John A. Sorensen
Partner
Co-Department Head, Toronto Business Law Department
On-demand webinar
CPD/CLE:
29
Stevan: Welcome to our third session of our Tax Dispute Resolution Monthly Updates. Please note that we will be taking December off in view of the holidays and that our next session will be on January 25. Being lawyers we have of course need to start with a disclaimer, and you can read this but the essential message is that these webinars cover the topics presented only generally, and are not intended to provide legal advice since every situation is different. So for today's speakers, again by way of introduction, my name is Steve Novoselac and I'm here with John Sorensen. We serve as co-Leaders of Gowling WLGs Tax Dispute Resolution practice in Canada, both working out of our Toronto office. We're joined again today by our partner, Pierre Alary, who works out of our Ottawa office. Pierre also specializes in resolving tax disputes along with transfer pricing issues and, as we mentioned at our previous sessions, we launched these webinars internally for our firm's national tax practice group about 6 years ago to discuss new policies, legislation and case law. Now that we've expanded to an external audience, and gotten some early feedback, we've been pleased to see that others are finding these sessions helpful as well. To stay up to date with current developments in tax dispute resolution. So, as always, if you have questions please feel free to submit them throughout with the question feature, or again, aiming to wrap up today by no later than 12:30 and depending on our timing we'll try to answer questions, either at the end of today's session or, if not, then at our next session in January. We also welcome suggestions for topics that you'd like us to discuss at future webinars and so please feel free to submit those as well. For today we have the following three topics. First, the precarious future of recission, which John will be discussing. Second, the Bank of Nova Scotia case: tax court does not rule in the arrears interest of fairness, that Pierre will be discussing, and thirdly I will be discussing how to effectively resolve tax disputes. With that, John, please go ahead and tell us about recission.
John: Thanks, Steve. So my presentation today is the third in a series of discussions that I've been doing about rectification and recission, which are doctrines that allow tax payers to correct or eliminate a mistake in transaction, in certain circumstances. So recission reaches back in time and it erases transactions while rectification may correct mistakes in transaction documents, where the documents did not accord with the parties true agreement. So today I'm going to focus on the arguments that are going to be raised in the Supreme Court hearing of the Collins Family Trust matter, and obviously our time is very limited, 7 to 10 minutes doesn't really allow me to go into the fine granular detail on every point. So at times this will be a high level overview and apologies if counsel on this matter actually watch this presentation because I'm not going to perhaps sufficiently deep for them, but anyway, by way of background the Collins Family Trust. They brought an application seeking to rescind certain transactions in the BC Courts on the count of adverse tax consequences. The application was successful, initially, and also before the BC Court of Appeal the Government of Canada then sought and obtained leave to appeal to the Supreme Court of Canada. So the Collins Family Trust matter will be heard by the Supreme Court this January, 2022. The substantive tax issue was summarized by the BC Court of Appeal as follows: An asset protection plan was created, intended to be taxed neutral. Tax neutrality and asset protection were viewed as being of equal importance. A holding company was incorporated and that holding company purchased the shares of an op co. A family trust was interposed. It was created using the holding company as a beneficiary. So the holding company then loaned funds to the trust. Those funds were used to purchase shares in the op co. The holding company had an option to repurchase the shares. Dividends on those purchase shares would be paid from the op co to the trust and then those funds could be deployed as the trustee saw fit.
So going to slide 7, to achieve a favourable tax outcome the structuring relied on subsection 75(2) of the Income Tax Act. This is an attribution rule. Essentially it's an anti-avoidance provision that attributes taxable income and thus, tax consequences from one entity to another when certain criteria are met. The subsection played a role in the structuring in this case in the sense that the dividend income that was received by the trust was attributed out to the holding company. But the holding company was entitled to a inter-corporate dividend deduction under subsection 112(1). So basically the trust receives and holds cash, which it can then distribute without paying tax, and then the holding company has the tax consequences attributed to it but then it uses the inter-corporate dividend deduction to nullify the tax. As I mentioned, 75(2) is an anti-avoidance provision and what it's supposed to do, it seeks to ensure the tax payers can't avoid tax on the use or distribution of property by transferring the property to another person, in trust while simultaneously the transferor retains a right to have that property revert back to them. So an example would be say where a settlor is also a beneficiary with a right to receive a distribution of trust property. It's a bit of a mouthful, sorry, but in any case at the time of the structuring, that's in issue here, the prevailing view was that 75(2) would apply and it wouldn't matter exactly how the property went into the trust. If you gift the property into the trust, if you sell the property into the trust, either way subsection 75(2) applies to project the tax consequences back out onto the transferor, in this case being the holding company that's writing off the tax consequences to land. So that interpretation, in this case it was a sale, that interpretation was scuttled by a case called Sommerer, which is a Federal Court of Appeal case. Totally unrelated to the Collins Family Trust matter. In Sommerer the Court concluded that subsection 75(2) does not apply where property is transferred into a trust by way of a bona fide sale. That's a huge problem and interpretation totally inconsistent with what anyone thought. When I say with anyone I also mean the CRA didn't think that either. In fact, in Sommerer CRA took the position that it didn't matter if property was transferred in the way of a gift or by way of a sale. Then once they lost Sommerer they thought, aha, and then used that outcome in Sommerer to go back and start reassessing structures like the Collins Family Trust structure, among others. Turning to the next slide.
