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ConocoPhillips: FCA Confirms Tax Court’s Jurisdiction to Determine Questions of Timing and the Validity of a Notice of Objection

In ConocoPhillips Canada Resources Corp. v. The Queen (2014 FCA 297), the Federal Court of Appeal overturned a Federal Court decision (2013 FC 1192) and dismissed an application for judicial review by the taxpayer finding that the Federal Court lacked jurisdiction in this case.

ConocoPhillips had commenced an application for judicial review as a result of a dispute between the CRA about whether a Notice of Reassessment had been validly sent to the taxpayer.  The CRA alleged that it mailed a Notice of Reassessment on November 7, 2008. ConocoPhillips alleged that it never received the Notice of Reassessment and that it first learned of the reassessment on April 14, 2010.

Accordingly, when ConocoPhillips filed a Notice of Objection on June 7, 2010, the CRA advised that it would not consider the objection on the grounds that it was not filed within 90 days of the alleged mailing date (i.e., November 7, 2008) and that no request for an extension of time was made within the year following the alleged mailing date of the reassessment.

The Federal Court considered the question of jurisdiction and found that it had jurisdiction because the Court was not being asked to consider the validity of the reassessment (which can only be determined by the Tax Court of Canada) but rather, was only being asked to review the CRA’s decision not to consider the objection.

Based on the standard of reasonableness, the Federal Court found in favour of ConocoPhillips on the basis that the CRA had not sufficiently engaged the evidence to appropriately render an opinion whether or not the reassessment was mailed on the alleged date. The Court set aside that decision.

The Crown appealed to the Federal Court of Appeal on the basis that the Federal Court lacked jurisdiction on this issue.  The Federal Court of Appeal allowed the appeal.

Section 18.5 of the Federal Courts Act provides that judicial review in the Federal Court is not available where, inter alia, an appeal is permitted on the issue before the Tax Court of Canada.  In the present case, the Federal Court of Appeal stated that, pursuant to subsection 169(1)(b) of the Income Tax Act (Canada), ConocoPhillips could have appealed to the Tax Court after 90 days had elapsed following the date its objection was initially filed and the Tax Court would have been the correct forum to determine if, or when, the Notice of Reassessment was mailed and when the time for filing a Notice of Objection expired.

The Federal Court of Appeal clarified that the Minister’s obligation to consider a Notice of Objection is triggered regardless of whether a Notice of Objection may have been filed within the required time-frame. Further, the Minister’s decision on this issue is not an impediment to filing an appeal to the Tax Court pursuant to paragraph 169(1)(b) of the Income Tax Act (Canada). Accordingly, judicial review of this issue was not available in the Federal Court.

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ConocoPhillips: FCA Confirms Tax Court’s Jurisdiction to Determine Questions of Timing and the Validity of a Notice of Objection

Lau: BC SC Corrects Articles of Incorporation After $17.3 Million Reassessment

Many tax rectification cases address situations in which certain transaction documents contain errors that do not accord with the parties’ intent to minimize or avoid taxes. However, there are several cases in which the courts are asked to correct errors in a company’s constating documents – errors that lead to unintended and adverse tax results for the company or its shareholders.

In Lau v. A.G. (Canada) (2014 BCSC 2384), the British Columbia Supreme Court considered whether a mistake in the drafting of a company’s Articles of Incorporation could be corrected under BC corporate law and/or the doctrine of rectification.

0777020 B.C. Ltd. was incorporated in 2006. The Articles of the company stated, among other things, that the Class E preferred shares could be issued (i) as a stock dividend, or (ii) in exchange for property. The directors of the company could establish the redemption amount of the Class E shares, but the Articles stated that this power of the directors existed only in respect of the issuance of the shares for property (i.e., no redemption amount could be determined where such Class E shares were issued as a stock dividend).

