Tax Blog

Compliance Challenges With New Naturopathic & Acupuncture GST/HST Exemptions

In a case of what could be considered “good news/bad news,” certain naturopathic and acupuncturist services became GST/HST-exempt effective February 12, 2014. The Canada Revenue Agency (“CRA”) recently released its administrative interpretation of these new exemptions (see Technical Information Bulletin TIB B-109, July 2015). This interpretation and some implications of the exemptions are discussed below.

Acupuncturist and naturopathic services are now GST/HST-exempt if they meet the following criteria:

  1. They are acupuncturist or naturopathic services in nature;
  2. They are rendered to an individual by a licenced acupuncturist or licenced naturopathic doctor (or person with equivalent qualifications in provinces where licensing is not required); and
  3. They are provided for the purpose of health care purposes and not for cosmetic purposes.

As a result, acupuncturists and naturopathic doctors (collectively, “Practitioners”) are no longer required to charge on such services. While welcome news for patients, the exemptions create a number of compliance challenges which Practitioners and their advisors should be aware of. To begin with, it becomes necessary to review the Practitioner’s business to determine which activities are now exempt and which remain taxable. This may not always be straightforward. For example, CRA does not consider acupuncturist or naturopathic assessments to be exempt if they are undertaken to provide information to an insurance company or lawyer. Moreover, if a Practitioner’s service includes related activities (such as product sales) or involves other health professionals, it may be necessary to determine whether the Practitioner is making a single exempt supply or multiple supplies with potentially different GST/HST treatments. Practitioners who incorrectly charge GST/HST on exempt supplies are required to remit such amounts to CRA. If they choose to, they may refund their customers and claim a corresponding adjustment in their tax return. Alternatively, customers can apply to CRA for a rebate.

Another key consequence of the new exemptions is that they limit the ability of Practitioners to claim input tax credits (“ITCs”) for GST/HST paid on expenses such as rent, utilities, consumables, and equipment. Previously, Practitioners who are GST/HST-registered could claim full ITCs on expenses used to supply acupuncturist and naturopathic services. Now, they can no longer claim ITCs for expenses related to such services exempt under the new rules, and must apportion ITCs based on the use of their expenses in exempt supplies and taxable supplies (e.g., separate sales of supplements, natural health products, books). A range of potential allocation methods exist (e.g., floor space, revenue) and they are frequently an area of controversy in audits, especially with regards to the treatment of common space.

Perhaps the least intuitive consequence of the exemptions is the potential requirement for Practitioners to self-assess (i.e., self-report and pay) GST/HST on capital personal property and capital real property acquired prior to the new exemptions coming into effect. For example, a Practitioner who purchased a treatment/examination table (assuming it is capital property for income tax purposes) prior to February 12, 2014 may be required to self-assess GST/HST when they use the table primarily to make exempt supplies under the new exemptions. Similar self-assessment may be required with respect to capital real property to the extent that use of the real property in making exempt supplies exceeds 10%. For example, a Practitioner who purchased a clinic prior to February 12, 2014 may be required to self-assess when and to the extent they use the clinic to make exempt supplies (if that use exceeds 10%). Given the high costs typically associated with real property, the self-assessed GST/HST could be significant.

The Rise of International Tax Collection

It is an entrenched common law rule that domestic courts must refuse to enforce tax claims of a foreign government (United States of America v. Harden, [1963] SCR 366).  This rule, known as the “revenue rule”, was once regarded as an unbreakable barrier to foreign governments seeking to collect taxes from individuals whose assets are situated in Canada.  However, the revenue rule was circumvented in 1995 when Canada entered into a bilateral agreement as part of the U.S-Canada income tax treaty to provide mutual assistance in collection of taxes.  The treaty now deems certain U.S. tax claims to be enforceable in Canada and requires the Canadian government to assist the U.S. government in their collection.  In the same way, the U.S. government is required to provide assistance in collection of certain Canadian tax claims in the U.S.

The tax collection agreement between the U.S. and Canada was the first of its kind adopted by Canada.  Since then, Canada has ratified a number of similar agreements with Netherlands, Germany, Norway and most recently, UK in 2014.  Canada also has signed tax collection agreements with New Zealand and Spain, which are waiting to be ratified.  However, certain exceptions may apply to narrow the scope of some agreements.  For example, under the U.S.-Canada treaty, Canada is not required to provide assistance in collection of U.S. tax if the taxpayer is a Canadian citizen during the period that relates to the tax claim.

