Tax Blog

Businesses wary of PST penalties, even if customers remit directly

This past Tuesday, April 1, 2014, marked the one-year anniversary of the new PST and the kick-off of audit season under BC’s Provincial Sales Tax Act (PSTA).  Businesses have reason for concern: despite significant confusion surrounding the implementation of the new PST, a larger tax base than the old PST and repeated legislative amendments, the province intends to put to use the very harsh penalty provisions in the PSTA for a failure to collect PST, which are more onerous than those that applied to the old PST.

The Ministry of Finance confirmed recently that, if a seller fails to charge PST on a taxable sale, the Minister may assess a penalty on the seller equal to 110% of the tax: a mandatory penalty of 100% for not charging the tax, and a discretionary penalty of 10% for not remitting the tax to the province.  BC’s budget bill, which was made into law two weeks ago, includes an amendment to the PSTA that gives the province the discretion to reduce the failure to levy penalty down from 100% if the seller can prove the customer remitted the tax directly, but – even still – a 10% failure to remit penalty would remain.

For example, in a business-to-business relationship, a seller may mistakenly believe that an exemption certificate provided by the customer for goods valued at $100,000 qualified for an exemption.  Following best practices the customer remits the $7,000 owed on the purchase on its next return.

In this setting, the PSTA provides that the Minister could assess the collector $7,000, despite the remittance from the customer.  Alternatively, the Minister could assess $700 but only if the customer is willing to provide proof of its remittance to the seller.  In that case, the province would gain $700 even though it received all the tax on time.

Additionally, the province also has the power to hit the seller with an extra 25% penalty if the seller wrongly concluded there was no need to register for PST.

Given how the new PST was rolled out and the differences from the old PST, the use of a strict penalty policy would be unreasonably harsh, and businesses need to be given a clear and fair picture of when and why penalties will be imposed.

This blog was co-authored by Rosemary J. Anderson.

Tax Court Confirms that the Minister is Not Above the Law

The decision in Fio Corporation v. The Queen, 2014 TCC 58 is an interesting and recent example in which the Minister’s attempt to gain exemption from well-established and long standing rules of litigation was met with censure from the court. In Fio, the rule in question was the rule of implied undertaking that is engaged in the discovery process.

The implied undertaking rule is fundamental to fairness in litigation and the leading Supreme Court of Canada decision of Juman v. Doucette, 2008 SCC 8 left no doubt about the existence, scope or importance of the rule. In brief, the rule provides that documentary or oral information obtained by a party through the disclosure or discovery process in the course of litigation is received by that party pursuant to an implied undertaking. This undertaking  forbids use of the information by the party outside of the litigation and the implied undertaking remains in force “unless and until the scope of the undertaking is varied by a court order or other judicial order or a situation of immediate and serious danger emerges.” (Juman, para.4)

As described in Juman (at para.24-26) the purpose of the rule is to ensure full and complete candour in discovery, and to balance privacy interests with the “public interest in getting at the truth in a civil action.” “The answers and documents are compelled by statute for the purpose of the civil action and the law thus requires that the invasion of privacy should generally be limited to the level of disclosure necessary to satisfy that purpose”.

In Fio, the Minister reassessed the Appellant/taxpayer for 2007 and 2008. A Notice of Appeal was filed and the Appellant provided various documents to the Minister as part of the discovery process. The Minister subsequently reassessed the Appellant and admittedly did so, in part, on the basis of the documents that the Appellant had provided.

The Appellant argued that the Minister had breached the implied undertaking and, as a result, should be prohibited from using the information and subject to sanction through a significant award of costs. In response, and perhaps surprisingly, the Minister argued that she is not a “normal litigant” and therefore not subject to the implied undertaking rule. (para.24)  In addition, the Minister argued that s.241 of the ITA is a “complete code” governing how taxpayer’s information can be used this overrides the implied undertaking. (para.27)

Both of these arguments were rejected. To begin, the Court held (para.48): “I cannot accept an argument that provides more favourable treatment to one of the parties before the Court.” Therefore, the Respondent “like all parties, is subject to the implied undertaking rule.” (para.50)

It follows that if the Respondent wanted to use the documents for purposes outside of the litigation, it was required to apply to the court to vary the implied undertaking. Finally, and with respect to the application of s.241, the court found that the statutory scheme which prohibits the use of taxpayer information “does not override common law rules, such as the implied undertaking rule.” (para.58)

These conclusions of the court are certainly important for confirming that the Minister is not a “special litigant” who is not bound the rules. However, the court’s analysis of remedy is equally and, perhaps more important.

