What's News

Year end is always a busy time for tax practitioners.  Besides the usual emergencies, typically there are a lot of new tax developments in the last month or so – and the final weeks of 2005 were no exception.  This article reviews what I consider to be the most important ones.

Dividends and Private Corporations

While I discussed the Liberal’s November 23^rd announcement on the taxation of dividends in last month’s issue, some additional comments are in order [1].  As I said, the tax break potentially applies to dividends paid out of general-business-rate income of both private and public corporations (this does not include investment income of CCPCs and income qualifying for the small business deduction).  Potentially, this may mean that bonusing down to the small business limit will be less attractive and that dividend payments should be delayed until after 2005. 

However, the announcement was short on content, leaving tax practitioners to try to read between the lines to flesh in the details.  For example, one big four firm’s release indicated that it is “uncertain” whether the reduction would apply to dividends paid out of pre-2006 general rate income, even though there was no mention of such a restriction in the government’s release.

I think it is fair to say that Ottawa’s hasty announcement left very little time for the Department of Finance to sort out the details.  In fact, what has rapidly become apparent is that the new regime has the potential of considerably complicating the taxation of private corporations and their shareholders.  I’ve heard rumors of a follow-up announcement delaying the regime for non-public corporations.  At time of writing, this has not occurred; however, on December 19^th, Quebec announced that it would not follow the federal changes, at least pending further information from Ottawa on the proposals.  

As readers will be aware, the announcement had added controversy because of the possibility that the changes could have been leaked.  For what it’s worth, I think that all that it would have taken is advance notice that an announcement in the income trust area would be forthcoming.  With an election in the wings, it wouldn’t exactly be rocket science to figure out the rest.

Personally, I find a certain amount of irony in the fact that, by the government’s own admission, the proposals would lose as much tax revenue as the recent losses to public coffers as a result of income trusts themselves – and I doubt that they will do much to stem the income trust tide, in view of the continuing advantages to tax exempt entities, which constitute the majority of income trust investors.  This is just another indication as to how far the government is willing to go in order to hang on to power.

Donation Schemes

An interesting development in the charitable donation battleground was the release of the Nash/Quinn/Tolly appeals (aka CVI Art Management Inc.)[2].  The cases are remarkable in that, at the Tax Court level, the CRA did not introduce its own appraisals of the art donations.  Nonetheless, the Court of Appeal overturned the cases on the grounds that fair market value is a determination of mixed fact and law, and that the Tax Court had made a palatable error in holding in favour of the taxpayers.  It indicated that, because the prints were only acquired and donated in groups, the relevant assets to be valued were the groups of prints which were donated, i.e., not the artwork on an piece-by-piece basis.[3] 

At just about the same time, the CRA issued a “taxpayer alert”, advising potential investors to exercise caution with respect to donation schemes.  These alerts have become annual events, singling-out gifting trusts and leveraged cash donation arrangements and, of course, buy-low, donate-high schemes.  This year’s release recommended that anyone considering participating in tax sheltered donation arrangements should obtain independent legal and tax advice.  All well and good, but for most taxpayers, the complicated nature of these arrangements mean that the fees involved in an analysis of these schemes would be prohibitive.  Isn’t this the sort of thing that was a big reason for bringing in the so-called “civil penalties” for tax advisors?  Although I have not exactly been a big fan of these rules, if the CRA are going to train the civil penalty guns in any direction, perhaps it should be here.  The way things are, I doubt that those involved in these schemes even turn their minds to these rules anymore.

New GAAR Cases

While taxpayers have ended up on the short end of the stick in recent donation cases, it has been a different story so far in the post-Canada Trustco/Kaulius GAAR cases, with spectacular victories, first in Univar Canada Ltd.[4] and more recently, Evans[5]  As Univar is of primary interest to international tax specialists, I will be brief: it primarily focused on trashing another anti-avoidance provision, subsection 95(6) which, among other things, indicates that, for the purpose of the foreign affiliate provisions, shares issued principally to reduce/avoid/defer tax can be ignored.  But for good measure the case also indicated that as far as GAAR was concerned, the transaction in question wasn’t even an avoidance transaction, let alone abusive. 

Evans will be of greater relevance to many readers.  It involved a dentist who sold shares of his professional corporation[6] to a partnership consisting of his wife and children, claiming the capital gains exemption on the sale.  A promissory note was given in return, which bore interest at the prescribed rate in effect at the time, so that the attribution rules did not apply to dividends paid on the shares now held by the partnership[7] (the interest was reported by the dentist and deducted by the partnership).  The partnership received dividends and redemptions to fund the interest and principal payments on the promissory note, with the partners (spouse/children) paying almost no tax on the dividends.  The result, of course, is that the dentist was able to remove a wad of dough from his company - with very little tax.  Not surprisingly, the CRA asserted that the series of transactions was a surplus strip and sought to tax the would-be note payments as dividends. 

Chief Justice Bowman held that none of the provisions relied upon in the scheme were abused[8] and, more remarkably, that the earlier GAAR cases[9] in the surplus-stripping area that went against taxpayers might have gone a different way, had only the courts had the benefit of the Canada Trustco/Kaulius decisions. 

While the tax planning in Evans would now be affected by the kiddie tax, otherwise, I see no reason why similar planning could not be done.  After all, the plan now has the blessing of the Chief Justice of the Tax Court of Canada. 

West Coast Offense

It seems that every time you turn around, there’s another Vancouver tax lawyer involved in a high-profile court battle.  In a move that took most tax advisors by surprise, the Supreme Court of Canada recently granted leave to appeal in the Strother case.  Very basically, Strother involves a tax lawyer who structured sophisticated film deals[10], and then “walked across the street” from a pre-existing client with new technology that was not disclosed to the old client.  This was after the previous methodology was plugged by the “matchable expenditure” rules, putting the old client out of showbiz (as it were).  Strother has been the subject of much discussion amongst tax advisors – or is “gossip” the better word?  If you ask me, one of the big reasons is that case discloses the huge amounts that a bright enterprising tax practitioner can rake in.  Alas, the British Columbia Court of Appeal[11] made Strother disgorge his profits – in excess of $30M.  The basic issues in the case are rooted in conflict of interest concepts.[12] Will Mr. Strother get his money back - or will the top court lay down Draconian rules forcing other enterprising legalists to chuck their law degrees?  I guess we’ll just have to wait and see.