The trend appears to be that Canada is expanding its network of tax collection agreements to gain the ability to collect taxes in other countries, and at the same time allowing more foreign governments to collect taxes in Canada.  The Canada-UK treaty likely will not be the last of its kind – Canada is currently negotiating and renegotiating income tax treaties with Australia, China, Israel, Madagascar and Malaysia.  These negotiations may well result in more tax collection agreements.

What the Supreme Court of Canada Has to Say About The Income Tax Act and Penalties

It is not often that tax cases wind their way to the Supreme Court of Canada  so both that Court’s judgments on specific points of tax law, as well as it’s more general observations about tax law are of interest. The recent decision of Guindon v. Canada, 2015 SCC 41 was much awaited for these reasons and also because court watchers and practitioners were anxious to see whether the Appellant’s success (and perhaps surprising success) at the trial level, which was overturned on appeal, would be restored. It was not.

At issue was whether the penalties imposed by s.163.2 of the Income Tax Act are so severe that the provision is criminal, rather than administrative in its nature. If criminal, the protections guaranteed by the Charter of Rights to those charged with a criminal offence would apply to those subject to these penalties.

The Appellant was a practicing lawyer but she did not practice tax law. She was retained to provide, and did provide an opinion on the tax consequences of a particular charitable donation program that was being promoted. For her efforts she received a fee of $1000.00. She was aware that her opinion would form part of the promotional materials and the opinion was based upon a precedent provided to her by the promoters of the scheme.  Unfortunately for the Appellant, the opinion referred to documents that were said to have been reviewed yet she had not reviewed the documents. Also unfortunately for the Appellant, she seemed to have had some awareness of the limitations of her expertise because she suggested that her opinion be reviewed by someone with expertise in tax law yet this review was never conducted.

The promotion was a success in the very limited sense that donors came forward and made donations to the charity in question and tax receipts were issued. The Appellant was one of the two persons to sign the receipts. Receipts in the amount of $3,972,775 were issued.

It is here that the donation program that was being promoted began to unravel. As characterized by the majority in the Supreme Court judgment, “[t]he scheme was a sham”, the tax credits based upon the donations were disallowed and the Appellant was assessed penalties in the amount of $546,747 pursuant to s.163.2 of the Income Tax Act. Section 163.2 creates both a planner penalty and a preparer penalty. The preparer penalty under which the Appellant was assessed states:

(4) Every person who makes, or participates in, assents to or acquiesces in the making of, a statement to, or by or on behalf of, another person…that the person knows, or would reasonably be expected to know but for circumstances amounting to culpable conduct, is a false statement that could be used by or on behalf of the other person for a purpose of this Act is liable to a penalty in respect of the false statement.

On appeal to the Tax Court, the Appellant argued, and the Tax Court agreed that the penalties created by this provision were criminal in their nature, that the legal effect of the assessment was that she was charged with an offence and therefore, the protections provided by s.11 of the Charter were engaged.

Section 11 begins with the words “Any person charged with an offence has the right” and the guaranteed protections include being informed of the offence charged, being tried within a reasonable time, the right not to be compelled to be a witness in the proceedings and the right to be presumed innocent until proven guilty. On this basis, the Appellant further argued that the proceedings should not be heard in the Tax Court and the assessment should be vacated. Again, in a manner that was unfortunate, no notice of constitutional question, as required by s.19.2 of the Tax Court of Canada Act, was filed and no notice of the constitutional argument was given to the attorneys general of the provinces.

There is no doubt that the penalties that can be imposed by s.163.2 can be significant and, in some instances, crushing. The Appellant’s argument therefore had, at least for some, a certain intuitive appeal. Indeed, the Appellant’s argument had sufficient appeal that she was successful in the Tax Court. The success was, however, short lived and the result was overturned on appeal and the Supreme Court of Canada confirmed that though potentially severe, the tax penalties in question are administrative and not criminal in their nature.

There are several points to be taken from this judgment. The procedural issue was whether the Supreme Court should entertain the constitutional question given that the Appellant has not filed the notice of the constitutional argument as required. Within the Court it was agreed that the Court had a discretion to consider the constitutional question.  The question which divided the court was whether the discretion should be exercised.

The majority held that because the appeal raised issues important to the administration of the Income Tax Act and the public interest, and because no prejudice would arise from the constitutional question being considered, the constitutional question should be adjudicated upon.

