 80(3) to (12). In general, subsection 80(13) requires that one half of any excess of the forgiven amount that does not reduce a tax attribute under subsections 80(3) and (12) be included in computing the debtor's income, unless it can be transferred to another taxpayer under section 80.04. One of the other amounts that reduces the forgiven amount is provided in paragraph (i) of the definition of “forgiven amount” which applies where a debtor is bankrupt at the time of the settlement of the commercial obligation. In such a case, the forgiven amount will be reduced by the principal amount of the obligation.

Some taxpayers are entering into arrangements in which they are temporarily assigned into bankruptcy prior to settling or extinguishing a commercial obligation in order to reduce a forgiven amount in respect of a commercial obligation to nil. As a result, there is no reduction in the taxpayer’s tax attributes and no income inclusion even though the bankruptcy is subsequently annulled.

Designated Transactions

The following series of transactions is hereby designated by the Minister of National Revenue for the purposes of section 237.4 of the Income Tax Act, effective November 1, 2023.

1. A person or partnership (“Debtor”) is assigned into bankruptcy.
2. While Debtor is a bankrupt, a commercial obligation of the Debtor is settled, deemed to be settled or extinguished for an amount that is less than the principal amount of the obligation.
3. At any point in time, Debtor files a proposal under Part III of the Bankruptcy and Insolvency Act and the bankruptcy is annulled either upon the approval of the proposal by a court or on the date stated in a court order.

Introduction

Section 256.1 contains rules meant to constrain the trading of corporate tax attributes among arm's length persons. 

For the purposes of the “attribute trading restrictions” defined in subsection 256.1(1), subsection 256.1(3) will apply if all of the conditions in subsection 256.1(2) are satisfied. 

Based on these conditions, subsection 256.1(3) will generally deem there to have been an acquisition of control at a particular time if at the particular time a person or group of persons holds shares of the corporation with a fair market value (“FMV”) that exceeds 75% of the FMV of all the shares of the corporation (the “75% FMV threshold test”), the person or group of persons did not immediately before the particular time hold shares of the corporation with a FMV that satisfied the 75% FMV threshold test and the person or group does not control the corporation at the particular time.

However, subsection 256.1(3) will only apply if, in accordance with paragraph 256.1(2)(d), it is reasonable to conclude that one of the main reasons that the person or group of persons does not control the corporation is to avoid the application of a “specified provision” defined in subsection 256.1(1). In addition, paragraph 256.1(4)(a) provides that, if it is reasonable to conclude that one of the reasons that one or more transactions or events occur is to cause a person, or a group of persons, not to hold shares having a FMV that exceeds the 75% FMV threshold test, the 75% FMV threshold test is to be applied without reference to those transactions or events.

Subsection 256.1(6) applies if, at any time as part of a transaction or event or series of transactions or events, control of a particular corporation is acquired by a person, or a group of persons, and it can reasonably be concluded that one of the main reasons for the acquisition of control is so that a “specified provision” does not apply to one or more corporations. Where subsection 256.1(6) applies, the “attribute trading restrictions” are deemed to apply to each of those corporations as if control of each of those corporations were acquired at that time. In general terms, subsection 256.1(6) targets situations where a loss corporation that has undeducted tax attributes acquires control of a profitable corporation in order to avoid an acquisition of control of the loss corporation and the application of a “specified provision”. 

The application of each of subsections 256.1(2), 256.1(4), and 256.1(6) is subject to satisfying a “one of the main reasons” or a “one of the reasons” test (each referred to as a “purpose test”).  The transactions listed below are aimed at identifying situations where taxpayers rely on one of the purpose tests to conclude that subsection 256.1(3) or 256.1(6) does not apply to transactions or events that would otherwise have satisfied all of the other conditions enumerated within those provisions. 

Designated transactions

The following transactions and series of transactions are hereby designated by the Minister of National Revenue for the purposes of section 237.4 of the Income Tax Act, effective November 1, 2023.

