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ConocoPhillips: FCA Confirms Tax Court’s Jurisdiction to Determine Questions of Timing and the Validity of a Notice of Objection

In ConocoPhillips Canada Resources Corp. v. The Queen (2014 FCA 297), the Federal Court of Appeal overturned a Federal Court decision (2013 FC 1192) and dismissed an application for judicial review by the taxpayer finding that the Federal Court lacked jurisdiction in this case.

ConocoPhillips had commenced an application for judicial review as a result of a dispute between the CRA about whether a Notice of Reassessment had been validly sent to the taxpayer.  The CRA alleged that it mailed a Notice of Reassessment on November 7, 2008. ConocoPhillips alleged that it never received the Notice of Reassessment and that it first learned of the reassessment on April 14, 2010.

Accordingly, when ConocoPhillips filed a Notice of Objection on June 7, 2010, the CRA advised that it would not consider the objection on the grounds that it was not filed within 90 days of the alleged mailing date (i.e., November 7, 2008) and that no request for an extension of time was made within the year following the alleged mailing date of the reassessment.

The Federal Court considered the question of jurisdiction and found that it had jurisdiction because the Court was not being asked to consider the validity of the reassessment (which can only be determined by the Tax Court of Canada) but rather, was only being asked to review the CRA’s decision not to consider the objection.

Based on the standard of reasonableness, the Federal Court found in favour of ConocoPhillips on the basis that the CRA had not sufficiently engaged the evidence to appropriately render an opinion whether or not the reassessment was mailed on the alleged date. The Court set aside that decision.

The Crown appealed to the Federal Court of Appeal on the basis that the Federal Court lacked jurisdiction on this issue.  The Federal Court of Appeal allowed the appeal.

Section 18.5 of the Federal Courts Act provides that judicial review in the Federal Court is not available where, inter alia, an appeal is permitted on the issue before the Tax Court of Canada.  In the present case, the Federal Court of Appeal stated that, pursuant to subsection 169(1)(b) of the Income Tax Act (Canada), ConocoPhillips could have appealed to the Tax Court after 90 days had elapsed following the date its objection was initially filed and the Tax Court would have been the correct forum to determine if, or when, the Notice of Reassessment was mailed and when the time for filing a Notice of Objection expired.

The Federal Court of Appeal clarified that the Minister’s obligation to consider a Notice of Objection is triggered regardless of whether a Notice of Objection may have been filed within the required time-frame. Further, the Minister’s decision on this issue is not an impediment to filing an appeal to the Tax Court pursuant to paragraph 169(1)(b) of the Income Tax Act (Canada). Accordingly, judicial review of this issue was not available in the Federal Court.

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ConocoPhillips: FCA Confirms Tax Court’s Jurisdiction to Determine Questions of Timing and the Validity of a Notice of Objection

Federal Court of Appeal hears argument on whether “break fees” are income (Morguard)

Is a “break fee” received in return for withdrawing from a takeover bid a capital receipt or an income receipt?

That was the issue before a panel of the Federal Court of Appeal (“FCA”) on November 20, 2012 in Morguard Corporation v. The Queen on appeal from a decision of the Tax Court of Canada. The panel consisted of Justice Evans, Justice Sharlow and Justice Stratas. At the conclusion of the hearing, judgment was reserved.

For the facts of the case and our analysis of the trial decision, see here. For a brief review of the issues raised in the factum filed by each party in the FCA, see here.

Arguments of the Taxpayer

Counsel for the appellant argued the trial judge had made an “error of law” in determining that Acktion Corporation (“Acktion”) was “essentially in the business of doing acquisitions and takeovers” (Acktion was the name under which Morguard Corporation (“Morguard”) operated during the period at issue). Counsel argued that Acktion was a holding company and that it had sought the takeover to increase its capital holdings. The standard of review for an error of law is “correctness”.

The panel asked counsel whether there was any error of law. Justice Stratas asked whether the issue was really a factual one, for which the standard of review is much higher, namely, “palpable and overriding error”.