Three judges disagreed on the grounds that: notice provides an opportunity for Attorneys General to intervene; notice ensures that a court will have the fullest possible evidentiary record upon which to decide a constitutional question; the wording of the notice provision within the Income Tax Act (s.19.2) is mandatory; given the mandatory language, the Tax Court was not as a matter of law permitted to consider the constitutional question; the SCC can consider new issues but it is a discretion that should be “sparingly” used; the discretion should not be exercised in the present case because “it undermines public confidence because it extinguishes the legislative assurances that this Court will have the benefit of a complete and tested record when scrutinizing the constitutionality of legislation.”

Because of the disagreement within the Court on the procedural question, the substantive or constitutional question was only considered by four judges. In upholding the judgment of the Federal Court of Appeal that the provision is administrative rather than criminal in its nature and that the Appellant was not a person who was charged with an offence, the majority held:

A proceeding is criminal by its very nature when it is aimed at promoting public order and welfare within a public sphere of activity. Proceedings of an administrative nature, on the other hand, are primarily intended to maintain compliance or to regulate conduct within a limited sphere of activity…

A “true penal consequence” is imprisonment or a fine which by its magnitude would appear to be imposed for the purpose of redressing the wrong done to society at large rather than to the maintenance of internal discipline within [a] limited sphere of activity.

When examined in its “full legislative context”, the penalty provision in question is part of a self -reporting scheme “which depends upon the honesty and integrity of the taxpayers for its success”. Further: “We can conclude that the purpose of this proceeding is to promote honesty and deter gross negligence, or worse, on the part of preparers, qualities that are essential to the self-reporting system of income tax assessment.”

In order to ensure that the objectives of an administrative scheme are achieved or, at least not thwarted, significant and even “very large” penalties may be utilized and the majority concluded that the penalties in question were “directly tied to the objective of deterring non-compliance with the ITA.”

It is worth noting that in its analysis, the majority considered the conduct that is captured by s.163.2.  On the appeal, the Minister argued that the conduct “was not intended to be different from the gross negligence standard in s.163(2)” which governs penalties for false statement and omissions. The court held that conduct must be beyond carelessness or simple negligence and must, instead, reflect at least an indifference with respect to compliance or intentional non-compliance. “[T]he standard must be at least as high as gross negligence [and the] third party penalties are meant to capture serious conduct, not ordinary negligence or simple mistakes on the part of the tax preparer or planner.”

To condense this for summer reading, here is what may be taken away from this case. First, if constitutional litigation is to be conducted, it must be properly conducted and failure to comply with notice provisions will likely stop litigation in its tracks regardless of merit.

Secondly, many judicial pronouncements refer to the way in which the integrity and honesty of the taxpayer is integral to the proper functioning of our self-reporting system of income tax. The decision in Guindon illustrates that the integrity and honesty of advisors, planners and tax preparers is equally important to the integrity of the self- reporting system.

Third, the objectives of the Income Tax Act are such that, at least in general terms, very significant penalties will not be prohibited by constitutional principles.

Finally, Guindon serves notice upon tax professionals who are considering a retainer which would require the preparation of an opinion, or assistance with planning or preparation on tax matters. The judgments from the courts do not reveal why the Appellant might have become involved in the manner she did, but the case does make perfectly clear that significant penalties can be assessed upon those who exercise insufficient care or skill in the professional services they provide. Therefore, before any retainer is accepted or undertaken, a person should ask him or herself whether he or she possesses the requisite skill to properly execute the terms of the retainer. Not every case is worth taking and it is easy to imagine that the Appellant in Guindon might now believe that the $1000.00 retainer she received was not worthwhile.

The Tax Court’s Use of Costs Awards as a Tool to Control the Parties’ Conduct

Traditionally, the Tax Court only awarded costs that deviated from the Tariff annexed to the Tax Court of Canada Rules (General Procedure) (the “Rules”) in the presence of reprehensible, scandalous or outrageous conduct on the part of one of the parties.  The Tax Court’s new approach to costs, as articulated by the now Chief Justice of the Court in Velcro Canada Inc. v. R., 2012 TCC 273, allows the judges to fix costs on a principled basis in accordance with the factors enumerated in Rule 147(3) instead of by reference to the Tariff.  A review of the Court’s recent costs awards shows that among the various factors taken into account by the judges in the exercise of their discretionary power to award costs in excess of the Tariff, considerable weight is given to the conduct of the parties.

