Principal Issues: What are the tax consequences relating to a particular situation?
Position: General comments.
Reasons: We would need an analysis of the contracts to determine the specific tax consequences in the particular situation.
XXXXXXXXXX 2016-065433 Sylvie Labarre, CPA, CA October 28, 2016
Dear Sir,
Subject: Transfer of right to income
This is in response to your email dated June 20, 2016 in which you requested an opinion regarding the application of subsections 9(1), 15(1), 56(2) and 56(4) and subparagraph 18(1)(a) of the Income Tax Act (hereinafter the "Act") in a particular situation.
Unless otherwise indicated, all legislative references herein are to the provisions of the Act.
Facts
1. A sold, to Corporation A, land for the purpose of carrying on the business of Corporation A.
2. This land was subject to a lease in favor of Corporation B, a corporation active in the field of XXXXXXXXXX.
3. The lease in favor of Corporation B existed before the sale by A to Corporation A.
4. The lease agreement provided that Corporation B had an exclusive right to operate its XXXXXXXXXX equipment located on Corporation A’s land.
5. Corporation B paid Corporation A an annual rent in accordance with the lease agreement.
6. Corporation A was subrogated to all the rights previously granted under the lease agreement by A to Corporation B.
7. Corporation A declared that it had read the lease agreement and that Corporation A undertook to comply with the terms and conditions and to collect the lease payments from the date of signature of the deed of sale.
8. At the time of sale, A and Corporation A agreed to a redistribution of income in which Corporation A undertook to pay to A all rental income that it received, during the entire period of the rental of the XXXXXXXXXX site.
9. Corporation A redistributed to A in full the income from the rental.
10. A and Corporation A did not deal at arm's length.
11. A was not be a shareholder of Corporation A.
Questions
You wish to know our view on the application of sections 9(1), 15(1), 56(2) and 56(4) and paragraph 18(1)(a) in the given situation to A and Corporation A.
You also wish to know if the conclusion would be different if there were instead a duly-executed agreement for royalties on a land sale [“redevances sur une vente de terrain”].
Our comments
This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
In a given situation such as the one you provided, an analysis of the contracts between the parties and other legal documents would be required to determine the tax consequences of the transactions. Similarly, it would be necessary to consider all the relevant facts of that particular situation. We do not conduct such an analysis of facts and contracts in the context of a request for a technical interpretation.
What follows are some general comments on the consequences where there is a transfer of rights to income.
With respect to your first question, it would be necessary to examine the contracts to see whether the transactions in fact represented a transfer of rights to income or whether there instead were merely instalments being made on account of the sale price of the land.
For the purposes of this letter, we have assumed that there was a transfer of rights to income from Corporation A to A, and that Corporation A collected the rents for A and Corporation A did not transfer the land that was the property giving rights to income.
Taking this assumption into account, the rent collections by Corporation A for remittance to A, who was entitled to them under the contract, would probably not have the "quality of income” to Corporation A since it would not be Corporation A which had an absolute and unconditional right to these amounts, as it was obligated to pay them over to A, who was entitled to them. Consequently, the amount of rents would not be included in Corporation A's income under subsection 9(1). Similarly, the payment of the amount to A would not be an expense incurred to earn income. If there has been a transfer of rental income to A, the rent amounts would be part of A's income subject to the administrative position set out below.
On the other hand, under the above assumptions, subsection 56(4) would apply to Corporation A. For this reason, Corporation A would have to include the rent amount in its income without a corresponding deduction for its payment to A. With respect to A's income, paragraph 10 of Interpretation Bulletin IT-440R indicates the CRA's position with regard to avoiding double taxation of the rent income. This paragraph reads as follows:
“An amount to which subsection 56(4) applies could be included in the income of both the transferor and transferee. However, where the transfer or assignment of the right to an amount that is income does not constitute a deliberate attempt to evade or avoid tax, the amount will be included only in the income of the transferor.”
Furthermore, with respect to the application of subsection 56(2), it would also be necessary to establish what was the consideration given by A for the right to the rent income. There could be situations where the consideration given does not represent the fair market value of the right to income. In such a situation, it would be necessary to consider whether subsection 56(2) applies since A is not a shareholder and cannot be subject to subsection 15(1). We do not have enough information to make a more specific comment on the situation. There may, however, be situations in which a shareholder of Corporation A could have been directed to give the right to income to A at a value less than its fair market value. In such a case, if the shareholder had received the benefit directly, the value of the benefit would have been included in the shareholder’s income under subsection 15(1). Depending on the circumstances, the shareholder may have desired to benefit A. Thus, all the criteria for taxation of the shareholder of Corporation A under subsection 56(2) may be satisfied if the right to income was not disposed of for consideration equal to its fair market value.
If it were concluded from an analysis of the contracts that there was not in fact a transfer of the right to income, the tax consequences would be different. For example, there could be situations where this element would have an impact on the consequences of selling the land.
Royalties
You requested our views with respect to the tax consequences if the contract between A and Corporation A were a royalty contract.
With respect to this alternative, it would be necessary to examine the contract in order to arrive at a conclusion.
It would be necessary to establish, among other things, whether the royalty represents a way of paying the sale price of the land or is a payment based on production or use by virtue of paragraph 12(1)(g), or if the contract discloses another relationship between the parties.
In short, it is difficult for us to give you general comments on this alternative without knowing the legal relationships between the parties.
For example, the transaction between the parties may not be a transaction that can be characterized as a transfer of a right to income. Thus, the rent income could be part of Corporation A's income. On the other hand, with respect to the royalties paid by Corporation A, the nature of the legal relationship between the parties should be examined to determine, among other things, whether the royalty expense is a capital expenditure that would be denied under paragraph 18(1)(b).
With respect to subsection 56(2), the royalty agreement could have been concluded at fair market value and Corporation A did not provide any benefit to A. If this were not the case, it could be, similarly to the above, that there was an advantage conferred by virtue of subsection 56(2).
We hope that our comments will be of assistance.
Stéphane Charette, CPA, CMA, MBA.
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch