Criminal Liability for Partnerships?

This article was written also in 2013 by Professor Darcy MacPherson and myself was triggered by the thought that a criminal act by a partner in an accounting partnership or a legal partnership could extend to the other partners vicariously. Here are our thoughts:

 

Although the lawyer in Guidon (2012 TCC 287) was a sole practitioner, the TCC's decision to characterize the section 163.2  penalties as criminal raises the question of whether a criminal penalty can extend to the partners of an adviser who is charged. Tax advisers who practise in a partnership should be cognizant of the potential reach of section 163.2 of the Act and the fraud provisions in the federal Criminal Code (Bill C-45, effective March 31, 2004).

 

A partnership comprises two or more persons who carry on a business together with a view to profit; it is not a separate legal entity, and every partner in a general partnership is deemed to be an agent of both the general partnership and the other partners. The doctrine of vicarious liability governs partners, and the courts have not hesitated to apply section 11 of the Ontario Partnerships Act in imposing civil penalties on a partnership because of the negligent actions of one partner. In Allen v. Aspen Group Resources Corp. (2012 ONSC 3498), the Ontario Superior Court concluded that the language of section 11 was broad enough to encompass the statutory wrong of misrepresentation created by section 131 of the Ontario Securities Act. However, Canadian and English courts have rejected a common-law doctrine of vicarious liability for a criminal offence on the principle that one should be held criminally responsible only for one's own criminal wrongdoing. Statutory law in Canada has sought to remedy that position by extending the potential imposition of criminal liabilities on partnerships.

 

Although a general partnership does not have a separate legal identity, it is subject to the Criminal Code and to the Act. For example, the preparer penalties with which the lawyer was charged in extend to a partnership. The lawyer in that case was assessed under the subsection 163.2(4)  preparer penalty, which provides that "[e]very person [specifically defined to include a partnership] 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." Culpable conduct is defined in subsection 163.2(1) to mean an act or a failure to act that (1) is tantamount to intentional conduct; (2) shows an indifference to whether the Act is complied with; or (3) shows a wilful, reckless, or wanton disregard of the law.

 

Under the Bill C-45 amendments to the Criminal Code, the actions and mental state of a partnership's senior officers determine whether it has committed a prohibited act or has the requisite mental state (sections 22.1 and 22.2). A senior officer is defined to include any person who plays an important role in the establishment of a partnership's policies or is responsible for managing an important aspect of the partnership's activities (section 2). A partnership is liable for an offence requiring proof of mental fault other than negligence if (1) a senior officer is party to the offence, (2) a senior officer has the intent to commit the offence but causes a subordinate to carry out the offence, or (3) a representative is about to carry out the offence and the senior officer has knowledge of the act but does not stop it (section 22.2).

 

Even if the promoter in  had been found to be a partner of the lawyer charged, the relevant facts occurred in 2001 before the effective date of Bill C-45 in 2004: criminal law has no retrospective application. However, the courts now have to consider the fate of an innocent partner of a partnership charged with a criminal penalty based on the Code and on the Act, which seek in certain circumstances to impose criminal liability on a partnership's members.

 

A partnership is generally considered to be a collective of all of the business's partners. Are partners innocent if they are uninvolved in the criminal activities? Whose money is at risk? (A partnership has no separate legal personality, and thus there is no partnership money per se.) Can the personal assets of a partner who is not involved in the offence be seized to pay the fine assessed by the court against the partnership? Can that partner claim the presumption of innocence? Is the imposition of criminal liability on an innocent partner a violation of freedom of association under the Charter? Can the criminal law attribute separate legal personality to a partnership for these limited purposes?

 

Exploring these questions is beyond the scope of this article, but they must be considered and acted on when a client's interests are at risk. Practically speaking, the inherent uncertainties in this area may create a unique opportunity for tax preparers and promoters to structure their operations to adequately allocate the risks associated with their activities. It may be possible to achieve this allocation through the isolation or quarantine of the partners and employees who engage in higher-risk promotion and other activities that may potentially attract liability under section 163.2. The challenges related to these uncertainties may alter the manner in which partners carry on business.