In 2008, the company issued 100 Class E shares as a stock dividend. The directors determined the redemption value to be $17,635,000. There were several subsequent transfers of these Class E shares among the individual shareholders and companies in the corporate group, and certain pre-existing liabilities were cancelled as a result of the Class E share transfers.

Subsequently, the CRA alleged the Class E shares had never been validly issued because no power to determine a redemption value existed in the company’s Articles. The CRA reassessed an individual shareholder to include $17.3 million in his income for 2008.

The individual shareholder objected and eventually appealed to the Tax Court. In the meantime, the company brought proceedings in the British Columbia provincial court to correct certain errors in the corporate documents, including the provision in the Articles addressing the directors’ power to determine the redemption value of the Class E shares. There were several proceedings that addressed the various errors:

  • May 21, 2013 – Taxpayers initiate first proceeding to correct various corporate documents
  • September 17, 2013 – Court grants requested relief in first proceeding
  • December 4, 2013 – Taxpayers initiate second proceeding to correct various corporate documents and Articles
  • April 10, 2014 – Taxpayer amends second proceeding to remove requested relief in respect of Articles
  • April 30, 2014 – Court grants requested relief in second proceeding
  • May 2, 2014 – Taxpayers initiate third proceeding to correct provision in Articles addressing Class E share redemption value

In the third proceeding, the taxpayers had revived the relief originally requested in the second proceeding in respect of the Articles. However, they adduced and relied on more extensive evidence concerning the drafting error. In response, the CRA argued that (i) the issue was barred by cause of action estoppel, (ii) the BC Court should decline jurisdiction, and (iii) rectification should not be granted.

On the first two issues, the BC Court held that (i) cause of action estoppel did not apply to prevent the taxpayers from seeking rectification of the Articles, and (ii) the BC provincial courts have exclusive jurisdiction to consider the requested relief (i.e., under the British Columbia Business Corporation Act or the doctrine of rectification) and it was not appropriate to decline jurisdiction in favour of the Tax Court of Canada.

On the third issue, the BC Court noted that the taxpayers had sought relief based on ss. 229 and 230 of the BC BCA and the court’s equitable jurisdiction. The BC Court held that the evidence of the individual shareholders and their counsel clearly established that the parties intended for the company’s directors to have the power to determine the redemption price of the Class E shares when issued as a stock dividend and in exchange for property. The absence of language in the Articles in respect of this power was a result of an error by the company’s solicitor.

The BC Court stated that ss. 229 and 230 of the BC BCA provide a court with the ability to correct any corporate mistake. Further, the BC Court was satisfied that the taxpayers had proven they had a common intention to empower the directors to determine the redemption amount and that the company’s Articles did not reflect this true intention.

The BC Court ordered that the Articles were corrected nunc pro tunc from 2006 to include language that established the proper powers of the directors.

On a sub-issue, the BC Court considered whether the CRA should have been named as a party in the third proceeding (the taxpayers had named the CRA as a party in the first two proceedings, but had refused to name the CRA as a party in the third).

The BC Court noted that there did not appear to be any consensus or consistent approach on this issue. The BC Court stated that the CRA need not be named as a party in every BC BCA or rectification proceeding. In the appropriate circumstances, the CRA may apply to be named as a party, and a court may exercise its discretion to join the CRA as a party. In this case, it was appropriate that the CRA be named as a party.

In light of the mixed success on the application, the BC Court did not award costs to either party.

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Lau: BC SC Corrects Articles of Incorporation After $17.3 Million Reassessment

Fairmont: Ont SCJ Unwinds Share Redemption and Substitutes Loan Arrangement

The common law doctrine of rectification operates to correct mistakes in transactions that produce (or may produce) unintended and adverse tax results. This was established in the landmark case of Juliar et. al. v A.G. (Canada) (50 O.R. 3d 728) (Ont. C.A.) (Dentons was counsel to the successful taxpayers).

