Current Issues Forum: Pipeline Planning; Section 159 ... · Pipeline Planning; Section 159 Clearance ... property cannot be distributed until a clearance ... The three principal techniques

1

Current Issues Forum:

Pipeline Planning; Section 159 Clearance Certificates; Charitable Sector; and Non-Profit Organizations

Chris Falk Stefanie Morand1

INTRODUCTION

This paper addresses a number of legislative and administrative developments in the income tax area that are not addressed in detail in other sessions of the 2011 British Columbia Tax Conference. The paper is a companion piece to the paper on current issues presented at the conference by Amanjit Lidder.

The paper addresses four broad topics that are of current interest to income tax practitioners in light of proposed legislative changes or administrative or interpretative positions taken by the Canada Revenue Agency (the “CRA”).

In respect of the topics addressed, the authors note as follows:

Pipeline Planning

“Pipeline planning”, described below, has for many years been one of the basic tools employed by tax practitioners to relieve against double taxation where shares of a private corporation have been deemed by the provisions of the Income Tax Act (Canada) (the “Act”)2 to be disposed of for proceeds of disposition equal to their fair market value (“FMV”) upon the death of a taxpayer.

Such planning has generally been considered by planners to be non-controversial and consistent with the overall scheme of the Act. However, over the past couple of years, and more explicitly over the past year, the CRA has taken the position that very standard pipeline planning may give rise to a deemed dividend to the estate of the deceased taxpayer pursuant to the provisions of subsection 84(2). In the authors’ view, the CRA’s position is likely wrong as a matter of law.

The paper comments generally on the manner and the circumstances in which pipeline planning has typically been employed, outlines recent comments by the CRA in respect of pipeline planning, and comments on the CRA’s position in light of the provisions and the scheme of the Act.

Section 159 Clearance Certificates

Subsection 159(2) requires generally that a legal representative of a taxpayer obtain a certificate from the Minister of National Revenue (the “Minister”) certifying that taxes and other amounts payable by the taxpayer pursuant to the Act have been paid (or security provided therefore) before property is distributed by the legal representative.

1 The authors note that the views expressed in this paper are their own and do not necessarily represent the views

of McCarthy Tétrault LLP. 2 Except as otherwise noted, all section references are to the provisions of the Act and all monetary references are

to Canadian dollars.

Chris Falk Stefanie Morand McCarthy Tétrault LLP

2

Subsection 159(3) provides generally that a legal representative who fails to obtain a clearance certificate prior to distribution becomes personally liable to pay the taxpayer’s taxes and other amounts payable under the Act.

The provisions of subsections 159(2) and (3) and the position taken by the CRA that it will not normally issue a clearance certificate until the taxpayer’s final return has been assessed typically result in a “Catch 22” (i.e., property cannot be distributed until a clearance certificate has been issued but until all property has been distributed a final return of a taxpayer cannot be filed or assessed). Consequently, tax practitioners have come to rely extensively on administrative practice in respect of the requirements of section 159. However, there has been little discussion of the myriad of technical interpretations and other releases that have been published by the CRA regarding this and other issues relevant in respect of section 159 clearance certificates.

In addition, over the past year or so, the CRA has issued a number of noteworthy technical interpretations and the Tax Court of Canada has dealt with an assessment issued under subsection 159(3) that might suggest that the CRA is becoming more aggressive in seeking to impose personal liability on a taxpayer’s legal representatives.

This paper comments upon the requirements of subsections 159(2) and (3), and upon many of the administrative positions, including recent ones, taken by the CRA.

Charitable Sector

The 2010 federal budget contained very important measures affecting the charitable sector, which measures were principally relieving in nature and which, generally, greatly simplified the disbursement requirements applicable to registered charities.

The 2011 federal budget also focussed on the charitable sector with a host of proposed new provisions. Unlike the 2010 changes, however, the 2011 proposals seek generally to tighten the rules applicable to registered charities and similar entities able to issue official donation receipts (collectively referred to as “qualified donees”).

This paper comments upon the various proposals from the 2011 federal budget applicable to qualified donees.

Non-Profit Organizations

The Act contains a very broad and simple exemption from income tax for a range of clubs, societies and associations described in paragraph 149(1)(l) and commonly referred to by practitioners as non-profit organizations (“NPOs”).

Over the past couple of years, the CRA has issued a number of technical interpretations and other publications as to the activities that may cause an NPO to lose its tax exempt status. Many in the tax community believe that these CRA publications are much more restrictive than the relevant jurisprudence.

Over the past year, the CRA has issued a number of additional publications in respect of this issue. These more recent publications may represent a subtle shift or refinement in the CRA’s views as to the activities that an NPO can undertake. These recent publications, in any case, help to clarify the CRA’s position in respect of this issue.


3

The paper comments on the requirements in the Act applicable to NPOs and the CRA’s position on this issue, with particular focus on the CRA’s most recent publications.

PIPELINE PLANNING

Background – Post-Mortem Tax Planning

Various post-mortem tax planning techniques have been developed and refined over the years to relieve against double taxation that can arise under the Act as a result of the deemed disposition on death.

In a situation in which an individual dies owning shares of a private corporation,3 the shares (as well as other properties owned by the deceased) are generally deemed to be disposed of by the deceased immediately prior to death at their then FMV (in the absence of a rollover to a spouse or spouse trust).4 Accordingly, where the FMV exceeded the adjusted cost base (“ACB”)5 to the deceased, a capital gain will be realized in the deceased’s terminal year.

As a consequence of the deemed disposition at FMV, where the shares of the private corporation are acquired by a person (e.g., the deceased’s estate6), that person is deemed to acquire the shares at a cost equal to the FMV immediately before death. However, this deemed disposition does not vary the ACB of the assets owned by the corporation itself or permit assets to be distributed from the corporation to its shareholders without additional shareholder level tax. Accordingly, in the absence of tax planning, the same economic gain that was taxed in the hands of the deceased can be taxed again in the hands of the corporation (and its shareholders) when its assets are ultimately disposed of (and the net proceeds distributed to shareholders), giving rise to economic double taxation.

The three principal techniques for relieving against this form of double taxation are:

Capital loss carryback planning, using the provisions of subsection 164(6) to create a loss in the deceased’s estate within the estate’s first taxation year, which capital loss the Act permits to be used to offset the capital gain arising on death;

“Bump” planning, using the provisions of paragraphs 88(1)(c) and (d) on a winding up into a new corporation that acquires all of the shares of the corporation the shares of which were owned by the deceased taxpayer (and which have a high ACB to the estate), to increase the ACB of non-depreciable capital property owned by the corporation; and

“Pipeline planning”, in which a new corporation is used to create a so-called “pipeline” of debt or high paid-up capital shares that allows assets to be distributed to the estate or beneficiaries of the estate without additional tax payable by the recipient.

3 These comments assume that, as would normally be the case, such shares were capital property of the

deceased taxpayer for purposes of the Act. Subsection 248(1) and section 54 define what constitutes a taxpayer’s “capital property”.

4 Subsection 70(5) provides for the deemed disposition of capital property at FMV; subsection 70(6) generally provides for a rollover to a spouse or spouse trust. The rollovers in section 70 for family farming corporations and family fishing corporations transferred to children of a deceased are ignored.

5 Subsection 248(1) and section 54. 6 More precisely, the deceased’s executor or executrix in his or her capacity as executor or executrix.


4

These techniques are sometimes used independently but often combined with a view to optimizing the after-tax result.

How and When a Pipeline is Used

Capital loss carryback planning typically involves the winding-up of the corporation owned by the estate, or a redemption (or purchase for cancellation) of its shares owned by the estate, within the first taxation year of the estate. In effect, pursuant to the provisions of subsection 164(6), the capital gain realized on the deceased’s death can be offset wholly or in part by a capital loss triggered in the estate’s first taxation year on the winding-up or share redemption, and deemed dividends are received by the estate. While the winding-up or redemption of shares may trigger corporate level tax on the disposition of assets, and deemed dividends to the shareholders, where such dividends can be paid on a tax-efficient basis (e.g., paying capital dividends out of the corporation’s capital dividend account or paying dividends that give rise to a dividend refund to the corporation), capital loss carryback planning is frequently beneficial.7

However, if dividends cannot be paid on shares of a private corporation on a tax-efficient basis, a pipeline strategy may be more effective, particularly if the corporation in question has cash or other assets with nominal gains associated with them (or where a “bump” can be used to increase the ACB of non-depreciable capital assets). Pipelines may be particularly attractive in British Columbia where there is a very substantial difference between the highest marginal rate applicable to an individual on capital gains (i.e., 21.85%, given the 50% inclusion rate on capital gains and the top marginal rate of 43.7%) and on dividends that are not eligible dividends (i.e., 33.71%).8, 9

Pipeline planning can be illustrated using the following simple example:10

Mr. X dies owning all of the shares of a private corporation, XCo;

The shares of XCo were held by Mr. X as capital property for purposes of the Act and had an ACB to Mr. X of $100,000 and an FMV immediately prior to Mr. X’s death of $1,000,000. Accordingly, the deemed disposition of the XCo shares would give rise to a $900,000 capital gain in Mr. X’s terminal year (assuming no rollover to Mr. X’s spouse or to a spouse trust);

To create a “pipeline”, Mr. X’s estate would incorporate a new corporation, Holdco, for nominal consideration. The estate would sell the shares of XCo to Holdco for $1,000,000 (assuming no accrued gain or loss in the estate since Mr. X’s death).11 The

7 While outside the scope of these comments, it is noted that capital loss planning involves complying with a

significant number of stop-loss and other technical rules. 8 The highest marginal rate on eligible dividends is 23.91% in BC for 2011. 9 Private corporations that are or were formerly carrying on business and that have significant retained earnings

(that did not give rise to capital dividends or to refundable tax) are often corporations in respect of which pipeline planning can be attractive.

10 XCo and Holdco, referred to below, are assumed to be taxable Canadian corporations (subsections 248(1) and 89(1)).

11 A section 85 rollover could, of course, be used if there were an accrued gain in the hands of the estate.


5

sale proceeds payable by Holdco would be a non-interest bearing demand promissory note payable by Holdco in the amount of $1,000,000;12

XCo would be wound-up into Holdco on a tax-deferred basis;13

Holdco would use cash on hand (or other assets with only nominal gains) to repay all or part of the promissory note held by the estate.

But for recent comments from the CRA suggesting that such a transaction might trigger a deemed dividend to the estate, tax practitioners had generally understood that the estate would receive proceeds on the promissory note on a tax-free basis given that the promissory note would have an ACB to the estate equal to its face amount.

CRA’s Position Regarding Pipelines

Concern that the CRA might take the position that a basic pipeline such as that described above could give rise to a deemed dividend to the estate pursuant to subsection 84(2) was raised in a CRA Round Table at the 2009 APFF Conference.14 In the round table, the CRA did not take the position that subsection 84(2) applied in the example considered but, rather, declined to comment on the possible application of subsection 84(2) in the absence of more detailed facts than had been provided.

The example considered in the round table assumed that a taxpayer, immediately prior to death, owned all of the shares of a taxable Canadian corporation, ACo, which had an FMV of $100,000 and an ACB of $100. ACo was assumed to have cash of $100,000, no liabilities, $100 in capital stock and $99,900 in retained earnings.

Given the lower rates applicable to capital gains, it was proposed to use a pipeline in which the shares of ACo would be sold to a new taxable Canadian corporation, BCo, incorporated by the estate, for a non-interest bearing demand note in the amount of $100,000, following which ACo would be wound up into BCo, which would then repay the $100,000 note payable to the estate after which BCo would be dissolved.

The pipeline transactions were intended to result in the estate acquiring the $100,000 subject only to tax on the capital gain on the ACo shares in the hands of the deceased taxpayer, as opposed to the estate receiving and being taxable upon a $99,900 deemed dividend if capital loss carryback planning had instead been undertaken pursuant to a simple winding up of ACo into the estate pursuant to subsection 88(2).15

12 This example assumes that the $1,000,000 ACB to the estate is “hard ACB” for purposes of section 84.1 (i.e.,

generally ACB not derived from pre-1972 gains or through the use of the capital gains exemption (subsection 84.1(2))). Instead of a promissory note, Holdco could issue redeemable, retractable preferred shares with a redemption amount and stated capital of $1,000,000.

13 Alternatively, instead of a tax-deferred winding-up undertaken pursuant to subsection 88(1), an amalgamation (e.g., a short-form vertical amalgamation) under section 87 could be undertaken.

14 CRA Document No. 2009-032691C6, dated October 9, 2009. 15 Simplified, if ACo were wound up into the estate, assuming that the shares of ACo had a paid-up capital for

purposes of the Act of $100, subsection 84(3) would deem the estate to have received a dividend of $99,900 (i.e., the $100,000 paid less the $100 paid-up capital). This deemed dividend would be excluded from the estate’s proceeds of disposition pursuant to the provisions of section 54 and, accordingly, the estate would have a capital loss of $99,900 given its $100,000 ACB. Provided that this capital loss was triggered in the estate’s first


6

In declining to comment on the possible application of subsection 84(2) in this example, the CRA noted that the provision requires that funds or property of a particular corporation must have been distributed or otherwise appropriated, in any manner whatever to or for the benefit of the shareholders on the winding-up, discontinuance or reorganization of the business of the particular corporation (i.e., ACo) (in which case a deemed dividend would result to the extent that the redemption proceeds exceeded the paid-up capital of the shares).

The CRA noted that while it had ruled favourable previously in prior advance rulings on the non-application of subsection 84(2) (in addition to ruling favourably on section 84.1 and the general anti-avoidance rule in subsection 245(2) (“GAAR”)),16 in the ruling applications referred to the proposed transactions indicated that:

the corporation in question (e.g., the equivalent of ACo in the example set out above in the paper) would remain a separate and distinct entity for at least one year (i.e., that it would not be wound up into or amalgamated with another corporation);

during this period, the corporation would continue to carry on its business in the same manner as before; and

only thereafter would the note be repaid, on a progressive basis.

The CRA indicated that in these circumstances it was reasonable to conclude that the conditions for the application of subsection 84(2) had not all been satisfied.

While the CRA declined to comment on the application of subsection 84(2) in the example considered, from the perspective of tax planners, perhaps somewhat hopefully the CRA noted that the three conditions summarized above that had been referred to in the favourable rulings were facts submitted by the taxpayers in question and could not be considered CRA requirements.17

While the CRA’s position remained uncertain following this round table discussion, the discussion placed tax practitioners on notice that the CRA might take the position that subsection 84(2) could give rise to a deemed dividend in a pretty typical pipeline plan. The CRA, however, continued to issue favourable rulings in circumstances in which the proposed transactions were generally similar to those that it had previously ruled favourably on.18

More importantly, in a withdrawn ruling request in respect of a proposed post-mortem pipeline plan involving a holdco that was inactive and owned only liquid assets (which assets were possibly only cash), the CRA took the position that the holdco’s surplus would be subject to

taxation year, subsection 164(6) would generally permit the executor or executrix to elect to have the capital loss treated as a capital loss of the deceased in his or her terminal year rather than a capital loss of the estate. This capital loss could then be used to offset the capital gain arising in the deceased’s terminal year by reason of the deemed disposition on death.

16 CRA Document Nos. 2002-0154223, dated November 13, 2002, and 2005-0142111R3, dated November 2, 2005.

17 The CRA had previously explained these rulings in a similar manner in a technical interpretation (CRA Document No. 2006-0170641E5, dated June 29, 2006).

18 See, for example, CRA Document Nos. 2010-0377601R3, from 2010, and 2010-0388591R3, from 2011.


7

dividend treatment in the hands of the estate (although the CRA noted that capital loss carryback planning could be undertaken to avoid double taxation).19

The CRA revisited this issue at the CRA Round Table at the 2010 Canadian Tax Foundation’s Annual Conference. While the PowerPoint questions and responses distributed by the CRA were not definitive, in the discussions the CRA seemed to suggest that subsection 84(2) would be applied to a post-mortem pipeline of a corporation that held all cash.

Provisions and Scheme of the Act Relevant to Pipelines

In considering whether a deemed dividend may arise on a pipeline transaction in the example set out above, the relevant provisions to consider, in addition to GAAR, are subsection 84(2), section 84.1 and paragraph 88(1)(d.1).

Simplified, subsection 84(2) provides for a deemed dividend on the winding up of a corporation in an amount equal to the FMV of the funds or property distributed to or for the benefit of the shareholders less the amount of the paid-up capital in respect of the shares in circumstances in which:

…funds or property of a corporation resident in Canada have … been distributed or appropriated in any manner whatever to or for the benefit of the shareholders of any class … on the winding-up, discontinuance of reorganization of its business…

Section 84.1 is also relevant in respect of the pipeline transaction contemplated in the pipeline example set out above. Section 84.1 applies in respect of surplus stripping transactions involving the transfer of shares of one corporation to another in circumstances in which the FMV of non-share consideration and the increase in the paid-up capital of the shares of the purchaser corporation exceed the greater of the ACB (as adjusted for purposes of section 84.1 (the ACB as so adjusted, the “Hard ACB”)) and the paid-up capital of the shares of the transferee corporation transferred to the purchaser corporation.

Accordingly, the language and clear policy of section 84.1 permit such transactions, provided that the aggregate of the FMV of non-share consideration and of the increase in paid-up capital of the shares of the purchaser corporation does not exceed the Hard ACB of the shares of the transferee corporation. For purposes of section 84.1, ACB is generally reduced in respect of both pre-1972 gains and capital gains exemptions claimed on the share (or a share for which the share was substituted) of the taxpayer or a person with whom the taxpayer did not deal at arm’s length. Accordingly, in the pipeline transaction contemplated in the example, provided that pre-1972 gains and capital gains exemption claims are not in issue, section 84.1 would appear to be intended to permit the form of surplus stripping contemplated (where the estate has “Hard ACB” by reason of the deemed disposition on death).

Subsection 88(1) governs the winding-up of XCo into Holdco in the example contemplated. On such a wind-up, paragraph 88(1)(d.1) provides that subsection 84(2) does “not apply to the winding-up of the subsidiary”.

In light of the above provisions, the CRA’s position that subsection 84(2) may apply in respect of a basic pipeline appears to be doubtful in the example contemplated for the following reasons:

19 CRA Document No. 2010-0389551R3, from 2010.


8

Subsection 84(2) is expressly made inapplicable to the winding-up of XCo into Holdco by reason of paragraph 88(1)(d.1).

On its face subsection 84(2) applies to distributions or appropriations “to or for the benefit of the shareholders … on the winding-up” of XCo. On the winding-up of XCo, its sole shareholder is Holdco (and subsection 84(2) would not apply to deem there to be a dividend triggered on the winding-up of Holdco into the estate to the extent that $100,000 is paid on the note rather than on the Holdco shares).20

The provisions of section 84.1, governing transactions of the type contemplated in the pipeline planning, permit the extraction of “Hard ACB” such as that of the estate.

Where the Act has deemed there to be a disposition at FMV by reason of a taxpayer’s death, particularly given the provisions of section 84.1, in our view, at least in the ordinary course, the estate should not be regarded as an “accommodation party” that has been inappropriately used to extract corporate assets, such that GAAR should not normally be engaged.