The Appellant applied to have the assessment vacated on the basis of the Respondent’s improper conduct. In its consideration of this application, the court in Fio observed that as the tax court is “the only superior court that has jurisdiction to vacate an assessment” (para.68), and an assessment may be vacated “if it is found not to be valid or if it is found not to be correct” (para.68)  In addition, and more interestingly,  “the Court may vacate an assessment under its implied jurisdiction to control its own process and ensure proper functioning as a court of law.” (para.69)  (Emphasis added)

Therefore, on the basis that the Tax Court “is both a superior court and a statutory court… any statutory limits placed on the Tax Court’s jurisdiction when disposing of an appeal of an assessment (or reassessment) do not apply in respect of a breach of an implied undertaking.” (para.71)  As a superior court which has jurisdiction to control its own process, “the Court may vacate an assessment if it believes it is the appropriate remedy for the breach of an undertaking to the Court.” (para.71)

In the result, the court found that the use of the documents by the Minister amounted to an abuse of process and the Appellant was awarded costs in the amount of $25,000. The court also prohibited the Minister from making use of the documents, but the court did not vacate the assessment, giving the Minister an opportunity to attempt to continue the litigation without the benefit of the documents.

Law does and must continue to evolve and the evolution is propelled, at least in part, through novel arguments that are advanced by either party in litigation. However, there is perhaps a distinction between novel argument and argument that attempts to rewrite the law in favour of one of the parties.

Courts oversee and control the processes before them and in so doing, courts have, and must have the jurisdiction to regulate the conduct of the parties. When appropriate, courts must also grant remedy based upon improper conduct. In Fio, the court has now clarified and confirmed that the Tax Court has jurisdiction to grant remedy for unfair, illegal or improper conduct by the Minister.

Guindon and s.163.2 Penalties: The Next Stop is the SCC

On March 20, 2014 the Supreme Court of Canada granted leave to appeal in the case of Guindon v. The Queen.  If one had been listening closely on that Thursday morning, it is likely that one could have heard both gasps and cheers from the various lawyers, CRA officials and tax advisers who have been following the Guindon case since the Tax Court first released its decision on October 16, 2012. In order to understand the gasps and cheers, and in order to engage in some idle prognostication with respect to how the Supreme Court of Canada might ultimately decide this case, it is necessary to recap.

Guindon is a lawyer, but not a tax lawyer. She issued an opinion on the tax implications of what was called The Global Trust Charitable Donation Program. That opinion was included in the promotional materials for the Program. After the Program had been in operation and monies were donated and charitable donation tax receipts were issued, the Minister assessed Ms. Guindon penalties pursuant to 163.2 of the ITA.

On appeal of the assessment, the Appellant, Ms. Guindon argued, and the Tax Court agreed, that 163.2 is in its nature, criminal rather than civil. This argument was premised upon the severity of the penalties imposed under 163.2.  In its introductory remarks, the Tax Court (2012 TCC 287) noted the significance of its conclusion (para.5):

Such a finding would entail far‑reaching consequences. In fact, if it is found that section 163.2 of the Act leads to a true penal consequence, then the protection of section 11 of the Canadian Charter of Rights and Freedoms (the “Charter”) will apply to guarantee fundamental substantive and procedural legal rights to any individual charged with an offence under section 163.2. Notably, the right to be presumed innocent would raise the burden of proof from that of proof on a balance of probabilities to proof beyond a reasonable doubt.

In the result, the appeal was allowed and the assessment was vacated.

An appeal was, of course, immediately launched and those who had applauded the decision of the Tax Court held their breath. On June 12, 2013 the hopes of those who disagreed with the Tax Court were rewarded and the Federal Court of Appeal overturned the Tax Court. The reasons were forceful. First, the appellate court held that the Tax Court did not even have jurisdiction to arrive at the result it did because, in order to engage the constitutional question a notice of constitutional question was required to have been served and this had not been done. (para.3)  In addition, and in case the court was wrong on this first issue, the appellate court went on to find that  “proceedings under section 163.2 are not criminal by their nature, nor do they impose true penal consequences. (para.5)

The Supreme Court of Canada may grant leave to appeal where the Court “is of the opinion that any question involved therein is, by reason of its public importance or the importance of any issue of law or any issue of mixed law and fact involved in that question, one that ought to be decided by the Supreme Court…”.