Counsel argued that it is settled law that a corporation cannot conduct a “business” of acquiring capital assets. Accordingly, counsel argued that the trial judge erred in concluding that Acktion had done so. In support of this proposition, counsel cited the 1978 FCA decision in Neonex International Ltd. v The Queen (78 DTC 6339). 

It was not clear whether the panel agreed with counsel on this point, as their other questions focused on whether the Supreme Court of Canada (“SCC”) decision in Ikea Ltd. v. Canada ([1998] 1 SCR 196) had displaced Neonex by instituting a “modern approach” that supports an organic assessment of the circumstances around the receipt.

Counsel argued the break fee was received in the pursuit of a capital acquisition and that, according to the modern approach, it should be characterised as a capital receipt. Counsel stressed that the expert evidence adduced at trial by both parties was that break fees are intended to support the acquisition of capital by deterring other bidders or to compensate for the various costs incurred in a failed takeover bid.

The panel sought clarification of the appellant’s position that there should be no tax liability arising from the receipt of the break fee. In its written submissions, the appellant argued that the break fee should not be taxed as a capital gain because there were no proceeds of disposition. Justice Sharlow noted that, according to this theory, the break fee could only be characterized either as income or a non-taxable capital gain.

Arguments of the Crown

Counsel for the Crown had to answer fewer questions from the panel. Counsel argued that the characterization of an “unusual receipt” such as a break fee requires a factual determination (relying on the SCC’s decision in Ikea on this point), which the Tax Court had made in this case.

Justice Evans asked about the distinction between conducting a real estate business that acquires companies as capital and being a real estate company in the business of acquisitions and takeovers. Counsel argued that, instead of acquiring real estate directly, Acktion’s business strategy was to acquire businesses that already owned real estate. Counsel further submitted that the corporate information distributed to its shareholders described the corporation as a real estate company and not as a holding company.

Justice Sharlow questioned the Crown’s reliance on the commercial description of Acktion’s business, noting that the technical distinction between income and capital is a legal distinction that would not generally be expected to appear in a commercial context. In response, counsel argued that Acktion treated the takeover bid as part of its regular business. After losing its takeover bid, Acktion negotiated a higher price for its remaining “toehold” in the company, then took the break fee and the proceeds of disposition of its shares and immediately sought to purchase another business. Counsel argued this course of conduct shows that Acktion considered the negotiation of break fees to be part of its real estate business.

In response to the appellant’s position that the break fee was a non-taxable capital gain, counsel submitted that the trial judge was correct in applying the factors set out by the FCA in Canada v. Cranswick ([1982] CTC 69) to determine whether a payment was a windfall. In this respect, the break fee was the product of an enforceable claim negotiated by the Appellant according to common practices in takeover bids and, thus, could not be characterised as a windfall.

*  *  *

The panel reserved judgment. We will report on the judgment when it is released.

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Federal Court of Appeal hears argument on whether “break fees” are income (Morguard)

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

Federal Court of Appeal Reserves Judgment in Transalta Corporation v. The Queen (Allocation of Goodwill in Arm’s-Length Transaction)

The Federal Court of Appeal heard the appeal in Transalta Corporation v. The Queen (Court File No. A-350-10) on December 13, 2011 in Calgary. The panel consisted of Justices Evans, Layden-Stevenson and Mainville.

The case concerns the allocation to goodwill of $190 million of a $818 million purchase price paid by AltaLink LP (“AltaLink”) to Transalta to purchase an electricity transmission business.  The Tax Court (2010 TCC 375) partially upheld the application of section 68 of the Income Tax Act  (the “Act”) to re-allocate a portion of the amount allocated to goodwill to tangible assets, despite the fact that the goodwill amount was approximately the amount in excess of the amount that all parties accepted as the net book value of the business assets and working capital.

On appeal, the Crown maintained its argument that not everything that increases the price of a business above its net book value must be regarded as goodwill, since goodwill is a distinct asset of the business with a value.  The Crown argued that the owners of a business would not receive any additional benefit from items such as a skilled employee force.

