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Guindon: SCC Hearing Scheduled for December 5, 2014

The highly-anticipated appeal to the Supreme Court of Canada in Guindon v The Queen has been scheduled for hearing on December 5, 2014, and the parties have now filed their factums in the appeal.

For our prior posts on this decision, refer to our summary of the Tax Court decision (2012 TCC 287), our guest blogger’s summary of the Federal Court of Appeal decision (2013 FCA 153), and our summary of the Supreme Court leave application (Docket No. 35519).

The Appellant’s (Ms. Guindon’s) Factum is available here, and the Respondent’s (Crown’s) Factum is here.

The appeal concerns the “third party” penalties under section 163.2 of the Income Tax Act.  In short, the Tax Court found that the penalty imposed under section 163.2 is a criminal penalty, not a civil one, and therefore subject to the protection of (inter alia) section 11 of the Charter of Rights and Freedoms.

The Federal Court of Appeal reversed on the basis that Ms. Guindon did not provide notice of a constitutional question, and thus the Tax Court lacked jurisdiction to make an order on the nature of section 163.2.  In any event, the Federal Court of Appeal also stated that the penalty under section 163.2 was not criminal in nature, and hence, was not subject to Charter protections.

Taxpayer’s Arguments

On appeal to the Supreme Court, the Ms. Guindon has framed her appeal as follows: based on the Supreme Court’s decisions in Wigglesworth and Martineau, section 163.2 is an offence provision that attracts the protection of (inter alia) section 11 of the Charter on the basis that section 163.2 is (1) an offence provision “by nature” and (2) an offence provision by virtue of its true “penal consequences”.

In addition, if section 163.2 is an offence provision, then Ms. Guindon argues that her section 11 Charter rights were breached in a manner that cannot be justified under section 1 of the Charter (applying the Oakes test).

Finally, Ms. Guindon asserts that a notice of constitutional question did not need to be filed in this case, since she was not seeking a declaration that section 163.2 was unconstitutional, but was rather merely asserting her Charter rights (and in the alternative, if notice of constitutional question was needed, Ms. Guindon argues that no prejudice resulted to the Crown and the Supreme Court can simply replace the lower court’s decision with its own).

Crown’s Arguments

The Crown, not surprisingly, has focused its primary argument on the fact that no notice of constitutional question was made by the taxpayer.  Accordingly, the Crown argues that the Supreme Court should dismiss the appeal on that basis alone and need not consider the substantive issues.

Alternatively, the Crown argues that section 163.2 is not an offence provision “by nature”, as its objects are purely administrative, the purpose of the penalty is to deter non-compliance under the Income Tax Act, and the process by which to challenge the penalty (i.e., the objection and appeal process under the Act) is not criminal in nature.

Moreover, the Crown asserts that section 163.2 does not impose true “penal consequences”, since (i) prosecution could have resulted in harsher sanctions (including prison time), and (ii) the magnitude of the penalty must be assessed in the context of the malady it intends to remedy (notwithstanding the lack of a penalty “ceiling”).  If the Supreme Court finds that section 163.2 infringes section 11 of the Charter, then the Minister will not seek to uphold it under section 1 of the Charter.

Potential Implications

Regardless of the Supreme Court’s finding on the issue regarding the notice of constitutional question, it would be surprising if the Supreme Court did not consider the substantive issue – it would be puzzling for the Court to grant leave and consider only the preliminary question. Accordingly, even if Ms. Guindon’s appeal fails on technical grounds, we expect the Court to offer much-needed guidance on the nature of section 163.2.

If the Court determines that section 163.2 infringes section 11 of the Charter (regardless of its finding on the “notice” issue), we can expect the Department of Finance may consider amendments to 163.2 (and the parallel provision under the Excise Tax Act) in a manner that takes into account the Supreme Court’s reasons.

The Court’s decision will also have implications for the Excise Tax Act (the “ETA”).  Section 285.1 of the ETA imposes a similar planner/preparer penalty for GST/HST purposes. At the CPA Commodity Tax Symposium in Ottawa (held on September 29 and 30, 2014), the CRA announced that it had recently issued the first penalty under section 285.1 of the ETA.

