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For US citizens and green card holders, the decision is more complex, as the income earned in the TFSA must be reported on the individual’s US personal income tax return, so the tax savings is limited.

The mechanics of the TFSA are simple:

• You can contribute up to $5,000 annually. If you contribute less than the maximum amount in any year, you can use that unused contribution room in any subsequent year. The cumulative contribution limit for 2012 is $20,000.
• Income and capital gains earned in the TFSA are not taxed, even when withdrawn.
• You can make withdrawals at any time and use them for any purpose without attracting any tax.
• Any funds you withdraw from the TFSA — both the income and capital portions — are added to your contribution room in the next year. This means you can re-contribute all withdrawals in any subsequent year without affecting your allowable annual contributions. Re-contribution in the same year may result in an over-contribution, which would be subject to a penalty tax.

Permitted investments for TFSAs are similar to those for registered retirement savings plans (RRSPs) and other registered plans. And like RRSPs, contributions in kind are permitted. But be aware that any accrued gains on the property transferred to a TFSA will be realized (at the time of transfer) and taxable, while any accrued losses are denied.

The Canada Revenue Agency (CRA) will track your contribution room and report it to you annually as part of your income tax assessment. If you overcontribute, as with RRSPs, the overcontribution will be subject to a penalty tax of 1% per month while it remains outstanding.

You’ll find more information on TFSAs and many other valuable tax-saving ideas in our popular guide Managing Your Personal Taxes: A Canadian Perspective 2011‑12.

Background

Instead of hiring a third party, professional practices often incorporate a holding company to perform management and administrative services on their behalf. . Under a management contract, the holding company pays some of the practice’s expenses, which the practice then reimburses, and charges the practice a management fee. The professional practice may then deduct both the expense reimbursement and the management fee paid as business expenses. Much debate has resulted in assessing the reasonability of the management fee and its corresponding deductibility.

In Holmes et al v the Queen (74 DTC 6143), the Federal Court ruled that the management fee charged totalling of 15% of the disbursements on behalf of the holding company was reasonable, since this rate represented “the normal and going rate for services of this kind.” Also, during the Canadian Tax Foundation’s Revenue Canada roundtable in 1985, the CRA stated that it viewed management fees not exceeding 115% of the cost of services to be reasonable.

In a 2009 technical interpretation, the CRA provided brief comments on the deductibility of management fees with respect to service corporations, stating that the expense must be incurred for the purposes of earning income from a business or property and must be reasonable in the circumstances. It also stated that such fees must generally correspond to the FMV of services provided.

APFF Conference question

The CRA was given the following example:

A dentist, operating within a partnership, is also a shareholder of a holding company that provides management services to the partnership. In the current economic environment, the flat monthly fee proposed by unrelated third parties for similar management services would exceed 15% of the expenses incurred by the partnership.

The CRA was asked the following questions:

• Would it agree to have the holding company charge a management fee comparable to the third-party fee?
• If so, would it consider a management fee exceeding 15% reasonable?
• What is its position concerning the increase in management fees between related entities?

The CRA’s response

The CRA expressed its view that an expense for management services is considered reasonable if the amount charged does not exceed the FMV of the services provided. In addition, if the FMV of such services exceeds 115% of the expenses incurred, the CRA would consider the expense to be reasonable if it can be established that the amount does not exceed the FMV of the services provided. This response is consistent with recent case law (see Bertomeu v the Queen (2008 DTC 4673)).

The CRA did not, however, answer the specific questions regarding the dentist example.

In summary, care must also be taken to ensure the management fee charged by the holding company is based on the FMV of the services provided. This analysis should be conducted on a regular basis to ensure the CRA will not disallow the management fee.

Facts

The J.J. Herbert Family Trust #1was settled under the laws of the Bahamas in 1991. The trustees consisted of Mr. Jean-Jacques Herbert (a non-resident of Canada), Richard Lewin (the appellant in this case) and one other individual.

During the relevant period, the trust was resident in Canada and filed Canadian income tax returns. (Although it’s not clear from the TCC decision, presumably the trust’s Canadian residency was either attributable to the fact that ’its central management and control was in Canada or it was deemed resident for tax purposes.)

The trust received a preferred share dividend of just over $2.2 million in 2001. Following this, the trustees adopted a resolution noting receipt of the dividend and declaring it “be paid to Mr. Jean-Jacques Herbert as capital beneficiary of the trust.” The resolution stated that Mr. Herbert had “the right at any time to require payment of the amount of the dividend by the trust to himself.”

