Friday 22 June 2012

IBC – A gateway for Canadian Corporations to the Caricom


The following will be published by Carswell in newsletter Privately Held Companies & Taxes and is reproduced here with permission.  I thought it would be of interest to readers expanding operations into the Caribbean. 


On November 8, 2011 the protocol to Barbados – Canada Income Tax Treaty was signed but has not been ratified by Canada as yet.  It is expected to be ratified this year.  The protocol now specifically addresses the IBC entity which was previously carved out of the treaty.  The Barbados – Canada Income Tax Treaty (“Treaty”) came into force in 1980.  The fact that the Treaty was so old meant that an IBC had to rely on the provisions of Regulation 5907(11.2) (c) of the Canadian Income Tax Act (“ITA”) in order to qualify as a foreign affiliate. (Regulation 5907(11.2)(c) provides that where a foreign entity has been carved out of a treaty signed prior to 1994 and where such treaty  has not been amended since but where  such foreign entity would qualify as a resident under the treaty in force then such foreign entity is accorded foreign affiliate status for the purposes of the ITA.  The IBC has always been an attractive entity for tax planning as it is subject to a maximum tax rate in Barbados of 2.5%.  Furthermore no withholding tax is levied on dividends and interest payments made by an IBC to another IBC or to a non-resident of Barbados. 

The protocol now extends treaty benefits to the IBC   but it should be noted that not all the provisions of the treaty apply to an IBC.  Specifically, Articles VI to XXIV do not apply to IBCs.  Consequently,  an IBC will not be able to benefit from the preferred treaty rates applied to payments in the form of dividends, royalties or interest derived from Canada and will be subject to a 25% withholding tax under the ITA.  The Protocol amends the residency determination provision (“the tie-breaker test”) to provide that where a company is deemed to be a resident of both Canada and Barbados, it will be deemed a resident of the country of which it is a national.  This amendment will  greatly reduce the difficulty of determining residency of an IBC for the purposes of Treaty.  Article IV of the 1980 Treaty refers to place of management as a criterion in determining residency of a corporation.  Garron (2012 SCC 14 (CanLII) however provides an illustration of the difficulty in determining place of management. 

The IBC provides a valuable gateway for Canadian business to access the Caricom markets.   Caricom is a free trade zone for countries in the Caribbean.  The Caricom now consists of 15 member countries including countries such as Suriname and Jamaica where Canadian companies are carrying out active mining activities.  An IBC structured correctly to meet the foreign affiliate definition of the ITA and the active business requirement will be able to distribute from its exempt surplus, consisting of active business income earned in certain Caricom  countries, dividends that will be received free from Canadian Income Tax by its Canadian corporate shareholders.  Under the Jamaica – Canada Income Tax Treaty, dividends paid from a Jamaican foreign affiliate to its Canadian corporate shareholder are subject to a Jamaican withholding tax rate of  22.5%.  Dividends paid from a Jamaican subsidiary to its Barbados shareholder is not subject to a Jamaican withholding tax under the Caricom double taxation agreement (“the Caricom Agreement”).  As the Caricom Agreement does not contain a limitation on benefits (“LOB”) clause, there are no barriers to utilising an IBC that is compliant with the foreign affiliate provisions of the ITA and the residency requirement of the Treaty for structuring investments into Caricom taking advantage of Barbados’s  position as a signatory to the Caricom Agreement Similar planning opportunities are also available under Barbados’s wide treaty network where the LOB clause is not present.

Ben Arrindell – International Tax Advisor, Bridgetown, Barbados.
Ben is an international tax consultant based in Barbados.  He is an advisor to the government of Barbados on international matters.  He has been a member of the Barbados government’s double taxation and bilateral investment protection treaty negotiation team since 1995 and has been a member of the United Nations Group of Experts on International Cooperation in Tax Managers for the past six years.  He is a former managing partner and international tax partner with Ernst & Young Barbados.

Sunita Doobay TaxChambers Toronto
Sunita Doobay’s tax law practice covers the full range of income taxation and income tax related matters with a primary focus on corporate tax. With a tax law background that spans over 20 years, she has provided tax advice on domestic and international tax issues to public and privately held companies.

Saturday 9 June 2012

R&D funding for collaborative Brazil-Canada projects




I am not sure why but when I think of Brazil and research I always think of Alberto Santo Dumont maybe because I adore the watch Cartier made for him and named after him.  For those of us who love watches, we have Alberto Santo Dumont to thank for the popularity of the wristwatch.   No, I am not going to go into the debate of who was the first inventor of the airplane the Wrights brothers or Santo Dumont ... However I do hope that we see many innovative projects resulting from the collaboration between Brazil and Canada  especially now through the new ISTPCanada program.

An often overlooked program for companies seeking bi-lateral research and development is the International Science and TechnologyPartnerships Inc. (“ISTPCanada”) has now launched an R&D collaboration program between Canada and Brazil.  This program is mandated by the Federal Government of Canada through Foreign Affairs and International Trade Canada (DFAIT) and provides an opportunity for a Canadian business to enhance its R&D with counterparts in Brazil.  Canada will provide up to $400,000 to Canadian company qualifying under the program.  It should be noted that this amount need not be repayable at the completion of the project.  If the Canadian entity is a Canadian university then the National Sciences and Engineering Council of Canada (“NSERC”) will award funding directly.  Under the Brazilian program, the Brazilian company will receive funding from the State it is carrying on research.


