In the Provincial Income Allocation Newsletter No. 4 (March 2013), the Canada Revenue Agency notes that the Allocation Review Committee (“ARC”) has changed its position on amounts previously excluded in calculating “salary and wages paid in the year” for provincial income allocation purposes:

Effective for the 2013 tax year, the amount of salaries and wages paid in the year for the purpose of provincial income allocation calculations will include all taxable benefits that are to be included in the employees’ income in the year. This includes deemed amounts such as stock option benefits under section 7 of the Income Tax Act (Canada), regardless of whether these benefits are deductible in calculating the employer’s income.

Corporations having a permanent establishment in more than one province will need to consider the ARC’s change in position when preparing their next income tax return.  Applying the previous year’s method of calculation salaries and wages may fail to include all of the amounts now required to be included in the calculation.

On March 21, 2013, the Supreme Court of Canada dismissed (with costs) the application for leave to appeal in the case of Donna M. Johnson v. Her Majesty The Queen.

The issue in Johnson was the tax treatment of receipts from a Ponzi scheme. The Tax Court (2011 TCC 540) allowed the taxpayer’s appeal and held that the receipts were not income from a source for the purpose of paragraph 3(a) of the Income Tax Act. The Federal Court of Appeal (2012 FCA 253) reversed the lower court’s decision, allowing the Crown’s appeal.

I commented on the decisions of the Tax Court and the Federal Court of Appeal in the March 2013 Ontario Bar Association Tax Section newsletter.

At today’s Canada Revenue Agency Toronto Centre Tax Professionals Group Breakfast Seminar (November 14, 2012), the CRA provided an update on a number of current audit issues.

The CRA was represented by Sal Tringali, Regional Technical Advisor of Aggressive Tax Planning, and James McNamara, Manager of International Taxation and Aggressive Tax Planning Audit Division from the Toronto Centre Tax Services Office. The discussion was moderated by Jacques Bernier (Baker McKenzie LLP) and Rachel Gervais (BDO Canada LLP).

The audit issues highlighted by the panel included the following:

GST/HST

1. Recapture input tax credit
2. ITC allocation % – mixed supplies
3. Financial services
4. Imported supplies
5. Reinsurance/loading
6. Loyalty reward points
7. VDP – Related parties

Income Tax

Additionally, the CRA made the following comments:

• The CRA’s access to/requests for accountants’ working papers remains a “hot topic”. Generally speaking, the CRA will first ask the taxpayer for information/documents, after which the CRA may request information/documents from the taxpayer’s accountants. The CRA’s objective is to perform high-quality audits, and access to complete information is required to do so.

• The CRA reminded taxpayers of its recent announcement that the CRA will not assess a taxpayer’s return where the taxpayer has claimed a charitable donation and the alleged gift is made as part of a donation arrangement. The delay in assessing the return could be two years or more (see Jamie Golombek’s recent article on the subject).

• The CRA is considering a variety of provisions that may be applied where the taxpayer has used a structure to divert business income to RRSPs through trusts and partnership interests held by shareholders or key employees. (See also the CRA’s announcement at the Canadian Tax Foundation’s 2012 Ontario Tax Conference, at which the CRA stated that it may apply s. 56(2) to the actions of a trustee.)

• The CRA has appealed the Tax Court’s decision in Guindon v. The Queen to the Federal Court of Appeal. In light of the Tax Court’s decision, the CRA is currently considering its options in respect of the assessment of third party penalties.

• The CRA has considered the application of third party penalties in 185 cases. In 71 of those cases the penalty was applied, resulting in the imposition of $79 million of penalties. In 50 cases the penalty was not applied, and 64 cases are ongoing.

• The CRA will continue to revoke e-file privileges where a tax preparer is subject to a penalty, even where a penalty against a single tax preparer may result in the revocation for his or her entire firm.

• The CRA referred to the recent Supreme Court decision in GlaxoSmithKline v. The Queen and stated that it intends to follow the new OECD guidelines on transfer pricing and the hierarchy of pricing methods. The CRA said that it did not expect to release any formal communication to the public on this issue, but Information Circular IC 87-2R “International Transfer Pricing” may be updated to reflect this position.

UPDATE: After the seminar, the CRA informed us that it intends to follow the guidance in the recently updated OECD Guidelines and will be issuing a Transfer Pricing Memoranda (TPM) on the matter to the public. This TPM will reflect a recently released internal Communique on the same subject and will be made available in the near future.