The trust included the preferred share dividend in its 2001 income. However, it also deducted the same amount on the basis that it was “payable in the year to a beneficiary.” At the same time, the trust calculated the Part XIII non-resident withholding tax on the amount of the dividend, but did not withhold or remit any Part XIII tax.

The appellant resigned as a trustee early in 2002. Shortly thereafter, the trust paid the $2.2 million to Mr. Herbert, the non-resident beneficiary.

The Minister took the position that the trust should have remitted Part XIII tax of over $500,000 in 2001. The appellant was assessed personally for the withholding tax on the basis that in his capacity as a trustee, he authorized a payment in respect of which Part XIII tax was payable, and he was therefore jointly and severally liable with the trust to remit the requisite withholding tax. Understandably, the appellant appealed this assessment to the TCC.

TCC decision

The TCC allowed the appellant’s appeal and vacated the assessment. Justice Paul Bédard focused on the distinction between the term “payable” in subsection 104(13) and the term “pays or credits” in paragraph 212(1)(c). He concluded that while the trust resolution resulted in the distribution being “payable” to Mr. Herbert, the amount was not “paid or credited” to him in 2001.

By way of background, subsection 104(24) requires that amounts payable to a beneficiary be included in the beneficiary’s income. When an amount becomes payable to a beneficiary, the trust may deduct it in that year. The same subsection subsequently states that an amount is not payable unless either it was paid or the beneficiary acquired the right to enforce its payment. As noted, in this case, the trust filed its tax return on the basis that this requirement had been met, and the Minister did not challenge the trust’s deduction of the $2.2 million distribution.

The Crown argued on the appeal that because the trust had an obligation to pay the amount to Mr. Herbert and since the resolution was more than “a simple accounting entry,” the trust should have withheld under section 212. That is, for the Crown, the trustees’ resolution amounted to a payment or credit as required by the language of paragraph 212(1)(c). In the Crown’s view, “to “pay” means to disburse an amount of money in fulfilment of an obligation and “to “credit” refers to a situation where a creditor has the right to enforce immediate payment of a sum but grants the debtor deferral of the payment until some future date.

The Tax Court rejected this argument and allowed the appellant’s appeal. The Court gave several reasons for rejecting the Crown’s definition of the term “credit” as used in section 212.

First, under the Crown’s interpretation, the creditor of the trust — that is, the beneficiary — would be the only person in a position to credit the amount, since it is the creditor who must grant the debtor the right to defer payment. Thus, the beneficiary would be determining whether to credit an amount to himself — an absurd and unintended result.

Second, the Crown’s argument would mean that an amount “payable” under the trust provisions in subsection 104(13) would always be “credited” under subsection 212(1). However, if these were intended to be equivalent concepts, then there would be no need to use different words to describe them. The presumption against useless legislative concepts is a longstanding principle of Canadian law. The court reasoned that since the term “credits” is paired with “pays” in section 212, it should be treated as a near synonym, referring to the fulfilment of an obligation.

Additionally, the structure of the provisions of the Act suggests that Parliament intended certain tax consequences of a trust’s obligations to pay an amount to a beneficiary to apply at the time of a trust’s creation (under section 104 in Part I), and other tax consequences to attach at the time that the obligation is actually discharged and funds leave the trust (under Part XIII).

Interestingly, the Court added that the CRA’s longstanding interpretation of “credited” in this context is more likely to be correct. The CRA (in IC 77-16R4) provides examples of situations where funds have actually been put aside or deposited in an account for the beneficiary. Practically, then, the beneficiary is in possession or has access to the funds. In these situations, the beneficiary has been credited with them.

The TCC noted that even if it had been able to conclude that the trust had credited an amount to the beneficiary, the appellant, as trustee, could not have been held liable for the unremitted withholding tax of the trust because that provision clearly states that it only applies to amounts paid.

Lessons learned

There are a few lessons to be learned from this case. First, a resolution creating an obligation does not necessarily mean an amount has been “credited.” In this context, “crediting” an amount for the purposes of section 212 means unconditionally placing of funds at the beneficiary’s disposal in fulfilment of the trust’s obligation to pay. Second, trustees who authorize distributions to non-residents should exercise caution and ensure they are not exposing themselves to liability for the ’trust’s unremitted withholding tax.

Even though the appellant was successful in this case, having to defend one’s position through litigation is never desirable. However, the matter is not truly resolved as the Crown has appealed this decision to the Federal Court of Appeal.

These are some of the conclusions drawn from tax executives, audit committee members, tax administrators and tax policymakers who participated in our 2011–12 Tax risk and controversy survey.

