Tax Litigation 

In 2009, the CRA commenced a broad review of the non-profit organization sector. You or your clients may have received a CRA questionnaire asking that the NPO provide information or documents in respect of its structure, activities, bylaws, finances, and membership.

Generally, NPOs have been exempt from tax in Canada since the introduction of the income tax in 1917. Under paragraph 149(1)(l) of the Income Tax Act, no Part I tax is payable by a club, society or association that is not a charity, is organized and operated for any purpose other than profit, and no part of the income of which is payable to any proprietor, member or shareholder. Currently, there may be up to 80,000 NPOs in Canada that qualify for the tax exemption under paragraph 149(1)(l). Prior to 2009, the CRA had not undertaken a general review of this sector.

Recently, the CRA published a report and Q&A on the Non-Profit Organization Risk Identification Project (NPORIP). In its report, the CRA stated the review revealed that many NPOs would fail to meet at least one of the requirements set out in paragraph 149(1)(l) of the Act:

The NPORIP was designed to provide the CRA with insight into the way certain organizations—those seeking an exemption from tax under paragraph 149(1)(l) of the Act—operate under the income tax rules. The NPORIP has given the CRA a better understanding of the issues these organizations face in complying with the Act, and, in particular, has highlighted a number of areas where the non-profit sector’s understanding of the law differs from that of the CRA. In addition, the NPORIP has revealed a significant issue with compliance by these organizations in several key areas.

The report provides only a high-level summary of its findings, none of which are surprising:

• The NPORIP identified a small number of cases where the NPO was, in fact, a charity;
  
• The NPORIP identified a small number of cases where the NPO’s governing documents (such as articles of incorporation, letters patent, and by-laws) indicated that it was not organized exclusively for a purpose other than profit;
• The NPORIP noted a variety of activities with apparent profit motives carried out by a wide range of NPOs; and
• The NPORIP identified a small number of cases where the NPO had income payable or made available for the personal benefit of a proprietor, member, or shareholder.

The report states that the CRA will seek to improve its education and outreach in the NPO sector, so as to increase awareness and compliance. Additionally, the CRA indicated that a copy of the report had been provided to the Department of Finance for the purpose of reviewing the NPO legislative framework.

We don’t think the report is the final word on this issue from either the CRA or the Department of Finance. In fact, in its 2014 federal budget, the Department of Finance stated:

… Budget 2014 announces the Government’s intention to review whether the income tax exemption for NPOs remains properly targeted and whether sufficient transparency and accountability provisions are in place. This review will not extend to registered charities or registered Canadian amateur athletic associations. As part of the review, the Government will release a consultation paper for comment and will further consult with stakeholders as appropriate.

We expect that future legislative changes (i.e., increased reporting requirements) may be forthcoming in the next few years.

The tax treatment of amounts paid out of failed Ponzi schemes is once again in the news. In Roszko v. The Queen (2014 TCC 59), the Tax Court of Canada allowed the taxpayer’s appeal and held that amounts paid out of a fraudulent scheme were not taxable as interest income.

Roszko follows two recent decision on this issue. In Johnson v. The Queen (2012 FCA 253), the Federal Court of Appeal held that amounts paid out of a Ponzi scheme in excess of the duped taxpayer’s original investment were taxable as income. And in Orman v. Marnat (2012 ONSC 549), the Ontario Superior Court of Justice held that amounts received out of a Ponzi scheme were not investment income (see also this article on the court’s consideration of whether it could rectify certain corporate documents of two companies that had invested in the fraud).

In Roszko, the taxpayer was induced to invest in TransCap Corporation, which was allegedly trading commodities, on the basis that the investment would return 18% to 22% annually. In 2006, the taxpayer made an initial investment of $100,000, which was structured as a loan.  In 2006 and 2007, the taxpayer loaned a total of $800,000 to TransCap. From 2006 to 2009, TransCap paid to the taxpayer a total of $408,000 as follows: $22,500 in 2006, $81,000 in 2007, $156,000 in 2008, and $148,500 in 2009.

In December 2009, the taxpayer became suspicious of the activities of TransCap, which lead to an investigation by the Alberta Securities Commission, which eventually determined that TransCap had perpetrated a fraud on investors.

The issue before the Tax Court was whether the $156,000 received by the taxpayer in 2008 was interest income under paragraph 12(1)(c) of the Income Tax Act.

The Tax Court cited the Federal Court of Appeal’s decision in Johnson for the proposition that there can indeed be a source of income in a Ponzi scheme. However, the Tax Court held that the facts in the Johnson case – wherein the Federal Court of Appeal held that the $1.3 million received by the taxpayer out of the Ponzi scheme was taxable – were different from the facts of the present case. Specifically, in Roszko, the taxpayer’s agreement with TransCap stipulated how the funds were to be invested, the taxpayer was lead to believe the funds would be so invested, the funds were not invested in that manner (i.e., the taxpayer’s contractual rights were not respected), it was agreed that TransCap perpetrated a fraud, and the fraud was described in a decision of the Alberta Securities Commission.

The Tax Court held that the facts of Roszko were more like those in the case of Hammill v. The Queen, in which the Federal Court of Appeal held that a fraudulent scheme from beginning to end cannot give rise to a source of income from the victim’s point of view and hence cannot be considered as a business under any definition.

The Tax Court noted that, in Roszko, the Crown had argued that the income was property income in the form of interest. However, the Tax Court held the amount received by the taxpayer was not income from property, but rather a return of capital to the extent of the original amounts invested. The Tax Court noted that excess returns might be considered income. The Tax Court allowed the appeal .

This is a victory for the taxpayer for the 2008 tax year, but the unanswered question that looms in the background is how the taxpayer’s overall loss ($392,000) on the Ponzi scheme investment will be treated for tax purposes.

International and Transfer Pricing Audits

At the Toronto Centre Canada Revenue Agency & Professionals Breakfast Seminar on February 18, 2014, the CRA provided an update on international and transfer pricing audits. The slides can be found here. The discussion was led by Paul Stesco, Manager of the International Advisory Services Section, International and Large Business Directorate, Compliance Programs Branch of the CRA and Cliff Rand, National Managing Partner of Deloitte Tax Law LLP.  Here is a brief overview of some of the highlights from the presentation on how such audits are performed:

• Research and Analysis Stage: the CRA uses the internet extensively for research (e.g. industry analysis, competitor analysis, etc.) as well as prior audit reports, tax returns and annual reports of taxapyers to identify transactions and the appropriate transfer pricing methods applicable to those transactions.
• Mandatory Referrals to Headquarters: mandatory referrals by the field auditor to the International Tax Division (“ITD”) are required in several situations including: cost contribution arrangements, reassessments that could be issued after the tax treaty deadlines, transfer pricing penalties under subsection 247(3), recharacterization under paragraphs 247(2)(b) and (d), the application of subsection 95(6) and downward pricing adjustments under subsection 247(2) and (10). Situations which involve the use of “secret comparables” to reassess the taxpayer (i.e. comparables used by the CRA that cannot be found in a public database) will automatically be forwarded to the ITD; the CRA will not forward audit issues to the ITD if the “secret comparables” were used only for risk analysis.
• Access to Taxpayers: during an audit, the CRA may request access to certain individuals involved in the taxpayer’s business. The CRA does not necessarily require physical access to non-resident taxpayers; a telephone interview may suffice. An interview with operational personnel is likely to streamline the audit and, as such, is in the best interests of the taxpayer. Taxpayers are permitted to record such interviews (even including the use of a court reporter to produce a transcript).
• Currency of Audits: instead of proceeding on a year by year basis, audits will now generally begin with the most current risk-assessed taxation year (and one back year) and may then move back to other open years in respect of the same issue.  Having said that, there are still “legacy files” within the CRA’s system.
• Concerns/Complaints: a taxpayer who wishes to express concerns about a transfer pricing audit should follow the appropriate local chain of command: first contact the auditor, then the Team Leader and the relevant Section Manager at the local TSO. Taxpayers should refrain from directly contacting Head Office. The CRA stressed the importance of communicating with the audit team on a regular basis.
• Contemporaneous Documentation Requirement in subsection 247(4): the CRA acknowledged that transfer pricing studies have been accepted even if they were prepared after the period to which they relate.
• Transfer Pricing Review Committee (TPRC): two types of referrals proceed to the TPRC: (1) penalty referrals under subsection 247(3) which involve transfer pricing adjustments in excess of 10% of gross revenue or greater than $5,000,000; and (2) referrals of recharacterization as an assessing position under paragraph 247(2)(b).
  • As of October 31, 2013, penalty referrals made up 86.5% of all referrals while recharacterization referrals accounted for 13.5% of all referrals.
  • The taxpayer does not have direct access to the TPRC to make submissions. However, minutes of committee meetings may be obtained by making an Access to Information request.

