2019-0806761I7 Late filing of 88(1)(d) designation

Principal Issues: Should CRA accept a late filed designation outside the normal reassessment period in the case after an audit action increased the bump room available at the time of amalgamation?

Position: Yes. As a fair administration of the policy, the designation should be allowed.

Reasons: See reasons discussed below.

Author: McPherson, Ryan
Section: 88(1)(d), 87(11), 152(3.1), 152(4)(b)(iii)

                                                                                                                                                     May 30, 2019

XXXXXXXXXX                                                                                                                             HEADQUARTERS
                                                                                                                                                      Income Tax Rulings Directorate
                                                                                                                                                      Ryan McPherson
                                                                                                                                                      (226) 751-2998

                                                                                                                                                      2019-080676

    Late-Filed Designations under paragraph 88(1)(d)

We are writing in response to a copy of a letter we received from XXXXXXXXXX (“XXXXXXXXXX Letter”). The XXXXXXXXXX Letter was addressed to XXXXXXXXXX . Based on our telephone conversations with the auditor (McPherson/XXXXXXXXXX) it was determined that we would provide you our current views on latefiled designations under paragraph 88(1)(d) of the Act as they may apply to the fact situation described in the XXXXXXXXXX Letter and the audit proposal letter dated XXXXXXXXXX (“Proposal Letter”).

Facts

Briefly, our understanding of the key facts in this case is as follows:

XXXXXXXXXX is a corporation that was incorporated in XXXXXXXXXX and is a non-resident of Canada.

XXXXXXXXXX incorporated a taxable Canadian corporation (“Acquireco”) for the purpose of acquiring all the shares of a public corporation (“XXXXXXXXXX”). XXXXXXXXXX owned the shares of several subsidiary corporations including a non-resident subsidiary corporation referred to as “XXXXXXXXXX US”.

Acquireco purchased the shares of XXXXXXXXXX.

Immediately following that share acquisition, Acquireco and XXXXXXXXXX amalgamated pursuant to subsection 87(1) to form “XXXXXXXXXX Cda” (also referred to as the “Taxpayer”). Pursuant to paragraph 87(2)(a), the first taxation year of XXXXXXXXXX Cda commenced at the time of the amalgamation and the final taxation year for each of Acquireco and XXXXXXXXXX (the predecessor corporations) were deemed to end immediately before the amalgamation.

Immediately following the amalgamation, XXXXXXXXXX Cda disposed of the shares of XXXXXXXXXX US to XXXXXXXXXX.

The shares of XXXXXXXXXX Cda were subsequently sold by XXXXXXXXXX to one of its wholly-owned subsidiaries (“XXXXXXXXXX”). XXXXXXXXXX subsequently sold the shares of XXXXXXXXXX Cda to one of its wholly-owned subsidiaries (“XXXXXXXXXX”). On XXXXXXXXXX Cda and XXXXXXXXXX amalgamated to form XXXXXXXXXX. As a consequence of the amalgamation XXXXXXXXXX Cda and XXXXXXXXXX, both predecessor corporations had taxation years ending on XXXXXXXXXX.

The proposed reassessment of XXXXXXXXXX Cda for its taxation year ending XXXXXXXXXX (i.e., its first taxation year commencing immediately after the amalgamation - “year-end #1”), as outlined in the Proposal Letter, is to adjust the transfer price in respect of the disposition of the XXXXXXXXXX US shares (the “bump property”) pursuant to paragraphs 247(2)(a) and (c) of the Act. While the normal reassessment period with respect to year-end #1 went statute-barred on XXXXXXXXXX pursuant to subsection 152(3.1), the Proposed reassessment is being made in accordance with the extended reassessment period in subparagraph 152(4)(b)(iii). The proposed reassessment is based on audit’s valuation of the FMV shares of XXXXXXXXXX US being significantly higher than the Taxpayer’s.

Upon receipt of the Proposal Letter, the Taxpayer requested a late-filed designation to increase the cost of the XXXXXXXXXX US shares pursuant to paragraph 88(1)(d) and subsection 87(11) for yearend #1.

Our Comments

The focus of our discussion is centred on the CRA’s ability to accept a late-filed designation pursuant to paragraph 88(1)(d) and subsection 87(11) beyond the normal reassessment period prescribed in subsection 152(3.1). Notwithstanding the other factors that would not allow the CRA to accept a latefiled designation request (footnote 1), it has to be determined if the CRA can accept a late-filed designation where the normal reassessment period pursuant to subsection 152(3.1) has expired for both the taxation year in which the amalgamation took place and the taxation year in which the cost of a property that was eligible to be “bumped” was disposed of.