• The CRA clarified that Tax Earned By Audit (“TEBA”) remains a metric for measuring ”tax at risk”, but it is not used to measure the performance of an auditor. Rather, the CRA measures the performance of auditors based on six major elements: (i) planning the audit, (ii) conducting the audit, (iii) applying the appropriate legislation/policy, (iv) the end product of the audit, (v) professionalism in the audit, and (vi) timeliness of completion of the audit.

• The CRA plans to convene face-to-face meetings with approximately 160 large businesses (i.e., annual sales over $250 million) as part of the CRA’s large business audit project. The CRA will continue to risk-assess all large businesses/entities annually.

• The CRA intends to clear a backlog of approximately 1,300 audit files so that it may assess the most recent taxation year and the immediately preceding taxation year for most businesses by 2015-16.

• The CRA reiterated that issues that arise during the audit process should be raised with the auditor, after which it may be appropriate to involve the auditor’s team leader. If the issue cannot be resolved at that level, it would be appropriate to raise the issue with the auditor’s manager or the assistant director of audit at the particular TSO.

On August 13 I came across this article in the Globe and Mail outlining how CRA treated prizes received by Canadian Olympic Medalists.

Gold medalists receive a $20,000 prize from the Canadian Olympic Committee, Silver medalists $15,000 and Bronze medalists $10,000. The CRA asserts that those amounts are taxable. The CRA’s position is based on what can only be described as a questionable interpretation of Income Tax Regulation 7700:

7700. For the purposes of subparagraph 56(1)(n)(i) of the Act, a prescribed prize is any prize that is recognized by the general public and that is awarded for meritorious achievement in the arts, the sciences or service to the public but does not include any amount that can reasonably be regarded as having been received as compensation for services rendered or to be rendered.

This regulation is directly related to the Nobel Prize in Chemistry awarded in 1986 to Dr. John C. Polanyi of the University of Toronto. There was considerable public sentiment that Dr. Polanyi not be subject to income tax on this prize. As a result the Income Tax Act was amended to introduce the concept of a tax exempt “prescribed” prize. It is one of the most straightforward provisions in Canadian tax law. All that is required is:

1. recognition of the prize by the general public; and
2. that the prize is awarded for meritorious achievement in the arts, the sciences or service to the public (I am intentionally omitting the irrelevant language about compensation for services).

Surprisingly, the CRA has concluded that Canada’s Olympic medalists were not being awarded for “service to the public”:

I must clarify that the media reports you refer to dealt not with the value of the medals themselves but with the prize money the Canadian athletes who won medals at the Games. Paragraph 56(1)(n) of the Income Tax Act states that the total of all amounts received in the year as, or on account of a prize for achievement in a field of endeavour that the taxpayer ordinarily carries on should be included in the taxpayer’s income. This provision of the Act would not normally apply to your example of a lottery winner; however, paragraph 56(1)(n) is sufficiently broad as to apply to a prize awarded to an athlete for winning an Olympic medal.

I note that the Act provides an exception to this rule for a prescribed prize. For purposes of this exception, section 7700 of the Income Tax Regulations defines a “prescribed prize” as any prize that is recognized by the general public and that is awarded for meritorious achievement in the arts, the sciences, or in service to the public. Although winning an Olympic medal may be an internationally recognized achievement and could indirectly promote a sense of nationalism, such a prize is not awarded in recognition of service to the public and therefore would not be a prescribed prize and would not fall within the exception.

CRA Document 2008-0300071M4 “Olympic medals” (26 June 2009)

Since it first participated in the games of 1900, Canada has won 278 medals in the Summer Games (an average of 11 per Games) and 145 in the Winter Games (an average of 7 per Games). It is astonishing that the CRA and the Department of Finance would regard the taxation of these awards as material. To suggest that these young men and women who spend years of their lives training for the chance once every four years to put the Canadian flag and anthem on display for the entire world to see and hear are not engaged in service to the Canadian public is not only unsupportable in light of the text, context and purpose of the provision, but serves to undermine the federal government’s own financial support of amateur athletics and best and brightest of Canada’s Olympic athletes. It is hoped that the CRA sees the light sooner rather than later and changes its position accordingly.