In Rochefort v. The Queen (2014 TCC 34), the Tax Court of Canada provided clarity on the definition of “ownership” for the purposes of the GST/HST New Housing Rebate. Justice Campbell Miller held that “ownership” in subparagraph 254(2)(e) of the Excise Tax Act (the “ETA”) does not necessarily mean holding legal title but denotes a more expansive view of ownership.

In the case, the recently-married Mr. and Mrs. Rochefort decided to buy a new home. Unfortunately, shortly before the closing, Mr. Rochefort was advised by his bank that, due to his failure to sell his current property and his wife’s poor credit rating, the couple no longer qualified for a mortgage. Having already paid $20,000 in deposits, the couple chose to close the deal, and so they enlisted Mr. Fontaine, the nephew of Mr. Rochefort, to act as a co-signor on a mortgage from another bank.

Mr. Fontaine testified that he was prepared to help his uncle by signing whatever documents were required. Mr. Fontaine in fact signed a Fixed Rate Mortgage form, as well as a Direction re: Title, authorizing the lawyers to transfer the deed to Mr. Rochefort and Mr. Fontaine as joint tenants.  It was evident from Mr. Fontaine’s testimony that he was not entirely clear as to what he had signed, and he had no intention of ever living in, or receiving a benefit from, the property. Rather, it was clear that the new home was for the sole benefit of Mr. and Mrs. Rochefort, and Mr. Fontaine was merely assisting a family member by doing a favour.

Mr. Rochefort signed the new housing rebate in 2010 and, as a result, the developer was credited with $27,278. The Minister of National Revenue reassessed Mr. Rochefort on the basis that he was not entitled to the rebate as the definition of “ownership” in subparagraph 254(2)(e) of the ETA had not been satisfied.

The Minister argued that, under subparagraph 254(2)(e), “ownership” must be transferred to a “particular individual” (the Court noted that, where there is more than one purchaser, subsection 262(3) of the ETA makes it clear that “particular individual” refers to both purchasers). Ownership had not been transferred to Mr. and Mrs. Rochefort but had been transferred to Mr. Rochefort and Mr. Fontaine. Therefore, in the Minister’s view, this requirement had not been met.

The Tax Court disagreed. Mr. and Mrs. Rochefort were the “particular individuals” who signed the Agreement of Purchase and Sale and, thus, Mr. Fontaine was not a “particular individual” for the purposes of the ETA. The requirements in subsection 254(2) of the ETA had been met by Mr. Rochefort. The only question was whether the other “particular individual” (i.e., Mrs. Rochefort)  had ownership transferred to her as required by subparagraph 254(2)(e).

The Minister argued that “ownership” meant title to the property, and suggested that definition of owner in the Ontario Land Titles Act (i.e., an owner in fee simple) should apply for the purposes of the ETA. However, the Tax Court noted that, if the drafters of the ETA had intended ownership to mean title, they could have said as much in the ETA. The Tax Court held that “ownership” for purposes of the GST/HST New Housing Rebate must be explored in a “textual, contextual and purposive manner for a fuller meaning than simply title.”

The Court interpreted subparagraph 254(2)(e) as a timing condition – ownership happens after substantial completion. This view is consistent with the views expressed by the CRA in GST/HST Memorandum 19.3.1 “Rebate for Builder-Built Unit (Land Purchased)” (July 1998, as amended in 2002 and 2005).

The Tax Court viewed Mr. and Mrs. Rochefort as the individuals the rebate was intended to benefit. They were the buyers of the property, the individuals liable for the GST, and they took possession of the property after its substantial completion in order to reside in it as their primary residence. Moreover, Mrs. Rochefort had acquired sufficient rights to constitute ownership thereby satisfying the requirements in 254(2)(e): she had signed the Agreement of Purchase and Sale to become an owner, she had made the necessary deposits, she acted as an owner in making decisions to amend the Agreement of Purchase and Sale, she was liable for the GST, she took possession of the property with her husband, and had acted in every way as an owner by enjoying the property.

The Tax Court concluded that Mrs. Rochefort was a beneficial owner of the property and that Mr. Fontaine had agreed to hold title solely for the benefit of the Rocheforts. As a trustee, Mr. Fontaine was required to convey title to the Rocheforts on demand or to any third party at their request. “Ownership” of the property had been transferred to Mrs. Rochefort.

Accordingly, the taxpayer’s appeal was allowed and Mr. Rochefort was entitled to the GST/HST New Housing Rebate under subsection 254(2) of the ETA.

In Black v. The Queen (2014 TCC 12), Lord Conrad Black argued that he was not subject to tax in Canada on certain income and taxable benefits. Both Lord Black and the CRA agreed that he was a resident of both Canada and the U.K. in 2002, and that under Article 4(2)(a) of The Canada-United Kingdom Income Tax Convention (the “Convention”) he was a “deemed” resident of the U.K. for the purposes of the Convention.

Lord Black had filed his Canadian tax return for 2002 on the basis that some $800,000 of income from the duties of offices or employments performed by him in Canada was taxable in Canada. However, Lord Black did not include certain other remuneration and benefits totalling $5.1 million in his Canadian income, including some $2.8 million of income from the duties of offices or employments performed outside Canada, $326,177 of taxable dividends, $365,564 of shareholder benefits, and $1.3 million of benefits arising as a result of his use of an airplane owned by Hollinger International Inc.

At the Tax Court hearing, Lord Black argued that by virtue of his “deemed” U.K. residency these other amounts were not taxable in Canada. As it happens, since he was not domiciled in the U.K., Lord Black was subject to tax in the U.K. only on the portion of his non-U.K. source income that was remitted to or received in the U.K.

The CRA alleged that, notwithstanding Lord Black being deemed a U.K. resident for the purposes of the Convention, he was subject to Canadian tax on income and benefits that were not covered by the Convention.

The Tax Court dismissed Lord Black’s appeal and held that he could be a deemed resident of the U.K. for purposes of the Convention and also be a resident of Canada for purposes of the Canadian Income Tax Act. Chief Justice Rip noted that the arguments presented on behalf of Lord Black had no supporting authority and were contrary to the liberal and purposive approach that must be taken when interpreting a tax treaty.