Further, subsection 84(2) can apply only where assets have been distributed or appropriated “on the winding-up, discontinuance or reorganization of … [XCo’s] business”. Accordingly, where XCo is not carrying on a business (and, if it was formerly carrying on a business, where the distribution does not occur on the winding-up, discontinuance or reorganization of that business), subsection 84(2) should not apply in any case.21

In suggesting that subsection 84(2) may be engaged in a typical pipeline transaction, the authors respectfully suggest that the CRA may in effect be seeking to tax an estate based upon a transaction that the estate might have undertaken rather than the transaction actually undertaken. Clearly subsection 84(2) should not apply to deem the estate to have received a dividend in the example set out and, it is suggested, GAAR should also generally not be engaged in light of the provisions of section 84.1 and the circumstances in which the estate acquired its Hard ACB.

Practical Advice Regarding Pipelines in Light of CRA’s Position

While the authors are of the view that in the normal course the CRA’s position is not well-founded that subsection 84(2) may apply to deem the estate to have received a deemed dividend in a typical pipeline transaction, they note as follows:

As far as the authors are aware, at least thus far CRA has not generally sought to take this position in dealing with a corporation that owns assets other than cash or near-cash.

20 It is acknowledged that some jurisprudence has taken a broad view of this aspect of subsection 84(2) (see, for

example, RMM Canadian Enterprises Inc. et al v. The Queen, 97 DTC 302 (TCC), but see also Collins & Aikman Products Co. et al v. The Queen, 2009 DTC 1179 (TCC), affirmed 2010 DTC 5164 (FCA)).

21 Some commentators have also suggested that even if the CRA were correct that subsection 84(2) could otherwise apply on a pipeline, as the deemed dividend would be inconsistent with the treatment accorded by section 84.1, the more specific wording of section 84.1 should govern. See, for example, Manu Kakkar and Nick Moraitis, “Post Mortem Planning: Does the “Pipeline” Work?” (2011) vol. 11, no. 1 Tax for the Owner Manager, 6-7, and Stuart Bellefer, CCH Estate Planner Newsletter 199, August 2011, “Summary of the CRA Round Table Held at the 13th National STEP Canada Conference”, 4-6.


9

In many cases, where the deceased did not wholly-own the corporation (e.g., where a prior estate freeze had been undertaken), it may be possible to implement a pipeline without it being necessary to wind up, discontinue or reorganize any business carried on by the corporation.

To avoid the audit risk, where viable in implementing a pipeline, it is preferable to fall within the circumstances in which the CRA has previously ruled favourably (e.g., keeping the corporation in existence as a separate entity for at least a year and having it continue its business, and only thereafter repaying the promissory note progressively over time). However, even where this is not viable, it is suggested that it will often be helpful for planners to structure pipeline transactions such that they include a subsection 88(1) wind-up so that subsection 84(2) is expressly stated not to apply on the wind-up.22 Recent commentary suggests that in appropriate cases it may be helpful to complete the transactions within the estate’s first taxation year so that subsection 164(6) capital loss carryback planning may be available as a “fallback” option.23

SECTION 159 CLEARANCE CERTIFICATES

Rationale for Clearance Certificate Discussion

Based upon the authors’ recent experience, there appears to be some uncertainty in the tax community as to the requirements of section 159, including what may constitute a distribution for purposes of the clearance certificate requirements, the circumstances in which liability may result and the protections afforded where a clearance certificate has been obtained.

This uncertainty, combined with both the virtual impossibility referred to previously of complying with subsection 159(2) given the CRA’s position that it will not normally issue a clearance certificate until after a taxpayer’s final return has been filed and assessed,24 and the tax community’s consequential reliance on administrative practice, suggests that a review of the clearance certificate provisions in section 159 and of the CRA’s administrative positions in respect of those provisions should be useful. This is particularly the case given that recent jurisprudence and a recent technical interpretation, discussed below, may suggest that the CRA may be quite aggressive in seeking to impose personal liability against legal representatives under subsection 159(3). Further, while it is unclear, another recent technical interpretation may suggest that the CRA believes that it can assess a legal representative under subsection 159(3) even where the underlying taxpayer’s taxation year is statute-barred.

22 Paragraph 88(1)(d.1). In this case, the issue should then focus on GAAR; whether there has been a misuse or

abuse for purposes of section 245 notwithstanding: (i) the deemed disposition on death; (ii) the provisions of section 84.1; and (iii) that the estate should not normally be regarded as an “accommodation party” in facilitating a surplus strip.

23 Stuart Bellefer, CCH Estate Planner Newsletter 199, August 2011, “Summary of the CRA Round Table Held at the 13th National STEP Canada Conference”, 4-6 (which notes that it would generally be necessary to late-file the subsection 164(6) designation, which would require that a fairness request be brought by the taxpayer pursuant to subsection 220(3.2) and Income Tax Regulation 600(b)).

24 See above under the heading Introduction – Section 159 Clearance Certificates.


10

Section 159 Overview

Pursuant to subsection 159(1), a taxpayer’s “legal representative” is made jointly and severally liable with the taxpayer to pay amounts payable by the taxpayer under the Act to the extent that the legal representative had possession or control of the taxpayer’s property.

A “legal representative” is defined broadly as:

…a trustee in bankruptcy, an assignee, a liquidator, a curator, a receiver of any kind, a trustee, an heir, an administrator, an executor, a liquidator of a succession, a committee, or any other like person, administering, winding up, controlling or otherwise dealing in a representative or fiduciary capacity with the property that belongs or belonged to, or that is or was held for the benefit of, the taxpayer or the taxpayer's estate.25

Subsection 159(2) provides that a taxpayer’s legal representative (other than a trustee in bankruptcy) is required, before distributing property in his or her possession or control as legal representative, to obtain from the Minister a certificate certifying generally that all amounts for which the taxpayer is liable under the Act, or can reasonably be expected to become liable, have been paid (or security provided therefore).26

Where a legal representative (other than a trustee in bankruptcy) distributes property in his or her possession or control without obtaining a clearance certificate, subsection 159(3) makes the legal representative personally liable for the payment of all amounts referred to in subsection 159(2) up to the value of the property distributed. Subsection 159(3) also empowers the Minister to assess the legal representative “at any time” in respect of an amount payable pursuant to subsection 159(3).27

Section 159 – What’s New?

Possible Assessment of Statute-Barred Years

As noted previously, a recent technical interpretation issued by the CRA, although its meaning is somewhat unclear, may suggest that the CRA believes that it can assess a legal representative under subsection 159(3) even where the underlying taxpayer’s taxation year is statute-barred.28 This technical interpretation has caused concern amongst tax practitioners as it appears to be internally inconsistent and may be contrary to long-standing jurisprudence and prior CRA interpretations.

Although the summary of the interpretation states that an assessment under subsection 159(3) would not enable the Minister to reassess a statute-barred year, the reasons that are summarized and the body of the interpretation appear to suggest a contrary response.

25 Subsection 248(1). 26 Subsection 159(3.1) provides generally that an appropriation by a legal representative of property in the

possession or control of the legal representative in that capacity is deemed to be a distribution for purposes of subsections 159(2) and (3).

27 While confirmation would not seem to be required, in CRA Document No. 9929917, dated November 23, 1999, the CRA confirmed that a trustee in bankruptcy was not subject to subsection 159(2) and (3). The CRA also indicated that it would not issue a clearance certificate to a trustee in bankruptcy on the basis that it would serve no purpose, a position that the CRA also takes in its CRA Audit Manual, Chapter 16.

28 CRA Document No. 2011-0394731E5, dated May 26, 2011.


11

In this regard, the reasons and the body of the technical interpretation state as follows:

Reasons:

The purpose of an assessment under subsection 159(3) is to enable collection of an amount owed by an estate. Furthermore, the legal representative is a person separate from the estate and an assessment under subsection 159(3) is not tied to the normal reassessment for assessing an estate.

Body of Technical Interpretation:

This is in reply to your inquiry as to whether the liability under subsection 159(3) … would enable the Minister to reassess a statute-barred taxation year of the estate of a deceased taxpayer.

The Minister may, pursuant to subsection 159(3), assess a legal representative at any time. The purpose of such an assessment is to facilitate collection of an amount owed by an estate, when a legal representative distributes property under his or her control without first obtaining a clearance certificate or posting acceptable security.

The legal representative is a separate person from the estate and the timing of an assessment under subsection 159(3) is not tied to the normal reassessment period for assessing an estate. Moreover, neither subsection 152(4) nor the normal reassessment period defined in subsection 152(3.1) applies to an initial assessment under subsection 159(3).

As noted above, subsection 159(3) does permit an assessment to be issued against a taxpayer’s legal representative “at any time”. Accordingly, the comments made by the CRA in the reasons and the body of the Technical Interpretation, read in isolation, may well be accurate. However, in response to the question of whether subsection 159(3) would enable the Minister to reassess a statute-barred year of the underlying estate, the comments appear to be superfluous unless they are meant to suggest that the Minister could thereby reassess in respect of the estate’s statute-barred year.

If the response is intended to take this position:

The result would appear to be counterintuitive given that the liability under subsection 159(3) is solely derivative. Although the Act provides that a taxpayer’s liability is not affected by the fact that no assessment has been made,29 if the Minister is statutorily precluded from assessing the underlying taxpayer it is suggested that much clearer language would be required to permit a third-party such as a taxpayer’s legal representative to be assessed in respect of that same liability. In this regard, it is submitted that the better reading of the “at any time” language of subsection 159(3) is to permit an assessment of a legal representative in respect of a taxpayer’s liability, even if the taxpayer could no longer be assessed, provided that the underlying liability is not at that time statute-barred (e.g., where the underlying taxpayer had been assessed within the time limited by the Act or where that time had not then expired).

29 Subsection 152(3).


12

As discussed below,30 the CRA has previously agreed that subsection 159(3) could not be used to assess a legal representative where the underlying taxpayer’s taxation year was statute-barred. This conclusion has also been reached in relevant jurisprudence.31

Further, as is also discussed below, in an even more recent technical interpretation, the CRA seems to accept that an assessment of a legal representative, where the underlying taxpayer had not been assessed (and had been dissolved), must be made within the limitation period applicable in respect of the underlying taxpayer.32

Inability to Retain and Pay Professional Advisor Without Risking Subsection 159(3) Assessment

Another recent technical interpretation represents a particularly harsh and perhaps surprising interpretation of the requirements of subsections 159(2) and (3).33

The interpretation related to a deceased taxpayer who had failed to file tax returns in the years prior to his death. Following the taxpayer’s death, very substantial assessments were raised which gave rise to a liability substantially in excess of the estate’s assets. The deceased’s father, who was the legal representative of the deceased, disagreed with the amount of the assessments and wished to use the estate assets to retain the services of an accountant to prepare the tax returns that the deceased had not filed.

In respect of this matter, the CRA stated as follows:

…an estate is first required to pay any tax liability before assets can be distributed. However, allowance can be made for the payment of reasonable funeral, testamentary, and administration costs.

The size of the tax liability, the extent of assets in the estate, and the disinclination of the deceased to comply with the Act, are factors, which are not conducive to agreement to allow estate assets to be used to dispute the assessments. At the very least the decision to dispute the assessments should be made objectively, which rules out anyone who stands to profit or gain from the outcome. Accordingly, the estate has three options: the estate could make an assignment into bankruptcy;34 the administrator could personally fund the services of an accountant; or the administrator could use estate assets to fund services of an accountant, but would do so at the risk of being held liable under subsection 159(3). Needless to say, there are pros and cons associated with each of the options. …

…should the administrator decide to pay for the services of an accountant out of the assets of the estate without first obtaining a clearance certificate, he would be at risk of being assessed under subsection 159(3).

30 See below under the heading Failure to Obtain a Clearance Certificate – Personal Liability of Legal

Representative, “Where Underlying Liability Statute-Barred”. 31 The Queen v. Wesbrook Management Ltd., 96 DTC 6590 (FCA). 32 CRA Document No. 2011-0399191I7, dated August 10, 2011. 33 CRA Document No. 2010-0390311E5, dated March 14, 2011. 34 In respect of the bankruptcy option, which can of course be quite expensive, it is noted that subsections 159(2)

and (3) do not apply to a trustee in bankruptcy.


13

The position taken by the CRA presupposes, consistent with a long-standing position of the CRA, that distributions for purposes of subsection 159(2) include payments made to creditors, a position that is commented upon below.35

Interestingly, and more positively, the interpretation goes on to confirm that should the father ultimately be assessed as legal representative:

It would be open to the administrator to challenge the underlying assessment, see Abrametz v. The Queen, [2009] G.S.T.C. 43, 2009 GTC 2013 (F.C.A.); and Gaucher v. The Queen, [2001] 1 C.T.C. 125, 2000 DTC 6678 (F.C.A.). (italics added)

The authors suggest this is the better interpretation (i.e., that the legal representative under subsection 159(3) can challenge the underlying assessment where it was challenged not by or on behalf of the taxpayer). However, this issue has been considered not to be fully resolved in the case of subsection 159(3) where the legal representative may have had the ability, albeit qua legal representative, to challenge the initial assessment.36 Accordingly, this confirmation from the CRA is welcome.

CRA Assessing Under Subsection 159(3) Where Funds Deposited in Estate Account Inadvertently

A recent decision of the Tax Court of Canada, Nguyen et al v. The Queen,37 may serve to illustrate how aggressively the CRA may seek to impose personal liability on a taxpayer’s legal representatives where clearance certificates were not obtained.

In this case, Mr. Hien Vohoang had died unexpectedly in 1993, leaving a wife and three children. Mr. Vohoang died intestate and with an estate that was in a very substantial deficit, including in respect of income taxes. The assets of the estate had been seized by creditors.

Mr. Vohoang had held some life insurance policies, however, in which his wife and/or three children were the designated beneficiaries (such that the proceeds from the policies would not flow through the estate, where they would have become available to creditors including the CRA).

Through inadvertence, some of the insurance proceeds were deposited into an estate bank account. The funds were ultimately paid out to Mr. Vohoang’s widow, Ms. Nguyen, and the three children. Virtually ten years later, in 2003, the Minister assessed Ms. Nguyen and the oldest of the three children on the basis that they were legal representatives who were personally liable in respect of payment from the estate as they had failed to comply with subsection 159(2). The Minister also issued assessments under section 160.

Based upon these facts, Angers J. concluded that the insurance proceeds that had been deposited into the estate bank account had never formed part of the estate. Accordingly, Angers J. found in favour of the taxpayers and allowed the appeal.

35 See below under the heading Whether a Particular Transfer is a Distribution?, “Payment to Unsecured

Creditors”. 36 This issue is commented upon below under the heading Failure to Obtain a Clearance Certificate – Personal

Liability of Legal Representative, “Ability to Challenge Underlying Liability”. 37 Nguyen v. The Queen, 2011 DTC 1059 (TCC).


14

It is possible that the Minister may have assessed under subsection 159(3) given uncertainty as to the facts. However, the case does illustrate how broadly the CRA may seek to apply the personal liability provision. The fact that the assessment under subsection 159(3) occurred so long after the relevant events also illustrates the dangers that a legal representative may face under subsection 159(3) given that the Minister is authorized to assess “at any time”.

Subsection 159(2) Mandatory – Additional Potential Exposure to Legal Representatives

The provisions of subsection 159(2) are mandatory. Accordingly, the failure of a legal representative to obtain a clearance certificate prior to making a distribution would expose the legal representative not only to personal liability pursuant to subsection 159(3) but could result in the legal representative being subject to penalties under paragraph 162(7)(b) and, in particularly egregious cases, possible charges of wilfully evading compliance with the Act.38

Accordingly, while the CRA confirmed many years ago that it would not normally consider proceeding under paragraphs 162(7)(b) or 239(1)(d) in respect of the failure of a legal representative to comply with subsection 159(2),39 this additional potential exposure illustrates how critical it is for a legal representative to take into account his or her obligations under section 159 prior to making distributions.40

Whether a Particular Transfer is a Distribution?

The clearance certificate requirements in subsection 159(2) and the personal liability provisions of subsection 159(3) will not be engaged unless the taxpayer’s legal representative makes a distribution. Subsection 159(3.1) generally deems an appropriation by a taxpayer’s legal representative of property in the possession or control of the legal representative acting in that capacity to be a distribution. Apart from that narrow deeming provision, the Act does not specify what constitutes a distribution for purposes of subsections 159(2) and (3).

Given that there is little relevant jurisprudence on this issue, the CRA’s various comments as to what it considers to constitute a distribution for purposes of section 159 are of considerable interest. In this regard:

Payment to Secured Creditors

The CRA has long accepted that, at least administratively, payment by a taxpayer’s legal representative to a secured creditor in payment of a properly secured debt is not a distribution to which the provisions of subsections 159(2) and (3) apply.

In this regard, the CRA has stated as follows:

38 Paragraph 239(1)(d). 39 CRA Document No. October 1971-74, dated October 1991. 40 The CRA confirms in Information Circular 82-6R8, “Clearance Certificates” its view that a legal representative

does not need to obtain a clearance certificate before each distribution so long as he or she keeps enough property to pay any liability due to the CRA (para. 2). This position does provide some administrative comfort in respect of possible exposure under paragraphs 162(7)(b) or 239(1)(d). However, it is generally of no assistance in respect of personal liability of the legal representative if it turns out that sufficient property was not retained (e.g., if there is a shortfall due to an unanticipated reassessment).


15

The Department’s administrative position … is that where a responsible representative (as described in subsection 159(2)) turns over the proceeds of realization to a secured creditor subject to a valid security instrument such payment is not considered to be a distribution for the purposes of subsection 159(2). … the sale or other disposal of a specific property to satisfy a debt secured by that property is also not considered a distribution.41

The CRA has explained this position by stating as follows:

Our policy of not considering payments to secured creditors (as long as the payment does not exceed the amount of the secured debt) as distributions under subsection 159(2) is based on the rationale that it would be unreasonable to insist on a clearance certificate before distribution of funds on which Revenue Canada would not have an enforceable claim.42

Payment to Unsecured Creditors

It has been the CRA’s long-standing position that the payment to an unsecured creditor by a taxpayer’s legal representative represents a distribution to which subsections 159(2) and (3) are applicable.

For example, in a technical interpretation, the CRA, after confirming that administratively the CRA considers that payments to secured creditors are not treated as distributions under subsection 159(2), states that:

In the event that distributions to secured creditors involved assets that are not subject to a valid security instrument (i.e., post-receivership operating profits not subject to a “floating charge”), we agree that subsection 159(2) should apply.43

Further, in the very recent technical interpretation discussed above, the CRA takes the position very clearly that payments to unsecured creditors constitute distributions under subsection 159(2), stating that an administrator might be assessed under subsection 159(3) if an accountant were retained and paid from assets of the estate to prepare tax returns of the deceased with a view to challenging assessments issued by the CRA.44 The CRA does state in this technical interpretation, however, that at least in the context of an estate, “allowance can be made for the payment of reasonable funeral, testamentary, and administration costs.”

41 CRA Document No. rrrr293, dated May 18, 1990. 42 CRA Document No. ACC9203, dated March 28, 1990. While less explicit, the CRA’s comments in CRA

Document No. 2009-0336911E5, dated January 29, 2010, appear consistent with this position. Further, relatively recent informal discussions between the authors and the CRA’s Rulings Directorate suggest that the CRA continues to maintain this position in respect of secured debt.

43 CRA Document No. ACC9203, dated March 28, 1990. See also CRA Document No. 7-4410, dated October 25, 1989, in which the CRA indicated that a subsection 159(2) distribution would seem to entail a pro rata distribution to one or more creditors. In CRA Document No. November 1990-280, dated November 1990, however, the CRA agreed that payments on account of a debt would not be considered distributions for purposes of subsections 159(2) and (3).