And for both the ITA and ETA, we expect there may be other potential penalty reassessments issued – or not – depending on the result of the Guindon case.

For these reasons, we eagerly await the hearing on December 5, 2014 and the Court’s subsequent decision.

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Guindon: SCC Hearing Scheduled for December 5, 2014

Foreign Charities and the Changing Landscape of CRA Charity Audits

There has been a flurry of recent scrutiny and activity in the areas of foreign and domestic charities – few foreign charities remain on the list of qualified donees since the changes to the definition of “qualified donee” in the Income Tax Act, and the CRA’s Charities Directorate appears to have taken a keen interest in the political activities of certain domestic charities.

Donors and charities would be prudent to monitor these developments and obtain professional advice where necessary.

Foreign Charities

Before 2013, a “qualified donee” under the Income Tax Act automatically included those foreign charities to which the Canadian government had made a gift in previous years (within a certain timeframe). However, that changed when the definition of qualified donee was amended to include only those foreign organizations that have applied to the CRA for registration, which would be granted if the foreign charity received a gift from the Canadian government and the CRA was satisfied that the foreign charity is carrying on relief activities in response to a disaster, providing urgent humanitarian aid, or carrying on activities in the national interest of Canada.

The CRA website lists only one foreign charity that has been registered – The Bill, Hillary and Chelsea Clinton Foundation. The CRA website also lists those organizations that had received gifts from the Canadian government before the changes to the definition of qualified donee.

Political Activities and CRA Charity Audits

The foreign charity changes occurred around the same time the CRA Charities Directorate increased its “political activities compliance efforts”. In general, charities are restricted from engaging in or supporting political activities unless those activities are wholly subordinate to their other charitable purposes. The CRA’s administrative position is that a charity must devote less than 10% of its total resources in a year to political activities.

The CRA focus on charities and political activities sparked many media articles raising the issue of whether the CRA’s auditing practices were themselves inherently politically-motivated (see articles here, herehere and here).

Cathy Hawara, the Director General of the CRA’s Charities Directorate, has denied accusations that these charity audits were politically motivated (see Ms. Hawara’s speech to the CBA Charity Law Symposium on May 23, 3014). The CRA also publicly stated that recent audits of charities were intended to focus on all types of charities and not only those with certain political inclinations. Further, the CRA has recently published a Charities Program Update which (among other things) aims to increase the transparency of its audits in the charitable sector and provide guidance as to how audits for charities involved in political activities are conducted. However, at the same time, the CRA has publicly stated that it will not divulge the guidelines for political activity audits of charities.

The controversy surrounding the CRA’s audit selection process persists. On September 15, 2014 a letter signed by 400 academics was released, demanding that the CRA halt its audit of the Canadian Centre for Policy Alternatives (“CCPA”). This letter was sent in response to the release of a CRA document obtained by the CCPA pursuant to an access to information request wherein the CRA states the reason for audit as follows: “A review of the Organization’s website… suggests that the Organization may be carrying out prohibited partisan political activities, and that much of its research/educational materials may be biased/one-sided.”

In their letter, the academics counter that “critical policy analysis does not equate with political activism, nor is it ‘biased’ or ‘one-sided’.” They argue that there is legitimate concern that charities are now self-censoring to avoid aggravating auditors and this audit activity will stifle sound, effective, and legitimate research.

On October 20, 2014, the Broadbent Institute released a report that adds further momentum to the speculative argument that the CRA is less interested in compliance and more interested in politically-motivated retribution against government critics (see also here).

The report highlights 10 “right-leaning” charities that have apparently escaped CRA audit, despite making public statements that may indicate that such charities are carrying out political activities without reporting them. The report concludes by suggesting that an impartial inquiry into the CRA’s audits of charitable organizations is the only way to come to a clear conclusion on this controversial matter.

The message is clear. The CRA is increasing scrutiny on political activities in the charitable sector. Charities should take active steps to ensure that they are compliant with applicable legislation.

