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Highlights from the Toronto Centre CRA & Tax Professionals Groups Breakfast Seminar (November 6, 2014)

On November 6, 2014 at the Toronto Centre Canada Revenue Agency & Tax Professionals Breakfast Seminar, representatives from the CRA provided an update on the Income Tax Rulings Directorate (“Rulings”) and discussed current topics of interest.

Income Tax Rulings Directorate Update

Mickey Sarazin, Director General of the CRA’s Income Tax Rulings Directorate in Ottawa, presented on recent developments at Rulings.

Mr. Sarazin noted that 10 years ago Rulings received approximately 500 ruling requests whereas today Rulings receives approximately 120 requests each year. As a result, there is an increased effort to engage with not only taxpayers but also the Department of Finance, Department of Justice, internal CRA employees, various accounting and legal professional organizations.

The slides from Mr. Sarazin’s presentation are available here.

Folios - In March 2013, 11 folios were published, which took approximately two years to draft and finalize. Ruling has partnered with the Canadian Tax Foundation and CPA Canada to increase the number and timeliness of Folios. Currently, there are 38 additional folios at the draft stage.

National Capacity Building Forums – Rulings is providing taped video sessions or webinars for all CRA employees in order to educate and raise awareness of certain tax issues and subjects. Attendees also include individuals from the Department of Justice and Revenue Quebec.

Pre-Rulings Consultations – This initiative was announced on November 26, 2013 at the Roundtable session at the 65th Annual Tax Conference of the Canadian Tax Foundation held in Toronto, Ontario. The initiative allows taxpayers to meet with Rulings to discuss potential transactions before a formal ruling application is filed. Although only 6-7 requests were received in the first nine months of the program, in the past three months 21 requests were received. Of these 21 requests, 17 have been concluded. In nine of the 17 requests, the CRA responded that a favourable ruling would not be issued.

Technical Capacity/Satellite Offices – Rulings is continuing efforts to hire new staff and reallocate existing staff. Rulings is also establishing satellite offices to attract new employees. For example, Rulings has recently established a presence in the Toronto Centre TSO and the North York TSO. In future years, Rulings expects that it will grow its presence in Toronto, Montreal, Calgary and Vancouver.

Stakeholder Engagement -In conjunction with CPA Canada, Rulings has established a framework for consideration of current issues. Seven committees have been struck under the framework:

  • Service Committee (i.e., how to improve services provided to taxpayers);
  • Compliance Committee (i.e., how to address early conflicts between auditors and taxpayers before the appeals stage);
  • Tax Administration Committee (i.e., dealing with flaws in the legislation);
  • SR&ED Committee (i.e., all issues relating to the scientific research and experimental development tax incentives);
  • HST/GST/Excise Committee (i.e., all issues relating to these areas of the law)
  • Training Committee (i.e., hiring new talent and training auditors)
  • Red Tape Committee (i.e., focusing on increasing efficiencies at a national level)

Current Topics of Interest

Vitaliy Anissimov, Industry Sector Specialist, Income Tax Rulings Directorate, discussed several topics that had been addressed in the CRA Roundtable at the recent APFF conference in Montreal (we expect that the full questions/answers will be published by the CRA in the future).

The slides from Mr. Anissimov’s presentation are available here. A general summary of some of the issues discussed is as follows:

  • In response to the interest deductibility discussion in Swirsky v. The Queen (2013 TCC 73), the CRA noted that as long as there is a reasonable expectation that a corporation will pay dividends then interest can be deducted on loans to acquire common shares of that same corporation (see paragraph 31, of IT-533). Each case will, however, be decided on its own facts.
  • The CRA’s position on the use of average exchange rates has not changed for the purposes of gains or losses on account of income (see CRA Document No. 2014-0529961M4 ” Capital gains on property in foreign currency” (June 10, 2014)).
  • The CRA noted that interest paid by a trust on a note issued by it to a beneficiary in settlement of a capital interest of the beneficiary in the trust is not deductible by the trust for the purposes of calculating its income under 20(1)(c)(ii) of the Act because there is no income-earning purpose;
  • In response to D&D Livestock v. The Queen (2013 TCC 318), which allowed a taxpayer to take into account twice the amount of safe income in the context of subsection 55(2) of the Act, the CRA noted that it would consider using GAAR in this type of case where there is a duplication of tax attributes by the taxpayer.
  • Subsection 98(3) would not apply where a partnership ceases to exist as a result of an acquisition by a single partner of all partnership interest. The requirements of subsection 98(3) would not be met in this type of case.
  • The CRA will consider the reasonableness of maintaining surplus accounts in a particular currency on a case by case basis (see also Regulation 5907(6) and section 261 of the Income Tax Act).

 

Highlights from the Toronto Centre CRA & Tax Professionals Groups Breakfast Seminar (November 6, 2014)

Devon: TCC considers large corporation rules

In Devon Canada Corporation v. The Queen the issue is whether the taxpayer (“Devon”) may deduct $20,884,041 paid to cancel issued stock options. After the close of pleadings, the Crown brought a procedural motion relating to the large corporations rules. The Tax Court allowed the motion in part, and struck certain portions of Devon’s Notices of Appeal (2014 TCC 255) (the main tax issue has not yet been heard by the Tax Court).

The content of objections and appeals for large corporations is subject to specific rules in the Income Tax Act (Canada). Under subsection 165(1.11), a large corporation’s Notice of Objection must describe each issue, the specific the relief sought for each issue, and facts and reasons in support of its position. Further, under subsection 169(2.1), the large corporation may appeal to the Tax Court only with respect to the issues and relief sought in the Notice of Objection. The Federal Court of Appeal recently considered these rules in Bakorp Management Ltd. v. The Queen (2014 FCA 104) (see our post on Bakorp here).

In the present case, the Tax Court highlighted some of the themes that have emerged from the case law on this issue:

  1. a taxpayer is not required to describe each issue exactly but is required to describe it reasonably (Potash Corporation of Saskatchewan Inc. v. The Queen, 2003 FCA 471);
  2. the determination of what degree of specificity is required for an issue to have been described reasonably is to be made on a case by case basis (Potash);
  3. a taxpayer may add new facts or reasons on appeal but not new issues (British Columbia Transit v. The Queen, 2006 TCC 437);
  4. if the proposed additional argument would result in the large corporation seeking greater relief than was previously sought, the courts are more likely to consider the argument to be a new issue rather than a reason (Potash; Telus Communications (Edmonton) Inc. v. The Queen, 2005 FCA 159);
  5. if the proposed additional argument would result in the large corporation seeking the same relief that was previously sought, the courts are more likely to consider the argument to be the same issue (British Columbia Transit; Canadian Imperial Bank of Commerce v. The Queen, 2013 TCC 170); and
  6. if the proposed additional argument would result in the large corporation seeking completely different relief than was previously sought, the courts are more likely to consider the argument to be a new issue rather than a reason (Bakorp Management Ltd. v. The Queen, 2014 FCA 104).

Devon raised three arguments in its Notices of Appeal for the deductibility of the payments to cancel stock options. These were summarized by the Tax Court as follows:

(a) Devon’s primary argument is that the payments are deductible as current expenses under subsection 9(1);

(b) In the alternative, Devon argues that the payments are eligible capital expenditures that, once added to cumulative eligible capital, would result in deductions pursuant to paragraph 20(1)(b). It further argues that, due to the fact that there were acquisitions of control of both of the predecessor companies during the taxation periods in which the payments were made, subsection 111(5.2) applies to cause significant additional deductions of cumulative eligible capital; and

(c) In the further alternative, Devon claims that the payments are financing expenses deductible under paragraph 20(1)(e).

The Crown argued that Devon, a large corporation in the years at issue, only referred to section 9 in its Notice of Objection. The other provisions – namely paragraph 20(1)(b) and subsection 111(5.2) and paragraph 20(1)(e) – were mentioned in a supplementary memorandum filed by Devon during the objection process. As such, references to provisions other than section 9 should be struck from Devon’s Notice of Appeal.