44 CRA Document No. 2010-0390311E5, dated March 14, 2011; see the discussion of this interpretation, above, under the heading, Section 159 – What’s New, “Inability to Retain and Pay Professional Advisor Without Risking Subsection 159(3) Assessment”. See also CRA Document No. 2009-0336911E5, dated January 29, 2010.


16

Whether a payment constitutes a distribution would typically depend upon the context in which the term is used. In the context of subsections 159(2) and (3), although more detailed consideration would be required, in the view of the authors it is not self-evident that the CRA is correct that a distribution necessarily includes payment of a liability owed to a creditor.45 For example, in dealing with a voluntary dissolution or winding up of a corporation, both the Business Corporations Act (British Columbia) (the “BCBCA”) and the Canada Business Corporations Act (the “CBCA”) generally contemplate that the corporation will pay, satisfy or compromise, and discharge or make provision for its liabilities and, thereafter make distributions to its shareholders.46

Accordingly, practitioners may wish to revisit this issue in dealing with assessments issued under subsection 159(3) in respect of payments to creditors. However, from a planning perspective, in light of the position taken by the CRA, a taxpayer’s legal representatives need to be careful in paying even unsecured arm’s length creditors of a taxpayer where there may ultimately be an inability to pay the taxpayer’s income taxes owing.

Payment of Income to Trust Beneficiaries

The CRA has confirmed that payments of the income from a trust or estate to a beneficiary are not considered to be distributions, such that a clearance certificate is not required.47

Transfer to a Replacement Executor or Trustee

The CRA has confirmed that the transfer of estate property from an executor to a replacement executor does not result in a distribution.48

Distribution by a Legal Representative

Corporate Director

Given that the definition of “legal representative”49 does not include a corporate director, it has long been debated whether or not a director may nonetheless be included as an “other like person” in the context of a winding-up.

The CRA takes the position that a director is a legal representative on the voluntary dissolution of a corporation where there is no formally appointed liquidator and where the relevant responsibilities are assumed by the director. In this regard, the CRA states as follows:

45 In this regard, the authors note that there is jurisprudence suggesting that the clearance certificate provisions

should be construed strictly given that the provisions are penal in nature (Taylor v. MNR, 86 DTC 1232 (TCC) and MNR v. Parsons, 83 DTC 5329 (FCTD)).

46 See, for example, sections 210 and 211 of the CBCA and sections 325, 330 and 336 of the BCBCA (although there is at least one reference, in section 330(h) of the BCBCA, to monies held by a liquidator required for “distribution” to creditors and shareholders, thus illustrating, in the view of the authors, that the term can derive its meaning partly from its context).

47 Information Circular 82-6R8, Clearance Certificates, December 10, 2010, para. 15, and CRA Audit Manual, Chapter 16.

48 CRA Document No. 9715633, dated 1997. An advance ruling referred to in a recent article may also have taken a similar position (Greg Boehmer, Kathleen Hanly, and Eric Xiao, "Insolvency: Selected Income Tax Issues Relating to Debt Restructuring and Liquidation," Report of Proceedings of Sixty-First Tax Conference, 2009 Tax Conference (Toronto: Canadian Tax Foundation, 2010), 7:1-36, at 34-35).

49 Subsection 248(1).


17

A legal representative is a person who administers, winds up, controls, or otherwise deals with a property, business, or estate of another person who may be an individual, a trust, or a corporation. The legal representative for the purposes of subsection 159(2) must be an assignee, liquidator, curator, receiver of any kind, trustee, heir, administrator, executor, committee, or any other like person other than a trustee in bankruptcy. The reference to any other like person includes any person acting as a liquidator, whether or not the person was formally appointed. For instance, in a voluntary dissolution, there may be no formally appointed liquidator and the responsibility may be assumed by an auditor, director, officer, or other person. The facts of each particular case will determine whether a person is a legal representative.50 (emphasis added)

Lawyer/Law Firm Holding and Disbursing Trust Monies

The CRA has confirmed that, absent other considerations, a lawyer or law firm should not be considered a “legal representative” for purposes of section 159 where the lawyer or law firm holds funds in a trust account and disburses the funds to close a transaction51 or acts on behalf of a client in a commercial transaction generally.52

Arm’s Length Purchaser

Not surprisingly, the CRA has previously agreed that an arm’s length purchaser would not normally be a “legal representative” for purposes of subsection 159(2).53

Non-Resident Legal Representative

The CRA has stated that the requirements of subsection 159(2) apply to all legal representatives, whether or not they are resident in Canada, such that non-resident executors would be required to obtain a clearance certificate prior to distributing Canadian real estate to the beneficiaries of an estate.54

RRSP Trustee

Interestingly, on at least one occasion the CRA has stated that the trustee of a registered retirement savings plan is required to obtain a subsection 159(2) clearance certificate prior to

50 Information Circular 82-6R8, Clearance Certificates, December 10, 2010, para. 3. Similarly, the CRA has stated

that “a person may be found to be a de facto liquidator, notwithstanding the fact that the formalities of a liquidation under corporate law have not been carried out (CRA Document No. 960885, dated January 10, 1996). The Courts have accepted that, depending on the facts, a person can be a de facto liquidator for purposes of these provisions (see Pâquet c. R., 92 DTC 2151 (TCC) and Malka et al v. The Queen, 78 DTC 6144 (FCTD)). It is noted, however, that in MNR v. Parsons, 83 DTC 5329 (FCTD) (reversed on other grounds by MNR v. Parsons, 84 DTC 6345 (FCA)), Cattanach, J. suggested that the position of a director was not of the same kind as any of those enumerated, such that, at least in the circumstances under consideration in that case, where the corporation was subsisting, the directors were not liable pursuant to subsection 159(3).

51 CRA Document No. 9905605, dated September 24, 1999. 52 CRA Document No. 991685, dated September 24, 1999. See also CRA Document No. 2002-0130675, dated

July 4, 2002 and Clark v. The Queen, 97 DTC 1047 (TCC). 53 CRA Document No. 2001-0112605, dated January 11, 2002. 54 CRA Document No. 2002-0117975, dated October 18, 2002. In this situation, the technical interpretation notes

that a section 116 certificate would also be required.


18

making any distribution, failing which the trustee would personally be liable under subsection 159(3) in respect of unpaid taxes owing by the RRSP trust itself.55

Winding-Up of a Partnership

The CRA has stated that the provisions of subsection 159(2) and (3) apply on the winding-up of a limited partnership, thereby requiring that the general partner apply for and obtain a clearance certificate.56

Funds Not in Estate or Not Within Legal Representative’s Possession or Control

Consistent with the language of the provisions, the CRA recently confirmed that an executor of an estate would not be liable under subsection 159(3) if certain funds were never part of the estate. The CRA also confirmed that if, instead, the funds were part of the estate, if they were never in the possession or control of the executor the executor would not be liable under subsection 159(3).57

Issuance and Effect of Interim Clearance Certificates

It used to be possible to obtain clearance certificates in respect of partial distributions.58 Whether it is still possible is uncertain; while the CRA has indicated in informal discussions that it will no longer issue clearance certificates in those circumstances, other discussions have suggested that the CRA may be prepared to issue clearance certificates in respect of partial distributions in appropriate circumstances.59

Avoidance of “Catch 22”:60 CRA’s Administrative Practice in Issuing Clearance Certificates

In its Information Circular dealing with section 159 clearance certificates, CRA in effect acknowledges the “Catch 22” that is often inherent in the requirement that a clearance certificate be obtained prior to making a distribution and the CRA’s position that it will not normally issue a clearance certificate until after the final return has been filed and assessed. In this regard, the CRA states as follows:

55 CRA Document No. 9305255, dated May 13, 1993. 56 CRA Document No. March 1991-82, dated March 1991. 57 CRA Document No. 2010-0376441E5, dated September 8, 2010. The recent decision in Nguyen, discussed

previously, is also consistent with this position (see the discussion of this decision, above, under the heading, Section 159 – What’s New, “CRA Assessing Under Subsection 159(3) Where Funds Deposited in Estate Account”.

58 See, for example, CRA Document No. December 1990-268, dated December 1990. 59 In this regard, the authors suggest that if the interests of different beneficiaries in an estate vest and are paid out

at different times (e.g., as each beneficiary reaches a certain age), this may be a situation in which the CRA might be prepared to consider issuing a clearance certificate in respect of a partial distribution. Note, however, as discussed below (see Practical Considerations Regarding Clearance Certificates, “Protection Afforded Under Subsection 159(3) Only to Legal Representative Acting in that Capacity”), that the clearance certificate would protect only the legal representatives (and not the estate or those beneficiaries of the estate that had not been fully paid out in the event that the estate were assessed).

60 As noted previously, the provisions of section 159 provide that property cannot be distributed until a clearance certificate has been issued but until all property has been distributed a final return of a taxpayer cannot normally be filed or assessed, such that the CRA will not issue a clearance certificate.


19

There may be times when you cannot determine the date of distribution because it may depend on completing the final assessment and issuing the clearance certificate. Since the final assessment has to include the period up to and including the date of distribution of property, it may seem we cannot issue the final assessment or the clearance certificate. For example, this situation could arise when the properties of an operating corporation continue to generate income until they are distributed. In such circumstances, you should contact the Assistant Director, Audit, at the tax services office where you file Form TX19 to make alternative arrangements.61

In the authors’ experience, the procedure typically followed is similar to that contemplated in the Information Circular in respect of a distribution at FMV from a trust or estate, which the CRA explains as follows:

(a) you establish a scheme of distribution by a date chosen by you, which is prior to the date of your request for a clearance certificate …;

(b) you calculate the tax payable as if the distribution had occurred on the chosen date;

(c) you file a final tax return for the tax year ending on the chosen date and pay any taxes, interest, and penalties that are chargeable against or payable out of the estate or trust property; and

(d) you submit your request in writing, and include a statement that you will complete the actual transfer of all the property of the estate or trust as soon as possible after you receive the clearance certificate.

We may not issue a clearance certificate if you have not filed a tax return or paid an amount for which the estate or trust is liable, or if there is an indication that the actual distribution will not take place as soon as possible after we issue the clearance certificate.

Once we issue the certificate, we consider the chosen date to be the actual date of distribution for tax purposes and regard the estate or trust representative as holding the properties for the beneficiaries since that date.62

In effect, therefore, while the practice does not technically comply with section 159, a notional distribution date is established and the properties distributed are treated as held in an agency or bare trust relationship after that time until the actual transfers occur.

Failure to Obtain a Clearance Certificate – Personal Liability of Legal Representative

Where No Underlying Assessment

In a recent technical interpretation, the CRA has confirmed its view that based upon the provisions of subsection 159(1), which provide that a taxpayer’s legal representative is jointly

61 Information Circular 82-6R8, Clearance Certificates, December 10, 2010, para. 12. In Interpretation Bulletin IT-

488R2, “Winding-Up of 90%-Owned Taxable Canadian Corporations” (archived), dated June 24, 1994, the CRA makes similar comments in respect of a subsection 88(1) winding-up (para. 21).

62 Para. 11. See also CRA Document No. 2000-0019645, dated July 4, 2000.


20

and severally liable with the taxpayer to pay any amount that is payable by the taxpayer and that actions or proceedings taken by the Minister against the representative will be binding on the taxpayer, it can assess a taxpayer’s legal representative even where the taxpayer was dissolved prior to being assessed (i.e., the CRA is therefore apparently of the view that it does not need to first restore the corporation and assess it prior to assessing the legal representative under subsection 159(3)).63

Where Underlying Liability Statute-Barred

As noted previously,64 a recent technical interpretation has raised some uncertainty as to whether the CRA is of the view that it can assess a taxpayer’s legal representative in circumstances in which the taxpayer itself was not assessed and where the matter had become statute-barred as against the taxpayer.

Given that the meaning of the technical interpretation is unclear, that the CRA has previously accepted that subsection 159(3) cannot be used in this manner,65 and that jurisprudence has also reached this same conclusion,66 it is hoped that the CRA has not changed its position on this issue. Further, as discussed above,67 in an even more recent technical interpretation, the CRA seems to agree that an assessment of a legal representative, where the underlying taxpayer had not been assessed (and had been dissolved), must be made within the limitation period applicable in respect of the underlying taxpayer.

In any event, what is clear is that in circumstances in which an underlying taxpayer’s liability will not become statute-barred under the Act (e.g., due to the taxpayer’s misrepresentation due to neglect, carelessness or wilful default; fraud; the filing of a waiver that has not been withdrawn; or simply in respect of a matter such as a failure of the taxpayer to withhold Part XIII tax where there may be no assessment such that the matter will not become statute-barred)68, a legal representative will remain at risk indefinitely69 where property has been distributed without a clearance certificate, even where at the time of distribution the legal representative reasonably understood that there was no underlying liability.

Ability to Challenge Underlying Liability

As noted previously, whether a legal representative assessed under subsection 159(3) has the ability to challenge the taxpayer’s underlying assessment (e.g., where the underlying assessment was not challenged by or on behalf of the taxpayer) has been considered uncertain.

As noted by David Sherman:

It is uncertain whether the executor can challenge the underlying assessment of the deceased when the executor is assessed. Parsons, [1984] C.T.C. 253 (FCA), and Armstrong, [1998] 4 C.T.C. 2006 (TCC) suggest not; more recent case law on ss. 160

63 CRA Document No. 2011-0399191I7, dated August 10, 2011. 64 See above under the heading Section 159 – What’s New, “Possible Assessment of Statute-Barred Year”. 65 CRA Document No. 2000-0014955, dated September 14, 2000. 66 The Queen v. Wesbrook Management Ltd., 96 DTC 6590 (FCA). 67 CRA Document No. 2011-0399191I7, dated August 10, 2011. 68 Subsections 152(3.1), (4) and (4.1). 69 Although perhaps in some cases subject to limitation periods of general application.


21

and 227.1 allows such a challenge: Gaucher, [2001] 1 C.T.C. 125 (FCA) and Abrametz, [2009] G.S.T.C. 43 (FCA), but these cases might not apply since the executor presumably had the legal right to contest the deceased's assessment.70

Accordingly, it is encouraging that the CRA has recently taken the position that a legal representative assessed under subsection 159(3) can challenge the underlying assessment.71 In the view of the authors, from a policy perspective this should be the correct interpretation; the fact that an underlying liability was not disputed by or on behalf of the taxpayer – even if the legal representative or representatives were then so acting – should not preclude the legal representatives in their personal capacities rather than in their capacities as the taxpayer’s legal representatives from challenging the underlying assessment.

Application to Liability Under Other Legislation

The CRA states that a clearance certificate applies in respect not only of federal income taxes but also in respect of provincial and territorial taxes administered by the CRA, as well as Canadian Pension Plan Contributions and Employment Insurance premiums, including associated interest and penalties on each of those items.72

Practical Considerations Regarding Clearance Certificates

Distributions Without or Prior to Obtaining Clearance Certificates

As the above discussion indicates:

Subsections 159(2) and (3) can have a very broad reach (e.g., permitting the CRA to assess a legal representative “at any time”, which could be many years after the distribution in issue, at least provided that the underlying tax liability is not statute barred, even where the legal representative reasonably believed at the time of distribution that there was no underlying liability).

The CRA takes an expansive view as to what constitutes a distribution for purposes of section 159 (e.g., the view of the CRA that the payment by a taxpayer’s legal representative to an unsecured creditor will be a distribution).

Legal representatives therefore need to be very careful in managing the affairs of the underlying taxpayer.

While it may often be completely impractical for a taxpayer’s legal representative not to make any distributions until after a clearance certificate has been obtained (e.g., in the case of a trust or estate being administered over many years where the interests of different beneficiaries vest at different times, such as when each beneficiary reaches a certain age), legal representatives should consider their potential exposure, their entitlement to keep hold-backs and their ability to

70 Practitioner’s Income Tax Act (2011; 40th Ed), notes to subsection 159(3), p. 1199. 71 CRA Document No. 2010-0390311E5, dated March 14, 2011. 72 Para. 4 of Information Circular 82-6R8, Clearance Certificates, December 10, 2010. CRA Document No. 2009-

0336911E5, dated January 10, 2010, also takes the position that section 159 applies in respect of both federal and provincial taxes (at least in provinces in which the provincial taxes are collected by the CRA). Section 279 of the Excise Tax Act (GST/HST Portions) includes, in respect of GST and HST, requirements similar to those of section 159.


22

protect themselves (e.g., through the provision of indemnities and security from parties to whom property is distributed) prior to making distributions to third-parties without having first obtained a clearance certificate.

In circumstances in which clearance certificates cannot reasonably be obtained prior to distributions being effected, it may be useful to consider whether potential exposure can be limited. For example:

In the case of certain reorganizations, it may be appropriate to consider whether an amalgamation of a parent and subsidiary corporation can be effected instead of a wind-up on the premise that an amalgamation should not give rise to a distribution for purposes of section 159 (notwithstanding that the amalgamated company is a new corporation for purposes of the Act).73

In the case of a voluntary winding-up of a wholly-owned corporation into its parent corporation, where no formal liquidator needs to be appointed, it may be appropriate to consider whether the parent corporation can be made the sole legal representative for purposes of subsection 159(2).74 In this regard, it is of interest that the CRA recently confirmed that in its view a parent corporation could be the legal representative of its subsidiary.75

In some limited circumstances, it may be appropriate to obtain an advance ruling that a transaction does not involve a distribution for purposes of section 159.76

Protection Afforded Under Subsection 159(3) Only to Legal Representative Acting in that Capacity

While the issuance of a subsection 159(2) clearance certificate is often thought by non-tax practitioners to be the “end of the matter” in respect of continuing tax exposure,77 the CRA has stated78 and the jurisprudence makes clear that the issuance of a clearance certificate protects against only the potential liability of the legal representatives under subsection 159(3) (e.g., it does not protect beneficiaries to whom property has been distributed that might be liable under

73 Paragraph 87(2)(a) generally deems the corporation continuing on a section 87 amalgamation to be a new

corporation for purposes of the Act. In dealing with amalgamations, in Information Circular IC 82-6R8 CRA takes the position that a clearance certificate should be obtained where it is not certain that a rollover is “complete”, but that otherwise a clearance certificate need not be obtained in an amalgamation governed by section 87 where no additional liability would be created (para 16). This may imply that the CRA is of the view that an amalgamation gives rise to a distribution for purposes of section 159 (although if that were the case, obtaining a clearance certificate would often be advisable whether or not additional liability was created on the amalgamation).

74 Particularly given that the parent corporation typically would be liable to the extent of the property distributed, pursuant to section 160, for the subsidiary’s obligations under the Act.

75 CRA Document No. 2011-0399191I7, dated August 10, 2011. 76 Interestingly, a recent paper indicates that in a particular transaction involving a trust-to-trust transfer pursuant to

subsection 248(25.1) not only was an advance ruling obtained but also an order of the Ontario Superior Court of Justice that the transactions were not “distributions” for purposes of section 159 (Greg Boehmer, Kathleen Hanly, and Eric Xiao, "Insolvency: Selected Income Tax Issues Relating to Debt Restructuring and Liquidation," Report of Proceedings of Sixty-First Tax Conference, 2009 Tax Conference (Toronto: Canadian Tax Foundation, 2010), 7:1-36, at 34 and 35). Query, however, if only a court order were obtained whether that would provide real protection to a legal representative.