In applying a liberal and purposive approach to Article 4(2) of the Convention, the Tax Court noted that the tie-breaker rule at issue merely provided a preference to the taxing authority of the U.K., but did not extinguish Canada’s claim to tax. Lord Black’s argument that there was an inconsistency between the Income Tax Act and the Convention was incorrect as it did not take into account the role of Article 4 in allocating taxing jurisdiction to avoid double taxation. As such, Lord Black was unable to point to any provision in the Convention that would result in double taxation if he were resident in Canada.

Lord Black also sought to rely on Article 27(2) of the Convention, which addressed the tax treatment of non-domiciled residents of the U.K. who are required to pay tax on foreign income only when received in the U.K. Article 27(2) essentially provides that where a person is subject to income tax in the U.K., and the Convention provides for tax relief in Canada, the tax relief will only be in respect of the amount of income that is actually taxed in the U.K. Thus, Lord Black argued that the Minister could not assess his non-Canadian income because none of the income was remitted or received in the U.K., and so there was no tax from which he could have been relieved in Canada.

Since the Tax Court had already determined that Lord Black was a resident of Canada for purposes of the Income Tax Act, the argument based on Article 27(2) could not succeed. The Tax Court agreed with the CRA that the Convention allocates the right to tax between Canada and the U.K. on an item-by-item basis, and any items not covered by the Convention were thus subject to tax on the basis of Lord Black’s residence in Canada. As a resident of Canada, Lord Black was subject to tax on his worldwide income, including income earned in the U.S.

We note that both parties agreed that subsection 250(5) of the Act, which deals with the deemed non-residency of a Canadian where the individual is deemed to be a resident in another country by virtue of a tax treaty, did not apply. This was because of the “grandfathered” application of subsection 250(5) (i.e., the provision is not applicable to a Canadian resident individual who was (i) a resident of two countries and (ii) deemed resident of one of those countries under a tax treaty at the time the subsection became effective in 1999). If subsection 250(5) had applied, then Lord Black would not be a resident of Canada for the purposes of the Income Tax Act.

On January 22, 2014, Lord Black filed his appeal in the Federal Court of Appeal (File No. A-70-14).

Tax authorities around the world continue to wrestle with the tax issues arising from the use and sale of Bitcoin currency. Sweden recently announced that it will treat Bitcoin as an asset, and Finland has stated that it will treat Bitcoin as a commodity. China has placed restrictions on the use of Bitcoin. Generally, the price fluctuations and uncertainties around the use and sale of Bitcoins seemed to have generated more questions than answers.

In Canada, the use of Bitcoin currency appears to be gaining popularity - Bitcoin ATMs have popped up in several cities, and various retailers and even some charities are accepting Bitcoins for payments or donations. However, the Canadian government apparently does not consider it a currency. The Canadian tax implications of Bitcoin transactions have been considered by the CRA and tax professionals, and now the CRA has published some additional guidance on the subject.

In CRA Document No. 2013-0514701I7 “Bitcoins” (December 23, 2013), the CRA summarized its views on how certain transactions involving the use or sale of Bitcoins may be taxed under the Income Tax Act and Excise Tax Act.

Buying and Selling Goods or Services in Exchange for Bitcoins

The CRA stated that the use of Bitcoins to purchase goods or services would be treated as a form of barter transaction (see, for example, Interpretation Bulletin IT-490 “Barter Transactions” (July 5, 1992)). The CRA’s view is that each party to a barter transaction has received something that is equal to the value of whatever is given up. For Canadian tax purposes, if a business sells goods or services in exchange for Bitcoins, that business must report its income from the transaction in Canadian dollars (i.e., the fair market value of the Bitcoins at the time of the sale). GST/HST would be applicable on the fair market value of the Bitcoins that were used to pay for the goods or services.

Donation of Bitcoins

The CRA stated that, if Bitcoins are transferred to a qualified donee, the fair market value of the Bitcoins at the time of the donation must be used in determining the value of the gift for tax purposes (see also CRA Pamphlet P113 “Gifts and Income Tax”). The determination of the fair market value is a question of fact.

Buying and Selling Bitcoins

The CRA stated that the trading or sale of Bitcoins like a commodity (i.e., speculating on the changes in the value of Bitcoins) may result in a gain or loss on account of income or capital. This determination can only be made on a case-by-case basis and on the specifics facts of each situation (see, for example, Interpretation Bulletin IT-479R “Transactions in Securities” (February 29, 1984)). Generally, the income tax consequences relating to the tax treatment of gains or losses arising from the purchase and sale of Bitcoins would be the same as for transactions involving other types of commodities.

“Now then, Pooh,” said Christopher Robin, “where’s your boat?”
“I ought to say” explained Pooh as they walked down to the shore of the island “that it isn’t just an ordinary sort of boat. Sometimes it’s a Boat and sometimes it’s more of an Accident. It all depends”.
“Depends on what?”
“On whether I am on the top of it or underneath it”
A. A. Milne, Winnie-the-Pooh

Readers who were tax practitioners in the mid-80s will well remember the luxury yacht tax shelters, which were sold in 1984, 1985 and 1986 and which were one of the most popular tax shelters of that period. Many of us had clients who invested in this tax shelter and are aware that the CRA was very upset with this tax shelter and reassessed all of the investors. Tax practitioners from that period will also remember that the promoter of the tax shelter and several of his associates were prosecuted and convicted in connection with the luxury yacht tax shelter.

Approximately thirty years later, Associate Chief Justice Eugene Rossiter of the Tax Court of Canada released his decision in Garber et al. v. The Queen on January 7, 2014. The three appeals involved investors in limited partnerships which were established in 1984, 1985 and 1986 to acquire and charter luxury yachts and the deductions claimed by the Appellants in their 1984 to 1988 taxation years. The Appellants, as limited partners, claimed losses relating to the operation of the partnerships, interest deductions on promissory notes which were used to pay for the limited partnership units and professional fees paid in the year the Appellants subscribed for partnership units. The reasons for judgment note that 600 investors were reassessed and approximately 300 investors settled with the CRA.

The hearing opened on January 11, 2012 and in total over 62 days of evidence was given by 34 witnesses and there were 23 agreed statements of fact. The decision of Associate Chief Justice Rossiter is over 150 pages long and may rank as one of the longest Tax Court decisions (we previously commented on the length of the decision by Justice Boyle in McKesson Canada Corporation v. The Queen which was released in December 2013 – for those of you who keep track of such matters, this decision is fifty percent longer that the decision in McKesson.)

In basic terms, each of the Appellants invested in a limited partnership which was created to purchase a luxury yacht from the promoter. The promoter, as general partner, was committed to providing the yachts and to market and manage a luxury yacht chartering business for each limited partnership. The projections provided to the Appellants showed significant deductible start-up costs and the Appellants also expected to benefit from the tax depreciation (capital cost allowance) on the yachts. The Appellants’ investments were heavily leveraged with financing organized by the promoter and, therefore, a taxpayer who acquired a limited partnership unit would benefit from an attractive tax deduction in excess of his or her cash investment.

Associate Chief Justice Rossiter carefully reviewed the background facts relating to the limited partnerships (almost 100 pages are devoted to recounting the evidence). He noted that the promoter of the tax shelter and several of his associates were convicted of fraud in connection with the arrangement and found that the scheme was a fraud because virtually no yachts were acquired and the money paid by investors was used to promote future partnerships and not used in a yacht chartering business.

