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SCC to Decide Tax Advisor Penalty Case on July 31

What is the nature of the third-party penalty in section 163.2 of the Income Tax Act? That question will be answered by the Supreme Court of Canada when it decides the case of Guindon v. The Queen (Docket No. 35519) on Friday July 31.

See our previous posts on the Guindon case here and here.

In Guindon, the Tax Court found that the penalty imposed under section 163.2 is a criminal penalty, not a civil one, and therefore subject to the protection of (inter alia) section 11 of the Charter of Rights and Freedoms.

The Federal Court of Appeal reversed on the basis that Ms. Guindon did not provide notice of a constitutional question, and thus the Tax Court lacked jurisdiction to make an order on the nature of section 163.2. In any event, the Federal Court of Appeal also stated that the penalty under section 163.2 was not criminal in nature, and hence, was not subject to Charter protections.

The Supreme Court heard arguments in Guindon in December 2014, and the Court’s decision will have significant implications for tax professionals across Canada.

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SCC to Decide Tax Advisor Penalty Case on July 31

Zhang: BC SC Refuses to Rectify Share Transfer

In Zhang v. Canada (A.G.) (2015 BSCS 1256), the British Columbia Supreme Court refused to grant rectification of a transaction in respect of which the taxpayers had no common intention to avoid capital gains tax on a share transfer.

The taxpayer was resident in British Columbia. He carried on a business of manufacturing and distributing laser equipment. In 2002, the taxpayer incorporated LABest Optronics Co. Ltd. (“LABest”) in China to carry on the business.

In 2003, the taxpayer met with his accountant to discuss his 2002 Canadian tax return. In the course of this discussion, the taxpayer asked about the distribution of income from LABest, and the accountant suggested that income earned in the company could be taxed in China and distributed to a Canadian corporate shareholder as exempt surplus dividends without further Canadian tax being imposed, and then later paid to the taxpayer.

Subsequently, the taxpayer incorporated Beamtech Optronics Co. Ltd. (“Beamtech”), a B.C. company. The accountant suggested that the shares of LABest be transferred to Beamtech. The taxpayer sought and obtained regulatory approval for the share transfer from the Chinese government, and such approval included a transfer value (determined by the government) of $150,000 USD. Beamtech paid $150,000 USD cash to the taxpayer, and no section 85 rollover of the shares was undertaken.

The CRA subsequently reviewed and assessed the transaction on the basis that the fair market value of the LABest shares was $661,164 CDN, resulting in a capital gain of $221,950 for the taxpayer in 2003.

The taxpayer sought rectification of the share transfer to substitute a section 85 rollover of the LABest shares to Beamtech.

The Court stated that the “proper approach” to rectification under B.C. law is as follows:

  1. The focus of the analysis in tax cases is on the intention of the related parties when they entered the transaction. This is because the “mistake” in the written instrument is usually a mistake as to the tax consequences of the transaction. It matters not if the mistake was caused by misinformation from the taxpayer to his advisors, or mistaken advice provided by a professional advisor to the taxpayer.
  2. There is nothing objectionable about taxpayers attempting to avoid tax.
  3. The real question which must be considered is whether the taxpayer is able to establish a specific continuing intention to avoid the particular tax in question. A general intention to avoid taxes is not sufficient. The determination of what constitutes sufficient specificity of intention will depend on the context and the circumstances of each case.
  4. Where rectification is aimed at a wholly distinct kind of tax avoidance, which was not specifically contemplated at the time the written instrument was formed, rectification will not be granted.
  5. A common specific intention is one which existed before the formation of the instrument in question and continued since that time. It must be a “precise” and “clearly-defined object” before rectification will be granted.

In the present case, the Court was concerned that there were significant inconsistencies in the evidence of the taxpayer and his accountant. Further, the evidence established only that the taxpayer intended to implement a corporate structure (i) for the tax-efficient movement of funds from LABest to Beamtech, and (ii) that was acceptable to the Chinese government. The taxpayer had only consulted his accountant about discrete tax issues, but never retained his accountant to provide a comprehensive review of all tax issues that may arise in respect of the transaction. The Court held that the taxpayer had no specific intention to avoid capital gains tax on the share transfer.

The Court dismissed the taxpayer’s application.

The more challenging aspect of Zhang is the Court’s discussion of the requirements for rectification – i.e., whether a specific or general intention to avoid tax must exist for rectification to be granted. The B.C. Court referred to the leading tax rectification case, Juliar v. A.G. (Canada) ((2000), 50 O.R. (3d) 728 (Ont. C.A.), leave to appeal to the Supreme Court of Canada dismissed (File No. 28304)) (Dentons was counsel for the successful taxpayer), and the B.C. cases that have interpreted Juliar (see, for example, McPeake v. Canada (A.G.) (2012 BCSC 132)). The Court stated that, in B.C., “Rectification will not be granted where there is only a general intention to avoid taxes.”

