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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 three cases (Roszko, Orman and Hammill) have held that amounts paid out a fraudulent scheme are not income to the duped investor. 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

Marzen: Tax Court Upholds Transfer Pricing Adjustments

The decision of the Tax Court of Canada in Marzen Artistic Aluminum Ltd. v. The Queen (2014 TCC 194) is the latest addition to a growing body of Canadian judgments on the application of the transfer pricing rules in section 247 of the Income Tax Act (Canada) (the “Act”).

In a lengthy set of reasons, the Tax Court upheld all but a fraction of the CRA’s reassessment of the taxpayer, such reassessments having disallowed the deduction of approximately $7.1M of fees paid by the Canadian taxpayer to its Barbados subsidiary. The Court also upheld the imposition of a penalty under subsection 247(3) of the Act.

The taxpayer was in the business of designing, manufacturing and selling aluminum and vinyl windows. Beginning in 1999, the taxpayer implemented what the Court referred to as the “Barbados Structure”. Under this structure, the taxpayer entered into a “Marketing and Sales Services Agreement” (“MSSA”) pursuant to which the taxpayer’s Barbados subsidiary (“SII”) would provide certain marketing and other sales-related services to the taxpayer in respect of certain jurisdictions, notably the U.S. The fee was calculated as the greater of $100,000 or 25% of sales originated by SII. In total, amounts paid by the taxpayer to SII under the MSSA and related agreements was $4.1M for 2000 and $7.8M for 2001. These amounts were deducted by the taxpayer in computing its Canadian income. SII paid nominal income tax in Barbados on this income. SII then declared dividends to the taxpayer, which were generally received tax-free as dividends out of exempt surplus, pursuant to the deduction in section 113 of the Act.

The Canada Revenue Agency reassessed under section 247 of the Act to disallow a portion of the deduction and imposed a penalty.

In considering the transfer pricing rules in section 247, the Court stated the issues were as follows: (i) whether the terms and conditions imposed in respect of the MSSA differed from what would have been agreed to by persons dealing at arm’s-length, (ii) if so, what adjustments should be made to the quantum of the fees paid under the MSSA so that it was equivalent to the price that would have been paid had the parties been at arm’s-length, and (iii) whether the taxpayer was liable to penalty under subsection 247(3) for the 2001 tax year.

The Court determined that the terms and conditions of the arrangement were not consistent with what arm’s-length parties would have agreed to. In the Court’s view, SII provided few or no marketing and sales services (such services having been subcontracted to another of the taxpayer’s foreign subsidiaries). Further, the Barbados Structure was purely tax-motivated, allowing deductible fees to be repatriated as tax-free exempt surplus dividends. These “attractive advantages” in the Court’s view, would not be available to arm’s-length parties. In the Court’s opinion, applying the “comparable uncontrolled price” method of determining the transfer price, as argued by the Crown, provided the most accurate arm’s-length price.

In this case, the taxpayer was entitled to deduct certain of the fees paid to SII plus $32,500 in each year for corporate and directorship services provided to SII by its director. In the result, the vast majority of the fees paid by the taxpayer to SII were denied and added back into the taxpayer’s income. The Court also found that the transfer pricing penalty was applicable, as the taxpayer failed to make reasonable efforts to determine and use arm’s-length transfer prices in 2001 (the 2000 adjustment did not meet the $5 million threshold for imposing a penalty under subsection 247(3) of the Act).

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Marzen: Tax Court Upholds Transfer Pricing Adjustments

Van Helden: Private Piano Lessons Not Eligible for Tuition Tax Credit

Under subsection 118.5(1) of the Income Tax Act, an individual taxpayer may claim a tax credit in respect of certain qualifying tuition fees. Pursuant to paragraph 118.5(1)(a), the following requirements apply: (i) the student must be enrolled at an educational institution in Canada; (ii) that educational institution must be a university, college or “other educational institution”; and, (iii) the educational institution must provide courses at a post-secondary school level. Tuition credits may be transferred to a parent or grandparent under section 118.9 of the ITA. (See also Income Tax Folio S1-F2-C2 “Tuition Tax Credit” (March 2013)).

In Van Helden v. The Queen (2014 TCC 196), the taxpayer had claimed the tuition credit in respect of fees paid for weekly private piano lessons for his two daughters.