77 Provided that the certificate is not issued in respect of a partial distribution. 78 CRA Document No. November 1990-10, dated November 1990.


23

section 160, including legal representatives in their capacity as beneficiaries rather than legal representatives).79

Accordingly, at least where a taxpayer’s underlying liability is not statute-barred, where a clearance certificate has been issued under subsection 159(3), the CRA is not precluded from seeking to enforce the liability, for example pursuant to the provisions of section 160. This is a point that needs to be very carefully borne in mind in many circumstances (e.g., in a trust or estate, where different beneficiaries may be entitled to distributions of capital at different times, such that the CRA might look to the estate for payment at a time at which some beneficiaries’ interests were disproportionately represented by the assets of the estate; or even where assets were being distributed to multiple persons in circumstances in which the CRA might proceed against some of them under section 160). In these circumstances, as well, the need to provide for hold-backs and to request indemnities and security should be considered; otherwise some recipients could be left “holding the bag” where the CRA proceeds against them rather than others.

CHARITABLE SECTOR

Background – Budget 2011

As mentioned above, the 2011 federal budget released on March 22, 2011 and reintroduced in substantially the same form on June 6, 2011 (“Budget 2011”) contains a host of proposals which seek generally to tighten the rules applicable to charities and similar entities and, in some circumstances, limit the tax benefits associated with the making of gifts to such entities. As stated in Budget 2011, the proposals are intended to “ensure that organizations given the privilege of issuing official donation receipts operate in compliance with the law, to clarify existing legislation and to limit unintended or excessive benefits”.

On August 16, 2011, the Department of Finance (“Finance”) released draft legislation (the “Draft Legislation”) intended to implement the various proposals.80 While the Draft Legislation, for the most part, tracks the Notice of Ways and Means Motion that accompanied Budget 2011 (the “NWMM”), there are a number of noteworthy departures.

The comments set out below discuss the various proposals, which may be broken down as follows:81

Proposals Applicable to the Donation of Flow-Through Shares;

Proposals Applicable to Gifts of Non-Qualifying Securities;

79 Bougie et al v. The Queen, 90 DTC 6387 (FCTD); Boger Estate v. MNR, 91 DTC 5506 (FCTD); Waxman Estate

v. The Queen, 94 DTC 1216. 80 Explanatory notes in respect of the Draft Legislation were subsequently released on September 1, 2011 (the

“Explanatory Notes”). 81 Two public consultations were launched in respect of the proposals: the first, which related to registered

Canadian amateur athletic associations specifically, was launched on July 4, 2011 and concluded on August 31, 2011; the second related to the Draft Legislation generally and concluded on September 16, 2011. As discussed below, it would not be surprising if the Draft Legislation is modified in response to submissions received.


24

Proposals Applicable to the Granting of Options to Qualified Donees;

Proposals to Recover Tax Assistance for Returned Gifts;

Proposals Intended to Enhance the Regulatory Regime for Qualified Donees; and

Proposals Intended to Safeguard Assets through Good Governance.

Proposals Applicable to the Donation of Flow-Through Shares

One of the most significant measures in Budget 2011 is the proposal to alter the donation regime in respect of gifts of “flow-through shares” (i.e., shares in the capital stock of a “principal-business corporation”82 that are accompanied by separate contractual rights to certain tax advantages).83

Stated generally, the provisions of the Act applicable to flow-through shares allow corporations in the oil and gas, mining and renewable energy sectors to renounce or “flow-through” expenses that the corporations would otherwise treat as Canadian exploration expenses (“CEE”)84 or Canadian development expenses (“CDE”)85 to investors who can claim the relevant deductions in calculating their own taxable income.

Pursuant to subsection 66.3(3), flow-through shares are generally treated as having a cost of nil for the purpose of calculating any gain or loss on their disposition.86 Accordingly, when such shares are disposed of, the entire proceeds will generally be taxed as a capital gain provided that the shares are held as capital property. In circumstances in which a flow-through share is sold for its issue price, the investor normally benefits from (i) a deferral of tax because of the upfront deduction for CEE/CDE, and (ii) an absolute tax savings since the deduction for CEE/CDE shelters income at the investor’s marginal tax rate whereas tax on the sale of the share is paid at the lower capital gains rates.

As stated in Budget 2011, “[t]axation as a capital gain of the proceeds up to the amount of the original cost represents a partial recovery of the tax benefit provided by the deduction for the original cost of the share, rather than a gain resulting from an appreciation in the share’s value”. However, as a result of changes introduced by the 2006 and 2007 federal budgets which eliminated capital gains tax on donations of publicly listed securities to registered charities and other qualified donees, taxpayers have been able to avoid this second stage of the normal flow-through share rules in respect of publicly listed flow-through shares. Accordingly, it has been

82 Subsection 66(15). 83 Subsections 248(1) and 66(15). The term also includes rights to such shares. 84 Subsections 248(1) and 66.1(6). 85 Subsections 248(1) and 66.2(5). 86 Subsection 66.3(3) provides that any flow-through share of a corporation acquired by a person who was a party

to the agreement pursuant to which it was issued shall be deemed to have been acquired by the person at a cost of nil. However, the cost will be averaged with the ACB of any identical shares of the issuer owned by the investor such that the investor may have a positive ACB in respect of flow-through shares in circumstances where the investor has acquired identical shares otherwise than under a flow-through share agreement.


25

possible for taxpayers to make donations of flow-through shares at little or no after-tax cost depending on the investor’s province of residence.87

More particularly, when publicly listed flow-through shares are donated, the donor generally benefits from:

the deduction for expenses renounced by the corporation;

applicable federal and provincial flow-through share credits;

a charitable donation tax credit or deduction (depending on whether the donor is an individual or a corporation); and

relief from capital gains tax in respect of any gain arising from the disposition of the shares.

Not surprisingly given these benefits, the gifting of flow-through shares has increased substantially in recent years, with one commentator estimating that donations of flow-through shares since 2006 have exceeded two billion dollars.88

Unlike other donation tax shelters, flow-through share arrangements have been accepted by the CRA, at least in certain circumstances.89 However, it appears that Finance or the government has determined that the level of tax support is excessive.

87 Budget 2011 sets out an example in which an Ontario taxpayer in the top marginal tax bracket is able to make a

$100 donation at a net after-tax cost of $5.00. 88 Adam Aptowitzer, “Charity Sector is the Focus of Budget 2011”, 19(5) Canadian Not-for-Profit News

(Carswell) 33-36 at 33 (May 2011). 89 See for example, Income Tax Technical News No. 41 (December 23, 2009) where the following was stated:

Question

Since both the flow-through share rules and the rules to eliminate taxable capital gains from charitable donations of shares of public corporations are incentives aimed at encouraging such subscriptions and donations, what is the CRA's position with regard to whether such donations will be classified as a tax shelter (and subject to the tax shelter registration rules)?

Response

The definition of "tax shelter" in subsection 237.1(1) of the Act includes a "gifting arrangement" which as defined in that subsection means any arrangement under which it may reasonably be considered, having regard to statements or representations made in connection with the arrangement, that if a person were to enter into the arrangement, the person would make a gift to a qualified donee. The exclusion of a flow-through share in paragraph (b) of the definition of "tax shelter" is in reference to the acquisition of a property that is a flow-through share that has not been acquired pursuant to a "gifting arrangement" described in paragraph (b) of that definition.

The purpose of the tax shelter registration rules is to identify the arrangements that fall within the definition of "tax shelter" for review by the CRA. The issuance of an identification number by the CRA is not to be construed as the CRA approving the arrangement. On the other hand, it also does not mean that a subsequent audit will result in adjustments.

The CRA has already issued identification numbers in respect of several flow-through share/donation arrangements and has in fact issued advance income tax rulings on some arrangements. Nevertheless the requirement to obtain a registration identification


26

Budget 2011 proposes to restrict the capital gains relief available on a donation of publicly-listed flow-through shares acquired by a donor pursuant to a flow-through share agreement entered into on or after March 22, 2011.

Generally, the capital gains exemption on such a gift will be available only to the extent that the capital gain on the donation exceeds a threshold amount (the “exemption threshold”) at the time of the donation. Conceptually, the exemption threshold is intended to ensure that the second stage of the normal flow through rules (i.e., the taxation as a capital gain of the proceeds up to the original cost of the property) applies notwithstanding the general exemption from capital gains tax on gifts of publicly-listed securities to qualified donees.

Stated generally, the exemption threshold will be the excess of (i) the donor’s original cost (determined without regard to subsection 66.3(3)) of all flow-through shares of the particular “flow-through share class of property” over (ii) the amount of the capital gains realized by the donor on a disposition after the donor’s “fresh-start date” and before the particular time in respect of flow-through shares of that class. For these purposes, a taxpayer’s “fresh start date” is generally the later of March 22, 2011 and the last day, if any, before the particular time, on which the taxpayer disposed of all property included in the class. An anti-avoidance rule that applies to the donation of property acquired by the donor in a tax-deferred transaction (i.e., a “rollover”) is also contemplated.

For the most part, the relevant provisions in the Draft Legislation track the proposed language set out in the NWMM; however, the Draft Legislation contains a few significant, albeit not surprising, expansions. More particularly, proposed section 38.1 has been revised to refer to a “transaction or series of transactions” and to include transactions to which subsections 88(1) and 98(3) apply.90

More generally, the draft provisions have been revised to contemplate partnership interests and to include in the definition of “flow-through share class of property” a group of properties each of which is an interest in a partnership if, at any time, more than 50% of the FMV of the partnership’s assets is attributable to property included in a flow-through share class of property. In the case of a partnership interest, the taxpayer’s exemption threshold will generally include the ACB of the interest if (i) the taxpayer makes a contribution to the partnership on or after August 16, 2011 or (ii) the taxpayer acquired the interest after the taxpayer’s fresh-start date which, in the case of a partnership interest, is defined to be the later of August 16, 2011 and the last day, if any, before a particular time, on which the taxpayer held an interest in the partnership.91

number allows us to review all such arrangements for compliance with the provisions of the Act. (emphasis added)

See also, CRA Document Nos. 2007-0242361R3 from 2007; 2008-0281941R3 from 2008; and 2009-0316961R3 from 2009.

90 The provision also applies in respect of transactions to which one or more of section 51, subsections 73(1), 85(1) and (2) and 85.1(1), and sections 86 and 87 apply.

91 A carve-out is provided for an interest acquired on or after August 16, 2011 if the taxpayer was obligated to acquire the interest pursuant to the terms of an agreement in writing entered into before August 16, 2011 between the partnership and the taxpayer.


27

Proposals Applicable to Gifts of Non-Qualifying Securities

Presumably in response to fact patterns in which individual and corporate taxpayers have been able to circumvent the existing rules, Budget 2011 proposes to alter the donation regime in respect of gifts of non-qualifying securities. These rules very generally provide that a donor’s tax credit or deduction in respect of gifts of certain private company shares, debt obligations and other securities may, in some circumstances, be denied or deferred until the security ceases to be a non-qualifying security or the donee disposes of the security.

Current Law

Simplified, subsection 118.1(18) defines a “non-qualifying security” of an individual at any time to mean:

(a) an obligation of the individual or of any person or partnership with which the individual does not deal at arm’s length immediately after that time;

(b) a share of the capital stock of a corporation with which the individual does not deal at arm’s length immediately after that time;

(c) any other security issued by the individual or by another person or partnership with which the individual does not deal at arm’s length immediately after that time.92

Subsection 110.1(6) provides that the non-qualifying security rules applicable to individuals93 are also applicable to corporations with necessary modifications.94

92 In full, subsection 118.1(18) provides as follows:

For the purposes of this section, “non-qualifying security” of an individual at any time means

(a) an obligation (other than an obligation of a financial institution to repay an amount deposited with the institution or an obligation listed on a designated stock exchange) of the individual or the individual’s estate or of any person or partnership with which the individual or the estate does not deal at arm’s length immediately after that time;

(b) a share (other than a share listed on a designated stock exchange) of the capital stock of a corporation with which the individual or the estate or, where the individual is a trust, a person affiliated with the trust, does not deal at arm’s length immediately after that time;

(b.1) a beneficial interest of the individual or the estate in a trust that (i) immediately after that time is affiliated with the individual or the estate, or (ii) holds, immediately after that time, a qualifying security of the individual or estate, or held, at or before that time, a share described in paragraph (b) that is, after that time, held by the donee; or

(c) any other security (other than a security listed on a designated stock exchange) issued by the individual or the estate or by another person or partnership with which the individual or the estate does not deal at arm’s length (or, in the case where the person is a trust, with which the individual or estate is affiliated) immediately after that time.

93 As set out in subsections 118.1(13), (14) and (16) to (20). 94 For these purposes, a reference to a non-qualifying security of a corporation is to be read as including a share

(other than a share listed on a designated stock exchange) of the capital stock of the corporation.


28

Under current law as set out in subsection 118.1(13), the donor of a non-qualifying security is generally denied a charitable tax credit or deduction unless one of two events occurs within 60 months of the donation. The first triggering event is if the security ceases to be a non-qualifying security of the donor.95 If this triggering event occurs within 60 months of the donation, the donor is deemed to have made a donation at the time of the triggering event and the FMV of the gift is, stated generally, deemed to be the lesser of (i) the FMV of the security at the time of the triggering event and (ii) the FMV of the security at the time it was actually donated.

The second triggering event is if the donee disposes of the non-qualifying security and the first of the two triggering events does not apply.96 If the second triggering event occurs within 60 months of the donation, the donor is deemed to have a made a donation at the time of the triggering event and the FMV of the gift is, stated generally, deemed to be the lesser of (i) the consideration received by the donee for the disposition (exclusive of any consideration that is a non-qualifying security of the donor or a property that would be a non-qualifying security of the donor if the donor were in existence at that time), and (ii) the FMV of the security at the time it was actually donated.

Subsection 118.1(13), the provision denying charitable tax credits or deductions, contains a carve-out which permits a donor to claim a charitable tax credit or deduction for a gift of a non-qualifying security where the gift is an “excepted gift” within the meaning of subsection 118.1(19). Under that provision, an excepted gift must meet four criteria:

(a) the security gifted must be a share;

(b) the donee must not be a private foundation;

(c) the donor must deal at arm’s length with the donee; and

(d) where the donee is a charitable organization or a public foundation, the donor must deal at arm’s length with each director, trustee, officer and like official of the donee.

The Remai Decision

The Tax Court of Canada and the Federal Court of Appeal recently had occasion to consider the non-qualifying security rules in Remai Estate v. R.97 The decision is of interest as it may have prompted the non-qualifying security proposals in Budget 2011.

Simplified, the facts in Remai were as follows:

the taxpayer, Frank Remai, was the sole shareholder of a management company (“FRM”);

in each of 1998 and 1999, FRM issued an interest bearing promissory note (each a “Note”, and collectively the “Notes”) to the taxpayer as payment for management fees that the taxpayer had earned in the relevant year;

95 Paragraph 118.1(13)(b). 96 Paragraph 118.1(13)(c). 97 2009 DTC 5188 (FCA), aff’g 2008 DTC 4567 (TCC) [“Remai”].


29

on the day each Note was issued, the taxpayer endorsed the Note to a private foundation (the “Foundation”) of which the taxpayer was the controlling mind – the Foundation was a registered charity for purposes of the Act;

the terms of the gifts contained a direction that the Notes were to be held by the Foundation for a period of no less than ten years and a day;

the Foundation issued official donation receipts to the taxpayer for the face value of the Notes and the taxpayer claimed charitable tax credits in respect of the gifts in each of 1998 and 1999;

the Minister disallowed the charitable tax credits on the grounds that the Notes were non-qualifying securities in respect of the taxpayer such that paragraph 118.1(13)(a) applied to deem the gifts not to have been made;

recognizing that the 1998 and 1999 gifts did not qualify for the credit, the taxpayer’s accountant proposed that the Foundation sell the Notes to an arm’s length third party in order to benefit from the relieving provisions of paragraph 118.1(13)(c);

after various options were rejected as being uneconomical, it was decided to sell the Notes to a company (“Sweets”) controlled by the taxpayer’s nephew and the Foundation, in fact, sold the Notes to Sweets in July 2001 in exchange for a new promissory note issued by Sweets on the same terms as the Notes;

the taxpayer claimed a charitable tax credit in 2001 on the basis that the Notes had ceased to be non-qualifying securities as a result of the sale to Sweets and that paragraph 118.1(13)(c) deemed the taxpayer to have made a gift to the Foundation at that time;

the Minister again disallowed the credit, this time on the basis that (i) the taxpayer and Sweets were not dealing at arm’s length such that the Notes remained non-qualifying securities of the taxpayer, or (ii) even if the sale of the Notes was an arm’s length transaction, the sale was a misuse or abuse of the relevant provisions of the Act such that GAAR applied;

acting in her capacity as the executrix of the taxpayer’s estate, Ellen Remai appealed the reassessment to the Tax Court of Canada.

The Tax Court of Canada allowed the appeal, finding that the taxpayer and Sweets were arm’s length parties and that the GAAR did not apply. The Federal Court of Appeal affirmed the lower court’s decision.

While the finding as to arm’s length status turned on the particular facts of the case, the courts’ statements in the context of GAAR are noteworthy since, in concluding that the GAAR did not apply, both the Tax Court of Canada and the Federal Court of Appeal rejected the Minister’s argument that the purpose of subsections 118.1(13) and (18) was “to prevent donors from


30

claiming a charitable tax credit for the capital value of a gift when they still retained control of the funds from which the obligation would be satisfied”.98

Finance was perhaps speaking directly to the courts in Remai in Budget 2011 when it stated as follows in respect of the proposals applicable to the non-qualifying securities rules:

Various proposals in the [ITA] reflect the policy that a Charitable Donations Tax Credit or Deduction generally should not be available to a donor until such time as the use and benefits of the donor’s property have been transferred to a registered charity or other qualified donee. One of these provisions applies in the case of donations of non-qualifying securities of the donor. …

98 As stated by the Federal Court of Appeal:

55 The Judge found that the purpose of paragraph 118.1(13)(c) was to enable a taxpayer to "redeem" an intended charitable gift, which did not take effect because it was a "non-qualifying security", by causing the donee to dispose of the note to an arm's length third party. The Judge held that since the sale of the FRM notes to Sweet was consistent with this purpose, it was not a misuse or abuse of the provision. He rejected as unfounded in the evidence the Minister's argument that the provisions were aimed at preventing a person from obtaining a charitable tax credit while retaining control of the funds underlying the gift.

56 I agree with the Judge's conclusion, although I would explain it a little differently. As I have already stated, a purpose of subsection 118.1(18) in disqualifying certain gifts from a charitable tax credit is because of the practical difficulty of assessing their fair market value. Paragraph 118.1(13)(c) permits taxpayers to claim the credit if, within the prescribed time, the charity disposes of the "non-qualifying security" to a third party in an arm's length transaction. The price paid by the third party for the security can be taken to be its fair market value. Thus, the arm's length sale to Sweet by the Foundation of FRM's notes, in exchange for a note from Sweet for the same amount, provides a reliable basis for the Minister to treat the face value of FRM's notes as their fair market value, and to allow the charitable tax credit claimed in respect of this amount.

57 The Crown argues that the 1997 amendments to [the Act] were intended to prevent donors from claiming a charitable tax credit for the capital value of a gift when they still retained control of the funds from which the obligation would be satisfied. Counsel says that the sale of the notes really changed nothing: the Foundation held only promissory notes, and FRM retained the use the capital amount owing on them. Consequently, it was said, the transaction must have been a misuse or abuse of subsection 118.1(13)(c).