In 2010, the Supreme Court granted leave on 55 of the 388 leave applications that were made. In 2011, leave was granted in 69 of the 449 applications and in 2012, leave was granted in 69 of the 468 applications that were made.

Therefore, as a statistical matter, it is more likely than not that for any application, leave will not be granted. Against these odds, in Guindon leave to appeal was granted and, thus, to the delight of some and disbelief of others, the case and the important constitutional issue will move to the third and final court.

So what happens next? To begin, hopefully some groups will apply to intervene so that the relevant legal and constitutional issues can be fully canvassed on the appeal. Next, anyone who has a 163.2 case would be well advised to give careful consideration as to whether a notice of constitutional question should be filed.

What the Court might ultimately decide is, of course a guessing game. However, one can be certain that because leave was granted, the Court will not dismiss the appeal on grounds that an appropriate notice had not been filed at the Tax Court. Indeed, serious constitutional issues such as this is should not be so easily dismissed.

Next, and as has been seen in recent decisions from the Supreme Court, the Court properly and dutifully performs its role in measuring legislation against constitutional standards. Therefore, it is certain that if s.163.2 is properly characterized as criminal rather than civil, the Court will make such a declaration and the ripple effect from that of providing required constitutional protections will simply need to be contended with.

There is undoubtedly a sense that because the automatic application of certain penalties contained within the ITA can be crushing in their effect, that the penalties can, for that reason, also be unfair. Therefore, and while this is admittedly not legal argument, there is for some an intuitive attractiveness to the rebalancing that would come from providing greater protection to those who might be subject to such penalties.

It will be some months before the Guindon appeal is heard and then, likely some more months before the case will be decided. Until then, tax practitioners should be asking themselves, if s.163.2 is possibly criminal, rather than civil in nature, what other penalty provisions within the ITA might also be vulnerable to this same attack?

A Fix for Paragraph 85(1)(f) of the Family Law Act?

British Columbia practitioners were shocked by paragraph 85(1)(f) of the Family Law Act (British Columbia), which was brought into force on March 18, 2013, because it effectively presumes that property held by a discretionary trust is 100% owned by a spouse/beneficiary for the purposes of the division of family property rules. Specifically, paragraph 85(1)(f) provides that to the extent that property held by a discretionary trust has grown in value from marriage, or the beginning of a common-law relationship, until the settlement of the division of family property claim following a separation that property is “excluded property”. Excluded property is a subset of family property; only the growth in value of excluded property is family property.

Section 96 of the Family Law Act provides that the British Columbia Supreme Court normally cannot order a division of excluded property. However, this means that a spouse/beneficiary will be required to account for the growth in assets of a discretionary trust as his or her family property even though the spouse/beneficiary may never receive any assets from the trust. It is only a presumption because subsection 95(1) of the Family Law Act permits the British Columbia Supreme Court to order an unequal division of family property if it would be “significantly unfair” to divide family property equally.

Given that paragraph 85(1)(f) can apply to spouse/beneficiaries of trusts created many years ago (see section 252 of the Family Law Act), it is easy to envisage situations where multiple claims could be made against spouse/beneficiaries of the same trust in respect of the same trust property.

A detailed discussion can be found in Property Held by Discretionary Trusts and the Family Law Act which is a paper presented at the 2012 British Columbia Tax Conference sponsored by the Canadian Tax Foundation.

On March 3, 2014, the British Columbia government tabled Bill 14, Justice Statutes Amendment Act, 2014 which proposes to change, inter alia, paragraph 85(1)(f) of the Family Law Act so that only a spouse’s beneficial interest in property held by a discretionary trust (i) to which the spouse did not contribute and (ii) that is settled by a person other than the spouse will be excluded property.

Existing paragraph 85(1)(f) avoids the difficulties associated with valuing an interest in a discretionary trust by providing that the property of the trust is excluded property. Draft paragraph 85(1)(f) provides that only a spouse’s beneficial interest in the property held by a discretionary trust is excluded property.

Although it is trite trust law that the beneficiary of a discretionary trust normally has no beneficial interest in trust property, it is unlikely that the British Columbia Supreme Court will treat draft paragraph 85(1)(f) as a nullity because that language should be read in a common rather than technical fashion and in a fashion that permits draft paragraph 85(1)(f) to serve a useful purpose (see for instance Williams v. R. [2005] 4 C.T.C. 2499).

