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The Canada Revenue Agency’s Voluntary Disclosure Program: Current Processing Issues

The Canada Revenue Agency’s Voluntary Disclosure Program (VDP) has gone through a number of organizational changes over the past few years. For many years, disclosures were made to the local Tax Services Office. More recently, the CRA has moved the handling of disclosures to Regional Centres; Shawinigan – Sud Tax Centre for the Atlantic, Quebec, and Ontario Regions, Winnipeg Tax Centre for the Prairie Region and Surrey Tax Centre for the Pacific Region.

With the move of the VDP to Regional Centres, the CRA has implemented a new screening process. Screeners are now reviewing disclosure packages soon after receipt and are comparing the package to a CRA developed checklist. If any item on the checklist is missing or incomplete, then the CRA returns the package to the sender, along with a covering letter and a checklist that identifies the missing or incomplete information. There are, however, certain issues that have arisen with respect to the CRA’s screening process and use of the checklist.

First, it prevents a disclosure from being made by a taxpayer who does not have a social insurance number, business number, etc. If an identification number is not available, the disclosure may need to be made on a no-names basis while the taxpayer applies for an identification number.

Second, the CRA will not accept a disclosure if the amount in issue is not identified. This is problematic as, often, disclosures are made before the work needed to calculate the omitted or under-reported amount has been completed. In the past, this information was forwarded within 90 days of filing the disclosure and was an approach acceptable to the CRA.

Third, where the disclosure package is large, screeners do not appear to be reviewing all of the documents before issuing the letter and checklist. Therefore, it is advisable to use a covering letter for each disclosure package which identifies compliance with each item on the CRA’s checklist and a detailed explanation as to why any checklist item is outstanding. It is not yet clear whether, even upon explanation, the CRA will accept a disclosure if a checklist item is outstanding.

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The Canada Revenue Agency’s Voluntary Disclosure Program: Current Processing Issues

Sales of condominium units under audit by Canada Revenue Agency

A Canada Revenue Agency (“CRA”) audit initiative is targeting taxpayers who have recently sold condominium units they did not occupy or occupied for only a short period of time (the “CRA Condo Project”).

The CRA is reassessing some of these dispositions on the basis that the condo was sold in the course of business, treating the profit as income (instead of capital gains) and, in some cases, assessing gross negligence penalties under subsection 163(2) of the Income Tax Act. In doing so, the CRA may be incorrectly reassessing some taxpayers whose gains are legitimate capital gains and that may be subject to the principal residence exemption (click here for a discussion of the principal residence exemption).

Consider this example. A taxpayer signs a pre-construction purchase agreement for a condo in 2007.  In 2009, the unit was completed and occupied by the taxpayer, before the entire development was finished and registered in land titles.  Land titles registration occurs in 2010, but shortly thereafter the taxpayer sells the condo for a profit.  Ordinarily, one would conclude the condo was held on account of capital and the gain would be at least partially exempt from tax on the basis that condo was the taxpayer’s principal residence.  The CRA may be inclined to reassess on the basis that land title records show the taxpayer on title for only a short time, as though the taxpayer had intended to merely “flip” the condo rather than reside in it.

This assessing position may be incorrect because the buyer of a condo does not appear on title until the entire condominium development is registered.  In fact, several years can pass from the date of signing the purchase agreement to occupancy to land titles registration – and, accordingly, the taxpayer’s actual length of ownership will not be apparent from the land title records.

This type of situation could cause serious problems for some taxpayers. If a taxpayer is audited and subject to reassessment on the basis that their entire gain should be taxed as income, the taxpayer will need to gather evidence and formulate arguments in time to respond to an audit proposal letter within 30 days, or file a Notice of Objection within 90 days of the date of a reassessment.

Taxpayers could respond to such a reassessment by providing evidence that they acquired the condo with the intent that it would be their residence, and that the subsequent sale was due to a change in life circumstances.  Taxpayers may wish to gather the following evidence to support such claims:

  • Purchase and sales agreements;
  • Letter or certificates granting permission to occupy the condo;
  • Proof of occupancy, such as utility bills, bank statements, CRA notices, identification (such as a driver’s license) showing the condo as a residence; or
  • Evidence of a change in life circumstances which caused the condo to no longer be a suitable residence, including:
    • Marriage or birth certificates;
    • A change of employer or enrollment in education that required relocation; or
    • Evidence showing the taxpayer cared for a sick or infirm relative, or had a disability that precluded using a condo as a residence.

Taxpayers should be prepared to provide reasonable explanations for any gaps in the evidence.  If a taxpayer wishes to explore how best to respond in the circumstances, they should consult with an experienced tax practitioner.