58 I do not agree. Nothing in the text of the provision supports this purpose. On the other hand, the 1997 Budget statement provides that the new measure will deal with loan-backs, which have been used to enable taxpayers to claim tax credits for charitable gifts without having to forego use of the funds: David M. Sherman ed., Income Tax Act Technical Notes 10th edn. (Toronto: Carswell, 1998), p. 885. Indeed, the problem of the retention of the use of the capital in respect of loan-back transactions is specifically dealt with by subsections 118.1(16) and (17). The retention of the use of funds after a charitable tax credit was claimed had been identified as a problem in relation to loan-backs: see M. Elena Hoffstein, "Private Foundations and Charitable Foundations", Report of Proceedings of Fifty-Ninth Tax Conference, 2007 Tax Conference (Toronto: Canadian Tax Foundation, 2008), 32:1-35.

59 The transaction in question in the present case is not a loan-back. On the basis of the submissions made by the Crown, I am not persuaded that a significant purpose of the more general provisions of subsections 118.1(13) and (18) was to deal with the issue of taxpayers' retention of the use of funds for which they have received a charitable tax credit. (emphasis added)


31

Budget 2011

Presumably in response to fact patterns such as in Remai, as well as fact patterns in which qualified donees effectively trade non-qualifying securities so as to benefit their respective donors, Budget 2011 proposes that the non-qualifying security rules be amended to defer the tax recognition of a donation of a non-qualifying security until such time, within 60 months of the donation, as the donee has disposed of the non-qualifying security for consideration that is not a non-qualifying security of any person, as opposed to merely a non-qualifying security of the donor.

Budget 2011 also proposes a number of anti-avoidances rules applicable to back-to-back type arrangements in respect of non-qualifying securities. In both cases, the proposals are to apply effective March 22, 2011.

As currently enacted, paragraph 118.1(13)(c) provides as follows:

For the purposes of this section (other than this subsection), where at any particular time an individual makes a gift (including a gift that, but for this subsection and subsection (4), would be deemed by subsection (5) to be made at the particular time) of a non-qualifying security of the individual and the gift is not an excepted gift,

…

(c) if the security is disposed of by the donee within 60 months after the particular time and paragraph (b) does not apply to the security, the individual is deemed to have made a gift to the donee of property at the time of the disposition and the fair market value of that gift is deemed to be the lesser of the fair market value of any consideration (other than a non-qualifying security of the individual or a property that would be a non-qualifying security of the individual if the individual were alive at that time) received by the donee for the disposition and the amount of the gift made at the particular time that would, but for this subsection, have been included in the individual’s total charitable gifts or total Crown gifts for a taxation year… (emphasis added)

In order to effect the first change contemplated by Budget 2011 in respect of the non-qualifying security rules, it is proposed that the parenthetical in paragraph 118.1(13)(c) be revised to read: “other than a non-qualifying security of any person” (emphasis added).

In order to effect the second change, it is proposed that section 118.1 be amended by adding the following after subsection 118.1(13):

(13.1) Subsection (13.2) applies if, as part of a series of transactions,

(a) an individual makes, at a particular time, a gift of a particular property to a qualified donee;

(b) a particular person holds a non-qualifying security of the individual; and

(c) the qualified donee acquires, directly or indirectly, a non-qualifying security of the individual or of the particular person.


32

(13.2) If this subsection applies,

(a) for the purposes of this section, the fair market value of the particular property is deemed to be reduced by an amount equal to the fair market value of the non-qualifying security acquired by the qualified donee; and

(b) for the purposes of subsection (13),

(i) if the non-qualifying security acquired by the qualified donee is a non-qualifying security of the particular person, it is deemed to be a non-qualifying security of the individual,

(ii) the individual is deemed to have made, at the particular time referred to in subsection (13.1), a gift of the non-qualifying security acquired by the qualified donee, the fair market value of which does not exceed the amount, if any, by which

(A) the fair market value of the particular property determined without reference to paragraph (a)

exceeds

(B) the fair market value of the particular property determined under paragraph (a), and

(iii) paragraph (13)(b) does not apply in respect of the gift.

(13.3) For the purposes of subsections (13.1) and (13.2), if, as part of a series of transactions, an individual makes a gift to a qualified donee and the qualified donee acquires a non-qualifying security of a person (other than the individual or particular person referred to in subsection (13.1)) and it may reasonably be considered, having regard to all the circumstances, that one of the purposes or results of the acquisition of the non-qualifying security by the qualified donee was to facilitate, directly or indirectly, the making of the gift by the individual, then the non-qualifying security acquired by the qualified donee is deemed to be a non-qualifying security of the individual.99

The Explanatory Notes contain two examples of how these new provisions are intended to apply. In respect of proposed subsections 118.1(13.1) and (13.2), the Explanatory Notes state:

Example 1

Mr. X transfers $100,000 in cash to Ms. Y in exchange for a demand note payable by Ms. Y. Ms. Y transfers the $100,000 in cash to Mr. Z in exchange for a demand note payable by Mr. Z. Mr. Z then makes a gift of $120,000 to a private foundation that is a registered charity. The foundation pays Mr. X $100,000 to acquire the demand note due from Ms. Y. At this point, the charity holds only $20,000 in cash, and a $100,000 note payable by Ms. Y. Ms. Y, in turn, holds a $100,000 note payable by Mr. Z. (This example

99 Subsection 110.1(6) is also proposed to be amended to refer to these additional provisions.


33

assumes that the transfer by Mr. Z to the charity is not conditional on the other transactions and that it is a gift at law.)

• In this example, the value for tax purposes of Mr. Z’s cash gift is reduced by $100,000, the value of the note due from Ms. Y that has been acquired by the foundation, to $20,000.

• The note due from Ms. Y is deemed to be a non-qualifying security of Mr. Z, and Mr. Z is deemed to have made a gift of that non-qualifying security, having a deemed value of the actual value of the cash gift less the deemed value of the gift ($120,000 - $20,000 = $100,000). Subsection 118.1(13) further deems that gift not to have been made at that time.

• If, within five years, the foundation disposes of the demand note of Ms. Y, then Mr. Z will be considered to have made a gift having a value not exceeding the amount of consideration (other than a non-qualifying security of any person) paid to the foundation for the note.

Similarly, in respect of proposed subsection 118.1(13.3), the Explanatory Notes state:

Example 2

This is the same as Example 1, except that Mr. X, instead of selling the note of Ms. Y to the foundation, transfers a demand note due from himself to the foundation in exchange for $100,000. In the result, the foundation has $20,000 and a $100,000 note due from Mr. X, who holds a $100,000 note due from Ms. Y, who holds a $100,000 note due from Mr. Z (the donor).

In these circumstances, it may reasonably be considered that the result of the acquisition of the demand note of Mr. X by the foundation was to facilitate the making of the gift by Mr. Z. Accordingly,

• The demand note of Mr. X is deemed to be a non-qualifying security of Mr. Z.

• The value for tax purposes of the cash gift of Mr. Z is reduced by $100,000, the value of that non-qualifying security that has been acquired by the foundation, to $20,000.

• Mr. Z is deemed to have made a gift of the non-qualifying security, having a deemed value of the actual value of the cash gift less the deemed value of the gift ($120,000 - $20,000 = $100,000). Subsection 118.1(13) further deems that gift not to have been made at that time.

• If , within five years, the foundation disposes of the demand note of Mr. X, then Mr. Z will be considered to have made a gift having a value not exceeding the amount of consideration (other than a non-qualifying security of any person) paid to the foundation for the note.


34

Comments

As noted above, Finance invited comments on the Draft Legislation. It would not be surprising if the Draft Legislation, including the provisions applicable to non-qualifying securities, were modified in response to submissions received. Some comments from the authors on the provisions applicable to non-qualifying securities are set out below.

Interaction with Proposed Split Receipting Rules

In the absence of a statutory definition of the term “gift”, courts have generally interpreted the charitable gift provisions of the Act in a manner consistent with the common law view that a gift entails the voluntary transfer of property owned by a donor to a donee in return for which no benefit or consideration flows to the donor.100 Accordingly, a sale on favourable terms is generally not considered to be a gift.

In 2002, the government proposed a set of amendments dealing with partial gifts and split receipting (the “Split Receipting Rules”). Although the proposed amendments have not yet been enacted, the CRA has stated that taxpayers may file on the basis that the Split Receipting Rules apply.101

As currently enacted, subsection 118.1(1) defines “total charitable gifts” of an individual for a taxation year as:

…the total of all amounts each of which is the fair market value of a gift (other than a gift the fair market value of which is included in the total Crown gifts, the total cultural gifts or the total ecological gifts of the individual for the year) made by the individual in the year or in any of the 5 immediately preceding taxation years… (emphasis added)102

As part of the Split Receipting Rules, it was proposed that the above references to “the fair market value of a gift” be replaced with a new concept, namely “the eligible amount of a gift”. The Split Receipting Rules would also add new subsections 248(30) through (41).

Stated generally, subsection 248(31) would define the eligible amount of a gift as the amount by which the FMV of a gift exceeds the amount of the advantage, if any, in respect of the gift. Proposed subsection 248(32) describes how the amount of an advantage is to be calculated while various other provisions deem the FMV of a gift to be other than its actual FMV in certain circumstances (e.g., when certain property is gifted within a specified number of years of its acquisition by the donor).

It is unclear how the Draft Legislation is intended to interact with the Split Receipting Rules.

100 See, for example, Maréchaux v. R., 2009 DTC 1379 (TCC), aff’d 2010 DTC 5174 (FCA) [leave to appeal denied

2011 CarswellNat 1911 (SCC)]. 101 See, for example, Income Tax Technical News No. 26, dated December 24, 2002. 102 Similarly, paragraph 110.1(1)(a) provides in the context of a corporation that:

For the purposes of computing taxable income of a corporation for a taxation year, there may be deducted such of the following amounts as the corporation claims:

(a) the total of all amounts each of which is the fair market value of a gift (other than a gift described in paragraphs (b), (c) or (d)) made by the corporation in the year or in any of the 5 preceding taxation years to… (emphasis added)


35

By way of example, if subsection 118.1(13.2) applies, proposed paragraph 118.1(13.2)(a) provides that:

for the purposes of [section 118.1], the fair market value of the particular property is deemed to be reduced by an amount equal to the fair market value of the non-qualifying security acquired by the qualified donee…(emphasis added)

In the context of the first of the two examples contained in the Explanatory Notes, this provision is intended to have the effect of reducing the value for tax purposes of Mr. Z’s cash gift to $20,000 (being the amount of the gift less the value of the non-qualifying security acquired by the foundation). The provision works since the definition of “total charitable gifts” in subsection 118.1(1), as currently enacted and under the Draft Legislation, refers to “the total of all amounts each of which is the fair market value of a gift” (emphasis added).

However, an issue exists since the Split Receipting Rules rely on a different definition of the term “total charitable gifts”. If one were to apply the definition of “total charitable gifts” as proposed under the Split Receipting Rules, the relevant concept is the “eligible amount” which is set out in proposed subsection 248(31), not section 118.1 for which purposes paragraph 118.1(13.2)(a) is stated to apply. Thus, if one were to apply the definition of “total charitable gifts” as proposed under the Split Receipting Rules, proposed paragraph 118.1(13.2)(a) would have no effect since the amount of Mr. Z’s gift for the year would be whatever amount is determined by subsection 248(31) independent of proposed paragraph 118.1(13.2)(a).

It is also unclear how the Split Receipting Rules and Budget 2011’s non-qualifying security proposals are intended to interact more generally. For example, query how the non-qualifying security rules are intended to apply when an advantage is received by the donor or where the Split Receipting Rules would otherwise deem the FMV of a gift to be other than its actual FMV (e.g., if Mr. Z’s gift in Example 1 had been a gift of non-certified art acquired less than three years before the time of the donation).

Interaction with Existing Provisions

Just as it is unclear how Budget 2011’s non-qualifying security proposals are intended to interact with the Split Receipting Rules, it is also unclear how the proposals are intended to interact with certain existing provisions.

For example, subsection 118.1(6) provides that if an individual donates capital property, the individual may designate a value between the ACB and FMV of the donated property to be treated both as the individual’s proceeds of disposition for purposes of calculating the individual’s gain and the amount of the gift for purposes of calculating any charitable donation tax credit.

In Example 1 of the Explanatory Notes, Mr. Z made a gift of $120,000 to the private foundation. If the gift was a gift of capital property with an FMV of $120,000 and an ACB of $1, query how subsection 118.1(6) would apply. Proposed paragraph 118.1(13.2)(a) is stated to reduce the FMV of the gifted property for the purposes of section 118.1 and there is no carve-out for subsection 118.1(6). Accordingly, it would seem that the options available to Mr. Z in recognizing proceeds of disposition are full proceeds of $120,000 pursuant to paragraph 69(1)(b) where no designation is made under subsection 118.1(6) or proceeds not exceeding


36

$20,000 pursuant to a designation under subsection 118.1(6). A policy rationale for precluding a designation between $20,000 and $120,000 is not apparent.

Scope of Budget 2011 Proposals

More fundamentally, it is unclear whether Budget 2011 intended to preserve the “excepted gift” exception to the non-qualifying security rules or whether it proposes to extend the rules to apply to all gifts of non-qualifying securities, including gifts of shares to arm’s length qualified donees that are not private foundations.

While it appears that the intention is to preserve the “excepted gift” exception, it is not clear in the view of the authors that this has been achieved.

In this regard, as commented upon in more detail in the attached Schedule “A”:

it is unclear whether, for example, the particular person referred to in proposed paragraph 118.1(13.1)(b) needs to be someone other than the qualified donee referred to in proposed paragraph 118.1(13.1)(c) or whether the particular property referred to in proposed paragraph 118.1(13.1)(a) needs to be a property other than the non-qualifying security referred to in proposed paragraph 118.1(13.1)(c);

depending on how the provisions of subsection 118.1(13.1) are interpreted, it may be possible for the conditions of subsection 118.1(13.1) to be met on a direct gift of a non-qualifying security, including a gift meeting the conditions of an excepted gift as defined in subsection 118.1(19);

regardless of whether the intention of Budget 2011 is to apply the non-qualifying security rules to excepted gifts described in subsection 118.1(19), there appears to be a technical issue with the drafting of the new provisions in circumstances in which the deemed gift for purposes of proposed subparagraph 118.1(13.2)(b)(ii) meets the conditions of an excepted gift as defined in subsection 118.1(19) – more particularly, it appears that where the gift deemed to have been made by proposed subparagraph 118.1(13.2)(b)(ii) meets the conditions of an excepted gift, the provisions – as drafted – would preclude the donor from ever claiming a deduction or credit in respect of the value of the deemed gift, regardless of whether the donee disposes of the non-qualifying security for good consideration within the 60 month period.

In light of the issues and concerns noted previously, the authors anticipate that changes to the Draft Legislation in respect of non-qualifying securities may still be forthcoming.

Proposals Applicable to the Granting of Options to Qualified Donees

Practitioners will know that the Canadian federal income tax consequences of granting, exercising and otherwise disposing of options are, in many cases, less than clear, especially if the options fall outside the context of sections 7 and 49. Budget 2011 proposes to provide some clarity in respect of options granted to qualified donees on or after March 22, 2011, stating that:

Budget 2011 proposes to clarify that the Charitable Donations Tax Credit or Deduction is not available to a taxpayer in respect of the granting of an option to a qualified donee to


37

acquire property of the taxpayer until such time that the donee acquires property of the taxpayer that is the subject of the option. The taxpayer will be allowed a credit or deduction at the time of acquisition by the donee based on the amount by which the fair market value of the property at that time exceeds the total of amounts, if any, paid by the donee for the option and the property. Consistent with previously proposed measures containing split receipting, a Charitable Donations Tax Credit or Deduction generally will not be available to the taxpayer if the total amount paid by the qualified donee for the property and the option exceeds 80 per cent of the fair market value of the property at the time of acquisition by the donee.

While the passage above indicates that the credit or deduction is to be deferred until such time as the donee acquires property that is the subject of the option, the NWMM and the Draft Legislation also contemplate a deduction or credit being available if the option is disposed of by the donee otherwise than on account of exercise.

To effect the proposals, parallel provisions have been drafted for corporations and individuals. In the case of corporations, it is proposed that section 110.1 be amended by adding new subsections (10) through (13) after subsection (9) while, in the case of individuals, it is proposed that section 118.1 be amended by adding new subsections (21) through (24) after subsection (20).

In the section that follows, we reproduce and comment on the provisions in the Draft Legislation applicable to the granting of options by individuals. The provisions applicable to corporations are similar such that the same comments generally apply. As discussed below, the Draft Legislation appears to have introduced a drafting error such that the provisions– at least in the view of the authors – may well be further revised prior to their enactment.

Proposed Subsections 118.1(21), (22), (23) and (24)

Subsection 19(6) of the Draft Legislation provides that section 118.1 of the Act be amended by adding the following after subsection (20):

(21) Subject to subsections (23) and (24), if an individual has granted an option to a qualified donee in a taxation year, no amount in respect of the option is to be included in computing an amount under any of total charitable gifts, total Crown gifts, total cultural gifts or total ecological gifts in respect of the individual for any year.

(22) Subsection (23) applies if

(a) an option to acquire a property of an individual is granted to a qualified donee;

(b) the option is exercised so that the property is disposed of by the individual and acquired by the qualified donee at a particular time; and

(c) either

(i) the amount that is 80% of the fair market value of the property at the particular time is greater than or equal to the total of

(A) the consideration (other than a non-qualifying security of any person) received by the individual from the qualified donee for the property, and


38

(B) the consideration (other than a non-qualifying security of any person) received by the individual from the qualified donee for the option; or

(ii) the individual establishes to the satisfaction of the Minister that the granting of the option or the disposition of the property was made by the individual with the intention to make a gift to the qualified donee.

(23) If this subsection applies, notwithstanding subsection 49(3),

(a) the individual is deemed to have received proceeds of disposition of the property equal to the property’s fair market value at the particular time; and

(b) there shall be included in the individual’s total charitable gifts, for the taxation year that includes the particular time, the amount by which the property’s fair market value exceeds the total described in subparagraph (22)(c)(i).

(24) If an option to acquire a particular property of an individual is granted to a qualified donee and the option is disposed of by the qualified donee (otherwise than by the exercise of the option) at a particular time

(a) the individual is deemed to have disposed of a property at the particular time

(i) the adjusted cost base of which to the individual immediately before the particular time is equal to the consideration, if any, paid by the qualified donee for the option, and

(ii) the proceeds of disposition of which are equal to the lesser of the fair market value of the particular property at the particular time and the fair market value of any consideration (other than a non-qualifying security of any person) received by the qualified donee for the option; and

(b) there shall be included in the total charitable gifts of the individual for the individual’s taxation year that includes the particular time the amount, if any, by which the proceeds of disposition as determined by paragraph (a) exceed the consideration, if any, paid by the donee for the option. (emphasis added)

A comparison of the proposed provisions set out in the Draft Legislation to the earlier provisions set out in the NWMM reveals a number of differences.103 As discussed below, the more significant changes are the additions of carve-outs for non-qualifying securities in proposed subsection 118.1(22).