Guindon Penalty Upheld

I just realized that I never posted this article I co-authored with Professor Darcy MacPherson in July of 2013. Guindon was recently heard by the Supreme Court of Canada - its decision has not been released as yet. The reason Guindon is of such importance is that a criminal penalty under the Income Tax Act was invoked against Ms. Guindon for participating in a fraudulent donation scheme causing concern amongst tax practitioners.

 

Recently the FCA reversed the TCC in Guindon (2012 TCC 287; rev'd. 2013 FCA 153) and restored the CRA's assessment of third-party penalties under section 163.2 of the Act (see "Criminal Liability for Partnerships?" Canadian Tax Highlights, January 2013). The TCC had concluded that the provision had "true penal consequences" that triggered Charter section 11 protections, such as the requirement of proof beyond a reasonable doubt and the presumption of innocence.

 

Ms. Guindon had provided a legal opinion that vouched for a donation scheme (which represented that she had reviewed documentation that she had not reviewed) and also prepared 134 tax receipts issued to participants in the scheme. The government appealed the TCC's finding that section 163.2, which on the facts resulted in penalties totalling $564,747, created a criminal offence. The FCA decided several points. First, in order for Charter section 11 to invalidate section 163.2, a notice of constitutional question must be served (and it was not). Second, section 163.2 did not meet the test for a criminal provision under SCC case law. Third, the FCA rejected the idea that some Charter section 11 rights applied to the extent that they were not inconsistent with section 163.2. Fourth, having decided that the constitutional argument could not be made, the court concluded that the taxpayer was liable under section 163.2.

 

Although the federal Crown was the appellant in this case, a factor that arguably diminished its need for notice, a notice of constitutional question must be served on both the federal and provincial attorneys general when a party seeks a finding that a section of the Act is invalid, inoperative, or inapplicable. Notice gives the attorneys general a chance to intervene and participate in the process that may affect their own laws. Service of the notice is a statutory procedural requirement under both the Tax Court of Canada Act and the Federal Courts Act, and the absence of service took away the TCC's jurisdiction to consider the matter. The FCA noted that Ms. Guindon did not ask the TCC to exercise its discretion to adjourn proceedings to allow notice to be served, and she did not serve notice or ask for an adjournment in the FCA.

 

Although the FCA concluded that service of notice of constitutional question is required before the court can consider the matter, it concluded that section 163.2 was constitutional because it was not criminal in nature. This raises the interesting question of the line between obiter dicta and binding conclusions of a court. Although there is jurisprudence to the effect that even obiter of the SCC is binding on lower courts, the situation for pronouncements of the FCA is an open question. Arguably, the discussion of an issue should be reserved for a court that has jurisdiction to hear the matter and has the benefit of hearing from all interested parties. Nonetheless, the FCA's reasoning about whether section 163.2 creates an offence that is criminal in nature will no doubt be given significant weight.

 

The court dismissed as "overstated" the concerns of commentators about the fairness of section 163.2 and the potential for its misuse. It pointed out that the jurisprudence is "in an embryonic state. What now appears to some to be uncertain and worrying may later be addressed satisfactorily in the jurisprudence."

 

The FCA briefly distinguished criminal activity from culpable conduct on the basis that the latter term is defined in section 163.2, a "definition [that] does not bring within it the notion of 'guilt' or conduct violating some criminal standard." The court prefaced that comment by saying that each penalty provision in the Act, including section 163.2, "prescribes a non-discretionary fixed amount or a non-discretionary formula for the calculation of the penalty. . . . In no way does the Minister evaluate the moral blameworthiness or turpitude of the conduct." In contrast, "each of the offence provisions is punishable by a fine, imprisonment, or both, none of which is fixed or calculated by a rigid formula." Arguably, even the mechanical calculation of a potentially onerous penalty against a third party with a reference to his or her "culpable activity" (as described in Finance's original technical notes) may indicate that the targeted offence is considered more than administrative in nature. The triggering phrase itself, "culpable conduct," suggests moral blameworthiness and is defined in terms that evoke wrongdoing. The court appears to have analogized the section 163.2 penalty to the administrative penalty for late filing, which is a strict liability provision that does not inquire into the taxpayer's mental state.