The Alberta Court of Queen’s Bench reached a similar conclusion in Graymar Equipment (2008) Inc. v A.G. (Canada) (2014 ABQB 154) and Harvest Operations Corp. v. A.G. (Canada) (2015 ABQB 237)).

This may conflict with the reasoning in Juliar and other Ontario cases (see TCR Holding Corporation v. Ontario (2010 ONCA 233) and Fairmont Hotels Inc. v. A.G. (Canada)(2015 ONCA 441) in which the Ontario Court of Appeal has clearly stated that rectification was available where the taxpayers had a general intent to carry out their transactions on a tax-efficient (or tax-neutral) basis and had no expectation as to the specific manner in which the transaction would be carried out.

However, Zhang raises the question as to whether the distinction between specific and general intent is meaningful at all. On any rectification application, a court’s focus will always be on the nature of the mistake, the circumstances of the error, and the evidence of the taxpayer’s intent. Whether their intent is described as “specific” or “general”, taxpayers who are careless or cavalier about the Canadian tax implications of a transaction likely cannot establish that they intended to minimize or avoid taxes and cannot expect to obtain relief from the courts.

As of the time of the writing of this post, the taxpayer had not appealed to the B.C. Court of Appeal.

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Zhang: BC SC Refuses to Rectify Share Transfer

CRA: Bitcoins may be Specified Foreign Property

The CRA recently provided its views on whether digital currency, including Bitcoins, are considered “specified foreign property” under the foreign property reporting rules in section 233.3 of the Income Tax Act.

See our previous posts on the tax treatment of Bitcoins and digital currency here, here and here.

Under the foreign property reporting rules in the ITA, if a Canadian taxpayer owns certain foreign property the aggregate cost of which exceeds $100,000 CDN, the taxpayer must file a Form T1135 on which the amount of “specified foreign property” is reported. “Specified foreign property” is defined in subsection 233.3(1) to include certain tangible or intangible property held outside Canada (subject to several exceptions – i.e., that the property is not held or used exclusively in carrying on an active business).

In CRA Document No. 2014-0561061E5 “Specified Foreign Property” (April 16, 2015), the CRA was asked whether digital currency or an interest in a foreign partnership holding digital currency are specified foreign property.

The CRA stated that, in its view, digital currency would be funds or intangible property, and would be specified foreign property if situated, deposited or held outside Canada and not used or held exclusively in the course of carrying on an active business.

Further, an interest in a partnership that owns or holds specified foreign property would itself be specified foreign property unless the partnership was a “specified Canadian entity” (i.e., a partnership wherein the total of all non-resident members’ shares of the income or loss of the partnership for the fiscal period is less than 90% of the total income or loss of the partnership for the period).

The CRA stated that, in this case, the digital currency would likely be specified foreign property and the partnership interest would be specified foreign property of the Canadian corporate owner.

This is helpful guidance from the CRA on the tax treatment of digital currency and a reminder of the many tax issues that arise in respect of digital currency and the reporting of foreign property.

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CRA: Bitcoins may be Specified Foreign Property

Tax Court Continues “New Approach” to Cost Awards

The Tax Court’s approach to cost awards has evolved significantly in recent years. The Court’s interpretation and application of the factors under subsection 147(3) and the new settlement offer rules in subsections 147(3.1) to (3.8) of the Tax Court of Canada Rules (General Procedure) indicate that the Court continues to formulate a “new approach” to costs that is much closer to the manner in which other Canadian courts use cost awards to compensate successful parties and control the conduct of the parties during litigation.

The Tax Court’s new approach can be traced to the costs decision in Velcro Canada Inc. v. The Queen (2012 TCC 273) (see our previous blog post here), in which the Court articulated an approach to costs that provided for a reduced role for the “Tariff” amounts (see in Tariff B of Schedule II of the General Procedure Rules) and much greater emphasis on and consideration of the factors under subsection 147(3). Further, the new settlement offer rules in subsections 147(3.1) to (3.8) create a default entitlement to substantial indemnity costs (i.e., 80% of solicitor and client costs) after the date of a settlement offer for a successful party that achieved a result in the appeal that was as good or better than the settlement offer.

This new approach is a welcome development in that it creates a fair system in the Tax Court for compensating a winning party, and raises the stakes for both parties to an appeal.

Three recent costs decisions of the Tax Court provide good examples of the Court’s analysis and awards under this new approach.

Repsol Canada Ltd. 