Should there be a judicially-created due diligence defence on the reporting of significant foreign property?

The following was co-authored with Darcy MacPherson and is published on TaxnetPro.  The article discusses whether a taxpayer can claim a due diligence defence for the failure to file Form T1135 - Foreign Income Verification Statement.  We argue no.  


            INTRODUCTION

 Since 1997 subsection 233.3(3) of the Income Tax Act[1](“Act”) mandates that Canadian resident taxpayers are required to file Form T1135 - Foreign Income Verification Statement - with their income tax returns where such taxpayers own specified foreign property with a cost amount of 100,000[2] or more.  Form T1135 is not required where the foreign property is personal property such as vacation property used by the taxpayer or personal property such as work of art, jewelry, rare books, stamps and coins. Failure to file Form T1135 will subject the taxpayer to a penalty of $25 a day up to a maximum of 100 days pursuant to subsection 162(7) of the Act.   There is no indication on the language of the statute that there is a defence of due diligence available when a taxpayer is late in filing this form.  Yet, in a recent case, Tax Court Judge Woods has clearly decided that the judiciary has the final say on the application of penalties.

In the view of the authors, there are problems with such an interpretation, on at least four levels.  First, as a matter as interpretation of taxing statutes, it is said that the taxpayer is always free to order his or her affairs so as to avoid liability to tax.  Thus, where a taxpayer does not do so, it lies ill in the mouth of the taxpayer to cry foul after litigation has commenced.  Second, as a matter of stare decisis, the case does not address other cases that have confronted the issue.  Third, as a factual matter, it is difficult to say how due diligence can be made on the facts of the particular case, or more generally.  Fourth, there are legitimate reasons that explain why a strict interpretation – meaning that the due diligence defence is unavailable in the case of a deliberate non-filing of the form –  is preferable, from a policy perspective.

I           THE FACTS

            In Douglas v. The Queen, 2012 TCC 73, a penalty was assessed against the taxpayer for the failure to file a form T1135 with respect to the 2008 tax year.  It is agreed that the tax return (and thus the form) was due on June 15, 2009, and was not filed until March 2010 (para. 5).  This is over 100 days late.  Therefore, the maximum penalty of $2,500 was imposed.  The taxpayer appealed, and represented himself. Under the informal appeal procedure, he claimed to have been duly diligent, and that therefore, the imposition of the penalty should be overturned.  The court agreed with the taxpayer.  The most directly relevant portion of the judgment (although we will refer to other portions further below) is as follows:

[14]         Although the penalty in subsection 162(7) is strict and Parliament has not provided for a due diligence defence, this Court has held that even strict penalties should not be applied if a taxpayer has taken all reasonable measures to comply with the legislation: Home Depot of Canada Inc. v. The Queen, 2009 TCC 281.

            In other words, the Court found that the actions of the taxpayer meant that it was appropriate to “read in” a due diligence defence where Parliament has not provided an explicit one.  Furthermore, the due diligence was not merely a theoretical possibility.  Mr. Douglas was entitled to use it on these facts.  As Her Honour puts it (at para. 17)

[17]         It has been my view that the judge-made due diligence defence should be applied sparingly. However, this is an appropriate case in which it should be applied.

While Tax Court Judge Woods claims that the defence should be “applied sparingly”, there is little to distinguish the facts of this case from that of those of many others.  For example, the Court says that it is “common knowledge in Canada” that a tax return can be filed late without negative consequences to the taxpayer if no tax is payable, by virtue of subsection 162(1) of the Act (para. 11).  The T1135 form says that the form is be filed with one’s tax return (para. 12).  To expect professional advice to be sought in these circumstances would not have been reasonable (para. 16).  The logic of Her Honour seems to be that the imposition of the penalty is inequitable, and that this inequity should not be visited upon the taxpayer.

II         ANALYSIS

A.                 Interpretation

Since 1935, it has been a basic principle of English and Canadian tax law that a taxpayer may organize his or her affairs in a way that seeks to avoid the application of tax.  See I.R.C. v. Duke of Westminster, [1936] A.C. 1.  From the point of view of the authors, the necessary corollary to this principle is that, if a taxpayer organizes his or her affairs in such a way that he or she is obligated by the rules to greater tax, or to make payments or other remittances to the government at a particular time, the taxpayer should be in no position to complain that had he or she organized his or her affairs in a different way, he or she would not have ben liable to these obligations.

This principle has been recognized by the drafters of the GAAR provision of the Act.  According to the Explanatory Notes to the GAAR provision subsection 245(3), Parliament recognized the Duke of Westminster principle that tax planning with the objective of attracting the least possible tax is a legitimate and accepted part of Canadian tax law.[3]


On the facts of Douglas, this would seem to suggest that since the taxpayer “made his bed” by not filing on time, he should not be allowed to avoid “lying in it”, that is, by paying the penalty.