In Ford Motor Company of Canada, Limited v. R., 2015 TCC 185, the Court awarded the taxpayer a lump-sum of $40,000, which represented about 63% of the taxpayer’s estimated aggregate costs incurred in successfully defending the Crown’s motion to strike very substantial portions of its amended notice of appeal pursuant to the specified corporation rules under the Excise Tax Act (Canada).  The Court justified its costs award by relying on its finding that the Crown had tried to “use the specified corporation rules opportunistically, as a sword against a taxpayer appellant, notwithstanding that the clear purpose and design of the rules are to protect and shield the fisc.”  The Court also qualified the Crown’s failure to file any written submissions or other advance notice of its arguments (even though it had committed at least twice to do so) as “disappointing”.

The Court further criticized the Crown for adopting the position that there was no basis for enhanced costs in excess of the Tariff as there was no reprehensible, scandalous or outrageous conduct on its part.  The Court held that it is “not acceptable for the Crown to simply recite that tired old phrase, clearly taken out of context upon a proper review, without even acknowledging the considerable jurisprudence to the contrary, much less actually seeking to challenge it.”  In addition to the lump-sum of $40,000, the taxpayer was awarded 75% of its reasonable actual costs incurred in seeking to resolve the issue of costs.

In The Standard Life Assurance Company of Canada. v. R., 2015 TCC 138, the Court deviated from the Tariff in part because it determined that although the trial itself had been conducted in an efficient and professional manner by both sides, the taxpayer had engaged in window dressing throughout the proceeding to enable it to argue that it met the factual criteria of the judicial tests for carrying on business when it did not.  The Court held that the taxpayer’s actions to create and rely on an illusion to obtain a tax benefit was “reprehensible and should be discouraged.”

The Court’s propensity to use costs awards to express disapproval of a party’s conduct is further illustrated by the Court’s decision in Martin v. R., 2014 TCC 50, where the Court found evidence that the auditor had deliberately misled the taxpayer in the course of the audit.  Being critical of the conduct of the Canada Revenue Agency (the “CRA”), the Court included in the costs award an allowance for costs the taxpayer incurred during the audit and objection stages of her dispute with the CRA.  The inclusion of the costs allowance was overturned in 2015 FCA 95, where the Federal Court of Appeal held that conduct that occurs prior to a proceeding may only be taken into account in a costs awards if that conduct impacts on the “proceeding”, defined to mean “an appeal or reference”.  The taxpayer sought leave to appeal to the Supreme Court on June 15, 2015.

These cases, however, must be contrasted with the decision in Invesco Canada Ltd. v. R., 2015 TCC 92, where the Court rejected the taxpayer’s argument that because the taxpayer had been cooperative throughout and was ultimately successful in the appeal, the Crown should have known the frailties of its own case and allowed the taxpayer’s objection.  The Court held that the finding that a party’s legal position was erroneous should not amount to misconduct on the party’s part or mean that its position was frivolous or vexatious.

Since the new costs approach is relatively recent, it remains to be seen to what extent the significant weight given to the conduct of the parties by the Tax Court judges in the exercise of their discretion to award costs in excess of the Tariff may influence the conduct of the parties in future proceedings.

One Appellant’s Unsuccessful Attempt to Strike GAAR From the Minister’s Pleadings and the Potentially Far Reaching Results

In litigation there are winners and losers. In Deans Knight Income Corp. v. The Queen, 2015 TCC 143 the Appellant lost in its attempt to have the court strike GAAR from the Minister’s pleadings and the court’s reasons leading to the result are worth noting.

In this case the Appellant claimed certain losses and was reassessed on grounds that included that GAAR precluded the losses from being claimed. On appeal, the Minister’s Reply continued to assert reliance upon GAAR and the Appellant applied to strike the Reply or portions of it on the basis that it disclosed no proper grounds on which the appeal could be opposed.

In arriving at the result, the Court applied the well- known test for striking pleadings, which is that a pleading will be struck only if it is “plain and obvious, assuming the facts to be true, that the pleading discloses no reasonable causes of action.”  On the basis of this test, the Court denied the Appellant’s application and permitted the GAAR related pleadings to remain intact. The Court held:

 I disagree with the Appellant’s position. The object, spirit or purpose of the provisions in question is something that the trial judge has to determine. It is not something that simply comes from the object, spirit or purpose that has been culled from the Act by judges in previous GAAR cases. It can hardly be said that the courts have completed an exhaustive analysis and description of the object, spirit and purpose of all provisions in the Act. As a result, I find it very difficult to conceive how it could ever be said that it was plain and obvious that the Respondent could not succeed on a GAAR argument in respect of a series of transactions of a type that had not previously been ruled upon. By its very nature, the misuse or abuse test in GAAR is something that can only be determined after the detailed analysis that a trial permits. Accordingly I dismiss the Appellant’s motion to strike the Respondent’s GAAR argument. (Emphasis added)