In describing the proposed provisions, the Explanatory Notes refer to the carve-out for non-qualifying securities in proposed subparagraph 118.1(24)(a)(ii), but do not explain why the

103 Some of these differences are instances of minor wordsmithing (e.g., changing “by which that fair market value

exceeds” in proposed paragraph 118.1(23)(b) to “by which the property’s fair market value exceeds”). Others are instances of harmonization with other rules (e.g., proposed subparagraph 118.1(22)(c)(i) has been changed from “is greater than” to “is greater than or equal to”, presumably to better accord with the proposed Split Receipting Rules).


39

carve-out has been included. 104 The carve-outs added to proposed clauses 118.1(22)(c)(i)(A) and (B) are not discussed in the Explanatory Notes.

In the view of the authors, it is not apparent what Finance was intending to achieve by way of the carve-outs and it appears that their inclusion may have the unintended effect of technically entitling taxpayers to a charitable donation tax credit or deduction in inappropriate circumstances (e.g., a fair market value sale by a taxpayer to a qualified donee in which a promissory note or other debt obligation is accepted by the taxpayer as payment).

In this regard and as commented upon in more detail in Schedule “B”:

the provisions provide that that upon the exercise of an option granted by an individual and the disposition of the underlying property to the qualified donee, there shall be included in the “total charitable gifts” of the individual for the year the amount by which the property’s fair market value exceeds the sum of proposed clauses 118.1(22)(c)(i)(A) and (B);

presumably, the intention is to permit the individual to claim a charitable tax credit based on the amount by which the FMV of the transferred property exceeds any consideration received by the individual in the course of the transactions – in other words, the individual should be entitled to claim a gift to the extent that he or she has been economically impoverished;

however, as a consequence of the carve-outs to proposed clauses 118.1(22)(c)(i)(A) and (B) for non-qualifying securities of any person, any consideration that takes the form of a non-qualifying security will be disregarded in determining the amount to be added to the individual’s total charitable gifts such that, in the extreme, it appears that an individual could sell a property to a qualified donee, receive FMV proceeds and technically claim a charitable tax credit based on the full FMV of the property.

In light of this issue, the authors anticipate that changes to the Draft Legislation applicable to the granting of options to qualified donees will be forthcoming.

A more minor observation on the drafting of proposed paragraphs 118.1(23)(b) and (24)(b) is that the provisions deem an amount to be included in the “total charitable gifts” of the individual regardless of the identity of the qualified donee or the nature of the underlying property. As a consequence, the percentage limitation set out in paragraph (a) of the definition of “total gifts” in subsection 118.1(1) will apply in all circumstances where an amount is determined under proposed paragraph 118.1(23)(b) notwithstanding that a direct gift of the particular property may have qualified as a “cultural gift” or “ecological gift” and, as such, not been subject to the limitation.

Proposals to Recover Tax Assistance for Returned Gifts

In keeping with the other proposals designed to tighten the rules applicable to qualified donees and limit unintended benefits to taxpayers, Budget 2011 sets out measures intended to ensure that a taxpayer cannot retain tax assistance in the form of a charitable donation tax credit or deduction if property supporting the credit or deduction (or property substituted for such

104 This carve-out was also in the NWMM.


40

property) is subsequently returned to the taxpayer.105 The measures are intended to address situations in which a charitable donation receipt was issued in error, as well as situations in which a transfer of property was a gift at law but is nevertheless returned to the donor.

Stated generally, the proposed provisions would:

deem the taxpayer to have neither disposed of the original property at the time of transfer to the qualified donee nor made a gift at such time;

if the returned property is identical to the original property, deem the returned property to be the original property;

if the returned property is not the original property:

o deem the taxpayer to have disposed of the original property, at the time the returned property is transferred to the taxpayer, for proceeds of disposition equal to the greater of (i) the FMV of the returned property at that time and (ii) the FMV of the original property at the time it was transferred to the qualified donee; and

o in some cases, deem the taxpayer to have transferred to the qualified donee, at the time of the original transfer, a property that is the subject of a gift having an FMV equal to the amount, if any, by which the FMV of the original property at the time of the original transfer exceeds the FMV of the property returned to the taxpayer;

if the FMV of the returned property exceeds $50, require the qualified donee to file an information return containing prescribed information within 90 days of the transfer and provide a copy of the return to the taxpayer;106 and

permit the Minister to reassess a return of income of any person to the extent that the reassessment can reasonably be regarded as relating to the transfer.107

105 Proposed subsections 110.1(14) and 118.1(25) provide that the rules would apply if a qualified donee has issued

an official donation receipt in respect of a transfer of a property (the “original property”) and a particular property that is:

(a) the original property is later transferred to [the taxpayer] (unless that later transfer is reasonable consideration or remuneration for property acquired by or services rendered to a person); or

(b) any other property that may reasonably be considered compensation for or a substitute for, in whole or in part, the original property, is later transferred to [the taxpayer].

Query whether the carve out in (a) applicable to a return of the original property should be added to (b) so as to clarify that the provisions would not apply if, for example, a donee were to sell the original property to a third-party in the ordinary course and subsequently transfer the proceeds of the sale to the donor as consideration for services rendered to the donee by the donor.

106 The requirement to file an information return was added as part of the Draft Legislation. The NWMM contemplated that the qualified donee provide the taxpayer with a revised official donation receipt and file a copy with the Minister; no time period for delivery and filing was specified in the NWMM.

107 Interestingly, although the Draft Legislation provides that the Minister may reassess a return of income of any person to the extent that the reassessment can reasonably be regarded as relating to the transfer, the Draft Legislation does not appear to amend the rules to permit reassessment outside the normal reassessment period despite the thinking of many that this was what the Budget measure contemplated. In this regard, the Draft


41

The returned proposals have received a negative reception from commentators, in part on the basis that the inclusion of the provisions in the Act might lead donors, charities and advisors who are not experts in charity law to think that it is appropriate for a charity to return gifts.108

Professional advice should be obtained before any return of a gift by a charity since, as a matter of common law, it is only in rare circumstances that property gifted to a charity may be returned to the donor. Furthermore, the contemplated divestiture may be in breach of the rules in the Act that prohibit a registered charity from gifting property to persons other than qualified donees. Such a breach could result in the imposition of sanctions or even the revocation of the entity’s charitable status.109

Proposals Intended to Enhance the Regulatory Regime for Qualified Donees

So as to “safeguard the tax system from abuse and to ensure compliance”, Budget 2011 proposes to extend a variety of rules currently applicable to registered charities to certain other qualified donees, namely:

registered Canadian amateur athletic associations (“RCAAAs”);

Canadian municipalities;

municipal and public bodies performing a function of government in Canada;

housing corporations resident in Canada and exempt from tax under Part I of the Act because of paragraph 149(1)(l);

universities outside of Canada that are prescribed to be universities the student body of which ordinarily includes students from Canada; and

certain charitable organizations outside of Canada to which Her Majesty in right of Canada has made a gift.110

In addition, Budget 2011 proposes to significantly alter the regulatory landscape applicable to RCAAAs.

We do not discuss the proposals to enhance the regulatory regime in detail; however, we do set out a few high level observations.

First, in order to maintain their status as qualified donees, the entities listed above will need to be registered by the Minister and listed on a publicly accessible list maintained by the CRA. They will also need to comply with the books and records requirements to which registered

Legislation appears not to amend the normal rules in section 152 applicable to assessments and proposed subsections 110.1(17) and 118.1(28) are not stated to override the normal limitation period in subsection 152(4).

108 See, for example, the August 2011 submission of the National Charities and Not-For-Profit Law Section of the Canadian Bar Association titled “Registered Canadian Amateur Athletic Associations and Charities Matters”, available at <http://www.cba.org/CBA/submissions/2011eng/>.

109 See, for example, subsections 149.1(2), (3) and (4). 110 The Government of Canada, provincial and territorial governments in Canada, and the United Nations and its

agencies are also qualified donees; however, Budget 2011 does not contemplate that they would be subject to the extended requirements.


42

charities are subject, with the exception that certain foreign entities will be permitted to keep their books and records in their own jurisdiction provided that such records are made available in Canada upon request by the CRA. Historically, the books and records requirements applicable to registered charities have been given an expansive interpretation by the CRA. Accordingly, it is not unlikely that entities not previously subject to these rules will need to take steps to ensure compliance. In the case of existing entities, professional advice should be sought well in advance of the proposed implementation date (i.e., the later of the day on which the legislation is assented to and January 1, 2012).

Second, in respect of RCAAAs, these entities are currently required to have as their primary purpose and primary function the promotion of amateur athletics in Canada on a nation-wide basis.111 Budget 2011 proposed that the Act be amended to require that an RCAAA be required, as a condition for registration:

to have, as its exclusive purpose and its exclusive function, the promotion of amateur athletics in Canada on a nation-wide basis, and

to devote all of its resources to the exclusive purpose and exclusive function of the association, except to the extent permitted by subsection 149.1(6.2) as it applies to registered charities in respect of political activities.112

On July 4, 2011, Finance announced that it was seeking comment on the proposed introduction of the exclusivity of purpose and function test for RCAAAs. More particularly, the consultation document stated as follows:

The Department of Finance is inviting stakeholders to comment on a proposal made in Budget 2011 as part of a package of initiatives to strengthen the regulatory framework that applies to registered Canadian amateur athletic associations (RCAAAs).

Specifically, stakeholders are invited to provide feedback on the proposal to require RCAAAs to operate for the “exclusive purpose and exclusive function” of promoting amateur athletics on a nationwide basis, rather than “primarily” for this purpose, as is currently required.

111 Subsection 248(1) – “registered Canadian amateur athletic association”. 112 In this regard, it is proposed that the definition of “registered Canadian amateur athletic association” in

subsection 248(1) be amended to refer to “a Canadian amateur athletic association […] that has applied to the Minister in prescribed form for registration, that has been registered and whose registration has not been revoked” and that the term “Canadian amateur athletic association” be defined in subsection 149.1(1) to mean an association that:

(a) was created under any law in force in Canada,

(b) is resident in Canada,

(c) has no part of its income payable to, or otherwise available for the personal benefit of, any proprietor, member or shareholder of the association unless the proprietor, member or shareholder was a club, society or association the primary purpose and primary function of which was the promotion of amateur athletics in Canada,

(d) has the promotion of amateur athletics in Canada on a nation-wide basis as its exclusive purpose and function, and

(e) devotes all of its resources to that purpose and function.


43

This proposed change would extend to RCAAAs the same key regulatory requirements that apply to registered charities, which are required to operate exclusively for charitable purposes. In addition, RCAAAs would be subject to the same accountability as registered charities regarding the use of tax-assisted funds.

Under the enhanced framework, RCAAAs would still be permitted to stage or engage in international events and competitions, as well as other activities that are consistent with their mandate to promote amateur athletics in Canada. In addition, consistent with the tax regime for registered charities, certain related activities would be permitted. RCAAAs would be permitted to carry on related business activities, such as selling merchandise related to their sport, and to engage in limited non-partisan political activities.

The public consultation is welcome since there are a number of significant policy and technical issues with the draft proposals, including issues of scope and “related business” and “undue benefit” concerns. For a good discussion, the reader is referred to the August 2011 submission of the National Charities and Not-For-Profit Law Section of the Canadian Bar Association titled “Registered Canadian Amateur Athletic Associations and Charity Matters”.113

Third, the Charities Directorate of the CRA has posted on its Charities and Giving web pages various questions and answers in relation to the proposals in Budget 2011.114 In respect of RCAAAs in particular, the following questions and answers are noteworthy:

4. How can an RCAAA ensure it continues to qualify under the new rules?

The CRA recommends that RCAAAs review their purposes and activities to determine if they are functioning exclusively to promote amateur athletics in Canada on a nation-wide basis. If an RCAAA determines that it has unrelated purposes, appropriate amendments would be required in order to come into compliance with the revised definition.

5. If changes are required, by when must they be made?

The Budget proposes that the rules will apply on the later of January 1, 2012, or the date that the legislation receives Royal Assent. The CRA will also allow additional time for changes to an RCAAA’s formal purposes, provided that the RCAAA is able to demonstrate that it is taking reasonable steps to become compliant.

6. What if an RCAAA cannot meet the new requirements?

The RCAAA can ask CRA for voluntary revocation. The RCAAA will be able to retain its assets and might continue to qualify for tax exemption as a non-profit organization. However, it will no longer be able to issue receipts for income tax purposes or receive funds from registered charities. The determination as to whether an organization qualifies for tax exemption as a non-profit organization is made by the CRA's Tax Services Offices. Go to Non-profit organizations for more information on these organizations. (bolding original; underlining added)

113 Available at <http://www.cba.org/CBA/submissions/2011eng/>. 114 Available at <http://www.cra-arc.gc.ca/chrts-gvng/chrts/bdgts/2011/>.


44

Proposals Intended to Safeguard Charitable Assets through Good Governance

Budget 2011 introduces the concept of an “ineligible individual” and proposes that the Minister be given the discretion to refuse or revoke the registration of a charity or Canadian amateur athletic association, as well as discretion to suspend the authority of a registered charity or RCAAA to issue official donation receipts, if a member of the board of directors, a trustee, officer or equivalent official, or any individual who otherwise controls or manages the operation of the organization is such a person.

As set out in the Draft Legislation, an ineligible individual, at any time, is proposed to mean an individual who has been:

(a) convicted of a relevant criminal offence for which a pardon has not been granted,

(b) convicted of a relevant offence in the five-year period preceding that time,

(c) a director, trustee, officer or like official of a registered charity or a registered Canadian amateur athletic association during a period in which the charity or association engaged in conduct that can reasonably be considered to have constituted a serious breach of the requirements for registration under [the Act] and for which the registration of the charity or association was revoked in the five-year period preceding that time,

(d) an individual who controlled or managed, directly or indirectly, in any manner whatever, a registered charity or a registered Canadian amateur athletic association during a period in which the charity or association engaged in conduct that can reasonably be considered to have constituted a serious breach of the requirements for registration under [the Act] and for which its registration was revoked in the five-year period preceding that time, or (e) a promoter in respect of a tax shelter that involved a registered charity or a registered Canadian amateur athletic association, the registration of which was revoked in the five-year period preceding that time for reasons that included or were related to participation in the tax shelter.

“Relevant criminal offence” is defined as “a criminal offence under the laws of Canada, and an offence that would be a criminal offence if it were committed in Canada, that (a) relates to financial dishonesty, including tax evasion, theft and fraud, or (b) in respect of a charity or Canadian amateur athletic association, is relevant to the operation of the charity or association”.

“Relevant offence” is defined as “an offence, other than a relevant criminal offence, under the laws of Canada or a province, and an offence that would be such an offence if it took place in Canada, that (a) relates to financial dishonesty, including an offence under charitable fundraising legislation, consumer protection legislation and securities legislation, or (b) in respect of a charity or Canadian amateur athletic association, is relevant to the operation of the charity or association”.


45

The CRA has stated that it will be developing detailed administrative guidance on how these rules will be applied.115

NON-PROFIT ORGANIZATIONS

Paragraph 149(1)(l) Overview

As noted above, the Act contains a very broad exemption from income tax for a range of clubs, societies and associations described in paragraph 149(1)(l) and commonly referred to by practitioners as NPOs. More particularly, paragraph 149(1)(l) provides that no tax is payable under Part I of the Act on the taxable income of a person for a period when that person was:

a club, society or association that, in the opinion of the Minister, was not a charity within the meaning assigned by subsection 149.1(1) and that was organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit, no part of the income of which was payable to, or otherwise available for the personal benefit of, any proprietor, member or shareholder thereof unless the proprietor, member or shareholder was a club, society or association the primary purpose and function of which was the promotion of amateur athletics in Canada.116

While the paragraph 149(1)(l) exemption is relatively simple on its face, its application is fraught with difficulty. Indeed, the requirement that NPOs be “organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit” has proved particularly problematic and has given rise to a fair amount of litigation.117 118

From time to time, the CRA has issued technical interpretations and other publications commenting on the conditions an organization must meet in order to qualify for the exemption. While practitioners and the CRA have long disagreed over how the requirements of paragraph 149(1)(l) should be interpreted, the divide widened in 2009 upon the issuance by the CRA of a number of technical interpretations and other publications that appeared to signal a more restrictive approach to the provision notwithstanding that many commentators believed that the CRA’s views were already too restrictive and had not kept up with the jurisprudence.

The section below sets out passages from some of the CRA’s pre-2009, 2009 and post-2009 positions with a view to highlighting how publications released in late 2010 and thus far in 2011 may represent a subtle shift or refinement in the CRA’s thinking. The post-2009 positions may

115 http://www.cra-arc.gc.ca/gncy/bdgt/2011/qa22-eng.html#_Toc288651106a, as at September 21, 2011. 116 Unlike in the case of charities that need to be registered by the Minister in order to benefit from tax exemption,

the exemption provided for NPOs by paragraph 149(1)(l) is automatic. However, if the organization ceases to meet the requirements of paragraph 149(1)(l), the organization will cease to be entitled to the exemption without any action being required of the Minister.

117 See, for example, BBM Canada v. R., 2008 DTC 4129 (TCC); Canadian Bar Insurance Assn. v. R., 99 DTC 653 (TCC); L.I.U.N.A. Local 527 Members' Training Trust Fund v. R., 92 DTC 2365 (TCC); Tourbec (1979) Inc. c. R., 88 DTC 1439 (TCC); and Gull Bay Development Corp. v. R., 84 DTC 6040 (FCTD).

118 Citing “indications of non-compliance in the NPO sector”, the CRA recently launched an audit project aimed at NPOs. The CRA explained at the CRA Round Table at the 2010 Canadian Tax Foundation’s Annual Conference that the purpose of this project – referred to as the NPO Risk Project – is to assist in determining “the level of non-compliance, any significant data gaps that may require mandatory filing of prescribed forms, and whether recommendations to the Dept. of Finance for more robust legislation are needed”.


46

indicate that the CRA has at least modified some of the more troubling language used in articulating its views in the 2009 positions.119

CRA’s Position Regarding Paragraph 149(1)(l)

Pre-2009 – IT-496R

Prior to 2009, one of the key documents setting out the CRA’s views on paragraph 149(1)(l) was the 2001 interpretation bulletin, IT-496R “Non-Profit Organizations”. In this document, the CRA commented as follows on the circumstances in which an organization would be considered to have a purpose other than profit:

7. It will be a question of fact to be determined with regard to the particular circumstances as to whether an association is carrying on a trade or business and if so, whether it will result in a finding that an association is not operated exclusively for non-profit purposes. Some characteristics that might indicate that an activity is a trade or business are as follows:

(a) it is a trade or business in the ordinary meaning, that is, it is operated in a normal commercial manner;

(b) its goods or services are not restricted to members and their guests;

(c) it is operated on a profit basis rather than a cost recovery basis; or

(d) it is operated in competition with taxable entities carrying on the same trade or business.

Generally, the carrying on of a trade or business directly attributable to, or connected with, pursuing the non-profit goals and activities of an association will not cause it to be considered to be operated for profit purposes.

8. An association may earn income in excess of its expenditures provided the requirements of the Act are met. The excess may result from the activity for which it was organized or from some other activity. However, if a material part of the excess is accumulated each year and the balance of accumulated excess at any time is greater than the association's reasonable needs to carry on its non-profit activities (see ¶ 9), profit will be considered to be one of the purposes for which the association was operated. This will be particularly so where assets representing the accumulated excess are used for purposes unrelated to its objects such as the following:

(a) long-term investments to produce property income;

(b) enlarging or expanding facilities used for normal commercial operations; or

(c) loans to members, shareholders or non-exempt persons.