The Tax Court held that no mechanism in the Act would permit the supplemental memorandum filed by Devon to amend the original Notice of Objection. However, the Tax Court struck out references to paragraph 20(1)(b) and subsection 111(5.2) but not paragraph 20(1)(e).

The Tax Court held that paragraph 20(1)(e) did not raise a new issue and was merely an alternative reason argued by the taxpayer in favor of deducting the payments to cancel the issued stock options. However, paragraph 20(1)(b) and subsection 111(5.2) raised new issues that were not otherwise raised in the Notice of Objection and would have entitled Devon to a deduction for amounts in its cumulative eligible capital that were unrelated to the payments to cancel the stock options.

Although the taxpayer did not describe the relief sought with respect to paragraph 20(1)(e) in the Notice of Objection and only specified allowing the deduction in full, the Tax Court agreed that if a full deduction is pleaded under subsection 169(2.1) then a partial deduction of the same nature should not necessarily have to be separately pleaded under the large corporation rules.

Both the taxpayer and the Crown have appealed this procedural decision to the Federal Court of Appeal (Court File No. A-389-14).

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Devon: TCC considers large corporation rules

McKesson: Trial Judge Recuses Self From Two Remaining Issues in Transfer Pricing Case

In McKesson v. The Queen (2014 TCC 266), Justice Patrick Boyle recused himself from the two remaining issues with which he was seized in the transfer pricing case – costs and the content of the court’s public file (i.e., the determination of whether certain information may be confidential).

This unusual decision arises as a result of the content of the Appellant’s factum filed in the Federal Court of Appeal in the appeal of Justice Boyle’s trial decision in McKesson (see our posts on the Tax Court case here and the Federal Court of Appeal proceeding here and here).

In his recusal reasons, Justice Boyle wrote:

[4]        As detailed below, I have, of my own motion, decided that I am compelled to consider whether I need to recuse myself from the two remaining issues before this Court. A consideration of this issue is required because I became aware that the Appellant and Appellant’s counsel, together with its co-counsel in the Federal Court of Appeal in respect of the appeal of the trial decision, had made certain public written statements about me in its factum in the Federal Court of Appeal (the “Factum”) which, upon reflection, appear to me to clearly include:

(i)         allegations that I was untruthful and deceitful in my Reasons;

(ii)         clear untruths about me, what I said and heard in the course of the trial, as well as the existence of evidentiary foundations supporting what I wrote in my Reasons; and

(iii)        allegations of impartiality on my part.

[5]        This requires me to consider whether:

(i)         I believe that a reasonable person reading the Factum, my Reasons, and the relevant portions of the transcript would believe that the trial judge so strongly complained of by McKesson Canada might not be able to remain impartial in his consideration of costs and confidential information;

(ii)         I believe I can impartially consider, weigh and decide the costs and confidential information issues before me; and

(iii)        whether the public challenge of my impartiality expressed by McKesson Canada and its co-counsel in the Factum is itself sufficient to warrant recusing myself at this stage.

 …

[133]     I view these as public allegations by a party to the costs and confidential information matters remaining before this Court that, regardless of the merits of their reasoning or their thoughts, I am unable to decide the remaining matters impartially. I believe that a reasonable person reading only these phrases from the Factum, without reviewing my Reasons or the trial Transcript, would believe that such strong complaints by McKesson Canada and its counsel may give rise to a serious doubt that I will be seen to be able to dispose of the two remaining issues and discharge my duties on an impartial basis.

[136]     For the Reasons identified above, I have decided I have to recuse myself from the remaining costs and confidential information issues in McKesson Canada’s proceeding in this Court.

[137]     It may be that some of the perceived untruths about the trial judge described above under heading II might individually not warrant recusal, and may be within an appellate advocate’s licence to overstate through the use of absolutes like ‘never’, ‘only’ and ‘any’.