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Foreign Charities and the Changing Landscape of CRA Charity Audits

1057513 Ontario Inc.: The Clear Meaning of Subsection 129(1)

At the heart of tax integration in Canada is the refundable tax and dividend refund mechanism in subsection 129(1) of the Income Tax Act (the “Act”).

Generally, to avoid undue deferral of tax on investment income earned through a “Canadian-controlled private corporation”, such corporations must pay refundable tax on investment income (either under Part I or Part IV of the Act), which effectively brings the corporate tax rate on such income to the same rate had the income been earned directly by the Canadian shareholder.

In order to ensure that such income once distributed to an individual shareholder is not subject to double taxation, the Act provides that taxable dividends paid by a private corporation entitle the corporation to a refund of the lesser of 1/3rd of the taxable dividends paid and the balance of the corporation’s “refundable dividend tax on hand” (“RDTOH”) account. Importantly, the Act imposes a strict deadline for obtaining the refund: the return for the year in which the refund is claimed must be filed within three years of the end of the year in which the dividend is paid.

Despite this seemingly clear-cut limitation period, a number of taxpayers over the years have turned to the courts to seek what amounts to a judicial extension of the filing deadline. 1057513 Ontario Inc. v. The Queen (2014 TCC 272) is the latest in a line of recent decisions considering whether the three-year refund limitation period is absolute.

In 1057513, the taxpayer declared and paid dividends to its shareholder in the 1997-2004 tax years. The taxpayer’s director and officer was unaware that a personal holding corporation had an obligation to file a tax return in the years in question. Upon the filing of the tax returns in 2008, the CRA assessed Part IV dividend tax (and interest and penalties) and denied the dividend refund claim.

On appeal, the taxpayer made three arguments: (i) the language in subsection 129(1) was ambiguous (or “at least not unambiguous”), (ii) a textual, contextual and purposive (“TCP”) analysis of the provision reveals latent ambiguities which should allow for a late refund, and (iii) the filing deadline is directory, not mandatory, meaning that not filing the return on time is not fatal to the refund claim.

Not surprisingly, the Tax Court dismissed the appeal. Relying on Tawa Developments Inc. v. The Queen (2011 TCC 440) and other relevant decisions, the Tax Court determined that there was nothing textually unambiguous about the requirement to file a return within three years, finding the statutory language to be “strikingly lucid and abundantly clear”.

Under the TCP argument, the taxpayer argued that the Court should read out the deadline because it was “antipodal” to the integration principal. The Court disagreed, and concluded that the rule was necessary in the context and for the purpose of achieving an effective self-assessing system. Finally, the Court was not swayed by the taxpayer’s argument that a filing deadline without a penalty is directory and not mandatory. The Court noted that while there may be no penalty per se, there was certainly a consequence of the failure to file – that being the inability to access the dividend refund.

It seems clear from the jurisprudence to date that the three-year filing deadline for obtaining a dividend refund under subsection 129(1) is absolute. Taxpayers and their advisors are encouraged to file returns as soon as possible to avoid the potential punitive double-taxation.

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1057513 Ontario Inc.: The Clear Meaning of Subsection 129(1)

Gariepy: When is a director’s resignation effective?

In Gariepy v. the Queen (2014 TCC 254), the Tax Court considered (i) whether two directors had effectively resigned from their positions, and (ii) if not, whether the directors were duly diligent in seeking to prevent the failure of the company to remit source deductions.

In Gariepy, the two directors argued that they were not liable under subsection 227.1(1) of the Income Tax Act (Canada) (the “Act”) for $500,000 in unremitted source deductions of 1056922 Ontario Limited (the “Corporation”) on the basis that they had resigned as directors more than two years prior to the assessment. In the alternative, the two directors put forth a due diligence defence.

The two appellants were the only directors of the Corporation, but it was in fact managed and operated by their husbands. After approximately two years, the husbands decided it was time for their wives to cease to be directors and have themselves appointed. One of the husbands – Mr. Chriss – contacted the Corporation’s law firm to advise of the change of directors.

There was conflicting or confused testimony presented in the 10-day hearing of the appeals, but the Tax Court held that there was sufficient evidence that the two directors had resigned in 2001 and the limitation period in subsection 227.1(4) of the Act had passed – even though written resignations prepared by a corporate law firm had not been signed by either of the directors.