The FCA cited the SCC as authority for the conclusion that either all or no section 11 Charter protections apply, depending on whether a person has been charged with a criminal offence. However, the court did not deal with a line of cases that gives a court the non-Charter authority to interpret a provision as requiring mens rea when it is silent concerning the mental element (see Beaver, [1957] SCR 531). Thus, apart from the Charter, the FCA could have interpreted section 163.2 to require a higher level of proof than other penalty provisions or a presumption of innocence, perhaps on the basis of an analysis of the term "culpable conduct."

 

The TCC concluded that as a question of fact Ms. Guindon had engaged in culpable conduct as defined in section 163.2 , and thus it was unnecessary for the FCA to decide the issue. The FCA went on to say that administrative penalties may be harsh, and the minister may be asked to exercise her discretion to cancel some or all of the penalty (subsection 220(3.1)). Perhaps anticipating criticism of this alternative-criticism that some would argue is warranted-the FCA pointed out that the minister must exercise her discretion on the basis of the fairness purpose behind subsection 200(3.1) and a rational assessment of all relevant circumstances. "Her discretion must be genuinely exercised and must not be fettered or dictated by policy statements such as Information Circular 07-1." The court also noted the possibility of a challenge under Charter section 12, which prohibits cruel and unusual punishment, but was skeptical-justifiably, in our view-of its success.

Please see attached the October 2014 issue of Thomson Reuters’ Privately Held Companies and Taxes focusing on tax credits in the film and television industries.

Doctrine of Estoppel does not apply to the CRA

In Academy of Applied Pharmaceutical Sciences (2014 TCC 171) the taxpayer, the Academy of Applied Pharmaceutical Sciences, was a GST/HST registrant (para. 3). The taxpayer provided two different educational services. The first, which was GST/HST exempt, was a Diploma Programme on pharmaceutical science. The second service was the provision of workshops providing continuing education in the form of conferences on new trends in pharmaceutical sciences.  This was subject to GST/HST (para. 4).

There were two audits for GST/HST purposes.  At issue at both audits was the fact that (i) the Taxpayer failed to keep expenses related to the GST/HST registered business separate from the exempt business and (ii) sought to offset all GST/HST incurred from both arms of the business against GST/HST payable. In June 2008, the Taxpayer was audited for its 2007 taxation year. The auditor, in discussion with the Taxpayer and its bookkeeper, determined that, for the purpose of the audit, 50% of the expenses incurred would be a reasonable percentage to be allocated to the Workshop as allowable ITCs. (para. 7)

Although the Auditor, in her report, recommended that taxable income (meaning, for current purposes, subject to GST/HST) should be segregated from exempt income (meaning not subject to GST/HST), expenses should be segregated whether it related to earning taxable income, expenses related to earning exempt income or expenses related to earning mixed taxable and exempt income, this recommendation was not followed by the Taxpayer. According to the Taxpayer, the Auditor advised that on a go-forward basis the same 50% allocation could be used for the purpose of claiming ITCs.

A second audit was carried on in November of 2012. This time, a new auditor found that the 50% allocation was not reasonable for the periods under review and that 11% should have been allocated for 2010 and 14% for 2011. (para. 8). The taxpayer although not disputing the reasonableness of the new percentage brought the action on the basis that the Taxpayer had relied on the first Auditor’s verbal recommendation that a 50% allocation was a reasonable one and that the Taxpayer was now penalized for relaying on the expertise of an auditor from the CRA (paras. 11 and 12).