In 2005, in Canada Trustco Mortgage Co. v. Canada the Supreme Court of Canada said of GAAR that it “draws a line between legitimate tax minimization and abusive tax avoidance [however] [t]he line is far from bright.”  Six years later not much had improved in terms of bringing clarity and certainty to the application of GAAR and  in Copthorne Holdings Ltd. v. Canada the Supreme Court of Canada observed: “It is relatively straightforward to set out the GAAR scheme. It is much more difficult to apply it.”

The result in Deans Knight Income Corp. is certainly consistent with the observations by the Supreme Court of Canada that the line between legitimate tax minimization and abusive avoidance is far from bright and that GAAR is difficult to apply. However, this result also illustrates the very practical legal issues that can arise from such a broad and uncertain principle of law.

The purpose that is served by allowing a court to strike pleadings is that it is both unfair to a litigant and a poor use of resources for time and effort to be spent on pleadings that are destined to fail. In Deans Knight Income Corp. the Court held that as long as a specific application of GAAR has not been determinatively ruled upon, a GAAR based pleading by the Minister will never be struck because the application of the rule “is something that can only be determined after the detailed analysis that a trial permits.” In other words, as long as the Minister is able to draft a GAAR based pleading in a manner that is at least marginally different from any previously decided case, the pleading will not be struck and the issue will have to be decided by a judge, after discoveries and after trial.

With the potential that arises from this judgement for making some GAAR related litigation to become more protracted, it is that much more unfortunate that the line between legitimate tax minimization and abusive avoidance is not a little brighter from what has so far been drawn.

Canada’s Anti-Terrorism Laws and Taxes – What’s the Connection?

The short answer to the question of the connection between Canada’s new anti-terrorism laws and taxes is that recent amendments to the Income Tax and Excise Tax Acts which arise through the Anti-Terrorism Act permit more extensive disclosure and sharing of private and confidential taxpayer information. The longer answer is that this is part of a trend of CRA offering greater levels of cooperation and assistance with other agencies, both domestically and internationally, with the result that the phrase, “except as authorized by law”, which qualifies the prohibition upon disclosure of taxpayer information has once again grown in scope.

Bill C 51, which is now the Anti-Terrorism Act received Royal Assent on 18 June 2015. Along the way to becoming law, debate and popular discussion revealed a significant division of opinion on whether the Bill represented the proper balance between the protection of individual rights and the collective need for security.

Two changes, which are now law and which received less public attention than many other features of the Act are tax related. Tax and taxpayer information is private and confidential and the use and dissemination of that information is controlled by section 295 of the Excise Tax Act and section 241(9) of the Income Tax Act.

The Anti-Terrorism Act amended these provisions to expand the list of circumstances under which this information may be shared. Under the amendments, this information may now be shared when there are reasonable and probable grounds for believing that the information is relevant to the investigation of a terrorism related offence.

As a first point, it should be noted that the test for disclosure, which is that the information is relevant to an investigation, is a very low threshold and easy to satisfy. It is only necessary that the information be a piece, if only a very small piece of the investigative puzzle. As long as this precondition has been satisfied, disclosure is permitted.

The increased sharing of confidential taxpayer information is consistent with a trend that continues to develop. For example, the Canadian and U.S. governments entered into an agreement to implement FATCA which requires Canadian financial institutions, under specified circumstances to provide account information to CRA and requires CRA, under specified circumstances, to in turn provide the information to the IRS.

Similarly, in June of this year the Minister of National Revenue issued a news release announcing that she signed an international Multilateral Competent Authority Agreement which is described as “an important step towards implementing the Common Reporting Standard for the automatic exchange of financial account information with other tax jurisdictions.” According to the announcement, the Agreement is part of the government’s commitment to addressing international tax evasion and improving tax compliance.

Canada has also entered into treaty agreements with several countries, some of which have not yet been ratified, through which Canada can accept a request from another country to commence collection action against a person in Canada, who has a tax debt to that other country. Through these agreements and with this cooperation, the reach of a foreign jurisdiction can, in some circumstances, now extend into Canada for the purpose of tax debt collection.