In an earlier case (Tarkowski v. The Queen (2007 TCC 632)), the Tax Court had determined that the Mississauga School of Music was an “educational institution” for the purposes of subsection 118.5(1), and the relevant music courses were “at a post-secondary school level” because a Grade 12 high school credit was a prerequisite to taking these courses.

In Van Helden, the taxpayer argued that, just as the Mississauga School of Music was found to be an “educational institution” in Tarkowski, the private instructors in this case should be found to be educational institutions.

However, the Tax Court disagreed and dismissed the taxpayer’s appeal (see also Kam v. The Queen (2013 TCC 266)). The Tax Court cited the Parliamentary debates (from 1961) regarding the intent and scope of the term “educational institution” and stated:

[20] In conclusion, the original intent of the tuition credit was to make post secondary education more accessible to students by lessening their financial burden. Although subsection 118.5(1) should be interpreted broadly, it is clear that Parliament did not intend that the provision should apply to fees which students paid for private piano lessons at an instructor’s home.

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Van Helden: Private Piano Lessons Not Eligible for Tuition Tax Credit

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

Morris Meadows: Judge Declines Job Offer and Workers Were Employees

In Morris Meadows Country Holidays and Seminars Ltd. v. M.N.R. (2014 TCC 191), the Tax Court considered whether certain hospitality workers were employees or independent contractors for the purposes of the Employment Insurance Act and the Canada Pension Plan.

Morris Meadows offered meeting facilities, sleeping facilities and dining facilities. In doing so it hired workers, as required, to perform certain duties such as cleaning, gardening, maintenance, cooking and serving food.

The CRA classified the workers as employees, and assessed the taxpayer for additional CPP contributions and EI premiums. The taxpayer appealed on the basis that the workers were (i) independent contractors or (ii) casual employees not employed for the purposes of Morris Meadows’ business.

In respect of the evidence, the Tax Court made this comment on a witness’s testimony:

[3] Mr. Morris, the moving force behind Morris Meadows, was the only witness for the Appellant. He was refreshingly forthright in his testimony to the point of offering me work as a cook at Morris Meadows. I declined the offer.

On the issue of the classification of the workers, the Tax Court considered the applicable tests in 671122 Ontario Ltd. v Sagaz Industries Canada Inc. (2001 SCC 59) and 1392644 Ontario Inc. o/a Connor Homes v Minister of National Revenue (2013 FCA 85) (see our previous post on Connor Homes).

In the present case, the Court held there was no written agreement expressing intent and thus no mutual intent (as per the Connor Homes analysis). The Court then pursued the traditional Sagaz/Wiebe Door analysis to determine whether the workers performed their services in business on their own account. On this point, the Court concluded that all but one of the workers were employees.

On the issue of whether the workers were engaged in employment of a casual nature other than for the purpose of the employer’s trade or business (see subsection 5(2) of the Employment Insurance Act and subsection 6(2) of the Canada Pension Plan), the Tax Court cited the Federal Court of Appeal’s decision in Roussy v Minister of National Revenue ([1992] F.C.J. No. 913), which stated:

[7] … the duration of the time a person works is not conclusive in categorizing employment as casual; the length of time may be a factor to be considered, but a more important aspect is whether the employment is “ephemeral” or “transitory” or, if you will, unpredictable and unreliable. It must be impossible to determine its regularity. In other words, if someone is spasmodically called upon once in a while to do a bit of work for an indeterminate time, that may be considered to be casual work. If, however, someone is hired to work specified hours for a definite period or on a particular project until it is completed, this is not casual, even if the period is a short one.

The Tax Court held that the workers were engaged in unpredictable “part-time” work rather than casual employment. Further, the Court noted that Morris Meadows advertised its dining facilities (available for business meetings or weddings), hired workers to serve the food, and profited from such commerce. In the Court’s view, Morris Meadows was in a business to which the employment related, and the casual employment was for the purpose of Morris Meadows’ business. The Court held the workers were not engaged in casual employment for the purposes of the EI Act and the CPP.

The Court allowed the appeals only in respect of the one worker who was an independent contractor.