119 This paper does not review the relevant jurisprudence or comment in detail on the CRA’s 2009 and pre-2009

positions as numerous articles have already been written on the subject. See, for example, Robert B. Hayhoe and Gail P. Black, "Charities and Not-For-Profit Update," 2011 Prairie Provinces Tax Conference, (Toronto: Canadian Tax Foundation, 2011), 3:1-30.


47

This may also be the case where the accumulated excess is invested in a term deposit or guaranteed investment certificate that is regularly renewed within a year and from year to year, whether or not the principal is adjusted from time to time.

9. The amount of accumulated excess income considered reasonable in relation to the needs of an association to carry on its non-profit activities and goals is a question of fact to be determined with regard to the association's particular circumstances, including such things as future anticipated expenditures and the amount and pattern of receipts from various sources (e.g., fund raising, membership fees, training course fees). …

As discussed above, accumulating surplus funds in excess of its current needs may affect the association's status as a tax-exempt NPO. However, in certain cases, when an association requires a time period in excess of the current and prior year to accumulate the funds needed to acquire a capital property that will be used to achieve its declared exempt activities, the association's tax-exempt status may not be affected. For example, this could be the case if an association annually sets aside funds to provide for a special project such as the construction of a new building to replace an existing building when it deteriorates or no longer meets the association's needs. In such cases, any funds accumulated for this purpose should be clearly identified and all transactions concerning a special project should be clearly set out in the association's accounting records. Provided the funds accumulated for a special project are used for that project, an association's tax-exempt status should not be affected. (emphasis added)

2009 – The Start of Something New?

In late 2009, the CRA issued two technical interpretations that appeared to signal a shift in the CRA’s position and sparked considerable outcry in the community.120

In the first interpretation (the “November 2009 Technical”),121 the CRA was asked to consider a number of questions, including whether an organization could intentionally earn a profit and still be exempt from tax under paragraph 149(1)(l) so long as the profit were used solely for the purpose of supporting the organization’s non-profit objectives.

In response, the CRA took the position that any profit should generally be “unanticipated and incidental to the purposes of the organization”, and that an organization generally will not qualify as an NPO if it intends to earn a profit even if it expects to use that profit to finance future capital projects or otherwise support its not-for-profit objectives. More particularly, the CRA stated as follows:

Paragraph 149(1)(l) of the Act requires that an organization be organized and operated "exclusively" for "any other purpose except profit" in order to be exempt from tax under that provision. In our view, the use of the word "exclusively" indicates that while an organization may have many purposes, none of those purposes may be to earn a profit. Thus, where an organization intends, at any time, to earn a profit, it will not be exempt from tax under paragraph 149(1)(l) even if it expects to use or actually uses that profit to support its not-for-profit objectives.

120 Despite the indications of a shift in position, the CRA continued to refer to IT-496R from time to time in 2010; as

at the time of writing, the bulletin does not appear to have been referred to by the CRA in any published 2011 technical interpretation or ruling although it remains in effect.

121 CRA Document No. 2009-0337311E5, dated November 5, 2009.


48

The CRA accepts that a 149(1)(l) entity can earn a profit; otherwise, the tax exemption provided would be unnecessary. Earning a profit, in and of itself, does not prevent an organization from being a 149(1)(l) entity. However, the profit should generally be unanticipated and incidental to the purpose or purposes of the organization. For example, an organization might budget with the intention of not earning a profit, but ultimately find itself with a profit because of expenses that were less than anticipated or that were reasonably expected but not actually incurred. If the original budget was reasonable, the profit earned would not, in and of itself, cause the organization to cease to be a 149(1)(l) entity.

…

…it is our view that in determining whether there is a profit purpose, "profit" should be given its ordinary commercial meaning, which does not include deductions for amounts related to future capital projects.

There are instances when a 149(1)(l) entity may have funds on hand in excess of its immediate operating requirements. While retaining excess funds may be evidence that an organization is operating with a profit purpose, generally, this will not in and of itself result in the organization failing to qualify as a 149(1)(l) entity. For example, in our view, a 149(1)(l) entity may accumulate members' contributions over a period of years in order to finance a planned, future capital project. Also, we acknowledge that the entity may earn reasonable investment income with respect to such accumulated funds, even though such income might otherwise be considered anticipated profit. However, if the excess funds were collected for the purpose of earning investment income rather than for the purpose of funding a specific capital project, then this would be a profit purpose and the organization would no longer be a 149(1)(l) entity. (emphasis added)

In the second interpretation (the “December 2009 Technical” and, together with the November 2009 Technical, the “2009 Technicals”), the CRA was asked to comment on (i) whether a condominium corporation could rent a suite for an amount in excess of its costs of operating and maintaining the suite and still qualify for the paragraph 149(1)(l) exemption, and (ii) whether the tax exemption would be affected if rental profits were used to reduce members’ fees. In response, the CRA stated:

While Income Tax Technical News # 4 [ITTN-4] comments that "most residential condominium corporations will qualify as non-profit organizations under paragraph 149(1)(l)" it also indicates that this is because it was assumed that such entities normally operate exclusively for any purpose except profit. Whether any entity operates exclusively for any purpose except profit is a factual determination that must be made on a case-by-case basis.

In order to meet the requirement of operating exclusively for any other purpose except profit, a condominium corporation can only offer services for which the fees charged are approximately equal to the amount the condominium corporation expects to incur to provide such services. A condominium corporation cannot intentionally charge fees in excess of costs; to do so is operating with a profit purpose. Thus, a condominium corporation that intentionally rents out a suite for an amount higher than the expected cost of maintaining and operating that suite does not qualify for the exemption provided by paragraph 149(1)(l) of the Act. This position applies equally to all activities a


49

condominium corporation might choose to undertake, such as the operation of a parking lot, laundry facilities or a fitness/health centre.

With respect to your second question, we agree that when a condominium corporation reduces members' fees as a consequence of intentionally charging rent in excess of expected costs, this would generally be considered to be making the income of the condominium corporation available for the personal benefit of its members.

As a final note, we understand that condominium corporations may levy amounts from members that are put aside for identified capital projects, for example, putting a new roof on a building. As the cost of such capital projects may be considerable, the condominium corporation may choose to collect these amounts over several years in order to raise the necessary funds. The CRA accepts that collecting amounts in this manner will not, in and of itself, prevent the condominium corporation from being exempt under 149(1)(l) of the Act. Moreover, a condominium corporation can earn reasonable interest income with respect to this fund and continue to qualify for the tax exemption. However, a condominium corporation cannot intentionally collect amounts in excess of what is reasonable to fund these identified capital projects, nor may it use these funds to aggressively earn investment income. Either of these two actions could result in a condominium corporation not meeting the criteria of paragraph 149(1)(l). (emphasis added)

On June 25, 2010, the CRA issued another technical interpretation122 in response to follow-up questions received with respect to the December 2009 Technical. In the June 2010 interpretation, the CRA reiterated its position that it would likely be problematic for a condominium corporation to rent out a guest suite during the 2010 Olympic Games for an amount significantly in excess of cost, and clarified that its position would be the same if, instead of using the income to directly reduce condominium fees for members, the corporation used the income to fund future capital projects. As stated by the CRA:

A condominium corporation is not exempt from tax simply by virtue of being a condominium corporation. It will only qualify for the exemption from tax provided by paragraph 149(1)(l) of the Act if it is operating exclusively for any purpose other than profit (among other criteria). This means that, generally, the condominium corporation cannot undertake activities that are intended to produce a profit, especially from transactions with third parties, and continue to meet the requirements of paragraph 149(1)(l). A 149(1)(l) entity should budget and charge fees for services so as to operate at cost, however, the Canada Revenue Agency ("CRA") accepts that a condominium corporation may charge fees to its members that include a portion to be allocated toward an identified capital project (such as a new roof).

In limited circumstances, it is possible for a 149(1)(l) entity to earn a profit and still qualify for the tax exemption found in paragraph 149(1)(l) of the Act. Apart from earning certain investment income as described below, a 149(1)(l) entity may earn a profit that is incidental to the entity's exclusively not-for-profit purposes. However, earning a profit that is incidental to an entity's not-for-profit purposes is not the same thing as earning a profit in support of the entity's not-for-profit purposes. The "destination of funds" argument has

122 CRA Document No. 2010-0357831E5, dated June 25, 2010.


50

been rejected by Canadian courts with respect to the funding activities of both charities (as defined under common law and in section 149.1 of the Act), and 149(1)(l) entities.

Paragraph 149(1)(l) of the Act precludes a 149(1)(l) entity from making income "available for the personal benefit of . . . any member". The CRA is particularly concerned about income being available for the benefit of members in situations where income is derived from outside (non-member) sources, other than basic investment income earned on (1) contributed amounts (or fees) from members that are earmarked for a particular capital project, or (2) reasonable operating reserves derived from member fees or incidental, generally unanticipated, income. Reasonable operating reserves generally refer to reserves maintained to meet existing, but conditional liabilities.

In the situation described in your previous letter, it appears that members of the condominium corporation will benefit, either directly or indirectly, from income earned by the corporation from an outside source. We note that condominium owners are already in an advantageous situation, compared to home-owners, with respect to the taxation of investment income on savings toward capital projects.

In summary, while the CRA recognizes that a 149(1)(l) entity may have several purposes, none of these purposes can be to earn a profit, even if that profit is intended to be used to meet the not-for-profit purposes of the entity. The condominium corporation you described to us in your original letter intended to charge rent to a third party at a rate significantly in excess of cost. The surplus generated was not incidental to the corporation's exclusively not-for profit purposes. Consequently, the condominium corporation did not appear to meet the requirements of paragraph 149(1)(l) of the Act during the period of the rental arrangement. However, whether or not a profit is incidental to the not-for-profit purposes of a particular entity is a question of fact that can only be determined upon a review of all the facts by the entity's Tax Services Office.

In your letter, you ask whether our answer would be different if the rental profit generated was set aside in a reserve fund intended to support future capital projects of the corporation. As explained above, and in our previous letter, intentionally undertaking a profitable activity will generally cause an entity to cease to meet the requirements of paragraph 149(1)(l) of the Act, regardless of how the profits are used after the fact. (emphasis added)

Post-2009 – Making Sense of It All

Perhaps not surprisingly given the uncertainty in respect of paragraph 149(1)(l) generally, the attention generated by the release of the 2009 Technicals and the recent launch by the CRA of the NPO Risk Project,123 2011 has seen the release by the CRA of a host of technical interpretations and other publications dealing with paragraph 149(1)(l). In particular, the post-2009 positions may indicate that the CRA is at least no longer expressly stating that profits that are incidental and derived from activities undertaken to meet its not-for-profit objectives must also be “unanticipated.”

123 As noted above, the CRA explained at the CRA Round Table at the 2010 Canadian Tax Foundation’s Annual

Conference that the purpose of this audit project aimed at NPOs is to assist in determining “the level of non-compliance, any significant data gaps that may require mandatory filing of prescribed forms, and whether recommendations to the Dept. of Finance for more robust legislation are needed”.


51

While the tenor of the documents dealing with the purpose limitation is generally consistent, the language employed by the CRA has varied from document to document and it is possible that some of these more recent documents represent a subtle shift or refinement in the CRA’s thinking from that set out in the 2009 documents.

Some of the documents that the authors consider to be the most interesting vis-à-vis the CRA’s interpretation of the purpose limitation are the following:

Technical Interpretation 2010-0380581I7 – Paragraph 149(1)(l) of the Income Tax Act (April 7, 2011)

In this document, the CRA sets out in bullet form seven general comments with respect to the requirement that an NPO be operated for any purpose except profit and provides examples of profitable activities that might be undertaken through an NPO. More particularly, it states:

With respect to the requirement to be operated for any purpose except profit, we have the following general comments that may be of assistance to you:

* An organization can earn profits, but the profits should be incidental and arise from activities that are undertaken to meet the organization's not-for-profit objectives (these profits are referred to below as "incidental profits").

* Earning profits to fund not-for-profit objectives is not considered to be itself a not-for-profit objective.

* An organization should fund capital projects and establish (reasonable) operating reserves from capital contributed by members, from gifts and grants, or from accumulated, incidental profits.

* Capital contributions, gifts and grants, and incidental profits should generally be accumulated solely for use in the operations of the organization (including funding capital projects or setting up operating reserves) and should not be used to establish long-term reserves designed primarily to generate investment income.

* Maintaining reasonable operating reserves or bank accounts required for ordinary operations will generally be considered to be an activity undertaken to meet the not-for-profit objectives of an organization. Consequently, incidental income arising from these reserves or accounts will not affect the status of an organization.

* Limited fundraising activities involving games of chance (e.g., lotteries, draws), or sales of donated or inexpensive goods (e.g., bake sales or plant sales, chocolate bar sales), generally


52

do not indicate that the organization as a whole is operating for a profit purpose.

* In determining whether an organization has any profit purpose, the activities of the organization must be reviewed both independently and in the context of the organization as a whole.

For an example of a situation in which the court found profits from business activities to be incidental to the organization, see the Federal Court Trial Division decision in Gull Bay Development Corporation v. HMQ, [1984] C.T.C. 159, 84 D.T.C. 6040. In this decision, the court held that the purpose of a logging operation was exclusively to provide employment and training opportunities to members of a First Nations band, and to support the general socio-economic development of the band's community. The decision in Tourbec (1979) Inc. v. MNR, [1988] 2 C.T.C. 2071, 88 D.T.C. 1442 (TCC) discusses the opposite situation, where the profitable activities were found to be a purpose of the organization.

Other examples of profitable activities that might be undertaken through a 149(1)(l) organization include running a canteen at a rink used for amateur hockey or a cafeteria at a not-for-profit youth hostel, or charging admission above direct cost for a children's concert (where the not-for-profit purpose of the organization was to organize and promote youth participation in music). In all of these cases, the profitable activities are directly in support of not-for-profit objectives -- providing appropriate facilities, promoting participation in music -- and will generally be incidental in terms of the amounts involved and the scope of the activities compared to the operations of the organization as a whole.

An organization will not be exempt from tax pursuant to paragraph 149(1)(l) of the Act if earning profits is a purpose of the organization, even if the profits are destined to support the not-for-profit purposes of the organization or another organization. This "destination of funds" argument has been rejected by the Canada Revenue Agency and the courts on numerous occasions for both charities and 149(1)(l) organizations. (emphasis added)

Technical Interpretation 2011-0394251I7 – Paragraph 149(1)(l) (April 7, 2011)

In this document, the CRA sets out its reasons for concluding that an association that operated a retail operation did not qualify for the paragraph 149(1)(l) exemption for its 2007 to 2010 taxation years, despite the association’s laudable aims. In so doing, the CRA states:

The Association may have, at one time, fit within the parameters of the Gull Bay decision (although this is not clear); in any event, this is no longer the case. The profit earned by the Association is


53

no longer incidental to its otherwise not-for-profit activities; instead, the Association appears to be a for-profit enterprise, operating in direct competition with taxable businesses, within the guise of a not-for-profit organization. Although the Association's ultimate aims may be laudable, it has a profit purpose and does not qualify for the exemption from tax provided by paragraph 149(1)(l) of the Act. In this it is no different from any for-profit business that decides to provide its profits to a worthwhile cause; such a business is only eligible for a reduction in tax to the extent that the donation is a gift to a registered charity (or other eligible donee) and a charitable donation receipt is obtained.

Significantly, the facts provide that during an interview with the general manager, he indicated that the association needed to earn a profit each year in order to support its non-profit objectives.

Technical Interpretation 2010-0380451E5 – Condominium corporation – solar panels (May 5, 2011)

In this document, the CRA comments as follows in the context of a condominium corporation that proposed to install solar panels on its roof in order to generate electricity which would be sold to the Ontario Power Authority under its “Fee in Tariff” program:

In order to qualify for the tax exemption described above, a condominium corporation must be organized and operated exclusively for any purpose other than profit, and none of its income can be available for the personal benefit of its members. The courts have recognized that an organization claiming a paragraph 149(1)(l) exemption can earn a profit, as long as the profit is incidental and arises from activities directly connected to its not-for-profit objectives. For example, maintaining reasonable operating reserves or bank accounts required for ordinary operations will generally be considered to be an activity undertaken to meet the not-for-profit objectives of an organization. Consequently, incidental profit arising from these reserves or accounts will not affect the tax-exempt status of an organization. Profit that is incidental and connected to the not-for-profit objectives of an organization, and that is used within the organization to support those objectives, generally is not taken into account in determining whether income is available for the personal benefit of a member.

Whether the profit earned from the "Feed in Tariff" program or any other activity is incidental and connected to the not-for-profit objectives of your residential condominium corporation can only be determined once all the facts have been reviewed at the end of a taxation year. However, we are generally of the view that the solar panel project may be connected to the not-for-profit objectives of your condominium corporation. If this is the case, and the profit related to the project is incidental, then participation


54

in the "Feed-in Tariff" program would not prevent the corporation from claiming the tax exemption provided by paragraph 149(1)(l) of the Act. (emphasis added)

Technical Interpretation 2010-0379561I7 – Condominium corporation – 149(1)(l) (June 21, 2011)

In this document, the CRA concluded that a condominium corporation operating a public golf course did not qualify for the paragraph 149(1)(l) exemption. Items remarked on by the CRA included the fact that: (i) the corporation budgeted to earn a profit from the operation of the golf course, (ii) the financial statements recorded net income from the golf course, the majority of which came from non-members, (iii) the amount of the net income appeared to be “more than incidental talking into account the overall budget of the Corporation”; (iv) the Corporation listed “land for resale” on its financial statements, suggesting a profit purpose in acquiring the land, (v) the operation of a golf course is not viewed by CRA as supporting the not-for-profit objectives of a condominium corporation, and (vi) the corporation allowed its income to be available for the personal benefit of its members to the extent that income from the golf course was used to reduce the amount of condo fees paid by member and as well as to the extent that members of the corporation (i.e., condo owners) were allowed free rounds of golf. The CRA reasoned that in order to provide the free golf, the associated expenses were likely paid out of income earned from non-members and stated that the amount of the benefit received by the members in respect of the free golf not only prevented the corporation from qualifying from the exemption but also appeared to be a shareholder benefit. The CRA also commented on the corporation’s reserve funds and stated that, while amounts required to be maintained by provincial legislation would generally be reasonable, the corporation’s unrestricted reserve fund could be additional evidence that the corporation was not operating exclusively for a purpose other than profit.

Technical Interpretation 2011-0405541I7 – Condo corporations; cell towers (July 13, 2011)

In this document, the CRA responded as follows to a request that it comment on the tax implications vis-à-vis paragraph 149(1)(l) of condominium corporations entering into arrangements in which (i) a telecommunications provider pays rent in order to set up a cell tower on space that forms part of the common area of the condominium building or premises, and (ii) amounts paid by the telecommunications provider for the use of space are generally significant and directly connected to a reduction in members’ condominium fees:

Although we agree with you that, based on this analysis, cell tower arrangements may jeopardize the tax-exempt status of a condominium corporation, we are of the view that in many cases the income is not the income of the corporation but is instead the income of the unit owners. While each case would have to be reviewed separately on its facts and applicable provincial law, it appears that in most situations the space being rented does not belong to the corporation; rather, the corporation may be better viewed as acting as an agent for the unit owners in entering into any cell tower arrangements. If this is the case, then such arrangements generally would not jeopardize the tax-exempt


55

status of the corporation, although the related profit would have to be allocated appropriately among unit owners for tax purposes.