Purpose test in paragraph 256.1(2)(d)

Lossco is a taxable Canadian corporation that has tax attributes that are subject to the application of one of the provisions listed in the definition of “attribute trading restriction” in subsection 256.1(1). Another person (“Aco”) does not, immediately before the particular time, hold shares of Lossco with a FMV that satisfies the 75% FMV threshold test. At a particular time, Aco acquires shares of Lossco and, following the acquisition, Aco does not control Lossco but satisfies the 75% FMV threshold test. The taxpayer takes the position that because the purpose test in paragraph 256.1(2)(d) is not satisfied, subsection 256.1(3) does not apply.

Purpose test in paragraph 256.1(4)(a)

Lossco is a taxable Canadian corporation that has tax attributes that are subject to the application of one of the provisions listed in the definition of “attribute trading restriction” in subsection 256.1(1). A corporation (“Profitco”) and another person (“Aco”) not dealing at arm’s length with Profitco acquire shares of Lossco. Following the acquisition of the Lossco shares, Profitco does not control Lossco and does not hold shares of Lossco with a FMV that satisfies the 75% FMV threshold test. However, Profitco would satisfy the 75% FMV threshold test if the acquisition of the Lossco shares by Aco is ignored. The taxpayer takes the position that subsection 256.1(3) does not apply solely because the purpose test in paragraph 256.1(4)(a) is not satisfied.

Purpose test in paragraph subsection 256.1(6)

Lossco is a taxable Canadian corporation that has tax attributes that are subject to the application of one of the provisions listed in the definition of “attribute trading restriction” in subsection 256.1(1). Lossco acquires control of a particular corporation (“Profitco”) and it can reasonably be concluded that one of the reasons for the acquisition is so that a specified provision as defined in subsection 256.1(1) does not apply. However, the taxpayers take the position that subsection 256.1(6) does not apply solely because its purpose test is not satisfied.

Introduction

In certain circumstances, the thin capitalization rules in subsections 18(4) to (8) and paragraph 12(1)(l.1) of the Income Tax Act deny a deduction, or provide for the inclusion of a deemed amount of income, in respect of an amount of interest that is paid or payable by a taxpayer or partnership on debts owing to certain non-residents specified in those rules, (generally, non-residents that hold a significant interest in the taxpayer, or that do not deal at arm’s length with a person that holds such an interest – in these notes referred to as a “relevant non-resident”). Supporting rules help to ensure the thin capitalization rules cannot be circumvented through the use of certain back-to-back lending arrangements involving intermediaries.

Parallel rules in subsections 212(3.1) to (3.3) help to ensure that withholding tax under Part XIII is not circumvented through the use of back-to-back lending arrangements, or back-to-back arrangements in respect of rents, royalties and similar types of payments. There are also character substitution rules in the Part XIII context.  

Designated transactions

The Canada Revenue Agency and the Department of Finance consider the following transactions and series of transactions to have the potential for tax avoidance or evasion, but they lack sufficient information to make that determination. Therefore, the following transactions and series of transactions are designated by the Minister of National Revenue for the purposes of section 237.4 of the Income Tax Act, effective November 1, 2023.

Thin capitalization

Non-resident 1 (NR1) is a relevant non-resident in respect of a taxpayer). NR1 enters into an arrangement with an arm’s length non-resident (NR2) to indirectly provide financing to the taxpayer. The taxpayer files, or anticipates filing, its income tax returns on the basis that the debt or other obligation owing by it, and the interest paid thereon, is not subject to the thin capitalization rules. 

Part XIII tax

A non-resident person (NR1) enters into an arrangement to indirectly provide financing to a taxpayer through another non-resident person (NR2). If interest had been paid by the taxpayer directly to NR1, it would be subject to Part XIII tax. The taxpayer’s income tax reporting reflects, or is expected to reflect, the assumption that the interest it pays in respect of the arrangement is either not subject to withholding tax at all or is subject to a lower rate of withholding tax than the rate that would apply on interest paid directly by it to NR1.

Alternatively, similar arrangements are entered into in respect of rents, royalties or other payments of a similar nature, or to effect a substitution of the character of the payments.