The BC Court of Appeal also noted that the Application Judge concluded that CRA probably would not have challenged the structure in this case before Sommerer. The Court talked about the allegation of aggressive tax planning, but you know, counsel for the Trust said, you know CRA has actually has issued a bunch of advance tax rulings that allow tax exempt First Nation Bands to transfer property to a trust and then rely on the attribution rule to divert income out of the trust into the tax exempt Band. So is this kind of planning that Collins Family Trust engaged in? Is it aggressive? Is it GAAR-able? Well not insofar as CRA has literally signed off on this, previously, again, prior to Sommerer. So going to slide 9 and just a little refresher on recission.
To get a transaction rescinded, the test relied on in BC concerns whether there's a voluntary disposition and a mistake of so called sufficient causative gravity that would make it unconscionable, unjust or unfair to leave a mistake uncorrected. A couple of final points before turning to the arguments that will be raised in the Supreme Court in January. After Sommerer, but before Fairmont Hotels and Jean Coutu, a whole other structure sought recission. This was the Pallen Family Trust. Same kind of structuring as in Collins Family Trust and Pallen succeeded in the BC Courts. What the BC Courts said was, in Collins Family Trust they said we're bound by the outcome. In Pallen Family Trust, same transactions and, you know, Jean Coutu, Fairmont, that's rectification. Sure, recission is an equitable remedy too but rectification/recission, these are different legal tests. They each apply in both tax and non-tax context and if you meet the test you get the remedy. Turning to slide 10.
The positions that were advanced by the Crown, and by counsel for the tax payers in this case, are pretty far apart which is not surprising, obviously they're going to the Supreme Court based on having different interpretations of fact and law. The Crown's goal is to seek to have the doctrines of rectification and recission harmonized, essentially, and rectification, we know it doesn't allow a tax payer to be relieved of the consequences of an intentional plan because that would be tantamount to allowing retroactive tax planning. But to date, equitable recission has had a different test, as mentioned above. There has to be a mistake of sufficient gravity and it will be unjust, unconscionable, unfair to leave it uncorrected. Totally different test than rectification and on the face of this it would seem to allow for a Court to reverse a structure based on a bad outcome, if that outcome falls into a zone of unfairness, if you will. Arguably recission actually does allow for retroactive tax planning. Going to slide 12, if we could, please.
The pro-tax payer argument, again, is that rectification and recission are just totally different doctrines. They apply in a tax context. They apply in a non-tax context. If rectification in a tax context has to harmonize with rectification law generally, well then recission in a tax context can also harmonize with recission generally, and that is a broad test. It is not contingent on whether there's retroactive tax planning. So I think this is a very good point counsel for the Trust has raised. It's a little bit surprising, I think, in the positions that have been put forward in the Supreme Court, in writing so far, is the extent to which the facts remain an issue and here's what I mean by that; in the Supreme Court filings counsel for the Trust argues that the BC Courts held that the purpose of the planning is to achieve asset protection without income tax liability. Asset protection and tax were equally important, and further, the tax plan was based on a common general understanding of the operation of subsection 75(2). An understanding shared by income tax professionals and shared by the CRA. Then along came the totally unrelated case of Sommerer that turned that interpretation on its ear and gave the CRA tools to then attack these kinds of structures. So going to slide 12.