B.                 Stare Decisis

1.                  General

Under the informal procedure, used in the Douglas case, the decision of the Tax Court Judge has no precedential value[4].  Therefore, it is clear that the Douglas case is not precedent-setting for future cases.  However, this is not the end of the issue of stare decisis.  Just because the Douglas case has no precedential value in future case cannot be read to allow the judge in Douglas to ignore prior cases.

It is virtually beyond debate that stare decisis has two components.  The first is horizontal stare decisis; the second is vertical stare decisis.  In terms of vertical stare decisis, this is the basic rule that a lower court is bound to follow the decisions of any court that is directly above it in the judicial hierarchy.  However, as far as the authors can tell, there are no higher court decisions that specifically contradict the holding in Douglas.  Therefore, vertical stare decisis is not really at play here.[5]

Horizontal stare decisis, on the other hand, is a critical component of this discussion. This element essentially holds that the Court as an institution should be relatively consistent in its application of the law.  In other words, one member of a court should not lightly depart from a precedent established by another member of the same court.  The authors have already written on this topic, in discussing the case of The Queen v. John H. Craig, a case with respect to which an appeal was heard by the Supreme Court of Canada on March 23, 2012.  There is no need to repeat ourselves.[6]    Below, we discuss both some recent case law dealing with the application of subsection 162(7) of the Income Tax Act, and the case of Home Depot Canada, on which Tax Court Judge Woods relies in reaching her decision.  In the view of the authors, the doctrine of stare decisis does not necessarily mean that there can be no change in the law.  However, in the Douglas decision, Her Honour paid insufficient attention to stare decisis in focussing her attention on the Home Depot case.

2.                  The Case Law

a.                   The Case Law on Point

                                                                                                   i.                  Asper

Tax Court Judge Woods was not without guidance on the proper interpretation of subsection 162(7) of the Income Tax Act.  In Leonard Asper Holdings Inc. v. Canada (Attorney General)[7] , a group of companies had not filed the required form, based on the belief that since the income from foreign property had been earned through Canadian money managers was to be reported to the taxing authorities by the money manager.  Therefore, the reasoning of the taxpayer was that Form T1135 did not need to be filed.  The Canada Revenue Agency disagreed, and assessed the penalty.  The case proceeded as a judicial review of the decision of an Agency official’s refusal of taxpayer relief, under an administrative program then in place at the Agency.  Just like in Douglas, the applicant taxpayer claimed confusion.  As the Court explains (at paras. 24-25):

The Applicant also submitted that the decision not to file the T1135 forms was the result of confusion. It cited guidelines on penalties associated with failure to file T1135 forms:

"No penalty will be assessed where it appears there was confusion concerning obligations and it is the first time a penalty is considered."

The Applicant submitted that if there was confusion with respect to the rules, then the CRA should have been more lenient about penalties. At the very minimum, the CRA should have accepted that the Applicant's representative was interpreting the rules in good faith, relying on accurate and timely reports being made to the CRA by money managers. It wrote: "The conclusion was wrong, but that does not detract from the reasonableness of the belief that the forms did not have to be filed."

Justice Mandamin responds to this argument as follows (at para. 40):

In my view, the Minister's delegate's reasons responded to the facts before him. He characterized the decision as a conscious decision by the Applicant's representative or the Applicant, one that was lacking due diligence rather than confusion. I find the reasoning draws a conclusion that was within the range of possible outcomes defensible on the facts. Moreover, since section 220(3.1) of the does not obligate the Minister to provide relief, the decision was clearly defensible in respect of the law as well as the facts.

Therefore, even though there was a specific program in place at the time to provide relief in appropriate circumstances, the Court indicated that the “confusion” on the part of the taxpayer was not attributable to a lack of clarity by the taxing authorities.  Rather, it was due to a lack of diligence by the taxpayer in fulfilling its obligations. 
It must be acknowledged that in Asper, the Court was engaged in a substantive review of the decision of an official (the “Minister’s delegate”) in an administrative-law context.  Also, the Court was reviewing the decision on a standard of reasonableness.  However, if the law demanded a due diligence defence on these facts, and the Minister’s delegate failed to even consider this issue, the authors would argue that the decision of the Minister’s delegate would have been unreasonable.  Given the result of the case, therefore, the sole conclusion to be drawn is that the due diligence defence is not available on these facts.  Therefore, given the similarity between the facts of this case and those presented in Douglas, if the due diligence defence was not available in Asper, there is little to distinguish Douglas and thus the same result should follow in the subsequent case.

