The purpose of statutory limitation rules is to introduce some finality into the law. For a country’s taxing authority, a limitation period may serve the additional purpose of allowing it to finally “close its books” and ascertain its tax base. In Canada, subsection 164(1) of the Income Tax Act1 (ITA) prevents an overpayment of tax from being refunded beyond three years from the year in which the taxpayer made the overpayment. The rules provide the Canada Revenue Agency (CRA) the discretion to extend this period to up to 10 years, although not for corporate taxpayers. Recent amendments to the ITA, namely the addition of paragraph 164(1.5)(c), as well as a recent CRA technical interpretation on the interaction between subsection 221.2(1) (dealing with the re-appropriation of debts) and subsection 164(1) have caused tax advisers to question the “three-year limitation” adage. In addition, certain tax treaty provisions, such as the Mutual Agreement Procedure (MAP) Article of the Convention Between Canada and the United States of America with Respect to Taxes on Income and Capital (Canada-U.S. Treaty)2, operate to further blur the rule. Many tax professionals are left wondering: has the three-year statutory limitation on refunds of overpayments for corporations, for all intents and purposes, become merely an unnecessary hurdle in the ITA?
Section 164 of the ITA allows the Minister of National Revenue to refund overpayments made by a taxpayer on account of its tax liability. A refund is not allowed unless an income tax return is filed within three years from the end of the tax year.3 For individuals or testamentary trusts, the CRA is granted the discretionary authority to allow a statute-barred refund of all or any part of an overpayment of tax. Pursuant to paragraph 164(1.5)(a), these taxpayers are afforded a 10-year time limit (rather than the normal three-year period) within which they may file a return in order to be eligible for a refund. Notably, this relief is not available to corporations. Further, the CRA is not obliged to grant relief under this provision; each request is reviewed on its own merit.4 The CRA’s administrative policy indicates that it may choose to allow the refund if it is satisfied that such a refund would have been made if the return or request had been filed on time, and provided that the necessary assessment is correct in law and has not been allowed already.5
The Canada-U.S. Treaty
The MAP Article of the Canada-U.S. Treaty (Article XXVI) provides taxpayers with an alternative to the dispute resolution process available under domestic law. The MAP allows the Canadian and U.S. competent authorities to interact for the purpose of resolving international tax disputes which generally arise where there has been a case of double taxation, or if there are inconsistencies in the interpretation of the convention.
Pursuant to paragraph 2 of the MAP Article contained in the Canada-U.S. Treaty, any agreement reached by the competent authority of each contracting state “shall be implemented notwithstanding any time or other procedural limitations in the domestic law of the Contracting States.” Until recently6, the Canada-U.S. Treaty was one of a select few of Canada’s tax treaties in which the Canadian competent authority is obligated (i.e., the obligation to provide relief of double tax “notwithstanding” Canadian domestic law). Therefore the effect of this “notwithstanding” clause in the provision is to allow refunds or reassessments of tax that would otherwise be statute-barred by subsections 152(4) or 164(1) of the ITA and other limitation provisions in the ITA. For example, despite the two-year limitation in subsection 227(6) of the ITA to apply for a refund of excess amounts withheld, the Canada-U.S. Treaty provides that, in the case of Part XIII withholding, the competent authorities may grant relief so long as they are notified within the six-year treaty limitation provided in the MAP Article.7
The federal budget released on March 4, 2010, contained amendments to the ITA that were designed to cure a deficiency in the Canadian tax system caused by the rigidity of the rules against the refunding of overpayments of tax for corporate taxpayers. Specifically, paragraph 164(1.5)(c) of the ITA was added to recognize an unfairness that was occasioned to non-resident corporations, where the CRA raised “failure to withhold” assessments at a time when the non-resident was already statute-barred from receiving a refund.
This situation most commonly arose in relation to CRA assessments against taxpayers for failing to withhold the prescribed 15 per cent under Regulation 105 of the ITA for payments made to non-residents in respect of services performed in Canada. As this amount is withheld on account of the non-resident’s potential Part I tax liability in Canada, any amount collected in excess of the non-resident’s actual tax liability is normally refunded to the non-resident. Thus, in circumstances where the income of the non-resident is exempt from Canadian tax, due to a tax treaty, for example, the entire amount of the withholding should be refunded. As there is no statutory time limitation in the ITA for the CRA to assess a taxpayer for a failure to withhold, prior to the 2010 amendments, a non-resident could find itself in a situation where it was unable to receive a refund of the amount assessed to a Canadian payer (due to a statutory bar), despite the non-resident not having any actual tax liability.