…

[W]e are of the view that incidental income from the rental of common areas may be treated as income of the condominium corporation and generally will not affect the tax-exempt status of the corporation. Incidental, in this context, means both minor and directly related to activities undertaken to meet the corporation's not-for-profit objectives of managing and maintaining the condominium property and required reserves.

Income that is not incidental will usually be considered to be income of the unit owners, if this is appropriate under the relevant provincial law. Where the relevant provincial law indicates that the income is the income of the corporation, then we agree that the corporation may not be tax-exempt pursuant to paragraph 149(1)(l) of the Act. In particular, we share your concern that income from a cell tower arrangement would likely be available for the personal benefit of members of the corporation through a material reduction in members' condominium fees. (emphasis added)

Accordingly, as indicated above, the post-2009 positions may indicate that the CRA is at least no longer expressly stating that profits must be “unanticipated” even where they are “incidental” and derived from activities undertaken to meet the relevant not-for-profit objectives.

Paragraph 149(1)(l) and Subsection 15(1) Shareholder Benefits

On a related topic, practitioners should also be aware of the fact that the CRA may seek to reassess taxpayers on the basis that a subsection 15(1) shareholder benefit has been conferred by a corporation thought to be an NPO, including NPOs that are non-share capital corporations.

In 2011, this possibility was alluded to by the CRA in the June 21, 2011 document referred to above dealing with a condominium corporation that operated a public golf course and provided free rounds of golf to its members.124 It was also the topic of another technical interpretation125 issued in the context of a corporation the objects of which were to purchase, maintain and manage land for the benefit of the corporation’s shareholders who built and owned cottages on such land. The CRA stated:

We understand that the objects of your corporation (the "Corporation") are to purchase, maintain and manage a property (the "Property") for use by its shareholders. The shareholders have built, and personally own, cottages on the Property. In our

124 CRA Document No. 2010-0379561I7, dated June 21, 2011. 125 CRA Document No. 2010-0379561I7, dated June 23, 2011. This document was issued further to an earlier

technical interpretation (CRA Document No. 2010-035802, dated June 28, 2010)) in which the CRA commented on the tax implications with respect to the sale of a piece of land by the corporation.


56

initial letter, we indicated that provided that the Corporation met the conditions in paragraph 149(1)(l) and subparagraph 149(5)(e)(ii), the gains realized from the sale of a particular piece of the Property would likely not be taxable to the Corporation. In addition, we indicated that the Corporation would be able to make payments to its shareholders without jeopardizing its status under paragraph 149(1)(l) as long as those payments were made from the gains realized from the sale.

Further to that letter, and in respect of subsequent telephone conversations with you…, we note that, as operated, the Corporation may be providing a subsection 15(1) benefit to its shareholders. This benefit arises because it does not appear that the Corporation, being operated as a 149(1)(l) entity, is receiving fair market value payments from the shareholders for the use of the Property.

Although the shareholders may have acquired a right to use the Property along with their shares (or as a share right), unless separate fair market value consideration was paid for the use of the Property, either at the time of purchase or subsequently, we are of the view that there may be a shareholder benefit if the shareholders are only paying a cost amount for the use of the Property. The shareholder benefit would be the difference between the current annual cost to the shareholders and the fair market value of the use of the Property. According to paragraph 11 of Interpretation Bulletin IT-432R2, "Benefits Conferred on Shareholders":

If corporate property is made available for the personal use of a shareholder, a benefit under subsection 15(1) is generally considered to have been conferred on the shareholder. This is so whether or not the shareholder has contributed to the cost of the property or has paid any related operating expenses . . . The calculation of the amount or value of the benefit is usually based on the fair market rent for the property minus any consideration paid to the corporation by the shareholder for the use of the property. (emphasis added)

AUTHOR INFORMATION

Of McCarthy Tétrault LLP


57

SCHEDULE “A” – BUDGET 2011 PROPOSALS RE NON-QUALIFYING SECURITIES

Scope of Budget 2011 Proposals

As discussed above, the preamble to subsection 118.1(13) contains a carve-out for an excepted gift which is defined in subsection 118.1(19) to mean, stated generally, a gift of shares to a non-private foundation donee with which the donor deals at arm’s length and, where the donee is a charitable organization or a public foundation, the donor deals at arm’s length with each director, trustee, officer and like official of the donee.

The Draft Legislation does not affect the preamble to subsection 118.1(13), nor does it contain any amendment to subsection 118.1(19).

Had the intention of Budget 2011 been to extend the non-qualifying security rules to all gifts of non-qualifying securities, it would have been logical to expect Finance to remove the carve-out in the preamble to subsection 118.1(13) and to revoke subsection 118.1(19) in its entirety. The fact that these changes were not made supports the view that Budget 2011 intended to preserve the exception for gifts described in subsection 118.1(19). However, the text of Budget 2011 and the Explanatory Notes are ambiguous and it is possible that the rules could be made to apply to an excepted gift through the application of new subsections 118.1(13.1), (13.2) and (13.3).

In this regard:

As stated above, it is proposed that section 118.1 be amended by adding the following after subsection 118.1(13):

(13.1) Subsection (13.2) applies if, as part of a series of transactions,

(a) an individual makes, at a particular time, a gift of a particular property to a qualified donee;

(b) a particular person holds a non-qualifying security of the individual; and

(c) the qualified donee acquires, directly or indirectly, a non-qualifying security of the individual or of the particular person.

As drafted, it is unclear whether, for example, the particular person referred to in proposed paragraph 118.1(13.1)(b) needs to be someone other than the qualified donee referred to in proposed paragraph 118.1(13.1)(c). Similarly, it is unclear whether the particular property referred to in proposed paragraph 118.1(13.1)(a) needs to be a property other than the non-qualifying security referred to in proposed paragraph 118.1(13.1)(c).

Absent clarifying language, consider the situation in which an individual donates shares of his or her holding company to an arm’s length charitable organization that is registered as a charity for purposes of the Act. Arguably, the mere donation is not part of a “series of transactions” as set out in the preamble of proposed subsection 118.1(13.1) such that the provision should not apply in any event but query whether the result is different if, in contemplation of the gift, the share capital of the company is


58

reorganized (e.g., as part of an estate freeze in which the donor takes back preferred shares and the donor’s children subscribe for common shares).

Drafting Issue re Excepted Gifts

Regardless of whether the intention of Budget 2011 is to apply the non-qualifying security rules to excepted gifts described in subsection 118.1(19), there appears to be a technical issue with the drafting of the new provisions in circumstances in which the deemed gift for purposes of proposed subparagraph 118.1(13.2)(b)(ii) meets the conditions of an excepted gift as defined in subsection 118.1(19). More particularly, it appears that where the gift deemed to have been made by proposed subparagraph 118.1(13.2)(b)(ii) meets the conditions of an excepted gift, the provisions – as drafted – would preclude the donor from ever claiming a deduction or credit in respect of the value of the deemed gift, regardless of whether the donee disposes of the non-qualifying security for good consideration within the 60 month period.

Consider the following situation:126

Ms. A transfers $100,000 cash to Mr. B in exchange for shares (the “BCo Shares”) of a private company (“BCo”) controlled by Mr. B;

Mr. B gifts $120,000 cash to QD, a charitable organization registered as a charity for purposes of the Act;

QD transfers $100,000 cash to Ms. A in exchange for shares (the “ACo Shares”) of a private company (“ACo”) controlled by Ms. A;

Ms. A and Mr. B. deal at arm’s length with each other, with QD and with each of QD’s directors, trustees, officers and like officials;

Ms. A deals at arm’s length with BCo and Mr. B deals at arm’s length with ACo;

The ACo Shares and the BCo Shares have an FMV of $100,000.

Assuming that the transactions form part of a series of transactions, the conditions set out in proposed subsection 118.1(13.1) appear to be met such that proposed subsection 118.1(13.2) should apply. More particularly:

(a) an individual (Mr. B) has made a gift of a particular property ($120,000 cash) to a qualified donee (QD);

(b) a particular person (at any given time, Mr. B or Ms. A) holds a non-qualifying security of the individual (shares of BCo, including the BCo Shares);

(c) the qualified donee (QD) acquires, directly or indirectly, a non-qualifying security of the particular person (the ACo Shares).

Since the conditions set out in proposed subsection 118.1(13.1) are met, proposed paragraph 118.1(13.2)(a) applies to deem – for purposes of section 118.1 – the FMV of the particular

126 This example is for illustrative purposes only.


59

property ($120,000 cash) to be reduced by an amount equal to the FMV of the ACo Shares ($100,000). As a consequence, Mr. B’s charitable tax credit will be calculated on the basis of a $20,000 gift ($120,000 less $100,000), notwithstanding that his actual gift was $120,000.

Next, proposed paragraph 118.1(13.2)(a) provides that, for purposes of subsection 118.1(13), the non-qualifying securities acquired by QD (the ACo Shares) are deemed to be a non-qualifying security of the individual (Mr. B).

In turn, proposed paragraph 118.1(13.2)(b) provides that, for the purposes of subsection 118.1(13), the individual (Mr. B) is deemed to have made, at the particular time referred to in proposed subsection 118.1(13.1) (the time of the gift of cash by Mr. B to QD), a gift of the non-qualifying security acquired by the qualified donee (the ACo Shares), the FMV of which does not exceed $100,000, with $100,000 being the amount by which:

$120,000 (i.e., the FMV of the particular property ($120,000 cash) determined without reference to proposed paragraph 118.1(13.2)(a) ($120,000)), exceeds

$20,000 (i.e., the FMV of the particular property ($120,000 cash) determined under proposed paragraph 118.1(13.2)(a) ($20,000)).

Since we have assumed that each of Ms. A and Mr. B deals at arm’s length with QD and with each of QD’s directors, trustees, officers and like officials, a gift of the ACo Shares by Mr. B to QD should be an excepted gift as defined in subsection 118.1(19).

Also, the loanback rules in subsection 118.1(16) should not apply since, while proposed paragraph 118.1(13.2)(a) provides that the ACo shares are deemed to be a non-qualifying security of Mr. B, the deeming rule is limited in its application to subsection 118.1(13); it is not stated to apply for purposes of the loanback rules in subsection 118.1(16).

If the intention of Budget 2011 is to preserve the exception to the non-qualifying security rules for excepted gifts meeting the conditions of subsection 118.1(19), it is arguable that the rules should be drafted in a way that permits Mr. B to calculate his charitable tax credit based on the entire $120,000 gift and not just the $20,000 deemed by proposed paragraph 118.1(13.2)(a) to be the amount of the gift. If the intention of Budget 2011 is that the non-qualifying security rules be extended to apply to gifts meeting the conditions of subsection 118.1(19), the appropriate result would be for subsection 118.1(13) to apply to suspend Mr. B’s ability to claim a charitable donation credit in respect of the additional $100,000 until such time, if any, within 60 months of the original donation as paragraph 118.1(13)(c) applies. However, it appears that, in either case, Mr. B will be forever precluded from accessing the benefit of the additional $100,000 since the carve-out for excepted gifts in the preamble to subsection 118.1(13) precludes the relieving provision in paragraph 118.1(13)(c) from being engaged and there is no other provision that would deem Mr. B to have made a $100,000 gift for purposes of section 118.1 generally, including the definition of “total charitable gifts” in subsection 118.1(1) and the calculation of the charitable tax credit in subsection 118.1(3).


60

SCHEDULE “B” – BUDGET 2011 PROPOSALS RE GRANTS OF OPTIONS TO QUALIFIED DONEES

As noted in the body of this paper, it appears that the inclusion of carve-outs for non-qualifying securities of any person in the proposed provisions applicable to grants of options to qualified donees could have the unintended effect of technically entitling taxpayers to a charitable donation tax credit or deduction in inappropriate circumstances.

By way of example, consider the following:127

QD, a charitable organization registered as a charity for purposes of the Act, lends $100,000 to Ms. A in exchange for a promissory note issued by Ms. A (the “Promissory Note”);

Mr. B owns a particular property (the “Property”) with an FMV and ACB of $100,000;

Mr. B grants QD an option to acquire the Property at an exercise price of $100,000 –nominal consideration (assumed for purposes of this example to be nil) is paid by QD for the grant of the option;

QD exercises the option and acquires the Property at a time when the FMV of the Property is $100,000 – QD satisfies its obligation to pay the exercise price by assigning the Promissory Note to Mr. B.

Tracing through the provisions, the conditions in proposed subsection 118.1(22) should be satisfied since:

(a) an option to acquire a property (the Property) of an individual (Mr. B) is granted to a qualified donee (QD);

(b) the option is exercised so that the Property is disposed of by Mr. B and acquired by QD at a particular time; and

(c) the amount that is 80% of the FMV of the Property (80% of $100,000 being $80,000) is greater than the total of:

(A) nil, being the consideration (exclusive of the Promissory Note) received by Mr. B from QD for the Property, and

(B) nil, being the consideration received by Mr. B from QD for the option.

The consequence of the conditions of proposed subsection 118.1(22) having been satisfied is that proposed subsection 118.1(23) should, in turn, apply to:

(a) deem Mr. B to have received on the disposition of the Property proceeds of disposition of $100,000 (being the Property’s FMV); and

127 This example is for illustrative purposes only. It is assumed for purposes of the example that the circumstances

are such that the making of the loan would not constitute an unrelated business of QD or otherwise contravene any of the rules in section 149.1 applicable to registered charities.


61

(b) provide that $100,000 is to be included in Mr. B’s total charitable gifts for the taxation year ($100,000 being calculated as the amount by which the Property’s FMV ($100,000) exceeds the total described in subparagraph (22)(c)(i) (nil)).

Thus, applying the provisions set out in the Draft Legislation, it appears that Mr. B would be technically entitled to claim a charitable tax credit based on a gift of $100,000, notwithstanding the fact that no gift was made and Mr. B was in no way impoverished by the transactions. Further, since proposed paragraph 118.1(23)(b) is drafted in such as way as to mandate that a particular amount be included in the definition of total charitable gifts (as opposed to, for example, deeming a gift to have been made), it appears that none of the non-qualifying security rules, the loanback rules, the Split Receipting Rules or even the common law meaning of “gift” would alter this result.128

Similar comments can be made in respect of the proposals applicable to grants by corporations.

* * *

128 While the definition of “gifting arrangement” does not appear to apply, consideration would, of course, need to be

given to the more general tax shelter rules.

i

TABLE OF CONTENTS

INTRODUCTION ............................................................................................................................ 1

Pipeline Planning ...................................................................................................................... 1 Section 159 Clearance Certificates......................................................................................... 1 Charitable Sector ...................................................................................................................... 2 Non-Profit Organizations ......................................................................................................... 2

PIPELINE PLANNING .................................................................................................................... 3

Background – Post-Mortem Tax Planning ............................................................................. 3 How and When a Pipeline is Used .......................................................................................... 4 CRA’s Position Regarding Pipelines ...................................................................................... 5 Provisions and Scheme of the Act Relevant to Pipelines ................................................... 7 Practical Advice Regarding Pipelines in Light of CRA’s Position ...................................... 8

SECTION 159 CLEARANCE CERTIFICATES ............................................................................. 9

Rationale for Clearance Certificate Discussion .................................................................... 9 Section 159 Overview ............................................................................................................. 10 Section 159 – What’s New? ................................................................................................... 10

Possible Assessment of Statute-Barred Years .................................................................... 10 Inability to Retain and Pay Professional Advisor Without Risking Subsection 159(3) Assessment ........................................................................................................................... 12 CRA Assessing Under Subsection 159(3) Where Funds Deposited in Estate Account Inadvertently.......................................................................................................................... 13

Subsection 159(2) Mandatory – Additional Potential Exposure to Legal Representatives14 Whether a Particular Transfer is a Distribution? ................................................................ 14

Payment to Secured Creditors ............................................................................................. 14 Payment to Unsecured Creditors ......................................................................................... 15 Payment of Income to Trust Beneficiaries ........................................................................... 16 Transfer to a Replacement Executor or Trustee .................................................................. 16

Distribution by a Legal Representative ................................................................................ 16 Corporate Director ................................................................................................................ 16 Lawyer/Law Firm Holding and Disbursing Trust Monies ..................................................... 17 Arm’s Length Purchaser ....................................................................................................... 17 Non-Resident Legal Representative .................................................................................... 17 RRSP Trustee ....................................................................................................................... 17 Winding-Up of a Partnership ................................................................................................ 18 Funds Not in Estate or Not Within Legal Representative’s Possession or Control ............. 18

Issuance and Effect of Interim Clearance Certificates ....................................................... 18 Avoidance of “Catch 22”: CRA’s Administrative Practice in Issuing Clearance Certificates .............................................................................................................................. 18 Failure to Obtain a Clearance Certificate – Personal Liability of Legal Representative 19

Where No Underlying Assessment ...................................................................................... 19 Where Underlying Liability Statute-Barred ........................................................................... 20 Ability to Challenge Underlying Liability ............................................................................... 20 Application to Liability Under Other Legislation ................................................................... 21

Practical Considerations Regarding Clearance Certificates ............................................. 21 Distributions Without or Prior to Obtaining Clearance Certificates ...................................... 21


ii

Protection Afforded Under Subsection 159(3) Only to Legal Representative Acting in that Capacity ................................................................................................................................ 22

CHARITABLE SECTOR .............................................................................................................. 23

Background – Budget 2011 ................................................................................................... 23 Proposals Applicable to the Donation of Flow-Through Shares ...................................... 24 Proposals Applicable to Gifts of Non-Qualifying Securities ............................................. 27

Current Law ........................................................................................................................... 27 The Remai Decision ............................................................................................................. 28 Budget 2011 .......................................................................................................................... 31 Comments ............................................................................................................................. 34

Interaction with Proposed Split Receipting Rules ............................................................ 34 Interaction with Existing Provisions .................................................................................. 35 Scope of Budget 2011 Proposals ..................................................................................... 36

Proposals Applicable to the Granting of Options to Qualified Donees ........................... 36 Proposed Subsections 118.1(21), (22), (23) and (24) ......................................................... 37

Proposals to Recover Tax Assistance for Returned Gifts ................................................. 39 Proposals Intended to Enhance the Regulatory Regime for Qualified Donees .............. 41 Proposals Intended to Safeguard Charitable Assets through Good Governance ......... 44

NON-PROFIT ORGANIZATIONS ................................................................................................ 45

Paragraph 149(1)(l) Overview ................................................................................................ 45 CRA’s Position Regarding Paragraph 149(1)(l) ................................................................... 46

Pre-2009 – IT-496R .............................................................................................................. 46 2009 – The Start of Something New? .................................................................................. 47 Post-2009 – Making Sense of It All ...................................................................................... 50

Paragraph 149(1)(l) and Subsection 15(1) Shareholder Benefits ................................... 55

SCHEDULE “A” – BUDGET 2011 PROPOSALS RE NON-QUALIFYING SECURITIES ........ 57

Scope of Budget 2011 Proposals ......................................................................................... 57 Drafting Issue re Excepted Gifts ........................................................................................... 58

SCHEDULE “B” – BUDGET 2011 PROPOSALS RE GRANTS OF OPTIONS TO QUALIFIED DONEES ....................................................................................................................................... 60

Documents

Current Issues Forum: Pipeline Planning; Section 159 ... · Pipeline Planning; Section 159 Clearance ... property cannot be distributed until a clearance ... The three principal techniques