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Morris Meadows: Judge Declines Job Offer and Workers Were Employees

Leroux: CRA owes duty of care to taxpayer

* This article was co-authored with Mr. Christopher Funt of Funt & Company.

Can a Canadian taxpayer successfully sue the Canada Revenue Agency?

In recent years, taxpayers have brought a number of civil actions against the Canada Revenue Agency (the “CRA”).  The allegations in such cases ranged from negligence to fraud, extortion and deceit.  Often, taxpayers’ claims are brought as the tort of misfeasance in public office or as claims in negligence.  So far, the courts have not clearly determined the scope of CRA’s civil liability.  The recent decision of the British Columbia Supreme Court in Leroux v. Canada Revenue Agency (2014 BCSC 720) provides guidance on the application of common law torts to CRA conduct.

Mr. Leroux, the taxpayer, alleged that he was threatened, deceived and blackmailed by a CRA auditor who was reviewing Mr. Leroux’s GST and income tax returns. After reassessments were issued, the CRA claimed Mr. Leroux owed more than $600,000 in taxes, interest and penalties. After an appeal to the Tax Court, some payments by Mr. Leroux and a successful application for interest relief, Mr. Leroux was actually refunded $25,000. In the meantime, Mr. Leroux lost his business and home. He sued the CRA for misfeasance in public office. The CRA argued that it owed no private law duty of care to an individual taxpayer.

In several other cases before Leroux, the courts have agreed with the CRA’s position. A successful negligence action requires a finding of a duty of care to the injured party.  As such, judicial acceptance of CRA’s position has presented a major barrier to bringing a civil claim against CRA.

In Leroux, the court splashed cold water on the CRA’s long-standing position and held the CRA did owe a duty of care to Mr. Leroux. The court also held the CRA had breached its duty of care to Mr. Leroux with respect to the imposition of gross negligence penalties. In a stinging rebuke to the case put forth by the CRA and its counsel, the court stated:

[348] To call Mr. Leroux’s tax characterizations “grossly negligent” is especially objectionable because, as mentioned above, CRA now uses the complexity of the issues involved in these characterizations as a reason why their decisions on exactly the same issue could never be termed negligent.  It is simply not logical for CRA to assess penalties against Mr. Leroux for being grossly negligent in having characterized his income in a particular way and to resist the application of the concept of negligence to their own characterization of the same income, one which was ultimately agreed to be wrong.  Or, to put it in the reverse, since CRA now takes the position that the characterization of capital loss versus revenue and the issue of “matching” are difficult and complex, it cannot be said that the assumption of contrary positions by Mr. Leroux, positions that were eventually accepted as correct, was grossly negligent.  To call them so, and to assess huge penalties as a result, ostensibly for the purpose of getting around a limitation period, is unacceptable and well outside the standard of care expected of honourable public servants or of reasonably competent tax auditors.  While being wrong is not being negligent, nor are [the auditor's] mistakes in fact or law negligent, it is the misuse and misapplication of the term “grossly negligent” that is objectionable.

The court continued:

[353] … CRA must live up to their responsibilities to the Minister and to the Canadian public, nearly all of whom are taxpayers, by applying a little common sense when the result is so obviously devastating to the taxpayer.  It is a poor response to say “we put together our position without regard to the law; leave it to the taxpayer to appeal to Tax Court because we are immune from accountability.”

Despite the finding that CRA owed a duty of care to Mr. Leroux, and that the CRA had breached this duty, the taxpayer’s claim was dismissed because the court held that Mr. Leroux’s losses were not the result of the CRA’s negligent conduct.

The Leroux judgment is a welcome development in the law regarding the CRA’s accountability for its assessing actions. Most CRA agents are diligent and very well-intentioned.  It is a rare case where the CRA’s conduct can properly be alleged to be actionable.  That said, the principles of civil liability shape what can and cannot be done by the CRA in the course of a tax assessment. While Leroux offers very insightful guidance, the broader scope of CRA’s civil law duties to taxpayers remains to be fully defined.

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Leroux: CRA owes duty of care to taxpayer

Bakorp: Appeal Dismissed for Failure to Comply with Large Corporations Rules

In Bakorp Management Ltd. v. The Queen (2014 FCA 104), the Federal Court of Appeal upheld a decision of the Tax Court dismissing the taxpayer’s appeal for failure to comply with the rules relating to objections and appeals filed by large corporations.