The Tax Court examined e-mails between the parties and their lawyers, corporate records, and minute books and determined that there was sufficient documentary and oral evidence to demonstrate the resignations were “meaningfully communicated” to the Corporation in 2001. The resignations were valid and effective as of the date the resignations were prepared by the corporate law firm. Although the Court noted serious credibility issues by both directors with respect to the resignations, it was held that these credibility issues were not relevant to decide the merits of the case but would be relevant to determining any cost awards.

The Tax Court noted that this conclusion was consistent with the Court’s earlier decisions in Perricelli v. The Queen (2002 GSTC 71)Walsh v. The Queen (2009 TCC 557)Corkum v. The Queen (2005 TCC 755)Irvine v. M.N.R. (91 DTC 91), and Cybulski v. M.N.R. (88 DTC 1531).

Although the above finding was sufficient to dispose of the appeals, the Court went on to discuss the directors’ alternative argument – whether it was nonetheless reasonable for the directors to think they had resigned and, if so, whether their complete failure to act or concern themselves with the company’s affairs during the non-remittance periods could support a due diligence defence.

On this alternative argument, the Tax Court came to different results for the directors. The Tax Court held that one of the directors – Mrs. Chriss – reasonably relied on her husband and the corporate law firm that her resignation was valid. Conversely, the Tax Court held that for the other director – Mrs. Gariepy – it was not reasonable for her to think that she had ceased to be a director. For Mrs. Gariepy, the evidence did not support a finding that she asked for, was advised of, or was otherwise aware that Mr. Chriss had been asked to or did contact a law firm to advise of the resignations.

Gariepy provides a reminder of the importance of meticulous record-keeping for directors when they resign from their positions. A signed resignation letter would have obviated the need for a lengthy proceeding, and would have clarified at the outset the potential liability of the directors for the company’s unremitted source deductions.

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Gariepy: When is a director’s resignation effective?

Tax Reminders? Now There’s an App For That

We have previously blogged about litigation apps and the absence of Canadian litigation and tax litigation apps.

Yesterday, the Canada Revenue Agency introduced a new tool for tax compliance with the release of the first CRA app for businesses.

From the CRA’s mobile apps webpage:

The Business Tax Reminders mobile app is recommended for small and medium-sized businesses with annual revenue of $20 million or less and fewer than 500 employees. The app was created based on consultations with small and medium-sized businesses, and allows business users to:

  • create custom reminders for key CRA due dates related to instalment payments, returns, and remittances.
  • customize and tailor the reminder system for their personal business deadlines with either calendar or pop-up messages.

The Canada Revenue Agency is committed to improving services for small and medium-sized businesses by reducing red tape. We have listened to these businesses across the country and created our Business Tax Reminders mobile app to ensure the CRA’s online services meet the needs of businesses by helping them fulfil their tax obligations.

We applaud the CRA for its commitment to helping Canadian taxpayers comply with their tax obligations, and we look forward to seeing how this new app is used by Canadian businesses. For tax advisors, we expect that apps, downloads, and mobile reminders will likely become a new aspect of our tax dispute discussions with the CRA.

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Tax Reminders? Now There’s an App For That

CRA: Tax treatment of Ponzi scheme investments

We have previously written about court decisions on the tax results arising from taxpayers’ (failed) investments in Ponzi schemes (see our posts on Roszko v. The Queen (2014 TCC 59), Johnson v. The Queen (2011 TCC 54) and (2012 FCA 253), Hammill v. The Queen (2005 FCA 252) and Orman v. Marnat (2012 ONSC 549)).

These decisions raise questions as to how the CRA may assess all aspects of the income earned and losses suffered by the duped investors. For example, while the cases focused on whether the taxpayer was required to report some of the returned funds as income, the tax treatment of losses after the collapse of the fraudulent scheme has not been considered.