In Repsol Canada Ltd. v. The Queen (2015 TCC 21) (under appeal), the Tax Court allowed the taxpayer’s appeal and held that certain of the taxpayer’s assets were Class 43 assets for the purposes of the capital cost allowance provisions in the Income Tax Act. The Court awarded costs to the taxpayer.

On its motion for increased costs, the taxpayer asked for substantial indemnity costs under new subsection 147(3.1) of the General Procedure Rules for legal fees incurred after the issuance of its settlement offer, an additional 10% of legal fees incurred after the issuance of its settlement offer, 75% of its legal fees incurred before the issuance of its settlement offer, and reasonable disbursements.

The Tax Court (2015 TCC 154) refused to reduce the taxpayer’s costs that would be subject to the substantial indemnity rule in subsection 147(3.1), held that the substantial indemnity rule applies to the legal fees for a costs motion, and refused to grant additional costs above the substantial indemnity amount for fees incurred after the issuance of its settlement offer.

The Court awarded post-settlement offer costs at 80% of solicitor-client costs ($264,334), pre-settlement offer costs at 50% of solicitor-client costs ($262,051), disbursements ($35,308), and 80% of solicitor-client costs plus reasonable disbursements for the costs motion.

The Crown has appealed the costs decision to the Federal Court of Appeal.

Standard Life Assurance Company of Canada

In Standard Life Assurance Company of Canada v. The Queen (2015 TCC 97) (under appeal), the Tax Court dismissed the taxpayer’s appeal and held that the taxpayer was not entitled to a bump in the cost base of certain insurance properties. The Court awarded costs to the Crown.

On its motion for increased costs, the Crown asked for substantial indemnity costs under new subsection 147(3.1) of the General Procedure Rules for legal fees incurred after the issuance of its settlement offer, 50% of legal fees incurred before the issuance of its settlement offer, and reasonable disbursements throughout.

The Tax Court (2015 TCC 138) held that the Crown’s settlement offer was a valid settlement offer that contained an element of compromise (see also the earlier case of Mckenzie v. The Queen (2012 TCC 329)). Accordingly, the taxpayer was entitled to substantial indemnity costs incurred after the issuance of the settlement offer.

The Tax Court made a minor adjustment for the hourly rate of junior counsel and awarded a lump sum amount of $474,663 (which included $37,818 in disbursements).

Sun Life Assurance Company of Canada

In Sun Life Assurance Company of Canada v. The Queen (2015 TCC 37), the Tax Court allowed the taxpayer’s appeal and held that the taxpayer was entitled to certain input tax credits. The Court awarded costs to the taxpayer.

On its motion for a enhanced costs, the taxpayer asked for a lump sum amount of $200,000, which approximated 80% of counsel fees of $157,430, plus taxes of $20,465 and disbursements of $21,365.

The Tax Court (2015 TCC 171) considered the taxpayer’s settlement offer, and concluded that it was a valid settlement offer that was capable of being accepted by the Crown (see also the earlier case of CIBC World Markets Inc. v. The Queen (2012 FCA 3)). Accordingly, the taxpayer was entitled to substantial indemnity costs incurred after the issuance of the settlement offer.

However, the Court reduced the amount of legal fees that would be subject to the 80% substantial indemnity rule because there was no evidence that the client had agreed to pay its counsel’s hourly fees (rather the fee charged to the client was a percentage of the amount recovered). Also, the taxpayer had not provided a detailed breakdown of the fees incurred before and after the issuance of the settlement offer.

Accordingly, the Court awarded substantial indemnity costs of $91,792, plus $1,050 for the Tariff amount for services rendered prior to examination for discovery, plus HST on these amounts (less any amount recoverable as an input tax credit), and disbursements of $21,356.

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Tax Court Continues “New Approach” to Cost Awards

McNally: CRA Does Not Have Unfettered Discretion to Delay Assessment

In McNally v. Canada (National Revenue) (2015 FC 767), the taxpayer brought an application to the Federal Court for an order requiring the Minister to assess his tax return. The Federal Court allowed the taxpayer’s application and ordered the Minister to examine the taxpayer’s tax return and issue a Notice of Assessment within 30 days.

Background

The taxpayer invested funds in a gifting tax shelter in respect of which he claimed a number of deductions.

The taxpayer filed his 2012 federal income tax return in April 2013. Two months later – in June 2013 – he received a letter stating that his return had not been assessed because the CRA was undertaking an audit of the gifting tax shelter program. In July 2013, the taxpayer filed an application for judicial review of the CRA’s decision not to assess his return. Two years later, the taxpayer’s 2012 return still had not been assessed.

Arguments

Under subsection 152(1) of the Income Tax Act, the CRA shall examine a taxpayer’s return of income and assess the tax for that taxation year “with all due dispatch.”