What happened next is the CRA then obviously ran with that new interpretation to attack existing structures. From a tax payer's perspective, the new Sommerer interpretation is retroactive tax attack, if you will. Government of Canada takes this new interpretation, and retroactively attacks existing structures that the CRA previously did not have tools to attack, using this interpretation which does seem unfair. Crown counsel have, and will argue, that the Trust engaged in aggressive or abusive tax planning and that equitable remedies should be unavailable to unwind aggressive tax strategies. In my view that argument is at odds with the facts because the fact is the BC Courts said that CRA would not have assessed the Trust before the new Sommerer interpretation came along. Further, if the CRA thought the Trust structure was GAAR-able, the timing for assessing the Trust does seem rather suspicious. CRA never raised the GAAR but they then rely on this new Sommerer interpretation to attack the interpretation of 75(2). I don't think there really is, in my humble opinion, a viable factual matrix to argue that the Trust engaged in abusive tax planning. It lacks what criminal lawyers call an error of reality. So I think there's been fact finding in the BC Courts. There's been affidavit evidence filed. There's no palpable overriding error that would allow the Supreme Court to reconsider whether there was any aggressive tax planning in place. So that argument seems like it would be stillborn, I think. Going to slide 14.
Also, the Pallen Trust Case, when that was determined the Court said based on the same facts so there's no aggressive tax planning, and again, in Pallen Trust the Court specifically noted that CRA issued advance tax rulings, specifically approving subsection 75(2), as part of a tax efficient structure. The Crown has advanced other arguments in its factum in the Supreme Court, which I think private practitioners will dispute. So one of the arguments they raised is look at the wording of the engagement letter with the Trust profession advisors. The opinion language includes the usual language that professionals like us use to protect ourselves. The opinion was based on the professional's understanding of the law and CRA administrative practice at the time and this is subject to change. The Crown realized on that opinion language qualification to suggest that while the tax payer's voluntarily assumed risk when they structured the tax portion of the planning, so they had to wear the outcome, which I think is a bit of a stretch for that usual qualification. I think the problem with the argument is that this kind of language is standard. In reality the level of risk as between transaction steps, or different transactions, can be really, really highly variable. The fact of the matter is that the opinion language concerning the application of 75(2) was based on what everyone thought was a settled interpretation, including the CRA. Then the final argument that the Crown raises is that recission of a transaction should not be available where there is an adequate alternative legal remedy available. I would go so far as to suggest that is a disingenuous argument and here's why.
Depending on the case, if you follow these cases, the Crown has been known to argue that you can't have recission because the tax payer could file a notice of objection instead, and I would go so far as to intemperately say that is nothing but pure nonsense. Anytime the remedies of rectification or recission are raised there's no way it would every succeed on those objections without rectification or recission. These are totally non-overlapping remedies. As well, depending on the case, as they have here the Crown may argue that the tax payer could apply for a remission order under the Financial Administration Act, however, if the Crown is fighting recission tooth and nail one wonders why the Government of Canada would then grant remission, and then to say nothing of the fact that remission takes years and is a strenuously guarded remedy. Again, that seems like a very disingenuous thing to argue. Finally, the Crown argues in its factum, recission shouldn't be allowed in this case because the tax payer could sue their advisors instead. But interestingly enough the Crown argues on one hand that the tax opinion included warnings to the tax payer. On the other hand they argue the tax payer could sue their advisors. Well, can they sue their advisors if they've been suitable warned in the tax opinion. Both of those positions can't be right so the Crown seems to speak out of both sides of its mouth on the base of these arguments. Anyway, I've gone on for a bit of a while. I've already cut into my partner's time, regrettably, but it will be interesting to see how this matter unfolds in the Supreme Court and what the Court does with the various sort of challenging arguments that will be tabled. As a private practitioner, fingers crossed that the recission remedy remains a viable option to address tax issues on a go forward basis, and with that, I apologize to Pierre for cutting in and turn it over to him.
Pierre: Thanks, John. As I'm sure everyone in this webinar is aware, when the CRA conducts an audit the audit always relates to earlier taxation years. In certain cases, such as a complex transfer pricing audit, by the time the CRA issues a reassessment, the reassessed year can be a decades old. As part of such a reassessment the CRA will assess arrears interest on the balance of tax owing and such interest can be significant. In the recent Tax Court decision of Bank of Nova Scotia an interesting question arose. If the tax payer had an available non-capital loss in the later taxation year to wipe out the new reassessed amount, should arrears interest be charged for the entire period or only up until the time that the non-capital loss became available. So let's go through the facts of the Scotiabank case to illustrate the issue.
