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Tax Law – Patrick Westaway

New business remains subject to the old taxes. Believing otherwise is wishful thinking. The latest tax topic in the world of technology is the Bitcoin. For those still using old-fashioned e-transfers and PayPal, the Bitcoin is the new currency. Unaffiliated with any country or bank, the Bitcoin works because the parties agree that it should. Bitcoins are accepted by an increasing number of online (and offline) vendors and service suppliers, and can even be converted into “real” money—provided someone with real money agrees. It’s like a barter system but without the bartering.

You might object that the Bitcoin has nothing to do with bartering since it is fundamentally liquid. It is fungible. A loonie is worth a loonie and a Bitcoin is worth a Bitcoin.  There is no squabbling over how many of my chickens your cow is worth, or which service has the greater value. Fundamentally then, Bitcoins are money, but without the underwriting of a bank or national treasury—which, given the experience of recent years, might not be such a bad thing. At least, that is what you might think. But for practical purposes, you would be wrong—at least where taxes are concerned.

The CRA posted its position on the Bitcoin late last year and the news was grim for those who thought that only national currencies are taxed and that the Bitcoin heralded a return to a pre-war income tax free nirvana-that-never-was. The Bitcoin—or more broadly, “digital currency”—is, we are told, “virtual money”. It can be bought and sold “like a commodity” and the receipt of this virtual-money-that-is-sometimes-a-commodity is taxable in the same way as any other income. This is not to say that every Bitcoin transaction is taxable, only that Bitcoins do not make taxable transactions into non-taxable ones.

This is bad news for the wishful thinkers but validation for the champions of stateless money. The rub for the latter bunch, however, is that the CRA did not bestow the status of “money” on the Bitcoin. That would have been unhelpful and a little meaningless since one cannot go onto the Bank of Canada website to check the Bitcoin’s exchange rate. Instead, the CRA simply said that the Bitcoin is subject to the same rules as barter transactions, meaning that Bitcoins are to be valued according to the goods or services for which they are exchanged. Sadly, then, despite its fungibility, the Bitcoin leaves us still asking after the underlying value at tax filing time.

It must also be recognized that when Bitcoins are bought and sold like a commodity—arbitraged like any other currency—their disposition must give rise to income or capital gains according to whether they are traded on income, or held on capital, account.

The takeaway is this. First, tax has always applied to non-cash receipts, such as are realized upon share exchanges, stock dividends, dividends in kind, shareholder benefits, employee benefits and, yes, even barter transactions—unless carefully structured to access a specific exemption or deferral. Whether you are paid in dollars, Bitcoins or ham sandwiches, there is a value to what you receive and you are taxed on that value. Were it otherwise, tax planning would be simple and tax planners could all retire—comfortably financed by the tax-free accruing Bitcoin. Second, although the Bitcoin and its digital ilk may have the hallmarks of real money, the distinction is academic since, without a State-sanctioned exchange rate, the Bitcoin does not bestow a value upon the goods or services but instead must derive its value from those goods or services, which must then still be valued in old fashioned dollars. And, finally, when investing in Bitcoins, be prepared to recognize income or gains when you cash in.

There is also a more technological concern, which should speak to every early adopter and everyone who has ever lost data. What happens when there is a bug in your Bitcoin, when problems with the software cause your digital bank to suspend operations until further notice? What is the value then? Just ask the clients of Mt. Gox, the Tokyo Based Bitcoin exchange that did exactly that in the days before this article was written.

* * This article is intended only to inform and educate. It is not legal advice.  Be sure to contact a lawyer to obtain legal advice on any specific matter.

 

Patrick Westaway is Tax Counsel to Sorbara, Schumacher, McCann LLP, a full service law firm based in Waterloo, Ontario. Patrick advises on a broad range of Canadian taxation issues such as corporate tax planning, structuring inbound investments, corporate reorganizations, cross-border financings, tax opinions for public disclosure documents, tax assessments, personal tax matters, wealth preservation, and on federal and provincial sales tax matters (HST/GST/PST). Patrick also practices corporate and commercial law with an emphasis on the implementation of matters related to his tax planning practice.

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Tax Law – Patrick Westaway

The Supreme Court of Canada has issued its latest ruling on the application of the General Anti-Avoidance Rule (the “GAAR”). This decision—Copthorne Holdings Ltd. v. Canada—is of interest not because it casts any new light on the GAAR but because it reminds us that we cannot lose sight of basic principles, no matter how complex the transactional mechanics may be.

—But first, a few words of context. A shareholders’ share capital, as adjusted for tax purposes, is known as paid-up capital (“PUC”). Since PUC represents the amount of the taxpayer’s investment (as opposed to income earned by the corporation), PUC can always be distributed tax free. And, unlike some other jurisdictions, Canada does not require a corporation’s earnings to be distributed before PUC such that PUC can be distributed at any time.

Now, if a shareholder subscribes for shares in a corporation and that corporation uses the money to subscribe for shares in a subsidiary, the PUC of both the parent and the subsidiary will be increased by the amount of the single investment. This is a right result since each entity in the vertical chain is entitled to the tax-free return of its investment. However, if a subsidiary’s PUC were added to its parent’s PUC upon an amalgamation, the amount that the shareholder could withdraw tax-free would be doubled; hence, a rule in the Income Tax Act (Canada) which cancels a subsidiary’s PUC in this situation. This is to be distinguished from horizontal amalgamations upon which the PUC of sister corporations may be combined because they represent separate investments.

Added to this analysis is Canada’s tax under Part XIII of the Income Tax Act on dividends, rents, royalties, interest and other forms of investment income distributed to non-residents. This tax applies at a rate of 25% subject to reduction or exemption under Canada’s various tax treaties. Or, to the extent that the non-resident’s shares in the payor corporation have PUC, Part XIII tax can be avoided without recourse to any treaty—which brings us back to the Copthorne case.

Briefly stated, a Mr. Ka-Shing controlled one corporation with PUC in excess of $96 million and its subsidiary with PUC in excess of $67 million. Through a series of transactions involving related corporations in Canada, the Netherlands and Barbados, these two PUC accounts were positioned within sister corporations. The corporations were amalgamated and, because they were sister corporations rather than parent and subsidiary, their PUC was aggregated. In fundamental terms, tax-free share capital of $97 million was parlayed into tax-free share capital of $163 million. The shares were then redeemed on the basis that the distributions were wholly exempt from Canada’s Part XIII tax.

Upon its review of these transactions, the Canada Revenue Agency (the “CRA”) applied the GAAR, disallowed the PUC increase and taxed the distribution accordingly. The Tax Court of Canada supported the CRA, as did the Federal Court of Appeal and, now, the Supreme Court of Canada.

The lesson to be drawn from Copthorne is to always hold in view the basic principles. Effective tax planning applies these principles, even manipulates them, but never tries only to hide them.

* * This article is intended only to inform or educate. It is not legal advice.  Be sure to contact a lawyer to obtain legal advice on any specific matter.

 

Patrick Westaway is Tax Counsel to Sorbara, Schumacher, McCann LLP, a full service law firm based in Waterloo, Ontario. Patrick advises on a broad range of Canadian taxation issues such as corporate tax planning, structuring inbound investments, corporate reorganizations, cross-border financings, tax opinions for public disclosure documents, tax assessments, personal tax matters, wealth preservation, and on federal and provincial sales tax matters (HST/GST/PST). Patrick also practices corporate and commercial law with an emphasis on the implementation of matters related to his tax planning practice.

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