The taxpayer argued that the CRA was deliberately delaying the assessment for the improper purpose of discouraging participation in gifting tax shelters. The court noted that, in the CRA’s view, widely-marketed tax shelters are generally invalid. In this case, the CRA admitted that it chose not to assess the tax returns of participants in the gifting tax shelters in order to discourage participation in such investments, to undertake an audit the tax shelter, and to educate the public about gifting tax shelters.

The CRA admitted that the main reason the taxpayer’s return was not reassessed was to discourage participation in gifting tax shelters. The CRA submitted that this motive did not conflict with its duty under subsection 152(1) of the Act.

Analysis

In allowing the application, Justice Harrington of the Federal Court followed the decision in Ficek v Canada (Attorney General) (2013 FC 502) in which the Court held that the Minister had failed to assess the taxpayer’s return “with all due dispatch.”

In Ficek, a delay in examining the taxpayer’s return arose from a new policy of discouraging certain types of tax shelter investments. In Ficek, the court acknowledged that the CRA has discretion in assessing taxpayers but noted “…the discretion is not unfettered, it must be reasonable and for a proper purpose of ascertaining and fixing the liability of the taxpayer” (para. 21). Importantly, the Court held that there should be some certainty to the taxpayer’s financial affairs (para. 34).

In McNally, Justice Harrington followed this reasoning. He held that the phrase “with all due dispatch” does not imply a specific time period before which the Minister must make an assessment. However, he found that while the Minister has discretion, it is not unfettered. The determination of whether the Minister has examined a taxpayer’s return “with all due dispatch” is a question of fact.

The Federal Court ultimately determined that the Minister had failed to assess the taxpayer’s tax return “with all due dispatch.”  The court held:

[41] … Although the Minister is responsible for administrating the Income Tax Act, ultimately it falls upon the courts to decide whether a claimed deduction is valid or not. It is plain and obvious that Mr. McNally’s rights have been trampled upon for extraneous purposes.

[42] The Minister owes Mr. McNally a statutory duty to examine his return “with all due dispatch.” There may well be circumstances in which it will take some time to reach a conclusion with respect to a given return. It may well be appropriate to await the audit of third parties. However this is not one of those cases.

[43] The CRA is entitled to express concerns with respect to certain shelters and to warn that such shelters will be audited. In Mr. McNally’s case, however, the resulting delay is capricious and cannot be allowed to stand. Even assuming these secondary purposes to be valid, they are overwhelmed by the primary main purpose and cannot save the day.

Interestingly, McNally goes a step further than the Court in Ficek, in which the Court had simply declared that the CRA had failed to assess with all due dispatch. McNally is a good example of the Federal Court exercising its judicial review authority to compel the CRA to carry out its statutory duty. This does not assure the taxpayer that he is entitled to his charitable donation claims, but at least he will be able to commence a challenge of the disallowance of the claims.

While the McNally decision does not go so far as to tell us what “with all due dispatch” means, the decision is the second important reminder that the CRA’s discretion in assessing taxpayers, while broad, is not unfettered.

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McNally: CRA Does Not Have Unfettered Discretion to Delay Assessment

New Judges Appointed to the Tax Court of Canada and the Federal Court of Appeal

A new judge has been appointed to the Tax Court of Canada.

From the news release published by the Department of Justice:

The Honourable Peter MacKay, P.C., Q.C., M.P. for Central Nova, Minister of Justice and Attorney General of Canada, today announced the following appointment:

The Honourable Guy R. Smith, a sole practitioner in Ottawa, is appointed a judge of the Tax Court of Canada to replace Mr. Justice J.E. Hershfield, who elected to become a supernumerary judge as of June 1, 2015.

Mr. Justice Smith received a Bachelor of Arts from the University of Manitoba (Collège universitaire de St-Boniface) and a Bachelor of Arts (History) (cum laude) from the University of Ottawa in 1982. He received a Bachelor of Laws (French Common Law Program) in 1985.

Mr. Justice Smith had been a sole practitioner since 2014. Previously, he had been the Judicial Affairs Advisor for the Federal Minister of Justice and Attorney General of Canada from March 2009 to July 2014. In December 2005, he became an investment advisor with ScotiaMcLeod and in June 2007 he joined CANNACORD Capital, where he worked until 2009. He practised administrative law, constitutional law and litigation with Perley-Robertson, Hill & McDougall LLP from 1997 to 2005 and as a sole practitioner from 1991 to 1997. After he was admitted to the Bar of Ontario in 1988, he practised with the Law Office of Coderre, Smith, Barristers and Solicitors until 1991.