This case is an informal procedure case.  This means that the case does not form a precedent.  The case is intriguing in that the first auditor did not indicate the 50% allocation in writing.  But, for current purposes, the case is interesting  because the Court considers the verbal representation made by CRA and reviews the doctrines of both estoppel and officially induced error. The doctrine of estoppel generally stems from equity and provides that if:  (i) a representation is made by a party or an agent of a party; (ii) another person relies on the representation and (iii) suffers detriment as a result of the reliance.  The question is whether the first auditor made a representation on which the appellant taxpayer could rely.  However it is a well-established principle that that estoppel cannot override the law of the land. In other words, a representation by anyone cannot make the law anything other than what the law is.  A representation as to the content of the law this however does not mean as Justice Bowman stated in Goldstein 96 DTC 1029 and reproduced at paragraph 21 of the decision in Academy of Applied Pharmaceutical Sciences:

It is sometimes said that estoppel does not lie against the Crown. The statement is not accurate and seems to stem from a misapplication of the term estoppel. The principle of estoppel binds the Crown, as do other principles of law. Estoppel in pais, as it applies to the Crown, involves representations of fact made by officials of the Crown and relied on by the subject to his or her detriment. The doctrine has no application where a particular interpretation of a statute has been communicated to a subject by an official of the government, relied upon by that subject to his or her detriment and then withdrawn or changed by the government. In such a case a taxpayer sometimes seeks to invoke the doctrine of estoppel. It is inappropriate to do so not because such representations give rise to an estoppel that does not bind the Crown, but rather, because no estoppel can arise where such representations are not in accordance with the law. Although estoppel is now a principle of substantive law it had its origins in the law of evidence and as such relates to representations of fact. It has no role to play where questions of interpretation of the law are involved, because estoppels cannot override the law. (Emphasis mine).

The case of Academy of Applied Pharmaceutical Sciences is a case where the doctrine of estoppel clearly did not apply, as the idea of a static allocation of 50% was contrary to the Excise Tax Act, RSC 1985, c. E-15, and the auditor had stated in writing that the expenses were to be tracked.  It was therefore possible to view the statement of the auditor as a second chance to track the expenses so that a more precise allocation would be possible, and not penalize the taxpayer for the period under review, but take the opportunity to improve their documentation practices.  Rather than taking this opportunity, the taxpayer thought that the allocation was now set up for them by the auditor.

The doctrine of officially induced error in essence holds that the Appellant was induced into a course of conduct that was to its detriment as a result of erroneous advice given by the first auditor to the Appellant. The Court held that this should generally not be available in tax appeals. 

The authors agree that the facts presented here do not validly allow for either estoppel or officially induced error.  This is due at least in part to the fact that the audits at issue were quite clearly each confined to the period covered by the audit, and not a guarantee of future treatment.  Furthermore, the taxpayer can be taken to have “cherry-picked” the statements of the first auditor (taking the reasonableness of the division, but ignoring the rest of the advice from the auditor.  However, the broader questions of the availability of these potential defences in other circumstances may be unwise.  After all it is usually better to wait and see whether different facts ought to lead to different results.  But, other than a concern about the future and different facts, it is clear to the authors that the case is rightly decided.

Sunita D. Doobay

TaxChambers LLP, Toronto

Darcy L. MacPherson

Faculty of Law, University of Manitoba, Winnipeg

Annotated Ontario Partnerships Act

Very excited that the Annotated Ontario Partnerships Act co-authored by myself and Professor Darcy MacPherson is now published.

Quoted in the National Post.

Non-wilful conduct and the IRS discussed in  the  August 2014 - Canadian Tax Highlights.

I was quoted on FATCA and the CRA in the National Post.

Appeal Filed With The Federal Court Of Canada Seeking A Declaration That FATCA Is Unconstitutional And Should Not Be Enforced In Canada

On Monday, the 11^th of August, an appeal was filed with the Federal Court of Canada in Vancouver seeking a declaration that the enforcement by the Canadian Government of the United States’ Foreign Account Tax Compliance Act (“FATCA”) on Canadian soil is unconstitutional. Under FATCA, financial institutions enter into an agreement with the IRS and disclose the names of all U.S. persons who hold accounts with U.S. $50,000 or more. This is on a voluntary basis but it is the rare financial institution that does not enter into a FATCA agreement as failure to comply with FATCA results in a punitive tax of 30% on gross U.S. source income and on gross income from non-U.S. sources but remitted by a financial institution that has entered into an agreement with the IRS.