Will draft paragraph 85(1)(f) invite judges of the British Columbia Supreme Court to attach significant value to a spouse’s beneficial interest in the property held by a discretionary trust as was done in Sagl v Sagl, [1997] OJ No. 2837 (OCJ Gen. Div.) where Macdonald, J. acknowledged that a pro rata valuation of an interest in a discretionary trust involved “turning trust law upside-down”? Normally, that will not be possible because the Family Law Act, unlike the old Family Relations Act (British Columbia), provides in paragraph 87(a) that the value of family property must be based on its fair market value.

While you might question the way in which draft paragraph 85(1)(f) proposes to fix the existing problem, perhaps the intention is to leave the status of discretionary trusts as uncertain under the Family Law Act as under the Family Relations Act. The Family Relations Act was first enacted in 1978 and I believe it is reasonable to say that the status of an interest in a discretionary trust is a family asset has never been clearly resolved. Certainly, this is an issue still being debated in division of family property disputes under the Family Relations Act. I think most would agree that the “old status quo”, although less than perfect, is significantly better than the “new status quo.”

Section 73 of the Justice Statutes Amendment Act, 2014 provides that the changes to the Family Law Act come into force by regulation rather than by Royal Assent. Accordingly, draft paragraph 85(1)(f) will not apply with retroactive effect.

Big Brother Gains a Powerful New Tool

Earlier this month, the federal government announced that it had reached an agreement with the U.S. to ameliorate the more drastic effects of the Foreign Account Tax Compliance Act (FATCA). The announcement came mere days before the 2014 Federal Budget was released, and was thus, understandably, lost in the fray – especially considering the significance of some of the Budget’s tax measures.  As a result, the intergovernmental agreement received relatively little fanfare and most Canadians remain unaware of how it provides the CRA and IRS with a powerful new tool for collecting personal information.

As many will recall, FATCA was enacted by the U.S. government in March 2010 and was designed to curb international tax evasion by requiring disclosure of information relating to offshore accounts maintained by U.S. citizens, corporations, partnerships, or trusts. Individuals have been subject to self-reporting under FATCA for years, and foreign financial institutions (FFIs) will generally be subject to similar obligations as of July 1, 2014. Failure to adhere to FATCA generally results in a punitive 30% withholding tax rate on outbound, U.S.-source payments (and potentially other consequences such as closure of the recipient’s account).

In essence, the intergovernmental agreement provides for the automatic exchange between Canada and the U.S. of certain information relating to accounts maintained by persons subject to tax in the other country. For example, bank accounts maintained by Canadian residents who are also U.S. citizens will generally be subject to the new reporting regime. One issue with the agreement, however, is that instead of FFIs reporting information directly to the IRS, the CRA is now interposed as an intermediary. While some of the consequences associated with FATCA (for example, the punitive withholding tax) have been mitigated, the concern is that now two taxing authorities are to be given personal banking information instead of just one.

Not all financial institutions are subject to the new rules (for example, smaller credit unions are exempt). Certain types of accounts, such as deferred income plans (e.g., RRSPs, RRIFs, TFSAs etc.) will also be exempt from the reporting requirements. However, given the nature of the Canadian banking industry (dominated as it is by the Big Five), most bank accounts will be caught. In addition, the due diligence procedures to which Canadian banks will have to adhere as of June 30, 2014 (likely resulting in detailed account-opening questionnaires) are exceedingly extensive.

The information to be disclosed by Canada to the IRS in respect of Canadian bank accounts maintained by U.S. Persons (as defined in the agreement) includes:

  • the name, address, and federal taxpayer identifying number (TIN) of the account holder;
  • the account number and year-end balance/value; and
  • the total amount paid or credited to the account holder in the year.

Similar information is to be provided by the U.S. government to the CRA in respect of U.S. accounts maintained by Canadian residents. Pre-existing accounts are grandfathered, but rules requiring FFIs to obtain the TINs of each such accountholder are required to be in place by January 1, 2017. This means that Canadian banks will, in relatively short order, need to obtain and disclose to the IRS the SIN of each existing accountholder.

Draft legislation amending the Income Tax Act (Canada) to implement the intergovernmental agreement was released the same day. The legislation proposes to introduce new Part XVIII, which, among other things, requires Canadian financial institutions not exempt from the new reporting regime to file a prescribed form by May 2nd of the following year. Comments on the draft legislation are open until March 10, 2014.