Mr. Justice Smith was a member of the Carleton County Law Association, the Canadian Tax Foundation and the Canadian Club of Ottawa.

Appointments to the country’s Superior Courts not only reflect the rich and diverse social fabric of our country, but also take into consideration the merit and legal excellence of each individual jurist. Through these appointments, the Government of Canada has demonstrated an awareness of the need to bring greater gender balance to the bench, to help ensure that the judiciary is more representative of Canadian society.

This appointment is effective immediately.

Additionally, two new judges were appointed to the Federal Court of Appeal:

The Honourable Peter MacKay, P.C., Q.C., M.P. for Central Nova, Minister of Justice and Attorney General of Canada, today announced the following appointments:

The Honourable Yves de Montigny, a judge of the Federal Court in Ottawa, is appointed a judge of the Federal Court of Appeal to replace Mr. Justice R. Mainville, who was appointed to the Court of Appeal of Quebec on July 1, 2014.

Mr. Justice de Montigny was appointed to the Federal Court in 2004. Prior to his appointment, he had held various positions in the Department of Justice Canada, including those of Chief of Staff to the Minister, Senior Advisor to the Deputy Minister, and Chief Legal Counsel, Public Law Group. He had also been Director General of Constitutional Strategy and Plans at the Privy Council Office. As well, he served as Special Advisor to the Executive Council of the Government of Quebec and Counsel in the Quebec Ministry of Justice. His main areas of practice included constitutional law, administrative law, criminal law and international and public law. He had been a professor at the University of Ottawa, Faculty of Law (1982-1997), and a lecturer at the École du Barreau du Québec and the Faculty of Law and Faculty of Continuing Education of the Université de Montréal.

Mr. Justice de Montigny received a Bachelor of Laws in 1978 and a Master of Laws in 1979, both from l’Université de Montréal. As well, he holds a Masters in Political Philosophy from Oxford University. He was admitted to the Bar of Quebec in 1983.

The Honourable Mary J.L. Gleason, a judge of the Federal Court in Ottawa, is appointed a judge of the Federal Court of Appeal to fill a new position created by Bill-C36.

Madam Justice Gleason was appointed to the Federal Court in 2011. Prior to her appointment, she had been a senior partner with Norton Rose LLP (formerly Ogilvy Renault LLP), where she practised labour and employment law in Ottawa after being admitted to the Bar of Ontario in 1986. Madam Justice Gleason held a number of management positions within her firm, including that of co-managing partner of its Ottawa office and Ottawa Chair of its Employment and Labour Group. She frequently guest lectured at the University of Ottawa and taught a course in employment law at the Faculty of Law of the University of Ottawa. She has written numerous articles and regularly presented papers to conferences hosted by a variety of organizations, including the Law Society of Upper Canada, the Canadian Bar Association, Insight, Lancaster House, the Council of Industrial Relations Executives of the Conference Board of Canada and the Canadian Association of Counsel to Employers (CACE), an association of Canadian management-side labour and employment practitioners. Justice Gleason was a founding member and past president of CACE. She also was active in the Canadian Bar Association and the Ottawa Human Resource Professionals’ Association, where she held the portfolio of Government Affairs Liaison on its Board of Directors for a number of years. Prior to her appointment she was a member of the Canada Industrial Relations Board’s Client Consultation Committee and the Federal Court Labour Law, Human Rights, Privacy and Access Review Liaison Group. She was recognized as a leading labour and employment practitioner by Best Lawyers in Canada, L’Expert, PLC Which Lawyer?, Guide to the World’s Leading Labour and Employment Lawyers, and Canadian HR Reporter’s Canada’s Employment Law Directory.

Madam Justice Gleason, from Regina, Saskatchewan, lived most of her earlier years in Calgary and then pursued her studies in Ottawa and Halifax. She received a Bachelor of Arts (Honours) in History (summa cum laude) from the University of Ottawa in 1981and a Bachelor of Laws from Dalhousie University in 1984.

Appointments to the country’s Superior Courts not only reflect the rich and diverse social fabric of our country, but also take into consideration the merit and legal excellence of each individual jurist. Through these appointments, the Government of Canada has demonstrated an awareness of the need to bring greater gender balance to the bench, to help ensure that the judiciary is more representative of Canadian society.

These appointments are effective immediately.

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New Judges Appointed to the Tax Court of Canada and the Federal Court of Appeal

Fairmont: OCA Dismisses Crown’s Appeal in Rectification Case

The Ontario Court of Appeal has dismissed the Crown’s appeal in Fairmont Hotels Inc. v. A.G. (Canada) (2015 ONCA 441).

In Fairmont (2014 ONSC 7302), the taxpayer was successful on an application for rectification of certain corporate transactions (see our previous post here).