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Sales of condominium units under audit by Canada Revenue Agency

Federal Court of Appeal deals a blow to the Canada Revenue Agency: Full disclosure must be made on ex parte applications

On February 21, 2013, the Federal Court of Appeal released two decisions related to the obligations of the Minister of National Revenue when making ex parte applications under subsection 231.2(3) of the Income Tax Act (the “Act”) for judicial authorization requiring taxpayers to produce certain information and documents relating to customers.  In Minister of National Revenue v. RBC Life Insurance Company et al., 2013 FCA 50, the FCA affirmed the decision of the Federal Court (reported at 2011 FC 1249) cancelling four authorizations issued by the Federal Court in relation to customers of the Respondent companies who had purchased a particular insurance product that has been described as “10-8 insurance plans”.  In Minister of National Revenue v. Lordco Parts Ltd., the FCA adopted its reasoning in RBC and again affirmed a judgment of the Federal Court cancelling an authorization that had required information in respect of certain employees of the Respondent.

In both cases, the FCA reaffirmed the Minister’s “high standard of good faith” and the powers of the Federal Court to curtail abuses of process by the Crown.

In RBC, the Minister argued that the facts that it failed to disclose on its ex parte application before the Federal Court were not relevant to the applications. Reviewing the judgment of the Federal Court, the FCA concluded that the Minister failed to disclose the following facts:

  • The Department of Finance’s refusal to amend the Act;
  • Information in an advance income tax ruling;
  • CRA’s decision to “send a message to the industry” to chill the 10-8 plans; and
  • The GAAR committee had determined the plans complied with letter of Act.

The FCA held that the Federal Court’s finding that these facts were relevant was a question of mixed fact and law and the Minister had not demonstrated palpable and overriding error by the Federal Court judge. At a minimum, this suggests the Crown may have to disclose information of the sort included in the enumerated list.  Examining that list is interesting and suggests a requirement to include in the disclosure to the Federal Court judge hearing an ex parte application facts related to legislative history and intent including discussions about potential problems and possible legislative “fixes”, internal analysis of issues within the CRA including other advance income tax rulings, motivations on the part of the CRA and its officers and agents that may extend beyond auditing the particular facts, and previous analysis of the facts known  to the CRA and indications that those facts might support compliance with the Act and inapplicability of the GAAR.  That is a very extensive list, and it is encouraging to know that Crown obligations extend into each of these areas.

Further, the FCA held that even if the Federal Court on review of an ex parte order determined that the Minister had a valid audit purpose, it was open to the Federal Court to cancel the authorization based on the Minister’s lack of disclosure.  Somewhat surprisingly, the Minister argued that section 231.2(6), unlike section 231.2(3), did not allow for judicial discretion. Once the statutory conditions are established, the Minister argued, the Federal Court judge MUST NOT cancel the authorizations, no matter how egregiously the Crown acted.  The FCA rejected this argument, reaffirming the importance of judicial discretion and the duty of the Minister to act in good faith:

[26] In seeking an authorization under subsection 231.2(3), the Minister cannot leave “a judge…in the dark” on facts relevant to the exercise of discretion, even if those facts are harmful to the Minister’s case: Derakhshani, supra at paragraph 29; M.N.R. v. Weldon Parent Inc., 2006 FC 67 at paragraphs 153-155 and 172. The Minister has a “high standard of good faith” to make “full disclosure” so as to “fully justify” an ex parte order under subsection 231.1(3): M.N.R. v. National Foundation for Christian Leadership, 2004 FC 1753, aff’d 2005 FCA 246 at paragraphs 15-16. See also Canada Revenue Agency, Acquiring Information from Taxpayers, Registrants and Third Parties (issued June 2010).

The Minister’s argument, the FCA held, also runs contrary to the inherent power of the Federal Court to “redress abuses of process, such as the failure to make full and frank disclosure of relevant information on an ex parte application” (para 33):

The Federal Courts’ power to control the integrity of its own processes is part of its core function, essential for the due administration of justice, the preservation of the rule of law and the maintenance of a proper balance of power among the legislative, executive and judicial branches of government. Without that power, any court – even a court under section 101 of the Constitution Act, 1867 – is emasculated, and is not really a court at all. (para 36)

Overall, the RBC decision strongly reaffirms the role of the Federal Court in ensuring the Minister acts in good faith when making ex parte applications.  Given the broad powers granted in subsection 231.2(3) and elsewhere in the Act, it is reassuring to know that the Courts can, and will, protect taxpayers and citizens generally by ensuring that the CRA puts all relevant information before the Court when it seeks to exercise those powers.

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Federal Court of Appeal deals a blow to the Canada Revenue Agency: Full disclosure must be made on ex parte applications

When is Voluntary Disclosure Voluntary?

In Worsfold v. The Queen (2012 FC 644), the Federal Court held that a taxpayer’s disclosure under the Voluntary Disclosures Program (the “VDP”) was “voluntary”, even though the Canada Revenue Agency (the “CRA”) had commenced enforcement action against a related party. Worsfold confirms that a link between the enforcement action and the disclosed information is what is important — not a link between the parties — when considering whether a disclosure made alongside an existing enforcement action is voluntary. Also, given that the sequence of events was integral to the findings in this case, this decision underscores the importance of keeping detailed records at every stage of a voluntary disclosure.

To read the full article, please click here.

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When is Voluntary Disclosure Voluntary?

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