In Fairmont Hotels Inc. et al. v A.G. (Canada) (2014 ONSC 7302) the Ontario Superior Court of Justice has provided another example of the manner in which rectification can be used to unwind certain impugned steps in a transaction and substitute the proper steps that accord with the parties’ intention to avoid tax.

Legacy Hotels REIT owned a collection of hotels, which were purchased from Fairmont in or around 1997. Fairmont continued to manage these hotels. In 2002 and 2003, Fairmont was involved in the financing of Legacy’s purchase of two hotels in Washington and Seattle. Through the use of several reciprocal loans between Legacy, Fairmont and several subsidiary companies, Legacy purchased the Washington hotel for $67 million USD and the Seattle hotel for $19 million USD. Fairmont hedged its loans to eliminate or reduce its foreign exchange tax exposure in Canada.

In 2006, Fairmont was acquired by two companies and its shares ceased to be publicly traded. This acquisition of control could have frustrated the parties’ intention that no entity would realize a foreign exchange gain or loss in connection with the reciprocal loan arrangements. A tax and accounting plan was created that would have allowed the companies to complete the acquisition and continue the full hedge of the foreign exchange exposure. However, this plan was modified before implementation with the result that certain foreign exchange exposure was not hedged.

In 2007, Legacy asked Fairmont to terminate the reciprocal loan arrangements on an urgent basis so that the Washington and Seattle hotels could be sold. A Fairmont officer mistakenly believed that the original 2006 plan had been implemented (i.e., the plan that continued the full hedge of the foreign exchange exposure) and agreed to the unwinding of the loans (which involved the redemption of certain preferred shares of the subsidiaries involved in the loan arrangements). Subsequently, the CRA reviewed the transactions and reassessed Fairmont on the basis that the 2007 share redemptions triggered a foreign exchange gain.

Fairmont brought an application to rectify the 2007 share redemptions and to substitute a loan arrangement. Fairmont argued that its intent from 2002 was to have the original reciprocal loan arrangements unwound on a tax-neutral basis. In response, the Crown argued that Fairmont had never intended the proposed substituted loan arrangement and thus was engaged in retroactive tax planning.

Fairmont relied on the Ontario Court of Appeal decision in Juliar for the principle that the exact method to achieve a common intention to avoid tax is not required at the time of the transaction. In response, the Crown argued that the Alberta Court of Queens’ Bench in Graymar Equipment (2008) Inc. v A.G. (Canada) (2014 ABQB 154) had been critical of Juliar and had stated that rectification is granted to restore a transaction to its original purpose and not to avoid an unintended effect.

However, in the present case, the Ontario Superior Court of Justice stated that, unlike the Alberta court, Ontario courts “do not have the luxury of ignoring” the Ontario Court of Appeal’s decision in Juliar. Further, the Ontario court stated that the Alberta court had not accurately described what happened in Juliar, and that another recent Alberta decision had in fact followed the reasoning in Juliar.

In the present case, the Ontario Court held that Fairmont’s intention from 2002 was to carry out the reciprocal loan arrangements on a tax- and accounting-neutral basis so that any foreign exchange gain would be offset by a corresponding foreign exchange loss. This intention remained unchanged when Fairmont was sold in 2006 and when the reciprocal loans were unwound in 2007. A mistake had caused the unintended tax assessments.

The Court also stated that this was not a situation in which the taxpayer was engaging in retroactive tax planning after a CRA audit. The parties intended to unwind the loans on a tax-free basis.

The Court allowed the application and rectified the corporate resolutions as requested. The Court awarded $30,000 of costs to the Applicants.

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Fairmont: Ont SCJ Unwinds Share Redemption and Substitutes Loan Arrangement

CRA: Financial Tools for Canadian Startup Companies

On November 26, 2014, the Canadian Government partnered with Startup Canada to convene Startup Canada Day on the Hill.

Minister of National Revenue Kerry-Lynne Findlay spoke at the event and highlighted the strategies the CRA has implemented to assist startup companies across the country.