On appeal, the Crown argued that the lower court had misapplied the test for rectification because the parties had not determined the specific manner in which their intention to avoid tax would be carried out. In the Crown’s view, the lower court’s judgment sanctioned retroactive tax planning.

The Court of Appeal disagreed:

[8]          In these circumstances, relying on this court’s decision in Juliar, the application judge held that the respondent was entitled to rectify the relevant corporate resolutions to correct the mistaken share redemptions.  This result, the application judge noted, would avoid the imposition of an unintended tax burden that the respondent had sought to avoid from the outset, as well as an unintended tax revenue windfall to the CRA arising from the mistaken share redemptions.

[9]          On the factual findings of the application judge, set out above, and the binding authority of Juliar, we see no basis for intervention with the application judge’s discretionary decision to grant rectification.

[10]       Juliar is a binding decision of this court.  It does not require that the party seeking rectification must have determined the precise mechanics or means by which the party’s settled intention to achieve a specific tax outcome would be realized. Juliar holds, in effect, that the critical requirement for rectification is proof of a continuing specific intention to undertake a transaction or transactions on a particular tax basis.

[11]       In this case, on the application judge’s findings, the respondent had a specific and unwavering intention from the outset of its dealings with Legacy to ensure that the Legacy-related transactions were tax neutral and, to that end, that no redemptions of the relevant preference shares should occur.  Nonetheless, by mistake, the redemptions were authorized by corporate resolutions.

[12]       Contrary to the appellant’s argument, in these circumstances, it was unnecessary that the respondent prove that it had determined to use a specific transactional device – loans – to achieve the intended tax result.  That the respondent mistakenly failed to employ an appropriate transactional device to achieve the intended tax result does not alter the nature of the respondent’s settled tax plan: tax neutrality in its dealings with Legacy and no redemptions of the preference shares in question.

[13]       At the end of the day, therefore, Juliar and the application judge’s factual findings, described above, are dispositive of this appeal.  It is not open to a single panel of this court to depart from a binding decision of this court.

[14]       The appeal is dismissed. …

The Court of Appeal’s decision in Fairmont is an important affirmation of the result and reasoning in Juliar v. A.G. (Canada) ((2000), 50 O.R. (3d) 728 (Ont. C.A.)) (Dentons was counsel for the successful taxpayer).

Recently, the Crown has been aggressively arguing in rectification cases that Juliar was either wrongly decided or should be narrowly applied (two Alberta cases have followed this argument – see, for example, Graymar Equipment (2008) Inc. v A.G. (Canada) (2014 ABQB 154) and Harvest Operations Corp. v. A.G. (Canada) (2015 ABQB 237)).

However, in TCR Holding Corporation v. Ontario (2010 ONCA 233) and Fairmont, the Ontario Court of Appeal has clearly rejected those arguments. This should put an end to the Crown’s arguments about Juliar – at least in Ontario.

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Fairmont: OCA Dismisses Crown’s Appeal in Rectification Case

Kruger: FX Derivatives Gains/Losses Taxed Only When Realized

In Kruger Incorporated v. The Queen (2015 TCC 119), the Tax Court held that the taxpayer could not value its foreign exchange options contracts on a mark-to-market basis, with the result that certain losses were not deductible by the taxpayer in a year. The Kruger case is another recent judgment of the Tax Court in the developing law on the Canadian tax treatment of financial derivative products (see George Weston Limited v. The Queen (2015 TCC 42)).

Facts

Kruger’s core business was manufacturing newsprint, paper-coated products and tissue paper. In the 1980s, Kruger started trading in foreign currency contracts, and over time these activities grew to involve more than 10 employees trading in currency, bonds and securities.

In 1997, Kruger was advised that it was required to start reporting its financial trading activities on a mark-to-market basis, which required the recognition of any change in market value in a year as an income gain or loss.

In 1998, certain of Kruger’s U.S. currency options contracts were “under water” due to fluctuations in the Canada-U.S. exchange rate. Accordingly, for its 1998 tax year, Kruger claimed losses totaling $91,104,379 from a business of trading in derivatives. The CRA reassessed to deny the deduction of $91,104,379, but excluded from income the amount of $18,696,881, which Kruger had included as the amortized portion of the net of premium income and expenses for the foreign exchange options contracts. The CRA also included the amount of $91,104,379 in Kruger’s taxable capital for the purposes of the large corporations tax (which has now been generally repealed).

Kruger appealed the reassessment on the basis that, in accordance with section 9 of the Act, it was entitled to value its foreign exchange options contracts using the mark-to-market method, and argued in the alternative that its foreign exchange options contracts were inventory and were to be valued at the lower of cost and fair market value under subsection 10(1) of the Act.