The result in Bakorp is a reminder to large corporations and their advisors of the need for careful consideration of the issues and relief sought in objections and appeals. In this regard, it would be good practice to have a Notice of Objection of a large corporation reviewed by a tax litigation lawyer before the objection is filed with the Canada Revenue Agency.

Background

The taxpayer was a large corporation under subsection 225.1(8) of the Income Tax Act (ITA). In 1992, five Class A shares of a corporation not connected with the taxpayer were redeemed by that corporation for $338,213,849 resulting in a deemed dividend pursuant to subsection 84(3). A portion of the proceeds was not payable until 1995, and the taxpayer reported that portion ($52,912,264) as taxable income in 1995, resulting in $13,333,059 of Part IV tax.

The CRA reassessed the taxpayer’s 1993-1995 tax years (only the 1995 tax year was at issue in the appeal), and for the 1995 tax year the CRA reduced the amount of the deemed dividend included as taxable income by $25,332,237, and the Part IV tax was reduced accordingly.

The taxpayer filed a Notice of Objection and claimed that its original filing position should be restored (namely that the entire $52 million deemed dividend should be included in income in 1995). The CRA issued a Notice of Confirmation stating that $28 million of the deemed dividend should be included in income in 1995.

Tax Court

The taxpayer filed a Notice of Appeal to the Tax Court and argued that no amount of the deemed dividend should be included in its income in 1995. In response, the Crown brought a motion under section 53 of the Tax Court Rules (General Procedure) for an order dismissing the appeal on the basis the taxpayer had failed to comply with subsection 169(2.1) of the ITA (and thus the appeal was not validly constituted).

Under the ITA, large corporations are subject to specific rules regarding the content of their objections and appeals. Under subsection 165(1.11) of the ITA, a large corporation in its objection must reasonably describe each issue, specific the relief sought for each issue, and provide facts and reasons in support of the taxpayer’s position. Under subsection 169(2.1), a corporation may appeal to the Tax Court only with respect to the issues and relief sought in the objection.

In the Tax Court, the Appellant argued the objection was clear that the issue was the particular amount of the redemption proceeds that were to be included in income in 1995. However, the Tax Court disagreed and stated that the taxpayer was taking too general an approach in identifying the issue. Further, the Tax Court held the taxpayer was seeking entirely different relief in respect of the issue. The Tax Court allowed the Crown’s motion and dismissed the taxpayer’s appeal (2013 TCC 94).

Federal Court of Appeal

The taxpayer appealed to the Federal Court of Appeal. The taxpayer argued that the large corporations rules require the taxpayer to describe the “point in question”, and in this case the objection was clear the debate was about the share redemption proceeds added to income as a deemed dividend. Further, less specificity is required in respect of the relief sought, and in this case that was simply relief in respect of the taxpayer’s Part IV tax liability. The Crown argued that the determination of whether the issue and relief sought were the same in the objection and the appeal was a question of fact, and on these factual issues the Tax Court made no palpable and overriding error.

Of the question of what was meant by “issue”, the Court of Appeal noted the large corporation rules require the taxpayer to reasonably describe each issue, which will differ in each case and will depend on the degree of specificity required to allow the CRA to know each issue to be decided. In the present case, the Court stated that the issue must be described in a manner that would result in the quantification as a specified amount of the relief sought.

The Court of Appeal criticized the taxpayer’s characterization of the issue in its Notice of Objection, but concluded that the issue was whether the taxpayer was correct in concluding that it had received $52 million in dividends in 1995. Accordingly, the taxpayer’s appeal was limited only to this issue. However, the Court of Appeal noted that the issue raised in the Notice of Appeal was not the issue raised in the taxpayer’s objection.

Although it was not necessary to dispose of the appeal, the Court commented on the question of whether or not the relief sought was the same in the objection and appeal. The Court noted that the taxpayer had challenged the reduction of Part IV tax in the objection, but on appeal the taxpayer was asking the court to eliminate the Part IV tax entirely. In the Court’s view, this was not the same relief.

The Court of Appeal dismissed the appeal.

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Bakorp: Appeal Dismissed for Failure to Comply with Large Corporations Rules