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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)

McKesson: Appellant’s Factum Filed‏

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

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

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

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

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

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

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

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

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

 

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McKesson: Appellant’s Factum Filed‏

Emerging Markets: Non-EU Investment Funds Eligible for Withholding Tax Refund

In Emerging Markets Series of DFA Investment Trust Company (C -190/12), the European Court of Justice (ECJ) confirmed that investment funds based outside the European Union (EU) should benefit from the EU free movement of capital rule regarding investments in Europe. Thus, if an EU domestic investment fund can benefit from local income tax exemptions, then non-EU investment funds (e.g., U.S. or Canadian) investing in the EU should also be entitled to apply for such exemptions.

In Emerging Markets, a U.S. investment fund applied for a refund of withholding tax paid on dividends derived from Polish companies. The ECJ stated that U.S. investment funds are entitled to put themselves in a position similar to that of local funds. This means that under certain conditions non-EU investors may benefit from local tax preferences/exemptions.

In light of the relevant Polish regulations (which provide for income tax exemptions for domestic investment funds and funds based in the EU/EEA) and the tax information exchange agreement between Poland and U.S., the dividends paid to a U.S. investment fund should also be exempt from withholding tax in Poland.

The ECJ’s judgment in Emerging Markets provides a basis for non-EU investors to benefit from certain EU rules and to rely on tax preferences granted to EU/EEA entities. Therefore, if these investors have paid withholding tax on dividends derived from EU/EEA companies, they should consider whether certain tax preferences are available for investment funds in the country of residence of the companies paying the dividends (subject to any applicable time limits).

Canadian companies should also consider whether a refund of withholding tax would impact the foreign tax credit available in respect of any withholding tax previously paid and not refunded.

Additional information is available here.

Cezary Przygodzki and Rafal Mikulski practice in Dentons’ Warsaw office. 

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Emerging Markets: Non-EU Investment Funds Eligible for Withholding Tax Refund

Canada’s Sommerer Decision and Double Taxation

A recent decision of Canada’s Federal Court of Appeal provides insight on the application of the country’s tax treaties to income that is attributed to a Canadian resident taxpayer under the Income Tax Act (Canada). Also, the court made useful comments on the classification of an Austrian private foundation (privatstiftung) for domestic Canadian tax purposes.

In Peter Sommerer v. The Queen, 2012 FCA 207, the court affirmed the decision of the Tax Court of Canada (2011 TCC 212) finding that gains realized on dispositions of shares by an Austrian private foundation were not taxable in the hands of an individual beneficiary of the foundation on the basis that either (a) the gains could not be attributed to the Canadian individual under the ITA’s attribution rules or (b) the capital gains article of the Austria-Canada Income Tax Convention of 1976, as amended, prohibited Canada from taxing the gains.

To read the full article by Jesse Brodlieb, Matthew Peters, and Tony Schweitzer, as published in Tax Notes International, Vol. 67, Number 6, August 6, 2012, please click here. For our earlier blog post on the decision, please click here.

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Canada’s Sommerer Decision and Double Taxation

Federal Court of Appeal: Canada Cannot Tax Treaty Income Twice

It is trite law that one of the main purposes of tax treaties is to prevent double taxation of the same income. In Canada this principle has often been treated with a grain of salt since Canadian domestic rules do not bar double taxation and, in fact, the Canada Revenue Agency often resorts to double taxation where, for example, a shareholder appropriation is disallowed as a corporate expense while fully taxed in the shareholder’s hands.

The recent decision of the Federal Court of Appeal in The Queen v. Sommerer illustrates a refreshing approach to the concept of double taxation, at least in the context of Canada’s network of bilateral tax treaties based on the OECD Model Convention (and, to a lesser extent, the UN Model Convention).