Startups have bright, innovative founder teams, but many lack the financial expertise, time, and money required to maintain adequate financial records. This may seem insignificant in the short-term, but this will become increasingly important when attracting investors and in dealing with the CRA.

Minister Findlay stated that, with this reality in mind, the CRA has worked toward reducing the red tape associated with starting and running a business in Canada. In November 2012, 52 small business owners and 91 small business service representatives and bookkeepers participated in meetings across the country to identify issues stemming from federal rules and regulations.

How is the CRA helping Startups?

  1. Through the operation of a secure online self-service portal, available 24/7 through which many different kinds of transactions can be completed, including managing banking information and filing tax returns replacing the need to keep track of copious amounts of paper;
  2. Through the development of the Small Business Checklist which includes user-friendly and detailed information on starting, maintaining and winding up a business;
  3. Through the Business Tax Reminders App, created in consultation with small and medium-sized business owners, which allows businesses to create reminders for when their various financial payments are due; and
  4. Through the Liaison Officer Initiative which provides in – person support to businesses at key stages in their growth cycle in an effort to avoid common tax pitfalls, among other things, that would cost them in the future.

Minister Findlay stated that, in the CRA’s view, these tools provide a solid starting point for tax compliance so company founders can focus on what’s most important to them – making their business grow.

As part of the Government’s commitment to consult with businesses every two years, the CRA recently completed another red tape reduction consultation process in November. Results should be available in the Spring 2015.

A version of this post was originally published on Dentons’ Tech Startup Centre blog

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CRA: Financial Tools for Canadian Startup Companies

Guindon: SCC Hears Arguments in Penalty Case

The Supreme Court of Canada heard oral arguments today in the case of Guindon v. The Queen (Docket No. 35519). At issue in the case is the nature of the third-party penalty in section 163.2 of the Income Tax Act.

See our previous post on the case here.

The taxpayer’s factum is available here, and the Crown’s factum is here. In written submissions, the taxpayer argued:

    1. Section 163.2 is an offence provision that attracts the protections of section 11 of the Charter, and
    2. No notice of constitutional question was required.

In response, the Crown argued:

    1. The taxpayer’s failure to file a notice of constitutional question is fatal to the appeal, and
    2. Section 163.2 is not an offence provision.

The seven-member panel was chaired by Justice Rosalie Abella. (Absent were Chief Justice Beverley McLachlin and recently appointed Justice Suzanne Côté.)

Taxpayer’s Arguments

The Appellant first addressed the question of whether notice of a constitutional question was required under section 19.2 of the Tax Court of Canada Act. The Appellant argued that it was not advancing the position that section 163.2 was invalid or inapplicable or inoperable, and thus no notice was required. Further, if notice was required, it had been provided in respect of the Supreme Court proceeding.

This brought a series of pointed questions from Justices Abella and Moldaver, who asked whether the effect of the Appellant’s interpretation would be to “throw out” the third-party penalty regime in section 163.2 because it would become subject to criminal procedural requirements. Further, the Court was unconvinced that providing the notice in respect of the Supreme Court hearing cured the failure to provide the notice in the Tax Court.

In respect of the Wigglesworth test, the Appellant argued that section 163.2 is directed at any person, and therefore it is intended to promote public order rather than to regulate a private sphere of conduct. Further, section 163.2 has a true penal consequence in that the penalty imposed under this section is identical to the penalty that could be imposed under section 239 for criminal tax evasion.

Justice Rothstein asked several questions about how section 163.2 differs from the other penalty provisions in the Act and whether a finding that section 163.2 was an offense would require Parliament to redraft the provision to include language similar to that found in section 239. On this point, Justice Abella returned to the issue of whether the Appellant was in fact seeking to have section 163.2 declared inoperable.

Crown’s Arguments

The Crown’s submissions were generally received with less judicial intervention from the Court.  The Crown began its submissions with a discussion of the issue of notice of constitutional question.  When asked whether the failure to give notice can be cured in subsequent proceedings, counsel for the Crown conceded that it could in certain cases, but that by the time the dispute comes before the Supreme Court, the matter should be fully argued and the evidentiary record should be complete.