[138]     However, I am satisfied that a reasonable fair-minded Canadian, informed and aware of all the issues addressed above, would entertain doubt that I could remain able to reach impartial decisions. I believe that such a reasonable fair-minded and informed person, viewing this realistically and practically would, after appropriate reflection, be left with a reasoned suspicion or apprehension of bias, actual or perceived. Canadians should rightly expect their trial judges to have broad shoulders and thick skins when a losing party appeals their decision, but I do not believe Canadians think that should extend to accusations of dishonesty by the judge, nor to untruths about the judge. Trial judges should not have to defend their honour and integrity from such inappropriate attacks. English is a very rich language; the Appellant and its counsel could have forcefully advanced their chosen grounds for appeal without the use of unqualified extreme statements which attack the personal or professional integrity of the trial judge.

[139]     For these reasons, I will be advising my Chief Justice that I am recusing myself from completing the McKesson Canada proceeding in the Tax Court. This extends to the consideration and disposition of the costs submissions of the parties in this case, as well as to the 2010 confidential information order of Justice Hogan in this case and its proper final implementation by the Tax Court and its Registry.

No date has been set for the hearing of the main matter by the Federal Court of Appeal.

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McKesson: Trial Judge Recuses Self From Two Remaining Issues in Transfer Pricing Case

McKesson: Respondent’s Factum Filed

Earlier this year, McKesson Canada Corporation appealed the decision of the Tax Court of Canada in McKesson Canada Corporation v. The Queen (2013 TCC 404) (see Federal Court of Appeal File Nos. A-48-14 and A-49-14).

At issue was the appropriate discount rate paid under a receivables sales agreement between McKesson Canada and its parent company, MIH, under section 247 of the Income Tax Act (Canada). A secondary issue was the assessment of withholding tax on a deemed dividend that arose as a result of the lower discount rate. For our earlier blog post on the Tax Court decision see here.

In the Federal Court of Appeal, the Appellant’s Memorandum of Fact and Law was filed on June 11, 2014. For our earlier post summarizing the appellant’s memorandum see here.

The Respondent’s Memorandum of Fact and Law was recently filed on August 11, 2014.

In its Memorandum, the Respondent states that the trial judge’s “carefully reasoned decision” and findings were “amply supported” by the evidence at trial and no palpable and overriding error can be found in the trial judge’s conclusions.

The Respondent summarizes its points at issue at paragraph 56 of its Memorandum:

  • The trial judge applied the correct test. His decision was based on what arm’s-length persons would agree to pay for the rights and benefits obtained and not on findings of tax avoidance, lack of need for funds, or group control.
  • Ample evidence supports the trial judge’s determination of the arm’s-length discount rate. Since no palpable and overriding error was committed, his decision should not be disturbed.
  • The trial judge did not commit an error of law in concluding that the five-year limitation period in Article 9(3) of the Canada-Luxembourg Tax Treaty does not apply to the Part XIII tax reassessment at issue.

No hearing date has yet been set for the hearing in the Federal Court of Appeal.

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McKesson: Respondent’s Factum Filed

McKesson: Appellant’s Factum Filed‏

On January 10, 2014, McKesson Canada Corporation appealed the decision of the Tax Court of Canada in McKesson Canada Corporation v. The Queen (2013 TCC 404) (see Federal Court of Appeal File Nos. A-48-14 and A-49-14).

In McKesson, the Tax Court upheld the CRA’s transfer price adjustments (made pursuant to section 247 of the Income Tax Act (Canada)) that had reduced the discount rate paid under a receivables sales agreement between McKesson Canada and its parent company, MIH, from 2.206% to 1.013%. The Tax Court also upheld the assessment of withholding tax on a deemed dividend that arose in a secondary adjustment resulting from the lower discount rate.

The Appellant’s Memorandum of fact and law was filed on June 11, 2014.