Transalta argued that the Tax Court had erred by adopting a new test for goodwill as something other than the established residual definition, i.e., the value of a business in excess of its realizable assets.  The test adopted by the Tax Court would require undue and costly subjective analysis and would be commercially unworkable.  Furthermore, one side of a transaction would usually be unaware of the reasons that another party would pay an amount in excess of the realizable value of the business assets.

Transalta argued that where sophisticated arm’s-length parties have agreed to an allocation, for the purposes of section 68 of the Act, there should effectively be a shift of the onus to the Minister of National Revenue to demonstrate that the allocation was not reasonable.  Translta argued that the test for section 68 should be whether a reasonable business person would have agreed to the allocation, having only business considerations in mind.  This would extend the test in Gabco Ltd. v. The Queen (68 DTC 5210), which is well-established as the test for the purpose of section 67 of the Act.

At the conclusion of the parties’ submissions, the panel reserved judgment.

The taxpayer’s Memoranda of Fact and Law are here and here.

The Crown’s Memorandum of Fact and Law is here.

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Federal Court of Appeal Reserves Judgment in Transalta Corporation v. The Queen (Allocation of Goodwill in Arm’s-Length Transaction)

Federal Court of Appeal Affirms Tax Court Decision that Free Parking at School is a Taxable Benefit in the “Branksome Hall” Cases

On December 1, 2011, the panel of Justice John Maxwell Evans, Justice Carolyn Layden-Stevenson and Justice David Stratas of the Federal Court of Appeal heard the “Branksome Hall” parking cases (Geraldine Anthony, Heather Friesen, Leslie Morgan, Jarrod Baker v. The Queen (2011 FCA 336)). The appeals were dismissed with a unanimous judgment delivered from the bench by Justice Layden-Stevenson shortly after Appellants’ counsel concluded his oral argument.

As discussed in an earlier post, the appeals of four employees of Branksome Hall (a private school in Toronto) (the “Appellants”) were heard collectively as test cases and on common evidence. The Appellants and approximately 100 other employees of Branksome Hall were reassessed for their 2003 and 2004 taxation years to include $92 per month (inclusive of GST and PST) in their income, representing the value of free parking provided by their employer. The issues were whether parking provided to the Appellants by their employer was a taxable benefit under paragraph 6(1)(a) of the Income Tax Act (the “Act”) and, if so, how the value of that benefit should be assessed.

Counsel for the Appellants argued in his opening statement that this is a case of the Canada Revenue Agency casting its tax net as wide as possible and attempting to tax items that it had not taxed in the past. In response to this statement, Justice Evans noted that the Federal Court of Appeal is required to apply the law as prescribed under paragraph 6(1)(a) of the Act and not make any findings on the practices of the Canada Revenue Agency.

The Appellants’ submissions focused on Justice Brent Paris’ conclusion in the Tax Court of Canada that the value of the taxable benefit was its fair market value. They argued that fair market value should only be applied to cases where there is an open market to test competitive prices. Since the demand for parking at Branksome Hall only came from staff members and Branksome Hall was restricted from charging members of the public for parking as a result of zoning restrictions, there was no open market and, therefore, fair market value should not be applied. The Appellants submitted that the value of the taxable benefit should be determined by considering only the cost incurred by the employer to provide the benefit.

In delivering reasons for judgment on behalf of the panel, Justice Layden-Stevenson stated that the Court: a) agrees with the Tax Court’s finding that even if it is accepted that the parking benefit to the Appellants should be valued at Branksome Hall’s cost of providing the parking, the evidence adduced by the Appellants was not sufficient to prove what those costs were; b) rejects the argument that the fair market value is an appropriate method of valuation only when there is an open market for the benefit in issue; and c) finds that the Appellants’ argument has been overtaken by the decision of the Federal Court of Appeal in Spence v. The Queen (2011 FCA 200).

In Spence v. The Queen (2010 TCC 455), the Tax Court had valued an employment benefit of reduced tuition costs by using the cost approach instead of the fair market value approach. The Federal Court of Appeal reversed the Tax Court’s decision and applied the fair market value approach to the taxable benefit on June 13, 2011 – after the Appellants in the “Branksome Hall” cases had submitted their Memorandum of Fact and Law.

