Asset managers, have you kept up with all the significant Canadian tax developments affecting your industry in 2016?
As a helpful reminder, KPMG has prepared the following summary of these developments. You may want to review this list to help ensure that you've taken all these changes into account in your business this year.
These developments may affect areas including:
Cost of partnership interest and dividend stop-loss rules
Proposed legislation released in September 2016 will reduce the adjusted cost base (ACB) of a partner's interest in a partnership that holds shares subject to the dividend stop-loss rules in situations where the partnership interest is held on income account.
Currently, a partner's adjusted cost base of a partnership interest is only reduced where it is held as capital property, and the partnership also treats the shares that are subject to the dividend stop-loss rules as capital property.
The new proposals will reduce the ACB to a taxpayer who holds a partnership interest on account of income, either as inventory or mark-to-market property, when the dividend stop-loss rules apply to shares owned by the partnership.
Negative partnership adjusted cost base
The CRA recently stated its view that loans made by a limited partnership to a limited partner could in theory cause a reduction in the ACB of the partner's interest in the partnership. The CRA's view is that, regardless of whether the loans are legally permissible, the applicable tax law is broad enough to require the ACB to be reduced by the loans made to a partner if the loans are viewed on account of (or in lieu of) distributions of the partner's share of the partnership profits or capital, which would immediately reduce the ACB.
With this new approach, the loan may cause the partner's ACB to become negative, and a deeming rule would force the partner to realize a capital gain. However, the CRA acknowledges that it would need to examine the partnership agreement, the amount of the partner's ACB, the profit or loss of the partnership, and all other relevant facts before it could determine whether a capital gain would be realized.
In light of the CRA's new approach, taxpayers should consider ensuring that any partnership loans are made and documented separately from partnership distributions.
Offshore investment fund property
A recent court case provides guidance for the application of the "offshore investment fund property rules" in section 94.1 of the Income Tax Act.
This anti-avoidance provision can impute income to applicable offshore investments in excess of the income that would otherwise be recognized for such investments. Two tests must be met for the anti-avoidance rule to apply: the value test and the motive test. The motive test is met if one of the main reasons for acquiring or holding the interest is to obtain a tax benefit that allows significantly less tax to be paid or deferred than if the investments were held directly.
In Gerbro Holding Co. v. The Queen, the Tax Court of Canada (TCC) provides guidance on the motive test, and confirms that there can be both a primary and ancillary motive for the investment purpose. The primary motive, which must include bona-fide, non-tax reasons, should also be objectively reasonable. Further, the opportunity to defer tax can be considered to be an acceptable ancillary motive, as long as it is secondary in nature to the primary motive.
On the basis of the taxpayer's evidence, the TCC concluded that, even though the taxpayer received a significant tax deferral advantage by investing through offshore hedge funds, it had invested mainly for various non-tax reasons. Therefore, the taxpayer did not meet the motive test for the purposes of the anti-avoidance rule.
Until now, there has been no meaningful case law on this matter. As such, this case provides some guidance in determining the primary and ancillary motives and demonstrates the importance of well-documented non-tax reasons for making the investment. Although the CRA has appealed to the Federal Court of Appeal (FCA), a decision is not expected until mid-2017.
New compliance issues
Finance clarifies reporting requirements for T5008 slips
The Department of Finance recently confirmed a new administrative position that aims to reduce duplication in issuing T5008, "Statement of Securities Transactions" slips to investors. In the past, when an entity redeemed, cancelled, or acquired securities, it was required to file a T5008 with the CRA. Further, every person who acts as a nominee or agent for the investor was also required prepare a T5008 slip.
Under the new administrative position, only an investment dealer is required to file the T5008 slips with the CRA when investment funds are held in nominee form through an Investment Industry Regulatory Organization of Canada dealer. Finance further clarified that, when investment funds are held in nominee form through a mutual fund dealer, only the fund manager would be required to file T5008 slips with the CRA and provide a copy to the client.
Quebec grants relief from filing certain summaries
Revenu Quebec informed the industry in November 2016 that it would ease the compliance burden by granting relief from the filing of the following summaries:
FX methodology for convertible securities
A recent FCA decision in Agnico-Eagle Mines Ltd. (Agnico) v. The Queen sets out a methodology for determining foreign exchange (FX) gains and losses on the conversion of U.S.-dollar denominated convertible debentures into shares. This decision reverses a prior TCC decision.
A gain or loss in a taxation year due to a value fluctuation in currency of a country other than Canada is deemed to be a capital gain or loss for the year. In its decision, the FCA disagreed with the TCC's earlier finding that FX gains were only realized on the redemption of certain debentures for cash. The FCA held that the taxpayer would have an FX gain on the conversion of a debenture if, in Canadian dollars, the amount of the issue price of the convertible debenture exceeded the repayment amount when the indebtedness was extinguished to the debenture holders. To determine these amounts, the FCA said it is appropriate to use the FX rate on the issue date of the debenture and the FX rate on the date of conversion, respectively. Further, the FCA held that the amount paid to extinguish the debt on a debenture on conversion was the applicable securities exchange trading price of the common share on the conversion day.