Canada entered into an intergovernmental agreement (Agreement Between the Government of the United States of the United States of America and the Government of Canada to Improve International Tax Compliance through Enhanced Exchange of Information under the Convention between the United States of America and Canada with respect to Taxes on Income and on Capital) on February 5, 2014 and which was entered into force on June 27, 2014. This agreement, commonly referred to as an IGA, results in Canada acting as an intermediary – Canadian Financial Institutions provide accountholder information of US persons to Canada, and Canada provides the account holder information to the United States. Information gathering started in July of 2014 and exchange of information will happen in the beginning of 2015.

Virginia (Ginny) Hillis and Gwen Deegan, the plaintiffs of the action, are U.S. persons because they were born in the United States. A U.S. person is any individual who was born in the United States, holds a U.S. citizenship or holds a U.S. green-card. The IGA also includes a U.S. person’s estate and a trust that is managed from the U.S.

Ginny and Gwen were born in the U.S. Both plaintiffs left the U.S. when they were five years of age. They never worked or lived in the U.S. Neither of them holds a U.S. passport. However because they were born in the U.S. they are subject to the FATCA reporting requirements. Ginny and Gwen argue in their statement of claim that the IGA unreasonably infringes their constitutional rights under the Charter.

Regardless of the lawsuit which could take years to resolve – it is prudent for Canadians who are considered U.S. persons to be compliant or become compliant with U.S. filing obligations through the new streamline filing compliance procedure or through the Offshore Voluntary Disclosure Program (“OVDP”) before the IRS becomes aware of their existence in Canada.

Last but not least, the following is reproduced from the IGA and it sets out the accounts in Canada that are not subject to FATCA’s disclosure:

A. Registered Retirement Savings Plans (“RRSPs”) – as defined in subsection 146(1) of the Income Tax Act.

B. Registered Retirement Income Funds (“RRIFs”) – as defined in subsection 146.3(1) of the Income Tax Act.

C. Pooled Registered Pension Plans (“PRPPs”) – as defined in subsection 147.5(1) of the Income Tax Act.

D. Registered Pension Plans (“RPPs”) – as defined in subsection 248(1) of the Income Tax Act.

E. Tax-Free Savings Accounts (“TFSAs”) – as defined in subsection 146.2(1) of the Income Tax Act.

F. Registered Disability Savings Plans (“RDSPs”) – as defined in subsection 146.4(1) of the Income Tax Act.

G. Registered Education Savings Plans (“RESPs”) – as defined in subsection 146.1(1) of the Income Tax Act.

H. Deferred Profit Sharing Plans (“DPSPs”) – as defined in subsection 147(1) of the Income Tax Act.

I. AgriInvest accounts – as defined under “NISA Fund No. 2” and “net income stabilization account” in subsection 248(1) of the Income Tax Act including Quebec’s Agri-Quebec program as prescribed in section 5503 of the Income Tax Regulations.

J. Eligible Funeral Arrangements – as defined under subsection 148.1 of the Income Tax Act.

K. Escrow Accounts. An account maintained in Canada established in connection with any of the following:

1. A court order or judgment.

2. A sale, exchange, or lease of real or immovable property or of personal or movable property, provided that the account satisfies the following requirements:

a. The account is funded solely with a down payment, earnest money, deposit in an amount appropriate to secure an obligation directly related to the transaction, or a similar payment, or is funded with a financial asset that is deposited in the account in connection with the sale, exchange, or lease of the property;

b. The account is established and used solely to secure the obligation of the purchaser to pay the purchase price for the property, the seller to pay any contingent liability, or the lessor or lessee to pay for any damages relating to the leased property as agreed under the lease;

c. The assets of the account, including the income earned thereon, will be paid or otherwise distributed for the benefit of the purchaser, seller, lessor, or lessee (including to satisfy such person’s obligation) when the property is sold, exchanged, or surrendered, or the lease terminates;

d. The account is not a margin or similar account established in connection with a sale or exchange of a financial asset; and

e. The account is not associated with a credit card account.

3. An obligation of a Financial Institution servicing a loan secured by real or immovable property to set aside a portion of a payment solely to facilitate the payment of taxes or insurance related to the real or immovable property at a later time.