                                                                                                 ii.                  Leclerc

The facts of Leclerc v. Canada, 2010 TCC 99 are even more similar to the Douglas case.  In Leclerc, the taxpayer has an expensive condominium in France, and did not report this in two non-consecutive years (2003 and 2006).  More accurately, because the taxpayer did not file his tax returns on time, the Forms T1135 for those years were also filed late.  From his other tax returns, the government knew that the taxpayer had this property (para. 12).  Though other factors were alleged to have contributed to his late filing, notably his studies and mental illness of his mother (see para. 9), Tax Court Judge Favreau upheld the imposition of the penalty.  This is also despite the fact that the administrative program that would have provided relief to the taxpayer had been withdrawn earlier by the taxing authorities, without notice to the taxpayer, even though the Agency knew that the change would affect him (para. 11).  As in Douglas, the total penalty was significantly higher than the total tax payable by the taxpayer for the years in issue (para. 13).  Nonetheless, the penalty was found to be appropriate.
In the end, therefore, the courts that had considered this issue prior to the Douglas decision found that the due diligence defence (even if there were one) had no application on facts similar to those before Tax Court Judge Woods.

b.                  The Home Depot Case

Interestingly, Tax Court Judge Woods does not even refers to either Asper or Leclerc.  Instead, Her Honour chooses to rely on the case of Home Depot of Canada Inc. v. Canada[8], a decision of Tax Court Judge Miller.  In this case, Deloitte Tax LLP was a company hired by the taxpayer to make its tax returns and other tax remittances, including the remittance of Goods and Services Tax collected pursuant to the Excise Tax Act, RSC 1985 c E15.  The remittance was sent to the wrong address by Deloitte.  The taxing authorities sought to impose a penalty for the lateness of the remittance. 
Tax Court Judge Miller writes as follows, with respect to the due diligence defence (at para. 12)

Can Home Depot avail itself of the due diligence defence? The Respondent argues that the jurisprudence relating to the development of the due diligence defence in tax matters supports a narrow, restrictive use of the term. The Respondent relies in large measure on comments of the Federal Court of Appeal in the 1998 decision of Canada (Attorney General) v. Consolidated Canadian Contractors Inc., to the effect that the defence is available in situations of uncertainty as to the correct amount to be paid on a timely basis. This approach appears to have been captured in the Government's Policy Statement P-237 dated July 28, 2008, which states:

Making a determination of due diligence
...
The CRA may accept a due diligence defence in a situation where a person remits or pays an amount that is less than the amount actually owed where that amount was arrived at after having made an incorrect assumption based on genuine uncertainty regarding the application of the ETA. In addition, in a situation where a person is a recipient who fails to report and remit the tax on a self-assessment situation and this failure can be attributed to an incorrect assumption based on genuine uncertainty over the application of the ETA, a due diligence defence may be accepted by the CRA. Also, the CRA may accept a due diligence defence where a person believed on reasonable grounds in a non-existent fact situation, which if it had existed, would have made the person's actions or omission innocent; that is, the person relied on a reasonable but erroneous belief in a fact situation. In any case, for a person to be duly diligent it must be clearly evident that despite making an incorrect assumption, or having an erroneous belief in a fact situation, all reasonable care has been taken to the best of the person's ability in ensuring that the correct amount was remitted or paid, and the return filed, when required.

Limitations on the application of due diligence
...
Late payment or remittance
The CRA would not generally accept a due diligence defence where the correct amount was paid or remitted after the due date. In particular, where the CRA determines that a person has complied with the obligation to collect the correct amount as required but has failed to remit this amount when required, the person's due diligence defence would not be accepted. It is the CRA's position that a person who has failed to take reasonable care to ensure that the correct amount was paid or remitted by its due date, has not exercised due diligence.

In Home Depot, the taxing authorities themselves had produced guidelines indicating that when a late remittance occurred notwithstanding the due diligence of the taxpayer, the penalty for such a late remittance would not be imposed.  These same guidelines continue on to explain what would be considered “due diligence” for the purposes of these guidelines, as well as what would generally not qualify.  With all due respect to Her Honour, this is in sharp distinction to the facts of Douglas.  There was no specific guidelines for a finding of due diligence mentioned in any of the cases involving the application of subsection 162(7).  Furthermore, in Home Depot, there was a genuine attempt on the part of the taxpayer at issue to comply with the requirements of the relevant statute on time.  In Douglas, the belief was not that he was making a genuine attempt to comply, but rather, the error was that the taxpayer believed that non-compliance would attract no negative consequences.  The authors discuss this issue in greater detail in the section immediately below.  For current purposes, however, it is sufficient to note the following. Home Depot arose under a different statute, with non-statutory guidance provided by governmental authorities (that the due diligence defence was potentially available, and the circumstances under which the defence was likely to be successfully invoked), and with a very different factual scenario (in that there was a genuine attempt by the taxpayer to comply with the statutory requirements).  These differences make it difficult for the authors to see why the Home Depot case is more persuasive than is either Asper or Leclerc.

C.                 Factual Concerns

Even if it were otherwise appropriate for there to be a due diligence defence available, in the view of the authors, it would be difficult to make out such defence on the facts of a case such as Douglas.  Nonetheless, the Court held as follows:

[15]         In this case, Mr. Douglas was not cavalier about his income tax obligations. As far as the evidence reveals, he was diligent in his compliance efforts and he acted reasonably, and competently. It was not suggested by the respondent that there was information readily available to Mr. Douglas that would have alerted him to this problem.