There can be no doubt that a government’s ability to detect, investigate and prosecute tax evasion, and to take enforcement measures against non-compliance will be enhanced through the increased sharing of financial information collected through financial institutions and taxpayer information collected through the relevant tax authorities. Equally, it is likely that Canadian courts will one day be called upon to examine the use of information by the CRA in civil or criminal tax proceedings which was shared and collected in these ways. Finally, there can be no doubt that the trend toward increased sharing of information between tax authorities, and cooperation between countries is not about to change and, in this way, for purposes of either lawful tax planning or unlawful tax evasion, the world is becoming a much smaller and more transparent place than it used to be.

Court Renders First Decision on Provincial Residency of a Trust

In Discovery Trust v. Minister of National Revenue, 2015 NLTD(G)86, the Newfoundland Supreme Court issued Canada’s first decision involving the provincial residency of a trust. This is also the first decision to apply the test for trust residency articulated by the Supreme Court of Canada in St. Michael Trust, 2012 SCC 14. In applying this test (which states that a trust is resident where its “central management and control” is located), the Newfoundland Court recognized the reality of the trust relationship. It was not prepared to find that the trustee gave up management and control in the context of a fairly typical case where the trustee appears to have discharged its duties prudently and in accordance with its fiduciary obligations and commercial reality.

The trust in this case, the Discovery Trust, was settled in 2002 by Craig Dobbin, founder of CHC Helicopter Corporation (CHC). Mr. Dobbin’s children were the initial beneficiaries and trustees of Discovery Trust. Following its formation, Discovery Trust acquired shares of Discovery Helicopters Inc. (DHI), the holding corporation for the Dobbin family’s shares of CHC.

In 2006, prior to Mr. Dobbin passing away, the Dobbin children were replaced as trustees by the Alberta office of Royal Trust Corporation of Canada (Royal Trust Corp). Two years later, CHC was sold. The proceeds of the sale (which were received by DHI) were distributed to Discovery Trust by way of dividends on the DHI shares and a redemption of DHI shares. Following the execution of a request for distribution by the Dobbin children, Discovery Trust disbursed the trust capital to them. In filing its tax return for 2008, Discovery Trust took the position it was resident of Alberta. By filing as a resident of Alberta rather than Newfoundland, Discovery Trust saved approximately $9 million in tax in 2008.

Following an audit that the Court found was driven by the auditor’s perception that emigrating Discovery Trust to Alberta was abusive (more on this below), the Canada Revenue Agency (CRA) reassessed Discovery Trust on the basis that it was resident, and therefore taxable on the gain, in Newfoundland. The CRA claimed that the “management and control” (and therefore residence) of Discovery Trust continued to be exercised by the Dobbin children in Newfoundland, even after Royal Trust Corp became the trustee in 2006: the beneficiaries (or their advisors) continued to make all the decisions relating to transactions concerning, investments of, and distributions from Discovery Trust, while Royal Trust Corp only performed administrative tasks.

The Court vacated the reassessment on the basis that Discovery Trust was resident in Alberta, as claimed by the appellant. The Court analyzed the residency issue by examining each action taken by Discovery Trust from the perspective of management and control. In so doing, the Court adopted a view of the trustee’s role that is consistent with commercial reality and common trust relationships. For example, the Court acknowledged that the expected level of activity by a trustee will depend on the nature of the particular trust.

In the course of reviewing the relevant transactions undertaken by Discovery Trust, the Court made the following observations:

  1. Informed consent by a trustee (to a transaction driven by another person) is not tantamount to submission by the trustee to the direction of the other person. As the Court states, “[i]ndependence of the Trustee is maintained by its review of the transaction, acquiring explanation sufficient that an informed decision can be made, ensuring the decision has no negative consequence and is in the best interest of the beneficiaries.”
  2. A document executed by the beneficiaries requesting an encroachment of the trust’s capital (effectively requesting that funds from the sale of CHC be disbursed to them) did not conflict with the trustee’s independent exercise of their authority. The Court observed that it is “not unusual” for the trustee to require such a written request to formally indicate the beneficiaries’ desire to take funds out of the trust before making a distribution.
  3. Acquiescence to a beneficiary’s request does not mean that the trustee has given up management and control to the person making the request. In this case, Royal Trust Corp agreed to the beneficiaries’ request to hold back estimated tax on the disbursement of funds, rather than 25% as Royal Trust Corp had initially proposed.
  4. A trustee cannot always be expected to know the value of the trust’s investments. In this case, the value of the DHI shares was entirely dependent on the value of the CHC shares. The Court observed that “operational knowledge of CHC is not in the Trustee’s possession of control.” As a result, the Court did not consider this issue relevant to whether there was an infringement on Royal Trust Corp’s authority to manage and control Discovery Trust.
  5. Consultation with a beneficiary regarding a decision to be made by the trustee does not constitute a delegation of authority or responsibility by the trustee. In this case, Royal Trust Corp and one of the beneficiary’s advisors discussed the short-term investment of the holdback for taxes from the CHC sale proceeds.