Ultimately, those who should worry most about the new intergovernmental agreement are U.S. citizens living in Canada. The time for them to voluntarily get up to speed with their U.S. tax filing obligations is quickly diminishing, and the new agreement is just a sign of the increasingly pervasive nature of governmental scrutiny.

Highlights of the 2014 Federal Budget

On February 11, 2014, the Minister of Finance released the federal government’s 2014 Budget. The Budget continued last year’s theme of “closing tax loopholes” and “improving the fairness and integrity of the tax system,” and to that end proposed a number of specific amendments to the Income Tax Act (Canada) (the “Act”). The Budget also announced the federal government’s intention to consult on the possible introduction or elimination of certain significant income tax rules and regimes.

Below is a summary of the more significant income tax proposals outlined in the 2014 Budget.

  • Kiddie Tax Extension – The so-called “kiddie tax” limits the ability to income-split with minors by applying the highest marginal tax rate to certain types of income earned by that minor, including: taxable dividends received from private corporations; capital gains realized on the disposition of private company shares to a non-arm’s length person; and income earned through a partnership or trust from the provision of property or services to a business carried on by a related person.

    The 2014 Budget announced the extension of the kiddie tax to a new type of income: income earned through a partnership or trust from business or rental activities conducted with third parties, if a person related to the minor either, in the case of a partnership, has an interest in the partnership or is actively engaged on a regular basis in the activities of the partnership or trust. In essence, these amendments further restrain the ability to income-split with minor children through a partnership or trust. This measure will apply to 2014 and subsequent taxation years.
  • Loss of Graduated Rates for Testamentary Trusts – Following the announcement made in the 2013 federal budget, the 2014 Budget proposes to apply flat top-rate taxation to all testamentary trusts (including estates), except to estates during their first 36-month “administration period.” In addition, testamentary trusts (except estates during their first 36 months) will lose their entitlement to certain tax-related benefits, including the ability to choose an off-calendar year-end, the basic exemption in computing alternative minimum tax (AMT), and the exemption from the income tax instalment rules. These measures will generally apply to 2016 and subsequent years.
  • Loss of Immigrant Trusts – Under the Act, a non-resident trust is deemed to be a resident in Canada if, generally, a Canadian resident has contributed to the trust. A main, long-standing exception to this rule is with respect to a so-called “immigrant trust,” which is a trust the only contributors to which are persons who have been resident in Canada for fewer than 60 months.

    The 2014 Budget proposes to eliminate the 60-month exemption on the basis that it raises “tax fairness, tax integrity and tax neutrality concerns.” As such, immigrant trusts have effectively become a thing of the past. The measure will apply to taxation years that end after 2014 for existing immigration trusts and that end on or after Budget Day in any other case.
  • International Back-To-Back Loans – The thin capitalization rules generally limit the deductibility of interest expenses by a corporation or trust where the total of all debts owing to specified non-residents exceeds a 1.5-to-1 debt-to-equity ratio. In addition, Part XIII of the Act generally imposes a 25% withholding tax (subject to reduction under a tax treaty) on interest paid or credited to a non-arm’s length, non-resident person.

    According to the 2014 Budget, some taxpayers have attempted to circumvent the application of those rules by establishing so-called “back-to-back” loan arrangements with an intermediary. That is, a third party (e.g., a foreign bank) is interposed between two related taxpayers in order to avoid the thin capitalization rules and withholding tax imposed by Part XIII. The 2014 Budget proposes to curtail the use of those arrangements by treating those arrangements as loans made directly by the relevant non-resident. These measures will generally apply after 2014.
  • Offshore Regulated Banks – The foreign accrual property income (FAPI) regime requires that certain types of passive income, including income from an investment business, earned by a non-resident corporation that is controlled by a Canadian resident (a “controlled foreign affiliate”) be included in the Canadian taxpayer’s income on an accrual basis. One of the exceptions to this rule is for an investment business carried on by the non-resident as a foreign bank where the activities are regulated under the laws of the country in which the business is carried on.