With the 2010 amendments, the CRA is now able to refund overpayments of tax by a taxpayer to the extent that the overpayment relates to an assessment of another taxpayer (i.e., the payer who was required to withhold).8 However, the amendments require that the taxpayer’s return be filed within two years of the date of the assessment of the other taxpayer. This two-year rule seems consistent with the Part XIII refund policy in subsection 227(6). Further, the assessment of the other taxpayer must relate to a payment of a fee to a non-resident for services rendered in Canada or an amount that was assessed against a purchaser for failing to withhold in connection with the sale of “taxable Canadian property.” The 2010 amendments will be effective for applications for refunds made after March 4, 2010.
Re-appropriation of Statute-Barred “Overpayments”
A recent technical interpretation by the CRA has confirmed that otherwise statute-barred overpayments of tax may be re-appropriated to effectively achieve the equivalent of a refund through the use of section 221.2 of the ITA. Although this interpretation makes clear that “a re-appropriation pursuant to section 221.2 would not override the three-year time limitation provided in subsection 164(1),” for practical purposes, the result is the same.9
The provisions of section 221.2 are discretionary. The section provides that a re-appropriation may be made to a year in which an amount “is or may become payable.” The CRA has provided two pieces of guidance on the meaning of this phrase. First, the words “may become payable” suggest “a reasonable anticipation of an indebtedness in the subsequent year.” Second, the re-appropriation needs “to be proportionate to the anticipated indebtedness.”10 This means that a statute-barred overpayment of tax in the amount of $100,000 could not be re-appropriated to an anticipated $1,000 tax debt. Short of these minor constraints, a taxpayer is free to apply to have its otherwise inaccessible overpayments of tax re-appropriated to reduce its current or future taxes owing.
From the government’s perspective, it is reasonable to look for certainty in determining the country’s tax base. As such, the limitation period contained in the ITA on the refund of overpayments helps the government to finally close its books on corporate taxes, and the Department of Finance evidently wishes to do so earlier rather than later.
Evidence of this “tax finality” can be further seen in the CRA’s approach to dividend refunds where the corporation failed to file a timely return (e.g., beyond three years) and was denied the refund pursuant to subsection 129(1) of the ITA. In spite of decisions such as Tawa Developments Inc. v. The Queen11 and Ottawa Ritz Hotel Company Limited v. The Queen12, the CRA, presumably with the support of the Department of Finance, is still maintaining the position that a corporation’s refundable taxable dividend tax on hand (RDTOH) is reduced by the statute-barred dividend refund. The concern here for the CRA is that in the absence of this approach, the finality objective of subsection 129(1) would be lost if the dividend refund could simply be achieved by a future dividend payment.
With the release of the technical interpretation dealing with re-appropriations of otherwise statute-barred overpayments, it would appear that the CRA’s interpretation of subsection 221.2(1) of the ITA may have opened Pandora’s box to scenarios that may be able to circumvent the ITA’s statute of limitations on tax refunds. Could there be strategies to allow for the movement of taxable profits into a corporation to create future taxes payable? If so, a corporation could thus apply to the CRA to have the overpayment reallocated to reduce or eliminate its tax debt, thereby enabling the corporation to access its otherwise statute-barred overpayment.
Although the wording of subsection 221.2(1) indicates that the Minister “may,” on application, appropriate the particular amount, it is expected that the CRA would only deny such applications in limited circumstances. Despite the relief being discretionary, it cannot be unreasonably withheld. Further, taxpayers may avail themselves of their entitlement to have the decision judicially reviewed if the CRA does not offset upon a taxpayer’s application. The recent Federal Court decision of Home Depot NRO Holdings Inc. v. The Minister of National Revenue13 is an example of a taxpayer successfully making such an application.
