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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 In Re Pallen Trust (2014 BCSC 405), the B.C. Supreme Court rescinded two dividends, the effect of which was to eliminate the tax liability in the trust.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

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