Analysis

The Court reviewed the key Canadian judicial authorities regarding the test for determining income under the Act, including Friedberg v. The Queen ([1993] 4 S.C.R. 285), Canderel Limited v. The Queen ([1998] 1 S.C.R. 147), Friesen v. The Queen ([1995] 3 S.C.R. 103). The Court referred to the oft-cited principles from Canderel that the determination of profit is a question of law, and a taxpayer is free to adopt any method for determining profit that is not inconsistent with the provisions of the Act, case law, and well-accepted business principles. Once the taxpayer has shown that it has provided an accurate picture of income, the onus shifts to the CRA to establish that the amount is not an accurate picture of profit or that another method would provide a more accurate picture.

The Court noted there were no provisions in the Act that required or authorized the valuation of property on a mark-to-market basis. Further, there is an important difference between financial and tax accounting:

[109] Financial accounting … is concerned with constructing a picture of profit from year to year in a consistent manner for the benefit of the audience for whom financial statements are prepared: shareholders, investors, lenders, etc. … FASB views mark to market valuation for the same reasons: to better enable investors, creditors and others to assess the entity’s performance. …

[110] Tax accounting normally is not overly concerned with the past; it wants a picture of income for a particular year and … the methodology used to calculate income in one year may be different from that used in an earlier year. … statements for tax purposes are solely concerned with the computation of income in achieving an accurate picture of income for the particular taxation year.

The Court noted that sections 142.2 to 142.5 of the Act require financial institutions and investment dealers to use mark-to-market, but these rules did not apply to Kruger. The Court stated,

[114] Mark to market accounting … would compel a taxpayer to include any loss or gain in value of the property at year-end in income for the year. This may be appropriate for financial statements for reasons discussed earlier. But, for income tax purposes, the taxpayer may be compelled to include an amount in income where there is no clear statutory language requiring him or her to do so. The realization principle is basic to Canadian tax law. It provides certainty of a gain or loss. Without some support of the statutory language or a compelling interpretation tool it ought not to be cast aside.

The Court also noted a difficulty in respect of the market prices for the foreign exchange options contracts, namely that such prices were formulated by the counter-parties to the contracts (i.e., Kruger’s banks). The Court held there was a “probably inconsistency in values” depending on the pricing method used by the counter-party.

In respect of Kruger’s alternative argument that the options contracts were inventory, the Court determined that Kruger was carrying on a business of speculating on foreign exchange currency options that was separate from its manufacturing business. Further, the Court determined that the foreign exchange options contracts were financial liabilities when such contracts were written by Kruger, and property (i.e., inventory) when purchased by Kruger.

The Court allowed the appeal only to permit Kruger to value its purchased foreign exchange options contracts in accordance with subsection 10(1) of the Act (which would have an effect similar to mark-to-market accounting in that the contracts would be valued each year at the lower of cost and fair market value). Additionally, the amount of $91,104,379 was to be added to Kruger’s taxable capital for the purposes of the large corporations tax

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Kruger: FX Derivatives Gains/Losses Taxed Only When Realized

BP Canada: CRA Entitled to Tax Accrual Working Papers

In BP Canada Energy Company v. Minister of National Revenue (2015 FC 714), the Minister brought an application pursuant to subsection 231.7(1) of the Income Tax Act (Canada) (the “Act”) before the Federal Court of Canada.

The Minister sought a compliance order requiring BP Canada to provide tax accrual working papers prepared by BP Canada’s own employees which were requested by the Canada Revenue Agency (“CRA”) during its audit pursuant to subsection 231.1(1) of the Act.

The Federal Court allowed the application and granted the compliance order.

Background

Under subsection 230(1) of the Act, a taxpayer must keep books and records in such form and containing such information as will enable the taxes payable under the Act to be determined.

Under sections 231.1 to 231.7, the CRA may request and a taxpayer may be required to produce such book and records. Additionally, the CRA has routinely made broad requests for tax accrual working papers.

Taxpayers are generally reluctant to produce tax accrual working papers to tax auditors because these documents could provide a roadmap of the taxpayer’s tax positions, an estimate potential exposure for tax, and an outline the possible assessing position the tax authorities may take. Moreover, these documents are required to be prepared pursuant to securities regulations and accounting standards rather than pursuant to the Act or for the determination of taxes payable.

In “Acquiring Information from Taxpayers, Registrants and Third Parties” the CRA stated that it will follow a policy of restraint in requesting tax accrual working papers during its regular income tax audits – namely, that it would only request them if a proper examination could not be carried out without access to those files.

In BP Canada, the CRA explicitly stated that it sought to obtain BP’s tax accrual working papers to assist the CRA in expediting its audit not only for the years for which the tax accrual working papers were prepared but also for subsequent tax years – thus implying that the documents were not required for the audit but were simply helpful as a matter of convenience for the auditor.