On 9 February, join our team of professionals for the first in a series of webcasts about tax risk and controversy as they discuss the following:

• Why tax risk and controversy are so important for companies
• How the tax risk and controversy landscape has changed in recent times
• How leading companies are designing and implementing global tax risk and controversy management frameworks
• The trends we expect to see in the next few years

You can hear our perspectives on these and other issues that matter to you at ey.com/Webcasts.

Business questions in a global world

• Where will the next big demand market be for our business?
• How should we be taking advantage of it?
• Where should we be investing?
• Do we need to invest there or can we operate virtually?
• How do we hedge our risk, including currency, business, economic and geopolitical risks?

Tax questions in a global world

• What is the most tax-efficient structure, and what local incentives exist for new investments?
• What are the tax compliance and reporting obligations of our business decisions? Can or should our in-house resources manage those needs?
• Do tax hurdles in some countries outweigh non-tax benefits? Do our decision and risk management processes take this into account?
• Are there pending policy decisions that could affect our tax position? Have these been factored into the decision-making process?

Tax risk and controversy questions in a global world

• Are we confident that our tax processes and controls enable our group to meet its tax compliance and reporting obligations?
• Are we comfortable that the level of tax we pay in all jurisdictions is in line with our business results? Could it be construed otherwise? If so, how do we feel about it?
• Are there indicators that suggest our tax payments are lower than current economic conditions suggest they should be?
• Are we comfortable that the tax function has clear and close input into major transactions and business plans?
• Are we aware of any material timing or permanent differences in the group’s tax-effect accounting? If so, are we comfortable with the reasons for those differences?
• Are there any areas of major disagreement between our company and a taxing authority? Are we satisfied with the way they are being handled?
• Have any potential additional tax liabilities been adequately provided for?

Tax Alerts – Canada

• 2011 Issue No. 44 - Holding corporations to incur additional costs as a result of QST harmonization
  On 30 September 2011, the Quebec and federal finance ministers signed a memorandum of agreement regarding sales tax harmonization that provides for further harmonization of the QST and GST. One of the significant changes is that the supply of financial services will be considered as exempt supplies for QST purposes as of 1 January 2013. As a result, holding corporations will no longer be entitled to claim the QST paid on their purchases as input tax refunds.
• 2011 Issue No. 45 - The latest on GAAR: Supreme Court of Canada releases decision in Copthorne Holdings Ltd.
  On 16 December 2011, the Supreme Court of Canada released its highly anticipated decision in the case of Copthorne Holdings Ltd. v the Queen (2011 SCC 63). The Court dismissed the taxpayer’s appeal — and in so doing confirmed that the General Anti-Avoidance Rule applied to a series of transactions that resulted in the “double counting” of paid-up capital (PUC).
• 2012 Issue No. 01 - Supreme Court of Canada hears the GlaxoSmithKline case
  On 13 January 2012, the Supreme Court of Canada heard the appeal of the Federal Court of Appeal’s decision in favour of Glaxo Canada in the GlaxoSmithKline transfer pricing case. The Court is expected to render its decision within the next 8 to 12 months. Since this is the first transfer pricing case heard by the Supreme Court, its decision should provide valuable guidance on transfer pricing concepts and practice.

Articles

• Treasury-related transactions pose problems for taxpayers and authorities in applying arm’s-length transfer-pricing
  In the December 2011 issue of CAmagazine, Ernst & Young partner Thomas Tsiopoulos, senior manager Andrei Tarassov and manager Jaime Nemeth discuss the attention various taxing authorities and certain judicial bodies have given to intercompany treasury-related transactions — particularly loans and guarantees
• Tax considerations for the newly self-employed
  In the 2011 Issue 4 of the Canadian Tax Journal, Ernst & Young senior managers Lucie Champagne and Yves Plante and manager Gael Melville review the tax aspects of many practical issues faced by the newly self-employed, together with a summary of recent legislative changes aimed at supporting the growing numbers of self-employed individuals in Canada.
• Family Trusts and the Reversionary Rules
  In the January 2012 issue of the Canadian Tax Foundation newsletter Tax for the owner-manager, associate partner Teresa Gombita and manager Marc Léger discuss the implications of the Sommerer decision (2011 TCC 212) on contributions of property to a trust and the application of the subsection 75(2) anti-avoidance provision.
• Business immigration alerts and updates
  For the latest information on Canadian and US business immigration issues from Egan LLP, a business immigration law firm allied with Ernst & Young LLP in Canada, visit EganLLP.com.