Mr. Sommerer was at all material times a resident of Canada. He was a contingent beneficiary of an Austrian Privatstiftung (the “Sommerer Private Foundation”) created by his father in 1996. The Sommerer Private Foundation was at all material times a resident of Austria for the purposes of the Canada-Austria Tax Treaty. The facts that gave rise to the assessments under appeal are summarized by Sharlow JA as follows:

[30] On October 4, 1996, Peter Sommerer sold to the Sommerer Private Foundation 1,770,000 shares of Vienna Systems Corporation (the “Vienna shares”) for their fair market value of $1,177,050 (66.5¢ per share). The Sommerer Private Foundation paid $117,705 of the purchase price on the date of the agreement and was legally obliged to pay the remainder at a later date, with interest. The sale was unconditional. The cash portion of the purchase price was paid using part of the initial endowment from Herbert Sommerer (paragraphs 67 and 88 of Justice Miller’s reasons).

[31] In December of 1997, the Sommerer Private Foundation sold 216,666 of the Vienna shares for $4.50 per share to three individuals unrelated to the Sommerer family, realizing a capital gain. In December of 1998, the Sommerer Private Foundation sold the remaining Vienna shares to Nokia Corporation for $9.00 per share, realizing a further capital gain.

[32] In April of 1998, Peter Sommerer sold to the Sommerer Private Foundation, unconditionally, 57,143 shares of Cambrian Systems Corporation (the “Cambrian shares”) for $100,000 (approximately $1.75 per share). In December of 1998, the Sommerer Private Foundation sold the Cambrian shares to Northern Telecom Limited for $14.97 (US) per share, plus a further $4.12 (US) per share conditional on certain milestones being met in 1999. That sale resulted in another capital gain for the Sommerer Private Foundation.

CRA assessed Mr. Sommerer on the basis of subsection 75(2) of the Income Tax Act alleging that the proceeds from the sale of the shares by the Foundation could possibly revert to Mr. Sommerer. Both Justice Campbell Miller in the Tax Court of Canada and Justice Sharlow in the Court of Appeal rejected that interpretation holding that subsection 75(2) could not apply on a sale of property at fair market value.

Justice Sharlow did not stop there however. She went on to agree with Miller J. that the position advocated by CRA violated the Treaty’s fundamental principle of avoiding double taxation:

[66] The OECD model conventions, including the Canada-Austria Income Tax Convention, generally have two purposes – the avoidance of double taxation and the prevention of fiscal evasion. Article XIII (5) of the Canada-Austria Income Tax Convention speaks only to the avoidance of double taxation. “Double taxation” may mean either juridical double taxation (for example, imposing on a person Canadian and foreign tax on the same income) or economic double taxation (for example, imposing Canadian tax on a Canadian taxpayer for the attributed income of a foreign taxpayer, where the economic burden of foreign tax on that income is also borne indirectly by the Canadian taxpayer). By definition, an attribution rule may be expected to result only in economic double taxation.

[67] The Crown’s argument requires the interpretation of a specific income tax convention to be approached on the basis of a premise that excludes, from the outset, the notion that the convention is not intended to avoid economic double taxation. That approach was rejected by Justice Miller, correctly in my view. There is considerable merit in the opinion of Klaus Vogel, who says that the meaning of “double taxation” in a particular income tax convention is a matter that must be determined on the basis of an interpretation of that convention (Klaus Vogel on Double Taxation Conventions: A Commentary to the OECD –, UN –, and US Model Conventions for the Avoidance of Double Taxation on Income and Capital, 3rd ed. (The Hague: Kluweer Law International, 1997)).

[68] I see no error of law or principle in the conclusion of Justice Miller that Article XIII (5) applies to preclude Canada from taxing Peter Sommerer on the capital gains realized by the Sommerer Private Foundation.

Unless this case is reversed by the Supreme Court of Canada (at the date of this comment, no leave application has been filed), it is likely to be a very important precedent for tax practitioners plying their craft in the highly complex area of international tax treaties.

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Federal Court of Appeal: Canada Cannot Tax Treaty Income Twice