The CRA had offered numerous reasons why the expenses claimed by the Appellants should be disallowed:

1. The limited partnerships did not constitute an income source under sections 3 and 4 of the Act because there was no genuine yacht charter business. The limited partnerships were not true partnerships because no actual business was carried out in common.
2. The transactions were “mere” shams.
3. Limited partnerships never actually incurred expenses for the purpose of gaining or producing business or property income.
4. In the alternative, under subsections 9(1) and 18(9) of the Act, certain expenses incurred were not deductible in the years claimed because services were to be rendered after the end of the taxation year.
5. In respect of interest payments, the CRA alleged that the promissory notes did not constitute actual loans and that no money was lent or advanced to the investors and, therefore there was no interest deductibility.
6. To the extent any yacht was acquired by the 1984 partnership, capital cost allowance was restricted by the leasing property rules in subsections 1100(15), (17) (17.2) and (17.3) of the Income Tax Regulations.
7. In the alternative, if interest was deductible, it would be limited by the half year rule in subsection 1100(2) of the Income Tax Regulations.
8. For partnerships marketed in 1986, the partnership losses are restricted by the “at–risk” rules introduced on February 26, 1986.
9. Subsection 245(1) of the Act is applicable because the expenses and disbursements claimed by an Appellant would unduly or artificially reduce the taxpayer’s income.
10. The expenses are not deductible under section 67 of the Act because they were not reasonable and were not incurred to earn income.

After his extensive review of the evidence, Associate Chief Justice Rossiter analysed the legal issues. He found that there was no source of income for purposes of the Act under section 9 because the transactions were a fraud (similar to Hammill v. Canada, a 2005 decision of the Federal Court of Appeal) and because the scheme was a fraud, there was no source of income. It was noted that it is possible to have a fraud and a business (several cases are cited in this regard); however, based on the facts, in this situation, there was no business whatsoever. Therefore, there was no source of income.

One of the arguments made by the Appellants is that the significant amount of money received from investors was spent by the promoter and this indicates that there was a business. However, the facts were clear that money was not spent on acquiring yachts or a yacht charter business. Some of the funds were spent on unrelated endeavours and most of the funds were spent by the promoter on marketing and promoting future limited partnerships.

Associate Chief Justice Rossiter also noted that the Appellants commented during the trial on the “aggressive or inappropriate behaviour by members of the CRA”. He stated that his task “is not to assess the conduct of the CRA, but rather to determine whether or not the expenses claimed in these appeals are legitimate”. He also noted that the tax shelters were a Ponzi-like scheme which were set to collapse eventually and the conduct of the CRA did not turn the Ponzi-like scheme, which was a fraud from beginning to end, into a genuine business. In effect, all the CRA did was “lift the veil” to reveal the pervasive nature of the fraud.

Associate Chief Justice Rossiter also made clear that because the investment by limited partners was heavily leveraged, there was a lack of capital and this was a significant indication that there was no business being carried on.

Accordingly, there was no genuine business and the Appellants did not have a source of income from which they could deduct expenses or losses.

Furthermore, there were no genuine partnerships. For a partnership to exist, the parties must be a) carrying on a business b) in common and c) with a view to profit. Here, there was no business carried on; merely a fraud perpetuated by the promoter. Business was not carried on “in common” despite the existence of a partnership agreement because the promoter was perpetrating a fraud even though the limited partners were ignorant of the fraud perpetrated on them. As to a “view to profit”, there was no “view to profit”; the promoter had the intention to profit at the expense of the limited partnerships and the activities were so underfunded and so limited that there was no intention to profit.

Associate Chief Justice Rossiter went on to state that if there was a business carried on, the expenses claimed were not incurred for the purpose of operating the limited partnerships’ yacht chartering business and therefore were not deductible pursuant to subsection 18(1) of the Act.

Associate Chief Justice Rossiter also reviewed the requirement under subsection 18(9) of the Act that a taxpayer match any prepaid expense for services, interest, taxes, rent, royalty or insurance to the year in which those expenses relate. Based on the facts, the deductions claimed had little relation to actual expenses incurred and therefore deductibility is precluded under this provision.

Associate Chief Justice Rossiter also stated that in respect of one yacht which the taxpayers argued had been acquired by one of the 1984 partnerships, no evidence was presented that ownership of the boat was acquired by the limited partnership and therefore capital cost allowance was not deductible pursuant to paragraph 1102(1)(c) of the Income Tax Regulations. In any event, a boat was never acquired for income gaining or earning purposes and was only used by the promoter as window dressing to perpetrate the fraud.

In respect of the interest expenses claimed, the test under sub-paragraph 20(1)(c)(ii) was not met, because there was never a legal obligation to pay interest. The taxpayers entered into promissory notes based on fraudulent misrepresentations and any contractual obligation to pay interest would have been vitiated by the fraud.

In addition, in respect of the 1986 partnerships, the “at-risk” rules applied. It had been argued by the Appellants that the partnerships were grandfathered under the legislation but the statutory test for grandfathering had not been met.

Finally, any expense would have been denied under section 67 of the Act as the expenses were not reasonable in the circumstances if one considers the entire scheme. The Appellants had offered no evidence to show that expenses were legitimate or reasonable in light of services rendered or if any services were rendered at all.

Associate Chief Justice Rossiter concluded by stating that because of the lack of a source of income, the non-existence of genuine limited partnerships, the fact that the expenses were not incurred for business purposes, as well as the alternative arguments he addressed in his decision, it was not necessary to deal with all of the CRA’s arguments (e.g. sham and section 245). Accordingly, the appeals were dismissed with costs.

Given the amounts involved, and the number of taxpayers who were awaiting these decisions, it is likely that this case will “sail” into the Federal Court of Appeal.

On Friday, December 20th, the Tax Court of Canada released the long-awaited and lengthy decision of Justice Patrick Boyle in McKesson Canada Corporation v. The Queen, a case involving transfer pricing adjustments under section 247 of the Income Tax Act (the “Act”) and the limitation period in Article 9(3) of the Canada-Luxembourg Tax Convention.

McKesson Canada is the principal Canadian operating company in the McKesson Group. The core business of the McKesson Group and of McKesson Canada is the wholesale distribution of “over the counter” and prescription pharmaceutical medicine products. Effective December 16, 2002 McKesson Canada and its Luxembourg parent company, MIH, entered into a Receivables Sales Agreement (the “RSA”) and a Servicing Agreement. Under the RSA, MIH agreed to purchase all of McKesson Canada’s eligible receivables as of that date (about $460,000,000) and committed to purchase all eligible receivables daily as they arose for the next five years unless earlier terminated as provided for in the RSA and subject to a $900,000,000 cap. The price to be paid for the receivables was at a 2.206% discount to their face amount (if one takes into account that historically receivables were paid on average within 30 days, this rate equates to an annual financing rate of approximately 27%). The Canada Revenue Agency reassessed McKesson Canada’s 2003 taxation year on the basis that if the RSA had been made between arm’s length parties the Discount Rate would have been 1.013% and made a transfer pricing adjustment under section 247 of the Act of $26,610,000 (the taxation year of McKesson Canada under appeal ended March 29, 2003 and was approximately three and a half months long – the annualized transfer pricing adjustment was therefore approximately $80,000,000).

The Tax Court trial lasted 32 days over a period of five months from October, 2011 to February, 2012 and following the Supreme Court of Canada’s decision in Canada v. GlaxoSmithKline Inc. in October, 2012, both parties made further written submissions.

Under the RSA, eligible receivables were trade receivables owing by arm’s length customers not in default and whose receivables would not represent in the aggregate more than 2% of McKesson Canada’s then outstanding receivable pool. However, the 2% concentration limit on eligibility did not apply to McKesson Canada’s largest customers who accounted for about one-third of the sales. MIH had the right to put non-performing receivables back to McKesson Canada for a price equal to 75% of the face amount to be later re-adjusted to the amount actually collected and MIH did not otherwise have recourse against McKesson Canada for unpaid purchased receivables. The receivables under the RSA were expected to be collected in a short period of time (historically, payment was made by customers in 30 days) and the historical bad debt experience was .043%.