The Crown argued that, in this case, the Federal Court of Appeal could have done one of three things, each of which would have been acceptable: (1) it could have said that notice of constitutional question is required, adjourned the proceedings to remedy the failure, and heard arguments on the substantive issue; (2) it could have returned the matter back to the Tax Court to have the notice served and arguments re-heard so that the evidentiary record could be completed at trial; or (3) it could have done what it did in this case, and held that failure to give notice prevented the court from considering whether section 163.2 implicates the Charter. On this point, Crown counsel argued that the Supreme Court should not sanction a practice that makes it better to ask for forgiveness on appeal rather than asking for permission in the Tax Court.

Regarding the substantive issue, Crown counsel argued that since the penalty is computed mathematically, and with specific reference to the amount of tax credits that the individual taxpayers claimed under the Income Tax Act, then the penalty in section 163.2 is a non-discretionary penalty that bears none of the principles of sentencing (e.g., blameworthiness, retribution, denunciation, reparation, etc.).

Crown counsel discussed the facts of the case to show the link between the penalty amount and the underlying income tax at issue.  Interestingly, Crown counsel distinguished this penalty (i.e., the “tax preparer” penalty) from the “tax advisor” penalty in section 163.2, on the basis that the tax advisor penalty takes into account “gross entitlements”, which this particular penalty does not (therefore, it remains to be seen in a future case whether the “tax advisor” penalty in section 163.2 could be treated differently).  In response to questions from Justices Abella and Rothstein, Crown counsel stated that this penalty is not an “outlier”, as counsel for the Appellant suggested, and that the type of stigma attached to this penalty is a different kind of stigma than the one attached to criminal sanctions.

Finally, regarding the issue of quantum, Crown counsel argued that the amount of the penalty was irrelevant to the analysis.  Justices Abella and Rothstein asked whether the analysis would change if the amount was sufficiently enormous.  Crown counsel argued that the analysis turns on whether the penalty is penal in nature, and if the answer is no, then only in extreme cases would the actual amount cause a penalty to be penal.

*     *     *

Following brief submissions made by the intervener, the Court reserved its decision.

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Guindon: SCC Hears Arguments in Penalty Case

CRA Announces Collaboration with CPA Canada

As expected, the CRA has formally announced the details of its collaborative efforts with CPA Canada.

The CRA recently spoke about this collaboration at the Toronto Centre CRA-Tax Professionals breakfast seminar.

The CRA news release, which is titled “Harper Government solidifies partnership with Canada’s Professional Accountants”, states,

The new Canada Revenue Agency (CRA)-Chartered Professional Accountants of Canada (CPA Canada) Framework Agreement was formally signed by Andrew Treusch, Commissioner of Revenue and Chief Executive Officer of the CRA, and Kevin Dancey, President and CEO of the CPA, during the Financial Management Institute’s Professional Development Week, being held in Ottawa from November 25 to 28. The Framework Agreement recognizes the important relationship between the CRA and CPA Canada in the successful administration of Canada’s tax system, and promotes regular dialogue between the two organizations on tax-related matters of common interest. It will also ensure that input from Canada’s accounting professionals is considered as the CRA moves forward with its change agenda.

A central part of the Framework Agreement includes the creation of seven committees, each co-chaired by a senior representative from both the CRA and CPA Canada, to focus on seven priority areas:

  • Services;
  • Compliance;
  • Tax Administration;
  • Scientific Research and Experimental Development;
  • Commodity Tax;
  • Red Tape Reduction; and
  • Training

The agreement is a key element in the CRA’s efforts to build strong relationships with the Canadian accounting community and tax service providers so that Canada continues to have a well-functioning and world-class tax system that benefits all Canadians.