However, with all due respect to Her Honour, the authors have great difficulty with this holding.  With respect to the last sentence, the Act itself draws the distinction.  The distinction was not “buried” in a regulation that could not be found without special skills, nor located in an administrative bulletin not easily accessed without professional assistance.  The matter is evident on the face of the Act itself. 
While it is true that the Form itself says that it is to be filed “with your tax return”, the Form is very short (two pages).  Therefore, to fully explain the expectations of the taxing authorities in a variety of circumstances, including the particular scenario of a tax return where no tax would be payable could add significantly to the size and complexity of the form.  Forms should not be more complex than necessary.
The essence of the claim of the taxpayer is not that the taxpayer attempted to comply with his obligations under Income Tax Act.  On the contrary, in past years, the taxpayer had not submitted his tax documentation until well after the applicable deadline.  This implies that the taxpayer knew what the deadline was, and thus knew what his obligations were.  In the view of the authors, the taxpayer’s real complaint was that he was ill-informed as to the consequence of shirking his obligations.  In past years, there had been no real negative consequence to the late filing.  The taxpayer assumed that this treatment of his late filing would continue.  It did not. Rather, the administrative indulgence previously granted in situations such as that involving Mr. Douglas was changed.  This in and of itself is not sufficient to ground a remedy.  Although taken from a different context (notably the law of promissory estoppel in the law of contracts), the case of John Burrows Ltd. v. Subsurface Surveys Ltd.[9], per Justice Ritchie, for the Court, is instructive.  The granting of an indulgence, even on multiple occasions, does not, in and of itself, change the legal relationship between the parties. 
Interestingly, in LeClerc, supra, Tax Court Judge Favreau dealt with the same argument, in the following terms (at para. 18)

[18]         The appellant made an honest mistake because he did not know the consequences of failing to file form T1135 by the due date. The penalty under subsection 162(7) of the Act was imposed correctly, and the due diligence defence is not applicable in this case.

In the view of the authors, not doing what the taxpayer knows he, she or it is expected to do is not a sign of due diligence.  This is not altered by the fact that the taxpayer believes (even on reasonable grounds of analogy) that there will no consequences to the taxpayer.  Due diligence is concerned with the actions of the taxpayer.  In this case, Douglas took none.  The law determines the consequences of that inaction.  In this case, Douglas made an assumption that his lack of diligence in filing his tax returns would have no negative consequences for him.  He was wrong.  In the view of the authors, the taxpayer’s mistaken assumption is neither diligence, nor a substitute for it.  As mentioned above, a bona fide attempt to comply on time is

D.                 Policy Considerations

1.                  Parliamentary Supremacy

There can be little doubt that there can be significant disagreement about the appropriateness of the application of this penalty to a situation where there is no income from the foreign property, and that, therefore, the tax return to which Form T1135 is supposed to be appended is not required to be filed in a timely way, or perhaps more accurately, there is no negative consequence for the taxpayer with respect to the late filing of the tax return.  Therefore, the penalty for the late filing of a Form T1135 seems incongruous.  The same is true of the fact that the government is charging a penalty where no unpaid tax is necessarily at issue, that is, there is not a direct financial loss to the public purse.  In Leclerc, Tax Court Judge Favreau wrote as follows:

[20]         It is not so much being subject to the penalty under subsection 162(7) of the Act that poses the problem as the lack of statutory provisions setting out a defence that does not require you to use a program that was not designed to deal with a simple late filing of a form. That is obviously a matter for Parliament. The same observation could be made with respect to the quantum of the penalty; Parliament could consider providing relief to take into account cases similar to the appellant's where the penalty is disproportionate to the tax otherwise payable.

In the view of the authors, everyone (the Asper companies, Mr. Leclerc, Mr. Douglas, the judges involved and the taxing authorities) seems to accept that the penalty provided for under subsection 162(7) of the Act is meant to be strict.  As Tax Court Judge Favreau points out in Leclerc, there are no problems of interpretation in the section (para. n).  In the view of the authors, this is accurate.  Each of the taxpayers involved sought relief from the consequences of the late filing.  It is one thing for judges to point out to the legislature the potentially undesirable effects that a particular provision are having.  In the view of the authors, it is quite another for the court to appropriate to itself the ability to countermand the directive of the legislature.  There is undoubtedly a degree of statutory construction in this exercise.  But, the Court acknowledges (i) the strict nature of the penalty and (ii) that Parliament could have provided for a due diligence defence and did not do so.  Therefore, this is not construction of the statute; this is judicial alteration of its express, and therefore, ignorance of the will of the legislature.  In the view of the authors, this cannot be countenanced.

2.                  Parliamentary Purpose

In the view of the authors, at least one of the reasons that these issues have developed is the distinction between a tax return where no tax is owed, on the one hand, and a Form T1135, on the other.  In the former situation, the Act is explicit that the penalty by virtue of the tax owing on the filing date (subsection 162(1)).  But this is only with respect to a “return of income” for a taxation year.  Subsection 162(7) applies to an “information return”.  The two are therefore intended to be treated differently.  This, of course, leads to the question as to why this is so.  In the view of the authors, subsection 162(2.1) helps illuminate this issue.  The text of the subsection reads as follows:

(2.1)        Notwithstanding subsections (1) and (2), if a non-resident corporation is liable to a penalty under subsection (1) or (2) for failure to file a return of income for a taxation year, the amount of the penalty is the greater of

(a)           the amount computed under subsection (1) or (2), as the case may be, and
(b)           an amount equal to the greater of

(i) $100, and
(ii) $25 times the number of days, not exceeding 100, from the day on which the return was required to be filed to the day on which the return is filed.