The CRA has now provided some guidance on how it will administer the Income Tax Act (Canada) in respect of the income and losses arising from Ponzi schemes. In CRA Document No. 2014-0531171M6 “Fraudulent Investment Schemes” (July 3, 2014), the CRA stated:

  • Income inclusion – Amounts paid to a taxpayer that are returns on their investment should be included in the taxpayer’s income. The fact that the funds were not invested on behalf of the taxpayer does not change the nature of the transaction for the taxpayer.
  • Bad debt – If the investment was a fraudulent scheme, the taxpayer may be able to claim a bad debt under paragraph 20(1)(p) of the Act in respect of the lost investment funds. The amount of the bad debt claim will be subject to certain adjustments. The bad debt should be claimed in the year the fraud is discovered (i.e., the year in which fraud charges are laid by the Crown against the perpetrator, or at such earlier time as the debt is established to have become bad).
  • Losses – The taxpayer may be able to claim a capital loss or business investment loss:
    • Capital loss – The taxpayer may be able to claim a capital loss under paragraph 39(1)(b) of the Act, which may be carried back three years or forward indefinitely. A net capital loss may only be applied against a taxable capital gain.
    • Business investment loss – Under paragraph 39(1)(c), a business investment loss is a capital loss from a disposition of a share of a small business corporation or a debt owing to the taxpayer by a Canadian-controlled private corporation that was a small business corporation. Under paragraph 38(c) of the Act, one-half of a business investment loss is an allowable business investment loss, which may be deducted against all sources of income.
  • Other deductions – The taxpayer may be able to claim interest expenses or other carrying charges not previously claimed by filing a T1 Adjustment Request form.
  • Recovered amounts – Where the taxpayer recovers funds from a scheme (i.e., through a legal settlement or otherwise), these recovered amounts may be taxable as recovery of a previously deducted bad debt, recovery of a previously deducted business loss, or recovery of a previously deducted capital loss.
  • Taxpayer relief – The CRA will consider requests for taxpayer relief on a case-by-case basis.

This guidance is helpful, but there are many technical requirements for the operation of these provisions, and further it is not clear how the CRA’s administrative views accord with the case law. For example, at least two cases (Roszko, Orman) have held that amounts paid out a fraudulent scheme are not income to the duped investor. A third case (Hammill) held that a fraudulent scheme cannot give rise to a source of income. In future cases, we expect the courts will continue to clarify the tax treatment of income and losses arising from failed Ponzi schemes.

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CRA: Tax treatment of Ponzi scheme investments

Health Quest: Appeal allowed where Crown failed to properly plead assumptions

What is the result of the Crown’s failure to properly plead its assumptions in the Reply? This issue was considered by the Tax Court in Health Quest Inc. v. The Queen (2014 TCC 211) in which the Crown’s Reply included “assumptions” that were statements of mixed fact and law rather than facts alone.

The taxpayer was a distributor of modified and “off-the-shelf” therapeutic footwear for relief of various disabling conditions of the feet. During the reporting periods at issue, section 24.1 in Part II of Schedule VI of the Excise Tax Act stated that zero-rated supplies included footwear designed for use by an individual who has a crippled or deformed foot or other similar disability when the footwear is supplied on the written order of a medical practitioner. (The provision was amended in 2012 to broaden the definition to include written orders by a “specified professional”.) The taxpayer considered that most or all of the footwear it sold was zero-rated under s. 24.1.

The CRA audited the taxpayer for the period of January 1, 2008 to December 31, 2009. Based on a sampling of the taxpayer’s sales (in the months of August and December 2009), the CRA assessed additional GST owing of $42,274.72 for the period.

In the Tax Court, the taxpayer argued that all of the shoes it sold were for a prescribed diagnosis and thus zero-rated. The Respondent argued that the “off-the-shelf” shoes sold by the taxpayer (i.e., sold “as-is” without modification) were not zero-rated and thus subject to GST.

Under section 6 of the Tax Court of Canada Rules of Procedure Respecting the Excise Tax Act (Informal Procedure), every Reply to a Notice of Appeal must contain (among other things) a statement of the findings or assumptions of fact made by the CRA when making the assessment and the reasons the Crown intends to rely on in support of the assessment. (The Tax Court’s other procedural rules contain substantially identical provisions – see, for example, section 49 of the Tax Court of Canada Rules (General Procedure)).