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Federal Court of Appeal Affirms Tax Court Decision that Free Parking at School is a Taxable Benefit in the “Branksome Hall” Cases

Federal Court of Appeal Hears Arguments in T1135 Penalty Cases: Judgment Reserved

A panel of the Federal Court of Appeal (Noël, Trudel and Stratas, JJ.A.) heard arguments this morning in Ottawa on appeals from judgments of the Federal Court which held that the Canada Revenue Agency acted reasonably in deciding not to cancel or reduce penalties and arrears interest on late-filed T1135 forms. See our earlier blog post for more information on the background to this case.

The Appellants’ main argument to the panel was that the Minister of National Revenue had improperly fettered his discretion in deciding that certain penalties and arrears interest should not be cancelled or reduced. In particular, the Appellants emphasized the fact that the CRA official, in his written reasons, held that the Appellants did not fit within the categories set out in the Taxpayer Relief Guidelines and thus that the Minister could not grant the request for relief. This, the Appellants argued, showed that the Minister did not appreciate or understand that he had unfettered discretion to provide relief. The Appellants argued, on the facts and with unfettered discretion, the reasonable conclusion would have been to grant relief.

Justice Stratas noted that on the reasonableness standard of review, a reviewing court may look to what might have been the reasons of the decision-maker.  In response, counsel for the Appellants responded that in Canada (Citizenship and Immigration) v. Khosa, the Supreme Court of Canada held that that what could have been the reasons of the decision-maker should not dilute the importance of giving reasons.

After putting the issue of “missing justification” to Crown counsel (who argued that cross-examination transcripts showed the CRA official had in fact considered all of the facts before him at the time), Justice Stratas wondered whether the CRA’s later justification was really just an exercise in bootstrapping. Members of the panel appeared concerned that taxpayers are obliged to file applications for judicial review simply in order to obtain an answer to their request for relief. Counsel for the Appellants argued that taxpayers “deserve the attention of the Minister” for their specific circumstances, given the nature of the discretion granted to the Minister under the Income Tax Act.

Justice Noël was interested in the fact that the Appellants failed to file the forms due to a common administrative error. Counsel for the Appellants described the policy objective underlying the penalty provision and argued that a multiplicity of penalties for what was actually just one common error would be disproportionate to the oversight by the taxpayers and would not advance the underlying purpose of the penalty. He argued that the existence of the common error should have had some significance to the exercise of the Minister’s discretion to cancel or reduce the penalties.

The panel reserved judgment.

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Federal Court of Appeal Hears Arguments in T1135 Penalty Cases: Judgment Reserved

Federal Court of Appeal Hears Arguments in CIBC World Markets Inc. v. The Queen: Judgment Reserved

On September 21, 2011, the Federal Court of Appeal (Sharlow, Layden-Stevenson, and Stratas, JJ.A.) heard an appeal by CIBC World Markets Inc. (“CIBC”) from a judgment of the Tax Court of Canada dismissing the taxpayer’s appeal of an assessment by the Minister of National Revenue under the Excise Tax Act.  For further details, see our earlier post.

The Appellant’s oral argument dealt with many of the points raised in the reasons for judgment of the Tax Court judge (Rip, CJ), specifically the interpretation of subsection 141.01(5) and section 225 of the Excise Tax Act.  Counsel for the Appellant was asked only a few questions from the bench during his submissions.

Counsel for the Respondent faced a number of questions from the panel.  Counsel for the Respondent argued that the Appellant had not adduced evidence to show that its revised input tax credit (“ITC”) allocation methodology was “fair and reasonable” within the meaning of subsection 141.01(5) of the Excise Tax Act.  The panel observed that the revised ITC allocation methodology had already been accepted by the Minister as a “fair and reasonable” method for subsequent years.  The panel was interested in hearing the Respondent’s submissions on what statutory basis exists in the Excise Tax Act precluding a taxpayer from using an alternative “fair and reasonable” allocation methodology in respect of prior years.

After a brief reply by Appellant’s counsel, the hearing concluded and the panel reserved judgment.

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Federal Court of Appeal Hears Arguments in CIBC World Markets Inc. v. The Queen: Judgment Reserved