Under the Servicing Agreement, McKesson Canada agreed to service the accounts receivable and received a servicing fee of $9,600,000 annually regardless of the amount outstanding. The amount paid under the Servicing Agreement was not challenged by the CRA.

The amount payable for a purchased receivable under the RSA was determined by multiplying the face amount of the receivable by one minus the Discount Rate. The Discount Rate was defined to be the sum of (a) the Yield Rate which was equal to the 30 day Canadian dollar banker’s acceptance (BA) rate or the Canadian dealer offered rate (CDOR) on the first business day of the relevant settlement plus (b) the Loss Discount which was intended to reflect the credit risk of the McKesson Canada customers whose receivables were covered by the RSA and was set at 0.23 for the year under appeal. For the remaining term of the RSA commencing January 1, 2004, the Loss Discount was to be recalculated as often as MIH considered necessary based on the credit risk of certain customers plus (c) the Discount Spread which was set at the fixed rate of 1.7305% and related to the risk that (i) McKesson Canada’s credit worthiness deteriorated significantly and receivable debtors might set off their rebate entitlements in such event, (ii) the risk that McKesson Canada’s customers might increase their take-up of available prompt payment discounts, (iii) the risk that MIH might decide to appoint a new service provider who would require a greater servicing fee, and (iv) the need for the Discount Rate to fully cover MIH’s cost of funds.

Toronto Dominion Securities Inc. (“TDSI”) was retained by counsel for McKesson Canada to provide advice on the arm’s lengths aspects of certain terms and conditions of the RSA and certain components of the Discount Rate calculation at the time the RSA was entered into. The TDSI reports were relied on by McKesson Canada as contemporaneous documentation and, therefore, a transfer pricing penalty under subsection 247(3) of the Act was not assessed by the CRA (had there been no contemporaneous documentation, McKesson Canada would have been automatically subject to a penalty of 10% of the transfer pricing adjustment). Interestingly, Justice Boyle states in a footnote that the CRA may need to review its threshold criteria in respect of contemporaneous documentation under subsection 247(4) of the Act and that he would not “have expected last minute, rushed, not fully informed, paid advocacy that was not made available to the Canadian taxpayer and not read by its parent would satisfy the contemporaneous documentation requirements.”

Justice Boyle stated that the CRA reassessment was made under paragraphs 247(2)(a) and (c) of the Act and that the task of the Court was to determine whether the terms and conditions of the transactions carried out by the parties resulted in a Discount Rate that was within the range of what McKesson Canada and MIH would have agreed to, had their transaction applied terms and conditions which persons dealing at arm’s length would have used. Interestingly, in light of recent OECD discussion papers, he noted that the CRA did not directly or indirectly raise “any fair share or fiscal morality arguments that are currently trendy in international tax circles” and that “it wisely stuck strictly to the tax fundamentals: the relevant provisions of the legislation and the evidence relevant thereto”. He noted that issues of fiscal morality and fair share are within the realm of Parliament.

Justice Boyle sets out in detail the evidence from the two material witnesses and the five expert witnesses who testified and criticizes much of the expert evidence. In respect of the transfer pricing report prepared by a major accounting firm in 2005 in response to the CRA’s review of the RSA transaction, he states that the report was primarily a piece of advocacy work, “perhaps largely made as instructed” and that the examples used by the accounting firm resulted in “picking and choosing” and mixing and matching the performance of the receivable pools which resulted in “transparently poor advocacy and even more questionable valuation opinions”.

Mr. Justice Boyle also criticized the taxpayer in respect of the manner in which the appeal was undertaken “Overall I can say that never have I seen so much time and effort by an Appellant to put forward such an untenable position so strongly and seriously. This had all the appearances of alchemy in reverse.”

In determining the appropriate methodology to determine the Discount Rate, Justice Boyle did not accept the conclusions of any of the experts or their reports in their entirety although he acknowledged that the Court’s analysis was informed by the testimony and information provided by the witnesses. He notes that the purpose of the RSA transaction was to reduce McKesson Canada’s Canadian tax liability by paying the maximum under the RSA that was justifiable (interestingly, McKesson Canada had been profitable for the years prior to the RSA but after the RSA was executed, McKesson Canada operated at a loss) and that there is nothing wrong with taxpayers engaging in “tax-oriented transactions, tax planning, and making decisions based entirely upon tax consequences (subject only to GAAR which is not relevant to this appeal)”. However, Justice Boyle also notes that the reasons for, and predominant purposes of, non-arm’s length transactions form a relevant part of the factual context being considered.

He then reviewed the various elements of the Discount Rate. In respect of the Yield Rate, he accepted that the 30 day CDOR rate is appropriate. However, for the period in question, he stated that it was necessary to review the historical evidence in respect of when payment would be made and that the parties should have taken into account the fact that the first period had a “missing” fifteen days because the agreement was entered into in the middle of the month. In respect to the Loss Discount which was fixed by the RSA at 0.23% Justice Boyle stated that this should be based on historical data which showed write-offs of approximately 0.04% and even if the parties provided a buffer of 50% to 100% increase in write-offs, the Loss Discount would be in the range of 0.6% to 0.8%. In respect of the Discount Spread, Justice Boyle looked at the various elements which were included in this number and based on the historical data and the facts provided, stated that the servicing discount risk would be in the range of 0.17% to 0.25%, the prompt payment dilution discount would be 0.5% to 0.53%, the accrued rebate dilutions discount (which involves a customer paying a lesser amount in respect of its accounts taking into account an expected rebate) was not justified and that the interest discount which was intended to provide MIH with a return from a discounted purchase of receivables would be between 0.0% and 0.08% for a total Discount Rate range of 0.959% to 1.17%. Accordingly, because the taxpayer did not rebut the CRA’s assumptions in respect of a reasonable Discount Rate, the taxpayer’s appeal in respect of the CRA’s transfer pricing adjustment was rejected.

The second issue reviewed by the Court involves the shareholder benefit and withholding tax on the deemed dividend which resulted from the excess amount paid by McKesson Canada to its Luxembourg parent MIH under paragraph 214(3)(a) and subsection 15(1) of the Act. By utilising a Discount Rate which was greater than an arm’s length rate, McKesson Canada provided a benefit to MIH which is to be treated as a deemed dividend and is subject to non-resident withholding tax and McKesson Canada was jointly liable with MIH for the withholding tax under subsection 215(6) of the Act. The taxpayer did not deny this liability but stated that it was statute-barred because the Canada-Luxembourg Tax Convention specifically provided for a five-year limitation period (Article 9 (3)) and the reassessment of McKesson Canada in respect of withholding tax was issued after this period. Justice Boyle held that because Article 9(3) of the Convention only deals with Article 9(1) of the Convention in respect of transfer pricing adjustments and not deemed dividends and because there was no evidence that MIH was subject to any “extra tax” in Luxembourg because of the deemed dividend, the five-year time limit in Article 9(3) does not apply and, therefore, the withholding tax assessed against McKesson Canada was not subject to the limitation period in the Convention. Therefore the taxpayer’s appeal in respect of withholding tax was also dismissed.

As noted above, the decision is a lengthy one (probably one of the lengthiest Tax Court decisions). In his final footnote, Justice Boyle apologizes for the length of the decision and quoting Lord Neuberger of Abbotsbury from a 2013 address, states:

“we seem to feel the need to deal with every aspect of every point that is argued, that makes the judgement often difficult and unrewarding to follow. Reading some judgements one rather loses the will to live – and that is particularly disconcerting when it’s your own judgment that you are reading”.