In 2013 the CRA began a transfer pricing audit of Scotiabank. On March 13, 2015, Scotiabank and the CRA entered into a settlement agreement to include certain income as transfer pricing adjustments for the 2006 to 2014 taxation years, and we'll focus today on the reassessment for the 2006 year, which increased the bank's part one income by nearly 55 million dollars. Another notable factor is that the Bank reported a non-capital loss of 3.3 billion dollars for it's 2008 taxation year. Therefore the day before entering into the settlement agreement with the CRA, Scotiabank wrote to the Minister to ask that the non-capital loss, from 2008, be carried back to offset the resulting increase in income for 2006. The Minister accepted this request, and as part of the same notice of reassessment added the 55 million dollars to the Bank's income, the Minister applied the non-capital loss against the income. However, in addition to this the Minister assessed arrears interest for the period beginning on April 27, 2007, which is the date the Bank's 2006 return was first filed, and ending on March 12, 2015, which is the date that Scotiabank requested that the non-capital loss be carried back. Scotiabank disagreed and took the position that the arrears interest should only accrue until the date on which the 2008 non-capital loss became available. In other words, here the Minister is arguing that interest should accrue for nearly 6 more years, and what Scotiabank thought was appropriate, and the assessed arrears interest in this case totaled 7.9 million dollars. The relevant section of the Act is paragraph 161(7)(b) which provides that a non-capital loss is deemed to have been applied on the day that is 30 days from the latest of four points in time. Two of the dates were not relevant in this case so we will focus on the other two.
The relevant date in Scotiabank's opinion is the day on which the return for the loss year was filed and for Scotiabank's 2008 taxation year this would have been April 28, 2009. The Minister argued that subparagraph 161(7)(b)(iv) of the Income Tax Act should apply. What that subparagraph states that in the case where the Minister reassessed a tax payer, as a consequence of a request in writing from the tax payer to take into account the deduction, then the fourth possible date would be the day on which the request was made. In this case the Minister argued that Scotiabank made a request in writing to the Minister on March 12, 2015, to have the non-capital loss carried back and therefore, as this is the latest of the four dates, this is the date that should apply. The Minister's position was that the words of the applicable provision in the Act are clear so the Court should defer to their ordinary meaning. Whereas Scotiabank's position was that Parliament did not intend for a tax payer to be subject to interest during periods when a loss was available for carry back, but the tax payer does not know to carry back that loss until the conclusion of an audit. Scotiabank also argued that in this case the Minister reassessed Scotiabank to make her transfer pricing audit adjustments rather than as a consequence of the written carry back request. As we just discussed, the fourth date in paragraph 161(7)(b) only applies if the Minister reassess the tax payer as a consequence of a request in writing from the tax payer. Therefore in Scotiabank's opinion, if the reassessment was made as a consequence of the transfer pricing audit, rather than the tax payer's written request, then the fourth date does not apply.
So the Tax Court Judge began her analysis by discussing some principles of modern statutory interpretation, including the well known principle that the words of an Act should be read in their entire context, in their grammatical and ordinary sense, harmoniously with the scheme of the Act, the object of the Act and the intention of Parliament. The Judge concluded that based on these principals she could not agree with Scotiabank's interpretation of the provision. In her view the wording of the provision is unambiguous and therefore the correct deemed date was April 11, 2015. The Judge explained that we have a self-assessing income tax system under the Income Tax Act which is full of examples that the onus is put on the tax payer. The Act is clear that one is liable for tax owing regardless of the assessment status. So regardless of whether an assessment is incomplete, incorrect or even if no assessment was made. In other words, the Judge is saying that Scotiabank had this 55 million dollar liability for 2006 taxation year dating back to when they filed their 2006 tax return. The liability here was not created as a result of the audit. Therefore because we live in a self-assessing system, and Scotiabank is responsible for accurately determining its tax liability each year, Scotiabank can only blame itself for not reporting it's income correctly in 2006.
So this decision has generated a lot of interest in the tax community. Some tax practitioners disagree with this Tax Court's findings and they're of the view that the Minister's reassessment was not made as a consequence of the written request but rather as a result of the audit. Others have argued that the intention of Parliament, when it introduced subsection 161(7), was for the provision to apply to situations where tax payers intentionally ignored the payment of taxes in a year in anticipation of a loss in a future year. This argument stems from a comment made by a Senator during the Senate Debates when the bill which added subsection 161(7) was being debated. Therefore, the argument is that if there was no intent on the Bank's part to ignore the payment of taxes in 2006 then the provision should not apply. This case has been appealed to the Federal Court of Appeal so it will be interesting to see which arguments will be raised by the Bank. With that I will send it back to Stevan.