In addition to dealing with the substantive matters raised by the reassessment, the judge had harsh words about the audit that led to the reassessment. In particular, the judge found that the outcome of the audit was essentially a foregone conclusion as it was conducted with an “overall negative view of the motive for minimization of tax.” The judge concluded that this “improper motive entered the discernment process and compromised in an apparent manner the integrity of an independent rationale for the findings upon which the reassessment could be based.”

In making these comments, the Court reminded tax authorities of the basic Duke of Westminster principle: taxpayers have the right to order their affairs as they see fit to minimize tax payable. The tax authority’s views as to the “morality” of tax planning should not enter into and dictate the result of the audit process.

Is the CRA bound by its agreements?

When a taxpayer enters into an agreement with the CRA in the course of an audit of a particular taxation year, the taxpayer likely expects that the CRA will not come back to audit and reassess that same year again. In an ongoing case in the Federal Court, Rosenberg v. Canada, the CRA is challenging this expectation, asserting that such an agreement does not and cannot limit its audit powers.

The taxpayer in Rosenberg was audited between 2008 and 2010 in relation to his 2006 and 2007 taxation years, with a focus on certain “straddle loss” transactions undertaken in those years. The taxpayer ultimately reached an agreement with the CRA in 2010. The taxpayer alleges that the CRA agreed not to reassess the 2006 and 2007 taxation years, except to make one specific adjustment, on the condition that the taxpayer agree not to engage in any similar straddle loss transactions in the future.

In January of 2013, the CRA commenced a second audit of the taxpayer’s 2006 and 2007 tax years and, as part of the second audit, served the taxpayer with a request for information under section 231.1 of the Income Tax Act. The information requested was in relation to the transactions that were the subject of the 2010 agreement.

The taxpayer’s challenge to the CRA’s second audit had a clumsy procedural start, beginning with an application to the Quebec Superior Court, which concluded that it did not have jurisdiction over the matter. Once that decision was affirmed by the Quebec Court of Appeal, the taxpayer commenced an action in Federal Court to enforce the agreement by seeking declaratory and injunctive relief. The Crown moved to strike the action on the basis that, inter alia, it disclosed no cause of action.

In Rosenberg v. Canada, 2015 FC 549, Madam Justice Bédard refused to strike out the action. Instead, she converted it into an application for judicial review of the Minister’s exercise of her audit powers, which is the proceeding the taxpayer ought to have commenced in the first place. Bédard J. ordered that the matter be specially managed so that a hearing on the merits can be scheduled as soon as possible.

The Crown’s positions are as follows:

  1. The CRA denies that it agreed never to reassess the 2006 and 2007 taxation years under the 2010 agreement. Rather, the agreement was that the CRA would not reassess beyond the agreed upon adjustment at that particular time on the basis of the information it had received from the taxpayer up to that point.
  2.  

  3. Even if the CRA did agree never to reassess the taxpayer for those years, such an agreement did not operate to waive the CRA’s audit powers.
  4.  

  5. Even if the CRA did agree never to exercise its audit powers against the same transactions in 2006 and 2007, such an agreement would be unenforceable. It would be illegal for the Minister of National Revenue to waive the audit powers conferred on her by the Income Tax Act because she has a duty to administer and enforce the Act and the audit powers are necessary to carry out those responsibilities.

The majority of income tax disputes are settled, whether at the audit stage, on objection, or after an appeal has been commenced in the Tax Court of Canada. Settlements at the litigation stage are enforceable under subsection 169(3) of the Income Tax Act (SoftSim Technologies Inc. v. The Queen, 2012 TCC 181), but there is no similar provision giving the CRA the authority to bind the Minister to an agreement in the course of an audit or objection.

In the vast majority of cases, an agreement with the CRA will be honoured and will resolve a dispute about a particular taxation year. Typically, the CRA agrees to reassess the taxpayer in a particular way and the taxpayer signs a waiver of her appeal rights in respect of that reassessment. However, taxpayers should be aware that the matter is not necessarily at an end, as such an agreement may not bind the CRA never to reassess that year.

We will continue to monitor the Rosenberg case with interest.