Clearly, then, for a non-resident corporation, the penalty for the failure to file on time is determined by both (i) the amount of tax due and payable; and (ii) the lateness of the performance of the filing obligation.  Why would this be so?  The Income Tax Act clearly treats non-residents differently than it does residents of this country, both in terms of their substantive obligations to tax (in terms of for example the availability of deductions), and their reporting obligations. 

When it comes to the latter, in the view of the authors, this is quite logical.  With respect to residents and their property within Canada, information may be obtained from a variety of sources.  Municipal tax records and provincial records with respect to land transfers (and other major purchases, such as motor vehicles) come to mind in this regard.  Similar records for foreign jurisdictions are not as easily accessible by Canadian authorities, if they exist at all.  Therefore, there must be a significant incentive for the major source of information with respect to the foreign assets to make full disclosure.  The major source is the taxpayer him- or herself. 

Given that in all three of the cases referred under subsection 162(7) were situations where no tax revenue was lost, are there other practical reasons why the penalty would need to be a possibility?  The concept of “out of sight, out of mind” is one potential reason.  By definition, the subsection is concerned with residents.  Residents spend more than half their time in Canada.  Yet, the property at issue is both high in value and elsewhere.  Many people have a tendency not to focus attention on material that they do not use on a regular basis.  It is unsurprising that the government decided to make reporting an annual requirement, regardless of the income produced by the property at issue.  By regular reporting, “out of sight, out of mind” is less likely to occur.  To make reporting truly regular in this sense, the need to report has to be independent of the income earned by the taxpayer, either from the foreign property or otherwise.

3.                  Duly Diligent in a Non-Filing?

As mentioned above, it is very difficult for the authors to accept the idea that a lack of action on the part of the taxpayer is a show of due diligence.  As a general rule, diligence requires active participation in the activity concerned.  In Soper v. Canada, [1998] 1 F.C. 124 (C.A.), Justice Robertson considered the use of the due diligence defence found subsection 227.1(3) of the Income Tax Act.  The section deals with the liability of corporate directors for the making of remittances of source deductions from the wages of employees.  In the case, a company, RBI, did not make its source deduction remittances.  Soper was an experienced businessman.  He claimed that there was a “conspiracy of silence” to avoid his learning of the fact that remittances were not being made (para. 58).  The Court held that Soper was aware of financial difficulties for RBI.  Therefore, this knowledge meant as a director, Soper was under an obligation to ask about whether remittances were being made.  In other words, diligence required that the director not make an assumption in the face of cause for concern, but to take an active role in ensuring that the obligation is met. 
It is true that parts of the decision in Soper  were questioned in the case of Peoples Department Stores Inc. v. Wise, [2004] 3 SCR 461.  Nonetheless, the principles referred to were not questioned.  In fact, the main point of contention in the Supreme Court of Canada was whether there was a subjective component in the due diligence defence.  The Federal Court of Appeal was of the view that there was a degree of subjectivity; the Supreme Court of Canada that the standard entirely objective under the duty of care for corporate directors (which used the same wording as the due diligence defence under subsection 227.1(3)).  If anything, the lack of a subjective element makes the due diligence harder to use than provided for in the Federal Court of Appeal’s decision in Soper.

In the view of the authors, even to the extent that a due diligence defence should be read into subsection 162(7), the judicially created due diligence defence should be no less rigorous than its statutory counterpart within the same statutory framework.  In other words, Mr. Soper could not rely on the due diligence defence because he was not active enough in light of what his knowledge.  In the same way, Mr. Douglas knew that he had significant foreign property.  In light of this knowledge, doing nothing with respect to reporting the significant foreign property to the government is not duly diligent on the part of Mr. Douglas.

CONCLUSION

In the end, the authors believe that it is problematic to imply a due diligence defence where the Court acknowledges that the intention of Parliament was to the contrary.  Such an approach is in the view of the contrary to the prior case law that considers the imposition of penalties under subsection 162(7).  Complete inaction by the taxpayer will rarely be duly diligent.  This view is also consistent the approach take to the statutory due diligence defence within the Income Tax Act.  Finally, the need for information from the taxpayer makes the imposition of the penalty a meaningful incentive for the taxpayer to be forthcoming about his or her significant foreign property.  This serves a legitimate practical purpose, and the decision of Tax Judge Woods in Douglas undermines this purpose to an extent.  Therefore, in the view of the authors, the decision in Douglas is highly questionable.


* TaxChambers Toronto, Ontario
** Associate Professor, Faculty of Law, University of Manitoba, Winnipeg, Manitoba.
[1] RSC 1985, c 1 (5th Supp)
[2]The cost amount is defined in subsection 248(1) as the cost based.  It is not the fair market value of the asset.  For new immigrants to Canada, the cost amount is equal to the fair market value of the property at time of entry into Canada.