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CRA Announces Collaboration with CPA Canada

Brent Kern Family Trust: FCA Dismisses Appeal

In Brent Kern Family Trust v. The Queen (2014 FCA 230), the Federal Court of Appeal dismissed the taxpayer’s appeal with reasons delivered from the bench. The taxpayer had argued that the decision of Canada v. Sommerer (2012 FCA 207) should not apply in this case and, in the alternative, that Sommerer was wrongly decided and ought not to be followed.

Brent Kern Family Trust was a case in which the taxpayer undertook a series of transactions whereby a taxpayer (Mr. K) completed an estate freeze for two corporations (the underlying facts are described in detail in the Tax Court decision (2013 TCC 327)).

Following the estate freeze, two family trusts were set up each with Mr. K and his family as beneficiaries as well as each trust having a separate corporate beneficiary. Next, each of the trusts subscribed for common shares in the corporate beneficiary of the other trust.

Once the structure was in place, a dividend was flowed through the structure and, as a final step, one of the trusts paid funds to Mr. K but relied on the application of subsection 75(2) of the Act to deem the dividend income received by the trust to be income in the hands of one of the corporate beneficiaries. Accordingly, if subsection 75(2) of the Act applied, the income would not be subject to tax as a result of section 112 of the Act and Mr. K could keep the gross amount of the funds.

In the decision rendered at trial, the Tax Court held that Sommerer case applied and subsection 75(2) of the Act did not apply on the basis that the trust purchased the property in question for valuable consideration and no “reversionary transfer” occurred.

In Brent Kern Family Trust, the Court of Appeal found that there was no reviewable error in the trial judge’s finding that Sommerer applied, that the Court of Appeal in Sommerer “spent considerable time analyzing the text, content and purpose of subsection 75(2)”, and no reviewable error had been brought to the Court’s attention in the present case.

The Court of Appeal dismissed the taxpayer’s appeal and upheld the Tax Court’s decision.

We note also that at least one taxpayer has brought an application in a provincial court to correct a transaction where the taxpayer never intended for Sommerer to apply. In Re Pallen Trust (2014 BCSC 405), the B.C. Supreme Court rescinded two dividends, the effect of which was to eliminate the tax liability in the trust. Re Pallen Trust is under appeal to the B.C. Court of Appeal.

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Brent Kern Family Trust: FCA Dismisses Appeal

Brogan Family Trust: CRA Not Entitled to Notice of Rectification Application

Is the CRA entitled to notice of a rectification application?

In Brogan Family Trust (2014 ONSC 6354), the Ontario Superior Court of Justice said “no”, and dismissed the Crown’s motion to set aside an earlier rectification order on the basis that the CRA had not been notified of the proceeding.

In Brogan, the taxpayer had restructured his business and settled a trust for family tax planning purposes in 2004. Subsequently, in 2010, the trustees became aware of an error in the trust agreement that prevented the distribution of trust property to intended minor beneficiaries. The trust made an application for rectification of the trust agreement so that the trust property could be distributed as intended. The trust’s tax litigation counsel advised that no notice to the CRA was required.

The rectification application proceeded in November 2010. Shortly before the rectification order was granted, the trust sold a business. In its 2010 tax return, the trust allocated the proceeds to the beneficiaries, who in turn reported the income in their returns.

The CRA commenced an audit of the sale of the business and the trust in June 2012, at which time it became aware of the 2010 rectification order that had corrected the trust agreement. In August 2012, the CRA was provided a copy of the rectification order. And then in May 2013, the CRA brought its motion for an order setting aside the 2010 rectification order.

The Court considered three issues:

  1. Did the CRA bring the motion “forthwith” after learning of the rectification order?
  2. Did the CRA have standing to bring the motion?
  3. Should the CRA have been notified of the rectification application?

The Crown argued that (i) the delay was not inordinate because there had been internal confusion at the CRA in respect of the rectification order, (ii) the CRA was a creditor and thus was affected by the rectification order, and (iii) the CRA’s own view and the custom among tax litigators is that the CRA should be given notice (see, for example, Income Tax Technical News No. 22, at pg. 6).