It will be interesting to see whether McKesson Canada decides to appeal this decision and if it does so, how Justice Boyle’s decision will be dealt with by the Federal Court of Appeal.

On November 26^th, 2013, the Canada Revenue Agency (“CRA”) participated in a Roundtable session at the 65^th Annual Tax Conference of the Canadian Tax Foundation held in Toronto, Ontario. The panelists announced a one-year pilot project for Pre-Ruling Consultations.

Taxpayers may now approach the Income Tax Rulings Directorate (“ITRD”) on a formal, written basis to obtain a preliminary ‘pre-ruling’ on a particular issue in order to determine whether the ITRD will issue a full ruling on the same issue in the future.  A fee will be charged for taxpayers who use this service.

As noted on the CRA website “the purpose of the pre-ruling consultation is to reduce the likelihood of the taxpayer incurring significant costs as a result of submitting a request for a ruling that ITRD will be unable to provide.”

Earlier today, the Supreme Court of Canada delivered its decision in two Quebec rectification cases, Agence du Revenu du Quebec v. Services Environnementaux AES Inc. and Agence du Revenu du Quebec v. Jean Riopel. In a unanimous decision rendered by Mr. Justice LeBel (the only civil law judge on the panel) the Court upheld the decisions of the Quebec Court of Appeal in these two cases, permitting the parties to correct mistakes which resulted in unintended tax consequences. However, the reasons set out in Mr. Justice LeBel’s decision differ in part from the decisions of the Quebec Court of Appeal.

By way of background, Canada has a bijuridical legal system. The French civil law is the law in Quebec relating to civil matters while the law in the rest of Canada is based on the English common law. In these two cases, the issue related to whether rectification (which is a concept under the common law) can also be applied under Quebec civil law. It should be noted that the term “rectification” is not used in the reasons for judgment in either of the two appeals.

After going through the facts of each case and the decisions of the lower courts (see our previous posts on these cases here and here) Mr. Justice LeBel stated that the dispute between the taxpayers and the Quebec tax authority raises both procedural and substantive issues. He then went on to state that the substantive issue of whether proceedings to amend documents are permitted under Quebec’s civil law is the main issue and that the procedural issues are of only minor importance.

Mr. Justice LeBel noted that there was uncontested evidence establishing the nature of the taxpayers’ intention in each case and that under the civil law, in most cases a contract is based on the common intention of the parties and not on the written document. In this case, it was clear that the taxpayers’ intention was not properly documented because of the errors made by the taxpayers’ advisors. Accordingly, the taxpayers could rescind the contract or amend the documents to implement their intentions. In this case, the taxpayers had agreed to correct the documents so that the documents were consistent with their intentions.

The issue that then arises is to how such correction affects the tax authorities. Mr. Justice LeBel notes that in this case, there is an interplay of civil law and tax law and he makes the important point that the tax authorities generally do not acquire rights to have an erroneous written document continue to apply for their benefit where an error has been established and the documents are inconsistent with the taxpayer’s true intention.

Mr. Justice LeBel held that the parties in these two cases could amend the written documents because there was no dispute as to the intention of the parties and that it is open to the court to intervene to declare that the amendments to the documents made by the taxpayers were legitimate and necessary to reflect their intentions. He goes on to state that if a document includes an error, particularly one that can be attributed to an error by the taxpayer’s professional advisor, the court must, once the error is proved in accordance with the rules of evidence, note the error and ensure that it is remedied. In addition, the tax authorities do not have any acquired rights to benefit from an error made by the taxpayers in their documents after the taxpayers have corrected the error by mutual consent to reflect their intentions.

However, Mr. Justice LeBel warns taxpayers not to view this recognition of the parties’ common intention as an invitation to engage in bold tax planning on the assumption that it will always be possible for taxpayers to redo their contracts retroactively should the planning fail.

In the cases under appeal, the taxpayers amended the written documents to give effect to their common intention. This intention had clearly been established and related to obligations whose objects were determinative or determinable. Accordingly, the taxpayers’ amendments to the written documents were permitted.

Interestingly, the Attorney General of Canada, who intervened in the appeals, asked the court to consider and reject a line of authority that has developed since the Ontario Court of Appeal‘s decision in Attorney General of Canada v. Juliar, 2000 DTC 6589 (Ont. C.A.). Juliar is recognized as the leading case in rectification matters and has been the basis of numerous successful rectification applications in respect of tax matters in the common law provinces of Canada. Mr. Justice LeBel stated that the two cases under appeal are governed by Quebec civil law and it is not appropriate for the court to reconsider the common law remedy of rectification in connection with these appeals. Accordingly, Mr. Justice LeBel refrains from criticising, approving or commenting on the application of Juliar and rectification under the common law.

It is also interesting to note that in Juliar the CRA sought leave to appeal the decision of the Ontario Court of Appeal to the Supreme Court of Canada and that leave was denied. We will have to wait to see if the CRA attempts to take another case to the Supreme Court of Canada to determine the applicability of Juliar and rectification under the common law. However, it is now clear that Quebec taxpayers can now “fix” most tax mistakes if they can prove that their intention was to undertake a transaction which does not result in tax and the transaction does not involve “bold tax planning”.

On November 25, 2013, I had the privilege of travelling to Ottawa to appear before the House of Commons Standing Committee on Finance to discuss certain aspects of Bill C-4, the second implementation act for measures proposed in the 2013 federal budget, as well as other measures.  Bill C-4 is at the second reading stage.  The Committee’s work on Bill C-4 began earlier in the month with testimony from government officials.  My task, from a practitioner’s point of view, was to address those provisions that close loopholes in the Income Tax Act.

I read my opening statement (each witness is limited to a five-minute opening) and answered a few questions.  I fielded questions from two members of the Committee (Mark Adler of the Conservatives and Murray Rankin of the NDP who happens to be a fellow graduate of the University of Toronto Faculty of Law and an accomplished litigator).  Both Mr. Adler and Mr. Rankin, along with the other members of the Committee, went out of their way to make me feel welcome.  Much of the time was taken up by a spirited discussion of the proposal to phase out tax credits for investors in Labour Sponsored Venture Capital Corporations (which appear to be predominantly located in the province of Quebec).  The entire meeting was recorded and transcribed.

Around the dinner hour, the Minister of Finance, Hon. Jim Flaherty, appeared before the Committee to describe some of the more important provisions of Bill C-4 and to answer questions from members of the Committee.  Hon. Scott Brison participated in a lively exchange with the Minister.

It was certainly a long day for members of the Committee and their staff.  They prepared for the meeting in the morning and participated in the proceedings from 3:30 p.m. until after 8:30 p.m. - and this was only one of a number of intensive sessions devoted to the close study and consideration of Bill C-4.  I look forward to tracking the progress of Bill C-4 through the House of Commons Standing Committee on Finance as well as the Senate Committee on National Finance.  If everything proceeds according to plan, Bill C-4 may very well become law before the end of the year.

On Thursday November 28, the Supreme Court of Canada will release its decisions in the companion cases of Agence du Revenu du Québec v. Services Environnementaux AES Inc., et al. (Docket #34235) and Agence du Revenu du Québec v. Jean Riopel, et al. (Docket #34393).

The narrow question on appeal is under what circumstances the Superior Court of Quebec may correct a written instrument that does not reflect the parties’ intentions. More broadly, the issue is how and to what extent the equitable principles of rectification operate in the context of the Quebec Civil Code. These will be the first substantive decisions of the Supreme Court on tax and the doctrine of rectification.