[3]See  Para. 48 of McClarty Family Trust, 2012 TCC 80

[4] Section 18.28 of the Tax Court of Canada Act R.S.C., 1985, c. T-2

[5] As will be seen in the case law section below, this is not in fact technically correct.  Prior to the formation of the Tax Court of Canada, the Tax Appeal Board was the initial level of appeal for decisions of the various predecessors of what is now known as the Canada Revenue Agency.  From the Tax Appeal Board, an appeal was available to what was then known as the Federal Court, Trial Division (now the Federal Court of Canada).  Currently, an appeal lies from the Tax Court of Canada to the Federal Court of Appeal.  Therefore, currently, there is no direct appeal from the Tax Court of Canada to the Federal Court of Canada.  Nonetheless, due to this historical reality, the Federal Court is viewed in some quarters as being above the Tax Court of Canada.  However, beyond this short explanation, the authors will not focus on this distinction.
[6] On this point, please see Sunita Doobay and Darcy L. MacPherson, “Craig and Stare DecisisCanadian Tax Highlights, (a publication of the Canadian Tax Foundation) Volume 20, No. 2 (February, 2012), at 2-3 and Sunita Doobay and Darcy L. MacPherson, “Gunn & Craig – Hobbies, Farms and Stare Decisis” (TaxNetPro and The Tax Practitioners’ Forum, January 2012) at 1.
[7] 2010 DTC 5154, [2010] FCJ No. 1174, 2010 FC 894
[8] 2009 TCC 281
[9] [1968] S.C.R. 507

Friday 1 June 2012

Canada Trustco GAAR Analysis in McClarty

The following was published in the May edition of the Canadian Tax Highlights which is published by the Canadian Tax Foundation.  It is republished with permission.  Note to reader - the following article discusses  a recent case which considered whether the income splitting between a father and three minors represented abusive tax avoidance.  Around 1988 the Canadian Parliament introduced  section 245 to the Income Tax Act.  Section 245 contains the general anti-avoidance rule better known as GAAR.  Essentially Canada Revenue Agency ("CRA") may use GAAR to attack any planning which the CRA deems to be abusive.  The tax benefit need not be great - the existence of a tax benefit is sufficient to invoke GAAR by the CRA.  It is up to CRA to prove that GAAR applies. Case law has established that GAAR does not apply where the transaction was undertaken by the taxpayer for bona fide purposes other than obtaining the tax benefit.  As such if the taxpayer can show that the taxpayer undertook the transaction primarily for reasons (e.g. commercial, philanthropic, family etc.)  other than to gain a tax benefit - GAAR should not apply.  The article is as follows:


On March 21, 2012, the TCC released its judgment in McClarty Family Trust (2012 TCC 80) on whether GAAR applied to what the CRA claimed was income splitting between a father and three minors for the 2003 and 2004 taxation years. The CRA sought to recharacterize as dividends the capital gains distributed from the McClarty family trust (MFT) to its minor beneficiaries. Although 2011 amendments to section 120.4 (new subsections 120.4(4) and 120.4(5)) render its planning obsolete, McClarty followed the SCC analysis in Canada Trustco (2005 SCC 54), which the SCC did not reject in Copthorne Holdings Ltd. (2011 SCC 63). McClarty's GAAR analysis thus continues to be relevant for tax practitioners.


The father of the minor beneficiaries, Mr. M, was a professional engineer specializing in geotechnical engineering. He was employed by Clifton Associates in its information technology division, Envista, where he designed and marketed Envista software. In 2001 his bid to purchase the Envista division from Clifton was turned down, and he resigned. Clifton unsuccessfully sought to retain Mr. M and even threatened him with a draft statement of claim. Mr. M and three other Clifton employees started a new company, Projectline Solutions Inc., which became a successful competitor of Clifton. Clifton threatened Projectline with lawsuits.


Mr. M sought to creditor-proof his holdings in Projectline against a potential lawsuit by Clifton. Following professional advice, he proceeded to transfer his shares in Projectline to a holdco, MPSI. A trust, MFT, was settled by Mr. M's father; Mr. M and his wife were trustees and also trust beneficiaries (together with their three minor children). A numbered company (101SK) was incorporated to capture future investments and facilitate the creditor protection scheme; Mr. M was its sole shareholder and director.


In 2003 and in 2004, MPSI declared a stock dividend on its class B common shares, which were held by MFT. The stock dividend consisted of 48,000 class E non-voting MPSI preferred shares; each share's PUC, ACB, and redemption price was $1. MFT then sold the stock dividend shares (class E) to Mr. M on the same day for $48,000 payable by a promissory note that carried interest at 0 percent (10 percent after payment was demanded). The transaction yielded a capital gain of $47,999 for MFT, which distributed the gain equally to its three minor beneficiaries (a taxable capital gain of $7,999 each); the amounts were paid by the issuance to each of a promissory note with the same interest terms as the note given to MFT by Mr. M.


On that same day, Mr. M repaid loans and advances of $48,000 to MPSI, which then paid $48,000 as a shareholder loan to MFT, which in turn made a loan to Mr. M (referred to as a trustee loan). Mr. M then repaid a second sum of $48,000 to MPSI for other shareholder loans.


