In Referred Realty Inc. (2018 FC 59), the Canada Revenue Agency's ("CRA") misguided approach to T2 re-appropriation was rejected by the Federal Court — for the third time in recent memory. Hopefully, the message has sunk in for the CRA and its absurd approach will be corrected sooner rather than later.
Evidently, the work of the taxpayer's office administrator was unsatisfactory and it was determined that books and records were not well maintained. A replacement office administrator did not bring the books and records up to date and that person's employment was also terminated. Finally, an outside bookkeeper was engaged and records were reconstructed. Because of these problems and the volume of work, records for the taxation years ending July 31, 2007 through July 31, 2011 were not completed until early 2012. Cognizant of its tax obligations, the taxpayer made what it believed were accurate instalments each year. However, on account of the failure to file timely T2 returns of income, the taxpayer was arbitrarily assessed and its bank account garnished.
Resulting from the timing of the remittances, garnishment and T2 filings, corporate tax that might otherwise have been refundable was subjected to the statute-barred refund regime in Income Tax Act ("ITA") ss. 164(1). The CRA relies on that provision to refuse to refund tax overpayments when a late-filer fails to file within three years of the end of the particular taxation year, although there is a relieving provision in s. 164 for individuals and graduated rate estates. Potential relief is available for corporations under ITA ss. 221.2, which provides for re-appropriation of amounts. Regrettably, the CRA's re-appropriation policy is predicated on criteria so narrow that it becomes difficult to imagine how re-appropriation could ever be allowed. As a result, narrow CRA policy trumps its statutory discretion.
In this case, the taxpayer sought re-appropriation so it could access its statute-barred refund from 2007. The CRA denied the request because "[a]lthough the corporation was made aware of its tax obligations, it did not comply with these requests. This indicates that the corporation knowingly had not taken measures to correct the non-compliance within a reasonable timeframe." The CRA's denial also cited ITA s. 230, which requires maintenance of books and records sufficient to enable tax payable to be determined and stated that the taxpayer failed to meet its filing obligations because it failed to maintain adequate books and records. The CRA also criticized the taxpayer's occasional late-filing of GST returns.
The FC pointed out that the CRA was "required to state a clear and supportable justification to deny" the re-appropriation request. The FC stated that there was no evidence that the taxpayer was neglectful, but instead the evidence pointed to active efforts to meet its responsibilities and, once its affairs were put in order, it paid all taxes and penalties without objection. The CRA's decision was rooted in compliance obligations and, in particular, the obligation to maintain books and records. In this regard, the CRA decision maker's subjective expectations were not met. The FC noted that the CRA decision maker referenced a lack of "sufficient action" within a "reasonable timeframe", without clarifying what those terms meant. The FC held that these statements were the only clear reason for the refusal to grant re-appropriation and constituted a "delivery of a punishment" for failing to meet a CRA officer's unclear, subjective expectations. Consequently, the decision to refuse re-appropriation was unreasonable. Further, the CRA decision maker's consideration of the GST filings was unfair as it was without notice and was an extraneous consideration that further rendered the decision on re-appropriation unreasonable.
Senior CRA officials are well aware of the significant problems with the CRA's application of the T2 re-appropriation regime and, at the 2017 CTF National Conference, indicated that this is under active consideration and that clarity may come in 2018. For anyone who has ever dealt with the absurdity of the CRA's current practice, a fix could not come soon enough.