Arguments

BP Canada submitted that tax accrual working papers are subjective opinions regarding tax filing positions and are not required to establish the tax payable under the Act and therefore do not qualify as books and records that are required to be provided to support a tax filing position.

Moreover, BP Canada submitted that, even if the statutory requirements for a compliance order are met, the Federal Court must justify the exercise of its discretion to grant the order.

In this case, BP Canada argued that such discretion could not be justified because it would constitute a compulsory self-audit by the taxpayer and would violate the Minister’s own policy not requiring such documents to be produced.

Decision

In granting the compliance order, the Federal Court found while the Minister may not need the tax accrual working papers to complete an audit, if the Minister wants them, she should have them.  The Federal Court did not accept BP’s “roadmap” argument and put weight on the fact that the tax accrual working papers are already prepared and thus no additional work would be required by the taxpayer.

The Federal Court also stated even though the Act does not require these types of documents be retained, if they are maintained for another reason they can be requested by the Minister.

Finally, the Federal Court relied on the Federal Court of Appeal case Tower v. MNR (2003 FCA 307) in finding that tax accrual working papers do fit within the scope of subsection 231.1(1) which provides that the CRA may request “the books and records of a taxpayer and any document of the taxpayer or of any other person that relates or may relate to the information that is or should be in the books or records of the taxpayer or to any amount payable by the taxpayer under this Act”.

The Federal Court endorsed the Minister’s audit approach in this case, stating that the Minister’s request for tax accrual working papers is not part of a fishing expedition if the Minister knows that she wants a clear roadmap to be used for current and future audits (see para. 38) (we note, however, that the decision does not consider whether a clear sign of a fishing expedition may be a broad request by the CRA for a roadmap of the taxpayer’s tax considerations).

The decision in BP Canada clearly outlines the Federal Court’s opinion that tax accrual working papers should be produced when requested pursuant to section 231.1 of the Act. The decision serves as an important reminder that taxpayers should be cautious in preparing and maintaining tax accrual working papers.

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BP Canada: CRA Entitled to Tax Accrual Working Papers

Two New Judges Appointed to Tax Court of Canada

Two new judges have been appointed to the Tax Court of Canada.

From the news release published by the Department of Justice:

The Honourable Peter MacKay, P.C., Q.C., M.P. for Central Nova, Minister of Justice and Attorney General of Canada, today announced the following appointments:

The Honourable Don R. Sommerfeldt, a counsel with Dentons Canada LLP in Edmonton, is appointed a judge of the Tax Court of Canada, to replace Madam Justice G. Sheridan who resigned effective May 1, 2014.

Mr. Justice Sommerfeldt received a Bachelor of Arts and Science from the University of Lethbridge in 1972 and a Bachelor of Laws from the University of Alberta in 1977.  He also received a Master of Arts from Brigham Young University in 1974 and a Master of Laws from Cornell University in 2004.  He was admitted to the Bar of Alberta in 1978 and to the bar of New York in 2004.

Mr. Justice Sommerfeldt has been with Dentons Canada LLP (formerly Fraser Milner Casgrain LLP) since 2000.  Prior to that, he practised taxation, estate planning and pensions with Edward A. Zelinsky Professional Corporation; Cruickshank Karvellas; Milner Fenerty; the Department of National Revenue (Rulings Directorate) while on secondment from Milner & Steer.

Mr. Justice Sommerfeldt is a member of the following associations: the Canadian Tax Foundation and is a past governor; the Society of trust and Estate Practitioners, the Canadian Bar Association; the Canadian Association of Law Teachers; the International Fiscal Association; and the New York State Bar Association.

The Honourable Henry A. Visser, a lawyer with McInnes Cooper in Halifax, is appointed a judge of the Tax Court of Canada, to replace Madam Justice D. Campbell, who elected supernumerary status as of June 19, 2015.  This appointment is effective June 19, 2015.

Mr. Justice Visser received a Bachelor of Commerce from Dalhousie University in 1988 and a Bachelor of Laws from the Dalhousie Law School (now the Schulich School of Law) in 1994.  He was admitted to the Bar of Nova Scotia in 1995 and to Prince Edward Island in 1998.

Mr. Justice Visser has been a lawyer with the firm McInnes Cooper since 1997 and became a partner in 2003.  His main areas of practice were tax law, corporate law, commercial law, labour law and employment law.  He was employed with Martin Visser and Sons, farming and export business, from June 1995 to May 1997.

These appointments are effective immediately, unless indicated otherwise.

Two New Judges Appointed to Tax Court of Canada