    Certain Canadian taxpayers that are not financial institutions have qualified for this exception by subjecting their controlled foreign affiliate to regulation under foreign banking laws. Budget 2014 indicates that the purpose of this rule was not to allow the affiliates to invest or trade securities on their own account and thus will add new conditions for the availability of this exemption, including that the Canadian resident be a regulated financial institution or that more than 50% of the taxable capital employed in Canada by the taxpayer is attributable to taxable capital employed in Canada by regulated financial institutions. This measure will apply to taxation years that begin after 2014.
  • Consultation on Proposed Treaty Shopping Rules – The 2014 Budget reiterated the government’s opposition to “treaty shopping” and proposed to introduce a “main purpose” provision in the Act whereby a tax benefit provided under a treaty would not be available to a party involved in a transaction if the main purpose of that transaction was to obtain the benefit. In the absence of proof to the contrary, the requirement would be presumed satisfied if the relevant income is primarily used to make transfers to others who would not have been entitled to an equivalent treaty benefit.

    Parties interested in providing comments on the proposed treaty shopping rules are requested to do so within 60 days after Budget Day.
  • Consultation on the Possible Elimination of the Eligible Capital Property (ECP) Regime – The 2014 Budget announced the government’s intention to consult on the possible elimination of the ECP regime, which generally deals with property such as goodwill and other intangibles not included in a class of depreciable property. The rules relating to ECP have been in place for decades, and the government’s stated impetus for seeking their removal is because those rules have “become increasingly complicated” and certain stakeholders have apparently suggested simplifying the regime.

    Generally, the 2014 Budget proposes to replace the ECP regime with a new class of depreciable property to which the capital cost allowance (CCA) rules would apply. Instead of 75% of an eligible expenditure being included in the taxpayer’s cumulative eligible capital pool, which may be deducted at the rate of 7% per year on a declining-balance basis, the proposals would see 100% of any eligible expenditure being included in a new CCA class of which 5% may be deducted per year on a declining-balance basis.

    Specific legislation, including transitional rules, is expected to be released for public consumption in the near future, after which stakeholders will be invited to submit their comments to the Department of Finance.

Foreign Affiliates

CRA narrowly interprets foreign affiliate income recharacterization rule. In 2012-0439661I7 (released February 5, 2014), the CRA narrowly construed the foreign affiliate income recharacterization rule in s. 95(2)(a)(i), which can operate to convert income from property (FAPI) of a foreign affiliate (FA 1) into active business income where: (A) the income from property is directly related to the active business activities of another foreign affiliate (FA 2), and (B) such income would be included in the active business income of FA 2 if that income had instead been earned by FA 2. The facts involved passive income generated in FA 1 from the investment of surplus funds which were earmarked for future (active business) projects in FA 2. The CRA said this did not meet the threshold for recharacterization on either branch of the above two-part test. More specifically:

  1. The concept of “directly related” in (A) requires a relationship of immediate closeness or causality, such that the investment of funds would not have occurred but for current active business activities in FA 2. The asserted link here was to a future activity in FA 2, which was not sufficient to meet the first test.
  2. In any event, in order to satisfy the hypothetical in (B) of otherwise being included in FA 2’s active business income, the active business of FA 2 must have a substantial financial relationship of dependence on the surplus funds – such that the funds are truly employed and risked in the existing business, and their removal from the existing business would have a decidedly destabilizing effect (Atlas Industries Ltd. v. MNR; Ensite Ltd. v The Queen; March Shipping Ltd v. MNR). The simple holding of surplus funds for future projects of FA 2 would not meet this hypothetical second test.

Taxpayer not entitled to challenge arrears interest in a nil assessment situation

In the recent decision of Nottawasaga Inn. Ltd. v. R. (2014 DTC 1021), the Tax Court of Canada (“TCC”) held that it had no jurisdiction to hear an appeal from a reassessment of arrears interest where there exists a nil assessment of taxes and the sole basis for the appeal is not the calculation of the interest itself but the computation of the underlying taxable income on which the interest was calculated.

The taxpayer in Nottawasaga reported nil income for the 2007 taxation year after claiming a deduction for capital cost allowance and other expenses. The Minister of National Revenue (the “Minister”) reassessed the taxpayer to deny various expenses and also reduced the taxpayer’s capital cost allowance claim after reclassifying the taxpayer’s capital assets into different classes that had a lower rate of depreciation. The result of the reassessment was to increase the taxpayer’s taxable income from nil to $144,166 and to require payment of arrears interest of $6,027.

Faced with this reassessment, the taxpayer requested that a loss carry-back of $144,166 from the 2010 taxation year be applied against its 2007 taxation year, thereby reducing the taxable income to nil. The Minister agreed with the taxpayer’s request and issued another reassessment that showed the income inclusion of $144,166 being offset by the loss carry-back, with the result that no tax was payable for the 2007 taxation year. The reassessment, however, made no adjustment to the arrears interest of $6,027. The taxpayer appealed the arrears interest on the basis that the Minister erred in her reclassification of the taxpayer’s assets which, as a result, set the wrong tax amount on which arrears interest was calculated.