In its Memorandum, the Appellant states that the Trial Judge made a “fundamental error of law” and requests that the appeal be allowed with costs and the matter be remitted to the Tax Court for a new trial before a different judge. The Appellant describes the issues on the appeal as follows:

Did the Trial Judge err in law by stepping outside the pleadings and the case put forward and as developed by the parties over the course of the trial to find against McKesson Canada, thereby depriving McKesson Canada of its right to know the case it had to meet and its right to a fair opportunity to meet that case?

Did the Trial Judge err in law when he misconstrued the arm’s-length principle by holding that, in determining what terms and conditions arm’s length parties would have made or imposed, he was to assume that one party (purchaser) controls the other (seller)?

As a result of stepping outside of the pleadings and the case put forward and as developed by the parties over the course of the trial and committing an error of law, did the Trial Judge calculate the discount rate in a manner that ignored the assumption of risk by MIH, contrary to the terms of the Agreement and resulted in a discount rate that is commercially absurd?

Did the Trial Judge err in permitting the Minister to assess non-resident withholding tax after the expiry of the applicable limitation period and in contravention of Canada’s obligations under a bilateral tax treaty?

See our previous commentary on the Tax Court’s McKesson decision here.

 

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McKesson: Appellant’s Factum Filed‏

Galachiuk: TCC Clarifies Due Diligence Defence Under 163(1)‏

Subsection 163(1) of the Income Tax Act (the “Act”) imposes a penalty of 10% on an amount that a taxpayer fails to report in his/her return where there has been a previous failure to report income in any of the three preceding taxation years.

The penalty under subsection 163(1) has been described as “harsh” due to the 10% federal penalty, a potential 10% provincial penalty, and the fact that the penalty may apply even where minimal or no additional tax is owing by the taxpayer (i.e., the tax relating to the unreported amount was withheld at source and remitted to the CRA).

In several cases, the courts have held that a taxpayer that is the subject of a penalty under subsection 163(1) has a due diligence defence. A taxpayer can satisfy the due diligence test in one of two ways: (i) By establishing that he/she made a reasonable mistake of fact (i.e., the taxpayer was mistaken as to a factual situation and the mistake was reasonable), or (ii) by establishing that he/she took reasonable precautions to avoid the event leading to the imposition of the penalty (see Les Résidences Majeau Inc v The Queen (2010 FCA 28)).

Some court decisions on the due diligence defence under subsection 163(1) appear to have reached inconsistent conclusions on the issue of whether the taxpayer’s due diligence must exist in respect of (i) either of the two years in which the failure occurred (see, for example, Franck v. The Queen (2011 TCC 179), Symonds v. The Queen (2011 TCC 274), Chan v. The Queen (2012 TCC 168) , and Norlock v. The Queen (2012 TCC 121)) or (ii) only the year upon which the penalty is imposed (i.e., the second failure) (see, for example, Chendrean v. The Queen (2012 TCC 205), and Chiasson v. The Queen (2014 TCC 158)).

This was the question considered by the Tax Court in Galachiuk v. The Queen (2014 TCC 188). In Galachiuk, the taxpayer failed to report portions of income in two consecutive taxation years: $683 in his 2008 tax return and $436,890 in his 2009 tax return. Given Mr. Galachiuk’s failure to report income on two separate occasions, the Minister imposed a penalty under subsection 163(1).

The taxpayer argued that he had been duly diligent in 2008 because he had taken steps to inform his investment broker and advisors of a change of residence, and had also arranged with Canada Post to have his mail forwarded to his new address. Despite these efforts, one T3 slip had not been forward to or received by the taxpayer. The Crown argued that the fact that some T-slips had the incorrect information should have alerted the taxpayer to the need to take additional steps to ensure he had all of his T-slips for the year.

For 2009, the taxpayer argued that he had received a T4 slip and a T4A slip from his former employer, and had concluded that no additional slips were forthcoming from the former employer and that the two slips he received had included all of the income he had received from the former employer in 2009. The Crown argued that a reasonable person would not have made this mistake in the circumstances.