See our previous posts on the cases here and here.

Hot on the heels of the CRA’s recent publication of a “fact sheet” on its views on the tax treatment of Bitcoin currency (which has been in the news recently – see articles here and here), the CRA has published two technical interpretations on the tax treatment of “crowdfunding“.

In CRA Document No. 2013-0508971E5 (October 25, 2013) and CRA Document No. 2013-0509101E5 ”Crowdfunding” (October 29, 2013) the CRA was asked about the tax treatment of amounts received by taxpayers through a crowdfunding arrangement.

The CRA stated that it understood crowdfunding to be a way of raising funds for a broad range of purposes, using the internet, where conventional forms of fundraising funds might not be possible (and which may or may not involve the issuance of securities).

The CRA stated that, depending on the specific circumstances, crowdfunding amounts received by the taxpayer could represent a loan, capital contribution, gift, income or a combination thereof. The CRA noted its position described in Interpretation Bulletin IT-334R2 “Miscellaneous Receipts” (February 21, 1992) that voluntary payments received by virtue of a taxpayer’s profession or carrying on of a business are considered taxable receipts. The CRA also noted that, on the other hand, a non-taxable windfall may exist where the taxpayer made no organized effort to receive the payment and neither sought nor solicited the payment. The CRA’s view is that a business has commenced where the taxpayer has started some significant activity that is a regular part of the business or that is necessary to get the business going (see Interpretation Bulletin IT-364 “Commencement of Business Operations” (March 14, 1977)). Conversely, a gift may exist where the donor transfers property with no right, privilege, material benefit or advantage conferred in return.

These two recent technical interpretations follow an earlier publication (CRA Document No. 2013-0484941E5 “Crowdfunding” (August 13, 2013)), in which the CRA stated that amounts received by a taxpayer from crowdfunding activities would generally be included in the taxpayer’s income pursuant to subsection 9(1) of the Income Tax Act as income from carrying on a business (and that certain expenses may be deductible).

These views from the CRA are helpful guidance for those who have undertaken or are considering crowdfunding. We agree that a taxpayer’s specific circumstances will be determinative of the tax treatment of the crowdfunded amounts (i.e., on a case-by-case basis). However, because of the various activities for which crowdfunding may be sought, and the ease with which crowdfunding may be accessed, it is less clear when a taxpayer’s activities (including seeking crowdfunding and any other associated activities) will result in the conclusion that a taxpayer has commenced carrying on business.

Accordingly, taxpayers who seek and obtain crowdfunding (for business and non-business purposes) should be aware of the potential tax implications, particularly in light of fact-specific results and the CRA’s evolving views on the subject.

On November 6, 2013, at the Toronto Centre Canada Revenue Agency & Professionals Breakfast Seminar, representatives from the CRA provided an update on objections and appeals.

Anne-Marie Levesque, Assistant Commissioner of Appeals, presented these slides and made the following comments:

• The Appeals Branch reviews objections to assessments from the following branches:
  • Compliance programs (audit)
  • Assessment and benefit services
  • Taxpayer services and debt management (collections)
• The Appeals Branch will not normally contact an assessing branch unless the assessing position is unclear or pertinent information is missing. If this is the case, the practice of the Appeals Branch is to note this in the file.
• The Appeals Branch is aware and concerned about the time required to process large files, which may take a few months to assign, and up to a year to resolve.
• The Appeals Branch manual is available at CRA Reading Rooms. A taxpayer may visit these rooms and ask for a copy, and an appeals officer will provide a copy.
• The Appeals Branch has been “swamped” by objections in the last 5-8 years, most relating to tax shelters. Historically, the Appeals Branch received 50,000 objections per year, but in recent years has received up to 100,000 objections per year. Currently there is a “significant backlog” of objections in the Appeals Branch’s inventory.
• The Appeals Branch is distributing certain files to particular offices across the country (i.e., alimony, Disability Tax Credits, Child Care Tax Benefits, GST credits, etc.) to streamline the resolution for less complex objections.
• Large group files (i.e., tax shelter objections) have been concentrated in the Toronto North Tax Services Office.
• The Appeals Branch has designated certain offices as industry specialists: forestry in Vancouver; resources in Calgary; insurance, banking and mining in Toronto North; and manufacturing in Montreal.
• The Appeals Branch has moved away from the practice of granting face-to-face meetings (too expensive and time consuming, requires that objections be assigned to offices located near taxpayer’s home or office). While some files may still require in-person meetings, for most files the appeals officer will not meet with the taxpayer or the taxpayer’s representative. However, the Appeals Branch is committed to communicating with taxpayers and their representatives over the phone and in writing.
• The Appeals Branch will continue to ask that taxpayers make written submissions. This is to protect the integrity of the decision-making process – both for the Appeals Branch’s internal quality standards and for the purposes of any external review by the Auditor General.
• Generally, the Appeals Branch is committed to resolving disputes prior to litigation. Taking a file to the Tax Court is the exception and not the rule for the Appeals Branch.
• The “benefit of the doubt” should go to the taxpayer where there is credible evidence in support of the taxpayer’s version of the facts. If the taxpayer’s version of the facts makes sense and is reasonable, the Appeals Branch may give the taxpayer the benefit of the doubt even in the absence of documentary evidence. However, in such cases, the Appeals Branch expects that the taxpayer will be diligent about maintaining proper documentation to avoid the same problem in the future.
• The Appeals Branch has had a settlement protocol with the Department of Justice since 2004, which has evolved over time. Recent amendments give Department of Justice counsel additional leeway to resolve low-complexity files without having to obtain instructions from the CRA litigation officer – this would apply to all informal procedure appeals and some general procedure appeals. Conversely, the settlement protocol empowers CRA litigation officers to settle informal procedure appeals without requiring sign-off by the Department of Justice.
• Historically, the Crown is successful in approximately 85% of appeals to the Tax Court. This rate fluctuates over time, but in the last three months the Crown’s success rate has increased. The increase may be due to the efforts of the CRA and the Department of Justice to settle those appeals that should not go forward to a full hearing.
• When the Crown loses an appeal in the Tax Court, the reasons for judgment are reviewed by the Adverse Decision Committee, which includes the Assistant Commissioner of the Appeals Branch, Assistant Commissioners from the assessing branches, senior counsel from the Department of Justice, and a senior representative from the Department of Finance. The Committee considers whether there has been an error of law and the chance of success on appeal.
• The Appeals Branch has initiated a pilot project in British Columbia under which appeals officers will be empowered to consider relief from interest and penalties at the same time they are considering the substantive tax issues on objection. The Appeals Branch is still considering how this process may work, due to the different processes by which these decisions may be appealed by the taxpayer (i.e., appeal to the Tax Court for tax assessments, and judicial review of decisions regarding interest and penalty relief).
• Auditors are empowered to “waive” interest and penalties before assessing, while appeals officers may “cancel” interest and penalties after assessment.
• Remission orders under the Financial Administration Act are not dealt with by the Appeals Branch and are granted to taxpayers only in rare circumstances.
• The Appeals Branch would prefer that taxpayers not appeal to the Tax Court immediately after 90 days have passed from the date of filing the Notice of Objection.

Join Dentons’ David Spiro as he and two other speakers, including General Counsel from the Department of Justice, discuss the best practices for managing the flow of information to and from the Canada Revenue Agency.