At year-end, Mr. M sold the class E shares to 101SK for a $48,000 promissory note without interest. On the same day, MPSI redeemed for $1 each the stock dividend (class E) shares (a total redemption price of $48,000). The deemed dividend received by 101SK on the redemption did not trigger tax because it was deemed paid by a taxable Canadian corporation.


The TCC turned to the guidance in Canada Trustco, which summarized the approach to GAAR. Three requirements must be established to permit GAAR's application: (1) a tax benefit must result from a transaction or part of a series of transactions (subsections 245(1) and (2)); (2) the transaction must be an avoidance transaction--it cannot be said to have been reasonably undertaken or arranged primarily for a bona fide purpose other than to obtain a tax benefit; and (3) there must be abusive tax avoidance--it cannot be reasonably concluded that the tax benefit was consistent with the object, spirit, or purpose of the provisions relied on by the taxpayer. The burden is on the taxpayer to refute the existence of the tax benefit and the avoidance transaction, and the burden is on the minister to establish the abusive tax avoidance. (In McClarty, only the first two requirements were addressed; in Copthorne, the appellants conceded the first two requirements and the third requirement was at issue.)


In McClarty, the appellants conceded only the first requirement--that there was a tax benefit as a result of a series of transactions. The appellants contested the minister's conclusion that the transactions were avoidance transactions and argued that they were undertaken for a bona fide purpose other than to obtain a tax benefit. The TCC agreed, following the SCC's guidance in Canada Trustco for determining whether there was a bona fide purpose for the transaction:


[T]his is a factual inquiry. The taxpayer cannot avoid the application of the GAAR by merely stating that the transaction was undertaken or arranged primarily for a non-tax purpose. The Tax Court judge must weigh the evidence to determine whether it is reasonable to conclude that the transaction was not undertaken or arranged primarily for a non-tax purpose. The determination invokes reasonableness, suggesting that the possibility of different interpretations of the events must be objectively considered.

The SCC also said that there should be "an objective assessment of the relative importance of the driving forces of the transaction." The TCC in McClarty cited Rothstein J's statement in OSFC Holdings Ltd. (2001 FCA 260) to the effect that the assessment should be done at the time the transaction was undertaken, not at a later time with the benefit of hindsight.

After considering the facts that existed when the transactions were structured, the TCC concluded that Mr. M was very much concerned with Clifton's actions and feared the loss of his personal assets in a lawsuit. He had already been threatened with a draft statement of claim; Clifton continually threatened to sue and had sent letters to the Canadian International Development Agency and to the Comision Interinstitucional de la Cuenca Hidrografica del Canal de Panama warning that Mr. M and others were falsely holding themselves out as the representatives of Clifton's Envista software. The TCC concluded that Mr. M felt threatened by Clifton, and that that threat was a bona fide reason for the transactions' structure: Mr. M wanted to remove his personal assets from Clifton's reach, a reason consistent with a creditor-proofing strategy. After all, "McClarty's assets in MPSI were partially reduced for the benefit of MFT and, once redeemed, the assets would be entirely out of the hands of MPSI and Darrell McClarty."

The TCC rejected the CRA's argument that the structuring was an avoidance transaction because creditor proofing could have been achieved by having MPSI pay a dividend to MFT, allocating the income to the minor beneficiaries by way of a promissory note, and loaning the funds to Mr. M. The TCC said that even if the suggested alternative structure would have achieved creditor proofing, it would have been less effective because of the higher tax rate on dividends allocated to the minor beneficiaries. The court also rejected an analysis that would splinter off the sale of shares by MFT to Mr. M and the subsequent sale to 101SK to reduce the tax consequences of the creditor proofing; those transactions would not have occurred in the absence of the need to protect MPSI's assets.

The TCC noted that the spirit of the holding in Duke of Westminster was mentioned in the explanatory notes to subsection 245(3), which said that tax planning with the objective of attracting the least possible tax is a legitimate and accepted part of Canadian tax law. The TCC quoted the SCC in Canada Trustco, where it in turn quoted Finance's explanatory notes:
Subsection 245(3) does not permit the "recharacterization" of a transaction for the purposes of determining whether or not it is an avoidance transaction. In other words, it does not permit a transaction to be considered an avoidance transaction because some alternative transaction that might have achieved an equivalent result would have resulted in higher taxes.
The TCC in McClarty concluded as follows:

The [SCC] has made it clear in many decisions that, absent a specific provision to the contrary, it is not the Court's role to prevent taxpayers from relying on the sophisticated structure of their transactions, arranged in such a way that the requirements of the particular provisions of the ITA are met, on the basis that to allow it would be inequitable for those taxpayers who have chosen not to structure their transactions that way (Shell Canada Ltd. v. R ., [1999] 4 C.T.C. 313; Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; Singleton v. R ., [2002] 1 C.T.C. 121).


Sunita Doobay
TaxChambers, Toronto

Canadian Tax HighlightsVolume 20, Number 5, May 2012
©2012, Canadian Tax Foundation