The TCC decision only deals with the jurisdictional issue of whether the taxpayer can challenge arrears interest by asserting that the underlying tax amount was incorrectly calculated where there is a nil assessment of taxes. The Minister argued that such a challenge was prohibited as it would effectively amount to a challenge of the underlying tax amount which the taxpayer has no right to appeal because no tax was payable.

As a general rule, it is true that taxpayers do not have the right to object or appeal an assessment of a nil amount. This is simply because there is nothing to appeal if there is no tax, interest or penalties payable. On the other hand, if the Minister issues an assessment to a taxpayer for interest payable, but there is otherwise no tax payable and the nil assessment of tax is not in dispute, the TCC acknowledged that taxpayers are entitled to object or appeal the assessment of interest. However, in dealing with a challenge to interest assessments, the court’s jurisdiction is generally limited to the following issue: whether the interest was properly calculated mathematically speaking or whether the interest was imposed in accordance with the Income Tax Act (Canada).

It follows that, when there is a nil assessment of taxes, a court has no jurisdiction to hear an appeal from an assessment of interest if the basis for the challenge is an error made by the Minister in computing the underlying tax amount on which the interest was calculated. This is precisely what the taxpayer was trying to do in Nottawasaga: it was not challenging the correctness of the calculation of the interest but the calculation of its taxable income. In other words, the taxpayer argued that its taxable income – not the interest – was incorrectly calculated due to the reclassification of its capital assets into different classes. This, in turn, resulted in the interest being imposed on the wrong underlying tax amount, according to the taxpayer.

The TCC rejected the taxpayer’s arguments and agreed with the Minister that it had no jurisdiction to hear the taxpayer’s appeal in this case. Instead of challenging the interest assessment, the taxpayer should have appealed the initial reassessment that increased its taxable income by $144,166 (i.e., the reclassification of its capital assets). However, the taxpayer chose not to do so and, instead, requested that a loss carry-back be applied to reduce its taxes payable to nil. It is therefore difficult to understand why the taxpayer should have been allowed to attack the reclassification for the purposes of challenging the arrears interest while the reclassification remained valid for the purposes of computing its taxable income.

Canco seconding it employees to foreign affiliate could generate FAPI

In 2013-0474431E5, a Canadian parent company (Canco) seconded employees to its foreign affiliate (FA).  The seconded employees represented 5% of the FA’s workforce engaged in providing services to arm’s length customers.  The FA reimbursed Canco the cost of its seconded employees plus a 25% mark-up. The CRA confirmed that Canco would be viewed as providing a service to the FA, such that 5% of the FA’s income would be considered “foreign accrual property income” (FAPI) under s. 95(2)(b)(ii).  Such FAPI would be taxed in Canco on a current basis.  The CRA also confirmed that this result could be avoided where the FA merely reimburses Canco’s costs without any mark-up, but only
if such cost-recovery represents an arm’s length fee under Canada’s transfer pricing rule in s. 247.  In such event, the activities of the seconded employees would not be considered part of Canco’s business. However, if s. 247 applies to impute a profit element to Canco (under applicable transfer pricing principles), the FAPI result would be the same as if Canco actually charged a mark-up.  In other words, where Canco actually earns a profit or is deemed to earn a profit (under transfer pricing principles), Canco would be viewed a providing a service to the FA such that s. 95(2)(b)(ii) would apply to treat 5% of the FA’s service income as FAPI.

CRA considers whether Brazilian tax on gain qualifies for foreign tax credit

In 2013-0512581E5, a Canadian company (Canco) sold shares of a Brazilian company (BrazilCo). The resulting gain was taxed in Brazil. The CRA said a foreign tax credit (FTC) would not be available to Canco under s. 126(1) because the gain was sourced to Canada, not Brazil (the sale contract was negotiated, signed, and executed in Canada and payment was made in Canada). However, the CRA said the gain was deemed to be sourced to Brazil under paragraph 2 of Article 22 of the Canada-Brazil tax treaty. A FTC was therefore available to Canco by reason of the treaty, with such FTC not to exceed its Canadian tax otherwise payable on the gain. (BrazilCo was apparently not a foreign affiliate of Canco.)