Ensure you know how to best manage the flow of documents and information to the CRA in the context of a corporate tax audit. Attend this lunch program to learn about the CRA’s statutory powers to obtain taxpayer information, setting up an effective audit process, challenging requirements for information, recent legislative changes to third party requirements, the compellability of tax accrual workpapers, and best practices for dealing with issues frequently faced by taxpayers and their advisors during the course of an audit. You will also get practical tips for obtaining taxpayer records from the CRA pursuant to the Access to Information Act and the Privacy Act.

Event Details
November 7, 2013
12:00 PM – 2:00 PM EDT
20 Toronto Street, 2nd Floor
Toronto, Ontario M5C 2B8

Click here for more information and to register.

As the Canada Revenue Agency becomes increasingly aggressive in pursuit of perceived domestic and offshore tax avoidance, it is more important than ever to be familiar with recent developments in legislation, policy and procedure. David W. Chodikoff (Miller Thompson LLP) and David E. Spiro (Dentons Canada LLP) are, therefore, delighted to chair this tax litigation conference – the first organized by Insight Information.

Leading litigators and clients have been gathered to participate in lively panel discussions covering a wide range of challenging issues – from how to deal with CRA requirements and misconduct to making successful voluntary disclosure applications and fairness requests. You’ll learn about the latest developments in transfer pricing and the GAAR and will find out how project management can help you win your case. Finally, for those cases that can be resolved before trial, his conference will explore when and how to take advantage of the opportunities for settlement. In short, you will leave with the tools to resolve tax controversies more confidently than ever!

Event Details
December 11, 2013
07:45 AM – 05:00 PM EDT
St. Andrew’s Club and Conference Centre
150 King Street West
Toronto, Ontario M5H 4B6

For more information, including a list of Distinguished Faculty members and Event Schedule, click here.

To register, click here.

The U.S. Supreme Court’s Fall term began on October 7, and there has been no shortage of recent articles on the docket and Judges of the Court. In a previous post, David Spiro noted a remarkable piece on U.S. Supreme Court Chief Justice John Roberts’ advocacy practice before he was appointed to the Court, and in a recent issue of New York Magazine, Justice Antonin Scalia provided his candid views on advocacy and judging.

Moliere once said, “Of all the noises known to man, opera is the most expensive.”

In Knapik-Sztramko v. The Queen (2013-799(IT)I, October 17, 2013), the Tax Court of Canada managed to reduce some of that cost, at least for one opera performer.

The taxpayer was an opera singer. In 1997, she entered a vocal competition organized by the Gerda Lissner Foundation. The taxpayer won the competition and from 1997 to 2006 she received monies for the payment of singing coaches, stage training, accommodation and travel expenses. The CRA reassessed the taxpayer to include in her income the amounts received from the Foundation.

Under paragraph 56(1)(n), a taxpayer must include in his/her income any amount received as or on account of a prize other than a “prescribed prize”. Section 7700 of the Income Tax Regulations states,

7700. For the purposes of subparagraph 56(1)(n)(i) of the Act, a prescribed prize is any prize that is recognized by the public and that is awarded for meritorious achievement in the arts, the sciences or service to the public but does not include any amount that can reasonably be regarded as having been received as compensation for services rendered or to be rendered.

In this case, the Crown conceded that the prize was recognized by the public and was for meritorious achievement in the arts. However, the Crown argued, the prize was paid as compensation for services. In the Crown’s view, the taxpayer had undertaken certain activities (coaching, training, career development, etc.) for, and provided services to, the Foundation in exchange for the money.

The Tax Court found that the taxpayer had provided no services to the Foundation, and that the activities undertaken by the taxpayer were consistently comprised of training, support and education to enhance her performance abilities:

The identification of the appellant as someone worthy of specialized study and training was the basis for awarding the prize from the Foundation’s perspective. This prize was not a relationship of, or in substitution for, employment, but a prize awarded on merit with reasonable conditions attached in order to ensure that the burgeoning talent identified was further refined by the benefactor.

The Tax Court allowed the taxpayer’s appeal.

The tax treatment of prizes is a nuanced area, dovetailing as it does with the taxation of scholarships, bursaries, fellowships and employment income. The issue seems to garner public attention every four years when the CRA responds to queries as to whether Olympic medal-winning athletes are subject to tax in Canada on their prizes (answer: Canadian athletes, yes (see CRA Document No. 2004-0098691E5 “Prizes paid to amateur athletes” (January 21, 2005), CRA Document No. 2008-0300071M4 “Olympic medals” (June 26, 2009) and CRA Document No. 2012-0458181M4 “Olympic performance awards” (September 18, 2012)); non-resident athletes, no (see subsection 115(2.3) of the Income Tax Act)).

The Tax Court’s decision in Knapik-Sztramko is a helpful case in a limited body of jurisprudence on what qualifies as a non-taxable prize under paragraph 56(1)(n) and Regulation 7700.

I first heard of John Roberts Jr. when he was nominated to the United States Supreme Court as Chief Justice.  I watched the coverage on C-SPAN which replayed a seminar that he gave to a group of law students on advocacy.  I was quite impressed – but not as impressed as I was after reading this article from The American Lawyer magazine.  Appellate advocates have much to learn from the Chief Justice of the United States:

http://www.americanlawyer.com/PubArticleTAL.jsp?id=1202620317367

In Paul C. Golini v. The Queen (2013 TCC 293) the Tax Court of Canada agreed to strike out portions of a taxpayer’s pleading suggesting that a protective reassessment issued by the Canada Revenue Agency (“CRA”) was invalid.

In June 2012, the CRA informed the taxpayer that his 2008 income tax return had been selected for an audit. In the following months, both parties continued to correspond and exchange information. In August 2012, the CRA asked the taxpayer to provide a waiver extending the limitation period to reassess the 2008 taxation year. The taxpayer declined to do so.

In September 2012, the Minister reassessed the taxpayer and informed him that the reassessment was a “protective reassessment;” supporting documentation would be provided upon completion of the audit.

The Crown brought a motion to strike out the allegation that the reassessment was invalid. The taxpayer contended that a “protective reassessment” was inconsistent with the assessing provisions of the Income Tax Act as it was issued solely to allow the Minister additional time to complete an audit.

The Tax Court judge looked to Karda v. HMQ (2006 FCA 238) for guidance on the issue. In that case, the Federal Court of Appeal held that the Minister may issue a protective reassessment where a taxpayer declines to provide a waiver so long as the CRA has completed “some review” and has requested further information. The Tax Court judge held that:

There is no law . . . to the effect that a protective assessment is invalid if issued for the sole purpose of leaving the door open to conduct or continue an audit.

He went on to note that:

. . . the law, I find, is clear that some review by the CRA followed by inquiries for more information and a request for a waiver, subsequently refused, is sufficient for a protective assessment to be a valid assessment. And that is exactly what we have here.

Whenever a taxpayer declines to grant the CRA a waiver, the CRA almost invariably reassesses before the “normal reassessment period” expires.  There is nothing surprising about that.  What is noteworthy here, though, is the willingness of the Tax Court to entertain the Crown’s request to strike out, before trial, an argument put forward by a taxpayer. As we noted in our blog post on the Federal Court of Appeal’s decision in Canadian Imperial Bank of Commerce v. The Queen:

Parties are generally given the opportunity to make whatever arguments they consider necessary to their case with the ultimate determination being made by the trial judge who is in the best position to decide questions of relevance and weight in light of all the evidence.  It is rather unusual for a legal theory, novel though it is, to be taken off the table at such an early stage.  At the same time, courts are increasingly concerned about “proportionality” and are reluctant to allow scarce judicial resources to be spent on matters that are unlikely to have any effect on the outcome of the hearing.

This decision is, therefore, consistent with recent jurisprudence from the Federal Court of Appeal and should reduce the number of issues to be decided at trial.