Is solicitor-client privilege for tax lawyers under threat?

A recent case out of the Federal Court is causing a stir in the tax community. In Canada (National Revenue) v. Revcon Oilfield Constructors Incorporated, 2015 FC 524, Mr. Justice Mosley made the following statements, which might suggest that a lawyer’s advice on tax planning matters is not subject to solicitor-client privilege:

Tax planning communications are not privileged. Also, facts that exist independently of a communication are not privileged: Belgravia, above, at paras 44-45.

Advice given by an accountant (or, I would add, by a lawyer for accounting or tax planning purposes) does not fall within the scope of solicitor-client privilege: Canada (National Revenue) v Grant Thornton, 2012 FC 1313 at para 22.

Read in isolation, these statements are alarming. Tax is an area in which clients often need extensive professional legal advice in order to understand and comply with the law. The Income Tax Act is the longest and most complex piece of legislation in Canada. While taxpayers are entitled to structure their affairs in order to minimize their tax obligations, running afoul of the requirements of Income Tax Act can result in severe penalties and even criminal charges.

Solicitor-client privilege has long been held to be an essential part of the Canadian legal system and is close to absolute. Special protection is afforded to communications between solicitors and clients to promote open communication between the lawyer and client, ensuring the client’s interests can be fully represented.

Despite initial appearances, the decision does not represent a radical erosion of privilege in relation to tax advice. When read in the context of the facts of the case and in light of the existing jurisprudence, there is no suggestion that a lawyer’s legal advice in relation to tax matters falls outside the scope of solicitor-client privilege.

As the judge in Revcon notes, a communication between a solicitor and a client is privileged where:

  1. legal advice is sought from a lawyer in her capacity as such;
  2. the communications relate to that legal advice; and
  3. the communications are made in confidence.

The “tax planning communication” referred to by the judge is an instance in which a lawyer gives accounting or business advice or deals with administrative transactional matters as opposed to giving legal advice. In this regard, it is useful to look at the facts and result in Revcon for clarity.

In the course of an audit, the CRA sought the production of documents from the taxpayer in relation to a corporate restructuring. The taxpayer refused to produce the documents, claiming solicitor-client privilege. The judge viewed the disputed documents for the purpose of determining whether they were privileged. While the judge held that the contents of a closing book (such as corporate board resolutions, shareholder agreements, and share purchase agreements) are not privileged as they are evidence of completed transactions as opposed to legal advice, he found that the following documents are protected by privilege:

  • a series of emails between a lawyer and the client pertaining to legal advice;
  • a letter from a lawyer to the client regarding income tax reporting requirements and tax consequences of the transactions;
  • charts illustrating the corporate structure before and after the reorganization; and
  • reporting letters from law firms containing advice relating to the tax obligations of the taxpayer’s directors and shareholders arising from the corporate reorganization.

Despite the judge’s statements that tax planning communications are not privileged, he did not conclude that any document containing legal advice was not privileged because it was a tax planning communication. His conclusions are exactly what one would expect in light of the well-established principles of solicitor-client privilege.

Thus, there is little cause for concern over the judge’s comments about tax planning. The case confirms that where a tax lawyer provides advice in relation to the tax consequences of a transaction or provides advice on the most tax efficient method of structuring a transaction –commonly referred to as tax planning advice – that advice will be privileged.

BC Expands Sales Tax Registration and Collection Requirements

A recent amendment to British Columbia’s Provincial Sales Tax Act extends the requirement to register for, and collect, the 7% provincial sales tax (“PST”) to any business located outside BC that holds inventory in BC for sale to a person in BC.

The new section 172.1, which will start to apply on September 1, 2015, generally requires PST registration and collection by a person that:

  1. accepts purchase orders originating in BC;
  2. sells goods to a customer in BC for the customer’s use (not resale); and
  3. holds the goods in inventory in BC at the time of sale.

Any person caught by this rule who fails to register once the amendment is in force may be subject to a penalty equal to the PST not collected, plus an additional 25% penalty along with other penalties and interest.

We understand the change was designed primarily for non-resident sellers that hold inventory in third-party warehouses in BC for sale to BC consumers.  We note, however, that the  change applies to more than just consumer sales; for example, sellers of industrial  goods, including those whose goods are being held in BC on consignment, may also be required to register and either collect PST or  obtain the appropriate exemption certificates from their customers. Section 172.1 does not apply to a person that sells only tax exempt goods, such as food.

This blog was co-written by Rosemary Anderson and Noah Sarna