In Health Quest, the Crown’s Reply stated, “In so assessing the Appellant, the Minister relied on the following …

(a)        the facts stated and admitted above;

(b)        the Appellant was a GST/HST registrant;

(c)        the Appellant was required by the Excise Tax Act, R.S.C. 1985, c. E-15, as amended (the “Act”) to file its GST/HST returns on a quarterly basis;

(d)       the Appellant was a corporation involved in the supply of footwear which were specially modified by the Appellant or were specially designed by the manufacturer for persons with physical disabilities;

(e)        the products described in subparagraph 7(d) above are zero-rated for HST pursuant to Schedule VI of the Act;

(f)        the Appellant also supplied other products which were not zero-rated pursuant to Schedule VI of the Act; and

(g)        during the periods under appeal, the Appellant failed to collect tax of not less than $42,274.72 on its supply of products which were not zero-rated pursuant to Schedule VI of the Act.”

The Tax Court noted that paragraphs (f) and (g) were problematic in that they both contained statements of mixed fact and law, which the Federal Court of Appeal has stated have no place in the Minister’s assumptions (see Anchor Pointe Energy Ltd. v. the Queen (2003 FCA 294) and Canadian Imperial Bank of Commerce v. The Queen (2013 FCA 122)). In Anchor Pointe, the Court of Appeal stated,

[23] The pleading of assumptions gives the Crown the powerful tool of shifting the onus to the taxpayer to demolish the Minister’s assumptions. The facts pleaded as assumptions must be precise and accurate so that the taxpayer knows exactly the case it has to meet.

In Health Quest, the Tax Court determined the Crown’s key “assumptions” were merely the Respondent’s view on the application of the law to the facts of the appeal.

The Court noted that where the Crown has not set out any proper assumptions of fact in the pleadings, the evidentiary onus reverts to the Crown to establish the correctness of the assessment (see Pollock v. Minister of National Revenue (94 DTC 6050 (Fed. C.A.) and Brewster v. the Queen (2012 TCC 187)). In other words, the normal requirement that a taxpayer must adduce evidence to “demolish” the Crown’s assumptions is reversed and the Crown must prove its case.

In Health Quest, the Respondent’s only evidence was the testimony of the appeals officer. The Tax Court held the testimony did not establish, on a balance of probabilities, that the footwear in question was not zero-rated. The Court noted that it would have been beneficial to have product literature, scientific studies, or the testimony of medical professionals, and this type of evidence would have been essential to engage in a meaningful textual, contextual and purposive analysis of the applicable legislation (there are no previous cases that have considered the interpretation of section 24.1).

The Tax Court allowed the appeal.

The Court’s decision in Health Quest is a helpful reminder of the importance of including only facts and not legal arguments in the assumptions in a Reply. Taxpayers and their counsel should closely scrutinize the assumptions and reasons described in a Reply to ensure the pleading conforms with the Tax Court’s rules.

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Health Quest: Appeal allowed where Crown failed to properly plead assumptions

Bolton Steel Tube: TCC Orders Crown to Reassessment in Accordance with Settlement‏

In Bolton Steel Tube Co. Ltd. v. The Queen (2014 TCC 94), the Tax Court of Canada allowed the taxpayer’s motion requesting an Order that would require the CRA to reassess the taxpayer in accordance with the terms of a settlement agreement. In doing so, the Tax Court discussed certain principles regarding settlement agreements and the resulting reassessments.

In Bolton Steel Tube, the CRA reassessed the taxpayer for its 1994, 1995, 1996 and 1997 taxation years on the basis that the taxpayer failed to report income in each of those taxation years (the “2007 Reassessment”).

In 1996, the taxpayer reported $1.2 million of income. The CRA added approximately $600,000 of unreported income for total income of $1.8 million. During examinations for discovery, the CRA’s representative admitted that approximately $200,000 of the $600,000 increase should not have been made. Accordingly, for the 1996 taxation year, the maximum amount of income the CRA could have added as unreported income was $400,000. The CRA further confirmed this admission in its Reply.