Paragraph 1.40 of Income Tax Folio S4-F7-C1, Amalgamations of Canadian Corporations states, inter alia, that the CRA will not allow a late-filed designation in situations “…where it would be necessary, in order to give effect to the designation, to issue a notice of assessment or reassessment for a tax year that is statute-barred.” This would be the case, for example, where the particular eligible property to be bumped was disposed of in a taxation year that is beyond the normal reassessment period.

In the current situation, the property to be bumped (i.e., the shares of XXXXXXXXXX US) was disposed of in the Taxpayer’s first taxation year that ended immediately following that amalgamation, being yearend #1. You have indicated that audit is relying on the extended reassessing period in subparagraph 152(4)(b)(iii) in order to reassess the adjustment of the transfer price on the disposition of the property subject to the Taxpayer’s requested late-filed designation request (i.e., the shares of XXXXXXXXXX US). The proposed reassessment to increase the transfer price of the shares of XXXXXXXXXX US sold by XXXXXXXXXX Cda to XXXXXXXXXX in year-end #1 appears to be the sole reason why the Taxpayer has filed a latefiled designation request pursuant to paragraph 88(1)(d) and subsection 87(11) for that year.

It is our understanding that at the time Acquireco purchased the shares of XXXXXXXXXX, the FMV of the XXXXXXXXXX shares were determined by a professional third-party valuator. Immediately after the purchase, Acquireco and XXXXXXXXXX were amalgamated to form XXXXXXXXXX Cda, which was followed by the disposition of the shares of XXXXXXXXXX US. Consequently, it was indicated by the Taxpayer (who presumably relied on the information in that third-party valuation) that at the time of the amalgamation, it had no ability to bump the cost of the shares of XXXXXXXXXX US.  It is for this reason the Taxpayer maintains that no timely designation pursuant to paragraph 88(1)(d) and subsection 87(11) to increase the cost of the XXXXXXXXXX US shares was filed with XXXXXXXXXX Cda’s Part I income tax return for year-end #1.

The decision of the Federal Court of Appeal (FCA) in The Queen v Nassau Walnut Investments Inc. (97 DTC 5051) is relevant to the present situation. In Nassau, the taxpayer was deemed to receive a dividend on the redemption of shares owned by it pursuant to subsection 84(3) and deducted the full amount of that taxable dividend pursuant to subsection 112(1) of the Act. It was determined during an audit action that the deemed dividend was subject to subsection 55(2), converting the entire taxable dividend into a capital gain. Upon receiving the proposed reassessment, the taxpayer requested the latefiling of a paragraph 55(5)(f) designation to designate a portion of the deemed dividend to be from safe income. The CRA denied the taxpayer’s request stating that there was no provision in the Act to allow for the acceptance of a late-filed 55(5)(f) designation request. In its analysis, the FCA stated:

The issue may therefore be recast in the form of a hypothetical as follows: assume that the taxpayer calculates his income based on the application of provision "A"; the Minister then denies the applicability of provision "A" and instead invokes provision "B"; the taxpayer does not dispute that provision "B" may apply but notes that provision "B" permits a partial deduction if a designation is made; he therefore seeks to amend his return to take advantage of that deduction but is denied the opportunity to do so on the ground that he failed to make the requisite designation; the taxpayer counters by asking how he could have made the designation when he did not know that provision "B" would apply. In this scenario, modification of the original tax return does not raise the spectre of retroactive tax planning as in the election cases. That is, our hypothetical taxpayer did not previously weigh the risks relating to making the designation or abstaining therefrom, nor does he now seek to avoid bearing the downside of a decision he made consciously after due consideration.

The FCA concluded by stating, among other arguments specific to 55(2) and 55(5)(f), that the taxpayer was entitled to file the late-filed designation and that entitlement arose once the Minister issued a notice of reassessment.

With respect to the facts of this particular situation, if the CRA has the ability to reassess the Taxpayer’s Part I income tax return for year-end #1 pursuant to subparagraph 152(4)(b)(iii) with respect to its disposition of the XXXXXXXXXX US shares, it is our view that the Taxpayer’s late-filed designation request could be considered.

We trust that the foregoing will be of assistance to you.

Yours truly,

Michael Cooke, CPA, CA
Manager
Corporate Reorganizations Section II
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  See in particular, paragraphs 1.39 and 1.40 of Income Tax Folio S4-F7-C1, Amalgamations of Canadian Corporations.

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