Perhaps another consequence of the CRA’s statements on this issue is that it could open the door for re-appropriations of Part XIII refunds that are statute-barred by subsection 227(6) of the ITA. Under this provision, and ignoring the MAP Article of the Canada-U.S. Treaty, a person has two years from the year in which an amount was paid to apply for a refund of excess amounts withheld.14 By logical extension of the reasoning in the CRA’s technical interpretation of subsection 221.2(1), it is fair to expect that beyond this two-year time limitation, non-resident taxpayers may apply to have these amounts re-appropriated to an existing or future tax debt (e.g., if the non-resident chose to carry on business in Canada and thus generate income and a Part I tax liability). While subsection 221.2(1) is a discretionary provision, such discretion may not be unreasonably withheld by the CRA, and a taxpayer unsatisfied by the CRA’s decision would have dispute resolution avenues at its disposal such as judicial review. The significance, therefore, of the ability for taxpayers to re-appropriate pursuant to subsection 221.2(1), is that this provision is likely to become a tool for taxpayers to access otherwise statute-barred refunds of “overpayments.”
In the opinion of the authors, and notwithstanding the Department of Finance’s desire to close its books within a relatively short period of time, a hard-line three-year statutory limitation rule for corporations versus a possible 10-year statutory limitation rule for individuals and trusts, albeit at the CRA’s discretion, is simply too large of a gap. Furthermore, in light of the various exceptions to the three-year statutory limitation rule described herein, it begs the question of whether this rule is even necessary. What is troubling is that this statutory limitation rule may only serve to punish small corporations. Presumably, large corporations have sophisticated tax advisers who will be aware of the various rules discussed in this article and may be able to circumvent the three-year statutory limitation rule. As this cannot have been the intent of the Department of Finance, it is hoped that serious consideration be given to these overly restrictive rules. If the solution is a change in treaty policy to add a “notwithstanding clause” in Canada’s treaties, it will take a long time to update Canada’s full treaty network. In the meantime, small corporations will generally be the ones denied a refund.
1 Income Tax Act, RSC 1985, c 1 (5th Supp).
2 Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital, (signed at Washington on September 26, 1980, as amended by the Protocols signed on June 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997 and September 21, 2007).
3 CRA, Income Tax Information Circular IC07-1, “Taxpayer Relief Provisions” ( 31 May 2007) at paragraph 66.
6 Recently negotiated tax treaties such as the Canada-Hong Kong Treaty and the Canada-New Zealand Treaty have introduced the “notwithstanding clause” in paragraph 2 of the MAP Article. This would appear to be a shift in Canada’s treaty policy.
7 CRA, Information Circular 71-17R5, “Guidance on Competent Authority Assistance Under Canada’s Tax Conventions”, states at paragraph 71, “[u]nder Article XXVI, a United States resident must approach the United States competent authority for assistance. However, administratively Canada will also allow a United States resident to directly approach the Canadian Competent Authority where an application for the refund of Part XIII tax withheld by Canada on interest, dividends or royalties is submitted beyond the two year domestic time limit set out in subsection 227(6) of the Act. The United States resident requesting such relief from the Canadian Competent Authority must do so within the six-year period specified in the Convention…”
8 In reality, this 2010 amendment is mainly helpful for non-resident corporations resident in countries other than the U.S. As alluded to above, U.S. corporations generally would have been able to rely on the MAP to obtain refunds beyond the three-year limitation period in subsection 164(1) of the ITA, provided the Canadian competent authority had been timely notified.
9 CRA, Technical Interpretation 2011-0410961I7(E), Re-appropriation of Statute Barred Amounts (13 January 2011).
11 2011 DTC 1324. In Tawa Developments, the taxpayer was denied its dividend refund because it failed to apply for its dividend refund within the three-year time limit. However, the Court found that the taxpayer’s RDTOH balance was not reduced by the amount of the unclaimed dividend refund. As per Hogan J., the ordinary meaning of "refund" generally involves a return of money from one party to another. Thus, “the term “dividend refund” in paragraph 129(3)(d) represents a dividend refund that was actually paid or credited against outstanding taxes [rather than] a notional amount that arises even where no refund was actually made.”
12 2012 DTC 1172. As was the case in Tawa Developments, there was also no reduction in the taxpayer’s RDTOH.
13 Home Depot NRO Holdings Inc. v. The Minister of National Revenue, (27 May 2011) Toronto T-2030-08 (FC).