In respect of the legal test, the Tax Court stated that subsection 163(1) is a harsh provision and the absence of language that would limit the due diligence defence made it clear that Parliament had intended that the defence was available to explain the omission in either year. The Court noted that there was no requirement in the provision that the penalty could only be imposed if the taxpayer had first been reassessed in respect of his/her first failure to report (see such a precondition exists in the language of subsections 162(1) and (2) regarding repeated failures to file returns). Accordingly, the defence can be made out where the taxpayer was duly diligent in respect of either of the failures to report income.

In the present case, the Court stated that the taxpayer had been duly diligent in 2008 because he had taken steps to ensure he received his T-slips, he carefully prepared his 2008 tax return, and the unreported amount was a “tiny portion” of his income for the year. Accordingly, the taxpayer was duly diligent in reporting his income in 2008, and the Court allowed the taxpayer’s appeal and ordered that the CRA reassess to delete the penalty imposed in 2009.

Additionally, the Court went on to consider whether the taxpayer had been duly diligent in 2009. On this issue, the Court concluded that it was not reasonable for the taxpayer to believe that his former employer would issue only one T4A in respect of the various amounts paid to him in the year. Further, there was a material difference between the amounts the taxpayer knew his former employer had paid to him in 2009 and the amount that had appeared on the single T4A slip he received. Accordingly, the taxpayer was not duly diligent in preparing and filing his 2009 return.

Interestingly, the Tax Court noted in a brief comment that it expected that there was a reasonable chance the Crown may appeal the decision to the Federal Court of Appeal in order to obtain clarity on the interpretation of subsection 163(1). As of the publication of this article, no appeal had yet been filed with the Court of Appeal.

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Galachiuk: TCC Clarifies Due Diligence Defence Under 163(1)‏

CRA Update: Aggressive Tax Planning

At the Toronto Centre Canada Revenue Agency & Tax Professionals Breakfast Seminar on June 10, 2014, the Canada Revenue Agency (“CRA”) provided an update on selected CRA Compliance Measures in the Aggressive Tax Planning Division. The update was provided by Len Lubbers, Manager, GAAR and Technical Support, Aggressive Tax Planning Division of the Compliance Programs Branch.

Mr. Lubbers displayed and referred to a collection of powerpoint slides (some of which contained detailed statistics), but unlike previous seminars the CRA did not distribute copies of the slides during or after the presentation.

The CRA provided updates on (i) reportable tax avoidance transactions, (ii) the CRA’s related party initiative, (iii) the T1135 foreign income verification statement, (iv) gifting tax shelters, and (v) third party penalties. Here is a brief recap of some of the highlights from the presentation:

Reportable Tax Avoidance Transactions

  • New subsection 237.3 of the Income Tax Act, which addresses reportable transactions, became effective as of June 26, 2013, with retroactive effect to January 1, 2011;
  • Taxpayers who must report a transaction under subsection 237.3 must file form RC312 “Reportable Transaction Information Return“;
  • The deadline for 2012 and earlier years was October 23, 2013, and for subsequent years the RC312 information return is due by June 30 of the year following the transaction;
  • The CRA is currently reviewing the forms filed as of October 2013. The CRA did not disclose the number of RC312 forms that have been filed.

Related Party Initiative/High Net Worth Individual Program

  • The related party initiative program was piloted in 2005 and fully adopted in 2009;
  • The CRA considers that the title “Related Party Initiative” was “not particularly descriptive” of the program;
  • Initially, the program was targeted at individuals with a net worth of $50 million or more and where a taxpayer had 30 or more entities in a corporate group;
  • Several recent changes have expanded the scope of this initiative – namely, the CRA eliminated the requirement that the taxpayer’s wealth be held in 30 or more corporate entities;
  • Additionally, the $50 million threshold for individuals will be relaxed to include corporate groups where there are significant assets held by a group of individuals. For example, consider three individuals that own companies valued at $100 million. Separately, these individuals would not meet the $50 million threshold, but under the new parameters these individuals will be included in the audit program if there is sufficient “economic interdependence”;
  • Further, the long-form “questionnaire” issued by the CRA to taxpayers under audit in the program will now be used by the CRA to gather information from high-net worth individuals who are not under audit;
  • The CRA has formed audit teams in the Aggressive Tax Planning Division to handle these files (previously, these files were handled by audit teams in the Large Business Audit Division).