The taxpayer argued that (i) the CRA’s 10-month delay was unreasonable and not “forthwith”, (ii) the CRA was not affected by the rectification application, and (iii) in any event, there was no requirement the CRA be notified of the rectification application.

The Court agreed with the taxpayer and dismissed the Crown’s motion.

The Court stated that the CRA was not a creditor and thus was not affected by the rectification order. The Court contrasted the current case with Snow White Productions Inc. v. PMP Entertainment Inc. (2004 BCSC 604), in which the rectification proceeding had been launched in response to an adverse ruling by the CRA and it was thus appropriate for the CRA to receive notice and participate (see also Aim Funds Management Inc. v. Aim Trimark Corporate Class Inc. (2009 CanLII 29491 (ON SC)).

On the issue of delay, the Court stated that the CRA had not brought the motion forthwith. The 10-month delay was the fault of the CRA, and even after the rectification order was referred to counsel, it still took two months for the motion to be launched.

And finally, on the issue of whether notice should be provided to the CRA, the Court stated that it had been directed to no authority on the point that the CRA should be given notice, nor on the point that notice is required if the CRA is not a creditor. The Court was not persuaded that providing notice to the CRA was the practice of tax litigators, and nor was it the law.

Rather, in the Court’s view, the delivery of a Notice of Assessment creates rights for the CRA to participate in a rectification proceeding as a creditor (see, for example, Canada (A.G.) v. Juliar ((2000) 50 O.R. (3d) 728 (C.A.) (a case on which Dentons was counsel for the successful taxpayer)).

The Court concluded as follows:

[22] … the CCRA is only required to be given notice of a proposed rectification proceeding when the CCRA’s legal interests might be directly affected by the outcome of the rectification proceeding, such as where the CCRA is a creditor and the rectification would affect its rights. Otherwise, the CCRA might be made a party when so advised by counsel that notice should be given to the CCRA.

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Brogan Family Trust: CRA Not Entitled to Notice of Rectification Application

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)

Maddin: Failure to Inquire Leaves Director Liable

In Maddin v. The Queen (2014 TCC 277), the taxpayer was a director of a corporation in the marble and granite industry (the “Corporation”) which failed to remit nearly $300,000 of source deductions related to salaries, wages and other remuneration paid to employees. The sole issue before the Tax Court was whether the taxpayer could make out a due diligence defence under subsection 227.1(3) of the Income Tax Act (Canada).

For earlier blog posts on directors’ liability see our blog posts here and here.

The evidence established that the taxpayer intended to play a limited advisory role in the Corporation. Mr. Barker, another director, was in charge of managing the daily operations of the Corporation. However, the Tax Court also noted the following additional facts:

  • The taxpayer was in the office 2-3 days a week;
  • The taxpayer was familiar with the Corporation’s business structure, its banking operations and the accounting systems;
  • The taxpayer executed various letters on behalf of the Corporation;
  • The taxpayer had a close relationship with the initial bookkeeper and communicated with her generally throughout the period at issue;
  • When a new bookkeeper (the mother of another director) was hired, the taxpayer was aware that she did not necessarily understand the bookkeeping systems; and
  • The taxpayer knew of the Corporation’s financial difficulties.

Ultimately, the Tax Court held that these factual circumstances should have prompted Mr. Maddin to inquire into the financial health of the Corporation. Mr. Maddin did not exercise the appropriate standard of care, diligence and skill required of a director to avoid being held personally liable for the unremitted source deductions.

This case is another reminder that the Courts will, in general, hold directors to a relatively high standard of conduct. In order to successfully argue a due diligence defence, directors involved in the business must take active steps to inquire into the financial state of affairs and communicate regularly with staff to obtain reports that source deductions are being remitted in a timely manner.

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Maddin: Failure to Inquire Leaves Director Liable