Stevan: Thanks, Pierre, and so I'm going to be discussing how to effectively resolve tax disputes from sort of a very high level, and I'll go through this fairly quickly. So here we have the various stages of a tax dispute, from the audit to the objection of the Court appeal, and when considering this issue there are some sort of overriding guiding principles. It's first important to understand that the approach in trying to resolve varies depending on which stage of the process we're at and there always needs to be a principled basis for settlement, as unlike private litigation where the parties can make an assessment of the risk of the outcome and split the difference on whatever basis they feel appropriate, there has to be an application of the facts to the law. It's always important to bear in mind to create an atmosphere conducive to settlement. Also important to bear in mind that it's almost impossible to recover costs from the CRA as a term of any settlement, short of going to Court.
So then first stage is the audit stage where it's being handled by an auditor or a team of auditors. But the auditor has a broad range of powers to obtain documents and information. There's no obligation of volunteer documents or information that are not requested on the basis that if it's not relevant to the audit, and this is particularly applicable when it's outside the audit period. There can also be issues arising around solicitor client privilege claims, and taking the position that privilege applies can give rise to CRA issuing requirements, and eventually seeking compliance orders which failure to comply with those can give rise to contempt of court orders and ultimately fines or even imprisonment. So we always, of course, work as hard as we can to proactively avoid this kind of escalation. One of the things that can be done there is to enlist the services of Department of Justice counsel, who will be insulated from other Justice counsel who are working on the matter, to do an evaluation of whether privilege applies and negotiate with counsel for the tax payer to make that determination without having to escalate the matter all the way to Court. I'd like to go to the objection slide, please. Next slide 29. If you could advance it to slide 29.
At the objection stage there's really a threshold issue that arises, and it's an important strategic call, and that is whether to try to negotiate with the Appeals officer to achieve a resolution at that stage or leapfrog, if you will, or forego that opportunity and appeal directly to Court, which can be done 90 days after the objection's filed. Some counsel will always tend to prefer one or the other of these two options. We've seen internal documents from the CRA where if a law firm has a preference to always go to Court, it's identified, and the Appeals officer is literally instructed not to bother working the file at that stage. In our view, however, the optimal strategy should always be determined on a case by case basis. So with that I'd like to go ahead, please, to slide 34, the tax litigation stages.
Assuming that we're jumping ahead to that stage in our process we now have a litigation officer handling the file. So this is a stage, has it's own considerations that inform the settlement negotiation strategy, and you can try to achieve a settlement at different stages of the process. A strategy that we've seen had some success with. We've seen effectiveness to approach Justice counsel before the reply is even filed, and suggest that there be an extension of time to file the reply, and instead of marching forward with all the procedural steps in the litigation to instead engage in settlement negotiation at that time. I'd like to go wrapping up then to slide 37, a tax dispute resolution versus tax litigation.
Years ago that's what this practice area was called, tax litigation, but I think tax dispute resolution is a much better descriptor. Tax payers generally don't relish the idea of litigating with the CRA. They just want to resolve their tax dispute as quickly and painlessly as possible.
With that, I'm not seeing any questions at this point, but if we could go to the next slide, please. This is our survey. So we'd be grateful if you could take a moment or two to complete that survey and let us have your thoughts and your feedback. It's always welcome and, again as a reminder, please don't miss our next webinar scheduled for January 25. So you'll see an invitation for that and with that, thank you again very much for attending, and all the best for the Holiday Season, to you and your family. Bye-bye.
With the Canada Revenue Agency deploying massive resources to crack down on perceived tax avoidance, it's now more important than ever to stay up to date with new CRA policies, legislation and case law. Please join Stevan Novoselac, John Sorensen and Pierre Alary for Gowling WLG's 30 minute interactive monthly tax dispute resolution (TDR) webinars, to keep up with current developments and learn practical insights on how to successfully resolve tax disputes with the CRA.
To submit a question or topic to be covered in future webinars, please email TDR@gowlingwlg.com.
Topics discussed at session three included:
This on-demand webinar is part of our 2021 Tax Dispute Resolution Monthly Update. Watch more from the series »
*This program is eligible for up to 30 minutes of substantive CPD credits with the LSO, the LSBC and the Barreau du Québec, and may be eligible for up to 30 minutes of CPD/CLE credits in other jurisdictions.
NOT LEGAL ADVICE. Information made available on this website in any form is for information purposes only. It is not, and should not be taken as, legal advice. You should not rely on, or take or fail to take any action based upon this information. Never disregard professional legal advice or delay in seeking legal advice because of something you have read on this website. Gowling WLG professionals will be pleased to discuss resolutions to specific legal concerns you may have.