T1135 Foreign Income Verification Statement

  • The T1135 Foreign Income Verification Statement was introduced in 1995 as a response to concerns about the growing popularity of the use of international tax havens;
  • A revised T1135 form was issued in June 2013;
  • Given the severity of penalties which result from failure to file the T1135 information form, the CRA recommends a voluntary disclosure be made by taxpayers.

Gifting Tax Shelters

  • The CRA continues to monitor and reassess gifting tax shelters;
  • As of 2014, the CRA has reassessed 189,000 taxpayers and denied more than $3 billion of donation tax credit claims;
  • The CRA has revoked the registration of charities that were involved in gifting tax shelters, and the CRA has imposed $162 million of third-party penalties;
  • The CRA noted that the number of participants in tax shelters has been decreasing (i.e., 2012: 8,410 participants vs. 2013: 2,517 participants). The total donations to gifting tax shelters has also decreased (i.e., 2012: $266,675,953 vs. 2013: $7,518,712);
  • The CRA noted the new rule in subsection 225.1(7) that requires a taxpayer to pay 50% of the amount assessed (or the amount in dispute);
  • As of 2013, for taxpayers who participate in a tax shelter, the CRA will not assess a taxpayer’s return until the CRA has audited the tax shelter. In such cases, the CRA will assess a taxpayer’s return if he/she agrees to have the tax shelter credit claim removed from the return.

Third-Party Civil Penalties

  • Section 163.2 was introduced in 2000 (section 285.1 of the Excise Tax Act contains a similar penalty);
  • The CRA’s views on third party penalties is found in Information Circular IC-01-1 “Third Party Civil Penalties” (September 18, 2001);
  • Under section 163.2 there are two types of penalties: a tax planner penalty (under subsection 163.2(2)) and a tax preparer penalty (under subsection 163.2(4)). The CRA noted that both could apply to a taxpayer, but the maximum amount of the penalty in such a case would be the greater of the two amounts (i.e., the penalties are not combined (see subsection 163.2(14));
  • The process for the (potential) application of a penalty under section 163.2 is as follows: The local CRA auditor will gather facts of the taxpayer’s activities and circumstances. If a third party penalty may be applied, the auditor will refer the file to his/her senior manager in the local office. If the senior manager agrees that a penalty may be applied, the file will be referred to the CRA’s Third Party Penalty Review Committee at the CRA’s Ottawa headquarters. A third party penalty will only be applied upon the approval of the Third Party Penalty Review Committee;
  • 195 files have been referred to the Third Party Penalty Review Committee. Of these files, the CRA has applied a penalty in 92 files (for penalties totalling $181 million), has declined to apply a penalty in 87 files, and 16 files remain on-going;
  • The CRA awaits the Supreme Court of Canada’s decision in Guindon v. The Queen (Docket # 35519), which is tentatively scheduled to be heard on December 5, 2014. See our earlier blog posts on the Guindon case here and here.

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CRA Update: Aggressive Tax Planning

International and Transfer Pricing Audits: Toronto Centre Canada Revenue Agency & Professionals Breakfast Seminar

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 Auditsinstead 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.

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International and Transfer Pricing Audits: Toronto Centre Canada Revenue Agency & Professionals Breakfast Seminar

CRA’s New Pre-Rulings Consultations Service

On November 26th, 2013, the Canada Revenue Agency (“CRA”) participated in a Roundtable session at the 65th 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.”

CRA’s New Pre-Rulings Consultations Service

Highlights from the Toronto Centre CRA & Professionals Group Breakfast Seminar (Objections and Appeals) – November 6, 2013

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.

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Highlights from the Toronto Centre CRA & Professionals Group Breakfast Seminar (Objections and Appeals) – November 6, 2013