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Devon: TCC considers large corporation rules

In Devon Canada Corporation v. The Queen the issue is whether the taxpayer (“Devon”) may deduct $20,884,041 paid to cancel issued stock options. After the close of pleadings, the Crown brought a procedural motion relating to the large corporations rules. The Tax Court allowed the motion in part, and struck certain portions of Devon’s Notices of Appeal (2014 TCC 255) (the main tax issue has not yet been heard by the Tax Court).

The content of objections and appeals for large corporations is subject to specific rules in the Income Tax Act (Canada). Under subsection 165(1.11), a large corporation’s Notice of Objection must describe each issue, the specific the relief sought for each issue, and facts and reasons in support of its position. Further, under subsection 169(2.1), the large corporation may appeal to the Tax Court only with respect to the issues and relief sought in the Notice of Objection. The Federal Court of Appeal recently considered these rules in Bakorp Management Ltd. v. The Queen (2014 FCA 104) (see our post on Bakorp here).

In the present case, the Tax Court highlighted some of the themes that have emerged from the case law on this issue:

  1. a taxpayer is not required to describe each issue exactly but is required to describe it reasonably (Potash Corporation of Saskatchewan Inc. v. The Queen, 2003 FCA 471);
  2. the determination of what degree of specificity is required for an issue to have been described reasonably is to be made on a case by case basis (Potash);
  3. a taxpayer may add new facts or reasons on appeal but not new issues (British Columbia Transit v. The Queen, 2006 TCC 437);
  4. if the proposed additional argument would result in the large corporation seeking greater relief than was previously sought, the courts are more likely to consider the argument to be a new issue rather than a reason (Potash; Telus Communications (Edmonton) Inc. v. The Queen, 2005 FCA 159);
  5. if the proposed additional argument would result in the large corporation seeking the same relief that was previously sought, the courts are more likely to consider the argument to be the same issue (British Columbia Transit; Canadian Imperial Bank of Commerce v. The Queen, 2013 TCC 170); and
  6. if the proposed additional argument would result in the large corporation seeking completely different relief than was previously sought, the courts are more likely to consider the argument to be a new issue rather than a reason (Bakorp Management Ltd. v. The Queen, 2014 FCA 104).

Devon raised three arguments in its Notices of Appeal for the deductibility of the payments to cancel stock options. These were summarized by the Tax Court as follows:

(a) Devon’s primary argument is that the payments are deductible as current expenses under subsection 9(1);

(b) In the alternative, Devon argues that the payments are eligible capital expenditures that, once added to cumulative eligible capital, would result in deductions pursuant to paragraph 20(1)(b). It further argues that, due to the fact that there were acquisitions of control of both of the predecessor companies during the taxation periods in which the payments were made, subsection 111(5.2) applies to cause significant additional deductions of cumulative eligible capital; and

(c) In the further alternative, Devon claims that the payments are financing expenses deductible under paragraph 20(1)(e).

The Crown argued that Devon, a large corporation in the years at issue, only referred to section 9 in its Notice of Objection. The other provisions – namely paragraph 20(1)(b) and subsection 111(5.2) and paragraph 20(1)(e) – were mentioned in a supplementary memorandum filed by Devon during the objection process. As such, references to provisions other than section 9 should be struck from Devon’s Notice of Appeal.

The Tax Court held that no mechanism in the Act would permit the supplemental memorandum filed by Devon to amend the original Notice of Objection. However, the Tax Court struck out references to paragraph 20(1)(b) and subsection 111(5.2) but not paragraph 20(1)(e).

The Tax Court held that paragraph 20(1)(e) did not raise a new issue and was merely an alternative reason argued by the taxpayer in favor of deducting the payments to cancel the issued stock options. However, paragraph 20(1)(b) and subsection 111(5.2) raised new issues that were not otherwise raised in the Notice of Objection and would have entitled Devon to a deduction for amounts in its cumulative eligible capital that were unrelated to the payments to cancel the stock options.

Although the taxpayer did not describe the relief sought with respect to paragraph 20(1)(e) in the Notice of Objection and only specified allowing the deduction in full, the Tax Court agreed that if a full deduction is pleaded under subsection 169(2.1) then a partial deduction of the same nature should not necessarily have to be separately pleaded under the large corporation rules.

Both the taxpayer and the Crown have appealed this procedural decision to the Federal Court of Appeal (Court File No. A-389-14).

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Devon: TCC considers large corporation rules

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

Tax Court of Canada Appeal of Large Corporation Thwarted by Wording of Objection

Since 1995, the Large Corporation Rules found in subsections 165(1.11), 169(2.1) and 152(4.4) of the Income Tax Act (Canada) have applied to discourage large corporations from objecting to tax assessments as a means of keeping tax years “open”. In Bakorp Management Ltd. v. The Queen, 2013 TCC 94, the Minister brought a motion to dismiss the corporation’s tax appeal on the basis that it failed to comply with the Large Corporation Rules. Basically, these rules require that an objection fled by a large corporation must reasonably describe each issue to be decided and, for each issue, must specify the relief sought as the amount of change in a balance. The rules also limit the issues and relief sought in a subsequent appeal to those set out in the objection. The locus classicus on the interpretation of these provisions is the decision of the Federal Court of Appeal in The Queen v. Potash Corporation of Saskatchewan Inc., 2003 FCA 471.

In Bakorp, the corporation owned shares of another corporation that were redeemed in 1992 for $338M. As the proceeds from the redemption were received over a number of years, Bakorp reported in 1995 the portion of the deemed dividend related to proceeds received in 1995. The Minister reassessed Bakorp’s 1995 tax year to reduce the deemed dividend from $53M to $25M, a reduction of $28M. The corporation objected to the Minister’s reassessment and the Minister confirmed the reassessment. The corporation then filed a Notice of Appeal taking the position that the $28M deemed dividend remaining in its 1995 income was actually received in 1993 and should be included in the corporation’s 1993 tax year, not the 1995 year.

The Minister was, no doubt, surprised by Bakorp’s position to reduce the 1995 deemed dividend to zero. In response, the Minister brought a motion to dismiss the corporation’s appeal, arguing that the issue and relief set out in the Notice of Appeal were not those set out in the Notice of Objection.

Bakorp argued that it had complied with the Large Corporation Rules because the issue in both its objection and appeal was, fundamentally, the amount of deemed dividend to be included in its 1995 income. The Court disagreed noting that it could not “imagine a fuller reconstruction than making a 180 degree turn in what is to be included in income.” In the Court’s view, applying such a general approach to identifying the issue would render the Large Corporation Rules meaningless. In respect of specifying the relief sought, the Court was not prepared to accept that a complete reversal from wanting $53M included in income to wanting nothing included in income could be seen as complying with the Large Corporation Rules.

As a notice of appeal has been filed with the Federal Court of Appeal, the Tax Court’s reasoning will not be the last word in this particular matter. However, it is safe to say that the Bakorp decision is a timely reminder that large corporations must take particular care in preparing a Notice of Objection. Failure to do so may seriously impact a later appeal to the Tax Court of Canada.

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Tax Court of Canada Appeal of Large Corporation Thwarted by Wording of Objection