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Tax Perspectives

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Please note that these publications may not be up-to-date as taxation matters are subject to frequent changes.


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Summer 2008
Volume 8, Number 1

The information in Tax Perspectives is prepared for general interest only. Every effort has been made to ensure that the contents are accurate. However, professional advice should always be obtained before acting and TSG member firms cannot assume any liability for persons who act on the basis of information contained herein without professional advice.


In Brief

By Howard L. Wasserman, CA, CFP, TEP
Cadesky and Associates LLP (Toronto)

CRA's Position on Safe Income Calculation

In general, safe income is the amount that can be distributed tax-free to a corporate shareholder in the course of reorganization, before a sale. It is often described as the "tax retained earnings". The notion of safe income is mentioned in the Income Tax Act but not defined. Therefore, the CRA determines safe income and then the courts decide whether the CRA's interpretation is correct. Many judicial decisions have modified the CRA's interpretation and no doubt there will be more as new situations arise.

In the past, it was the CRA's position that non-deductible expenses should not be deducted in computing safe income. However, in a Federal Court of Appeal case, Kruco Inc. (2003 DTC 5506), the court decided that a reduction in safe income was warranted for non-deductible expenses. Consequently, all expenditures will reduce safe income, whether or not they are deductible for tax purposes. Non-deductible items, such as interest on taxes and 50% of meals and entertainment expenses, reduce safe income on hand. According to the CRA's Income Tax Technical News No. 37, this adjustment will apply to dividends paid after February 15, 2008.

Restrictive Covenants

In 1999, the Fortino case (2000 DTC 6060) held that payments received for non-competition agreements were not taxable because they were not "income from a source". This decision was upheld in the Manrell case (2003 FCA 128) by the Federal Court of Appeal. The Department of Finance was not pleased with these decisions and issued a News Release on October 7, 2003 stating that non-competition receipts or restrictive covenant receipts would be taxable as ordinary income subject to certain exemptions. This meant that receipts in respect of non-competition and restrictive covenants became fully taxable. Amazingly, the new legislation has still not been finalized. Draft legislation was introduced three times and is currently under review by the Senate Committee on Banking, Trade and Commerce. It is not clear when the legislation will receive Royal Assent. In our view, the amendments are unduly complex and unduly harsh.

Theoretically, this means that the law as interpreted in Fortino and Manrell still applies. There is only draft legislation at present. Although the draft legislation is stated to apply from October 7, 2003, it is unclear how the government will be able to apply these rules in respect of amounts received as long as five years ago if taxpayers were bold enough to take the position after October 7, 2003 that such payments were tax-free. The 2003 year is now closed for reassessment and 2004 will be closing shortly.

Certificates of Compliance on Amalgamation

The CRA has recently clarified its position on the requirement for a compliance certificate when there is an amalgamation of Canadian corporations. In general, when a non-resident disposes of taxable Canadian property, the purchaser is required to remit 25% of the gross proceeds to the CRA. However, the seller can apply to the CRA for a compliance certificate (formerly known as a "clearance certificate"). When the compliance certificate is received from the CRA, withholding tax is based on 25% of the capital gain, rather than on the gross proceeds. Under many of Canada's tax treaties, there is no Canadian tax on the sale of shares of a Canadian corporation, provided that no more than 50% of the Canadian corporation's value is derived from Canadian real estate.

In the past, the CRA's position was that a compliance certificate was not required for the amalgamation of two Canadian private corporations. However, in Interpretation Bulletin IT 474R2, released on December 17, 2007, the CRA stated that a compliance certificate will be required in future. In the case of an amalgamation, there is no purchaser to remit the 25% withholding tax, as there has been no change in ownership. This would impose a 25% tax liability on the shareholders, with no outside cash to fund the liability.

On January 8, 2008, the CRA revised its Interpretation Bulletin again, to state that a compliance certificate is not required. This is very helpful, since the CRA is currently far behind in processing compliance certificates. In some cases, approval can take six to eight months. This is a significant problem, since withholding taxes are supposed to be remitted within 30 days of the transaction. To deal with this problem, the CRA has been providing "comfort letters", advising the purchaser that it does not have to remit withholding tax until a compliance certificate is approved or a notice is received from the CRA to remit the withholding tax. As announced in the 2008 Federal Budget, when a non-resident disposes of a treaty-protected property after 2008, a notification rather than a certificate will be required. It appears that even in situations where there is no treaty protection, a compliance certificate will not be required on the amalgamation of two Canadian companies.

Foreign Investment Entity Rules

In the last issue of Tax Perspectives, we reported that the Bill that incorporated the changes to the Foreign Investment Entity ("FIE") draft legislation was approved by the House of Commons and received first reading in the Senate on June 18, 2007. The legislation was reintroduced when Parliament reconvened last fall and is now stuck in the Senate, who have had the good sense to take a careful look at the legislation. With another election possible, we may see the legislation die again, even though it is stated to apply from January 1, 2007. There is no question that a country such as Canada needs FIE type legislation. However, the draft is unduly complex and will discourage Canadians from making foreign investments, which is unacceptable.