At the CRA Roundtable in the Canadian Tax Foundation's 2016 Annual Conference held on November 29, 2016, it was noted that the Agnico-Eagle methodology provided by the FCA could result in an issuer of debentures realizing a loss. The CRA was asked whether they agreed that an issuer could be considered to realize a loss on the conversion and whether that loss could be a subsection 39(2) loss or a deductible capital loss.
The CRA responded that, in its view, there is no loss under subsection 39(2) because the loss was not a loss from the fluctuation of currency relative to the Canadian dollar. Further, in the CRA's view, the loss does not arise under subsection 39(1) either because it arose on the settlement of debt (due to the appreciation of the value of the shares). Therefore the loss could not be applied against capital gains.
The CRA said that, although not argued in the Agnico-Eagle case, it would consider applying subsection 143.3(3) to similar facts which would change the calculation of the gain or loss. The CRA would consider whether on a conversion the holder is exercising an option such that the amount paid by the holder is the cash value of the debenture for purposes of paragraph 143.3(3)(b).
For details, see KPMG's TaxNewsFlash-Canada 2016-52, "Asset Managers - New FX Methodology for Convertible Securities".
Investment management fees paid outside registered plans
The CRA has a long-standing administrative policy of accepting that the payment of investment management fees outside of a registered plan by the plan annuitant or holder (referred to as the "controlling individual") will not be considered to be a contribution or gift to the plan for purposes of the over-contribution rules.
However, during the CRA Roundtable in the Canadian Tax Foundation's 2016 Annual Conference held on November 29, 2016, the CRA stated that if the payment of fees outside the plan results in an indirect increase in the value of the plan, this is likely an advantage. As a result, the advantage tax rules could apply to tax 100% of the fees paid. The CRA said that the advantage tax rules will not automatically apply given that there is a purpose test, but there is a strong inference that there is an advantage, especially if the fees paid outside the plan are large and are paid on a percentage of the invested capital.
Further, the CRA said that existing plan arrangements should be changed so that plan fees are charged to the plan itself. The CRA will give the industry time to make any system changes related to new fee structures and won't apply the advantage rules to fees paid outside of plans until January 1, 2018.
Corporate class mutual funds ("switch funds")
Investors in a mutual fund corporation have been eligible for a tax deferral upon a "switch" between the corporation's various portfolios. However, taxable investors that "switch" their investments between the various corporate classes of mutual funds will have a taxable disposition starting on January 1, 2017.
In addition, the definition of "capital gains redemptions" has been amended to ensure that exchanges of shares will be treated as redemptions effective January 1, 2017; an adjustment to the capital gains redemption mechanism (CGRM) formula has been provided. As a result, any "switch" between investment classes which effectively hold identical properties (but only differ in terms of expense ratios) should not be regarded as a taxable disposition, similar to the treatment of mutual fund trusts.
Mark-to-market accounting method valid
In a recent decision, the Federal Court of Appeal (FCA) determined that a non-financial institution could apply the mark-to-market accounting method to its foreign exchange (FX) options for tax purposes. In allowing that taxpayer's appeal in Kruger Incorporated v. The Queen, the FCA held that the realization principle was not the only option available, and marking the options to market was an accurate reflection of income (similar to the principles set out in a previous case, Canderel).
To many, the FCA's decision was a surprise. For some investment funds, this case may reaffirm their recognition of income and losses for tax purposes of certain derivative contracts. Alternatively, investment funds may now have a policy choice in determining which methodology represents the most accurate picture of its income.
Trust loss restriction event exemptions
Investment funds should exercise caution to ensure they do not fall offside of the latest changes to the trust loss restriction event rules, as it would not be possible to re-qualify for an exemption from these rules. While new legislation enacted December 15, 2016 addresses concerns raised since relieving amendments were released earlier in January 2016, they still fall short of providing relief for all commercial investment funds. For example, the latest amendments exclude certain [p5] single asset funds as well as investment funds which hold non-resident investment funds as part of their strategy from the exemption rules.
HST compliance obligations
From an HST perspective, the most significant legislative development in 2016 is the proposed new rules for investment vehicles structured as limited partnerships. Under proposals released in July 2016, the selected listed financial institution (SLFI) rules would be extended to include Canadian-resident investment funds structured as limited partnerships (LP funds). Legislation for this change could potentially be released in 2017.
For funds based in Ontario, this proposed change may reduce their net HST liability. However, non-resident LP funds with substantial Canadian investors could become subject to an HST self-assessment requirement (LP funds resident outside Canada currently are not subject to HST).
These proposed amendments also contain a new relief mechanism for all investment plans, including plans structured as limited partnerships. Canadian funds currently incur HST regardless of the residence of their investors. Under the July 2016 proposals, a rebate would become available to offset HST incurred to the extent of a fund's non-resident investors.
These measures, if implemented, are expected to substantially impact the asset management industry's HST compliance obligations and recovery prospects. Fund managers should review how these proposed changes may apply to their fund structures and affect their tax obligations and costs.
For more information, contact your KPMG adviser.
Information is current to December 16, 2016. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500.