On June 15, 2012, the taxpayer delivered to the Crown an offer to settle which proposed to settle the appeals on the basis that (i) the CRA would vacate the reassessments for 1994, 1995 and 1997, and (ii) the CRA would reassess the 1996 taxation year to add $403,219 to the taxpayer’s income and impose a penalty under subsection 163(2) of the Income Tax Act (the “Act”). The Crown accepted this offer without further negotiation, and the parties entered Minutes of Settlement on these terms.

Following the settlement, the CRA issued a reassessment that calculated the taxpayer’s income for its 1996 taxation year to be $2,266,291, essentially adding $403,219 to the $1.8 million that had been previously assessed (the “2012 Reassessment”). The result was illogical: The agreed amount of unreported income – $403,219 – was added twice, and the $200,000, which the CRA had admitted was not to be added to the taxpayer’s income, was included as well.

In requesting the Order, the taxpayer argued that:

The 2012 Reassessment was not supported on the facts and the law;

The 2012 Reassessment violated the principle that the CRA cannot appeal its own assessment; and

The 2012 Reassessment was made without the taxpayer’s consent, which would be required pursuant to subsection 169(3) of the Act.

The Crown argued that if the 2012 Reassessment was varied or vacated then there had been no meeting of the minds, the settlement was not valid, and the 2007 Reassessment should remain under appeal.

The Tax Court agreed with the taxpayer on all three arguments.

With respect to the first argument, the Tax Court found the CRA’s interpretation of the Minutes of Settlement to be “divorced from the facts and law”. The Crown’s position was unsupportable since settlements must conform with the long-standing principal from Galway v M.N.R. (74 DTC 6355 (Fed. C.A.)) that settlements must be justified under, and in conformity with, the Act. In Bolton Steel Tube, the Tax Court went as far to say “even if both parties consented to settling in this manner, it could not be permitted” and “there is nothing to support the [Crown's] interpretation and nothing to support the [Crown's] further contention that the [taxpayer] offered this amount in exchange for other years to be vacated”.

With respect to the arguments surrounding subsection 169(3) of the Act, the Tax Court found that the taxpayer had not consented to having its income increased by the amount in the 2012 Reassessment.

The Crown argued that subsection 169(3) of the Act, which allows the CRA to reassess an otherwise statute-barred year upon settlement of an appeal, also allows the CRA to increase the amount of tax which the CRA could reassess despite subsection 152(5) of the Act. Subsection 152(5) of the Act is the operative provision that prevents the CRA from increasing an assessment of tax. Here, the Tax Court maintained the longstanding principle that a reassessment cannot be issued that results in an increase of tax beyond the amount in the assessment at issue. This is tantamount to the CRA appealing its own reassessment, which is not permitted, and thus renders the 2012 Reassessment void. We note that the Tax Court also considered the 2012 Reassessment to be void on the basis that it was an arbitrary assessment.

The Tax Court rejected the Crown’s argument that the settlement was ambiguous and therefore there was no meeting of minds as would be required for a valid contract. The Crown argued that the settlement was not valid and therefore the years under appeal should remain in dispute. The Tax Court turned to fundamental principles of contractual interpretation and found that the contract validly existed since it could reasonably be expected that the Crown would have known that the addition of $403,219 was to be added to the appellant’s income as originally reported (i.e., $1.2 million) and not to the income amount in the 2007 Reassessment (i.e., $1.8 million).

Accordingly, the Tax Court rejected the Crown’s argument, found that the settlement was valid and that the Minister should reassess on the basis that $403,219 should be added to the taxpayer’s income as originally reported. Since the 2012 reassessment was not valid, and therefore did not nullify the 2007 reassessment, and a notice of discontinuance had not yet been filed, the Tax Court continued to have jurisdiction over the appeal.

The result of this motion was a clear victory for the taxpayer and for common sense. It serves as a reminder that precision is essential when entering into settlement agreements.