4. An obligation of a Financial Institution solely to facilitate the payment of taxes at a later time.

For more information, please refer to the following:
Statement of Claim
IGA

See my latest article published in the July 2014 ABA Section of International Law.

Designated Beneficiary and Creditors

See my latest article on designated beneficiaries and creditors published in the June 2014 Canadian Tax Highlights:

Reproduced here from the April 2014 Canadian Tax Highlights:

Reproduced here from the March 2014 Canadian Tax Highlights:

Amended Ontario Estate Tax

Reproduced here from the March 2013 Canadian Tax Highlights

UPDATE: The Domestic & International Tax Treatment of Crowdfunding

It seems equity crowdfunding in Ontario may become a reality much sooner than expected. Recently, Sunita Doobay wrote on the topic in the March 2014 issue of Thomson Reuters Carswell Newsletter Privately Held Companies and Taxes. Since then, regulators in six different provinces have jointly released a proposed framework that would allow companies to raise funds online for equity. Sunita has revisited the issue and summarized the proposed changes in an update to the newsletter.

The Domestic & International Tax Treatment of Crowdfunding

Crowdfunding is on everyone’s mind these days. Recently, I wrote on the topic in the March 2014 issue of Thomson Reuters Carswell Newsletter Privately Held Companies and Taxes.

Revenue from” Click” Advertising Taxable in Canada

Recently published in the ABA Section of International Law Privacy, E-Commerce & Data Security Committee Quarterly Newsletter and reproduced here:

The Canada Revenue Agency (“CRA”) was asked in CRA Views 2011-0416181E5 to opine on whether revenue generated from the sale of advertising space on a U.S. website through an independent agent situated in Canada would be subject to Canadian Income Tax. The facts are as follows.  A U.S. resident corporation operates a website that is hosted by one or more servers that are all physically located solely in the U.S. The website is managed and maintained in the U.S. The U.S. resident through an independent agent in Canada sells advertising space on its website.  U.S. situated employees of U.S. resident update the website in the U.S. to reflect the Canadian advertisers’ ads.  Residents in Canada viewing the website can click on the Advertiser’s ad to view more information.  Advertisers in turn would pay the independent agent in Canada a fee based on the number of “clicks” on their ads by customers.  Part of the fee is retained by the independent agent as fee for services and the remainder of the fee is remitted to the U.S. resident. 

In this opinion CRA was not asked to consider whether the U.S. resident was carrying on business in Canada but was asked to determine whether the portion of the revenue remitted to the U.S. resident would be subject to a 25% Canadian income tax withholding.  The CRA concluded that the revenue generated from the clicks was a direct result of the services provided by the U.S. resident and its U.S. based employees because the revenue was generated through the services performed by a non-resident person and the amount payable was dependent on the sale of such services (clause 212(1)(d)(iii)(A) of the Income Tax Act.  The amount payable however could not be characterized as royalties but according to the CRA was business income.

Where a tax treaty exists between Canada and the country wherein the non-resident taxpayer resides, Canada will cede its jurisdiction to tax to the non-resident’s country unless the business of the non-resident was carried on through a permanent establishment in Canada. Under the business services article of the Treaty, a U.S. resident earning business profits in Canada not through a Canadian permanent establishment will not be subject to Canadian income taxation. 

The CRA stated in CRA Views 2008-0279141E5 that Canada is following the OECD on the taxation of electronic commerce.  As such CRA confirmed that a website solely by itself will not constitute a permanent establishment. However a non-resident who presents a website to its Canadian customers will be considered to be carrying on business in Canada where (i)the host server is located in Canada; (ii)the business is carried on, wholly or in part, through the operation of the website on that server; (iii)the host server is at the non-resident’s disposal; (iv)the host server is more or less permanently linked to a geographic location in Canada and (v)the website is hosted by the particular computer server on a more than merely temporary or tentative basis.    The revenue earned from the click ads would therefore not be subject to Canadian income tax because it was not income generated through a Canadian permanent establishment. 

Sunita D. Doobay

Partner

TaxChambers LLP