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Bolton Steel Tube: TCC Orders Crown to Reassessment in Accordance with Settlement‏

Spruce Credit: Avoidance Transactions and the Duke of Westminster

In Spruce Credit Union v. The Queen (2014 FCA 143) the Federal Court of Appeal upheld the lower court’s interpretation and application of the inter-corporate dividend deduction under subsection 112(1) of the Income Tax Act (Canada) (the “Act”). The Court of Appeal also considered the interpretation of “avoidance transaction” for purposes of the general anti-avoidance rule (“GAAR”) in section 245 of the  Act.

Spruce Credit Union (“Spruce”) was a member of a network of credit unions providing financial services to individuals in British Columbia. Two separate provincially-owned entities were responsible for insuring the deposits of B.C. credit unions during the relevant period: the Credit Union Deposit Insurance Corporation (“CUDIC”) and the Stabilization Central Credit Union of British Columbia (“STAB”).

Certain regulatory changes required that funds held by STAB were to be transferred to CUDIC. After considering alternatives, it was decided that CUDIC would assess the member credit unions the amount in aggregate necessary to meet the fund requirement, and STAB would pay a dividend on its Class A shares to the credit unions, roughly equal to the assessment. In fact, two dividends were declared and paid: (a) “Dividend A”, from STAB’s “aggregate cumulative investment income”, and (b) Dividend B, from STAB’s “aggregate cumulative assessment income”.

The Canada Revenue Agency (the “CRA”) reassessed Spruce, denying the inter-corporate dividend deduction (under subsection 112(1) of the Act) in respect of Dividend B (Dividend A was not reassessed). The CRA assessed Spruce on two grounds: (a) the dividend was not deductible under ordinary rules, but rather was governed by specific rules in the Act pertaining to credit unions, and (b) the GAAR applied.

The Tax Court (2012 TCC 357) held the deduction under subsection 112(1) was available to Spruce in respect of Dividend B. Further, there was no “avoidance transaction” and therefore the GAAR could not apply. (Note: The Tax Court’s costs award in Spruce Credit (2014 TCC 42) was not considered in the present case. That decision is the subject of a separate appeal before the Federal Court of Appeal (Court File No. A-96-14).)

On appeal, the Crown argued that the Tax Court erred because it was “inappropriate to consider whether the taxpayer chose the particular transaction among alternatives primarily based on tax considerations”. In the Crown’s view, the Federal Court of Appeal’s decision in MacKay v. The Queen (2008 FCA 105) required the Court to consider whether the non-tax objective could have been obtained without the particular impugned transaction or through an alternative transaction.

In the present appeal, the Federal Court of Appeal held the lower court had made no error in respect of its findings regarding the availability of the deduction under subsection 112(1). Further, the Court of Appeal rejected the Crown’s arguments regarding the GAAR.

The Court held that when determining whether a particular transaction is an avoidance transaction, the existence of an alternative transaction that may have attracted additional tax is only one factor to consider. The very existence of such alternative transaction is not, in and of itself, determinative of whether there has been an avoidance transaction. The fact that this alternative transaction exists is only one consideration in determining whether any transaction in a series in an avoidance transaction.

The Federal Court of Appeal noted that the Crown’s suggested interpretation would undermine the long-standing Duke of Westminster principle in Canadian tax law that taxpayers are free to organize their affairs in a manner to pay the least amount of tax within the bounds of the law. The Supreme Court of Canada has affirmed the validity of the Duke of Westminster principle in numerous GAAR decisions.

It is not entirely clear what distinction may be made between the facts and reasoning in the present case and those in MacKay. In Spruce Credit, there was a regulatory regime that required compliance and which necessitated the transfer of funds from STAB to CUDIC. The taxpayers chose a tax-efficient manner in which to achieve the regulatory compliance. In MacKay, the taxpayers choose a course of tax-efficient planning based on a voluntary acquisition of certain real property. That said, in neither case is this distinction particularly clear.

Perhaps future court decisions may provide some guidance on this point and on the interpretation of “avoidance transaction” generally. At the time of publication of this article, the Crown had not yet sought leave to appeal the decision to the Supreme Court of Canada.

A longer version of this article will appear in an upcoming edition of CCH’s Tax Topics.

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Spruce Credit: Avoidance Transactions and the Duke of Westminster

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